AO exceeded jurisdiction by expanding limited scrutiny scope without mandatory procedures under section 143(2) and violated section 144C

The ITAT Bangalore held that the AO exceeded jurisdiction by expanding the scope of 'limited scrutiny' without following mandatory procedures. The AO improperly inquired into capital loss issues not identified for limited examination under section 143(2), disallowing capital loss and determining business loss without prior approval from PCIT/CIT. Additionally, the AO violated section 144C by passing final assessment order under section 147 without issuing mandatory draft assessment order to the non-resident assessee, constituting incurable illegality. The assessment order was declared null and void for lack of jurisdiction. Appeal allowed.

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Issues Presented and Considered

1. Whether the Assessing Officer (AO) exceeded jurisdiction by expanding the scope of a 'limited scrutiny' assessment without following mandatory procedures prescribed by the Central Board of Direct Taxes (CBDT), thereby rendering the assessment order void.

2. Whether the purchase and sale of shares of Bharat Electronics Limited (BEL) by the assessee constitute an 'adventure in the nature of trade' or are to be treated as capital asset transactions.

3. Whether the bonus shares allotted by BEL should be classified as stock-in-trade or capital asset, especially when original shares are recharacterized as stock-in-trade.

4. Whether the reassessment proceedings under section 147 read with section 144B of the Income Tax Act, 1961 (the Act) were valid, particularly regarding jurisdiction, issuance of notices, and procedural compliance.

5. Whether the AO had jurisdiction to initiate reassessment proceedings given the assessee's residential status and administrative control.

6. Whether the reassessment proceedings should have been conducted under the new reassessment regime introduced by the Finance Act, 2021, effective from 01.04.2021.

7. Whether the faceless assessment procedure under section 144B was applicable to the assessee.

8. Whether the long-term capital gains (LTCG) arising from the sale of bonus BEL shares are exempt under section 10(38) or taxable as business income.

9. Whether interest under sections 234A, 234B, and 234C is leviable on the assessee.

10. Whether the AO's failure to issue a draft assessment order (DAO) under section 144C(1) before passing the final assessment order under section 147 renders the assessment void ab initio.

Issue-wise Detailed Analysis

1. Jurisdiction and Scope of Limited Scrutiny (AY 2016-17)

Legal Framework and Precedents: The CBDT's instructions and orders, including Instruction No. 20/2015 dated 29.12.2015, Instruction No. 5/2016 dated 14.7.2016, and Order No. F.No.225/402/2018/ITA.II dated 28.11.2018, govern the procedure and scope of limited scrutiny cases selected under the Computer Aided Scrutiny Selection (CASS) system. These mandate that the AO must confine the scrutiny to the issues specified in the notice under section 143(2) and may expand the scope only with prior written approval of the Principal Commissioner of Income Tax (PCIT) or Commissioner of Income Tax (CIT).

Court's Interpretation and Reasoning: The Tribunal noted that the case was selected for limited scrutiny on two specific issues: (i) justification of refund claim, and (ii) disclosure of investment and income relating to foreign bank accounts. However, the AO expanded the scrutiny to examine the purchase and sale of BEL shares, which was not part of the limited scrutiny scope and did so without obtaining the mandatory approval from PCIT/CIT. The Tribunal observed that the AO's action amounted to an unauthorized expansion of scope and was contrary to CBDT's binding instructions.

Key Evidence and Findings: The notices under sections 143(2) and 142(1) were examined, showing that the AO sought information beyond the limited scrutiny issues. The AO's assessment order disallowed capital loss claimed on sale of BEL shares based on a presumption of artificial arrangements, which was beyond the limited scrutiny scope.

Application of Law to Facts: The Tribunal held that AO's expansion of scrutiny without following prescribed procedure was a jurisdictional error. The limited scrutiny process is designed to be confined to specific issues, and expanding it without approval violates the statutory mandate and CBDT instructions.

Treatment of Competing Arguments: The Revenue argued that since the refund arose from the entire computation of income, AO could verify all heads of income. The Tribunal rejected this, stating that such an argument would defeat the purpose of limited scrutiny.

Conclusion: The Tribunal set aside the AO's order for lack of jurisdiction and held that the disallowance of capital loss and determination of business loss were without jurisdiction and bad in law. Consequently, the additional grounds raised by the assessee were allowed, and the merits of other grounds were kept open.

2. Classification of BEL Shares and Bonus Shares (AY 2016-17)

This issue was not adjudicated by the Tribunal due to the acceptance of the jurisdictional ground in favor of the assessee. The merits were kept open for adjudication in further proceedings.

