2010 (2) TMI 271 - HC - Income Tax

Reassessment under s.148 set aside; AO lacked reasonable belief under Explanation 2(b) to s.147 requirement

HC held the reassessment notice issued under s.148 invalid and set it aside. The court found no basis for the AO to form the requisite belief that income ... Reopening of assessment under section 147 - Notice under section 148 - Reason to believe - Reasons recorded - Explanation 2 to section 147 - understatement in return - Payments to retiring partner not a transfer within section 2(47) - Retirement payment not taxable as business income under section 28(iv) and 28(v) - Prohibition on supplementing recorded reasons by affidavit or later materialReopening of assessment under section 147 - Notice under section 148 - Reason to believe - Reasons recorded - Prohibition on supplementing recorded reasons by affidavit or later material - Explanation 2 to section 147 - understatement in return - Validity of the notices issued under section 148/s147 having regard to the reasons recorded and the material available to the Assessing Officer - HELD THAT: - The court applied the settled principle that the legality of reopening under section 147 must be tested only by reference to the reasons recorded by the Assessing Officer at the time of forming the belief and that those reasons cannot be supplemented later by affidavit or other material. The recorded reason in the present cases was limited to the appellate order in the firm's case treating payments to retiring partners as revenue expenditure; no other contemporaneous material disclosed a reasonable foundation for the belief that income had escaped assessment. Explanation 2(b) to section 147 creates a deeming fiction where the Assessing Officer 'notices' understatement or excessive claims in a return, but such notice must be based on a reasonable foundation consistent with law and not on mere speculation or on conclusions that a prudent person could not reasonably form. Reliance on the firm's appellate order, which itself was under challenge by the Revenue, did not furnish the requisite reasonable belief. In view of Rajesh Jhaveri and related authorities, an established fact of escapement is not required at the initiation stage, but there must exist relevant material on which a reasonable person could form the requisite belief; that threshold was not met here. Consequently the notices were held to be without foundation and were quashed. [Paras 12, 17, 18, 20, 21]Notices dated January 19, 2009, January 23, 2009 and February 9, 2009 issued under section 148 were quashed for lack of reasonable belief based on the reasons recorded.Payments to retiring partner not a transfer within section 2(47) - Retirement payment not taxable as business income under section 28(iv) and 28(v) - Characterisation of amounts received by retiring partners and whether such receipts could validly support reopening as income chargeable to tax under section 28 or as a 'transfer' under section 2(47) - HELD THAT: - The court reviewed binding precedent that an amount paid to a partner on retirement, representing his share in the net partnership assets after taking accounts and deducting liabilities, is a realisation of a pre-existing interest and does not amount to a 'transfer' within section 2(47). The Supreme Court and earlier High Court authorities were held to establish that a retiring partner receives his share in the partnership-not consideration for transfer of an interest in specific partnership assets. Consequently, there was no basis to treat the retirement payment as a transfer attracting capital gains treatment. Further, clause (iv) of section 28 relates to benefits or perquisites (not cash payments) and clause (v) pertains to remuneration/interest/bonus by whatever name called; a payment in realisation of a partner's share in net assets on retirement does not fall within clause (v). Given these legal principles, the Assessing Officer's reliance on section 28(iv) and (v) to support reopening was misplaced and could not provide a reasonable foundation for belief that income chargeable to tax had escaped assessment. [Paras 13, 14, 15, 16, 19]Amounts paid to the retiring partners were not transfers under section 2(47) and did not fall within section 28(iv) or 28(v); therefore those provisions could not validly underpin the belief required for reopening.Final Conclusion: The High Court set aside and quashed the reassessment notices issued under section 148 for assessment years 2005-06 and 2006-07 because the reasons recorded did not furnish a reasonable foundation for a belief that income chargeable to tax had escaped assessment; the recorded material could not be supplemented, and, on the legal position regarding retirement payments, there was no basis to treat the amounts as taxable either as transfer or as business income. Issues Involved:1. Validity of reassessment notices issued under Section 148 of the Income-tax Act, 1961.2. Whether the amounts received by the petitioners on retirement from the partnership firm are chargeable to tax.Issue-wise Detailed Analysis:1. Validity of Reassessment Notices Issued Under Section 148:The principal challenge in these proceedings is to the notices issued by the first respondent under section 148 of the Income-tax Act, 1961, proposing to assess the income of the petitioner for the assessment years 2005-06 and 2006-07 on the ground that there is reason to believe that income chargeable to tax had escaped assessment within the meaning of section 147. The petitioners argued that the validity of reassessment has to be determined on the basis of reasons recorded. The reasons recorded only refer to the fact that the payment made by the partnership firm to the retiring partners has been treated as revenue expenditure. From this, it does not follow that the amount becomes a revenue receipt in the hands of the assessee.The court emphasized that the reasons recorded by the Assessing Officer for reopening an assessment are the only reasons that can be considered when the formation of the belief is impugned. The recording of reasons is a check against arbitrary exercise of power. The reasons recorded must be clear and unambiguous and should not suffer from any vagueness. The reasons recorded must disclose the mind of the Assessing Officer and should be self-explanatory. The court cited previous judgments to support this principle, such as N. D. Bhatt, IAC of I.T. v. I. B. M. World Trade Corporation and Hindustan Lever Ltd. v. R. B. Wadkar, Asst. CIT (No. 1).The court found that the only reason recorded by the Assessing Officer was that the Commissioner of Income-tax (Appeals) had allowed a claim for treating the payment to the retiring partners as revenue expenditure. The court held that this could not reasonably lead to the belief that the receipts had escaped assessment within the meaning of section 147.2. Whether the Amounts Received by the Petitioners on Retirement from the Partnership Firm are Chargeable to Tax:The petitioners argued that assuming the stand of the Department is that the amount is chargeable as capital gains, this would be contrary to the law laid down by the Supreme Court in successive decisions that an amount paid to a retiring partner in a partnership firm does not amount to a transfer within the meaning of section 2(47). The court referenced several judgments, including CIT v. Mohanbhai Pamabhai and Addl. CIT v. Mohanbhai Pamabhai, where it was held that an amount paid to a partner upon retirement, after taking accounts and upon deduction of liabilities, does not involve an element of transfer within the meaning of section 2(47).The court also noted that the reliance on clauses (iv) and (v) of section 28 to sustain the belief was misplaced. Section 28(iv) specifies the value of any benefit or perquisite arising from business or the exercise of profession, which does not apply to benefits paid in cash or money. Clause (v) refers to any interest, salary, bonus, commission, or remuneration received by a partner from the firm, which does not include payments made to a partner in realization of his share in the net value of the assets upon his retirement from a firm.The court concluded that there was no basis for the first respondent to form a belief that any income chargeable to tax had escaped assessment within the meaning of section 147. The reasons recorded could never have led a prudent person to form an opinion that income had escaped assessment within the meaning of section 147.Conclusion:The court allowed Writ Petition No. 2287 of 2009 by quashing and setting aside the notice dated January 19, 2009, and Writ Petition No. 59 of 2010 by quashing and setting aside the notices dated January 23, 2009, and February 9, 2009. The rule was made absolute with no order as to costs.