In a significant and cautionary ruling that blends technology, law and due process, the Bombay High Court (HC) has quashed an income-tax (I-T) assessment against KMG Wires Pvt Ltd after finding that the assessing officer (AO) relied on non-existent, artificial intelligence (AI)-generated case laws to justify major additions to the company’s declared income.
In an order earlier this month, the division bench of justice BP Colabawalla and justice Amit S Jamsandekar held that in the era of AI, tax authorities exercising quasi-judicial powers cannot blindly rely on AI-generated results and must cross-verify all such references before using them to support legal conclusions. "...it can be seen that while calculating peak balance, the National Faceless Assessment Centre (NFAC) has considered the opening balance, and for which purpose, he has relied upon three decisions. The judicial decisions relied upon are completely non-existent. In other words, there are no such decisions at all which are sought to be relied upon by NFAC. It is for NFAC to show from where such decisions were fetched."
"In this era of 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 (which are thrown open by AI) are not to be blindly relied upon, but the same should be duly cross-verified before using them. Otherwise mistakes like the present one creep in. It is also one of the grievances of KMG Wires that they are clueless as to how the figures are arrived at as no basis or working was ever shown to the company, nor was any show cause notice (SCN) issued before making the addition of peak balance. Even this grievance of KMG Wires is justified," the bench says.
The HC found the assessment to be in gross violation of the principles of natural justice, setting aside the entire chain of proceedings, including the assessment order dated 27 March 2025, the notice of demand under Section 156, and the penalty notice under Sections 274 and 271AAC of the Income Tax Act, 1961.
The case arose from a faceless assessment for assessment year (AY)23–24, in which NFAC assessed KMG Wires’ total income at Rs27.91 crore against the Rs3.09 crore originally declared. The company approached the HC alleging serious procedural lapses, including failure to consider crucial evidence, absence of an SCN for certain additions, and reliance on fictitious case laws purportedly generated by an AI-assisted system. The I-T department defended the assessment but conceded that certain lapses occurred, including the use of judicial references that could not be found.
The assessment included two major additions, both later found to be defective. The first concerned purchases worth Rs2.15 crore from Dhanlaxmi Metal Industries, Surat, which the assessing officer disallowed on the ground that the supplier failed to respond to a notice under Section 133(6) of the I-T Act, a provision empowering tax officers to seek information from third parties during an inquiry.
However, KMG Wires produced evidence that Dhanlaxmi Metal Industries had, in fact, responded on 8 March 2025, confirming all transactions and submitting over 100 pages of supporting documents, including invoices, e-way bills, transport receipts and goods and services tax (GST) returns. Despite the response being on record, the assessment falsely recorded that no reply had been received. The tax department later admitted in an affidavit dated 22 September 2025 that this reply had been overlooked.
The second addition, far more concerning, involved an alleged peak balance of Rs22.66 crore in unsecured loans from directors. The assessing officer included even the opening balances in this computation and cited three judicial precedents to justify the addition under Section 68 of the act, which deals with unexplained cash credits.
However, KMG Wires demonstrated that the three cited decisions did not exist — they were fabrications or 'AI hallucinations'.
The Court recorded that there were no such decisions at all which were sought to be relied upon by the assessing officer. In a sharp observation with broader implications, the bench warned that in this era of AI, one tends to place much reliance on the results thrown open by the system. The Court directed the assessing officer to show from where such decisions were fetched, noting that unverified AI output had no place in judicial or quasi-judicial reasoning.
While the tax department attempted to downplay the lapse, claiming that the error had been rectified through a subsequent order, the bench found that the rectification failed to cure the core procedural defects. The Court noted that KMG Wires had never been issued a proper SCN explaining the computation of the peak balance or given a chance to respond.
The company was clueless about how the figures were arrived at, the judges observed, concluding that this amounted to a serious breach of natural justice. Given the cumulative lapses — factual, procedural, and technological — the HC declined to relegate the petitioner to the statutory appellate process, holding that this was a fit case to interfere under Article 226 of the Constitution.
The bench quashed and set aside the assessment order under Section 143(3) read with Section 144B of the Act (Faceless Assessment), the notice of demand under Section 156, and the penalty notice under Section 274 read with Section 271AAC. The matter was remanded to the assessing officer with strict directions to issue a fresh SCN clearly setting out the proposed additions and disallowances, to grant the assessee adequate opportunity and a personal hearing and to pass a reasoned and speaking order by 31 December 2025.
The HC also imposed an important safeguard for future proceedings by directing that if any decisions are relied upon, KMG Wires must be given adequate notice of not less than seven days to counter such judgements. The Court clarified that it had not expressed any view on the merits of the additions themselves, keeping all rights and contentions of both parties open. No costs were imposed.
This judgement carries implications beyond the tax domain. It represents one of the first judicial cautions in India against the unverified use of AI-generated content in administrative or quasi-judicial functions.
By explicitly recognising that AI-generated results can mislead when unverified, the Bombay HC has drawn a clear procedural boundary: while AI may aid legal research, it cannot replace human verification or judicial prudence.
The decision serves as a warning not just to tax officers but also to other regulators increasingly adopting AI-driven document and decision-support systems. The ruling reinforces the Constitutional guarantee of fair hearing and natural justice, reminding authorities that technology must be a tool of transparency, not a shortcut to judgement.
(Writ Petition (L) No. 24366 of 2025 Date: 6 October 2025)
