Practical Aspects in Income Tax Scrutiny proceedings

We are in month of July and the due date of completion of assessment i.e. 31^st December is fast approaching. There are many issues which my professional colleagues ignore while appearing for assessment proceedings before Assessing Officer [AO]. In this article, I tried to highlight some of those issues.

Scrutiny assessment refers to the examination of a return of income by giving an opportunity to the assessee to substantiate the income declared and the expenses, deductions, losses, exemptions, etc. claimed in the return with the help of evidence.

Selection of Cases for Scrutiny Assessment:

Presently the returns of income filed by the tax payers are accepted by the Income Tax Department without any questions. Only a small percentage of cases are getting selected for scrutiny. The cases are mostly selected through the process of computer assisted scrutiny selection (CASS) and there is no element of subjectivity in this process.

In addition to the above CASS system, the cases where there is information about concealment of income, which may be based on an enquiry report, survey report or any other source, can also be selected for scrutiny. Only deserving cases are identified for scrutiny assessment in this manner. The selection in this manner is made by the AO only with the approval of higher authorities so that the selection is fair and proper.

There is yet another category of cases in which scrutiny assessment is framed under section 143(3) of the Act. There is a provision in the Income Tax Act which enables the reopening of cases where there is reason to believe that any income has escaped assessment. This reopening can be resorted to even in cases which had been subjected to scrutiny assessment earlier. A case can be reopened within a period of four/six years from the end of the relevant assessment year depending upon the situations.

Further if any person has undisclosed Income / assets and he has not disclosed the same in the recently concluded Income Declaration Scheme, in that case the case of the assessee can be reopened beyond six years. Section 147 of the Income Tax Act deals with the same, which says that

“Where any income has accrued, arisen or received or any asset has been acquired out of such income prior to commencement of this Scheme, and no declaration in respect of such income is made under this Scheme,—

1. such income shall be deemed to have accrued, arisen or received, as the case may be; or
2. the value of the asset acquired out of such income shall be deemed to have been acquired or made,

in the year in which a notice under section 142, sub-section (2) of section 143 or section 148 or section 153A or section 153C of the Income-tax Act is issued by the Assessing Officer, and the provisions of the Income-tax Act shall apply accordingly.”

Category of Assessment:

CBDT has classified the assessments in two categories namely:

(A) Limited Scrutiny (B) Detailed Scrutiny

(A) Limited Scrutiny

The CBDT had issued an important Guidelines for selection of returns for Complete Scrutiny during the financial-year 2019-20 vide Guidelines No F.No.225/169/2019/ITA-11.

The parameters for selection of returns for Complete Scrutiny during financial year 2019- 20 are as under.-

(i) Cases involving addition in an earlier assessment year(s) on a recurring issue of law or fact:-

(a) exceeding Rs. 25 lakhs in eight metro charges at Ahmedabad, Bengaluru, Chennai, Delhi, Hyderabad, Kolkata, Mumbai and Pune while at other charges, quantum of addition should exceed Rs. 10 lakhs;

(b) exceeding Rs. 10 crore in transfer pricing cases.

and where such an addition:-

1. has become final as no further appeal has been filed against the assessment order; or
2. has been confirmed at any stage of appellate process in favor of revenue and assessee has not filed further appeal; or
3. has been confirmed at the 1^st stage of appeal in favor of revenue or subsequently; even if further appeal of assessee is pending, against such order.

(ii) Cases pertaining to Survey under section 133A of the Income-tax Act, 1961 (‘Act’) excluding those cases where books of accounts, documents, etc. were not impounded and returned income (excluding any disclosure made during the Survey) is not less than returned income of preceding assessment year. However, where assessee has retracted from disclosure made during the Survey, such cases will be considered for scrutiny.

(iii) Assessments in search and seizure cases to be made under section(s) 153A, 153C, 158BA, 158BC & 158BD read with section 143(3) of the Act and also for return filed for assessment year relevant to previous year in which authorization for search and seizure was executed under section 132 or 132A of the Act.

(iv) Cases where registration/approval under various sections of the Act such as 12A, 35(1)(ii)/(iia)/(iii), 10(23C), etc. have not been granted or have been cancelled/withdrawn by the Competent Authority, yet the assessee has been found to be claiming tax-exemption/deduction in the return. However, where such orders of withdrawal of registration/approval have been reversed/set-aside in appellate proceedings, those cases will not be selected under this clause.

