Case Law Details
Vishal Balvantrai Agarwal Vs PCIT (ITAT Ahmedabad)
Conclusion: AO conducted a detailed inquiry based on the information provided by assessee, satisfying the condition that AO had exercised due diligence within the scope of the limited scrutiny. The mere disagreement with the AO’s view did not make it erroneous, nor had any tangible prejudice to the Revenue been established. The conditions required to invoke Section 263, namely, the order being erroneous and prejudicial to the interest of the Revenue, were not satisfied in this case.
Held: Assessee, was a partner in four firms during the assessment year 2018-19, earning interest income and profits claimed as exempt under Section 10(2A). During the assessment year 2018-19, assessee earned Rs. 3,60,45,261 as interest from four partnership firms and reported a profit of Rs. 1,97,28,100, exempt under Section 10(2A). He claimed a deduction under Section 57 for interest expenses on borrowed funds used as capital contributions, asserting a direct nexus with the income earned. Assessee’s case underwent limited scrutiny regarding the deduction from income from other sources. AO issued notices under Section 142(1) inquiring about the Section 57 deduction. Assessee explained that borrowed funds were used for investments in partnership firms, generating interest income exceeding expenses. AO accepted the claim and approved the returned income as assessed income. PCIT examined the assessment records and found that AO had allowed the assessee’s interest expenses without adequate inquiry. He initiated revision proceedings under Section 263, highlighting two issues. First, he noted that the balance sheet lacked borrowing or investment figures, questioning the nexus for the Rs. 3,26,45,179 in claimed interest expenses, which he determined should have been disallowed. Second, he observed that assessee earned exempt income of Rs. 1,97,28,100 but failed to disallow any amount under Section 14A, stating that 1% of the investment ( Rs. 34,54,952 ) should have been disallowed. PCIT criticized the AO for not expanding the scope of scrutiny and rejected the assessee’s arguments. He ultimately set aside the assessment order under Section 143(3) and directed a fresh assessment on the interest expenses and disallowance issues. It was held that AO conducted a detailed inquiry based on the information provided by the assessee, satisfying the condition that AO had exercised due diligence within the scope of the limited scrutiny. The decision to allow the deduction under Section 57 was based on the available evidence. As per the Supreme Court’s dictum in Malabar Industrial Co. Ltd. vs. CIT, for an order to be revised under Section 263, it must be both erroneous and prejudicial to the interest of the Revenue. PCIT had failed to demonstrate that the AO’s order was fundamentally flawed. The mere disagreement with the AO’s view did not make it erroneous, nor had any tangible prejudice to the Revenue been established. In the present case, the interest income earned from the partnership firm exceeded the interest paid on the borrowed funds. Therefore, in line with these judicial precedents, PCIT’s contention that the order was prejudicial to the interest of the Revenue was not justified and could not be sustained. The conditions required to invoke Section 263, namely, the order being erroneous and prejudicial to the interest of the Revenue, were not satisfied in this case.
FULL TEXT OF THE ORDER OF ITAT AHMEDABAD
This appeal by the assessee arises against the order dated 30.03.2023 passed by the Principal Commissioner of Income Tax, Ahmedabad-1(hereinafter referred to as “PCIT”), under Section 263 of the Income Tax Act, 1961(hereinafter referred to as “the Act”), for the assessment year 2018-19. The assessee challenges the revisionary jurisdiction exercised by the PCIT, setting aside the assessment order dated 12.01.2021 passed by the Assessing Officer ((hereinafter referred to as “AO”) under Section 143(3) read with Sections 143(3A) and 143(3B) of the Act.
Facts of the Case:
2. The assessee, an individual, is a partner in multiple partnership firms. During the assessment year 2018-19, the assessee was a partner in four partnership firms: Vraj Corporations, Vimala Developers, Vishal Spintex, and Venus Denim. The assessee’s main income sources included interest income from capital invested in these firms and profits from these firms, which were claimed as exempt under Section 10(2A) of the Act. The assessee filed his return of income on 09.10.2018, declaring a total income of Rs. 36,65,880/-. The assessment was completed under Section 143(3) read with Sections 143(3A) and 143(3B) of the Act on 12.01.2021.
