Section 245 Refund Adjustment: How to Respond When Your Refund is Set Off Against Demand

Your client filed their return, the refund was due, and then — nothing. Weeks pass. When they finally check the e-filing portal, there's a message saying the refund has been adjusted against an outstanding demand from a prior year. No cheque, no bank credit. Just a set-off.

This is Section 245 in action. And if you're a CA dealing with it, the first thing you need to know is that the department can't just do this silently. There are procedural safeguards, and when the department skips them, you have grounds to challenge the adjustment.

What is Section 245? The Refund Adjustment Mechanism

Section 245 of the Income Tax Act, 1961 gives the Assessing Officer the power to set off a refund (or any part of it) due to an assessee against any outstanding tax demand. The section reads simply enough: where a refund is found to be due to any person, the AO may, in lieu of payment of the refund, set off the amount against the tax, interest, penalty, or any other sum remaining payable by that person.

The operative words here are "may" and "set off." This is a discretionary power, not an automatic process — though in practice, the CPC at Bengaluru applies it almost mechanically for centrally processed returns.

The logic behind Section 245 is straightforward from the department's perspective. Why issue a refund to someone who owes money on another assessment? It's administratively efficient to net the two amounts. But this efficiency can cause real problems when the underlying demand is disputed, incorrect, or already the subject of an appeal.

For context on how demands arise and how to challenge them, see our Section 156 demand notice guide.

Mandatory Prior Intimation: Your Most Important Right

Here's the part that matters most in practice. Section 245 contains a mandatory procedural requirement: before making the adjustment, the Assessing Officer must give intimation to the assessee of the proposed action.

This isn't optional. The Supreme Court and multiple High Courts have consistently held that prior intimation is a condition precedent to a valid adjustment under Section 245. An adjustment made without prior intimation is illegal and liable to be set aside.

What Constitutes Valid Intimation?

The intimation must:

• Clearly state the proposed adjustment — which refund is being adjusted, against which demand, and the amounts involved
• Give the assessee a reasonable opportunity to respond — typically 30 days from the date of intimation
• Be served properly — either through the e-filing portal, by post, or through email (in the faceless regime, portal intimation is the primary mode)

In the centralized processing environment, the intimation usually appears as a notice on the e-filing portal under "Pending Actions" > "Response to Outstanding Tax Demand." The system generates this automatically when the CPC identifies an outstanding demand against a PAN that has a refund due.

The 30-Day Window

Once you receive the intimation, you typically have 30 days to respond. During this window, you can:

1. Agree to the adjustment — if the demand is valid and the client wants to settle it
2. Partially agree — accept adjustment for the undisputed portion, object to the rest
3. Disagree entirely — provide reasons why the adjustment should not be made

If you don't respond within 30 days, the department treats silence as consent and proceeds with the adjustment. This is why timely monitoring of the portal is critical for every client.

When Can the Department Adjust Your Refund?

Not every outstanding demand justifies a refund adjustment. The department's power under Section 245 is subject to certain conditions.

Valid Grounds for Adjustment

The adjustment is legitimate when:

• An outstanding demand exists against the same PAN — whether from a Section 143(1) intimation, a scrutiny assessment, or any other order
• The demand is final or undisputed — the assessee hasn't challenged it
• The demand hasn't been stayed by any authority (AO, CIT(A), ITAT, or a court)

Cross-Year Adjustments

The most common scenario is a current-year refund being adjusted against a prior-year demand. For example, a refund arising from the AY 2025-26 return might be adjusted against an outstanding demand for AY 2022-23.

This cross-year adjustment is explicitly permitted under Section 245. There's no requirement that the refund and the demand must relate to the same assessment year. The power extends to setting off refunds against demands from any year, as long as the demand is outstanding.

Adjustment Against Different Types of Dues

Section 245 covers set-off against:

• Tax (including surcharge and cess)
• Interest under Sections 234A, 234B, and 234C
• Penalty
• Any other sum payable under the Act

This means even a penalty demand — provided it's not stayed or set aside — can be a valid basis for adjustment.

How to Object to a Refund Adjustment

When you receive the prior intimation and want to challenge the proposed adjustment, here's the step-by-step process.

Step 1: Log Into the E-Filing Portal

Go to incometax.gov.in, navigate to Pending Actions > Response to Outstanding Tax Demand. You'll see a list of outstanding demands with an option to submit a response.

