BOMBAY CHARTERED ACCOUNTANT SOCIETY LECTURE MEETING ON 22 ND NOVEMBER, 2006 ISSUES RELATING TO ASSESSMENTS AND REASSESSMENTS

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1 BOMBAY CHARTERED ACCOUNTANT SOCIETY LECTURE MEETING ON 22 ND NOVEMBER, 2006 ISSUES RELATING TO ASSESSMENTS AND REASSESSMENTS DILIP V. LAKHANI, CHARTERED ACCOUNTANT CURRENT ISSUES IN ASSESSMENTS AND REASSESSMENTS 1. General Even though Government has been promising / announcing that only 2% of the cases are selected for scrutiny, when we consider the guidelines issued by CBDT, almost all big cases and wherever exemptions are claimed, are selected for scrutiny. The experience shows that once the case is selected for scrutiny, due to several additional / disallowances, automatically it reaches minimum upto Tribunal and for legal issues upto the Supreme Court. In the light of the above experiences, we have to consider the current issues relating to assessments and reassessments including the assessments in case of search, seizure cases. Brief synopsis is prepared on the topics which I am proposing to deal with. 2. Amendments relating to self assessment tax payable (Sec.140A): (a) Before filing of return, tax due including the interest due for the late filing of return or any default or delay in the payment of advance tax, needs to be paid. If the amount paid falls short of total tax and interest due, then the amount paid will first be adjusted against the interest payable and the balance towards the tax payable. View has been taken by the Tribunals that this proviso in sec.140a is applicable only in respect of S.A. Tax payable and not for finding out whether full tax is paid by the Assessee as per return, for the purpose of filing of appeal etc. For the purpose of sec. 249(4) it is sufficient that assessee pay tax due on returned income, there is no requirement to pay interest due. Refer: Subbaih Nadar & Sons 84 ITD 55 (Chennai), V.N. Sudhakaran 83 ITD 159 (Chennai), Pawan Kumar Ladha 84 ITD 178 (Indore). Also Refer Bharatkumar Sakhsaria 82 ITD 512 (Mum) (Against). It has been clarified that even for considering the provisions regarding non filing of appeal by the Revenue before the Tribunal, High Court etc., only tax effect has to be seen without considering the interest. Refer: Roopchand Jain 79 TTJ 406 (Nagpur Trib)

2 2 (b) As per the amendment by the Finance Act, 2006 while working out the interest payable u/s.234a, advance tax, TDS / TCS, DIT relief as per sec.90 and tax credit as per sec.115jaa, is to be reduced from the total tax payable. This amendment is effective from A.Y It is for consideration whether this amendment could be treated as clarificatory and could be made applicable for the past years also. In fact, in the following cases, the Tribunals, before this amendment, have taken a view that tax credit as per sec.115jaa has to be given before calculation of interest. Refer: Synthetic Industrial Chemicals 85 TTJ 162 (Coch)/ 90 ITD 851 (Coch) and Chemplast Sanmar 83 TTJ 427 (Chenai). Similar amendment is made in respect of working of interest u/s.234b and sec.234c. 3. Notice for inquiry before assessment (Sec.142): (a) For the purpose of making an assessment, the AO may make such inquiries. For purpose of making assessment, he may serve on any person who has not filed a return, within the time allowed u/s.139(1) or before the end of relevant assessment year to furnish the return of income (underlined portion inserted by the Finance Act, 2006 w.e.f ). Proviso has been added by the Finance Act, 2006 with retrospective effect from to regularize some of the irregularities committed by the Assessing Officers. As per this proviso, if the Notice under this section has been served after the end of the relevant assessment year after , to a person who has not made return within the time allowed u/s.139(1) or before the end of the relevant assessment year, any such Notice issued by him, shall be deemed to have been served in accordance with the provisions of this sub-section. By making this retrospective amendment, the law makers have sought to regularize the defaults committed by the AOs in issue of Notices under this section. This was basically to overcome the ratio laid down by the decisions in the case of Motorola 95 ITD 269 and Raj Kumar Chawla 92 TTJ 1245 (Del)(SB), Mrs. C. Malathy 88 ITD 37 (Chennai ). (b) sec.142(2a) gives the power to the AO to direct to get the accounts audited of any Assessee having regard to the nature and complexities, from the Chartered Accountant. This provision has not been properly and successfully used by the AOs for understanding the complexities of the accounts etc. of the Assessees. 4. Assessments (Sec.143): (a) Where return has been made by the Assessee u/s.139 or sec.142 and if the tax or the interest is found to be due or refundable on the basis of such return, after crediting the taxes paid by the Assessee, Intimation shall be sent by the AO specifying the sum so

