AO properly reviewed interest expense; PCIT revision under Section 263 found unjustified, appeal allowed in favor of assessee.

The ITAT Mumbai held that the AO had adequately examined the allowability of interest expenditure despite the auditor's objection. The AO issued notices and sought detailed information on loans and interest, which the assessee provided, including the breakup of capitalized interest. The tribunal found no error in the AO's order prejudicial to revenue and ruled that the PCIT's revision under Section 263 was unwarranted, as no factual or legal error was demonstrated. The appeal by the assessee was allowed.

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ISSUES:

Whether the Principal Commissioner of Income Tax (PCIT) had jurisdiction to initiate proceedings under section 263 of the Income Tax Act, 1961.Whether the assessment order passed under section 143(3) of the Act was erroneous and prejudicial to the interests of the revenue for failure to properly examine the allowability of interest expenditure claimed as revenue expenditure.Whether the PCIT was justified in revising the assessment order solely on the basis of audit objections without independent verification.Whether the Assessing Officer (AO) made adequate inquiries and applied his mind in accepting the interest expenditure claimed by the assessee.

RULINGS / HOLDINGS:

The PCIT erred in assuming jurisdiction under section 263 as the AO had made necessary inquiries into the interest expenditure, and the order was not "erroneous in so far as it is prejudicial to the interests of the revenue."The AO conducted specific inquiries into the interest expenses, including obtaining break-ups of capitalized and revenue expenditures, and took a "conscious decision" to accept the income returned by the assessee; hence, the assessment order cannot be deemed erroneous or prejudicial.The PCIT's revision of the assessment order based solely on audit observations without additional material or verification was improper and does not satisfy the conditions for invoking section 263.The error contemplated under section 263 must be "actually an error either of fact or of law," not a mere possibility or guesswork; no such error was established by the PCIT in this case.

RATIONALE:

The Court applied the statutory framework of section 263 of the Income Tax Act, 1961, which permits revision only if the AO's order is both erroneous and prejudicial to the revenue.Explanation 2 to section 263 clarifies that an order is deemed erroneous if passed without necessary inquiries or verification, or allowing relief without inquiry.The Court emphasized that the PCIT must examine the entire record of proceedings, not merely rely on audit objections, before forming an opinion under section 263.It was noted that the AO had issued notices under section 142(1) seeking detailed information on interest expenditure and had received and considered the breakup of capitalized and revenue interest expenses, indicating adequate inquiry.The Court rejected the PCIT's reliance on audit comments as a negative finding, recognizing them as mere observations rather than adverse qualifications.The decision reaffirms that revisionary powers under section 263 are to be exercised cautiously and only when there is clear material establishing an error prejudicial to revenue, not on speculative grounds.

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