2025 (5) TMI 746 - AT - Income Tax

Assessment order set aside for violating natural justice principles despite being within limitation period under section 153

Sri Maharaja Refineries Versus The Assistant Commissioner of Income-tax, Circle-1, Erode.

ITAT Chennai held that while the assessment order was not time-barred under section 153(5) read with section 153(3), it violated principles of natural ... Validity of assessment orders passed by AO as barred by limitation u/s 153(5) - HELD THAT:-CIT(A) is right in holding that the present case falls under the second proviso of section 153(5) read with section 153(3) of the Act. Hence, the order of AO is not time barred in the light of the first proviso to section 153(3) which says, after 01.04.2019 if any order u/s 254 is received by the PCCIT or Chief Commissioner or Principal Commissioner or Commissioner or as the case may be, the provisions of this subsection shall have effect, as if for the words ‘nine months’, the words ‘twelve months’ has been substituted. We affirm the order of the ld. CIT(A) on this issue. Whether CIT (A) erred in not considering the violation of principles of natural justice, as the AO did not provide a copy of the alleged Report of the Department of Economic Affairs under the Ministry of Finance, which was the sole basis for framing the impugned assessment? - There is dispute in the instant case that material collected by the AO was never confronted to the assessee. Whatever the evidence collected by the AO which was used against the assessee was not confronted to the assessee and he was never given an opportunity to rebut. The revenue has filed the report. This principle is established by the judgment of the Supreme Court in Dhakeswari Cotton Mills Ltd [1954 (10) TMI 12 - SUPREME COURT (LB)] Thus, in the light of the principle established in Dhakeswari Cotton Mills Ltd [supra] and applied by that court in Kishinchand Chellaram [1980 (9) TMI 3 - SUPREME COURT] we also set aside the assessment order dated 23.02.2024 passed u/s 143(3) r.w.s 254 of the Act and direct the AO proceed afresh on this issue as directed by the Tribunal in first round of the proceedings, after giving proper opportunity to the assessee and supplying all reports, documents or any other materials, if any, which are adverse to the assessee. Appeal of the assessee is allowed for statistical purposes. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal in these appeals for Assessment Years 2013-14 and 2014-15 are as follows:(a) Whether the assessment orders passed by the Assessing Officer (AO) were barred by limitation under Section 153(5) of the Income-tax Act, 1961, particularly with reference to the applicability of the provisos to Section 153(5) and Section 153(3) in the context of orders passed pursuant to the ITAT's directions;(b) Whether the AO's reliance on a report of the Department of Economic Affairs under the Ministry of Finance, which was not furnished to the assessee, violated the principles of natural justice;(c) Whether the reference to the Transfer Pricing Officer (TPO) for specified domestic transactions under Section 92BA(i) was valid, and consequently, whether the transfer pricing adjustments made by the AO could be sustained;(d) Whether the disallowance under Section 40A(2)(b) of the Act was justified, considering the prices of Palm Oil adopted by the assessee and the relevant legal standards for invoking Section 40A(2);(e) Whether the AO was required to record an opinion before invoking Section 40A(2) and whether the assessee was given adequate opportunity to respond to the materials relied upon;(f) Whether the CIT(A) erred in upholding the assessment orders without properly considering the submissions of the assessee, including issues of limitation, natural justice, and evidentiary basis for disallowances.2. ISSUE-WISE DETAILED ANALYSIS(a) Limitation under Section 153(5) and Applicability of ProvisosLegal Framework and Precedents: Section 153(5) mandates that where effect is to be given to an appellate order under Sections 250, 254, 260, 262, 263, or 264, the AO must do so within three months from the end of the month in which the order is received. The first proviso allows an extension of six months for reasons beyond AO's control. The second proviso applies where the order requires verification by way of submission of documents or hearing opportunity, in which case the time limit specified in Section 153(3) applies. Section 153(3), post 01.04.2019, provides for a 12-month period for fresh assessment or reassessment following receipt of appellate orders.Court's Interpretation and Reasoning: The Tribunal examined the timeline of events, noting that the ITAT's order was dispatched on 21.02.2023, the first hearing notice was issued on 25.09.2023, and the assessment order was completed on 31.03.2024. The