Bombay H.C : validity of a notice of the AO seeking to reopen an assessment would have to be determined on the law as it prevailed on the date of the notice for reopening of the assessment

High Court Of Bombay

Iot Infrastructure & Energy Services Ltd. Vs. ACIT

Assessment Year : 2004-05

Section : 147

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

Writ Petn. No. 805 Of 2010

June  21, 2010

JUDGMENT

Dr. D.Y. Chandrachud, J. :

Rule, by consent returnable forthwith. With the consent of counsel and at their request the petition is taken up for hearing and final disposal.

2. The AO has purported to exercise the power under section 147 of the IT Act, 1961, by issuing a notice under section 148 on 16th March, 2009. The assessment year in question is 2004 05.

3. The assessee filed a return of income on 29th Oct., 2004, disclosing nil income under the normal provisions of the Act and book profits of Rs. 23.35 crores under section 115JB. An assessment order was passed under section 143(3) on 28th Dec, 2006. A notice was issued under section 148 on 16th March, 2009. The reasons and the basis on which the assessment is sought to be reopened were intimated to the assessee on 18th June, 2009 and are as follows :

“A perusal of P&L a/c reveals that company had debited provision on account of diminution in the value of the assets amounting to Rs. 1,41,50,927. This was not a proper charge on the profit of the company as the amount represents the provision made for fall in the value of capital assets which was capital in nature and needs to be disallowed and added back to the income of the assessee company.

In view of this, I have reason to believe that income of the assessee has escaped the assessment within the meaning of provisions of section 147 of the IT Act. Accordingly, notice under section 148 is issued.”

4. The assessee submitted its objections on 18th March, 2010. The AO has passed an order on 22nd March, 2010 rejecting the objections.

5. In order to appreciate the basis on which the assessment is sought to be reopened, a reference to some of the salient aspects of the case would be in order. The assessee, in Sch. 18 to its balance sheet as of 31st March, 2004 made a provision for diminution in the value of assets of Rs. 1.41 crores under the head of operating and other expenses. In the computation of income, among the items disallowed by the assessee, was an expenditure in the amount of Rs. 1.12 crores incurred during the construction period, which was a write down. In the tax audit report under section 44AB, the assessee disclosed in item 17 amounts debited to the P&L a/c. Sub-para (a) of item 17 deals with expenditure of a capital nature. While furnishing a break-up under this item, the assessee disclosed that an amount of Rs. 1.12 crores was a write down in the value of assets. This was stated to exclude an amount of Rs. 29.23 lakhs which, according to the assessee, was a “write down in the value of slow/non-moving inventory valued at estimated realizable value being considered as not in the nature of capital expenditure”. Therefore, a plain reading of item 17 of the tax audit report shows that the assessee disclosed that an amount of Rs. 29.23 lakhs was not in the nature of capital expenditure and represented a write off on account of slow or non-moving inventory which was valued at its estimated realizable value. The AO has purported to reopen the assessment on the ground that the assessee had debited a provision amounting to Rs. 1.41 crores on account of diminution in the value of assets. This, according to the AO, is not a proper charge on profits as the amount represents a provision made for a fall in the value of capital assets, which is considered to be capital in nature. The assessee filed its objections on 18th March, 2010 in which the attention of the AO was drawn to the fact that in the statement of total income, under the head “Items disallowed”, the amount of Rs. 1.12 crores had already been added back in the return of income. Hence, it was urged that there could be no reason to believe that income has escaped assessment in respect of the amount of Rs. 1.12 crores because the assessee had disallowed the amount in the computation of income. As regards the balance of Rs. 29.23 lakhs, the assessee noted that it relates to a write down in value on account of slow or non-moving inventory estimated on the basis of realizable value which could not be regarded as being in the nature of capital expenditure. The assessee relied on precedents to support its contention. The AO dealt with the objections of the assessee in his order dt. 22nd March, 2010 and accepted the factual position that the amount of Rs. 1.12 crores out of Rs. 1.41 crores had been disallowed by the assessee in the return of income. However, the balance of Rs. 29.23 lakhs was treated by the AO to be of a capital nature. At this stage, it appears from record that the objection of the assessee that a write down in the value of slow moving or non-moving inventory could not be treated as of a capital nature was not dealt with in the order of the AO.

6. In this background, counsel appearing on behalf of the assessee has urged five submissions for the consideration of the Court. Firstly, it has been submitted that with respect to the amount of Rs. 1.12 crores, there could be no question of the AO forming a reason to believe that income has escaped assessment, because the assessee had itself disallowed it in its computation which has been accepted in the order passed by the AO on 22nd March, 2010. Secondly, on the balance of Rs. 29.23 lakhs, the submission is that a write down of inventory can never be regarded as being capital in nature. Thirdly, the AO has only made a reappraisal of the material on record and there was no tangible material for him to come to the conclusion that there is an escapement of income. Fourthly, the officer having accepted in reply to an audit query that what the assessee had done was right, the AO could have had no reason to believe that income had escaped assessment. Fifthly, the reference to the provisions of section 115JB by the AO while disposing of the objections of the assessee and in the affidavit in reply is incorrect. The amendment to section 115JB was brought into force by Finance Act 2 of 2009 (with retrospective effect from 1st April, 2001) and on the date on which the AO recorded his reasons for coming to the conclusion that the income has escaped assessment, these provisions were not on the statute book. Consequently, the validity of the reasons recorded by the AO cannot be determined with reference to the provisions as amended.

