ITAT Quashes Final Order for Non-Compliance with DRP Directions

Introduction & Executive Summary

The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT), in a decisive ruling dated 8 June 2026, quashed the final assessment order passed by the Assessing Officer (AO) under section 143(3) read with section 144C(13) of the Income Tax Act, 1961. The sole ground for quashing was that the AO had failed to pass the final order in conformity with the directions issued by the Dispute Resolution Panel (DRP) under section 144C(5). The Tribunal held that such non-compliance contravened the mandatory requirement of section 144C(13) and, following binding precedents of the jurisdictional Karnataka High Court, set aside the assessment order entirely.

This case serves as a powerful reminder to tax practitioners: any final assessment order that does not accurately reflect the DRP’s directions is void ab initio and liable to be struck down. The Tribunal also clarified the hierarchy of judicial precedents – a coordinate bench must follow its own jurisdictional High Court, even if another High Court has taken a different view. This decision reinforces the protective framework for taxpayers under the DRP mechanism and underscores the need for meticulous drafting and verification by Assessing Officers.

Factual Background of the Dispute

The assessee, Marlabs Innovations Private Limited, is a company engaged in Custom Software Application Development, IT-enabled services (including legal support, IT support, accounting support, HR services, and IT consulting). For the assessment year 2022-23, the assessee filed its return of income on 28 November 2022, declaring a total income of Rs. 35,94,83,750. The return was selected for scrutiny, and statutory notices under sections 143(2) and 142(1) were issued and served.

During the assessment proceedings, a reference was made to the Transfer Pricing Officer (TPO) under section 92CA. The TPO passed an order under section 92CA(3) on 10 January 2025, proposing a transfer pricing adjustment of Rs. 23,16,49,912. Conforming to the TPO’s order, the AO issued a draft assessment order on 19 March 2025, proposing to assess the total income at Rs. 59,29,35,662, which included the full transfer pricing addition proposed by the TPO.

Aggrieved by the proposed additions, the assessee filed detailed objections before the DRP. The DRP, vide directions dated 3 December 2025 issued under section 144C(5), partially agreed with the assessee’s submissions. The DRP granted relief in respect of the Software Development Segment adjustment of Rs. 15,88,10,000, reducing it to nil. However, the adjustments concerning the IT-enabled Services (ITeS) segment and interest on delayed receivables were upheld. The DRP directed the AO to give effect to these directions.

On 24 December 2025, the TPO passed an order giving effect to the DRP’s directions. This order computed the total transfer pricing adjustment at Rs. 6,71,47,000, thereby granting a relief of Rs. 16,45,02,912 from the originally proposed adjustment. Despite this clear reduction, the AO proceeded to pass the final assessment order on 18 December 2025 assessing the total income at the same figure as the draft order – Rs. 59,29,35,662. The AO erroneously recorded that the DRP had rejected all grounds of objection filed by the assessee, which was factually incorrect and directly contradicted the DRP’s own directions.

The Petitioner’s Evidence & Witnesses

Before the Tribunal, the assessee was represented by Shri Ketan Ved, CA, who raised a preliminary and potentially case-dispositive issue. The learned AR submitted that the impugned final assessment order was not in conformity with the DRP’s directions, thereby violating the mandatory provisions of section 144C(13). He placed strong reliance on two decisions of the Karnataka High Court:

• PCIT vs. Flextronics Technologies (India) (P.) Ltd. (2023) 459 ITR 493 (Karnataka) – where the High Court held that a final assessment order passed without conforming to the DRP’s directions is invalid and must be quashed.
• PCIT vs. M/S VMWARE Software India Pvt. Ltd. (ITA No. 221/2023) – the same principle was reiterated. The Revenue’s Special Leave Petition against this decision was dismissed by the Supreme Court on 14 November 2024 (SLP (C) Diary No.47414/2024), confirming the correctness of the High Court’s view.

The assessee further demonstrated, through the TPO’s effect order dated 24 December 2025, that the DRP had indeed granted partial relief. The AR argued that the AO’s statement that the DRP had rejected all objections was a clear misrepresentation of the record. The final assessment order therefore suffered from a fundamental procedural defect and deserved to be quashed.

Discrepancies & Challenges Identified by the Tribunal

The Tribunal meticulously examined the facts and identified a clear discrepancy between what the DRP actually directed and what the AO recorded. The key discrepancy was:

“The AO vide final assessment order assessed the total income of the assessee equivalent to the total income proposed vide draft assessment order on the basis that the grounds of objections raised by the assessee before the learned DRP were rejected vide directions issued under section 144C(5) of the Act. However, on the contrary, we find that the TPO, vide its order dated 24.12.2025, giving effect to the various directions issued by the learned DRP, computed the total transfer pricing adjustment at Rs. 6,71,47,000/-, thereby granting a relief of Rs. 16,45,02,912/-.”

The Tribunal noted that the AO had mechanically reproduced the draft assessment figure without considering the effect of the DRP’s directions. This was a clear violation of the statutory mandate under section 144C(13), which requires the AO to pass a final order “in conformity with” the DRP’s directions.

