Citation Codes

Equivalent Citations

citation codes

Case Number

I.T.A No. 582.PN/10, Asstt. Year 2005-06, ITA No. 585.PN/10, Asstt. Year 2005-06, ITA No. 586.PN/10, Asstt. Year 2005-06 and ITA No. 588.PN/10, Asstt. Year 2005-06

Advocates

Appellants by: Shri C.H Naniwadekar
Respondent by: Shri Hareshwar Sharma

Judges

I.C Sudhir, J.M
G.S Pannu, A.M

Acts

SECTION 263 INCOME TAX ACT 1961

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Smart Summary

Structured Summary of the Tribunal's Opinion (Lead: ITA No. 582.PN/10)

Factual and Procedural Background

The proceedings consolidate appeals of four family members; the lead appeal is ITA No. 582.PN/10 filed by Shri Apoorva Patni challenging the Commissioner of Income-tax-II, Pune's order dated 29.3.2010 under section 263 of the Income-tax Act, 1961. The Commissioner had set aside the assessment order passed by the Assessing Officer (AO) under section 143(3) dated 11.04.2007 for assessment year 2005-2006 and directed fresh enquiries. The AO had accepted the return of income which included gains from trading in shares (some earnings declared as capital gains through Portfolio Management Services — PMS — and some trading in a proprietary concern declared as business income). The Commissioner considered the assessment erroneous and prejudicial to revenue because certain gains from share transactions (including amounts of Rs. 3,38,40,379 and Rs. 1,19,77,765) should possibly have been assessed as business income. The Commissioner issued a notice under section 263, considered written submissions, and concluded that the AO had failed to examine multiple factual and legal facets of the PMS-driven transactions; he remitted the assessment to the AO for fresh enquiry on several issues. The assessee appealed to the Tribunal, contesting the correctness of invoking section 263.

Legal Issues Presented

Whether the Commissioner was justified in invoking section 263 of the Income-tax Act to set aside the AO's assessment on the ground that the AO's order was "erroneous in so far as it is prejudicial to the interests of the Revenue"?
Whether the gains earned by the assessee through Portfolio Management Services ought to be treated as business income (Profits & Gains of business or profession) or as capital gains, i.e., whether the factual and legal tests established for distinguishing business activity from investment activity had been applied by the AO?

Arguments of the Parties

Appellant's Arguments (Assessee)

The invocation of section 263 was unjustified because the AO had applied his mind and taken a possible view by treating gains from PMS as capital gains while treating trading in the proprietary concern as business income.
The assessee had filed detailed returns and accompanying documents: statements of long-term and short-term capital gains from PMS, personal income & expenditure account, capital account, balance sheet, and separate books for trading business. Copies of PMS agreements were placed on record.
The AO had issued a query letter dated 15.3.2007 requesting month-wise mutual fund printouts, details of reinvested mutual funds with evidence, books of account for trading, etc., indicating the AO was aware of and had enquired into relevant matters.
For the subsequent assessment year (2006-2007) the Commissioner of Income-tax (Appeals) held the PMS activity to be investment activity (capital gains) after referring to ITAT Pune decision in ARA Trading & Investments Pvt. Ltd.; this, it was contended, demonstrated that a possible view had been taken and therefore section 263 should not be invoked.
Reliance was placed on CIT v. Design & Automation Engineers (Bombay) (323 ITR 632 (Bom)) to argue that inadequate enquiry is not a ground for invoking section 263 as opposed to complete lack of enquiry.

