ITAT upholds PCIT's Section 263 revision over unexamined depreciation on impaired goodwill from amalgamation, dismisses assessee objections

ITAT Pune upheld the PCIT's revisionary jurisdiction u/s 263, holding the assessment order for AY 2020-21 to be erroneous and prejudicial to the interests of Revenue due to the AO's failure to examine the assessee's claim of depreciation on goodwill arising on amalgamation. Since the goodwill had been fully impaired in the books and shown at nil, a detailed inquiry into the allowability of depreciation was mandatory, which the AO omitted. The PCIT's direction to the AO to verify the depreciation claim was affirmed, while observations relating to earlier years were held to be irrelevant for the set-aside assessment. The assessee's grounds, including on DIN validity, were dismissed.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether the assessment order allowing depreciation on goodwill, despite complete impairment of that goodwill in the books, without specific enquiry by the Assessing Officer, was "erroneous in so far as it is prejudicial to the interests of the revenue" within the meaning of section 263.

1.2 Whether the Principal Commissioner, while exercising revisionary jurisdiction under section 263 for the year under consideration, could rely on facts relating to the amalgamation and creation of goodwill in an earlier year, and whether such reference vitiated the revision order.

1.3 Whether the absence of a Document Identification Number (DIN) on one of the show cause notices rendered the revision proceedings and the order under section 263 invalid.

1.4 Whether, in the course of section 263 proceedings for the relevant year, the Principal Commissioner could conclusively determine the actual cost/WDV of goodwill as nil and hold that no depreciation was allowable from earlier years, instead of confining himself to the limited issue of lack of enquiry by the Assessing Officer for the year under consideration.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of revision under section 263 on account of non-enquiry into depreciation on impaired goodwill

Legal framework

2.1 The Tribunal reproduced and analysed section 263(1) and its Explanations, and referred to the four stages of the Commissioner's powers: (i) calling for and examining records; (ii) forming an opinion that the order is erroneous and prejudicial; (iii) issuing show cause and conducting enquiry; and (iv) passing an appropriate order.

2.2 The Tribunal relied on the ratio of the Supreme Court in "Malabar Industrial Co. Ltd. vs. CIT" that section 263 can be invoked when an order is both erroneous and prejudicial to the interests of the revenue, including where there is incorrect assumption of facts or law, lack of application of mind, or failure to conduct enquiry.

Interpretation and reasoning

2.3 The Principal Commissioner found that:

(a) Goodwill had been created in F.Y. 2015-16 on amalgamation and depreciation thereon had been allowed from A.Y. 2016-17 onwards.

(b) For the year under consideration, the opening goodwill of Rs. 18,89,24,584 in the audited books was fully impaired and written down to nil, yet depreciation of Rs. 1,86,95,184 was claimed in the computation under the block-of-assets concept, and was allowed by the Assessing Officer.

2.4 The Tribunal noted that:

(a) The audited financial statements and tax audit report were before the Assessing Officer.

(b) The fixed asset schedule in the audited balance sheet clearly showed full impairment of goodwill and a nil closing balance.

(c) Notwithstanding this, depreciation on goodwill was claimed in the return under the Income-tax Act.

2.5 The Tribunal held that, in these circumstances, the Assessing Officer was required to notice the impairment and enquire how depreciation could be claimed on an asset whose book value had been written down to nil. No such enquiry was made and the assessee's counsel admitted that no query was raised on this specific issue.

2.6 The Tribunal rejected the contention that mere availability of the tax audit report and audited accounts justified allowance of the claim without enquiry. It held that non-examination of an evident issue arising from the records amounted to lack of application of mind and rendered the assessment order erroneous and prejudicial to the interests of the revenue, within the scope of section 263 and the principles in "Malabar Industrial Co. Ltd.".

Conclusions

2.7 The assessment order was held to be erroneous and prejudicial to the interests of the revenue, but only to the limited extent of the Assessing Officer's failure to examine the allowability of depreciation of Rs. 1,86,95,184 on goodwill that had been fully impaired in the books. The direction of the Principal Commissioner to the Assessing Officer to verify and examine this claim was upheld.

Issue 2: Use of amalgamation-related facts and earlier-year goodwill aspects in section 263 for the year under consideration

Legal framework

2.8 Section 263(1) and Explanation 1(b) were considered, particularly that "record" includes all records relating to any proceeding under the Act available at the time of examination by the Commissioner.

Interpretation and reasoning

2.9 The Principal Commissioner, while examining the depreciation on goodwill, entered into an extensive discussion of:

(a) The amalgamation in F.Y. 2015-16;

(b) The method of computation of goodwill as excess consideration over net assets;

(c) Applicability of section 32(1), including the 6th proviso, and section 43(1), including Explanation 3;

(d) Whether any actual cost was incurred by the amalgamated or amalgamating company;

(e) The proposition that the cost/WDV of goodwill in the hands of the assessee should be treated as nil and that no depreciation should have been allowed from A.Y. 2016-17 onwards.