7. On the other hand, it has been urged on behalf of the Revenue that the assessee had made a provision as revenue expenditure. The assessee could well have reduced the value of closing stock instead of making a provision. The reopening of the assessment has taken place within a period of four years of the end of the relevant assessment year and it is open to the AO to come to the conclusion that income has escaped assessment. Moreover, the AO having failed to consider the issue, a case for reopening had, it is urged, been made out.

8. While considering the rival submissions, it would be necessary to record that the only basis on which the assessment has been sought to be reopened is that the assessee had incorrectly made a provision on account of diminution in the value of assets amounting to Rs. 1.41 crores by making a debit to the P&L a/c. According to the AO, this could not have been a charge on the profits of the company since the amount represented a provision made for a fall in the value of capital assets. Now, as the admitted material before the Court would show, it is undisputed that of the amount of Rs. 1.41 crores, an amount of Rs. 1.12 crores was reflected by the assessee in item 17 of the tax audit report as being a write down in the value of assets. The assessee had disallowed this amount in the computation of income. This has fairly been accepted by the AO in his order dt. 22nd March, 2010. That being the position, there is merit in the first submission which has been made on behalf of the assessee that there could have been no occasion for the AO to form a reason to believe that this part of the income (Rs. 1.12 crores) had escaped assessment. As regards the balance of Rs. 29.23 lakhs, the assessee in item 17(a) of the tax audit report clearly stated that this was a write down in the value of slow/non-moving inventory which was valued at its estimated realizable value and which was not in the nature of capital expenditure. The AO has perhaps mistakenly proceeded on the basis that since this amount is shown in item 17(a) of the tax audit report which is entitled “Expenditure of a capital nature”, it was to be regarded as of a capital nature. Ex facie the AO has missed the fact that the assessee had clearly stated that the amount of Rs. 29.23 lakhs was not in the nature of capital expenditure. But more importantly, in its objections dt. 18th March, 2010, the assessee clarified the position and stated that a write down in the value of inventory could never be regarded as of a capital nature. Evidently, that submission of the assessee is supported by the weight of judicial precedent. In Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC),a Constitution Bench of the Supreme Court referred to the principle that “closing stock is to be valued at cost or market price whichever is the lower” and the Supreme Court held that this is “now generally accepted as an established rule of commercial practice and accountancy”. The same principle was reiterated in a subsequent decision of the Supreme Court in CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108 : [1991] 188 ITR 44 (SC),where the Supreme Court once again considered it to be “a well recognized principle of commercial accounting to enter in the P&L a/c the value of stock-in-trade at the beginning and at the end of the accounting year at cost or market price, whichever is the lower”. The AO did not deal with the submission of the assessee while disposing of the objections.

9. We are conscious of the circumstance that the reopening of the assessment has taken place in the present case within a period of four years of the end of the relevant assessment year. But, it is now a settled position of law that though, after 1st April, 1989, the power to reopen an assessment is much wider than previously, the words “reason to believe” do not confer an arbitrary power upon the AO to reopen an assessment merely on the basis of a change of opinion. In CIT v. Kelvinator of India Ltd. [2010] 228 CTR (SC) 488 : [2010] 34 DTR (SC) 49 : [2010] 320 ITR 561 (SC), the Supreme Court held that the AO must possess tangible material to come to the conclusion that there is an escapement of income from assessment. Such tangible material is conspicuous by its absence in the present case. As a matter of fact, it would be necessary to refer to the response of the AO himself to an audit objection. In his response dt. 20th Jan., 2009, the AO stated, as regards the amount of Rs. 29.23 lakhs, that it was mentioned in clause 17 of the audit report that the. estimated realizable value of the inventory was considered “not in the nature of capital expenditure”.

10. In the circumstances, there is merit in the submission which has been made on behalf of the assessee that the reopening of the assessment is not founded on tangible material and that the AO has acted outside the fold of his jurisdiction.

11. In the present case, it would also be necessary to note that the reasons of the AO were recorded before the provisions of section 115JB were amended by Finance Act No. 2 of 2009 though w.e.f. 2001. As a result of the amendment, clause (i) has been inserted in Expln. 1 to the section which defines the meaning of the expression “book profits”. By the amendment, the amount or amounts set aside as provision for diminution in the value of the assets is to be added to the net profit as shown in the P&L a/c for the relevant previous year, prepared under sub section (2). When the reasons were recorded by the AO, this provision was not on the statute book and hence, could not have been referred to and, as a matter of fact, has not been referred to in support of the notice for reopening the assessment. Though the judgment of the Supreme Court in CIT v. Max India Ltd. [2007] 213 CTR ‘(SC) 266 : [2008] 166 Taxman 188 (SC), arose in the context of section 263, the principle that emerges is that the validity of a notice of the AO seeking to reopen an assessment would have to be determined on the law as it prevailed on the date of the notice for reopening of the assessment and has to be assessed with reference to the reasons recorded by the AO. This position has also been laid down in the judgment of this Court in Rallies India Ltd. v. Asstt. CIT (Writ Petn. No. 2514 of 2009, dated 4-3-2010) [reported at (2010) 37 DTR (Bom) 33 : (2010) 232 CTR (Bom) 143—Ed.].

12. For the aforesaid reasons, we allow the petition and make the rule absolute by setting aside the notice dt. 16th March, 2009 issued under section 148 by the first respondent seeking to reopen the assessment for assessment year 2004-05. There shall be no order as to costs.

[Citation : 332 ITR 587]

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