assessee contended that the assessment was barred by limitation as the three-month or even the extended period had expired, and that the second proviso to Section 153(5) was inapplicable as no submission of documents by the assessee was required.The AO and CIT(A) held that the matter was restored for 'examination' of allowability of expenditure under Section 40A(2), which necessitated verification and opportunity to the assessee, thus attracting the second proviso to Section 153(5) read with Section 153(3). The Tribunal analyzed the distinction between 'examination' and 'verification,' concluding that the term 'examination' used by the ITAT is of the same genus as 'verification' in the statute, justifying application of the extended timeline.The Tribunal relied on the principle that the second proviso applies when verification or hearing is required, which was the case here because the issue of disallowance under Section 40A(2) had not been examined previously and was remitted for fresh consideration.Application of Law to Facts: Since the assessment was set aside for fresh examination involving verification and opportunity to the assessee, the AO was entitled to the extended period under Section 153(3) and the second proviso to Section 153(5). The assessment order dated 31.03.2024 fell within this extended period and was not time-barred.Treatment of Competing Arguments: The assessee argued that no document submission was required and that the AO relied on material already in possession, thus the extended period was not applicable. The Tribunal rejected this, emphasizing the statutory language and the necessity of verification and hearing in the set-aside proceedings.Conclusion: The Tribunal upheld the CIT(A)'s finding that the assessment order was not barred by limitation.(b) Violation of Principles of Natural Justice - Non-supply of Department of Economic Affairs ReportLegal Framework and Precedents: It is a settled legal principle that the AO is not bound by strict rules of evidence but must inform the assessee of any material on which adverse action is proposed and provide an opportunity to explain. The Supreme Court judgments in Dhakeswari Cotton Mills Ltd. v. CIT and Kishinchand Chellaram v. CIT emphasize that assessments based on material not disclosed to the assessee violate natural justice and are liable to be set aside.Court's Interpretation and Reasoning: The AO had relied on a report of the Department of Economic Affairs to determine fair market value of palm oil but did not provide a copy to the assessee during assessment proceedings. The CIT(A) held that since the report was publicly available and the assessee did not request it, no violation occurred. The Tribunal disagreed, stating that the AO must disclose any material used against the assessee, regardless of public availability, to enable a fair opportunity to rebut.Application of Law to Facts: The AO's failure to supply the report or any material adverse to the assessee constituted a breach of natural justice. The assessee was denied an opportunity to effectively contest the basis of disallowance.Treatment of Competing Arguments: The revenue argued that the assessee did not cooperate or request the report and that it was publicly accessible. The Tribunal held that mere public availability does not absolve the AO of the duty to disclose and provide opportunity.Conclusion: The Tribunal set aside the assessment order on this ground and directed the AO to proceed afresh after furnishing all relevant materials to the assessee and affording proper opportunity to respond.(c) Validity of Reference to Transfer Pricing Officer and Consequential AdjustmentsLegal Framework and Precedents: Section 92BA(i) relating to specified domestic transactions was omitted from inception. Hence, references to TPO for such domestic transactions are invalid. The Tribunal and High Courts have held that transfer pricing adjustments based on invalid references cannot be sustained.Court's Interpretation and Reasoning: The Tribunal followed the coordinate Bench's earlier order and relevant decisions, holding that the reference to TPO for domestic transactions was invalid and consequential transfer pricing adjustments were unsustainable.Application of Law to Facts: The AO's downward adjustment on purchases from associated enterprises based on TPO's order was set aside. The matter was restored to the AO for examination under Section 40A(2) instead.Treatment of Competing Arguments: The revenue did not contest the invalidity of the reference but sought to uphold disallowances under Section 40A(2). The Tribunal accepted the restoration for fresh examination under Section 40A(2).Conclusion: The reference to the TPO was invalid; transfer pricing adjustments were not sustainable; the matter was remitted for fresh examination under Section 40A(2).