Income Tax Return Scrutiny Invalidated: Administrative Approval Breach Renders Assessment Proceedings Null and Void Under CBDT Instruction 5/2017

The HC examined the validity of an income tax return scrutiny for AY 2016-17. The court found the selection invalid due to lack of prior administrative approval as mandated by CBDT Instruction No. 5/2017. Despite Revenue's arguments, the HC upheld the ITAT's decision, ruling that procedural non-compliance renders the assessment proceedings unsustainable. The assessment order was set aside, emphasizing strict adherence to prescribed scrutiny selection guidelines.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Court are:

(a) Whether the selection of the Assessee's income tax return for scrutiny for Assessment Year 2016-17 was valid in the absence of prior approval from the jurisdictional Principal Commissioner of Income Tax (PCIT) or Principal Director of Income Tax (PDIT) as mandated by the Central Board of Direct Taxes (CBDT) Instruction No. 5/2017;

(b) Whether the return could be legitimately selected for scrutiny as a "search and seizure" case under paragraph 1(iii) of Instruction No. 5/2017, despite no search warrant or authorization under Section 132 of the Income Tax Act being issued in the Assessee's case;

(c) Whether the return could be selected for scrutiny under paragraph 1(vi) of Instruction No. 5/2017, which permits selection based on specific and verifiable information of tax evasion from any Government Department or Authority, subject to prior administrative approval;

(d) Whether the assessment proceedings framed under Section 143(3) of the Income Tax Act for AY 2016-17 are sustainable where the procedural requirements of the CBDT instructions have not been complied with.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a): Validity of Selection of Return for Scrutiny Without Prior Approval

The relevant legal framework is Instruction No. 5/2017 issued by the CBDT, which lays down the procedure for compulsory manual selection of returns for scrutiny during the financial year 2017-18. Paragraph 1(vi) of the Instruction mandates that cases selected on the basis of specific and verifiable information pointing to tax evasion require prior administrative approval from the concerned jurisdictional PCIT/PDIT/CIT/DIT before selection.

The Court noted that the Assessee's return was selected for scrutiny on the basis of paragraph 1(vi) as per the DCIT's notice dated 29.09.2017, which stated the presence of verifiable information pointing towards tax evasion. However, it was undisputed that no such prior approval from the jurisdictional PCIT/PDIT was obtained before initiating scrutiny proceedings.

The Court emphasized the mandatory nature of this procedural requirement and held that failure to comply with it vitiates the selection process. The Court did not delve into whether the DCIT indeed possessed verifiable information but underscored that the procedural safeguard of prior approval is a prerequisite for valid scrutiny selection under paragraph 1(vi).

Issue (b): Applicability of Paragraph 1(iii) of Instruction No. 5/2017 Regarding Search and Seizure Cases

Paragraph 1(iii) of Instruction No. 5/2017 provides for compulsory scrutiny of assessments in search and seizure cases under Sections 158B, 158BC, 158BD, 153A, and 153C read with Section 143(3). It also includes returns filed for the assessment year relevant to the previous year in which authorization for search or seizure was executed under Section 132 or 132A of the Act.

The Revenue contended that the Assessee's return was selected under this clause since a search was conducted in the Airwill Group of cases, which included the Assessee's premises.

The Court examined the facts and found no authorization or warrant for search under Section 132 issued specifically in the Assessee's case. Further, no incriminating material belonging to or related to the Assessee was found during the search conducted in the Airwill Group. Consequently, no notice under Sections 153A or 153C was issued to the Assessee.

Given these facts, the Court held that paragraph 1(iii) applies only where a search has been conducted in the Assessee's case or where assessments are to be framed based on incriminating material found during such search in the case of a person other than the searched person. Since neither condition was satisfied, paragraph 1(iii) was inapplicable.

Issue (c): Selection Under Paragraph 1(vi) and Requirement of Prior Approval

The Court reiterated that paragraph 1(vi) permits selection of cases for scrutiny based on specific and verifiable information of tax evasion provided by any Government Department or Authority. However, such selection is conditional upon prior administrative approval from the jurisdictional PCIT/PDIT/CIT/DIT.

The DCIT's notice dated 29.09.2017 indicated that the Assessee's return was selected under this clause. The Court noted the absence of any approval from the concerned authority, which is a mandatory procedural step.

The Court observed that while it was not necessary to determine whether the DCIT indeed had such verifiable information, the lack of prior approval rendered the selection invalid.

Issue (d): Validity of Assessment Proceedings Under Section 143(3) in Absence of Compliance with CBDT Instructions

The assessment order dated 06.12.2018 was passed under Section 143(3) of the Income Tax Act following scrutiny of the return. The ITAT had set aside the assessment on the ground that the return was selected for scrutiny without the mandatory prior approval required under CBDT Instruction No. 5/2017.

The Court upheld the ITAT's decision, holding that the failure to obtain prior approval in terms of paragraph 1(vi) rendered the assessment proceedings invalid. The Court found no infirmity in the ITAT's order setting aside the assessment.

Treatment of Competing Arguments

The Revenue argued that the return was selected under paragraph 1(iii) due to the search in the Airwill Group cases, thus exempting it from the prior approval requirement. The Court rejected this argument based on the absence of a search warrant or incriminating material linked to the Assessee and the non-issuance of notices under Sections 153A or 153C.

The Assessee contended that no search was conducted in their case and no incriminating material was found, which the Court accepted. The Assessee also emphasized the lack of prior approval for scrutiny, which the Court found decisive.

3. SIGNIFICANT HOLDINGS

The Court held:

"It is apparent from the plain language of Clause (iii) of paragraph 1 of the Instruction No. 5/2017 that it is applicable only in cases where the search has been conducted in the case of an assessee or where assessments are required to be framed based on any incriminating material found during the said search in case of an assessee being a person other than the searched person. In the present case, none of the said conditions are satisfied."

"If the DCIT had any such information [specific and verifiable information pointing to tax evasion], it could select the Assessee's return for scrutiny subject to the necessary approval of the concerned jurisdictional Pr. CIT/Pr.DIT/CIT/DIT. Admittedly, in the present case no such approval was taken."

Core principles established include:

(i) Selection of returns for scrutiny under CBDT Instruction No. 5/2017 must strictly comply with the procedural safeguards prescribed therein, including obtaining prior administrative approval where mandated;

(ii) The criteria for selection under paragraph 1(iii) (search and seizure cases) are strictly applicable only where a search has been conducted in the Assessee's case or incriminating material linked to the Assessee has been found;

(iii) Non-compliance with mandatory procedural requirements, such as prior approval for scrutiny under paragraph 1(vi), vitiates the assessment proceedings framed under Section 143(3) of the Income Tax Act;

(iv) The absence of a search warrant or incriminating material, and the consequent inapplicability of search-related provisions, cannot be circumvented by invoking search case provisions for selection of returns.

Final determinations:

The Court dismissed the Revenue's appeal and upheld the ITAT's order setting aside the assessment for AY 2016-17 on the ground of invalid selection of the Assessee's return for scrutiny without the requisite prior approval from the jurisdictional PCIT/PDIT, as required under CBDT Instruction No. 5/2017.

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