Additionally, the Tribunal distinguished the decision relied upon by the Revenue – Hitachi Astemo Haryana Private Limited vs. DCIT (Delhi Bench) – on the ground that the Delhi Bench was bound by the Delhi High Court, whereas the Bangalore Bench is bound by the Karnataka High Court. The Karnataka High Court’s decisions in Flextronics and VMWARE were directly on point and binding.

High Court’s Legal Analysis & Reasoning

While the judgment under analysis is of the ITAT, the Tribunal relied heavily on the legal reasoning of the Karnataka High Court. The core legal principle that governed the outcome can be summarised as follows:

A. Section 144C(13) – A Non-Negotiable Mandate

Section 144C(13) provides that: “The Assessing Officer shall, notwithstanding anything to the contrary contained in this Act, pass the final assessment order in conformity with the directions issued by the Dispute Resolution Panel.” The use of “notwithstanding anything to the contrary” and “shall” makes this requirement absolute. The AO cannot deviate from the DRP’s directions on any ground. In this case, the AO’s order was a carbon copy of the draft order, effectively nullifying the relief granted by the DRP. This was a direct violation of the section.

B. Binding Precedent and Judicial Discipline

The Tribunal emphasised that a coordinate bench of the ITAT must follow the decisions of its jurisdictional High Court. The Revenue’s reliance on a Delhi Bench decision was misplaced because the Delhi Bench was applying Delhi High Court law. For a Bangalore Bench, the Karnataka High Court is the highest judicial authority. The Tribunal explicitly stated:

“As this Bench is covered under the Jurisdiction of the Hon’ble Karnataka High Court, the decisions of the Hon’ble Karnataka High Court cited supra are binding on it, being the judicial pronouncements by the Jurisdictional Hon’ble High Court.”

C. Supreme Court’s Seal of Approval

The Supreme Court had dismissed the Revenue’s SLP against the Karnataka High Court’s judgment in VMWARE Software India Pvt. Ltd., which affirmed the same principle. This gave additional weight to the assessee’s argument and left no room for the Revenue to contest the correctness of the Karnataka view.

D. Consequence – Quashment of Final Assessment Order

Applying the above principles, the Tribunal quashed the final assessment order. The other grounds raised by the assessee were rendered academic and were left open. The appeal was allowed, effectively wiping out the flawed assessment.

Why It Matters: Cross-Application to Income Tax Matters

This judgment is a powerful reminder of the protective framework available to taxpayers under the DRP mechanism. For practitioners dealing with transfer pricing or other complex assessments where a DRP is involved, the key takeaways are:

• Vigilance on final orders: Always cross-verify the final assessment order against the DRP’s directions. Any deviation, even if unintentional, can be challenged and the entire order quashed.
• Documentary proof: Keep a copy of the DRP’s directions and any order giving effect (like the TPO’s effect order) to establish the actual relief granted.
• Courting binding precedent: When arguing before a Tribunal, always cite the jurisdictional High Court’s view. Tribunals are bound by their own High Court, and other High Court decisions (or Tribunal decisions based on other High Courts) are not binding on them.
• Supreme Court dismissals: Even an SLP dismissal is a strong indication that the lower court’s reasoning is correct, though technically not a binding precedent on the merits. However, it adds persuasive weight.

While the judgment does not deal with issues under section 68 (cash credits) or section 56(2)(x) (gifts), the procedural principle – that a statutory authority must strictly comply with a superior authority’s directions – is universal. The same logic applies to any assessment order that fails to follow the first appellate authority’s directions or the ITAT’s remand directions. The rule of law demands compliance.

Checklist for CAs and Legal Practitioners

Based on this judgment, here is a practical checklist for handling DRP-related matters:

• Immediately on receipt of DRP directions: Compare the directions with the draft assessment order. Identify specific reliefs (whether TP adjustments, disallowances, or additions are reduced or deleted).
• Track the effect order: The TPO or AO may pass a separate order giving effect to the DRP’s directions. Obtain a copy and verify that it correctly implements the DRP’s relief.
• Scrutinise the final assessment order: Ensure that the income assessed, additions made, and tax computed are consistent with the DRP’s directions as clarified in the effect order. If the AO reproduces the draft order figures, raise an objection immediately.
• File an appeal if non-compliance persists: The first ground of appeal should be that the final assessment order is void for non-compliance with section 144C(13). Cite the jurisdictional High Court decisions cited above.
• Prepare for the Revenue’s arguments: The Revenue may cite decisions from other jurisdictions (like the Delhi Tribunal in this case). Be ready to argue that those are not binding and that the jurisdictional High Court view must prevail.
• Keep an eye on Supreme SLP developments: Even if an SLP is dismissed, note it in your submissions to show that the High Court’s view has been implicitly affirmed.

In conclusion, the Marlabs Innovations case is a classic example of how procedural precision can snatch victory from the jaws of a heavy substantive tax demand. It reaffirms that the DRP’s directions are sacrosanct and any departure, however minor, renders the final order legally unsustainable. For tax practitioners, it is a gold standard to rely upon when challenging flawed final assessment orders.

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