1999 (6) TMI 31 - HC - Income Tax

Court Invalidates Second Draft Assessment Order; Enhancements Disallowed; Ship Compensation Not Capital Gains

The court held that the second draft assessment order issued by the Income-tax Officer was invalid as only one draft order can be issued under Section ... Assessment, Draft Assessment Order, Assessing Officer, Capital Gains, Transfer, Extinguishment Of Right Issues Involved:1. Validity of the second draft assessment order issued by the Income-tax Officer.2. Taxability of capital gains on compensation received from the insurance company for the destruction of a ship.Issue-wise Detailed Analysis:1. Validity of the Second Draft Assessment Order:The first issue pertains to the validity of the second draft assessment order issued by the Income-tax Officer. The assessee, a private limited company, submitted its return of income for the assessment year 1978-79. The Income-tax Officer, after considering the material available, made an assessment and forwarded a draft assessment order to the assessee on March 3, 1981. The assessee did not file any objection within the stipulated seven days nor applied for an extension. Despite this, the Income-tax Officer forwarded a second draft order on March 23, 1981, disallowing the investment allowance of Rs. 13,76,350 which was allowed in the first draft order, thereby enhancing the assessed income.The Tribunal held that the second draft order was invalid, relying on the Delhi High Court decision in Sudhir Sareen v. ITO [1981] 128 ITR 445. The Revenue challenged this decision, citing contrary judgments from the Madhya Pradesh High Court in Banarsidas Bhanot and Sons v. CIT [1981] 129 ITR 488 and the Calcutta High Court in Shahdara (Delhi) Saharanpur Light Railway Co. Ltd. v. CIT [1994] 208 ITR 882.The court analyzed Section 144B of the Income-tax Act, 1961, which mandates that if the Income-tax Officer proposes a variation in the income returned by the assessee exceeding Rs. 1,00,000, a draft assessment order must be forwarded to the assessee. If no objections are received within the specified period, the Income-tax Officer is to complete the assessment based on the draft order. The court emphasized that once a draft order is communicated, the Income-tax Officer's quasi-judicial function ends, and he cannot issue a second draft order.The court supported its conclusion with the Supreme Court decision in Panchamahal Steel Ltd. v. U. A. Joshi, ITO [1997] 225 ITR 458, which held that revised returns could not be filed after the draft order is made. The court also referred to the Delhi High Court decision in Sudhir Sareen v. ITO, affirming that only one draft order can be issued under Section 144B. Consequently, the court disagreed with the Madhya Pradesh and Calcutta High Courts' contrary views.The court concluded that the second draft order was beyond the Income-tax Officer's powers and answered the first question in favor of the assessee and against the Revenue.2. Taxability of Capital Gains on Compensation for Destruction of a Ship:The second issue concerns the taxability of capital gains on compensation received by the assessee from the insurance company for the destruction of a ship. The assessee received Rs. 85,00,000 as compensation, while the cost of the ship was Rs. 55,05,400. The Income-tax Officer included the difference as capital gains, considering it an extinguishment of right in a capital asset. This view was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal.However, the Supreme Court in Vania Silk Mills P. Ltd. v. CIT [1991] 191 ITR 647 held that the extinguishment of a right in an asset due to the destruction of the asset itself is not a transfer of the right but its destruction. Therefore, the difference between the compensation received and the cost of the asset is not chargeable to tax under Section 45 of the Act.Both parties agreed that this Supreme Court decision concluded the controversy, and the court answered the second question in favor of the assessee and against the Revenue.Conclusion:The reference was disposed of with both questions answered in favor of the assessee and against the Revenue, with no order as to costs.