Step 2: Select Your Response for Each Demand

For each demand listed, you can choose:

• Demand is correct — you accept it
• Demand is partially correct — specify the correct amount
• Demand is not correct — disagree entirely
• Demand already paid/adjusted — if the demand has been satisfied through other means

Step 3: Provide Grounds for Objection

This is where your response needs substance. The strongest grounds for objection include:

Demand under dispute / appeal pending: If your client has filed an appeal against the assessment order that created the demand, mention the appeal number, date of filing, and the authority before whom it's pending. A demand under active appeal should not be adjusted without a stay order — but it happens frequently. Cite CBDT Instruction No. 1914 and the Office Memorandum dated 29.02.2016 which directs AOs to grant stays when appeals are pending, subject to payment of 20% of the disputed demand.

Rectification pending under Section 154: If you've filed a rectification application pointing out apparent errors in the demand computation, the demand is potentially going to change. Adjustment before the rectification is disposed of is premature. For more on rectification, see our Section 154 rectification guide.

Demand is time-barred: Under Section 231, a demand that has not been enforced for a long period may face limitation issues. If the demand is very old and no recovery proceedings were initiated, raise this point.

Computation errors: The demand itself may be wrong — TDS credits not given, advance tax not accounted for, incorrect application of tax rates, or interest computed incorrectly.

Step 4: Upload Supporting Documents

Attach challan copies, appellate order copies, rectification application copies, Form 26AS extracts, or any other evidence supporting your objection. The portal allows PDF uploads.

Step 5: Submit and Track

After submission, note the acknowledgment number. Follow up if you don't hear back within 30 days. The response should appear in the "Submitted" tab under the same section.

Common Issues with Section 245 Adjustments

In our experience working with CAs across India, certain problems with Section 245 adjustments come up repeatedly.

Adjustment Without Prior Intimation

This is the most common and most egregious violation. The CPC sometimes processes the adjustment without sending the intimation at all, or sends it and processes the adjustment simultaneously without waiting for the 30-day response period.

If this happens, the adjustment is procedurally void. File a grievance on the e-filing portal and cite the mandatory nature of prior intimation under Section 245. If the grievance doesn't work, approach the CIT (Centralized Processing Centre) or the jurisdictional CIT.

Adjustment Despite a Stay of Demand

If a stay has been granted — whether by the AO, CIT(A), ITAT, or a High Court — the demand is suspended and cannot be adjusted against a refund. Yet the CPC's system sometimes doesn't reflect stay orders, especially when they're granted by appellate authorities.

When this happens, immediately write to the AO with a copy of the stay order and demand reversal of the adjustment. If the AO doesn't act, file a writ petition. Courts have consistently struck down adjustments made in violation of stay orders.

Adjustment of Disputed Demands

Even when no formal stay is in place, adjusting a refund against a demand that's under active appeal raises fairness concerns. CBDT circulars direct AOs to limit recovery to 20% of the disputed demand while an appeal is pending. The department adjusting the full demand amount against a refund contravenes this policy.

Incorrect Computation of the Demand

Sometimes the underlying demand itself is wrong. The CPC may not have processed a rectification application, or the AO may have ignored TDS credits visible in Form 26AS. Before you object to the adjustment, verify the demand itself. If it's inflated, your first step should be a rectification application under Section 154.

Adjustment Across Different PANs

This is rare but does happen — particularly in cases involving mergers, demergers, or succession where the department confuses entities. If a refund due to one PAN is adjusted against a demand of a different PAN, this is plainly illegal. The power under Section 245 applies only to demands against the same person.

Interest on Delayed Refunds Under Section 244A

When we talk about refund adjustments, we can't ignore the interest component. Section 244A entitles the assessee to interest on refunds at 0.5% per month (or part of a month).

When Does Interest Start?

For refunds arising from excess tax payment (self-assessment, advance tax, TDS):

• Section 244A(1)(a): Interest runs from April 1 of the assessment year to the date of refund, if the return is filed on or before the due date
• Section 244A(1)(aa): For TDS/TCS refunds, interest runs from April 1 of the assessment year to the date of refund
• Section 244A(1)(b): For refunds arising from any other proceedings (appeal, rectification), interest runs from the date of payment of tax to the date of refund

What Happens to Interest When a Refund is Adjusted?

This is where it gets nuanced. When a refund is adjusted under Section 245 against an outstanding demand, the date of adjustment is treated as the date of refund for computing interest under Section 244A.

So if your client's AY 2025-26 refund is adjusted against an AY 2022-23 demand in March 2026, interest under Section 244A on the refund should be computed up to the date of adjustment. The refund amount (inclusive of interest) is then set off against the demand.

