COMMISSIONER OF INCOME TAX AHMEDABAD IV vs. SHILP GRAVURES LTD

The following is the substantial question of law arising in this Tax Appeal preferred by the revenue under Section 260A of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’) aggrieved by the order passed by the Income Tax Appellate Tribunal (‘ITAT’ for short) dated 26/10/2012 in ITA No. 1138/Ahd/2010; “Whether in the facts and circumstances of the case, the learned ITAT has erred in law in confirming the order of CIT(A) in holding the reopening of assessment under Section 147 by issuing notice under Section 148 of the Income Tax Act as invalid?”

The only question that we are required to deal with is as to whether notice of reopening issued under Section 148 of the Act and thereby seeking to reopen the assessment under Section 147 of the Act was at the instance of the audit objection or was there any subjective satisfaction of the Officer in issuance of such a notice.

Having heard learned Counsel, Mr. Varun Patel, appearing on behalf of the revenue, who has strenuously argued before us that once the audit objection was raised, it could be a starting point, however, eventually that has resulted into issuance of notice under Section 148 of the Act and, therefore, such a decision would not be liable to scrutiny and the same could be construed as subjective satisfaction of the Assessing Officer. He also has argued that the audit objection rightly had not allowed the R & D expenses as the revenue expenses and, therefore, the correspondence, which resulted into formation of the belief of the Assessing Officer, should be held to be his belief and, therefore, the quashing of the notice by the tribunal is not justifiable.

As can be noted from the record that for the Assessment Year 2004-05 the case of the assessee was taken in scrutiny and the assessment under Section 143(3) of the Act was completed on 29/12/2006 wherein while assessing income at Rs.1,74,89,890/- the R & D expenses to the tune of Rs.54.07 lakhs in respect of inhouse research was held allowable as the revenue expenses. Subsequently, when the audit objection was raised, the Assessing Officer initially replied to the audit party that these expenses were rightly claimed as revenue expenditure and the same were also correctly allowed. However, the Assessing Officer issued notice under Section 148 of the Act on 20/02/2009 at the instance of audit party and applied Section 35AB(2) and Section 32A(2B) of the Act. The Assessing Officer held in reassessment proceedings that the expenditure of Rs.54.07 lakhs incurred on inhouse research and development of various process was capital in nature and assessee having debited entire amount in P & L account treating the same as revenue expenditure was not accepted by the Assessing Officer. He consequently disallowed the amount of Rs.36.05 lakhs being 1/3 rd of the total amount of Rs.54.07 lakhs.

The reassessment proceedings were thereafter challenged before the CIT(A). The CIT(A) quashed the said proceedings by holding that it was nothing but a mere change of opinion on the part of the Assessing Officer. It was further held that the assessee commenced its business in Assessment Year 1994-95 and Section 32A(2B) would not be applicable as the same applies to plant installed after 30/06/1977 and before 01/04/1987. 6. The said decision of CIT(A) same came to be challenged before the tribunal. The tribunal after examining the issue in detail concurred with the finding of the CIT(A) and confirmed the quashment of such proceedings. This is challenged in this Tax Appeal by raising the aforesaid proposed substantial question of law.

We have heard learned Counsel Mr. Varun Patel for the revenue and also deemed it fit to call for the files for our satisfaction. It could be noticed from the correspondence dated 09/02/2009 addressed to the Commissioner of Income- tax while seeking the permission for taking remedial action under Section 147 of the Act that an objection had been raised by the auditor in the following manner; GIST OF AUDIT OBJECTION:­ The assessee­company engaged in the business of manufacturing and job work in electronically engraved  copper rollers filed its return of income   for   assessment   year   2004­05   declaring   total   income   of Rs.1,54,66,000/­. The case was taken under scrutiny under Section 143(3)   of   the   Act   on   29/12/2006   and   scrutiny   was   completed determining total income of Rs.1,74,89,890/­. The audit has found that the assessee has debited an amount of expenses of Rs.54.07 lakhs in Profit & Loss Account treating it as revenue expenditure.  However, according to Section 35AB of the Act the assessee was eligible for a deduction of 1/3rd  of Rs.54.07 lakhs paid   in  the   previous   year   on  research  and  development   and   the balance amount in equal installments immediately in two succeeding previous years for which the working is given below: Total amount spent on R & D Rs.54.07 lakh Less : 1/3rd (eligible deduction) Rs.18.02 lakh Rs.36.05 lakh Thus the allowance of deduction for entire expenditure of Rs.54.07 lakh against Rs.18.02 lakh resulted in an under assessment of income of   Rs.36.05   lakh   with   consequential   short   levy   of   tax   of Rs.25,78,929/­.

The Assessing Officer maintained the stand that the R & D expenses incurred by the Company on inhouse research, being in the nature of consumption of raw material on test production and salary / wages of personnel deployed for R & D activities, have been rightly claimed as revenue expenses. It also maintained the stand that the objections raised by the audit party is not acceptable.

However, such reply was not found acceptable by the audit party and, therefore, the only remedial action available was to initiate the action under Section 147 of the Act and, therefore, the permission was sought of the Commissioner of Income-tax.