Respondent's Arguments (Revenue)

The Commissioner correctly demonstrated that the AO did not conduct necessary enquiries into how capital gains were earned through PMS providers; the AO had accepted the assessee's claim without applying mind.
In the absence of material showing the AO had verified key issues, invoking section 263 to set aside such an assessment was justified, even if the Commissioner had not reached a firm conclusion on tax evasion (relying on Commissioner Of Income-Tax v. Assam Tea House (2010) 48 DTR (P & H) 112).
Reliance was placed on the Supreme Court decision in Malabar Industrial Co. Ltd. (2000) 243 ITR 83 (SC) to support the proposition that an assessment passed without application of mind falls within the scope of section 263.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
CIT v. Design & Automation Engineers (Bombay) (323 ITR 632 (Bom))	Authority relied upon by the assessee to distinguish inadequate enquiry from lack of enquiry for purposes of section 263.	The Tribunal noted the assessee relied on this case to argue that inadequate enquiry is not sufficient for s.263; however, the Tribunal concluded factually that the AO had failed to apply his mind (a lack of enquiry), and thus the precedent did not preclude invoking s.263 in this matter.
Commissioner Of Income-Tax v. Assam Tea House (2010) 48 DTR (P & H) 112	Supports the proposition that where there is no material showing AO carried out verification on certain issues, invoking section 263 is justified even without a firm conclusion of tax evasion.	The Revenue relied on this authority; the Tribunal considered the argument and treated lack of AO verification as a valid basis for invoking s.263 in the present facts.
Malabar Industrial Co. Ltd. (2000) 243 ITR 83 (SC)	Establishes that an assessment passed without application of mind falls within the expression "erroneous in so far as it is prejudicial to the interests of the revenue" under section 263.	The Tribunal expressly applied this Supreme Court precedent to hold that the AO's acceptance of the return without due application of mind amounts to an assessment that is erroneous and prejudicial, thus justifying the Commissioner's exercise of s.263 powers.
ARA Trading & Investments Pvt. Ltd. (ITA No. 499.PN/08 dated 31.8.2009) — ITAT Pune	Used by the Commissioner of Income-tax (Appeals) in a subsequent assessment year to characterize PMS transactions as investment activity (capital gains).	The assessee relied on the CIT(A)'s reliance on this ITAT decision for AY 2006-07 to argue a possible view had been taken; the Tribunal acknowledged the existence of that decision and the CIT(A)'s finding but held that a subsequent favourable CIT(A) result did not cure the lack of application of mind in the earlier assessment under challenge.

Court's Reasoning and Analysis

The Tribunal began by restating the statutory scope of section 263 — the Commissioner may call for records and, if he considers an AO's order erroneous and prejudicial to revenue, after giving opportunity and making enquiries, pass appropriate orders including directing fresh assessment.

The Commissioner had set aside the AO's assessment on three issues (treatment of gains from PMS as business income, treatment of derivative losses as speculative loss, and disallowance under section 40A), but the assessee contested only the PMS-gains part before the Tribunal. The Tribunal examined the record: the AO's assessment order, the query letter dated 15.3.2007, and the assessee's reply dated 21.3.2007, and noted:

The Commissioner in his order had referred to CBDT Circulars, certain case laws, and enumerated specific tests (volume/frequency of transactions, DEMAT account ownership, intention to hold, holding period, dividend considerations, repurchases, differences between mutual funds and PMS, the nature of the arrangement with PMS provider, and risk element) to determine whether transactions amounted to business or investments.
The Tribunal found that, despite the existence of PMS agreements and related documents on record, nothing established that the AO was aware of the terms of those agreements or had applied his mind to determine the true nature of the PMS transactions.
Having reviewed the material, the Tribunal concluded the AO had not made the necessary factual and legal examinations — effectively accepting the return's treatment of PMS gains without a conscious application of mind. The Tribunal characterized this as a "lack of application of mind" rather than merely an "inadequate enquiry."
The Tribunal applied the Supreme Court's holding in Malabar Industrial to confirm that an assessment passed without application of mind is "erroneous... prejudicial to the interests of the revenue" and therefore amenable to correction under section 263.
As to the assessee's argument that a later favorable CIT(A) order (and reliance on an ITAT decision) established that a possible view had been taken originally, the Tribunal held that the earlier assessment was accepted by default and not the result of a conscious, considered view by the AO; accordingly, the defense of "possible view" was not available where there had been no proper application of mind.

On these grounds the Tribunal concluded that the Commissioner had validly exercised powers under section 263 in remitting the assessment for fresh enquiry on the contested issue.

