ITAT rules adjustments under Section 143(1) invalid without mandatory communication to assessee, orders deletion of additions

ITAT Chennai held that adjustments made under Section 143(1) without issuing mandatory communication to the assessee as required under the first proviso to Section 143(1)(a) are unsustainable in law. The AO failed to provide details of communication proposing adjustments, citing CPC-2.0 Project transition phase. The tribunal directed deletion of additions made through the intimation. Additionally, ITAT ruled that for determining concessional tax rate eligibility, notional income items under INDAS standards should not be included in gross turnover computation. The assessee qualified for 25% tax rate as turnover remained below Rs.250 crores after excluding notional income items. Appeal allowed.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these consolidated appeals are:

• Whether the intimation issued under section 143(1) of the Income Tax Act, 1961 (the Act) is valid in the absence of issuance of mandatory show cause notice as required under the first proviso to section 143(1)(a) of the Act before making adjustments to the total income;
• Whether the adjustments made by the Assessing Officer (AO) under section 143(1)(a) of the Act, including disallowance of various expenses, are sustainable when the mandatory procedural requirements are not complied with;
• Whether the concessional tax rate of 25% is applicable to the assessee company for the assessment year 2019-20, considering the turnover/gross receipts threshold of Rs. 250 crores as prescribed under the Finance Act, 2019;
• Whether the items classified as 'other income' should be included in the computation of gross turnover/gross receipts for determining eligibility for concessional tax rates, specifically when such income includes notional gains arising from restatement of liabilities under IND-AS accounting standards.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of Intimation under Section 143(1) of the Act without Show Cause Notice as per First Proviso to Section 143(1)(a)

Relevant Legal Framework and Precedents: Section 143(1)(a) of the Income Tax Act provides for processing of the return of income by the AO and making certain adjustments, including arithmetic errors, incorrect claims apparent from the return, and other specified adjustments. The first proviso to section 143(1)(a) mandates that no adjustment shall be made unless an intimation is given to the assessee of such adjustment either in writing or electronic mode. This implies that before issuing the intimation, the AO must issue a show cause notice proposing the adjustment, thereby giving the assessee an opportunity to respond. The principle of audi alteram partem (right to be heard) is thus embedded in this provision.

The Tribunal relied on the decision of the ITAT Ahmedabad Bench in Arham Pumps v. DCIT, which emphasized the mandatory nature of the first proviso to section 143(1)(a) and held that failure to issue the required communication renders the intimation invalid.

Court's Interpretation and Reasoning: The Tribunal examined the facts and found that the AO did not issue any show cause notice or communication proposing the adjustments prior to issuing the intimation under section 143(1). The Revenue's contention that the non-availability of communication records was due to the CPC-2.0 Project being in a transition phase was accepted as a factual position but did not absolve the AO from the statutory mandate. The Tribunal held that absence of such communication violates the first proviso to section 143(1)(a) and renders the intimation unlawful and unsustainable in law.

Key Evidence and Findings: The assessee produced screenshots from the ITBA portal showing no communication was issued. The Revenue conceded that records of such communication were not available. The Tribunal noted that the CIT(A) and the National Faceless Appeal Centre (NFAC) did not consider this procedural lapse and proceeded on merits, which was held to be erroneous.

Application of Law to Facts: The Tribunal applied the statutory requirement strictly, emphasizing that the AO must issue a show cause notice proposing adjustments before issuing intimation under section 143(1). The failure to comply with this mandatory procedure vitiates the entire assessment process under section 143(1).

Treatment of Competing Arguments: The Revenue's argument that adjustments under section 143(1)(a) are mandatory and based on the Tax Audit Report was rejected because the procedural requirement of issuing a show cause notice is independent and mandatory. The Tribunal also rejected the Revenue's contention that the absence of communication was due to technical transition, holding that statutory compliance cannot be excused on such grounds.

Conclusion: The intimation issued under section 143(1) of the Act without prior issuance of show cause notice as mandated by the first proviso to section 143(1)(a) is invalid. Consequently, the additions and disallowances made in the intimation cannot be sustained and are quashed.