2.1. During the assessment year 2018-19, the assessee earned business income by way of interest of Rs. 3,60,45,261/- from his investments as a partner in the four partnership firms. The assessee also reported a profit of Rs. 1,97,28,100/- from these firms, which was exempt from tax under Section 10(2A) of the Act. Against this interest income, the assessee claimed a deduction of Rs. 3,26,45,179/- under Section 57 of the Act, as interest expenses on borrowed funds. The borrowed funds were utilised as capital contributions in the partnership firms, and the nexus between the borrowed funds and the income earned was claimed to be directly established.
2.2. The assessee’s case was selected for limited scrutiny. The scrutiny was limited to the issue of “deduction from income from other sources.” During the assessment proceedings, the AO issued notices under Section 142(1) dated 22.01.2020 and 11.11.2020, raising specific queries about the deduction claimed under Section 57. In response, the assessee provided detailed submissions along with supporting documents, including the balance sheet, bank statements, ledger accounts of the partnership firms, and details of funds borrowed from various parties. The assessee explained that the borrowed funds were directly utilised for investment in the partnership firms, thereby earning interest income, which was more than the interest expenses incurred. The AO, after considering the submissions and examining the documents, accepted the assessee’s claim and passed the order accepting the returned income as assessed income.
3. The PCIT, upon examining the assessment records, observed that the AO had allowed the interest expenses claimed by the assessee without conducting adequate inquiry or verification. The PCIT initiated revision proceedings under Section 263 of the Act, issuing a show cause notice to the assessee on 10.03.2023, proposing to revise the AO’s order.
3.1. The PCIT raised two primary issues:
(i) Disallowance of Interest Expenses Under Section 57: The PCIT noted that the assessee’s balance sheet showed no borrowing or investment figures, questioning the validity of the nexus between the borrowed funds and the interest income claimed under Section 57. The PCIT concluded that the assessee had failed to substantiate that the interest expenses were incurred exclusively for earning income from other sources. As a result, the PCIT held that the interest expenses of Rs. 3,26,45,179/- should have been disallowed and added back to the assessee’s income.
(ii) Disallowance Under Section 14A read with Rule 8D: The PCIT observed that the assessee earned exempt income of Rs. 1,97,28,100/-from partnership firms under Section 10(2A) but did not make any disallowance under Section 14A. According to the PCIT, an amount equal to 1% of the investment (Rs. 34,54,952/-) should have been disallowed under Section 14A. The PCIT held that the AO failed to expand the scope of limited scrutiny to address this issue, which rendered the assessment order erroneous and prejudicial to the interests of the revenue.
3.2. The PCIT rejected the assessee’s submissions dated 13.03.2023, wherein the assessee contended that the AO had conducted a detailed inquiry, raised specific queries, and considered all relevant facts before concluding that the interest expenses were allowable. The assessee also argued that disallowance under Section 14A was beyond the scope of limited scrutiny, and the net interest income being positive precluded any disallowance under Section 14A. The PCIT concluded that the AO had failed to make adequate inquiries and had not applied his mind properly while allowing the interest expenses under Section 57. The PCIT also found fault with the AO for not considering the disallowance under Section 14A, which the PCIT argued could have been examined by expanding the scope of scrutiny with the competent authority’s approval. Based on these observations, the PCIT set aside the assessment order passed under Section 143(3) and directed the AO to conduct a fresh assessment, specifically examining the issues of the allowability of interest expenses under Section 57 and the disallowance under Section 14A of the Act, read with Rule 8D of Income Tax Rules, 1962.
3. Aggrieved by the order of the PCIT, the assessee is in appeal before us with following grounds of appeal:
1. The learned CIT has erred in law and on facts in passing an order u/s 263, setting aside the assessment order passed by the learned AO u/s 143(3), r.w.s. 143(3A) & 143(3B) of the Act, with direction to make fresh assessment, which was neither erroneous nor prejudicial to the interest of revenue. The conditions of section 263 having not been satisfied the learned CIT has no jurisdiction to invoke provisions of section 263. It be so held now and the order passed by CIT under section 263 be cancelled.