Another communication dated 10/02/2009 by the Additional Commissioner of Income-tax), Range-8, Ahmedabad referring to the order passed by the Assistant Commissioner of Income-tax (O ) Circle – 8 also says that in view of the detailed facts mentioned by the Assistant Commissioner of Income-tax (O ) Circle-8 the audit objection is not acceptable, however the remedial action as per the Board’s instruction No. 9/2006 is required to be initiated and, therefore, it agreed with the view of the Assessing Officer that appropriate remedial action would be re-opening of the assessment under Section 147 of the Act.

These communications are clearly indicative of the fact that the Assessing Officer was not satisfied with the audit party having pointed to it the issue of allowability in respect of the R & D expenses. The Assessing Officer having reason to believe Income Tax & Anr. reported in (2012) 65 DRT (Guj.) 385 wherein it is held that any such initiation of reassessment proceedings solely at the instance of the audit objection would not be maintainable. “(i) CIT Vs. Lucas T.V.S. Ltd. (2001) 168 CTR (SC) 311 : (2001) 249 ITR 306 (SC) in which the apex Court upheld the decision of the DTR (Guj.) 7: (2011) 15 Taxmann.com.170 (Guj.) wherein Division Bench of this Court was pleased to quash the notice for reopening where the only basis was the revenue audit objection as regards the eligibility of the assessee for exemption. (iii) Adani Exports Vs. Dy. CIT (1999) 153 CTR (Guj.) 308: (1999) 240 ITR 224 (Guj.) wherein Division Bench of this Court   held as under; “It is true that satisfaction of the AO for the purpose of reopening is subjective in character and the scope of judicial review is limited. When the reasons recorded show a nexus between the formation of belief and the escapement of income, a further enquiry about the adequacy or sufficiency of the material to reach such belief is not open to be scrutinised.  However, it is always open to question existence of such belief on the ground that what has been stated is not correct state of affairs existing on record.  Undoubtedly, in the face of record, burden lies, and heavily lies, on the petitioner who challenges it.  If the petitioner is able to demonstrate that in fact the AO did not have any reason to believe or did not hold such belief in good faith or the belief which is projected in papers is not belief held by him; in fact, the exercise of authority conferred on such person would be ultra vires the provisions of law and would be abuse of such authority.   As the aforesaid decision of the Supreme Court indicates that though audit objection may serve as information, the basis of which the ITO can act, ultimate action must depend directly and solely on the formation of belief by the ITO on his own where such information passed on to him by the audit that income has escaped assessment.  In the present case, by scrupulously analysing the audit objection in great detail, the AO has demonstrably shown to have held the belief prior to the issuance of notice as well as after the issuance of notice that the original   assessment   was   not   erroneous   and   so   far   as   he   was concerned, he did not believe any any time that income has escaped assessment on account of erroneous computation of benefit under Section 80HHC.  He has been consistent in his submission of his report to the superior officers.  The mere fact that as a subordinate officer he added the suggestion that if his view is not accepted, remedial actions may be taken cannot be said to be belief held by him.   He has no authority to surrender or abdicate his function to his superiors, nor the superiors can arrogate to themselves such authority.   It needs hardly to be stated that in such circumstances conclusion is irresistible that the belief that income has escaped assessment was not held at all by the office having juri iction to issue notice and recording under the office note on 8th Feb, 1997 that he has reason to believe is a mere pretence to give validity to the exercise of power.  In other words, it was a colourable exercise  of  juri iction  by  the AO  by  recording reasons for holding a belief which in fact demonstrably he did not held that income of assessee has escaped assessment due to erroneous computation   of   deduction   under   Section   80HHC,   for   the   reasons stated by the audit.  The reason is not far to seek.”

Under the circumstances, it clearly emerges from the record that the AO was of the opinion that no part of the income of the assessee has escaped assessment.  In fact, after the audit party brought the relevant aspects to the notice of the AO, she held correspondence with the assessee.   Taking into account the assessee’s explanation regarding non­requirement of TDS collection and ultimately accepted the explanation concluding that in view of the Board’s circular, tax was not required to be deducted at source.  No income had therefore escaped assessment.   Despite such opinion of the AO, when ultimately the impugned notice came to be issued the only conclusion we can reach is that the AO had acted at the behest of and on the insistence of the audit party.   It is well­settled that it is only the AO whose opinion with respect to the income escaping assessment would be relevant for the purpose of reopening of closed assessment.   It is, ofcourse true, as held  by the decisions of the apex Court in the case of P.V.S. Beedies (p) Ltd. (Supra) and Indian & Eastern Newspaper Society (Supra), if the audit party brings certain aspects to the notice of the AO  and thereupon, the AO form his own belief, it may still be a valid basis for reopening assessment.  However, in the other line of judgment noted by us, it has clearly been held that mere opinion of the audit party cannot form the basis for the AO to reopen the closed assessment   that   too   beyond   four   years   from  the   end   of   relevant assessment year.”

Siji