(d) Justification of Disallowance under Section 40A(2)(b)Legal Framework and Precedents: Section 40A(2) permits disallowance of expenditure if the AO forms an opinion that the payment is excessive or unreasonable. The jurisdictional Madras High Court has emphasized that the AO must form an honest opinion based on well-founded reasons and tangible material. The AO's opinion must be communicated to the assessee with opportunity to rebut.Court's Interpretation and Reasoning: The Tribunal noted that the AO did not record an opinion or furnish tangible material justifying the disallowance. The assessee's prices of palm oil were aligned with the fair market value as per Ministry reports. The AO's reliance on a report not shared with the assessee further weakened the basis for disallowance.Application of Law to Facts: Since the AO failed to substantiate his opinion and denied the assessee the opportunity to contest the material, the disallowance under Section 40A(2)(b) was not justified.Treatment of Competing Arguments: Revenue contended that the ITAT's order itself held the transactions fall under Section 40A(2) and that no formal opinion recording was necessary. The Tribunal rejected this, underscoring the statutory requirement of recording opinion with reasons and providing opportunity.Conclusion: The disallowance under Section 40A(2)(b) was unwarranted in the absence of a recorded opinion and proper opportunity to the assessee.(e) Requirement of Recording AO's Opinion and Opportunity to AssesseeLegal Framework and Precedents: The AO must form an opinion based on tangible material before invoking Section 40A(2) and must communicate the basis to the assessee to enable effective response. Failure to do so violates principles of natural justice and statutory mandate.Court's Interpretation and Reasoning: The Tribunal found that the AO did not record any opinion or furnish the basis for disallowance, nor did the AO provide the assessee with the report or material relied upon. The assessee was thus deprived of the opportunity to rebut.Application of Law to Facts: The AO's failure to record opinion and provide material was contrary to law and fair procedure.Treatment of Competing Arguments: Revenue argued that the ITAT's remand sufficed and that the AO's reliance on the Department of Economic Affairs report was justified. The Tribunal rejected this, emphasizing the need for transparency and opportunity.Conclusion: The AO was required to record opinion and provide material to the assessee; failure to do so vitiated the assessment.(f) CIT(A)'s Consideration of Assessee's SubmissionsCourt's Interpretation and Reasoning: The CIT(A) upheld the AO's assessment and limitation findings but dismissed the contention of violation of natural justice on the ground that the report was publicly available. The Tribunal held this approach unjustified as it ignored settled legal principles requiring disclosure of material used against the assessee.Conclusion: The Tribunal set aside the CIT(A)'s order on the natural justice issue and remanded the matter to the AO for fresh proceedings.3. SIGNIFICANT HOLDINGS'The word 'examination' used by the Tribunal is of same generis with the word 'verification' as found mentioned in the second proviso to sub-section 153(5) of the Act.''The second proviso to section 153(5) applies where the order under section 254 requires verification of any issue by way of submission of any document by the assessee or any other person or where an opportunity of being heard is to be provided to the assessee.''The assessment order dated 31.03.2024 is not barred by limitation in light of the first proviso to section 153(3) read with the second proviso to section 153(5) of the Act.''It is a settled position of law that the Income-tax Officer is not bound by any technical rules of evidence but must inform the assessee of any material used against him and provide adequate opportunity of explanation.''The AO's failure to supply the report of the Department of Economic Affairs to the assessee, which was relied upon for disallowance, constitutes violation of principles of natural justice.''Reference to the Transfer Pricing Officer in respect of specified domestic transactions under Section 92BA(i) is invalid and consequential transfer pricing adjustments cannot be sustained.''The AO must form an honest opinion based on well-founded reasons and tangible material before invoking Section 40A(2), and must provide the assessee an opportunity to rebut.''In the absence of recording of opinion and furnishing of material to the assessee, the disallowance under Section 40A(2)(b) is unwarranted.''The assessment order dated 23.02.2024 is set aside and the AO is directed to proceed afresh after giving proper opportunity to the assessee and supplying all adverse reports or documents.'