3 3 payable / refundable and such Intimation shall be deemed to be Notice u/s.156 and all other provisions of the Act. (b) Where there is no tax / interest due or refundable on the basis of return filed, the acknowledgement of return filed shall be deemed to be Intimation under this section. (c) No Intimation by the AO shall be sent after the expiry of one year from the end of the Financial Year in which return is made. For e.g. in respect of return filed for A.Y in October 2004, Intimation can be sent only upto (d) On failure to comply with certain requirements as specified in sec.144, the AO after taking into account all relevant material which he has gathered, shall after giving the Assessee an opportunity of being heard, make assessment of the income or loss. These assessments are supposed to be best judgment assessments. The Courts have held that even while passing the orders u/s.144, the AO cannot pass order on adhoc or arbitrary basis. Refer: Laminarain Badridas 5 ITR 170 (PC), Mohanlal Mahribal 133 ITR 683 (MP), Gangaprasad Sharma 132 ITR 87 (MP), K.T. Thomas 184 ITR 561 (Ker). (e) The time limit for completion of assessment, which was 24 months from the end of the assessment year, has been reduced to 21 months by the Finance Act, 2006 i.e. all assessments for A.Y will now have to be made before (f) Issues arising in the assessments Treatment of income received on purchase and sale of shares and securities is going to be contentious issue for few years. We have to consider the implications of the instructions issued by the CBDT for assessments of such transactions. One view which is expressed is, looking to the volume and frequency, we have to decide whether the shares are held on investment account or trading account. If the quoted shares (on which ST is paid) dealt with are on investment account, then LT capital gain will be exempt from capital tax and ST capital gain will be liable at 10%. In case however, if dealings are on the trading account, the entire gain will be liable as business income or speculation income, as the case may be. Refer: Draft Instruction to provide guidelines for determining whether a transaction is in the nature of trade or investments issued in May Refer :V.A. Trivedi 172 ITR 95 (Bom), Laxmi Surgical Pvt. Ltd. 202 ITR 601 (Bom), Vesta Investments & Trading Co. (P) Ltd. Vs. CIT 70 ITD 200 (Chd), Arjun Kapur 70 ITD 161 (Del), H. Holck Larsen 160 ITR 67 (SC) As per the amendment by the Finance Act w.e.f. A.Y , by insertion of proviso (d) to sec.43(5), income from derivative transactions, is held to be business income from A. Y The question for consideration is, whether it is a clarificatory amendment and therefore, even for earlier years, the

