Refund being adjusted against an old tax demand? How do you respond to an outstanding demand notice?

You filed your return on time, the portal shows a refund is due, and then the credit never lands. Weeks later an intimation appears under Pending Actions telling you the refund has been, or is about to be, set off against a demand from an assessment year you had half-forgotten. This is not a glitch. It is the Income Tax Department exercising a specific statutory power under Section 245 of the Income-tax Act, 1961, and how you respond in the days after that intimation decides whether the adjustment sticks.

The Scenario

Picture a salaried taxpayer for AY 2026-27 whose Form 26AS shows Rs 1,00,000 of tax deducted at source against a final liability of Rs 81,900, leaving a genuine refund of Rs 18,100. Before that money reaches the bank account, the Centralised Processing Centre (CPC) notices an outstanding demand of Rs 32,000 sitting against the same PAN for AY 2023-24 — the residue of a Section 143(1) adjustment where a claimed deduction was disallowed at processing. The system now proposes to net the two.

The mechanism is the "Response to Outstanding Demand" workflow. Per the Income Tax Department's own FAQ (incometax.gov.in), if you do not respond, "the demand will be confirmed and will be adjusted against your refund (if any) or show as demand payable against your PAN (in case, no refund is due)." In other words, silence is treated as consent. The refund you were owed for one year is used to part-pay a demand from another, and only the shortfall survives as a payable balance.

The reason this catches people off guard is timing: a demand raised in 2023 can lie dormant for two or three years until a later-year refund gives the department something to grab. Reviewing your tax refund status and your open demands together, rather than one at a time, is the only way to see the set-off coming before it happens.

Statutory Answer

The governing provision is Section 245 of the Income-tax Act, 1961 — "Set off, and withholding, of refunds in certain cases" (indiacode.nic.in). Sub-section (1) permits the tax authority, in lieu of paying a refund found due to a person, to "set off the amount to be refunded or any part of that amount against the sum, if any, remaining payable under this Act by the person to whom the refund is due." Critically, the same sub-section requires this to be done "after giving an intimation in writing to such person of the action proposed to be taken." The prior written intimation is not a courtesy; it is a statutory precondition, and the courts have struck down adjustments made without it.

That intimation is precisely the "Response to Outstanding Demand" notice you see on the portal. It exists to give you a window to Agree or Disagree before the set-off is finalised. Once the window lapses without a response, the department is entitled to proceed under Section 245(1) and confirm the demand. The demand itself would have originated from an earlier order — most commonly a Section 143(1) intimation for a mismatch, or a Section 143(3) or 147 assessment.

Two further sections shape the arithmetic. Under Section 220(2), any demand not paid within the period allowed carries simple interest at 1% for every month or part of a month of default, so an old demand rarely stays at its face value. Conversely, a refund that is legitimately due to you carries interest under Section 244A at 0.5% per month. Both accrue independently, which is why the numbers on your intimation seldom match the figure you remember from years ago. If you want to see how your current-year liability is built up before any set-off, run your figures through the Income Tax Calculator.

Your options on the portal

Log in at incometax.gov.in and open Pending Actions > Response to Outstanding Demand. The FAQ sets out three substantive paths, summarised below.

If your ground for disputing is not on the predefined list, the FAQ confirms you can "select Others as a reason" and enter the details yourself. Where you only partly disagree, the department is explicit that "you should pay the portion of the demand which is undisputed (i.e. with which you agree)."

Worked Resolution

Take the salaried taxpayer above and follow the money. First, establish that the AY 2026-27 refund is real. On a gross salary of Rs 14,00,000 under the new regime for FY 2025-26, the computation runs as follows.

The slab tax of Rs 78,750 is built from the FY 2025-26 new-regime rates: nil on the first Rs 4,00,000, 5% on the next Rs 4,00,000 (Rs 20,000), 10% on the next Rs 4,00,000 (Rs 40,000), and 15% on the remaining Rs 1,25,000 (Rs 18,750). Because net income of Rs 13,25,000 exceeds the Rs 12,00,000 ceiling, the Section 87A rebate of up to Rs 60,000 available in the new regime does not apply here, so the full Rs 78,750 plus 4% cess stands. You can reproduce this line by line in the New Regime Calculator, and cross-check the deducted figure against your TDS statement.

Now the set-off. The department proposes, under Section 245(1), to adjust the Rs 18,100 refund against the AY 2023-24 demand of Rs 32,000. The outcome depends entirely on your response.

Read the "Disagree in Full" row carefully. If the 2023-24 demand arose because a TDS credit was omitted at processing, or a challan was mis-tagged, and you can prove it, the demand collapses to zero and the entire Rs 18,100 refund is released with Section 244A interest. This is why responding beats staying silent: the difference between the first row and the third is the whole refund. The moment you let the window lapse, the set-off under Section 245 is confirmed and you are left chasing the Rs 13,900 shortfall, which continues to attract 1% monthly interest under Section 220(2).

Where a demand is genuinely wrong on the face of the record — a totalling error, an ignored TDS credit visible in Form 26AS — the cleaner cure is a rectification request under Section 154, filed for the offending assessment year. Disagreeing on the demand-response screen registers your objection; a Section 154 rectification actually deletes the erroneous demand at source once accepted.

FAQ

How long do I have to respond before the refund is adjusted?

The Section 245 intimation is a time-bound notice; the response window is stated on the intimation itself in your Pending Actions tab. The FAQ (incometax.gov.in) is explicit that if you do not respond within that window, "the demand will be confirmed and will be adjusted against your refund." Treat the notice date shown on the portal as your clock, and respond before it lapses rather than assuming the department will wait.

Can the department adjust my refund without telling me first?

No. Section 245(1) of the Income-tax Act, 1961 permits set-off only "after giving an intimation in writing to such person of the action proposed to be taken." That prior written intimation is a statutory precondition. An adjustment made without giving you the opportunity to respond is open to challenge, which is exactly why the "Response to Outstanding Demand" screen exists.

What if I only disagree with part of the demand?

Use "Disagree with demand (Either in Full or Part)" and, per the FAQ, "pay the portion of the demand which is undisputed." In the worked example, if Rs 20,000 of the Rs 32,000 is correct and Rs 12,000 is not, you clear the Rs 20,000, contest the Rs 12,000 with a reason, and only Rs 1,900 remains payable after your Rs 18,100 refund is applied.

The demand is from an old year I already paid. What do I do?

Select "Disagree in Full" and choose the reason that matches — for instance, demand already paid — attaching the challan identification number (CIN) as proof. If the payment simply was not mapped to the demand, a Section 154 rectification for that assessment year is the durable fix. Keep the CIN and BSR code from your original challan; the demand cannot be deleted without them.

Will I still get interest on the refund that was adjusted?

A refund lawfully due carries interest under Section 244A at 0.5% per month up to the date of set-off, and that interest is computed on the Rs 18,100 before it is applied to the older demand. The adjustment does not erase the Section 244A interest already accrued; it is factored into the amount set off.

My refund failed to credit for a different reason — is that also Section 245?

Not necessarily. A refund can fail because of a bank-account or validation issue rather than a set-off, in which case you raise a refund reissue request instead. See our walkthrough on raising a refund reissue request; a Section 245 adjustment, by contrast, always arrives as an outstanding-demand intimation you must respond to.

Does agreeing to the demand waive my right to appeal?

Agreeing and paying settles the demand on the portal, but it does not by itself extinguish a separately filed appeal against the underlying assessment order. If you have a pending appeal under Section 246A, note that on the response screen using the appropriate "Disagree" reason so the demand is flagged as under dispute rather than simply confirmed.