Holding and Implications

Holding: The Tribunal UPHELD the Commissioner's order under section 263 in respect of the issue contested by the assessee and DISMISSED the assessee's appeal (ITA No. 582.PN/10).

Direct consequences and implications:

The Tribunal sustained the Commissioner's direction to remit the assessment for the assessment year 2005-2006 to the Assessing Officer for fresh enquiry regarding the treatment of gains arising through PMS (and the other specified issues, though only the PMS issue was contested at the Tribunal stage).
On parity of reasoning, the Tribunal applied the same conclusion to the other consolidated appeals (ITA Nos. 585.PN/10, 586.PN/10 & 588.PN/10) and dismissed them as well.
The Tribunal clarified that rejecting the assessee's plea on the procedural ground of lack of application of mind is no reflection on the substantive merits of whether the transactions in question are business income or capital gains; the substantive controversy is to be adjudicated in appropriate proceedings after due enquiry.
No new legal precedent was laid down by the Tribunal; the decision was an application of existing principles (including Malabar Industrial) to the facts before it, and the immediate practical effect was remand for fresh consideration by the AO.

Note: This summary strictly reflects the facts, arguments, authorities, reasoning and outcome as contained in the provided Tribunal opinion and does not add or infer information beyond that text.

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Shri Apoorva Patni, S. No. 1A, Irani Market Compound, Yerawada, Pune v. Jt. Commissioner Of I.T (Osd) Cir. 2, Pune .

G.S Pannu, A.M:— The captioned proceedings relate to four assessees belonging to the same family and since the issue involved is common, all the appeals were heard together and are being disposed off by way of a consolidated order for the sake of convenience and brevity.

2. We shall take up the case of Shri Apoorva Patni vide ITA No. 582.PN/10 as the lead case. This appeal by the assessee is directed against the order under section 263 of the Income-tax Act, 1961 (in short “the Act”) dated 29.3.2010 passed by the Commissioner of Income-tax-II, Pune (in short “the Commissioner”) setting aside the assessment order dated 11.04.2007 passed by the Assessing Officer under section 143(3) of the Act for the assessment year 2005-2006 and directing the Assessing Officer to frame a fresh assessment after making detailed enquiries on various points as directed by the Commissioner.

3. In this case, assessment for the assessment year 2005-2006 was made by the Assessing Officer under section 143(3) of the Act determining the total income of the assessee at Rs. Rs. 9,79,58,390/- as against returned income of Rs. 9,79,58,390/-. On examination of record, the Commissioner noticed that the assessment order passed by the Assessing Officer is erroneous insofar as it is prejudicial to the interests of Revenue because, according to him, the gains of Rs. 3,38,40,379/- plus Rs. 1,19,77,765/- emanating from trading in shares ought to have been assessed under the head ‘Profits and Gains of business or profession’. In the opinion of the Commissioner, the transactions resulting in the gains had all the ingredients of a ‘business’ as inclusively defined in sub-section (13) of section 2 of the Act and the failure of the Assessing Officer to take cognizance of the said facts and consequently to ascertain the appropriate head of income under which the profit derived from sale of shares should have been taxed, rendered the assessment erroneous insofar as prejudicial to the interests of Revenue. The Commissioner accordingly issued a notice under section 263 of the Act requiring the assessee to explain its position. The assessee appeared and filed detailed written submissions. After hearing the assessee as well as considering the written submissions, the Commissioner held that the Assessing Officer failed to examine the various factual as well as legal aspects relating to assessee's transactions in shares, etc. According to the Commissioner, the Assessing Officer failed to examine the agreement between the assessee and the Portfolio Management Service (‘PMS’ in short) providers and that the Assessing Officer ought to have seen whether the PMS provider acted in the capacity of an agent or like a mutual fund. He further observed that if the PMS provider has acted in the capacity of an agent, then the Assessing Officer should have examined the manner in which the business of PMS provider was conducted. In the view of the Commissioner, the Assessing Officer failed to examine the share transactions from the point of:

a. Volume of transactions,

b. Frequency of transactions,

c. In whose DEMAT account the shares were purchased?

d. Whether the intention of the assessee was to hold the shares as investment e. Holding period of shares,

f. Whether the shares were sold before earning dividends,

g. Whether the assessee has repurchased same shares after selling them, i.e he has invested in the same scrips after booking profits,

h. Difference between the investment in mutual funds and PMS,

i. Whether the arrangement between the assessee and the PMS provider speak of the business relationship with regard to the investments an the share of profits/

j. Whether there was a component of risk involved in the share transactions?