4 4 transactions would be treated as business income. Issue may also arise if the derivative transactions in earlier years are treated as speculative transactions and there is a carry forward loss on account of such transactions, will such loss be set off against the profit from derivative transactions from A.Y ? Issue may also arise as to the derivative transactions in respect of other than shares and securities like in commodity exchange like gold and other food grains etc. Since there is no specific provision, whether the AO is likely to treat such transaction as speculative transaction. Very strong view is expressed that derivative transactions cannot be treated as speculative transactions as the derivatives are always backed by securities. After the amendment in sec10(38) by which long term capital gain on the sale of quoted shares and units through recognized stock exchange is exempt from income tax. The question is, whether the loss on the sale of such shares or units, would be allowed to be set off against the other taxable capital gains. One view is that the transaction of shares is a transfer and only the gain is exempt if it is long term and taxed at 10% in case of short term transactions. Therefore, if there is a loss, it will have to be allowed to be carried forward, in absence of there being no specific provision either in sec.47 or in sec.74. One more issue relating to the shares and securities held as investment is subject matter of litigation i.e. regarding whether the interest paid on borrowing for acquisition of shares and securities, income from which is exempt u/s.10(34). Dept. is taking a view that since the income is exempt u/s.10(34), no expenditure including interest will be allowed as a deduction. Under Section 14A the issue of allocating administrative expenses to exempt income is also relevant. The controversy also arose as to the eligibility of exemption u/s.54ec in respect of long term capital gain arising before but investment for which as per the provisions of sec.54ec is made after The CBDT vide Notification No. 142 & 143 /2006/F. No. 142/09/2006-TPL dated has clarified this aspect and given time for investment upto Still there are many areas still left unanswered. 5. Method of accounting in certain cases (Sec.145A): As per this provision, valuation of purchase, sale of goods and inventory for the purpose of computation of profits and gains of business or profession, shall be in accordance with the method of accounting regularly followed by the Assessee and shall further include the amount of tax, duty, cess or fee, actually paid or incurred by the Assessee to bring the goods to its place of location on the date of valuation.

5 5 As per the Guidance Note issued by ICAI, even after this amendment, by adopting the Inclusive Method for the purpose of income tax, it will be tax neutral, particularly if the tax due or provided for on closing stock, has been paid in the subsequent year before filing of return. Recently however, the Tribunals in some of the cases have made departure from the view to the recommended view of the ICAI. 6. Income escaping assessment (Sec.147): (a) If the AO, has reason to believe that any income chargeable to tax has escaped assessment, he may subject to the other provisions, assess or reassess such income / loss / depreciation or any other allowances and any other income chargeable to tax which has escaped assessment and which has come to his notice subsequently in the course of proceedings under this section. (b) As per the proviso to sec.147, where assessment has been made u/s.143(3) or u/s.147, no action shall be taken under this section after the expiry of 4 years from the end of the relevant assessment year unless Income chargeable to tax has escaped assessment by reason of failure on the part of the Assessee to make a return or To disclose fully and truly all material facts necessary for the purpose of assessment for that assessment year. (c) Expl. 1 and Expl. 2 have been inserted to clarify the scope of disclosure by the Assessee or the cases where the income chargeable to tax could be deemed to be held to have escaped assessment. (d) No Notice after the expiry of 4 years from the end of the assessment year, shall be issued u/s.148 without the prior approval of the Chief Commissioner or Commissioner who after being satisfied on the reasons recorded by the AO that, it is a fit case for reopening of assessment. (e) Time limit for Notice No Notice u/s.148 for the relevant assessment year shall be issued (a) after the end of 4 years from the end of the relevant assessment year or (b) after the period of 4 years, but before the end of 6 years, from the end of the relevant assessment year, unless income chargeable to tax amounts to or likely to amount to more than Rs.1 lakh. (f) The Courts and Tribunals have watered down the rigours of this provision. Refer: Kelvinator India Ltd. 256 ITR 1 (Del) (FB), Foramer France 264 ITR 566 (SC), Circular of CBDT No.549 dated It has been clarified that there is no difference in earlier provisions of sec.147(a) and 147(b) and the new provision sec.147 (amended w.e.f ). No assessment could be reopened merely on the