2.10 The assessee argued, by additional ground and main grounds, that:

(a) The Principal Commissioner had proceeded on the premise that goodwill was generated in the course of amalgamation, which facts allegedly were not part of the assessment record for A.Y. 2020-21; and

(b) The Principal Commissioner could not, in a revision for A.Y. 2020-21, refer to such earlier-year facts or question the origination and cost of goodwill determined in those earlier assessments.

2.11 The Tribunal observed that:

(a) The revisionary proceedings were confined to A.Y. 2020-21.

(b) The written down value of goodwill as on 01.04.2019 was a brought-forward figure from earlier years, already embedded in completed assessments for those years.

(c) For A.Y. 2020-21, the Assessing Officer had no occasion to re-determine the correctness of the original creation or cost of goodwill in A.Y. 2016-17; similarly, in section 263 for A.Y. 2020-21, the Principal Commissioner could not conclusively alter that cost or WDV.

2.12 The Tribunal held that the extensive observations of the Principal Commissioner regarding the computation of goodwill at nil, the legitimacy of its creation, and the correctness of depreciation in earlier years were in the nature of general discussion and were "uncalled for" in a revision restricted to A.Y. 2020-21.

2.13 However, the Tribunal also held that such excessive or obiter discussion did not render the revision order invalid, because the operative revisionary action that affected A.Y. 2020-21 was only the direction to examine the depreciation claim on goodwill for that year, which was independently sustainable on the ground of non-enquiry by the Assessing Officer.

Conclusions

2.14 The Tribunal confined the effect of the section 263 order to A.Y. 2020-21 and to the non-examination of depreciation on goodwill in that year only.

2.15 Observations of the Principal Commissioner about self-generated goodwill, its cost being nil, and disallowance of depreciation from A.Y. 2016-17 onwards were treated as surplus and not forming the operative basis for setting aside the assessment. They do not by themselves invalidate the revision order, though they may at best be used, if legally permissible, for separate proceedings in earlier years.

2.16 Grounds challenging the revision on the basis that it relied on amalgamation facts and earlier-year goodwill treatment (including the additional ground) were rejected.

Issue 3: Effect of alleged absence of DIN on the section 263 show cause notice

Interpretation and reasoning

2.17 The assessee contended that the show cause notice dated 05.03.2024 issued by the Principal Commissioner did not bear a Document Identification Number (DIN) and hence the revision order was invalid.

2.18 The Tribunal examined the impugned order and noted that:

(a) The order itself recorded DIN No. 1061484781(1)/3809.

(b) The show cause notice under section 263 dated 26.02.2024, referred to in the order, also contained this DIN.

2.19 On these facts, the Tribunal found no substance in the plea that absence of DIN in any notice vitiated the proceedings, as the relevant section 263 notice was traceable and duly identified by a DIN.

Conclusions

2.20 The challenge to the validity of the section 263 proceedings on the ground of non-mention of DIN was rejected and the corresponding ground dismissed.

Issue 4: Extent of Principal Commissioner's power to decide merits of depreciation on goodwill in section 263 proceedings for the year under appeal

Interpretation and reasoning

2.21 The Principal Commissioner, apart from finding lack of enquiry, went further and recorded detailed conclusions that:

(a) No actual cost had been incurred on goodwill by either the amalgamating or amalgamated company;

(b) Goodwill created on amalgamation was a "fictitious asset" for tax purposes;

(c) By reference to the 6th proviso to section 32(1), Explanation 3 to section 43(1) and related provisions, the cost/WDV of goodwill in the hands of the assessee should be treated as nil and no depreciation should be allowable.

2.22 The Tribunal noted that for A.Y. 2020-21 the only identified lapse rendering the order erroneous and prejudicial was the Assessing Officer's failure to enquire into the allowability of depreciation on goodwill after its complete impairment in the books.

2.23 The Tribunal therefore held that:

(a) The Principal Commissioner was justified in invoking section 263 to direct the Assessing Officer to examine and verify the depreciation claim for A.Y. 2020-21.

(b) However, the Principal Commissioner could not, within the framework of these particular section 263 proceedings, conclusively fix the actual cost or WDV of goodwill as nil for earlier years or finally adjudicate the substantive allowability of depreciation across prior years.

(c) Those remarks, even if made, do not constitute the operative part of the revision in respect of A.Y. 2020-21 and cannot be read as binding directions to re-write the earlier years' assessments in these proceedings.

2.24 The Tribunal clarified that while such discussion may incidentally assist the Revenue if it chooses to initiate permissible proceedings in earlier years, it does not affect the validity of the present revision relating only to the non-enquiry in A.Y. 2020-21.

Conclusions

2.25 The section 263 order was upheld only to the limited extent that the Assessing Officer must re-examine and verify the claim of depreciation of Rs. 1,86,95,184 on goodwill for A.Y. 2020-21, in light of the impairment reflected in the books.

2.26 The broader conclusions of the Principal Commissioner regarding nil cost of goodwill and disallowance of depreciation from earlier years were treated as beyond the necessary scope of the present revision and not determinative for A.Y. 2020-21, though they do not, by themselves, render the order under section 263 invalid.

2.27 All grounds of the assessee, except those challenging the non-enquiry based revision on depreciation for the year under appeal, were dismissed; the appeal was dismissed in entirety with the section 263 order sustained in the constrained manner described above.

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