2025 (7) TMI 897 - HC - Income Tax

Karnataka HC quashes reassessment proceedings under section 148 for lack of mandatory prior approval and procedural defects

M/s. Inesh Realtors Private Limited Versus The Income Tax Officer Ward 3 (1) (4) Bengaluru.

M/s. Inesh Realtors Private Limited Versus The Income Tax Officer Ward 3 (1) (4) Bengaluru. - 2025:KHC:18733 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Court in this matter are:Whether the reassessment proceedings initiated under Section 148 of the Income Tax Act, 1961, are valid in the absence of prior approval as mandated by law.Whether the income earned by the petitioner as interest from its Holding Company should be classified as 'Income from Business' or 'Income from Other Sources.'Whether the petitioner is entitled to claim expenditure incurred on borrowing as a deductible expense, even if the interest income is treated as income from other sources.Whether the Assessing Officer properly considered the petitioner's objections and reasons before passing the reassessment orders and demand notices.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Validity of Reassessment Proceedings in the Absence of Prior ApprovalRelevant legal framework and precedents: Section 148 of the Income Tax Act, 1961, empowers the Assessing Officer to reopen assessments if there is reason to believe that income has escaped assessment. However, such reassessment proceedings require prior approval from a prescribed authority before issuance of notice, as per the procedural safeguards intended to prevent arbitrary reopening.Court's interpretation and reasoning: The Court emphasized that the petitioner was not shown any prior approval for initiating reassessment proceedings, which is a mandatory prerequisite. The absence of such approval renders the reassessment proceedings invalid. The Court held that if the prior approval is not granted by a competent authority, the entire reassessment process must fail.Key evidence and findings: The petitioner demonstrated that no copy of prior approval was furnished despite repeated requests. The Assessing Officer did not rebut this fact or produce evidence of such approval.Application of law to facts: The Court applied the statutory requirement strictly, holding that non-compliance with the mandatory procedural step vitiates the reassessment proceedings.Treatment of competing arguments: The respondent contended that the reassessment was justified on merits, but the Court found procedural non-compliance decisive irrespective of the merits.Conclusion: The reassessment notices and orders issued without prior approval are quashed, and proceedings are restored for fresh consideration after compliance.Issue 2: Classification of Interest Income as Business Income or Income from Other SourcesRelevant legal framework and precedents: Income tax law distinguishes between income derived from business operations and income from other sources, with different implications for assessment and allowable deductions. The classification depends on the nature of the transaction and the business activities of the recipient.Court's interpretation and reasoning: The Assessing Officer contended that since the Holding Company had only entered into an agreement and had not commenced any business, the interest income earned by the petitioner could not be considered business income but must be treated as income from other sources. The petitioner, however, had declared the interest income as business income by adjusting it against Work-in-Progress (WIP).Key evidence and findings: It was undisputed that the Holding Company had not commenced business operations and only had an agreement in place. The petitioner's accounting practice of treating such interest as business income was challenged by the Assessing Officer.Application of law to facts: The Court accepted the Assessing Officer's position that income from a non-operational entity cannot be classified as business income. This classification affects the treatment of related expenses.Treatment of competing arguments: The petitioner argued for the classification as business income based on its accounting practice, but the Court found the legal position and facts more aligned with income from other sources.Conclusion: The interest income earned from the Holding Company is to be treated as income from other sources, subject to further consideration of related expenses.Issue 3: Allowance of Expenditure Incurred on Borrowing Against Interest IncomeRelevant legal framework and precedents: Under the Income Tax Act, expenses incurred wholly and exclusively for the purpose of business or profession are generally allowable as deductions. The treatment of expenditure related to borrowing costs depends on the nature of income to which it relates.Court's interpretation and reasoning: The petitioner contended that even if the interest income is treated as income from other sources, it would still be entitled to claim the expenditure incurred on borrowing as a deductible expense because the borrowed funds were used to lend money to the Holding Company, and the interest earned offsets the borrowing cost.Key evidence and findings: The Assessing Officer did not consider this contention in the reassessment orders. The Court found that this aspect was not duly examined before passing the impugned orders.Application of law to facts: The Court held that the Assessing Officer must consider whether the expenditure on borrowing is allowable as a deduction even when the income is treated as income from other sources. This requires a detailed examination of the nexus between the borrowing cost and the income earned.Treatment of competing arguments: The petitioner's argument for allowance of expenditure was not addressed by the Assessing Officer, and the Court found this omission significant.Conclusion: The matter is remanded to the Assessing Officer for fresh consideration of the petitioner's claim for allowance of borrowing expenditure, irrespective of the classification of the interest income.Issue 4: Proper Consideration of Petitioner's Objections and ReasonsRelevant legal framework and precedents: The principles of natural justice and statutory mandates require that the Assessing Officer consider the objections raised by the assessee before passing reassessment orders. The reasons for reopening must be disclosed to enable effective representation.Court's interpretation and reasoning: The Court noted that the petitioner was served only with an extract of the reasons to believe and not the full reasons as recorded in the Assessment Orders. Further, the petitioner's objections were not fully considered, especially regarding prior approval and expenditure allowance.Key evidence and findings: The petitioner filed objections highlighting procedural lapses and substantive issues, which were not adequately addressed.Application of law to facts: The Court underscored the necessity for the Assessing Officer to consider all objections comprehensively and pass reasoned orders.Treatment of competing arguments: The respondent defended the reassessment on merits but did not demonstrate that objections were properly considered.