6 6 change of opinion and the law that assessment could not be reopened merely on the change of opinion has been reaffirmed even after the amendment by the above circular and decisions. Also refer IPCA Lab Ltd. 251 ITR 416 and 420 (Bom) (g) The issue came up before the Courts as to whether, even within the period of 4 years assessment could be reopened merely on the basis of change of opinion, when there is full and complete disclosure of the facts in the return and during the course of assessment and the AO after application of mind has accepted the contention of the Assessee. The Gujarat High Court in the case of Saradbhai M Lakhani 231 ITR 779 has held that the assessment cannot be reopened even within 4 years merely on the basis of change of opinion. The Supreme Court in Phoolchand Bajranglal 203 ITR 456 has held that reason to believe should not construe as reason to suspect. Similar view is taken by the Tribunals in many decisions in this respect. (h) The Courts are unanimous that after the period of 4 years, assessment made u/s.143(3) or u/s.147 cannot be reopened if complete facts and details are available on record, even if there is mistake (either of the Assessee or the AO) in claiming or allowing of deduction or allowances. Refer: Maharashtra Sugar Mills Ltd. 263 ITR 180 (Bom), Parshuram Potteries Ltd. 106 ITR 1 (SC), ICICI Ltd. 268 ITR 203. (i) The Gujarat High Court in the case of Praful C. Patel 236 ITR 832 and the Bombay High Court in the case of Dr. Amin pathology Laboratory 256 ITR 683 have held that if the AO has not applied his mind or formed his opinion on certain aspects at the stage of original assessment (as is clear from the enquiry conducted in the original assessment) and if he discovers or finds himself that taxable income has escaped assessment, it could be said that he had reason to believe about income escaping assessment. The Court has observed that the justification for his belief is not to be judged from the standard of proof required for coming to final decision. This view however, has not been followed in the subsequent decisions of the Courts. (j) The Courts have taken a view that if the order or Intimation is passed u/s.143(1), it is only acceptance of the return without application of mind. Therefore, when on scrutiny later on if the AO finds that there is escapement of income, he can reopen within the period of 6 years (Refer MTNL 246 ITR 173 (Delhi) ) (k) The Supreme Court in GKN Driveshaft Ltd. 259 ITR 19(SC) has held that unless the reasons for reopening are recorded and communicated to the Assessee, reassessment is not valid. The Court has also laid down the procedure to be followed giving opportunity to the Assessee to file his objections etc. The Bombay High Court in the following cases have struck down the reopening for not giving fair and proper opportunity or for dealing with objections of the Assessee. Refer Ajantha Pharma 267

7 7 ITR 200 (Bom), CIT V. Kelvinator of India Ltd. 256 ITR 1 (Del) (FB), Jindal Photo Films Ltd. 234 ITR 170 (Del), Maharashtra Sugar mills Ltd 263 ITR 180 (Bom.). (l) The Courts have also held that if the Commissioner has given approval in mechanical manner without proper application of mind, the same would also be treated as not complying with the requisite condition and therefore, reopening is bad in law. (m) Time limit for completion of assessment has also been reduced from 24 months to 21 months from (n) Amendment has been made in sec.148 to regularize the Notices issued beyond the period for taking up scrutiny of the assessments of the returns filed in response to Notices u/s.148. As per this provision inserted by the Finance Act, 2006 w.e.f , if the Notice u/s.143(2) in respect of the assessment for the returns filed during the period to , in response to Notice u/s.148 is issued, after the expiry of time specified u/s.143(2) but before the expiry of time for completing the assessment or reassessment, such Notice shall be deemed to be valid Notice and thereby valid reassessment. This amendment has been made to supercede the decision of the Tribunals etc. wherein the Notices issued for taking up cases for scrutiny beyond the time limit in reassessments were quashed. Refer: Raj Kumar Chawla 92 TTJ 1245 (Del)(SB), Mrs. C. Malathy 88 ITD 37 (Chennai ). 7. Special provisions dealing with assessments in case of search (sec.153a): (a) After the withdrawal of the provisions dealing with block assessments under Ch.XIVB, the new provisions u/s.153a, sec.153b and sec.153c have been introduced in the statute by the Finance Act, 2003 w.e.f (b) As per the new provisions, notwithstanding anything contained in the other provisions of the Act, in case of person where a search is initiated u/s.132, after , the AO shall issue Notice to the Assessee requiring him to furnish, within such period, return of income in respect of each of the assessment year falling within 6 years immediately preceding the assessment year in which search is conducted. (c) The scope and object of this provision is clarified by the Circular No.7/2003 dated (d) As per the scheme, the AO shall assess or reassess the total income in respect of each of the assessment year falling within such 6 assessment years. So also, assessment or reassessment relating to any assessment year falling within the period of 6 assessment years, referred to in this section, pending on the date of initiation of search u/s.132 shall abate.