2. The learned CIT has further erred in law and on facts in not accepting the detail submissions dated 13.03.2023. where from it was evident that the learned AO has taken a correct and legally permissible view after raising specific queries, detailed scrutiny and application of mind regarding expenditure claimed as deduction u/s 57 along with respective documentary evidence. The learned CIT ought not to have passed an order cancelling the said order of AO with direction to make fresh assessment which was neither erroneous nor prejudicial to the interest of the revenue simply because he held another view about the claim of deduction u/s 57 of the IT Act. It be so held now and the order u/s 263 be cancelled.
3. The learned CIT has erred in law and facts in not accepting the contention of the assessee raised vide letter dated 16.03.2023. Stating that the assessee’s case is selected for limited scrutiny assessment under, E-assessment scheme 2019 for the issue “deduction from income from other source”, and hence Suo moto revisional power under section 263 cannot be exercised on the issue not covered by the ‘Limited Scrutiny’, when the AO could not have possible examined such issue. The issue of disallowance u/s 14A read with rule 8B was not the issue under limited scrutiny and hence to find fault with the assessment order of the AO on this ground is beyond the scope of provisions of section 263 of the Act. It be so held now.
4. The learned CIT has erred in law and facts in not accepting the detail submissions dated 13.03.2023 stating that the provisions of section 14A cannot be invoked if net interest income offered is surplus as held by the jurisdictional High Court, and other court of laws. The assessee has declared interest income from partnership firms amounting to Rs 3,60,45,261/-, whereas interest expenses claimed are Rs 3,26,45,179/-. Net interest offered for tax is Rs 34,00,082/-. It be so held now.
5. The learned CIT has erred in law and facts is holding that the assessee has not declare interest income of Rs. 3,60,45,281/- from partnership firms along with share of profit aggregating Rs. 1,97,28,100/-, which is claimed as exempt u/s 10(2A) of the Act. It be so held now.
6. The learned CIT has erred in law and facts in not verifying the details submitted by the assessee such as Balance sheet, details of funds borrowed from various parties, bank statements, utilizations of funds in respective firm, copies of ledger accounts of partnership firm etc. to prove the direct nexus of the utilization of borrowed funds. The learned CIT failed to appreciate the fact that without borrowing of funds the assessee could not have earned interest income from partnership firms. Thus, there is direct nexus of expenses incurred for earning the income as required by provisions of section 57 or section 28 of the Income Tax Act. It be so held now.
7. The order of learned CIT u/s 263 is wholly unjust, illegal, invalid and bad in law. The learned CIT ought to have dropped the revision proceedings erroneously initiated by him. It be so held now, and order passed by CIT under section 263 be cancelled.
The appellant craves leave to add, amend, alter, edit, delete, modify or change any of the grounds appeal at the time of or before the hearing of the appeal.
4. During the course of hearing before us, the Authorized Representative (AR) of the assessee stated that the assessee has wrongly claimed the interest expense u/s 57 of the Act and the same should have been claimed as expense under the head business expense. The AR also stated that it is the case of change of wrong head of expense because of which the valid claim should not be denied. The AR placed his reliance on the judgement of Hon’ble High Court of Punjab and Haryana in case of CIT, Ludhiana Vs. M/s Hero Cycles Ltd. The AR further argued that the PCIT has not disputed the nexus between interest income and interest expense and therefore the proposed adjustment is tax neutral. The AR explained the cash flow to establish the nexus between funds borrowed and transferred to firm’s account which was submitted to lower authorities. So far as allowability of interest expense, the AR placed reliance on judgment of Hon’ble Supreme Court in case of CIT, West Bengal III, Calcutta Vs Rajendra Prasad Moody (1979 AIR 373) and decision of Coordinate bench in case of Mayank Ratibhai Patel Vs. ITO (ITA No. 2011/Ahd/2018 dated 20-07-2022). The AR also argued that case was selected for limited scrutiny specifically to examine the “deduction from income from other sources.” This defined the scope of the AO’s assessment. The AO was neither required nor permitted to expand this scope to examine other issues, such as disallowance under Section 14A, without prior approval from the competent authority. The AR stated that PCIT’s observation and suggestion that the AO should have expanded the scope of scrutiny with approval to examine disallowance under Section 14A read with Rule 8D reflects a mere difference of opinion rather than pointing to any procedural or legal error and the AO’s decision not to expand the scrutiny was correct and in line with the scope of limited scrutiny assessments.
