Reopening of Income Tax Assessments: Addressing Assessing Officer’s Error under Section 40(b)

Introduction

The case of Price Waterhouse & Co v. Assistant Commissioner Of Income Tax adjudicated by the Income Tax Appellate Tribunal (ITAT) on September 21, 2017, presents significant insights into the procedural and substantive aspects of income tax assessments concerning partnership firms. The primary parties involved are the assessee, a Chartered Accountant firm represented by Price Waterhouse & Co, and the Assistant Commissioner of Income Tax. The core issue revolves around the validity of reopening an assessment based on previously available documentation and the correct application of Section 40(b) of the Income Tax Act, 1961, concerning remuneration to partners.

Summary of the Judgment

The assessee initially filed its income returns for the assessment year (AY) 2010-11, disclosing an income of ₹1,09,01,953. The original assessment under Section 143(3) accepted this return. Subsequently, the Income Tax Department issued a notice under Section 148 to reopen the assessment, leading to a reassessment where an addition of ₹1,24,80,000 was made, disallowing remuneration to partners under Section 40(b)(v). The assessee appealed against this decision, arguing that the reopening was invalid as it relied solely on existing records without any new material. The ITAT upheld the Department's decision, emphasizing that the initial assessment was patently unlawful due to the oversight concerning the retrospective remuneration authorization.

Analysis

Precedents Cited

The judgment references two pivotal High Court cases:

• CIT v. Usha International Ltd: This case dealt with the admissibility of reopening assessments based on original records and clarified the boundaries of Section 147 regarding reassessment.
• Berger Paints India Ltd v. ACIT: This judgment underscored that absent any apparent mistake in the original assessment, reassessment under Section 147 cannot be initiated merely due to the drop of rectification proceedings under Section 154.

However, the ITAT distinguished the present case from these precedents, noting that the rectification proceedings were dropped not because there was no error, but because the error required correction through reopening under Section 147.

Legal Reasoning

The crux of the ITAT's reasoning lies in the application of Section 40(b)(v) of the Income Tax Act, which disallows remuneration to partners unless it conforms strictly to the terms of the partnership deed. The original partnership deed did not authorize remuneration, and the supplementary deed executed on September 23, 2010, provided such authorization effective from April 1, 2009. However, Section 40(b)(iii) prohibits retrospective remuneration beyond the date of executing the supplementary deed. The Assessing Officer initially allowed remuneration for the period before the supplementary deed's execution, a decision deemed patently unlawful by the ITAT. The ITAT emphasized that this oversight was not a mere change of opinion but a fundamental error against the clear provisions of the law. Consequently, the reopening of the assessment was justified to rectify this substantial mistake, even though no new external material was introduced.

Impact

This judgment reinforces the principle that Assessing Officers possess the authority to revisit and correct assessments where clear procedural or substantive errors are identified, irrespective of the absence of new external information. It clarifies that the mere presence of internal oversight or error justifying alignment with statutory provisions is sufficient grounds for reopening an assessment within the stipulated time frame. This serves as a cautionary directive to tax authorities to meticulously adhere to legal provisions during assessments to avoid subsequent controversies.

Complex Concepts Simplified

Section 40(b) of the Income Tax Act, 1961

Section 40(b) pertains to the disallowance of certain payments made to partners of a firm. Specifically:

• Subsection (v): Disallows remuneration to partners unless it is authorized by the partnership deed and corresponds strictly with the terms specified therein.
• Clause (iii): Prohibits remuneration for periods before the execution of a supplementary partnership deed that authorizes such payments. In essence, if a firm modifies its partnership deed to allow remuneration, this change cannot be applied retroactively to periods before the amendment.

In this case, the firm sought to claim remuneration for partners for a period before the supplementary deed was executed, which the ITAT rightly disallowed based on the explicit provisions of Clause (iii).

Reopening of Assessment under Section 147

Section 147 empowers the Assessing Officer to reopen an assessment upon the discovery of new material. However, the interpretation of what constitutes "new material" has been debated. The ITAT in this judgment clarified that reassessment could be initiated not only on genuinely new external information but also on a thorough re-examination of existing records where previous assessments contained fundamental errors or were patently unlawful.

Conclusion