“Lack of Inquiry” vs. “Inadequate Inquiry” – Madras High Court Narrows Section 263 Jurisdiction in Arul Industries v. Assistant Commissioner of Income-tax (2025)

1. Introduction

Court & Date: Madras High Court, 11 August 2025
Bench: Chief Justice Manindra Mohan Shrivastava & Justice Sunder Mohan
Parties: M/s. Arul Industries (Assessee / Appellant), a partnership firm manufacturing kitchen utensils, versus the Assistant Commissioner of Income-tax, Central Circle-II, Madurai (Revenue / Respondent).

At the heart of this tax appeal lay the proper scope of the Commissioner’s revisional powers under Section 263 of the Income-tax Act, 1961 (“the Act”). Specifically, the Court was asked to decide whether the Commissioner may revise an assessment when the Assessing Officer (“AO”) has made some inquiry but, in the Commissioner’s view, the inquiry was not adequate.

The case emerges from a chain of events surrounding a search (u/ss 132 & 133A), a subsequent block assessment under Section 153C, and the Commissioner’s assumption of Section 263 jurisdiction on the ground that depreciation and capital-gains issues were allegedly overlooked.

2. Summary of the Judgment

• The High Court allowed the appeal and set aside the Section 263 order.
• It held that where the AO has conducted an inquiry and formed a view, the order cannot be branded “erroneous and prejudicial to the interests of the Revenue” merely because the inquiry could have been more exhaustive. That scenario constitutes “inadequate inquiry,” which is insufficient to invoke Section 263.
• Consequently, only the first substantial question of law was answered (in favour of the assessee). The other two questions became academic and were not decided.

3. Analysis

3.1 Precedents Cited & Their Influence

1. CIT v. Sunbeam Auto Ltd. (2010) 189 Taxman 436 (Del.)
   – Distinguished between “lack of inquiry” (no verification at all) and “inadequate inquiry” (some verification). Only the former empowers the Commissioner under Section 263.
   – The Madras High Court relied heavily on this ratio.
2. CIT v. Gabriel India Ltd. (1993) 203 ITR 108 (Bom.)
   – Established that Section 263 is not meant for “substituting the Commissioner’s judgment for that of the AO.” It demands a demonstrable order that is both erroneous and prejudicial.

3.2 Court’s Legal Reasoning

• Existence of Inquiry: The AO had:
  • Examined records relating to purchase and sale of factory building;
  • Discussed depreciation calculations with assessee’s representative; and
  • Re-worked depreciation based on deemed usage for business.
  Hence, the AO’s order was the result of a conscious inquiry.
• Scope of Section 263: The provision targets orders that are both (a) erroneous and (b) prejudicial to Revenue. A mere possibility of a “better” order does not suffice.
• Inquiry Test Applied:
  • Lack of inquiry ⇒ order can be revised.
  • Inadequate inquiry ⇒ Commissioner cannot step in simply to conduct a “deeper dive.”
  The case was categorized as the latter.
• Final Holding: Commissioner exceeded jurisdiction; Section 263 order quashed.

3.3 Potential Impact

• Narrows Revisional Power: Reinforces that Section 263 cannot be used as a supervisory tool to “improve” assessments.
• Search & Seizure Blocks: Even in Section 153C assessments—where stakes are high—the Commissioner must respect the inquiry/inadequacy line.
• Litigation Strategy: Taxpayers can guard against Section 263 by demonstrating that the AO did undertake some examination, however brief.
• Administrative Efficiency: Encourages AOs to document at least minimal reasoning to shield their orders from revision.

4. Complex Concepts Simplified

Section 263 (Revision by Commissioner)

Allows the Commissioner to revise an AO’s order if it is both “erroneous” (wrong in law or fact) and “prejudicial” (results in revenue loss). The power is supervisory but not appellate.

“Erroneous and Prejudicial” Dual Test

Both conditions are mandatory. An order may be erroneous but not prejudicial (or vice-versa). Section 263 applies only when both exist.

Search Assessment under Section 153C

Applies to a person other than the one searched, when seized material “belongs to” them. It repopens six previous years, and the AO passes an order u/s 143(3) read with 153C.

Difference: Lack vs. Inadequate Inquiry

• Lack of Inquiry: AO ignores an issue altogether; no questions asked.
• Inadequate Inquiry: AO examines the issue but depth/extent may be debatable.

Only the former empowers the Commissioner under Section 263.

Depreciation & Written Down Value (WDV)

Depreciation is an annual deduction for wear‐and‐tear of assets. WDV is the un-depreciated cost carried forward. In this case, the AO “deemed” depreciation even though it was not claimed earlier.

5. Conclusion

The Madras High Court’s decision in Arul Industries fortifies an important procedural boundary: the Commissioner’s power under Section 263 is not a license for second-guessing every assessment. As long as an Assessing Officer applies his mind and conducts some inquiry, the order is shielded from revision, even if the inquiry could have been more comprehensive. This precedent will likely resonate in future disputes—especially surrounding search-related assessments—by discouraging routine or speculative Section 263 revisions and reinforcing finality in tax adjudication.