Bombay H.C : The second respondent had validly invoked jurisdiction and exercised powers under s. 263 of the IT Act, 1961

High Court Of Bombay

Ranka Jewellers vs. Additional Commissioner Of Income Tax

Section 40A(3), 263(1), Expln. (c)

Block period 1st April, 1996 to 24th Oct., 2002

Dr. D.Y. Chandrachud & J.P. Devadhar, JJ.

IT Appeal No. 1311 of 2009

26th March, 2010

Counsel Appeared :

Soli E. Dastur with Nishant Thakkar i/b Atul K. Jasani, for the Appellant : Vimal Gupta, for the Respondent

JUDGMENT

DR. D.Y. CHANDRACHUD, J. :

The appeal by the assessee under s. 260A of the IT Act, 1961, has been admitted on the following substantial question of law : “Whether the Tribunal was right in holding that the second respondent had validly invoked jurisdiction and exercised powers under s. 263 of the IT Act, 1961 ?”

2. The assessee manufactures and trades in gold jewellery and silver articles. A search was conducted at its premises on 24th Oct., 2002. A special audit was carried out under s. 142(2A). By an order dt. 31st Dec., 2004, a block assessment was completed for the period 1st April, 1996 to 24th Oct., 2002 under s. 158BC. The undisclosed income of the assessee was estimated at Rs. 5.23 crores. A notice was issued on 9th Feb., 2007 by the CIT (Central) to the assessee to show-cause why the order of assessment should not be revised in exercise of powers under s. 263. The assessee responded to the notice following which an order was passed on 26th March, 2007 by the CIT (Central) under s. 263, setting aside the order of block assessment and directing the AO to pass a fresh order of assessment.

The power under s. 263 has been exercised on two grounds which are elucidated in the notice dt. 9th Feb., 2007 that was issued to the assessee. The first ground is that during the course of the search and seizure action, documents which were seized revealed the purchase and sale of gold and silver jewellery which was not disclosed to the Department. These documents included “Jama Kharch Panas” for the period 2nd Nov., 1999 to 17th Sept., 2002. The CIT(A), on a reference made by the AO estimated the initial investment of the assessee at Rs. 10 lakhs on the basis of an average turnover of Rs. 75 lakhs. According to the revising authority, the average turnover was computed only for the first three years of the block period, while for the subsequent part of the block period, the undisclosed turnover, which was much higher, was not considered by the CIT(A). According to the revisional authority, the initial investment determined of Rs. 10 lakhs is not commensurate with the investment required to achieve a substantially higher turnover of Rs. 38 crores, in the subsequent period of the block, starting from financial year 1999-2000 till the date of search. Accordingly, it has been stated that because of the failure to determine the initial investment, particularly with reference to the undisclosed turnover during financial year 1999-2000 and onwards, the assessment order issued by the AO is erroneous and prejudicial to the interests of the Revenue.

The second ground on which the power under s. 263 has been exercised, is that the seized material revealed for the period between 1999-2000 and 2002-03 total purchases of Rs. 93.76 crores by the assessee in cash. Under s. 40A(3), twenty per cent of these purchases should have been disallowed. The AO having failed to do so, it has been concluded that the assessment order is erroneous and prejudicial to the interests of the Revenue. These are the two grounds on which the jurisdiction under s. 263 has been exercised. The submission of the assessee is that neither of these grounds can sustain a valid exercise of power under s. 263. The Revenue contends that the invocation of the jurisdiction under s. 263 is proper. For convenience of exposition, it would be appropriate to consider the challenge to the exercise under s. 263 on the aforesaid two grounds separately, taking the second ground up for consideration initially. Re : Sec. 40A(3) :

