2024 (9) TMI 1792 - AT - Income Tax

Reassessment Notice Under Section 148 Without Proper Approval Is Invalid and Quashed

ITO, Ward-1, Jharsuguda Versus Hirakhand Transport and Multi Purpose Cooperative Society Pvt. Ltd. And (Vice-Versa)

ITO, Ward-1, Jharsuguda Versus Hirakhand Transport and Multi Purpose Cooperative Society Pvt. Ltd. And (Vice-Versa) - TMI 1. ISSUES PRESENTED and CONSIDERED 1. Whether the learned CIT(A) was justified in estimating income @6% without adequately appreciating the explanations and records relating to payments to related party subcontractors and without substantiating whether the expenditure was excessive or unreasonable under section 40A(2)(b) of the Income Tax Act. 2. Whether the comparison of net profit percentage to disallowance by the CIT(A) is supported by any provision of the Income Tax Act or is based on conjectures and surmises. 3. Whether the assessee furnished cogent documentary evidence before the Assessing Officer to prove that the expenditure claimed was actually incurred and allowable under section 40A(2)(b) of the Act. 4. Whether the assessee's own return of income reporting no allowance under section 40A(2)(b) affects the validity of income estimation by the CIT(A). 5. Jurisdictional validity of reassessment proceedings initiated under section 147 read with section 148, including: Validity of prior approval obtained from JCIT instead of PCIT/PCCIT as mandated under section 151(1) for reopening beyond four years; Fulfillment of twin conditions under the proviso to section 147 (failure to make return or failure to disclose fully and truly all material facts); Validity of notice issued under section 148 on 31.03.2021 but served on 01.04.2021, post amendment by Finance Act, 2021; Jurisdictional competence of AO issuing notice contrary to CBDT Instruction No. 1/2011 on pecuniary limits. 6. Whether the order passed under section 147 based on the old law becomes infructuous after initiation of proceedings under the amended law (section 148A) following the Supreme Court judgment in Ashish Agarwal. 7. Applicability of section 40A(2)(b) to cooperative societies and whether disallowance under this section is permissible against such entities. 8. Distinction between reporting requirements under Form 3CD by the tax auditor and disallowance by the Assessing Officer under section 40A(2)(b). 9. Whether the Assessing Officer must demonstrate excessiveness or unreasonableness of expenditure to justify disallowance under section 40A(2)(b). 2. ISSUE-WISE DETAILED ANALYSIS Issue 1-4: Validity of Income Estimation and Disallowance under Section 40A(2)(b) Legal Framework and Precedents: Section 40A(2)(b) disallows expenditure paid to related parties if such expenditure is excessive or unreasonable compared to fair market value, legitimate business needs, or benefit derived. The onus lies on the Revenue to establish excessiveness. The tax auditor's report (Form 3CD) requires only reporting payments to related parties, not an opinion on excessiveness. The Supreme Court and various High Courts have held that disallowance cannot be made merely on reporting without demonstration of excessiveness or unreasonableness. Court's Interpretation and Reasoning: The CIT(A) deleted the entire disallowance of Rs. 5,44,88,752/- made by the AO, holding that the AO failed to establish beyond doubt that payments were excessive or unreasonable, thus the condition under section 40A(2)(a) was not fulfilled. However, the CIT(A) proceeded to estimate net income at Rs. 46,64,000/- on an adhoc basis invoking section 251(1)(a) powers. Key Evidence and Findings: The assessee submitted explanations and records relating to major subcontractors who were related parties. The tax audit report disclosed payments to related parties but the assessee's return reported nil disallowance under section 40A(2)(b). No cogent documentary evidence was found on record by the AO to prove excessiveness. Application of Law to Facts: The AO's disallowance lacked material to prove excessiveness or unreasonableness. The CIT(A)'s adhoc income estimation was beyond the scope of appeal as the issue of disallowance was the subject matter. The estimation was not based on any statutory provision or concrete evidence. Treatment of Competing Arguments: The Revenue contended that the disallowance was justified and the CIT(A)'s adhoc estimation was improper. The assessee argued that no disallowance was warranted without proof of excessiveness and that the cooperative society status exempts it from section 40A(2)(b). Conclusions: The disallowance under section 40A(2)(b) was not sustainable due to lack of demonstration of excessiveness. The adhoc income estimation by CIT(A) was beyond jurisdiction and not supported by law or facts. Issue 5: Jurisdictional Validity of Reassessment Proceedings Relevant Legal Framework and Precedents: Section 147 read with section 148 governs reassessment. Section 151(1) mandates prior approval from PCIT/PCCIT/Pr.CCIT for reopening beyond four years. The proviso to section 147 requires failure on part of assessee to disclose fully and truly all material facts. CBDT Instruction No. 1/2011 specifies pecuniary jurisdiction of AO. The Finance Act, 2021 amended reassessment provisions effective 01.04.2021 introducing section 148A. Court's Interpretation and Reasoning: The AO obtained prior approval from JCIT instead of the competent PCIT/PCCIT, violating