ITAT AGRA BENCH
Where the Assessing Officer has not carried out necessary enquiry which ought to have been carried out for allowing deduction to the assessee under section 40(b), the order passed by the Assessing Officer was erroneous and prejudicial to the interest of the Revenue and CIT has rightly invoked the provisions of section 263
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ITAT AGRA BENCH, AGRA (THIRD MEMBER)
ITA No. 110/Agr./2006
April 13, 2010
The assessment in the case of the assessee was completed under section 143(3) of the Income-tax Act, 1961 ('the Act’ hereinafter) vide order dated 29.08.2003, assessing the income of the assessee at Rs.91,240/-. In the assessment order, salary and interest to the partners was allowed at Rs. 1,22,646/- and Rs.32,685/- respectively and the assessee was assessed in the status of a firm. Subsequently, the C.I.T. issued show-cause notice under section 263 of the Act to the assessee on 9-3-2006 requiring him to show-cause as to why the assessment order dated 29-08-2003 may not be set aside by invoking the provisions of section 263 of the Act.
Against this notice, the assessee submitted reply to the C.I.T. vide his submissions dated 27-03-2006 and 29-03-2006. The main contentions of the assessee was that the order passed by the A.O. on 29-08-2003 under section 143(3) is not erroneous because the provisions of section 185 can be applied only when the assessee does not fulfil the provisions of section 184 of the Act which are as under :-
i) The partnership deed is evidenced by an instrument;
ii) The individual shares of the partners are specified in that instrument;
iii) Certified copy of the partnership deed is filed.
Since the assessee complied with all the conditions, the assessee has to be assessed as a firm and not as AOP under section 185 of the Act. As per section 184(3), once the firm is assessed as a firm for any Assessment Year, it shall be assessed in the same capacity for every subsequent year, if there is no change in the constitution of the firm or the shares of the partners. The firm is assessed to tax as partnership firm since 1-4-1998. Therefore, the question of assessing the assessee as AOP does not arise. It was also submitted that there is no bar in the Partnership Act to transfer the assets from the partners to the firm or vice versa. The credit entries made in the capital account of the partner represented genuine transaction and do not violate the terms of the partnership deed as well as the provisions of section 184 of the Act. The payment of interest was made in accordance with the provisions of section 40(b) of the Act. The provisions of section 14A cannot be applied as the income from trading of the shares is not totally exempt. Only a part of the income earned as dividend is exempt. As per proviso to section 14A the A.O. has no power to reassess or rectify the assessment for disallowing the interest. The C.I.T. after considering the submissions of the assessee came to the view that the issue under consideration is not concerned with the transfer of the shares from partners to the firm, but the same is concerned with the distribution of profits from dividend/shares, in accordance with the partnership deed. It was observed that the assessee filed partnership deed and the assessee was assessed as a firm since 1-04-1998, but according to the C.I.T. if the partnership deed is not being followed in practical sense, the same becomes merely a written instrument, having no legal sanctity whatsoever. According to the C.I.T., since the dividend derived from the shares did not appear in the books of accounts of the assessee and there is no evidence to show that the same is distributed amongst the partners as per the provisions of partnership deed, the A.O. failed to investigate this issue and, therefore, ultimately the CIT, concluded that the order passed by the A.O. on 29-08-2003 was erroneous in-so-far as prejudicial to the interest of the Revenue. Accordingly, he set aside the assessment order with the directions that the A.O. shall make enquiries about the genuineness of the provisions contained in sections 184 and 185 of the Act. If the profit of the firm has not been distributed in accordance with the partnership deed, the firm has to be assessed as per the provisions of section 185. It was further directed that the A.O. should see that the expenses including interest against exempt income are not allowed. The assessee came in appeal against the order of C.I.T. before the Tribunal.
It is apparently clear that in order to invoke the provisions of section 263, both the conditions that the order passed by the AO is erroneous and also that it is prejudicial to the interest of Revenue must be satisfied. If one of them is absent, the provisions of section 263 cannot be invoked. The term 'erroneous’ has not been defined under the Income-tax Act but it is well settled that each and every type of mistake or error committed by the AO cannot be said to be an error. An order can be said to be erroneous if there is incorrect assumption of facts or incorrect application of law in the order by the AO. If the AO after making the enquiries and examining the records taken one of the possible view, it cannot be said that the order passed by the AO was erroneous.
While in the instant case the proceedings u/s 263 of the Act has been initiated by the CIT not on the basis that the assessee had made entries in the partners' capital account represented by creditors otherwise than credit of money, i.e. transfer of shares held in the name of partners by book entry without the shares having been transferred in the name of the firm. He was of the view that the interest allowed by the AO to the partners on the capital in respect of such credits is not admissible as deduction within the meaning of section 36(l)(iii) read with section 14A. This is a fact that the assessee was not dealing in shares. The dividend income from the shares so transferred to the firm by book entries has been enjoyed by the partners. Even if this income is exempt but it amounts to sharing the profits of me firm otherwise than in accordance with the partnership deed. Ultimately CIT held the assessment order dt. 29.8.03 to be erroneous as well as prejudicial to the interest of the revenue on two grounds one being that the dividends from shares is not appearing in the books of account of the assessee and there is no evidence to show that the same is being distributed amongst the partners as per the provisions of the partnership deed and the AO has failed to investigate this issue. Second being the interest against the dividend income is not allowable and the AO has failed to look into this aspect. But, in the case before me, there is no application of mind on the part of the A.O. as the A.O. has not at all made any enquiry or applied his mind on the aspect whether the interest as claimed by the assessee is disallowable in view of the fact that the capital account of the partners have been credited by the shares held in the name of the partners and the dividend income received on the shares was exempt. The assessee has claimed interest on the capital account for which the credit has arisen due to the shares, the income on which is exempt. The provision of section 14A has not at all been examined. This is also fact that the A.O. has also not applied his mind to the fact whether the dividend income as received by the partner on the shares which has been brought into the partnership firm has been brought into the P&L account of the firm or not. This case clearly lays down, if there is lack of enquiry on the part of the A.O., provisions of section 263 of the Act can be applied.
In the case of the assessee the Assessing Officer has not carried out necessary enquiry which ought to have been carried out for allowing deduction to the assessee u/s 40(b) of the Act. Therefore, in my opinion, the order passed by the Assessing Officer was erroneous and prejudicial to the interest of the Revenue. The CIT has rightly invoked the provisions of section 263.