8 8 (e) (f) (g) (h) For removal of doubts, it is also clarified that the assessment or reassessment made in respect of assessment year under this section, tax shall be chargeable at the rates as applicable to such assessment years. There is a power given u/s.153c to make assessment on income of any other person based on the valuables or books seized or requisition belonging to such person, from the person on whom action u/s.132 has been taken. The assessments u/s.153a shall be completed within 21 months from the date on which last of the authorization for search u/s.132 has been issued. Issues need to be considered: Whether assessment u/s.153a is similar to assessment / reassessment u/s.147. Whether interest will be leviable in respect of additional income, which is offered for tax and if so, for what period. Whether penalty will be leviable u/s.271(1)(c) on the difference between the original return and the return u/s.153a or the assessed income u/s.153a. Or alternatively, it is the difference between the revised income as per sec.153a and assessed income under that section Does it mean that the return u/s.153a substitutes the original return for all purposes or is on the same basis as that of return u/s.147? Will the difference in the original return / assessment and u/s.153a will be treated as undisclosed income like in the case of block assessments? Will the penalty be automatically leviable in respect of higher income assessed in pursuance of assessment u/s.153a or it will be subject to the bonafides etc. So also, if such additional income is disclosed voluntarily without detection in the course of search etc., will it escape penal provisions? 8. Revision (Sec.263): (a) If the Commissioner on examination of records, considers that any order passed therein by the AO is erroneous in so far as it is prejudicial to the interest of revenue, he may after giving opportunity to the Assessee, pass such order including order for enhancing, modifying or canceling the assessment and directing fresh assessment. As per the provisions, if the particular issue is subject matter of appeal before the Commissioner, the powers of the Commissioner shall extend to such matters as has not been considered and decided in such appeal. (b) No order under this section shall be passed after the expiry of 2 years from the end of the financial year in which order sought to be revised was passed. (c) The Courts have held that in order to attract the provisions of sec.263, the CIT has to establish that order passed by the AO was not only erroneous but also prejudicial to

9 9 the interest of revenue. Merely because the order is not passed in detail or that view taken by the AO is different than the view held by the CIT, it cannot be reason for revision of the assessment. It has also been held that, the CIT has to come to conclusion as to how order passed by the AO is erroneous, he cannot merely set aside the assessment for giving fresh inning to the AO. Refer: Gabriel India Ltd. 203 ITR 108 (Bom), Malabar Industrial Co. Ltd. 243 ITR 83 (SC), Jai kumar Kankaria 251 ITR 707 (Cal), Hem Raj Vijay Kumar & Co. 78 ITD 304 (Del. )(SB) 9. Interest u/s.234d: (i) View has been taken by the Dept. that interest u/s.234d is automatically leviable for all orders passed including for appeal effects, after the amendment w.e.f on the tax demands made, after the grant of refunds. The Tribunals have however, held that this provision is not applicable in respect of assessments made in respect of assessments prior to and will only apply for the later assessments. Refer: Cybertech Systems ITA No. 4857/M/04 dated (Mum Trib), Glaxo Smithkline Asia (P) Ltd. 97 TTJ 108 (Del), CBDT has clarified this amendment vide Circular no No.7/2003 dated Right to review evidence in the possession of Assessing Officer at the time of assessment proceedings a) The assessee has inherent legal right to demand from the Assessing Officer the material/evidence on which he intends to rely while framing the assessments. The assessee can also ask for the copies of the said material/evidence. The assessee can also ask for cross examination of the persons on whose statement the Assessing Officer wants to rely. b) It is observed in many cases that at the time of assessment proceedings the assessee does not take adequate precaution to exercise his rights. In the appeal proceedings inaction of the assessee at the time of assessment creates hinderence for legal rights and remedies available to the assessee. 11. Rejection of the Book Results a) The Assessing Officer rejects the book results and makes addition on the ground that day to day stock records are not maintained. The assessee has an option to prove the gross profit disclosed in the books through various other means when the day to day stock record is not maintained. The options available with the assessee are