The Commissioner further observed that the Assessing Officer has also not made any examination whatsoever in relation to investments in Mutual Funds and that the Assessing Officer failed to apply the tests of legal pronouncements with regard to the issue of deciding whether such income was assessable as Business income or Capital gains. The Commissioner finally concluded as under:

“13. The Assessing Officer has not examined the above issues which are vital to decide as to whether the transactions carried out by the assessee through the PMS provider and otherwise are in the nature of investments or business. For enabling such examinations, the assessment for the Assessment Year 2005-2006 is hereby remitted to the file of the assessing officer. The Assessing Officer shall give the assessee reasonable opportunity of being heard and decide the issues afresh, as per law.”

Being aggrieved, the assessee is in appeal before us.

4. Before us, the learned counsel for the appellant has assailed the order of the Commissioner on the ground that the invoking of section 263 of the Act in the present case was not justified. The learned Counsel submitted that the assessee is an individual who had declared income from house property, capital gains on share investments and also business income from trading of shares, apart from earning dividend and interest income under the head income from other sources. The learned Counsel pointed out that along with the return of income, assessee had annexed detailed statement of the long term and short term capital gains earned by the assessee by utilizing the Portfolio Management services of DSP Merrill Lynch Fund Managers Ltd. and Kotak Securities Ltd. It was pointed out that the return of income was accompanied by the Personal Income & Expenditure account, Capital account and Balance sheet. Apart therefrom, the assessee was carrying on share trading business in a proprietary concern whose Balance sheet and Profit & Loss account was separately enclosed. It was thus contended that the assessee had declared capital gain on share dealings separately, whereas the trading in shares carried out in the proprietary concern was declared as business income. The learned Counsel submitted that the Assessing Officer in para 3 of the assessment order has noted the distinction, inasmuch as the engagement of the assessee in the business of trading in shares and also deriving income from long term capital gains has been noted. The learned Counsel also pointed out that in the course of assessment proceedings the Assessing Officer had raised queries vide letter dated 15.3.2007 whereby the assessee was required to inter-alia, furnish month-wise print out of mutual fund account, details of mutual fund reinvested with supporting evidence, books of account in respect of the business of trading in shares, etc. In this manner, the learned Counsel has pointed out that the Assessing Officer was aware of the dealing in shares carried out by the assessee, wherein one segment was treated as a trading activity in the proprietary concern, whereas the other activity which was carried out through the portfolio managers was declared as capital gains. The learned Counsel also pointed out that in the subsequent assessment year of 2006-2007, the Assessing Officer in an assessment made under section 143(3) of the Act dated 12.2.2008 had treated the income from portfolio management services as business income and that the same has not been upheld by the Commissioner of Income-tax (Appeals) in its order dated 28.12.2010 It is submitted that the Commissioner of Income-tax (Appeals), after analyzing the factual aspects of the portfolio management services engaged by the assessee, held that it was a discretionary portfolio management services where the PMS provider had got absolute independence in taking day to day decisions so far as investment in shares, etc are concerned. The Commissioner of Income-tax (Appeals) referred to the decision of the ITAT Pune Bench in the case of ARA Trading & Investments Pvt. Ltd. (ITA No. 499.PN/08 dated 31.8.2009 for assessment year 2004-2005) and held that activity of transactions in shares/mutual funds by engaging a PMS provider carried on by the assessee was an investment activity and the resultant gain was assessable under the head capital gains. It was, therefore contended that in this view of the matter the assessment order dated 11.4.2007 in the instant year cannot be considered as erroneous and prejudicial to the interests of Revenue, because the Assessing Officer had taken a possible view. Moreover, the learned Counsel submitted that the Commissioner has merely held that the Assessing Officer had failed to make enquiry in a particular manner and such an objection is not valid for the purposes of section 263 of the Act. In this regard, it was submitted that there is a difference between lack of enquiry vis-à-vis inadequate enquiry and it is only in the case of former, invoking of section 263 is justified. In the present case, as per the Commissioner it is a case of inadequate enquiry and according to the assessee, the same is not a ground for invoking of section 263 and in this regard, reliance has been placed on judgment of the Hon'ble Bombay High Court in the case of CIT v. Design & Automation Engineers (Bombay) P. Ltd. 323 ITR 632 (Bom). In nut-shell, it is the case of the assessee that it is only a case of difference of perception between the Commissioner and the Assessing Officer on the issue of share transactions which cannot be a ground for invoking section 263 of the Act.