Delayed Processing and Interest

If the department sits on the return for months and then adjusts the refund, the assessee is entitled to interest for the entire period of delay. The department can't avoid paying Section 244A interest simply by adjusting the refund instead of issuing it. This is an important point that gets overlooked — make sure the interest component is correctly computed before accepting any adjustment.

Interaction with Section 234D

Section 234D deals with interest on excess refund. If a refund was granted during Section 143(1) processing and is later found to be excessive after regular assessment, the assessee must pay interest under Section 234D. When this intersects with a Section 245 adjustment, the computation can get complex. Verify each component separately.

Key Case Laws on Refund Adjustment

Deloitte Haskins & Sells v. Union of India (Bombay High Court)

This is the landmark judgment on Section 245. The Bombay High Court held that the requirement of prior intimation under Section 245 is mandatory and not directory. The court emphasized that the word "intimation" implies that the assessee must be given an opportunity to present their case before any adjustment is made. An adjustment without intimation was set aside.

Modi Industries Ltd. v. CIT (Allahabad High Court)

The court held that the AO cannot adjust a refund against a demand that is the subject of a pending appeal unless the appellate authority has specifically refused to grant a stay. The court observed that adjusting disputed demands defeats the purpose of the appellate remedy.

Tata Communications Ltd. v. ACIT (Bombay High Court)

The Bombay High Court reiterated that prior intimation is a condition precedent, and directed the department to refund the amount adjusted without proper intimation, along with interest under Section 244A.

CIT v. Chhabil Dass Agarwal (Supreme Court, 2013)

While not directly a Section 245 case, this Supreme Court judgment is relevant because it established that where an alternate statutory remedy exists, the assessee should exhaust it before approaching the High Court under Article 226. However, the court carved out exceptions for cases where there's a breach of fundamental rights or where the authority has acted without jurisdiction — which includes cases of adjustment without prior intimation.

Courtknit India Pvt. Ltd. v. DCIT (ITAT Delhi)

The ITAT held that the department's practice of adjusting refunds against demands under appeal — without any stay application being rejected — is contrary to law and CBDT circulars. The tribunal directed the release of the refund with interest.

Response Strategy for CAs

Here's a practical framework for handling Section 245 adjustment notices for your clients.

Timeline: Act Within 21 Days

Don't wait for the full 30-day window. Give yourself at least 7-10 days of buffer for follow-ups and portal delays. The moment you see a Section 245 intimation on the portal, start your response process.

Documentation Checklist

Before responding, gather:

• The assessment order creating the outstanding demand
• Computation of total income and tax
• Form 26AS / AIS for the relevant year (cross-check for missing TDS credits)
• Any pending rectification applications with acknowledgment numbers
• Appeal memo and acknowledgment (if appeal is pending)
• Stay order (if granted)
• Challan copies for any payments already made against the demand
• Previous correspondence with the AO regarding the demand

Decision Matrix

Scenario	Recommended Action
Demand is correct and not under dispute	Accept the adjustment
Demand is partially correct	Accept partial adjustment, object to the balance with evidence
Appeal pending, no stay	Object + immediately file stay application with the AO
Stay already granted	Object + attach stay order, demand reversal if already adjusted
Demand computation is wrong	File Section 154 rectification first, then object to adjustment
No prior intimation received	File grievance on portal, cite Deloitte Haskins & Sells

Portal Steps Summary

1. Login > Pending Actions > Response to Outstanding Tax Demand
2. Select the demand entry and choose "Disagree"
3. Enter detailed grounds with legal basis
4. Upload supporting documents (stay orders, appeal memos, challans)
5. Submit and download acknowledgment
6. If no prior intimation was given, file a separate grievance under "Grievance" tab

Tracking and Follow-Up

Section 245 matters can drag on if you don't follow up. Mark your calendar for 30 days post-submission. If there's no response, escalate through the grievance mechanism and, if necessary, file a representation with the jurisdictional PCIT/CIT.

For practices handling multiple clients, keeping track of Section 245 intimations across dozens of PANs becomes a real operational challenge. TaxNoticeAI helps CAs monitor notice deadlines and track response statuses in one place, so nothing falls through the cracks.

Key Takeaways

• Section 245 prior intimation is mandatory — adjustment without it is void
• You have 30 days to respond; use them wisely
• Disputed demands under appeal should generally not be adjusted, per CBDT instructions
• Always verify the underlying demand computation before accepting any adjustment
• Interest under Section 244A must be computed up to the date of adjustment
• Document everything and follow up — the department's systems don't always process responses promptly

Getting the Section 245 response right often means the difference between a client receiving their legitimate refund and losing it to a demand they're actively contesting. Know the law, know the procedure, and act quickly.