Unsecured loan entries via alleged shell lenders: lack of inquiry on genuineness and creditworthiness led to s.263 revision upheld

The dominant issue was whether the PCIT validly assumed revisionary jurisdiction under s.263 to set aside an assessment that accepted unsecured loan transactions allegedly routed through entry-operator shell entities. The HC held the assessment order was "erroneous and prejudicial to the interests of the Revenue" because it contained no discussion or verification of the loans' genuineness and creditworthiness despite adverse investigation material, and such matters cannot be concluded merely from ledgers/returns when the lenders' identities are suspect; deeper scrutiny is required. Consequently, s.263 invocation was upheld and the tribunal's finding that adequate inquiry was made was reversed. The HC further held Explanation 2(a) to s.263 (deeming lack of inquiry as error) applied to AY 2016-17, answering the questions in favour of the Revenue.

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Issues Involved:
1. Whether the ITAT was justified in setting aside the order passed by PCIT under Section 263 of the Income Tax Act, 1961 without adequate inquiry into the genuineness and creditworthiness of the transactions.
2. Applicability of Explanation 2 to Section 263 of the Income Tax Act, 1961 for AY 2016-17.

Issue 1: Justification of ITAT in Setting Aside PCIT Order

The Revenue filed an appeal against the ITAT order dated 14 February 2022, which set aside the PCIT's order under Section 263 of the Income Tax Act, 1961. The PCIT had considered the assessment order dated 26 December 2018 to be erroneous and prejudicial to the interests of the Revenue, directing the AO to re-examine the case. The ITAT, however, accepted the assessee's contention that the AO had conducted proper inquiries.

The court examined the assessment order, which only discussed disallowance under Section 14A of the Act and did not address the genuineness and creditworthiness of unsecured loan transactions. The PCIT had invoked Section 263, citing lack of inquiry into loans from M/s. Sarvottam Securities Ltd. and M/s. Upaj Leasing & Finance Pvt. Ltd., identified as shell companies by the DDIT investigation report.

The court referenced the Supreme Court's decision in Malabar Industrial Co. Limited v. CIT, emphasizing the need for both conditions'erroneous and prejudicial to the interests of the Revenue'to be satisfied for invoking Section 263. The court found that the AO had not conducted sufficient inquiries into the loan transactions, making the assessment order erroneous and prejudicial to the Revenue.

Therefore, the court held that the ITAT was incorrect in concluding that the AO had made due inquiries and that the PCIT had wrongly assumed jurisdiction under Section 263.

Issue 2: Applicability of Explanation 2 to Section 263

The court noted that Explanation 2 to Section 263, introduced by the Finance Act, 2015, with effect from 01 June 2015, applies to the case of the assessee for AY 2016-17. This explanation deems an order erroneous and prejudicial to the interests of the Revenue if it is passed without making necessary inquiries or verification.

Given that the assessment order lacked discussion on the loan transactions and the AO did not adequately verify the findings of the DDIT investigation report, the court found that Explanation 2 to Section 263 was applicable. Consequently, the court answered this question in favor of the Revenue.

Conclusion:

The court set aside the ITAT order dated 14 February 2022, allowing the appeal and disposing of any pending applications.

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