5. On the other hand, learned Departmental Representative, appearing for the Revenue, has vehemently argued that the Commissioner has established in detail that no enquiry has been conducted by the Assessing Officer with regard to the manner of earning of capital gains through the PMS providers and, therefore, it is a case where assessee's claim for assessment of the income from shares as capital gain has been accepted without application of mind. Thus, the assessment order dated 11.4.2007 passed by the Assessing Officer has been rightly held to be erroneous and prejudicial to the interests of Revenue within the meaning of section 263 of the Act. The learned Departmental Representative referred to a judgment of the Hon'ble Punjab & Haryana High Court in the case of Commissioner Of Income-Tax v. Assam Tea House (2010) 48 DTR (P & H) 112 to submit that in the absence of any material to show that the Assessing Officer had carried out verification on certain issues, the invoking of section 263 of the Act by the Commissioner to set aside such assessment was justified, even if the Commissioner had not come to a firm conclusion regarding evasion of tax. Reliance was also placed on the judgment of the Hon'ble Supreme Court in the case of Malabar Industrial Co. Ltd. (2000) 243 ITR 83 (SC).

6. We have carefully considered the rival submissions. Section 263 of the Act empowers a Commissioner to call for and examine the record of any proceeding under this Act and if he considers that any order passed therein by the Assessing Officer is erroneous in so far as it is prejudicial to the interests of the Revenue, he may after giving the assessee an opportunity of being heard and making such enquiries he may deem fit, pass such order thereon as the circumstances of the case justify, including an order enhancing or modifying the assessment, or cancelling the assessment and directing a fresh assessment. In the present case, the Commissioner has held the assessment order dated 11.4.2007 as erroneous and prejudicial to the interests of Revenue and the same has been set aside and directed to be made afresh on three issues, namely, (a) treatment of gains in respect of investment through PMS as business income; (b) treatment of loss on account of derivative transactions as speculative loss, and, (c) disallowance under section 40A of the Act. At the time of hearing, the appellant has contested before us the invocation of section 263 by the Commissioner only on a single issue relating to the gains in respect of investment through PMS. The Assessing Officer had accepted the return of income filed by the assessee qua the transactions in shares undertaken through engagement of a PMS provider as assessable under the head ‘capital gains’. The Commissioner, in an elaborately written order, has made out a case that the Assessing Officer has not examined various factual and legal aspects relating to such activity which was critical to conclude as to whether such income was assessable as ‘business income’ or as ‘capital gains’. The Commissioner has referred to the CBDT Circulars in para 8.3, some of the relevant case laws in para 8.2 and thereafter in para 8.4 he has enumerated various tests to decide as to whether the impugned activity constituted business activity or investment activity. Consequently, in paras 12 and 13 of the order, the Commissioner has pointed out the non-examination of the impugned activity in the context of the aforesaid tests. Quite clearly, the case made out by the Commissioner is that the Assessing Officer has failed to apply his mind to the legal and factual aspects before determining as to whether the impugned activity constituted business or an investment activity. In this background, we have examined the query letter dated 15.3.2007 issued by the Assessing Officer and which has been referred by the appellant before us. We have also perused the assessment order and also the reply of the assessee to the Assessing Officer on 21.3.2007 which has been placed before us. The claim of the assessee is that the Assessing Officer duly applied his mind, though the enquiry was not conducted in the manner stated by the Commissioner and in any case, as per the appellant, it is not a case of lack of enquiry. In our considered opinion, after having perused the entire material on record, it clearly emerges that the Assessing Officer has not applied his mind in the manner in which the assessee has earned income from its PMS dealings. Undoubtedly, the assessee has made investment through the PMS provider in terms of written agreements, copies of which have been placed on record. There is nothing brought on record to say that the Assessing Officer was aware of such agreements, much less the terms and conditions of such agreements so as to appreciate appropriately the nature and the manner of earning of income by the assessee through the PMS provider. Therefore, factually speaking, the Commissioner is correct in asserting that the Assessing Officer failed to apply his mind to the facts and related legal aspects of the impugned activity and, therefore, such an approach of the Assessing Officer, in our view, clearly falls within the meaning of expression “erroneous in so far as it is prejudicial to the interests of the revenue”, as contained in section 263 of the Act. An assessment order passed without application of mind certainly falls within the purview of section 263 of the Act in terms of the judgment of the Hon'ble Supreme Court in the case of Malabar Industrial Co. Ltd. (supra). In so far as the plea set up by the assessee that it is a case of inadequate enquiry and not lack of enquiry is concerned, in our view, the factual aspects clearly point out that it is a case where the Assessing Officer has failed to make enquiries and it is a case of lack of application of mind, which clearly justifies invoking of section 263 of the Act.