5. On the other hand, the Departmental Representative (DR) relied on the order of PCIT and stated that the reason for limited scrutiny was deductions from income from other sources u/s.57 of the Act, which was claimed in return of income and assessee has failed in establishing the nexus between such deduction and income from other sources. The DR placed reliance on the decision of Mumbai Bench in case of Chomansingh M. Deora. v. PCIT (ITA No. 401/Mum/2023 dated 07-09-2023). The DR also stated that the assessee has not disclosed investment in the ITR to claim deduction u/s 57 of the Act. The DR also stated that the PCIT’s power u/s. 263 of the Act is not limited to reasons for which the limited scrutiny was made, and he can go beyond the scope of the limited scrutiny. The DR placed reliance on the judgement of High Court of Kerala in case of Sahyadri Agencies Ltd. Vs. PCIT reported at [2023] 149 taxmann.com 202. The DR stated that the PCIT has assumed his jurisdiction in accordance with Explanation 2 to section 263 of the Act, after observing that the AO has passed order without making enquiries and verification which should have been made.
6. In rejoinder, the AR stated that the AO has enquired in detail about the interest and after satisfying himself has allowed the claim of interest as expenses. The issue is only related with the head of income under which expense was claimed. The assessee has already explained the investments during the course of assessment by way of submission of financial statements and the investments are primarily capital in partnership firms.
7. We have heard the rival contentions and perused the material available on record. Section 263 of the Income Tax Act, 1961, empowers the Principal Commissioner of Income Tax (PCIT) to revise an assessment order, if it is found to be erroneous and prejudicial to the interests of the Revenue. The twin requirements for invoking Section 263, as laid down by the Hon’ble Supreme Court in Malabar Industrial Co. Ltd. vs. CIT [(2000) 243 ITR 83 (SC)], are that (i) the order of the AO must be erroneous, and (ii) it must be prejudicial to the interest of the Revenue. If either of these conditions is not met, the PCIT cannot validly exercise jurisdiction under Section 263. In the present case, the PCIT invoked Section 263 of the Act on the grounds that the Assessing Officer (AO) failed to adequately verify the allowability of interest expenses claimed under Section 57 and did not consider disallowance under Section 14A, thereby rendering the assessment order erroneous. The assessee’s case was selected for limited scrutiny under the Computer Aided Scrutiny Selection (CASS), specifically to examine the “deduction from income from other sources” under Section 57 of the Act. As per CBDT Circulars and guidelines, the AO is required to confine his examination strictly to the issues flagged under limited scrutiny unless approval for expanding the scope is obtained from the competent authority.
7.1. In Sahyadri Agencies Ltd. vs. PCIT, the Hon’ble Kerala High Court dealt with whether the PCIT can invoke Section 263 in the context of limited scrutiny when the AO failed to examine certain transactions due to the assessee’s non-cooperation during assessment proceedings. The Court emphasised that the PCIT’s powers are supervisory, allowing intervention where the AO’s lack of verification results in an erroneous and prejudicial order. Paragraph 4.1 of the Sahyadri judgment noted:
“The Commissioner further noticed that due to the assessee’s non-cooperation during assessment proceedings, the Assessing Officer did not verify the details regarding the applicability of provisions of Section 56(2)(viib) and Section 68 of the Act and these transactions undertaken by the assessee company during the relevant Financial Year.”
7.2. The non-consideration of the effect of these transactions due to a lack of inquiry constituted an omission that justified invoking Section 263 in case of Sahyadri Agencies Ltd.. The factual matrix in the present case is different and therefore, the reliance placed by the DR in the case of Sahyadri Agencies Ltd. is distinguished. When the AO fails to conduct an inquiry into specific aspects of the case, especially when prompted by incomplete or noncooperative behaviour from the assessee, the PCIT is within his rights to revise the order to address such omissions.
