Section 154 rectification orders invalid without mandatory notice to assessee violates natural justice principles

ITAT Chennai held that rectification orders under section 154 of the Income Tax Act for assessment years 2016-17, 2017-18, and 2018-19 were invalid due to non-issuance of mandatory notice to the assessee. The tribunal found violation of statutory procedure prescribed under section 154(3), emphasizing that when rectification enhances assessment or reduces refund, prior notice and hearing are mandatory. The department's contention that failure to issue notice caused no prejudice was rejected, as statutory compliance cannot be waived arbitrarily. The tribunal set aside the rectification orders, citing violation of natural justice principles and Article 14 of the Constitution.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Appellate Tribunal (AT) in these appeals for Assessment Years (AY) 2016-17 to 2018-19 are:

• Whether the Assessing Officer (AO) had jurisdiction to pass rectification orders under section 154 read with section 143(3) of the Income-tax Act, 1961 ("the Act") without complying with the statutory procedure, specifically without issuing a notice and providing a reasonable opportunity of being heard to the assessee as mandated under section 154(3) of the Act.
• Whether the failure to issue such notice and opportunity of hearing violates principles of natural justice and renders the rectification orders liable to be quashed.
• Whether the contention of the department that no prejudice was caused to the assessee by non-issuance of notice can be sustained.
• Whether the provisions of section 155(4) of the Act, relating to reduction of loss, apply to the facts of the instant cases and can justify the AO's action without issuing notice.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Jurisdiction of AO to pass rectification orders without notice and opportunity of hearing under section 154(3)

Relevant legal framework and precedents: Section 154 of the Act empowers the AO to rectify any mistake apparent from the record within four years from the end of the financial year in which the order sought to be amended was passed. Subsection (3) of section 154 explicitly mandates that where the amendment has the effect of enhancing assessment, reducing refund, or increasing the liability of the assessee, the AO must give notice to the assessee of his intention and allow a reasonable opportunity of being heard before passing such an order.

The Hon'ble Supreme Court in NTPC Ltd. v. CIT (1998) 229 ITR 383 (SC) has held that the question of jurisdiction can be raised at any stage and must be adjudicated to render substantial justice. The principle of natural justice is incorporated in section 154(3), making issuance of notice and hearing mandatory in cases of enhancement or increase of liability.

Court's interpretation and reasoning: The Tribunal examined the records and the remand report submitted by the AO regarding issuance of notices under section 154(3) for the three assessment years. It was found that for AY 2016-17 and 2017-18, no notice could be traced in the physical record or ITBA system. For AY 2018-19, though a notice dated 09.11.2022 was issued, it was delivered by email only on 25.11.2022, three days after the rectification order dated 22.11.2022 was passed.

The Tribunal held that this constitutes a clear failure to comply with the statutory procedure under section 154(3). The AO's action of passing rectification orders enhancing assessment or increasing liability without prior notice and opportunity to be heard was without jurisdiction and therefore liable to be quashed.

Key evidence and findings: The remand report from the AO's office confirming absence or delayed delivery of notices; the dates of rectification orders; and the statutory provisions of section 154(3).

Application of law to facts: The Tribunal applied the plain language of section 154(3) and the principle of natural justice to find that the AO's failure to issue notice before enhancement of assessment was illegal.

Treatment of competing arguments: The department argued that no prejudice was caused to the assessee by non-issuance of notice and that the rectification related to reduction of loss under section 155(4), which does not require notice. The Tribunal rejected these contentions, holding that statutory procedure cannot be bypassed on the ground of no prejudice and that section 155(4) was not applicable to the facts.

Conclusions: The rectification orders passed without notice and opportunity of hearing are invalid and must be set aside.

Issue 2: Applicability of section 155(4) and prejudice argument

Relevant legal framework: Section 155(4) of the Act deals with adjustments in case of loss claimed in one year becoming apparent mistake due to assessment in another year.

Court's interpretation and reasoning: The Tribunal was not convinced that section 155(4) applied to the facts of the present cases, as the AO failed to demonstrate how the reduction of loss claimed was a matter falling within the ambit of section 155(4). The department's contention that no prejudice was caused was held untenable because the statute mandates notice and hearing as a matter of law, and non-compliance cannot be excused.

Key evidence and findings: The remand report and submissions by the department did not establish applicability of section 155(4) or absence of prejudice.

Application of law to facts: The Tribunal reaffirmed that procedural fairness is a fundamental principle embedded in the statute and the Constitution (Article 14), and the AO cannot act arbitrarily.

Treatment of competing arguments: The department's arguments were rejected as contrary to settled law and statutory mandate.

Conclusions: Section 155(4) does not justify the AO's action without notice; prejudice argument is not sustainable.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"No amendment, which has the effect of enhancing an assessment or reducing a refund or otherwise increasing the liability of the assessee shall be made under this section unless the authority concerned has given notice to the assessee of its intention so to do and has allowed the assessee a reasonable opportunity of being heard." (Section 154(3) of the Act)

"There has been a failure of sending notice to the assessee u/s. 154(3) of the Act for AY 2016-17 & 2017-18; and for AY 2018-19 even though notice was sent, it was delivered in the e-mail account of the assessee after three (3) days of passing of the rectification order. Thus, there is per-se violation of statutory procedure prescribed by section 154."

"Principles of audi alteram partem lie at the very heart of procedural fairness. No one can be condemned without being given an opportunity to present one's case. Question about prejudice caused due to non-observance of this principle couldn't be raised when such principle is incorporated in statutory proceedings."

"The action of the AO omitting to issue statutory notice u/s. 154(3) of the Act for AY 2016-17 & AY 2017-18 as well as failure to dispatch/deliver the notice for AY 2018-19 before passing the rectification order cannot be countenanced."

Core principles established include the mandatory nature of notice and hearing before enhancement of assessment under section 154(3), the incorporation of natural justice principles in statutory tax proceedings, and the invalidity of rectification orders passed without compliance.

Final determinations were that the impugned rectification orders for AY 2016-17, 2017-18, and 2018-19 were set aside for failure to comply with section 154(3). Other grounds raised by the assessee were not adjudicated as they became academic.

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