Issue 2: Applicability of Concessional Tax Rate of 25% for AY 2019-20 Based on Turnover/Gross Receipts Threshold

Relevant Legal Framework and Precedents: The Finance Act, 2019, Part 1, Chapter 2, prescribes a concessional tax rate of 25% for domestic companies whose total turnover or gross receipts in the previous year do not exceed Rs. 250 crores. If the turnover or gross receipts exceed Rs. 250 crores, the normal corporate tax rate of 30% applies.

Court's Interpretation and Reasoning: The Tribunal analyzed the turnover and gross receipts of the assessee for the relevant financial year (2016-17) to determine eligibility for the concessional tax rate. The Revenue contended that the total gross receipts, including other income, exceeded Rs. 250 crores, thereby disqualifying the assessee from the concessional rate. The assessee argued that only revenue from business operations should be considered, excluding other income items such as guarantee commission, fair value gains on financial instruments, and gains on extinguishment of financial liability, which are not part of core business turnover and are notional in nature.

Key Evidence and Findings: The audited financial statements showed business revenue of Rs. 173.30 crores and other income of Rs. 235.51 crores. The Tribunal noted that the 'other income' included notional gains arising from restatement of liabilities due to adoption of IND-AS accounting standards, which are not actual cash receipts or business turnover.

Application of Law to Facts: The Tribunal held that for the purpose of determining the concessional tax rate, only turnover/gross receipts arising from the business activity should be considered. Notional or accounting gains do not qualify as turnover or gross receipts. Excluding the specified other income items, the assessee's total receipts were below the Rs. 250 crore threshold.

Treatment of Competing Arguments: The Revenue's argument that total gross receipts inclusive of other income should be considered was rejected. The Tribunal accepted the assessee's submission that the other income items are not linked to core business operations and are notional in nature, thus not to be included for turnover computation.

Conclusion: The assessee was rightly allowed to adopt the concessional tax rate of 25% for AY 2019-20. The Revenue's appeal on this issue was dismissed.

3. SIGNIFICANT HOLDINGS

The Tribunal made the following crucial legal determinations:

• On validity of intimation under section 143(1): "As per the provisions of Sec.143(1)(a) of the Act, and proviso provided therein, no adjustment shall be made unless an intimation is given to the assessee of such adjustments either in writing or electronic mode... Unless the AO communicates to the assessee on proposed adjustment as per the provisions of Sec.143(1)(a) of the Act, intimation issued u/s. 143(1) of the Act, is unlawful, and thus, additions proposed in the said intimation cannot be sustained."
• On procedural fairness: "The Ld. NAFC is thus erred in conducting the faceless appeal proceedings in a more mechanical manner without application of mind... We therefore hereby quash the intimation issued by the CPC and allow the appeal filed by the assessee."
• On computation of turnover for concessional tax rate: "There is no dispute with regard to the fact that as per audited financials... the assessee has reported gross Revenue from operations at Rs.173.30 Crs. which is less than the prescribed limit for applying concessional rate of tax. Further, other income reported by the assessee does not constitute gross turnover/gross receipts generated from main business activity of the assessee... If you exclude those three items, then the gross turnover/ gross receipts of the assessee, including other income does not exceed Rs.250 Crs."
• On treatment of notional income: "Three major items i.e. income from guarantee commission, fair value gain on financial instrument and gain on extinguishment of financial liability are notional incomes credited to P &L A/c for re-statement of existing income and liabilities while adopting INDAS standards, and thus, same cannot be considered as gross receipts or other income generated from business."

Final determinations: The Tribunal allowed the assessee's appeal for AY 2020-21 by quashing the intimation under section 143(1) due to non-compliance with the procedural requirement of issuing show cause notice. It dismissed the Revenue's appeal for AY 2019-20, upholding the concessional tax rate of 25% applied by the assessee after excluding certain notional other income from gross receipts.

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