3. Validity of Reassessment Proceedings (AY 2017-18)

Legal Framework and Precedents: Sections 147, 148, and 144B of the Act govern reassessment proceedings and faceless assessments. Section 144C mandates issuance of draft assessment orders (DAO) to eligible assessees before final assessment orders. The Finance Act, 2021 introduced a new reassessment regime effective 01.04.2021, which applies to proceedings initiated thereafter unless a saving clause exists.

Precedents include judgments of the Hon'ble High Courts of Gujarat, Bombay at Goa, Andhra Pradesh, and the Supreme Court, emphasizing the mandatory nature of section 144C procedures and invalidity of assessments without compliance.

Court's Interpretation and Reasoning: The Tribunal found that the AO passed the final assessment order under section 147 without issuing a DAO under section 144C(1), violating a mandatory procedural safeguard. The assessee was a non-resident individual, thus an "eligible assessee" under section 144C(15)(b)(ii), and entitled to the protections therein.

The Tribunal held that failure to issue a DAO is not a mere procedural irregularity but a jurisdictional defect rendering the assessment order void ab initio. The Tribunal relied on binding precedents which held that such non-compliance cannot be cured by subsequent actions or corrigenda.

Regarding jurisdiction, the Tribunal noted that the AO who issued the reassessment notice was not the administrative authority for the non-resident assessee, whose jurisdiction lies with the Director General of Income-tax (International Tax). The AO's assumption of jurisdiction was therefore incorrect.

On the issue of reassessment regime, the Tribunal observed that the reassessment notice was issued on 31.03.2021, just before the new regime came into effect on 01.04.2021. However, no saving clause was applicable, and hence reassessment should have been completed under the new regime. The AO's failure to do so was an error.

Regarding faceless assessment, the Tribunal found that the assessee did not belong to the notified class for faceless assessments; thus, the faceless procedure applied incorrectly.

Key Evidence and Findings: The assessment order dated 29.03.2022 was passed without issuing a DAO. Notices and objections filed by the assessee were on record. The reassessment proceedings were initiated without jurisdiction and procedural compliance.

Application of Law to Facts: The Tribunal applied the statutory provisions and precedents mandating compliance with section 144C and proper jurisdictional exercise. The AO's failure to issue a DAO and incorrect jurisdictional assumption invalidated the reassessment.

Treatment of Competing Arguments: The Revenue argued that non-issuance of DAO was a curable procedural defect, relying on Supreme Court decisions on procedural irregularities. The Tribunal distinguished those cases, emphasizing the mandatory and substantive nature of section 144C protections and binding High Court precedents holding such non-compliance as jurisdictional.

Conclusion: The Tribunal held the reassessment order void ab initio for non-compliance with section 144C and lack of jurisdiction. The additional grounds raised by the assessee were allowed, and other merits were kept open.

4. Classification of Long-Term Capital Gains from Bonus Shares (AY 2017-18)

This issue was not adjudicated due to the acceptance of procedural and jurisdictional grounds in favor of the assessee, leaving the merits open.

5. Levy of Interest under Sections 234A, 234B, and 234C

This issue was not adjudicated for the same reason as above.

Significant Holdings

"The AO has exceeded his jurisdiction by expanding the scope of 'limited scrutiny' without obtaining prior approval from the PCIT/CIT as provided in the CBDT order. Such expansion without due procedure is bad in law and renders the assessment order void."

"The procedure laid down under section 144C of the Act is mandatory and not merely procedural. Failure to issue a draft assessment order before passing the final assessment order to an eligible assessee renders the assessment order void ab initio."

"The reassessment proceedings initiated without jurisdiction, including incorrect assumption of jurisdiction by an AO not competent to assess the non-resident assessee, are void."

"Limited scrutiny cases must be confined strictly to the issues specified in the notice under section 143(2). The AO cannot convert a limited scrutiny into a complete scrutiny without following the mandatory procedure of obtaining prior approval and informing the assessee."

"The examination of refund claims in limited scrutiny cases does not confer jurisdiction to the AO to scrutinize unrelated issues such as share transactions beyond the scope of the scrutiny notice."

"The faceless assessment procedure under section 144B applies only to notified classes of assessees; its application to non-notified assessees is erroneous."

"The burden of proof regarding jurisdiction and procedural compliance lies on the Revenue, and failure to comply with mandatory provisions vitiates the assessment."

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