Order must be Erroneous and Prejudicial to Revenue Interests for Invoking S.263 of Income Tax Act: ITAT [Read Order]

The Ahmedabad Bench of Income Tax Appellate Tribunal ( ITAT ) ruled that for invoking Section 263 of the Income Tax Act,1961 an order must be both erroneous and prejudicial to the interests of the Revenue.

Vishal Balvantrai Agarwal,the appellant-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) of the Act. He filed his return on 09.10.2018, declaring an income of Rs. 36,65,880. The assessment was completed on 12.01.2021 under Section 143(3) read with Sections 143(3A) and 143(3B) of the Act.

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During the assessment year 2018-19, the 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 of Rs. 3,26,45,179 under Section 57 for interest expenses on borrowed funds used as capital contributions, asserting a direct nexus with the income earned.

The assessee's case underwent limited scrutiny regarding the "deduction from income from other sources." The Assessing Officer ( AO ) issued notices under Section 142(1) on 22.01.2020 and 11.11.2020, inquiring about the Section 57 deduction. The assessee provided responses and supporting documents, explaining that borrowed funds were used for investments in partnership firms, generating interest income exceeding expenses. The AO accepted the claim and approved the returned income as assessed income.

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The Principal Commissioner of Income Tax ( PCIT ) examined the assessment records and found that the AO had allowed the assessee's interest expenses without adequate inquiry. On 10.03.2023, 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 the 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.

The 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.

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The tribunal reviewed the case and noted that Section 263 of the Income Tax Act allows the PCIT to revise an assessment order if it is both erroneous and prejudicial to the interests of the Revenue. Citing Malabar Industrial Co. Ltd. vs. CIT [ (2000) 243 ITR 83 (SC) ], the tribunal emphasized the two conditions for invoking Section 263: (i) the order must be erroneous, and (ii) it must be prejudicial to the interests of the Revenue.

The PCIT invoked Section 263, claiming that the AO failed to verify interest expenses under Section 57 and did not consider disallowance under Section 14A. However, the tribunal found that the AO conducted a thorough inquiry within the limited scrutiny scope under CASS, as per CBDT guidelines. The tribunal distinguished this case from Sahyadri Agencies Ltd. vs. PCIT, where the AO's failure was due to the assessee's non-cooperation.

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Additionally, the tribunal cited Nirma Credit and Capital Pvt. Ltd. ( Tax Appeal No. 514 of 2017 ), ruling that Section 14A could not apply when interest income exceeded interest expenditure. The two member bench comprising T.R. Senthil Kumar ( Judicial Member How to Compute Income from Salary with Tax Planning, Click Here ) and Makarand V.Mahadeokar ( Accountant Member ) concluded that the AO's order was neither erroneous nor prejudicial to the Revenue, quashing the PCIT’s revisionary order and allowing the assessee’s appeal.

To Read the full text of the Order CLICK HERE

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