2025 (10) TMI 1238 - HC - Income Tax

Assessment set aside for ignoring supplier's Section 133(6) reply, relying on unverified AI-based decisions, and failing to issue show-cause notice

The HC held the assessment flawed: the AO ignored a supplier's timely Section 133(6) reply and supporting documents, relied on non-existent judicial ... Disallowance of purchases - said party did not reply to the Notice under Section 133(6) - HELD THAT:- On the first addition, it is apparent that the addition was made without considering the reply to the Notice u/s 133(6) - Petitioner has annexed the copy of the Notice issued to the supplier of the Petitioner under Section 133(6), wherein he was asked to furnish various details by 5th March 2025. The said supplier had duly filed his reply on 8th March 2025. In this reply, not only did the supplier confirm the transaction but also provided various documents in support thereof like invoices, e-way bills, transport receipt, GST returns etc. The reply with the supporting documents itself ran into 100 pages. Further, such reply was filed much before the impugned order was passed. Thus, it is apparent that such a crucial piece of evidence, though available, was not considered by Respondent No. 1 and in fact, it was stated in the Assessment Order that no such reply has been filed. Now, in the Reply Affidavit, an apology is tendered for not considering the reply filed by the supplier. Addition of peak balances in respect of loans from directors, it can be be seen that while calculating peak balance, Respondent No. 1 has considered the opening balance, and for which purpose, he has relied upon three decisions. The judicial decisions relied upon are completely non-existent. In other words, there are no such decisions at all which are sought to be relied upon by Respondent No. 1. It is for Respondent No. 1 to show from where such decisions were fetched. In this era of Artificial Intelligence (‘AI’), one tends to place much reliance on the results thrown open by the system. However, when one is exercising quasi judicial functions, it goes without saying that such results [which are thrown open by AI] are not to be blindly relied upon, but the same should be duly cross verified before using them. Otherwise mistakes like the present one creep in. It is also one of the grievances of the Petitioner that they are clueless as to how the figures are arrived at as no basis or working was ever shown to the Petitioner, nor was any Show Cause Notice issued before making the addition of peak balance. Even this grievance of the Petitioner is justified. Thus, in the peculiar facts of the present case, the Petitioner should not be relegated to avail the alternate remedy. We find that this a fit case to interfere under Article 226 of the Constitution of India. We remand the matter back to the file of the Assessing Officer. He shall issue a fresh Show Cause Notice to the Petitioner bringing out clearly the proposed addition and disallowance, grant reasonable opportunity of being heard to the Petitioner including sufficient time to file a reply to the notice. Before passing the Assessment Order, a personal hearing shall be granted to the Petitioner. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessment Order under Sections 143(3) read with 144B and the consequential Notice of Demand under Section 156 and penalty show-cause under Sections 274 read with 271AAC are vitiated for breach of principles of natural justice by failing to consider the supplier's reply to a Section 133(6) notice and by recording incorrect factual findings. 2. Whether the addition of peak balances of unsecured loans from directors (including consideration of opening balances) under Section 68 without providing basis/working or issuing a show-cause notice is procedurally and legally unsustainable, particularly where the Assessing Officer relies upon non-existent judicial decisions. 3. Whether the Writ Court should exercise jurisdiction under Article 226 despite the existence of an alternative remedy by way of appeal, given the alleged procedural infirmities. 4. What remedial directions are appropriate where assessments are set aside for breach of natural justice and procedural infirmities without adjudication on merits. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Breach of natural justice: failure to consider supplier's reply to Section 133(6) notice and incorrect factual findings Legal framework: Principles of natural justice require an Assessing Officer to consider material evidence and to afford an opportunity to be heard before making adverse additions; Section 133(6) provides for obtaining information from third parties which, if received, must be considered in assessment proceedings. Precedent Treatment: The Court referenced established requirements that assessment orders be based on material on record and that failure to consider relevant replies from third parties constitutes procedural infirmity warranting interference. No precedent was overruled; existing supervisory jurisdiction under Article 226 was applied. Interpretation and reasoning: The Court found that a voluminous reply (including invoices, e-way bills, transport receipts and GST returns) was filed by the supplier before the impugned order. The Assessment Order incorrectly recorded that no reply was filed. The omission to consider this materially exculpatory evidence amounted to gross violation of principles of natural justice and defective fact-finding. An admission in the departmental reply that the supplier's response was not considered reinforced the procedural lapse. Ratio vs. Obiter: Ratio - an assessment passed without considering a supplier's timely and relevant reply to a Section 133(6) notice is vitiated by breach of natural justice and