2004 (6) TMI 315 - AT - Income Tax

Summary

Issues Involved:
1. Validity of initiation of proceedings under Section 147 of the Income Tax Act.
2. Validity of the assessment order made under Section 147.
3. Status of the assessee (AOP vs. registered firm).
4. Allowability of expenses under Section 57 and Section 37 of the Act.
5. Applicability of Section 14A of the Act.

Issue-wise Detailed Analysis:

1. Validity of initiation of proceedings under Section 147 of the Income Tax Act:
The assessee challenged the initiation of proceedings under Section 147 on the grounds that both conditions, namely, "reason to believe" and "income chargeable to tax has escaped assessment," were not fulfilled. The assessee argued that the notice under Section 148 did not mention the status of the assessee and that the AO had no valid reason to believe that income had escaped assessment. The tribunal referenced several judicial pronouncements, including the Hon'ble Supreme Court's decision in Ganga Saran & Sons (P) Ltd. vs. ITO & Ors., emphasizing that the "reason to believe" must be rational and not arbitrary. The tribunal concluded that the AO's formation of belief was based on doubts and surmises, and thus, the initiation of proceedings under Section 147 was invalid.

2. Validity of the assessment order made under Section 147:
The tribunal found that the AO issued a notice under Section 148 without mentioning the status of the assessee and later passed the assessment order treating the assessee as a 'registered firm' instead of 'AOP'. The tribunal held that this discrepancy rendered the assessment order invalid. The tribunal emphasized that if the AO had reason to believe that the income of the registered firm had escaped assessment, he should have issued a notice to the registered firm, which was not done. Consequently, the assessment order was deemed illegal and was cancelled.

3. Status of the assessee (AOP vs. registered firm):
The assessee filed the return in the status of 'AOP', which was initially accepted by the AO. However, the AO later treated the assessee as a 'registered firm' without issuing a notice under Section 148 to the registered firm. The tribunal noted that the CIT(A) directed the AO to adopt the status of the assessee as 'AOP' but upheld the reassessment proceedings. The tribunal concluded that the reassessment order passed in the status of 'registered firm' without issuing a notice to the registered firm was illegal and cancelled the assessment order.

4. Allowability of expenses under Section 57 and Section 37 of the Act:
The AO disallowed certain expenses like salary, rent, and interest paid on borrowed funds, reasoning that these were not incurred for earning interest income and were related to exempt income from M/s Kripa Traders. The assessee contended that once the interest income from M/s Herbertsons Ltd. was treated as business income, the expenses should be allowable under Section 37 and not restricted under Section 57. The tribunal did not specifically address the allowability of these expenses in detail but focused on the invalidity of the reassessment proceedings.

5. Applicability of Section 14A of the Act:
The assessee argued that the AO did not invoke the provisions of Section 14A, which deals with the disallowance of expenditure incurred in relation to income not includible in total income. The tribunal did not delve into this argument in detail but noted that the AO's actions were based on a change of opinion, which was not permissible for initiating action under Section 147.

Conclusion:
The tribunal allowed all three appeals directed by the assessee, cancelling the reassessment orders for the assessment years 1997-98, 1998-99, and 1999-2000. The primary reasons were the invalid initiation of proceedings under Section 147 and the improper issuance of notice under Section 148 without specifying the correct status of the assessee.