(v) Cases in respect of which specific information pointing out tax-evasion for the relevant year is given by any law-enforcement/intelligence/regulatory authority or agency. However, before selecting a return for scrutiny under this criterion, Assessing Officer shall take prior administrative approval from jurisdictional Pr. CIT/Pr.DIT/CIT/DIT concerned.

Through Computer Aided Scrutiny Selection (CASS), cases are being selected in two categories viz. Limited Scrutiny & Complete Scrutiny in a centralized manner under CASS-2019. CASS is a system-based method for scrutiny selection which identifies the cases through data-analytics and three-hundred sixty-degree data profiling of taxpayers and in a non-discretionary manner. The list of these cases is being/has been separately intimated by the Principal DGIT(Systems) to the Jurisdictional authorities concerned for further necessary action. In respect of cases selected under CASS cycle 2019, the following guidelines are specified.

(i) Cases where returns are selected for scrutiny through CASS but are not verified by the assessee within the specified period of e-filing and such returns remain unverified before the due date for issue of notice u/s 143(2), should be reopened by issue of notice under section 148 of the Act.

(ii) Cases selected for ‘Limited Scrutiny’ but credible specific information has been/is received from any law-enforcement/intelligence/regulatory authority or agency regarding tax-evasion in such cases, then only issue(s) arising from such information can be examined during the course of conduct of assessment proceedings in such ‘Limited Scrutiny’ cases, with prior administrative approval of the Pr. C!T/CIT concerned as per the procedure laid down in Board’s letter dated 28.11.2018 issued vide No.225/402/2018/ITA.II. In such ‘limited Scrutiny’ cases, Assessing Officer shall not expand the scope of enquiry/investigation beyond the issue(s) on which the case was flagged for ‘Limited Scrutiny’ and the issue(s) arising from the information received from the above referred agency or authority.

It means subject to incriminating evidences & approval of higher Authority, Limited scrutiny can be converted in to details scrutiny. A sample of notice u/s 143(2) of Limited Scrutiny is given below for understanding:

“Notice under section 143(2) of the Income Tax Act, 1961

Limited Scrutiny

This is for your information that return of income for assessment year 2019-20 filed on 24/01/2020 has been selected for scrutiny. Following issues have been identified for examination

(i) Derivative (Future) transactions

(ii) Salary Income Mismatch.

I view of the above, we would like to give you an opportunity to produce or cause to be produced, any evidence which you feel is necessary in support of the said return.”

(B) Detailed Scrutiny Assessment:

In this proceeding, AO makes a detailed inquiry on each and every aspect of the Return of Income.

• The procedure begins with a Notice u/s 143(2) which is the key to open the door of scrutiny proceedings. It needs to be “Served” on an assessee prior to expiry of six months from the end of the financial year in which the return is furnished. Assessment framed u/s 143(3) without serving notice u/s 143(2) shall be void-abinitio. It was held by the Supreme Court in case of Hotel Blue Moon that “Omission on the part of the assessing authority to issue notice under section 143(2) cannot be a procedural irregularity and is not curable.
• It is followed by a notice u/s 142(1) calling for various information by AO for carrying out the assessment.
• AO shall consider all the information furnished by an assessee at the assessment stage in response to his notices or queries raised vide order sheet entries.
• AO shall issue a Show Cause Notice (SCN) intimating the assessee about the additions which he proposes to make in the assessee’s case.
• Assessee shall furnish a reply in response to such SCN which shall be considered by AO prior to making the additions.
• AO can use some special powers in assessment proceedings like:
  • As per section 131(1), AO may issue “Summons” to any person for discovery and inspection, enforcing attendance and for compelling production of books of accounts.
  • As per section 131(3), AO may impound and retain books of accounts or any other document produced before him during the assessment proceedings.
  • As per section 133(6), AO may call for information from third parties.
• Finally, an Asst Order shall be passed u/s 143(3).
  

Precaution to be taken in assessment proceedings:

♥ Assessment proceedings commences with the issue of notice under Section 143(2). The assessee takes it lightly that it is a formal notice. This is not a correct approach since when the question whether adequate opportunity is given or not, the formal notice is also considered. In reply to the first notice, there should be some written communication with the AO.