6. During the course of the block assessment proceedings, on 2nd June, 2004, the AO called for a special audit under s. 142(2A). The audit was required inter alia in respect of cash transactions which fell within the ambit of the provisions of s. 40A(3). The audit report contained the following observations on the issue of the cash transactions, particularly with reference to s. 40A(3) : “The details of cash payments in excess of limits specified under s. 40A(3) are given in para 11 of audit report wherein page-wise explanation of seized material is given. However, since a consolidated figure of purchase and expense is given in Jama Kharch papers it is not possible to state whether any individual payment is made in excess of limits specified under s. 40A(3). The assessee has explained that in view of decisions in cases of Janta Tiles vs. Asstt. CIT (2000) 66 TTJ (Pune) 695, Sharma Associates vs. Asstt. CIT (1996) 54 TTJ (Pune)(TM) 207 : (1995) 55 ITD 171 (Pune)(TM) and Madhuvana House Building Co-Operative Society vs. Asstt. CIT (2002) 76 TTJ (Bang) 948 the undisclosed transactions are outside the purview of s. 40A(3). The AO may consider these decisions.” Thereafter, an internal audit query was raised within the Department on the ground that purchases amounting to Rs. 93.76 crores were made in cash and that twenty per cent thereof, which works out to Rs. 18.75 crores, should be disallowed under s. 40A(3) and added to the taxable income. Shri S.K. Rastogi, Addl. CIT, Central Range-1, Pune, who was the AO observed that the audit observation was not correct. In his response, the AO noted that as per the seized documents, the figures of purchases made were consolidated lump sum figures and it was difficult to infer as to whether there was any violation of s. 40A(3). The AO noted that in a series of decisions, the Tribunal had held that where the undisclosed income had been found out by estimating gross profit, or where the assessee was carrying on business outside the books of account, the provisions of s. 40A(3) would be inapplicable. In forming this view, the AO relied upon the decision of the Ahmedabad Bench of the Tribunal in Hynoup Food & Oil Industries (P) Ltd. vs. Asstt. CIT (1993) 47 TTJ (Ahd) 556 : (1994) 48 ITD 202 (Ahd); of the Pune Bench in Sharma Associates vs. Asstt. CIT (1996) 54 TTJ (Pune)(TM) 207 : (1995) 55 ITD 171 (Pune)(TM); and of the Mumbai Bench in Western India Bakers (P) Ltd. vs. Dy. CIT (2004) 84 TTJ (Mumbai) 223. Some of these decisions had also been relied upon in the report of the auditor in the special audit report under s. 142(2A). Both the reports of the special auditor as well as of the AO who responded to the audit query, relied upon decisions of the Tribunal in support of their view that there was no violation of the provisions of s. 40A(3). The view of the AO was confirmed by the CIT (Central) in the following terms : “It is evident from the report of Addl. CIT, Central Range-1, Pune who was also the AO in the case, that the observations made by the Revenue audit are not acceptable. Therefore, in my considered opinion, there is no mistake committed by the AO.” The response which was generated from the AO and from the CIT (Central) appears from the records to have been remitted under a covering letter dt. 19th June, 2006 of the Addl. CIT, Central Range-1, Pune.

7. The grievance of the assessee is that despite the fact that the issue of the applicability of s. 40A (3) formed the subject-matter of the special audit and though the AO did not come to the conclusion that there was any violation of those provisions, on 9th Feb., 2007, a notice was issued under s. 263 by the same CIT contrary to his own view which was recorded in response to the audit query. From the material on the record, it has emerged that during the course of the assessment proceedings, the AO had directed a special audit under s. 142(2A) and among the aspects on which the audit was requisitioned, was the issue relating to transactions which were carried out in excess of an amount of Rs. 20,000 in cash. The auditor came to the conclusion that it was not possible to state as to whether any individual payment had been made in excess of the limit specified in s. 40A (3). The auditor recorded the submissions of the assessee, based on decisions of the Tribunal, that undisclosed transactions were outside the purview of s. 40A(3). Evidently, the AO, during the course of the assessment proceedings did not consider that there was any violation of the provisions of s. 40A(3). As a matter of fact, the AO in response to the internal audit query relied upon several judgments of the Tribunal in support of his conclusion that the provisions of s. 40A(3) were not applicable and that in any event, it was his view that it was difficult to infer from the consolidated figures that were available as to whether any individual transaction had taken place in cash in excess of the limit prescribed by the statutory provisions.

