2016 (2) TMI 1061 - HC - Income Tax

Reopening of assessment - loss as a result of fluctuation in foreign exchange derivatives - Held that - The escapement of income by itself is not sufficient for reopening the assessment in a case covered by the first proviso to Section 147 of the said Act and unless and until there was failure on the part of the assessee to disclose fully and truly all the material facts necessary for assessment, the power to reopen the assessment should not be invoked. It was insisted that the reasons for reopening of the assessment should specifically indicate which material fact was not disclosed by the Assessee in the course of the original assessment under Section 143(3) of the Act failing which there should not be any reopening of the assessment. The submission of Mr. Manchanda that relevant and material facts have to be specifically discussed in the returns of income of the tax audit report appears to overlook the fact that the Assessee cannot be expected to guide the AO on how he should scrutinize the accounts. In the letter dated 28th November 2011 of the Assessee in reply to the query of the AO in the original assessment proceedings, there was a whole note on exchange fluctuation enclosed in the form of Annexure-B. Despite this it cannot be said that the AO was ignorant of what the Assessee was doing in respect of foreign exchange loss while accounting for derivatives contracts. The change in the method of accounting and the consequential change in the loss figure have been adequately explained by the Assessee. Under Note J in the Statement of significant accounting policy in Schedule 22 to the audited annual accounts, the Assessee had made a distinction between foreign exchange contracts not intended for trading and speculative purposes and those for trading and speculative purposes. It is, therefore not possible to accept the plea of the Revenue that there was any deliberate failure on the part of the Assessee to make full and true disclosure of the change in the accounting policy that led to computation of loss as a result of fluctuation in foreign exchange derivatives. This has to be also appreciated in the context of the Assessee following the mercantile system of accounting and Section 145 of the Act. The income of the Assessee is to be computed consistent with the regular method of accounting followed by the Assessee. The Assessee has been following AS-11 and AS-30 issued by the ICAI, in terms of which the loss/gains on outstanding derivatives contracts are to be recognized on mark to market basis. The Assessee is right in contending that CBDT Instruction No. 3 of 2010 cannot possibly override the existing decisions of the Supreme Court/ High Court on similar issues. - Decided in favour of assessee.

Issues Involved:
1. Validity of notice issued under Section 148 of the Income Tax Act, 1961 for reassessment.
2. Alleged failure of the Assessee to disclose true particulars of its income.
3. Increase in financial charges and their relation to short-term investments.
4. Disallowance of foreign exchange loss on mark-to-market basis.
5. Whether the reassessment was based on new tangible material or a mere change of opinion.

Detailed Analysis:

Validity of Notice Issued Under Section 148:
The Assessee challenged the validity of a notice dated 11th March 2013 issued by the Deputy Commissioner of Income Tax (DCIT) under Section 148 of the Income Tax Act, 1961, proposing to reassess the income for the Assessment Year (AY) 2008-09 on the grounds that income had escaped assessment. The Court examined whether the Assessee had made complete disclosure during the original assessment proceedings and whether there was any new tangible material available for forming the reason to believe that income had escaped assessment.

Alleged Failure of the Assessee to Disclose True Particulars:
The DCIT alleged that the Assessee failed to disclose the true particulars of its income, particularly regarding the substantial financial charges and foreign exchange loss. The Assessee contended that all relevant queries were raised and replied to during the original assessment proceedings, and the original assessment order was passed after exhaustive verification.

Increase in Financial Charges:
The DCIT noted an increase in financial charges to Rs. 2,27,24,801 compared to Rs. 60,58,887 in the previous year, primarily due to short-term investments through borrowed funds. The Assessee argued that the investments were made in a Growth Plan, which did not yield any exempt income, and therefore, no disallowance could be made under Section 14A of the Act read with Rule 8D of the Rules.

Disallowance of Foreign Exchange Loss:
The DCIT also noted a foreign exchange (FE) loss of Rs. 1,71,43,726 claimed on a mark-to-market (MTM) basis, which was considered notional and contingent, thus not allowable. The Assessee argued that the loss was allowable as business deduction under Section 37(1) of the Act, following the mercantile system of accounting and in compliance with AS-11 and AS-30 issued by the Institute of Chartered Accountants of India (ICAI).

New Tangible Material vs. Change of Opinion:
The Court held that the reassessment was sought to be done only on the basis of a change in opinion upon review of the existing material on record, which is impermissible in law. The Court emphasized that the Assessing Officer (AO) must have "tangible material" to conclude that there is escapement of income from assessment. The Court found that the AO did not apply his mind independently and acted on the direction of the CIT, which is not permissible.

Conclusion:
The Court quashed the notice dated 11th March 2013 and the order dated 19th February 2014 rejecting the Assessee's objections. The writ petition was allowed, with no order as to costs. The Court reiterated that erroneous decisions could be corrected by resorting to the power under Section 263 of the Act, but not through reopening under Section 147 based on a mere change of opinion.

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