♥ Preparation of details in response to Notice of AO

• On receipt of Notice a detailed list of documents required from the assessee should be prepared and should be immediately inform to the assessee with date of hearing so as to enable its timely compliance.
• The reply should be prepared point wise as per notice / questionnaire received from AO.
• A proper index of papers should be prepared and all the papers in the file should be numbered so as to help the assessing officer to locate the papers easily. All supporting documents regarding the explanations given in the submission should be duly attached with reference page no. This helps in completion of security assessment in smooth manner.
• Any document which are not being submitted at the time of hearing should be specifically noted and informed that those will be submitted in due time or those cannot be submitted.
• A proper covering letter should always accompany the submission.
• Even if no documents are ready or able to be produced on the date of hearing, at-least a letter stating that it should be submitted to the department informing the inability.
  

♥ Whenever difficult query is raised, the assessee at times either gives vague reply or avoids to give reply. This is very risky. In fact, the assessee should try to find out the proper reply and should give the reply with adequate evidences. This is because it is difficult to produce additional evidence before the appellate stage. Non-compliance of notices under Sections 142(2) and 143(2) attracts penalties as per law.

♥ Before making any addition in the assessment, the AO normally issues final show cause notice or makes entry in the order sheet and inform the Authorised Representative about the same. Assessee should make sure about timely compliance of this notice because the AO will not wait for the reply after the specified date of the compliance and will make the addition. It will be more difficult to defend these types of additions in appellate proceedings.

Other Important Points to remember in assessment proceedings:

1. Ad-hoc additions / suspicion is not permissible in Assessment proceedings

Many a times we found that certain % of the Expenditure has been disallowed on ad-hoc basis by the AO(like ad-hoc disallowance of 20% of travelling expenditure being personal in nature). Hon’ble Supreme Court in the case of Dhakeshwari Cotton Mills has held that Ad-hoc disallowance is not permissible in Assessment proceedings. As per the Apex court there must be something more than bare suspicion to support the assessment u/s 143(3).

2. Notice deemed to valid in certain circumstances:

Section 292BB provides that where an assessee has appeared in assessment proceedings or co-operated in any proceedings or co-operated in any inquiry related to an assessment or reassessment, it shall be deemed that any notice under the provisions of the act has been duly served upon him in time in accordance with the provisions of the Act. Further, such an assessee shall be precluded from taking any objection in any proceedings or inquiry under the act that notice was not served upon him or served in an improper manner. However the provisions of section 292BB shall not be applicable where the assessee raised the aforesaid objection before the completion of the assessment.

3. Presumption and burden of proof in assessment:

This presumption applies to the bona fides of the assessee’s transactions as well as his accounts. It cannot be presumed that an assessee is a notorious black marketer or smuggler or Hawala Dealer or that, in the circumstances prevalent in the accounting year, he must have entered into transactions not lawful, above board or dishonest. The presumption is similarly regarding his books of account, that the entries in the account books are made in the ordinary course of business and there is no concealment of income. The books of account maintained in the regular course of business are relevant and afford prima facie proof of the entries and the correctness thereof. It is for the department to prove to the contrary and there should be adequate grounds for disbelieving the accounts. It is for A.O. to prove that there is income from that source. The assessee cannot prove the negative.

Where an assessee produced unsatisfactory and unbelievable evidence the department can reject the same and need not produce contrary evidence before drawing an adverse inference against the assessee. Again, if the income was shown as having suddenly diminished from the previous year, the onus will be on the assessee to explain. The onus is on the assessee to show that his return is correct, as all the facts are exclusively in his knowledge and that he has incurred a loss.

4. Principle of Natural Justice should be followed

The principle of Natural justice is applicable to assessment proceedings and the assessee should have knowledge of the material that is proposed to be used against him, in order to enable him to rebut it. If the A.O. proposes to act on such material as he might have gathered as a result of his private inquiries behind the back of the assessee, he must disclose the substance of all such material, though not the sources thereof to the assessee and if this is not done, the principle of natural justice stands violated. An order passed in violation of principle of natural justice may not, however, render the act one totally outside the Act. It may still be an order under the Act liable to be corrected or set-aside to be redone after complying with such principle.

5. Value of Audit Report when books were destroyed

Where the books of account of an assessee are examined and audited under statutory provisions and audit report is submitted thereabout, reliance could be placed by the income tax authorities on such a report treating the same as “a material” in case the books of account of the assessee were destroyed by fire etc. This is so because an auditor is required by the statute to find out if the deductions claimed by the assessee in its balance sheet and profit and loss account are supported by the relevant entries in assessee’s books of account. Therefore, it may be presumed that the auditor has done so and has found that the books of account supported the claim for deductions made by the assessee.