The order that has been passed by the CIT under s. 263 proceeds on the basis that the AO did not consider the applicability of s. 40A(3) while determining the undisclosed income and hence, the order appears to be erroneous and to be prejudicial to the interests of the Revenue. There is merit in the submission of the assessee that this finding is contrary to the record. The record shows that the AO had applied his mind to the issue of the violation of s. 40A(3) during the course of the assessment proceedings by calling for a special audit on several items including the question as regards cash transactions which fell within the purview of s. 40A(3). Similarly, the Tribunal also proceeded on the basis that the record before it did not contain any discussion on the issue. This aspect of the finding of the Tribunal suffers from the same error as the order passed by the AO. Though the assessment order did not contain a specific reference to the applicability of s. 40A(3), the response of the AO to the audit query shows that it was his view that those provisions were not applicable to the facts of the present case. The AO supported his view with reference to decisions of the Tribunal. This view of the AO was also affirmed by the CIT. In the circumstances, the exercise of the power under s. 263 cannot be sustained. The revisional jurisdiction could not have been exercised where a possible view was taken on the applicability of s. 40A(3) based on decisions of the Tribunals. It is a settled principle of law that if the view which was taken by the AO is a possible view, it would not be within the jurisdiction of the revisional authority to exercise the power under s. 263. Re : Initial investment or seed capital :

The second basis on which the jurisdiction under s. 263 has been exercised is that while determining the initial investment at Rs. 10 lakhs, the turnover of Rs. 75 lakhs was taken only on the basis of the first three years of the block period. The CIT is of the view that in considering the turnover of only the first three years of the block in determining the initial investment, the substantially higher turnover for the remaining years of the block had been ignored. Now, on this aspect of the case, the record indicates that following the order of assessment, during the pendency of the proceedings before the CIT(A), a request for enhancement was made by the Addl. CIT, Central Range-1, Pune, by a letter dt. 16th May, 2005. In his request for enhancement of the returned income, the Addl. CIT stated that in the block assessment order, an estimation of the initial investment required to carry out undisclosed business had remained to be done for the first year of the block period. The CIT(A) was, therefore, requested to enhance the undisclosed income on account of the initial investment. Following the request for enhancement, by an order-sheet entry dt. 20th May, 2005, the assessee was called upon to explain as to why an enhancement should not be made for the initial investment for undisclosed business transactions. The assessee’s response to the notice governed the entire period of the block assessment. The CIT (A) in the course of the order dt. 22nd May, 2006 observed as follows in para 16.5 : “There is no denying fact that for the period 2nd Nov., 1999 to 17th Sept., 2002 there is seizure of duplicate cash book which is written very scientifically giving full details of incoming and outgoing cash. The undisclosed profit of the appellant and accepted by the Department at Rs. 69,33,940 for the period 1996-97 upto 1st Nov., 1999 can be considered as ploughed back in the unaccounted trading. This profit can be considered as capital used in the undisclosed trading as per the stand taken by the appellant. However, the stand taken by the AO that in the first year of the block period initial seed capital requires to be considered also merits consideration. Incidentally, in the first year of the block period i.e., 1996-97 the turnover is not fully based on the seized materials and that the sales and purchases are not fully recorded and that Department was constrained to estimate the turnover at Rs. 50 lacs. The profit derived therefrom came to Rs. 5,35,000. The appellant has accepted this finding. Similarly, in the next two years of the block period i.e., for 1997-98 and 1998-99 in the absence of full details, the turnover has once again been estimated at Rs. 75 lacs and Rs. 1 crore respectively and profit worked out therefrom as per the AO and accepted by the appellant came to Rs. 8,22,000 and Rs. 14,24,000 respectively. Since for the first three years of the block period, the turnover and profit are estimated figures, in my considered opinion, it is deemed fit to take average of the turnover of the first three years and then to work out the seed capital by applying a reasonable percentage. The average of the turnover for the three years will work out to Rs. 75 lacs and @ 12.5 per cent which is a reasonable percentage, the profit comes to Rs. 9,37,500. However, this figure is rounded off to Rs. 10,00,000. The undisclosed income will go up by Rs. 10 lacs as worked out.”

