Section 147 – Internal audit cannot perform functions of judicial supervision. Initiation of re-assessment on the basis of an interpretation of the provisions of law by the audit party is forbidden, the communication of law or the factual inconsistencies by the internal audit party, do not operate as a hindrance in the initiation of re-assessment proceedings.
Facts:
The assessee filed its return of income declaring a loss of Rs.12,48,92,067. The Assessing Officer (AO) completed the assessment u/s. 143(3) of the Act determining the loss at Rs.11,32,76,728. While assessing the total income the AO allowed deduction of Rs.3,61,75,597 out of unpaid interest of earlier year amounting to Rs.5,01,38,035 u/s. 43B on the basis of the claim of the assessee that it was discharged / paid.
The audit scrutiny of the assessment records revealed that out of the amount of Rs.3,61,75,597 which was allowed by the AO as a deduction, a sum of Rs.2,45,01,117 was transferred to a wholly owned subsidiary company. The audit party pointed out to the AO that this sum of Rs. 2,45,01,117 was not actually paid but only transferred to subsidiary company and consequently it ought to have been disallowed.
The AO, after recording reasons, issued notice u/s. 148 of the Act. In the order passed u/s. 143(3) r.ws. 147 of the Act, the AO disallowed the claim of Rs.2,45,01,117.
Aggrieved, the assessee preferred an appeal to CIT(A) who upheld the action of the AO in reopening the assessment and also on merits.
Aggrieved, the assessee preferred an appeal to the Tribunal where interalia, it challenged the re-opening on the ground that in view of the ratio of the decision of the Apex Court in the case of Indian and Eastern Newspaper Society vs. CIT 119 ITR 996 (SC) initiation of reassessment on the basis of internal audit report was not sustainable.
Held:
The Tribunal noted that it had to examine whether the assessee’s case fell within the ratio laid down in the case of CIT vs. PVS Beedis Pvt. Ltd. 237 ITR 13 (SC) in which the initiation of reassessment proceedings on the basis of audit objection has been held to be valid or in Indian and Eastern Newspaper Society (supra) and further CIT vs. Lucas T.V.S. Ltd. 249 ITR 306 (SC).
The logic in not sustaining the initiation of reassessment on the basis of interpretation of law by the audit party is that the internal auditor cannot be allowed to perform the functions of judicial supervision over the Income-tax authorities by suggesting to the AO about how a provision should be interpreted and whether the interpretation so given by the AO to a particular provision of the Act is right or wrong. An interpretation to a provision given by the audit party cannot be construed as a declaration of law binding on the AO.When an internal audit party objects to the interpretation given by the AO to a provision and proposes substitution of such interpretation with the one it feels right, it crosses its jurisdiction and enters into the realm of judicial supervision, which it is not authorised to do. In such circumstances, the initiation of reassessment, based on the substituted interpretation of a provision by the internal audit party, cannot be sustained.
The Tribunal noted that the Madras High Court has in the case of CIT vs. First Leasing Co. of India Ltd. 241 ITR 248 (Mad) aptly explained the position that although, the audit party is not entitled to judicially interpret a provision, but at the same time, it can communicate the law to the AO, which he omitted to consider. It also noted that the Madras High Court has observed that the Supreme Court has made a distinction between the communication of law and interpretation of law.
Where the audit party interprets the provision of law in a manner contrary to what the AO had done, it does not lay down a valid foundation for the initiation of reassessment proceedings. If however, the audit party does not offer its own interpretation to the provisions and simply communicates the existence of law to the AO or any other factual inaccuracy, then the initiation of reassessment proceedings on such basis cannot be faulted with.
In a nutshell, whereas the initiation of reassessment proceedings on the basis of an interpretation to the provisions of law by the audit party is forbidden, the communication of law or the factual inconsistencies by the internal audit party, do not operate as a hindrance in the initiation of reassessment proceedings.
The Tribunal noted the audit objection, in this case, divulged that the audit party simply suggested that the interest of Rs.2.45 crore was not actually paid, but, only transferred to a subsidiary company and the same should have been disallowed and this omission on the part of the AO resulted in over assessment of loss of Rs.2.45 crore. This, according to the Tribunal, showed that the AO was simply informed of the fact which had escaped his attention during the course of assessment proceedings to the effect that the sum of Rs.2.45 crore was not allowable u/s. 43B of the Act which is nothing, but a communication of law to the AO. The Tribunal observed that it was not confronted with a situation in which the AO, after due consideration of the matter in the original assessment proceedings interpreted 43B as allowing deduction for a sum of Rs.2.45 crore in respect of interest not paid to financial institutions, but, transferred to assessee’s wholly owned subsidiary company, but, the audit party interpreted this provision in a different manner from the way in which it was interpreted by the AO and then suggested that the amount ought to have been charged to tax. According to the Tribunal, the instant case is fully covered by the decision in the case of PVS Beedis Pvt. Ltd. (supra) and consequently the audit objection in the instant case constituted an `information’ about the escapement of income to the AO, thereby justifying the initiation of reassessment.
