2025 (4) TMI 1039 - AT - Income Tax

Reassessment proceedings for bank deposit verification invalid without tangible material showing escaped income

Late Shri Pawan Bansal, (through L/H Mrs. Meena Bansal) Versus PCIT, Hisar.

Late Shri Pawan Bansal, (through L/H Mrs. Meena Bansal) Versus PCIT, Hisar. - TMI 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in the judgment include:Whether the notice issued under section 148 of the Income Tax Act, 1961 (the Act) for reopening the assessment was valid and lawful, particularly when the reopening was based on unexplained cash deposits in the assessee's bank account.Whether the order of assessment framed under sections 147/143(3) of the Act, consequent to the reopening, was valid and sustainable.Whether the Principal Commissioner of Income Tax (PCIT) had jurisdiction to initiate revision proceedings under section 263 of the Act against the assessment order, especially when the reopening under section 147 was allegedly without jurisdiction.Whether the revisionary order under section 263 was justified on the ground of erroneous allowance of interest deduction under section 36(1)(iii) of the Act, particularly interest paid to partnership firms where the assessee had a debit balance in capital account.Whether audit objections alone can form a valid basis for initiating revision proceedings under section 263 of the Act.Whether the assessee was denied the opportunity of being heard before the disallowance was proposed in the revision proceedings, thus violating principles of natural justice.Whether the assessee can challenge the validity of the reopening under section 147 of the Act in collateral proceedings arising from an appeal against the revision order under section 263.2. ISSUE-WISE DETAILED ANALYSISValidity of Notice under Section 148 and Reopening of AssessmentLegal Framework and Precedents: Section 148 empowers the Assessing Officer (AO) to reopen an assessment if he has reason to believe that income has escaped assessment. The 'reason to believe' must be based on tangible material and not mere suspicion or conjecture. The Supreme Court and High Courts have held that reopening cannot be done merely for verification or inquiry purposes. The Delhi High Court in United Electrical Co. (P) Ltd. v. CIT emphasized that tangible material is a pre-requisite, and the belief must be that of an honest and reasonable person on reasonable grounds. The Apex Court in CIT v. Indian Oil Corporation distinguished 'reason to believe' from 'reason to suspect'. The judgment in Ashok Kumar Sen v. ITO further clarified that the AO must have material to form a genuine belief, not mere suspicion or rumor.Court's Interpretation and Reasoning: The reopening was based solely on the fact that the assessee deposited Rs. 53,85,000 in cash in a bank account during the financial year 2008-09, and the source of this deposit was allegedly unexplained. The AO did not have any additional material to form a reason to believe that income had escaped assessment beyond this unexplained deposit.The Tribunal relied on the recent decision of the Nagpur Bench in Vijaya Vinod Duragkar, which held that reopening cannot be done merely for verification of source of investment. The reopening in the instant case was similarly held to be invalid as it was done only to verify the source of cash deposit.The Tribunal also referred to the Delhi High Court and Supreme Court precedents emphasizing the necessity of tangible material and bona fide belief, which were absent here.Application of Law to Facts: Since the reopening was based on a mere assumption of unexplained cash deposit without any tangible material or credible information, the reopening notice under section 148 was held to be illegal and without jurisdiction.Treatment of Competing Arguments: The Revenue argued that the validity of reopening cannot be challenged in appeal arising from section 263 proceedings. However, the Tribunal relied on the Mumbai Bench decision in Westlife Development Ltd. which held that jurisdictional defects in the original assessment can be challenged in collateral proceedings such as appeals against revision orders under section 263, for the limited purpose of testing the validity of the subsequent proceedings.Conclusion: The reopening under section 148 and the consequent assessment order under sections 147/143(3) were held to be without jurisdiction and invalid.Jurisdiction and Validity of Proceedings under Section 263Legal Framework and Precedents: Section 263 allows the PCIT to revise an assessment order if it is erroneous and prejudicial to the interests of the Revenue. However, the revision cannot be based solely on audit objections or a mere difference of opinion between the AO and the PCIT. The Bombay High Court in CIT v. Maharashtra Hybrid Seeds Co. Ltd. held that the PCIT cannot substitute his own opinion for that of the AO without establishing that the AO's view was impossible or perverse. The Tribunal in Raghuvir Singh v. PCIT held that initiation of revision proceedings based solely on audit objections is not in accordance with law.Court's Interpretation and Reasoning: The PCIT initiated revision proceedings based on audit objections regarding the allowability of interest deduction under section 36(1)(iii). The Tribunal observed that the AO had considered all explanations and allowed the