The submission of counsel appearing on behalf of the assessee is that these observations of the CIT(A) ex facie demonstrate that the appellate authority has not merely confined itself to the determination of the initial investment on the basis of the turnover for the first three years of the block, but, as a matter of fact, the CIT also estimated what has been ploughed back in unaccounted trading for the remaining years of the block.

Reading para 16.5 of the order of the CIT(A), as it stands, there is merit in the submission of the assessee. The order of the CIT(A) refers firstly to the fact that for the periods between 1996-97 and 1st Nov., 1999, the undisclosed profit of the assessee was determined at Rs. 69.33 lakhs which could be considered as being ploughed back in unaccounted trading. The CIT(A) observed that this profit could be considered as capital used in undisclosed trading. The CIT(A) then noted that the initial seed capital required for the first year of the block period needed to be estimated. In this regard, the CIT(A) noted that the average turnover for the first three years of the block was Rs. 75 lakhs and taking a rate of 12.5 per cent as a reasonable percentage, the profit was worked out at Rs. 10 lakhs. This was treated in the order of the CIT(A) as an initial investment for carrying on undisclosed transactions. Both aspects were evidently considered. This is clear from para 16.5 of the order.

We must, at this stage, observe that in these proceedings we are not concerned with the merits or correctness of the determination that has been made by the CIT(A) in the order dt. 22nd May, 2006. The scope of the present proceedings is confined to the validity of the recourse to the powers under s. 263. During the course of the hearing, the Court has also been informed that an appeal is pending before the Tribunal in which the correctness of the order dt. 22nd May, 2006 passed by the CIT(A) will fall for determination. A copy of the authorization memo dt. 20th Feb., 2007 issued by the CIT (Central) in regard to the filing of the appeal is produced during the hearing. The authorisation memo specifically deals with the correctness of the order passed by the CIT(A) while enhancing the assessee’s income on the request made by the AO. The authorization memo states that the AO erred in adopting what is described as “an arbitrary percentage of 12.5 per cent of average turnover of Rs. 75 lakhs thereby considering estimated turnover of only first three years as seed capital and in not considering huge unaccounted turnover of Rs. 38 crores per year in the latter three years of the block”. The case of the Revenue in the appeal before the Tribunal is to the effect that the amount estimated at Rs. 10 lakhs as initial investment is a gross underestimate to meet the turnover of Rs. 38 crores and is lacking in reasonableness. The Court is informed that the ground which is sought to be urged by the Revenue is still to be admitted by the Tribunal. We have adverted to these facts because the correctness of the order that has been passed by the CIT(A) on merits is an issue which, it is open to the Revenue to urge before the Tribunal and for the Tribunal to address. The legitimacy, correctness and maintainability of the ground which is sought to be advanced will be dealt with by the Tribunal. The Revenue having taken recourse to its appellate remedy before the Tribunal, we are of the view that the exercise of the jurisdiction, in the facts of this case under s. 263 was not warranted since the exercise cannot be sustained under the section.

We must also advert to the circumstance that insofar as the second ground for the exercise of the jurisdiction under s. 263 is concerned, there was an audit query specifically with reference to the initial investment made in purchases in the year 1999-2000. The audit query was responded to by the Addl. CIT. The Asstt. CIT in his response to the audit query was of the view that the observation in the audit was not correct. The view of the Addl. CIT was confirmed by the CIT (Central), Pune. The CIT while passing his order under s. 263 has observed that the request for enhancement made by the AO to the CIT(A) was only for the first year, namely, asst. yr. 1997-98. The CIT has proceeded on the basis that the initial investment computed at Rs. 10 lakhs was determined only for the first year of the block period and that the CIT(A) did not further examine the issue as to whether the initial investment of Rs. 10 lakhs together with income computed for the first three years would be sufficient to achieve unaccounted sales to the extent to which they emerge during the remaining years of the block assessment. Similarly, the Tribunal has also observed that there was no assessment either by the AO or by the CIT(A) in respect of the initial capital for the latter part of the block period. Ex facie, a reading of para 16.5 of the order passed by the CIT(A) would show that this ground which weighed with the CIT and with the Tribunal is not correct. Para 16.5 of the order passed by the CIT(A) would show that an estimation was made of the initial investment based on the turnover of the first three years of the block period. Having done so, the CIT(A) also computed undisclosed profits for the period 1996-97 till 1st Nov., 1999 which he treated as being ploughed back in unaccounted trading. This would indicate that the CIT (A) had dealt not merely with the initial investment required on the basis of the turnover for the first three years of the block, but also made an estimation of the profits which were ploughed back in the unaccounted sales during the subsequent period between 1996 and 1st Nov., 1999. Be that as it may, it would be necessary for this Court to clarify that the merits of the aforesaid determination will fall for consideration before the Tribunal in the pending appeal. We have not expressed any opinion one way or other on the merits of the determination which has been made by the CIT(A).

