AI Can't Replace Judicial Reasoning: Bombay High Court Quashes ₹27 Cr Tax Order Against KMG Wires for Natural Justice Breach

"One tends to place much reliance on the results thrown open by the system… But they are not to be blindly relied upon" – Bombay High Court set aside a ₹27.91 crore income tax assessment order passed against KMG Wires Private Limited, ruling that the assessment suffered from gross procedural irregularities and violated the principles of natural justice. A Division Bench of Justice B. P. Colabawalla and Justice Amit S. Jamsandekar quashed the order passed under Section 143(3) read with Section 144B of the Income Tax Act, 1961, along with the consequential demand notice and penalty show cause notice.

The Court found that the entire assessment was based on erroneous facts, non-consideration of material evidence, and reliance on fictitious case laws, possibly generated through artificial intelligence tools.

"Reply Ignored, Judgments Fictitious, No Show-Cause Issued": Court Dissects Fundamental Errors in Assessment

KMG Wires challenged the assessment order dated 27 March 2025 for AY 2023–24, which had raised its taxable income from the returned figure of ₹3.09 crore to ₹27.91 crore. The two main additions made by the Assessing Officer (AO) were:

1. Disallowance of purchases worth ₹2.15 crore from Dhanlaxmi Metal Industries, alleging non-response to a notice under Section 133(6).

2. Addition of ₹22.66 crore towards unsecured loans from directors, calculated as "peak balances".

KMG Wires contended that both these additions were illegal and uninformed:

• On the purchases, the supplier had in fact responded on 8 March 2025, providing confirmations, invoices, e-way bills, transport receipts and GST filings. The AO had failed to consider this voluminous response.

• On the loan addition, the petitioner was never issued a show-cause notice, and the AO had relied on three judicial decisions that do not exist while adding the opening balances to peak credit—which, as per settled law, cannot be done.

The High Court found merit in both submissions.

“Such a crucial piece of evidence, though available, was not considered by Respondent No. 1... It was stated in the Assessment Order that no such reply has been filed,” the Court noted.

On the issue of reliance on fictitious judgments, the Bench observed:

"The judicial decisions relied upon are completely non-existent. In other words, there are no such decisions at all... In this era of Artificial Intelligence (‘AI’), one tends to place much reliance on the results thrown open by the system. However, when one is exercising quasi-judicial functions, it goes without saying that such results are not to be blindly relied upon."

No Show-Cause Notice, No Working Provided: Court Finds Violation of Due Process

The Court held that no opportunity of hearing was granted in respect of the substantial addition made towards unsecured loans. There was no working provided, and the assessee was left "clueless" as to how the figure was arrived at.

“The Petitioner was never asked to show cause as to why the peak balance should not be added... no basis/working was provided, and the judgments cited were non-existent.”

Alternate Remedy No Bar Where Natural Justice is Breached

Though the petitioner had already filed an appeal before CIT(A), the Court refused to relegate the petitioner to alternate remedies, noting that this was a fit case for exercise of writ jurisdiction under Article 226 of the Constitution, given the egregious nature of the violations.

“In the peculiar facts of the present case, the Petitioner should not be relegated to avail the alternate remedy... We find that this is a fit case to interfere.”

Assessment Quashed; Matter Remanded with Detailed Directions

The High Court quashed the entire assessment, the Section 156 demand notice, and the Section 274 read with Section 271AAC penalty notice, and remanded the matter back to the AO with clear directions:

• A fresh show-cause notice must be issued outlining proposed additions.

• Petitioner must be granted reasonable time to reply and be provided a personal hearing.

• Judgments intended to be relied upon must be pre-disclosed with at least 7 days’ notice.

• The assessment order must be a speaking order, dealing with all submissions of the petitioner.

• The fresh order must be passed on or before 31 December 2025.

The Court clarified that it had not made any observations on the merits of the additions, and all rights and contentions remain open.

Date of Decision: 6 October 2025