10 10 (i) comparing the GP of the other traders / competitors in the same trade. (ii) giving physical quantity of stock at the end of the year and the valuation (iii) comparative GP of the assessee in last 5 years, if accepted by the Department. b) The Assessing Officer rejects the closing stock disclosed by the assessee in books of accounts on the ground that the value of the closing stock disclosed to bank against credit facilities is more than the value of the closing stock disclosed in the books of accounts. The assessee must take care to compare both the stock statements and ensure that the quantity of the closing stock disclosed in the books of accounts and the quantity of the closing stock given to the bank matches. If there is difference in the valuation then it is possible to substantiate the claim on the ground that higher valuation to the bank is given for availing higher credit facilities. c) Addition on account of low GP. The Assessing Officer will have to give comparable cases whose GP he intends to adopt while rejecting the book result. If the GP of the earlier years of the same assessee is higher then the assessee can explain this either by proving that the product mix is different, the items dealt in earlier years may be different than the items dealt in relevant year, the cost of the purchase and sale price is different then earlier year. If the profit margin in terms of rupees is same but in terms of percentage it may defer if the cost of the purchase is increased. Eg. Purchase price Rs.90/- Sale price Rs.100/- GP Rs.10/- GP 10% Purchase price Rs.100/- Sale price Rs.110/- GP Rs.10/- GP 9.09% 12. Rejection of claim of purchase/sale on the ground that the parties have not attended in response to summons u/s 131 It is a common phenomenon that the Assessing Officer issues large number of summons to the suppliers or to the customers of the assessee to confirm the transactions. For various reasons the suppliers/customers do not respond or there is some difference between the transactions recorded by the assessee and the transactions recorded by them. The assessee can lead evidence to the effect that the goods have been actually purchased by producing the challans. In case of a manufacturing company the purchase of raw material can be proved by showing consumption and sale of the finished products. The rates of the purchases can be justified by comparing the purchase rates of the similar product from the other supplier. In the case of a trading concern the stock book will reflect the corresponding sales and the profit disclosed in the transaction. It is necessary to lead evidence at the time of assessment so that the issue of additional evidence does not arise before the Appellate Authorities.

11 Applicability of Section 41(1) a) The Assessing Officer in the course of assessment proceedings generally takes a view that in respect of the old creditors which have not been paid the provisions of Section 41(1) will be applicable. The assessee will have to establish the liability still exist and there is no remission of liability. Unilateral act on the part of the creditor to write off amount cannot be a ground for invoking Section 41(1). b) In respect of deposits taken by the assessee in the course of business and such deposit is either forfeited or is not payable. The issues arises as to whether provisions of Section 41(1) can be invoked. If the deposit is in relation to let out of the property whether the answer will be different. c) If the assessee has taken loans from banks/financial institution and there is remission of liability whether such remission will attract provisions of Section 41(1). Also issue of applicability of S. 28(iv) may be considered. Whether, under provisions of Section 115JB the assessee will have to pay tax in respect of remission of loan routed through profit & loss account. Whether it is possible for assessee to route the remission of loan amount directly through General Reserve. 14. Cash Credit a) In assessment proceedings an issue generally arises regarding the genuineness of the cash credit. The assessee will have to prove the identity, the capacity and the credit worthiness. The cash credit can be justified as genuine by producing the confirmation of the party, confirmation of the broker, details of acceptance of loans through account payee cheques, repayment of loan through account payee cheques, payment of interest, deduction of tax at source on interest, submission of PAN. It is the obligation of the Assessing Officer to issue summons if the basic information about the loan is given by the assessee during the assessment proceedings. b) In case of a corporate assessee whether provisions of Section 68 can be invoked in respect of share application money received from the shareholders?