16. The position in law was settled by the judgment of the Supreme Court in Malabar Industrial Co. Ltd. vs. CIT (2000) 159 CTR (SC) 1 : (2000) 243 ITR 83 (SC). In CIT vs. Max India Ltd. (2007) 213 CTR (SC) 266 : (2007) 295 ITR 282 (SC), the Supreme Court while adverting to the earlier judgment in Malabar (supra) has laid down the following principle of law : “Every loss of revenue as a consequence of an order of the AO cannot be treated as prejudicial to the interests of the Revenue. For example, when an ITO adopted one of the courses permissible in law and it has resulted in loss of revenue, or where two views are possible and the ITO has taken one view with which the CIT does not agree, it cannot be treated as an erroneous order prejudicial to the interests of the Revenue, unless the view taken by the ITO is unsustainable in law.”

17. The power under s. 263(1) can be exercised by the CIT where he considers that any order passed by the AO is erroneous insofar as it is prejudicial to the interests of the Revenue. Explanation (c) to the provision provides that where any order referred to in sub-s. (1) and passed by the AO has been made a subject-matter of any appeal, the powers of the CIT under the subsection shall extend to such matters as had not been “considered and decided” in the appeal. In other words, the exercise of powers under s. 263(1) is in respect of an order passed by the AO, where the order is regarded as being erroneous and prejudicial to the interest of the Revenue. Where an order passed by the AO is subject to an appeal that has been filed, the power of the CIT to invoke his revisional jurisdiction under s. 263 can only extend to such matters which have not been considered and decided in the appeal. The words which have been used in Expln. (c) to sub-s. (1) of s. 263 are “considered and decided”. In other words, it is not merely a consideration that disables, but the matter has to be considered and decided in the appeal. The submission of counsel appearing on behalf of the Revenue that the CIT(A) has not decided the issue, while dealing with the question of enhancement, cannot be accepted. The submission which has been urged on behalf of the Revenue is that the CIT(A) was requested to exercise his power of enhancement in pursuance of the request made by the Addl. CIT on 20th May, 2005 and that the request which was made was to carry out an estimation of the initial investment for the first year of the block period. Now, the power of the CIT(A) is structured by the provisions of s. 251. Sec. 251 inter alia provides that in disposing of an appeal the CIT(A) shall have the power in an appeal against an order of assessment to confirm, reduce, enhance or annul the assessment. Consequently, when a request for enhancement was made to the CIT(A), he had the jurisdiction, in terms of s. 251, to confirm, reduce, enhance or annul the assessment. A reading of the order passed by the CIT(A), particularly para 16.5 of the order, would lead to the conclusion that the CIT(A) had considered and decided the issue. Once the issue was considered and decided by the CIT(A), the remedy of the Revenue cannot lie in the invocation of the jurisdiction under s. 263. The Revenue has already invoked its remedy in the form of a substantive appeal before the Tribunal which will be decided in accordance with law. The observations in this order are confined to determining whether the invocation of jurisdiction under s. 263 was valid. These observations will not affect the determination of the issues which are raised in the appeal to the Tribunal.

18. For the reasons aforesaid, we dispose of the appeal by answering the question as framed in the negative, in favour of the assessee and against the Revenue. There shall be no order as to costs.

[Citation : 328 ITR 148]