section 151(1). The notice under section 148 dated 31.03.2021 was digitally signed but served on 01.04.2021, post amendment, requiring compliance with new provisions. The AO lacked pecuniary jurisdiction as per CBDT Instruction No. 1/2011 since the returned income exceeded Rs. 15 lakhs but reassessment was initiated by ITO instead of ACIT/DCIT. The proviso to section 147 was not satisfied as the assessee had disclosed all material facts in the original assessment. Key Evidence and Findings: The notice itself showed approval from JCIT. Certified email copy established service on 01.04.2021. The original return declared income above pecuniary limit for ITO jurisdiction. No material indicated failure to disclose fully and truly all material facts. Application of Law to Facts: The notice issued without proper sanction is invalid. The reassessment initiated post amendment without following new procedure is void. Jurisdictional limits under CBDT Instruction were breached. Absence of failure to disclose material facts negates jurisdiction to reopen beyond four years. Treatment of Competing Arguments: The Revenue urged validity of notice and reassessment. The assessee relied on binding High Court precedents and Supreme Court rulings to challenge jurisdiction and validity of notice. Conclusions: Reassessment proceedings were without jurisdiction, invalid, and liable to be quashed. Issue 6: Effect of Supreme Court Judgment in Ashish Agarwal on Proceedings under Old and New Law Legal Framework and Precedents: The Supreme Court held that reassessment notices issued under old section 148 after 01.04.2021 but up to 30.06.2021 are deemed to have been issued under new section 148A. Defenses and rights under new law remain available. Court's Interpretation and Reasoning: The AO issued notice under section 148 on 31.03.2021 but served on 01.04.2021. Proceedings under section 148A were initiated but dropped as not a fit case. The order under section 147 based on old law became infructuous after initiation of section 148A proceedings. Key Evidence and Findings: The AO's order under section 147 dated 31.03.2022 was followed by notice under 148A(b) and order under 148A(d) dropping proceedings. No fresh notice under section 148 was issued. Application of Law to Facts: The old law order loses effect once new law procedure is followed and proceedings are dropped. Keeping old order alive is impermissible. Conclusions: The reassessment order under old law is infructuous and void. Issue 7: Applicability of Section 40A(2)(b) to Cooperative Societies Legal Framework and Precedents: Section 40A(2)(b) does not mention cooperative societies. Bombay High Court held that cooperative societies are distinct from Association of Persons (AOP) and section 40A(2) does not apply to them. Cooperative societies enjoy mutuality doctrine and specific deductions under section 80P. Court's Interpretation and Reasoning: The assessee is a cooperative society formed under law, engaged in transportation business. Payments made to members are not covered under section 40A(2)(b). The disallowance invoking section 40A(2)(b) is contrary to law. Key Evidence and Findings: Registration documents and nature of business confirm cooperative status. Payments were to members. Application of Law to Facts: Section 40A(2)(b) is not applicable to cooperative societies; hence disallowance under this section is impermissible. Conclusions: Disallowance under section 40A(2)(b) is not sustainable against cooperative societies. Issue 8: Distinction Between Reporting in Form 3CD and Disallowance by AO Legal Framework and Precedents: Clause 23 of Form 3CD requires reporting payments to related parties but does not mandate opinion on excessiveness or fair market value. Courts have held that reporting is not evidence for disallowance. Court's Interpretation and Reasoning: The tax auditor's report only discloses payments made, not that payments are excessive or unreasonable. The AO cannot disallow expenditure solely on the basis of tax audit report. Key Evidence and Findings: Tax audit report disclosed payments but did not opine on reasonableness. Application of Law to Facts: Reporting in Form 3CD is distinct from disallowance which requires independent assessment and evidence. Conclusions: Disallowance cannot be based solely on tax auditor's report. Issue 9: Requirement of Demonstrating Excessiveness or Unreasonableness for Disallowance under Section 40A(2)(b) Legal Framework and Precedents: Section 40A(2)(a) empowers AO to disallow expenditure only to the extent it is excessive or unreasonable considering fair market value, legitimate business needs, or benefit derived. The Supreme Court and various High Courts have emphasized the need for AO to demonstrate such excessiveness. Mere payments to related parties are insufficient. Court's Interpretation and Reasoning: The AO failed to conduct any exercise or produce material to establish excessiveness or unreasonableness. Judicial precedents require a clear demonstration of such excessiveness before disallowance. Key Evidence and Findings: No material or market comparison was placed on record by AO. The CIT(A) rightly deleted disallowance for lack of proof. Application of Law to Facts: Without demonstration of excessiveness, disallowance under section 40A(2)(b) cannot be sustained. Conclusions: Disallowance under section 40A(2)(b) without proof of excessiveness is invalid.