liable to be set aside. Obiter - factual notes regarding the content of the supplier's reply (length and documents) serve to illustrate prejudice but are not novel legal propositions. Conclusions: The Court concluded that the addition disallowing purchases of Rs. 2,15,89,932/- was made in breach of natural justice and was therefore unsustainable. Issue 2 - Addition of peak balances of directors' loans: failure to provide basis, absence of show-cause notice, and reliance on non-existent decisions Legal framework: Additions under Section 68 (or relevant provisions addressing unexplained cash/loans) require the Assessing Officer to disclose the basis of computation, to issue show-cause notice where a significant addition is proposed, and to rely on authentic legal precedent when citing authority. Precedent Treatment: The Court noted that several High Courts have held that opening balances cannot be mechanically added under Section 68; the Assessing Officer's reliance on three decisions was found to be misplaced because those decisions did not exist. The Court emphasized that judicial precedents must be verifiable and cannot be treated as authoritative if non-existent. Interpretation and reasoning: The Assessing Officer calculated a peak balance by including opening balances and cited three judgments that could not be traced. No basis or working for the calculation was provided to the assessee, and no show-cause notice was issued to explain the computation or invite response. The Court criticized reliance on potentially AI-sourced, unverified results when exercising quasi-judicial functions, observing that such material must be cross-verified before use. The absence of disclosure and opportunity to be heard rendered the addition procedurally unfair. Ratio vs. Obiter: Ratio - an addition based on peak balances that incorporates opening balances, without showing working, without issuing a show-cause notice, and supported by unverifiable or non-existent judicial authorities, is procedurally infirm and can be set aside. Obiter - cautionary remarks about the use of AI-retrieved authorities are advisory but underscore the requirement of verification in quasi-judicial decision-making. Conclusions: The Court held the addition of Rs. 22,66,06,740/- as peak loans (with opening balances included) to be procedurally unsustainable and vitiated by failure to provide basis, denial of opportunity of hearing, and reliance on non-existent precedents. Issue 3 - Appropriateness of writ jurisdiction despite alternate remedy Legal framework: Writ jurisdiction under Article 226 is discretionary; ordinarily, availability of an efficacious alternate remedy (such as appeal) militates against interference, but interference is justified where there is a fundamental breach of natural justice or where irreparable prejudice would result. Precedent Treatment: The Court applied established principles permitting writ relief where procedural injustice is patent and cannot be remedied adequately by appellate processes, especially where records show admitted failure to consider material evidence. Interpretation and reasoning: Given the admitted non-consideration of the supplier's reply and the procedural defects in the computation of peak balances (including failure to show workings and citation of non-existent authorities), the Court found that relegation to appeal would be futile or inadequate to cure the breach. The Court characterized the facts as 'peculiar' warranting interference in exercise of writ jurisdiction. Ratio vs. Obiter: Ratio - where there is a clear breach of natural justice and glaring procedural infirmity admitted on record, the Writ Court may exercise jurisdiction notwithstanding the existence of an alternate remedy. Obiter - observations on the practical inefficacy of appellate remedies in such factual settings. Conclusions: The Court refused to remit the petitioner to the appellate forum and entertained the writ petition, quashing the impugned orders for procedural violations. Issue 4 - Appropriate remedy and directions upon quashing assessment orders for procedural defects Legal framework: Where an assessment is quashed for procedural infirmity without adjudication on merits, the appropriate remedy is remand to the Assessing Officer with directions to afford opportunity of hearing, to issue fresh show-cause, to provide reasons and working, and to pass a speaking order within a fixed time-frame. Precedent Treatment: The Court followed supervisory remedial principles of issuing directions to cure procedural defects while preserving parties' substantive rights on merits. Interpretation and reasoning: The Court set aside the assessment order, notice of demand and penalty show-cause, and remanded the matter with detailed directions: issue fresh show-cause clearly stating proposed additions and disallowances; grant reasonable time to file replies; provide personal hearing before finalizing assessment; give at least seven days' notice if relying on judicial decisions; ensure the assessment is a speaking order addressing all submissions; and complete reassessment by a specified date. The Court expressly refrained from expressing any opinion on merits, keeping all rights open. Ratio vs. Obiter: Ratio - where procedural vitiation is established, quashing with remand coupled with specific procedural directions is the proper remedy; merits remain open. Obiter - the specific timelines and notice-periods are pragmatic directions tailored to this matter but illustrative for similar cases. Conclusions: The Court quashed the impugned orders and directed fresh proceedings conforming to natural justice and reasoned decision-making, preserving substantive contestation on merits for the Assessing Officer to decide within the prescribed directions.