Introduction

The case of DCIT, Circle-1, Jaipur vs. P.R. Rolling Mills Pvt Ltd., Jaipur adjudicated by the Income Tax Appellate Tribunal (ITA) in Jaipur on October 4, 2022, addresses critical issues surrounding the validity of tax deductions under Section 35(1)(ii) of the Income Tax Act, 1961. This case involves the disallowance of a substantial weighted deduction claimed by P.R. Rolling Mills Pvt Ltd. (hereinafter referred to as the Assessee), based on alleged misuse of donations made to the School of Human Genetics and Population Health (SHG&PH), an institution initially approved under Section 35(1)(ii) but later rescinded.

The primary issues at hand include:

• Whether the Assessee's deduction claim under Section 35(1)(ii) is justified despite the subsequent findings of misuse by the beneficiary institution.
• The impact of retrospective cancellation of approval granted to the beneficiary on the validity of the deduction.
• Applicability of precedents and legal principles in adjudicating the dispute.

Summary of the Judgment

The Directorate of Income Tax (DCIT) challenged two orders dated March 12, 2022, passed by the National Faceless Appeal Centre (NFAC) for the assessment years 2012-13 and 2013-14. These orders stemmed from the initial disallowance by the Assistant Commissioner of Income Tax (AO) in Jaipur, who contended that the Assessee's claims under Section 35(1)(ii) were based on bogus donations intended to reduce taxable income through accommodation entries.

The AO's position was underpinned by findings from a survey action conducted under Section 133A, which revealed that donations made to SHG&PH were allegedly misused in connivance with brokers and donees to facilitate unauthorized tax deductions. Consequently, Rs. 1.75 crore was added back to the Assessee's income.

The Assessee appealed, referencing previous favorable ITAT decisions that upheld similar deduction claims when the beneficiary had valid approval at the time of donation. The NFAC, however, upon reevaluating the facts in light of additional evidence from the Settlement Commission and the Supreme Court's stance on retrospective tax actions, sided with the DCIT, resulting in the final disallowance of the deduction claims.

Analysis

Precedents Cited

The judgment extensively referenced several key precedents to substantiate the legal reasoning:

• Hitendra Vishnu Thakur vs. State of Maharashtra: Emphasized that procedural statutes should not be applied retrospectively to impose new obligations or liabilities.
• CIT(Central-1), Delhi vs. Vatika Township Pvt. Ltd.: Highlighted that beneficial amendments warrant retrospective application, whereas procedural or burden-adding changes do not.
• M.S. R. Rolling Mills Pvt. Ltd. vs. Deputy Commissioner of Income Tax (ITA No. 529/JP/2018): Initially favored the Assessee by allowing deductions based on valid donations at the time of transaction.
• Saimed Innovation vs. ITO (ITA No. 2231/Kol/2016): Asserted that deductions under Section 35(1)(ii) cannot be denied solely based on third-party statements without cross-examination opportunities.
• CIT vs. Batanagar Education Trust [2021] (SC): Upheld the cancellation of registrations under Section 12A and 80G, reinforcing that misuse by beneficiaries can invalidate deduction claims.

Legal Reasoning

The Tribunal employed a multifaceted legal analysis:

• Validity of Initial Approval: Initially, SHG&PH was recognized and approved by the CBDT under Section 35(1)(ii), making the Assessee's donation claim legitimate at the time.
• Retrospective Cancellation: Subsequent to the donations, the CBDT rescinded the approval of SHG&PH retroactively from April 1, 2007, based on findings of misuse during the survey action.
• Section 35(1)(ii) Interpretation: The Tribunal interpreted the section to mean that deductions cannot be withdrawn retrospectively unless there is clear evidence of misuse at the time of deduction.
• Misuse Confirmation: The Settlement Commission's admission that SHG&PH did not undertake significant research and misused donations through commission-based entries was pivotal in determining the deduction's disallowance.
• Procedural Fairness: The Tribunal emphasized the necessity of fair procedural conduct, such as allowing cross-examination of third-party witnesses, which was lacking in this case.

Ultimately, the Tribunal concluded that the Assessee was complicit in the misuse of the donation scheme, thereby justifying the disallowance of the claimed deductions.

Impact

This judgment has significant implications for both taxpayers and tax authorities:

• Strengthened Anti-Abuse Measures: Reinforces the government's stance against the misuse of tax deduction schemes, ensuring that benefits under Section 35(1)(ii) are not exploited.
• Retrospective Scrutiny: Validates the authority's power to reassess and revoke deductions if evidence of misuse surfaces post-donation, even if the initial claim was compliant.
• Due Diligence for Beneficiaries: Encourages taxpayers to perform exhaustive due diligence before making donations to ensure the authenticity and compliance of beneficiary organizations.
• Legal Precedence: Serves as a precedent for future cases where the legitimacy of deductions under tax provisions is contested due to subsequent findings of misuse.

Complex Concepts Simplified

Section 35(1)(ii) of the Income Tax Act, 1961

This section allows taxpayers to claim a weighted deduction (1.5 times the donated amount) for sums paid to approved research associations or institutions engaged in scientific research. The key conditions include:

• The beneficiary must be approved by the Central Government as per the guidelines.
• The donation should be for genuine scientific research purposes.

Retrospective Cancellation

Retrospective cancellation refers to the annulment of an approval or recognition granted to an entity, effective from a date preceding the establishment or commencement of an activity. In this context, SHG&PH's approval was rescinded retroactively, impacting the validity of deductions claimed for donations made during the period of prior approval.

Survey Action under Section 133A

Section 133A empowers tax authorities to conduct surveys to verify the correctness and genuineness of tax returns filed. Findings from such surveys can lead to reassessment and penalties if discrepancies or malpractices are uncovered.

Conclusion

The judgment in DCIT vs. P.R. Rolling Mills Pvt Ltd. underscores the judiciary's commitment to combating tax evasion and the misuse of tax deduction provisions. By validating the Department's authority to retract deductions based on subsequent evidence of beneficiary misuse, the Tribunal reinforces the principle that tax benefits should align with their intended purpose.

For taxpayers, the case serves as a cautionary tale to exercise due diligence in selecting legitimate and compliant institutions for donations. For tax authorities, it affirms the importance of vigilant post-assessment scrutiny to uphold the integrity of tax laws.

In the broader legal context, this judgment contributes to the evolving jurisprudence on tax deduction schemes, balancing the facilitation of charitable contributions with the prevention of fiscal malpractices.