Supreme Court: Under Section 263 of Income Tax Act, CIT has Revision Powers Over Erroneous Order Issued by AO Causing Prejudice to Revenue

Supreme Court: Under Section 263 of Income Tax Act, CIT has Revision Powers Over Erroneous Order Issued by AO Causing Prejudice to Revenue

The Supreme Court by its division bench of Justices M.R. Shah and A.S. Bopanna held, that in order to exercise the jurisdiction under Section 263(1) of the Income Tax Act, 1961 (the Act) the Commissioner must be satisfied of twin conditions, namely, (i) the order of the Assessing Officer sought to be revised is erroneous; and (ii) it is prejudicial to the interests of the Revenue. It further observed that if one of them is absent, recourse cannot be taken, as per Section 263(1) of the Act.

In the present case, an appeal was filed by the Commissioner of Income Tax (CIT) against the respondent- M/s. Paville Projects Pvt. Ltd.

The brief background of the case is that the respondent assessee was engaged in manufacture and export of garments, shoes etc. It filed its income tax return for the AY 2007-08 wherein it showed sale of the property / building “Paville House” for an amount of Rs. 33 crore. That, the building “Paville House” was constructed by the assessee on the piece of land which was purchased in the year 1972. The said house of the company was duly reflected in the balance sheet of the company.

There was ongoing litigation between the shareholders of the Company being family members, culminated in arbitration proceedings, where an interim award was passed in terms of a “family settlement” recorded between the parties. In terms of the arbitral award, the shareholders were to be paid a certain sum. As per the assessee, the property / building owned by it was sold to discharge the said encumbrances, i.e., the amount payable to its shareholders.

In its income tax return filed for the relevant assessment year, the respondent/assessee showed the sale proceeds of the property as “long term capital gains,” after deducting the amount paid to its shareholders towards settlement of litigation. The assessee claimed that the said amount was deductible as “cost of improvement” under the Income Tax Act. The assessment was completed on 15.12.2019 by the Assessing Officer (AO) under Section 143(3) of the Act accepting the “long term capital gains” as per sheet attached in computation of income.

Thereafter, the CIT passed an order under Section 263 of the Income Tax Act setting aside the assessment order passed by the AO.

The CIT, in its order, held that the assessment order was erroneous and prejudicial to the interest of the Revenue on the issue relating to the deduction claimed by the assessee. It opined that the said deduction claimed by the assessee did not fall under the definition of “cost of improvement” under Section 55 (1)(b) of the Income Tax Act.

In an appeal filed before the Income Tax Appellate Tribunal (ITAT) against the order of the CIT, the ITAT concluded that the CIT had wrongly invoked the jurisdiction under Section 263 of the Income Tax Act. The ITAT upheld the assessee’s claim of deduction and set aside the order of the CIT.

Subsequently, the revenue department’s appeal against the ITAT’s order was dismissed by the Bombay High Court, who affirmed the ruling passed by the ITAT. The High Court ruled that the amount paid towards settlement was deductible by the assessee under Section 55(1)(b) of the Income Tax Act.

Hence, the CIT filed an appeal before the Apex Court.

The Court noted that the Commissioner, in exercise of the powers under Section 263 of the Income Tax Act and in exercise of the revisional jurisdiction, set aside the assessment order by specifically observing that the assessment order was erroneous as well as prejudicial to the interest of the Revenue. However, the High Court by the impugned judgment and order had set aside the order passed by the Commissioner by observing that the Commissioner wrongly invoked the powers under Section 263 of the Act.

The Apex Court while referring to the case Malabar Industrial Co. Ltd. Vs. CIT 2000, observed that in order to exercise the jurisdiction under Section 263(1) of the Income tax Act, the Commissioner must be satisfied of twin conditions, namely, (i) the order of the Assessing Officer sought to be revised is erroneous; and (ii) it is prejudicial to the interests of the Revenue. It is further observed that if one of them is absent, recourse cannot be had to Section 263(1) of the Act.

“The scheme of the Act is to levy and collect tax in accordance with the provisions of the Act and this task is entrusted to the Revenue. It is further observed that if due to an erroneous order of the Income Tax Officer, the Revenue is losing tax lawfully payable by a person, it will certainly be prejudicial to the interests of the Revenue. However, only in a case where two views are possible and the Assessing Officer has adopted one view, such a decision, which might be plausible and it has resulted in loss of Revenue, such an order is not revisable under Section 263,” discerned the Court.

The Court while going through the assessment order as well as the order passed by the Commissioner of Income Tax, was of the view that the assessment order was not only erroneous but prejudicial to the interest of the Revenue also.

In this regard, the Court opined that in the facts and circumstances of the case, it could not be said that the Commissioner exercised the jurisdiction under Section 263 not vested in it.

While holding that the erroneous assessment order passed by the AO had resulted into loss of the Revenue in form of tax, the bench remarked that the Bombay High Court had committed a ‘very serious error’ in setting aside the order passed by the CIT in exercise of its revisionary powers under Section 263 of the Income Tax Act.

The Court thus, restored the order passed by the CIT.