deduction. The revision was thus an attempt to substitute the PCIT's view for that of the AO without establishing any error or prejudice to revenue.Application of Law to Facts: The Tribunal found that the revision proceedings were initiated on the basis of audit objections without independent application of mind by the PCIT. The PCIT's reliance on audit objections as the root cause for revision was held to be legally untenable.Treatment of Competing Arguments: The Revenue contended that audit objections can form a basis for revision, but the Tribunal rejected this, relying on binding precedents.Conclusion: The revision proceedings under section 263 initiated on the basis of audit objections were held to be without jurisdiction and not in accordance with law.Merits of Disallowance of Interest Deduction under Section 36(1)(iii)Legal Framework and Precedents: Section 36(1)(iii) allows deduction of interest on borrowed capital used for business purposes. However, interest paid to partnership firms where the assessee has a debit capital balance and withdrawals may not qualify as allowable deduction if such payments are in the nature of capital contribution rather than genuine interest expense.Court's Interpretation and Reasoning: The PCIT disallowed Rs. 32,91,577 claimed as interest paid to two partnership firms, treating such payments as capital contributions rather than deductible business expenses. The PCIT reasoned that since there was a debit balance in the capital account and withdrawals exceeding interest payments, the interest payments were not genuine and hence not deductible.Application of Law to Facts: The Tribunal noted that the disallowance was proposed in the revision proceedings without giving the assessee an opportunity of being heard, violating principles of natural justice. The Apex Court in CIT v. Amitabh Bachchan held that no adverse order can be passed without affording the assessee an opportunity.Treatment of Competing Arguments: The assessee contended that the interest payments were made on behalf of partnership firms and were genuine business expenses. The Tribunal found that the PCIT's conclusion was based on assumptions and not on objective appreciation of facts.Conclusion: The disallowance proposed in the revision proceedings without opportunity was held to be invalid and the revision order setting aside the assessment on this ground was quashed.Challenge to Validity of Reopening in Collateral ProceedingsLegal Framework and Precedents: The question whether validity of reopening under section 147 can be challenged in collateral proceedings such as appeals against revision orders under section 263 has been addressed by the Mumbai Bench in Westlife Development Ltd. The Court held that jurisdictional validity of primary proceedings can be examined in collateral proceedings to test the validity of subsequent proceedings.Court's Interpretation and Reasoning: The Tribunal accepted the assessee's plea that the reopening was invalid and that such invalidity could be raised in the present appeal against the revision order under section 263.Application of Law to Facts: Since the reopening was invalid, the assessment order framed thereunder was null and void, and the revision proceedings based on such order were also without jurisdiction.Conclusion: The assessee was entitled to challenge the validity of reopening in the present collateral proceedings.3. SIGNIFICANT HOLDINGS'No re-assessment can be done to make an enquiry or verification of the deposits in the bank account.''The Assessing Officer must have facts before him that reasonably give rise to the belief that income has escaped assessment, but the facts on the basis of which he entertains the belief need not at this stage be rebuttal conclusive to support his tentative conclusion.''The words 'if the income tax officer has reason to believe' used in section 147(a) suggest that the belief must be that of an honest and reasonable person based upon reasonable grounds and that the ITO may act under this section on direct or circumstantial evidence but not on mere suspicion, gossip or rumor.''The validity of the order passed in the primary (original) proceedings should be allowed to be examined even at the subsequent stages, only for the limited purpose of examining whether the collateral (subsequent) proceedings have been initiated on a valid legal platform or not and for examining the validity of assumption of jurisdiction to initiate the collateral proceedings.''There is no bar in initiation of proceedings u/s 263 on the basis of observations by Audit Party' is not in accordance with law.'No adverse order can be passed without affording the assessee an opportunity of hearing.'Final determinations:The notice issued under section 148 and the assessment order framed under sections 147/143(3) were held to be without jurisdiction and invalid.The revision proceedings under section 263 initiated on the basis of audit objections were held to be without jurisdiction and not in accordance with law.The disallowance of interest deduction proposed in revision proceedings without opportunity was held to be invalid.The assessee is entitled to challenge the validity of reopening in collateral proceedings arising from revision under section 263.The impugned revision order under section 263 was set aside and the appeal of the assessee was allowed.