7.3. In the present case, unlike in Sahyadri Agencies, the AO conducted a detailed inquiry during the assessment proceedings. In contrast to the facts in Sahyadri Agencies, where the AO did not verify key aspects due to noncooperation, the present case demonstrates that the AO engaged in a detailed examination within the permissible scrutiny limits. The PCIT’s intervention appears to stem from a difference of opinion rather than any substantive omission by the AO. The AO issued notices under Section 142(1) specifically querying the deduction claimed under Section 57. The assessee responded promptly and cooperatively by providing all relevant details, including balance sheets, bank statements, details of borrowed funds, and ledger accounts of partnership firms. The AO thoroughly examined these submissions and applied his mind to the issue, concluding that the interest expenses were allowable. The inquiry conducted was within the scope of the limited scrutiny as mandated, and there was no failure on the part of the AO to verify the nexus between the interest expenses and the income earned.
7.4. While the PCIT’s powers under Section 263 are broad, these powers do not allow an arbitrary expansion beyond the limited scrutiny scope without clear evidence of the AO’s omission or error. The exercise of revisionary powers under Section 263 of the Act cannot be a tool to expand the scope of scrutiny unless the order passed by the AO shows a clear lack of inquiry into the issues flagged under the limited scrutiny or those directly related. The mere non-examination of a tangential issue does not make the order erroneous. In the present case, the AO conducted a detailed inquiry based on the information provided by the assessee, satisfying the condition that the AO had exercised due diligence within the scope of the limited scrutiny. The decision to allow the deduction under Section 57 was based on the available evidence. As per the Supreme Court’s dictum in Malabar Industrial Co. Ltd. vs. CIT, for an order to be revised under Section 263 of the Act, it must be both erroneous and prejudicial to the interest of the Revenue. The PCIT has failed to demonstrate that the AO’s order was fundamentally flawed. The mere disagreement with the AO’s view does not make it erroneous, nor has any tangible prejudice to the Revenue been established.
7.5. We have considered the judicial precedents relied on by the AR and noted that the allowability of expenditure under Section 57(iii) does not depend on whether the income was actually earned but on whether the expenditure was laid out wholly and exclusively for the purpose of earning income. In the present case, the AO allowed the interest expenses after verifying the submissions. The Co-ordinate Bench of the Tribunal, in case of Mayank Ratibhai Patel, held that if the nexus between the borrowed funds and the income earned is established, the interest expenses are allowable. The AO, in this case, conducted a similar verification based on the documents submitted by the assessee and took a permissible view. The PCIT’s attempt to revisit the same issue constitutes a mere change of opinion, which is not permissible under Section 263 of the Act. The Hon’ble High Court of Punjab and Haryana, in case of Hero Cycles Ltd., held that a deduction cannot be denied merely because it has been claimed under an incorrect head, provided the overall tax impact remains neutral. In the present case, the AR argued that even if the deduction was claimed under a different head, the PCIT’s interference was unwarranted as the AO had considered all the relevant factors and the claim was ultimately tax neutral.
7.6. Numerous judicial precedents, including the judgement of Jurisdictional High Court in case of Nirma Credit and Capital Pvt. Ltd. (Tax Appeal No. 514 of 2017) have held that Section 14A cannot be invoked when the interest income earned is greater than the interest expenditure, resulting in a net taxable income, and where the primary purpose of borrowing was not to generate exempt income. The assessee placed reliance on the decision of Nirma Credit and Capital Pvt. Ltd. in the submission before PCIT, which was not considered by the PCIT. In the present case, the interest income earned from the partnership firm exceeds the interest paid on the borrowed funds. Therefore, in line with these judicial precedents, we conclude that the PCIT’s contention that the order is prejudicial to the interest of the Revenue is not justified and cannot be sustained.
7.7. In light of the above analysis and judicial precedents, it is evident that the AO conducted a proper inquiry and took a reasonable view within the scope of limited scrutiny. The conditions required to invoke Section 263, namely, the order being erroneous and prejudicial to the interest of the Revenue, are not satisfied in this case. Therefore, the revisionary order passed by the PCIT is unjustified and is accordingly quashed. Accordingly, the appeal of the assessee is allowed.
8. In the result, the appeal of the assessee is allowed.
Order pronounced in the Open Court on 25th September, 2024 at Ahmedabad.
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