7. The other aspect argued is on the basis of the order of the Commissioner of Income-tax (Appeals) dated 28.12.2010 for the assessment year 2006-2007 wherein assessee's stand has been upheld. On this basis, it is argued that it is a case of a mere difference of perception between the Assessing Officer and the Commissioner and in any case, a possible view has been taken by the Assessing Officer in the assessment order dated 11.4.2007 In our considered opinion, having regard to the factual situation in the instant case, the aforesaid argument of the assessee has to fail. As noted earlier, in this case, the Assessing Officer has failed to examine the relevant facts thereby leading to determination of an assessment without proper application of mind on the issue of share transactions undertaken by the assessee through the services of a PMS. Once it is established that the return of income on a particular aspect has been accepted without application of mind, the same would tantamount to be an assessment which is erroneous and prejudicial to the interests of the revenue within the meaning of section 263 of the Act and the same cannot be defended on the plea that it was a possible view. Rather, it is a case where the view contained in the return of income has been accepted by default and not a case where a conscious view has been taken by the Assessing Officer after due application of mind on the relevant factual and legal aspects of the matter. Therefore, the impugned order of the Commissioner invoking section 263 of the Act on the impugned issue cannot be defeated on the aforesaid plea set up by the assessee.

8. In the result, we uphold the order of the Commissioner qua the plea raised by the assessee and accordingly the assessee has to fail in this appeal.

9. Before parting, we may add that our decision to reject the pleas of the assessee is no reflection on the merits of the controversy, which is liable to be adjudicated in the appropriate proceedings as per law.

10. Resultantly, the appeal of the assessee is dismissed.

11. The facts and submissions of rival sides being similar in the other captioned appeals, viz. ITA Nos. 585.PN/10, 586.PN/10 & 588.PN/10 in the cases of Mrs. Sadhana Patni, Mrs. Ruchi Patni & Shri Arihant Patni respectively, our decision given in the case of Shri Apoorva Patni, vide ITA No. 582.PN/10, will apply mutatis mutandis to those appeals also. On the parity of reasoning, therefore, ITA Nos. 585.PN/10, 586.PN/10 & 588.PN/10 are also dismissed.

Shri Apoorva Patni, ... v. Jt. Commissioner Of ...