6. Additional Claim before AO in assessment proceedings :

Hon’ble Supreme Court in case of Goetze (India) Ltd held that AO cannot entertain any new claim made by the assessee otherwise than by way of revised return. However, there is no such barrier to make additional claim in appellate proceedings. It is always wise for the assessee to make new claim, if any, along with all supporting documents before the AO only, so that they have a strong case in appellate proceedings and that shall not be treated as additional evidence in appellate proceedings.

7. Cross Examination of Witness:

If an assessing authority is relying on the testimony of a witness, the assessee is to be afforded an opportunity to cross-examine him. It is not open to the assessing authority to get over this hurdle on the plea that the witness had not been produced by the assessee. Gujarat High Court in case of D.M. Joshi held that, in the absence of any opportunity for cross- examination, the assessment is invalid. The cross-examination depends upon the facts of each case.

Hon’ble Supreme Court in case of Kishinchand Chellaram held that though the proceedings under the Income-tax Act are not governed by the strict rules of evidence, the department is bound to afford an opportunity to controvert and cross examine the evidence on which the department places its reliance. Opportunity of cross examination must be given. The consequence of breach of natural justice is that either the addition is void or matter may have to be to be remanded to lower authorities.

8. Method of accounting section 145

Section 145 lays down the Method of Accounting. The section states, briefly, that the assessee’s income will be computed in accordance with the cash or mercantile system of accounting regularly employed by the assessee. Section 145(3) also lays down that where the AO is not satisfied about the correctness or completeness of the accounts, or if the accounting standards have not been regularly followed, the AO may make a best judgment assessment as in sec. 144. The principle, that there should be a loss to revenue for invoking sec. 145, was reinforced in case of Realest Builders and Services (SC) where the assessee chose to adopt a different method of accounting. The SC held that a vital aspect to be seen is whether the method adopted by the assessee results in underestimation of profits, for which the facts and figures to demonstrate this have to be given by the AO. This case also serves to highlight the importance of burden of proof, viz. The AO has to show by evidence that the assessee’s claim was untenable.

9. Past History :

An assessment cannot be based on a presumption relating to some issues in the earlier years. Past history may be legitimate material but that is not sufficient by itself without more, to justify assessment in a particular year. There must be some material relatable to the accounting, which taken with the past history may reasonably entitle the AO to hold that there must in fact have been concealed income during the accounting year which is liable to assessment.

10. Principle of ‘Res Judicata’ and it’s Exceptions:

Though the principle of “res judicata” has no application to proceedings under the Income Tax Act and the finding reached for one particular assessment year cannot be held to be binding in the assessment proceedings for subsequent years, yet this general rule is subject to the qualification that a finding reached in the assessment proceedings for an earlier year, after due enquiry, would not be reopened in a subsequent year if it is not arbitrary or peverse, and if no fresh facts are found in the subsequent assessment year. Hon’ble SC in case of Radhasoami Satsang held that in the absence of any material change justifying the Department to take a different view from that taken in earlier proceedings, it is not permissible to take different and contradictory stand in a subsequent year with regard to the exemption earlier granted. The fact that the departmental officers took a particular view of the statutory provisions at an early stage will not stop them from taking a corrective view of the statutory provisions at a later point of time.

11. Non service of Notice u/s 133(6):

During the course of assessment proceedings, AO generally sends notice u/s 133(6) to get confirmation from third party to verify the claim of the assessee. In case the notice u/s 133(6) gets un-served, AO generally makes addition by giving reason of non service of notice. Mumbai ITAT in case of Eagle Impex held that only non service of notice u/s 133(6) should not be made basis for making addition in the hands of the assessee and if any addition made by the AO solely on that basis, that is liable to be deleted. While filing the details with the AO, the assessee should ensure that they are submitting the latest addresses of different parties as asked by the AO to avoid above circumstances.

Conclusion:

Majority of the additions made in the assessment proceedings is due to non – compliance of the notices issued by the AO. A proper care should be taken while responding the queries / notices of the AO. As a professional our responsibility should be like due to our negligence, the assessee should not suffer and at the same time it is the responsibility of the assessee to provide the details on time for timely compliance of notices of AO.

DISCLAIMER: The information contained in this write up has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. It cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. The Author, it’s Firm, its partners and employees do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it. In case of any query / suggestions regarding the same, please mail at bikashbogi@sbrca.in.

(Author is partner with SBR & CO., Chartered Accountants, Mumbai)

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(Republished with Amendments by Team Taxguru)