A case where the Gujarat High Court quashed a reassessment notice
The belief that income has escaped assessment must be held by the AO and such a belief cannot be thrust on him either by audit or superiors in the I-T Department.
Litigation and audit fetter the judicial discretion of the income-tax officer (ITO) in the exercise of his assessment functions.
The ITO may honestly believe that the course of action adopted by the taxpayer during the assessment proceedings was legally correct. Yet, he may have to scrutinise the assessment lest he is faulted by the superior authorities.
Audit is another bugbear. Often, long after the assessment, the audit party of the Comptroller and Auditor-General (C&AG) visit the offices of the ITO and carry out detailed scrutiny of completed assessments.
There is generally no word of commendation for the good work done by the ITO. The purpose of scrutiny by audit has always been to pick holes in the ITO's work.
A long-established procedure requires the ITO to study the audit objection and send a reply. Generally, ITOs defend the assessments and reject the audit note. The matter then goes to the higher authority. Audit paras figure in the Public Accounts Committee report that is laid before Parliament every year. Even if the Revenue Department does not accept the audit objection, it is open to the C&AG to insist that its point of view is correct and that remedial action be taken. Quite often, reassessment proceedings are initiated to give effect to the audit's point of view.
The Rajesh Jhaveri case
In this case (Rajesh Jhaveri Stock Brokers (P) Ltd vs Assistant Commissioner of Income-Tax 2006 284 ITR 593 Gujarat), the company, Rajesh Jhaveri Stock Brokers (P) Ltd, filed its returns for assessment year (AY) 2001-02 in October 2001, declaring a total loss of Rs 2,70,85,105. The return was accepted.
In May 2004, the Assistant Commissioner of Income-Tax (ACIT) reopened the completed assessment proceedings by issuing a notice under Section 148 of the Income-Tax Act, 1961. It came to light that the re-opening was based on audit party objection. It was also found that the I-T Department did not accept the objection and was pressing for its withdrawal.
The objection related to the claim for allowance of bad debts under Sections 36(1)(vii) and 36(2) of the Act. According to the audit, there was under-assessment of income of Rs 1,014.59 lakh. The assessing officer (AO) did not accept the objection and wrote to the Deputy Accountant-General to drop the same. The ACIT agreed with the AO's view.
Even the Central Board of Direct Taxes (CBDT) concurred with the AO's views. However, the Accountant-General insisted on remedial action. In this background, the AO made a note in the file to the effect that the claim for bad debts was not correct and observed that there was escapement of income. The company filed a writ petition before the Gujarat High Court challenging the reopening notice.
The court scrutinised the records of the case and found that the audit para alone was responsible for the reassessment notice. Now, audit objection may serve as information on the basis of which the ITO can act. However, ultimate action must depend directly and solely on the formation of belief by the ITO on his own when such information is passed on to him by audit indicating escapement of income.
In the case before the Gujarat High Court, the AO had scrupulously analysed the audit objection and reiterated his belief that the original assessment was not erroneous.
The court pointed out that the ITO had no authority to surrender or abdicate his function to his superiors. The belief that income has escaped assessment must be held by the AO and such a belief cannot be thrust on him either by audit or superiors in the I-T Department.
Notice issued in such cases will represent a colourable exercise of jurisdiction by the AO, by recording reasons for holding a belief which, in fact, demonstrably he did not hold about income escaping assessment. The court held that the exercise of recording reasons on the file is a mere pretence to give validity to the exercise of power for assuming jurisdiction.
Instructions of the CBDT directing remedial action by way of reassessment even when the audit objection is not accepted by the ITO were considered ultra vires. The Gujarat High Court quashed the reassessment notice.
In yet another case (Ajay Oxycholoride Floorings vs Iyer ACIT 2006 203 CTR Bombay 232), the Bombay High Court held that when a protective assessment has been made on the ground that the income is assessable in the hands of the assessee, initiation of reassessment proceedings cannot be resorted to.
Audit objections and protective assessments were long considered to be excuses for reopening completed assessments. The judiciary has now held that such reassessment notices are bad in law.
T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)