An AO's order is not erroneous for not examining issues outside limited scrutiny's scope.

An AO’s order is not erroneous for not examining issues outside limited scrutiny’s scope.

Issue

Can an assessment order passed under the limited scrutiny framework be considered “erroneous” for the purpose of revision under Section 263 of the Income-tax Act, 1961, simply because the Assessing Officer did not examine an issue that was outside the specific scope of that limited scrutiny?

Facts

The assessee-company’s case was selected for a limited scrutiny assessment, with the specific reason being “Very Low PBDIT as compared to business turnover.”
The Assessing Officer (AO) conducted the assessment within this defined scope, examined the relevant details, was satisfied with the explanations provided, and completed the assessment by accepting the returned loss.
Subsequently, the Principal Commissioner of Income Tax (PCIT) invoked revisionary jurisdiction under Section 263.
The PCIT’s ground for revision was that the AO had failed to investigate a loan received by the assessee from another company, which the PCIT believed was a deemed dividend under Section 2(22)(e). This issue was entirely separate from the reason for which the limited scrutiny was initiated. The case was never formally converted from a limited to a complete scrutiny.

Decision

The Tribunal ruled in favour of the assessee.

It held that under the Faceless Assessment Scheme, an AO conducting a limited scrutiny is statutorily required to confine the examination to the specific issues for which the case was selected.
The AO cannot travel beyond these parameters unless the case is formally converted into a complete scrutiny with prior approval from the competent authority, which was not done.
Since the AO had no obligation to investigate the deemed dividend issue, the failure to do so cannot be termed an “error.”
As the foundational condition for invoking Section 263—that the order must be erroneous—was not met, the PCIT’s assumption of jurisdiction was held to be unsustainable in law.

Key Takeaways

Limited Scrutiny has Strict Boundaries: An AO’s jurisdiction in a limited scrutiny case is strictly confined to the specific reasons for which the case was selected for scrutiny.
An Order is Not Erroneous for Omissions Outside its Scope: An assessment order cannot be deemed “erroneous” for the AO’s failure to investigate an issue that they had no statutory duty to investigate in the first place.
Prerequisites for Section 263: For the PCIT to validly invoke Section 263, the underlying order must be both erroneous and prejudicial to the interest of the revenue. If the order is not erroneous, the revision is invalid.
Procedural Sanctity: The procedure for converting a case from limited to complete scrutiny is a significant procedural safeguard for the taxpayer and cannot be bypassed by resorting to revisionary powers.

A deemed dividend is taxable only in a shareholder’s hands, not the recipient concern.

Issue

Can the amount of a loan or advance be treated as a deemed dividend under Section 2(22)(e) in the hands of the recipient company, if that recipient company is not itself a shareholder in the company that gave the loan?

Facts

The assessee-company received a loan from another company, ‘K’.
While two of the assessee-company’s directors held a substantial shareholding in the lending company ‘K’, the assessee-company itself was not a shareholder in company ‘K’.
The Principal Commissioner of Income Tax (PCIT), invoking Section 263, sought to tax this loan as a deemed dividend under Section 2(22)(e) in the hands of the assessee-company (the loan recipient).

Decision

The Tribunal ruled in favour of the assessee, setting aside the revisionary order.

It reiterated the well-settled legal principle that a deemed dividend under Section 2(22)(e) can be legally assessed only in the hands of a person who is a shareholder of the lending company.
Since the assessee-company, which received the loan, was not a shareholder in the lending company ‘K’, the provisions of Section 2(22)(e) could not be attracted in its case.
The Tribunal also noted that the advances were in the nature of inter-corporate deposits made in the ordinary course of business and did not bear the character of a dividend.

Key Takeaways

Recipient Must Be a Shareholder: The most fundamental condition for taxing a deemed dividend under Section 2(22)(e) is that the income must be assessed in the hands of a registered and beneficial shareholder of the company giving the loan or advance.
Separate Legal Entity Principle: The law does not automatically tax a separate legal entity (the recipient company) just because its directors or shareholders are also shareholders in the lending company. The identity of the loan recipient is distinct from the identity of the shareholder.
Substance of the Transaction: The nature of the transaction is also relevant. Genuine inter-corporate deposits or trade advances made in the ordinary course of business are generally not intended to be covered by the deeming fiction of Section 2(22)(e).

IN THE ITAT AHMEDABAD BENCH ‘C’

Kesar Buildcon (P.) Ltd.

Principal Commissioner of Income-tax

Sanjay Garg, Judicial Member
and MAKARAND V. MAHADEOKAR, Accountant Member

IT Appeal No.790 (Ahd) of 2025
[Assessment year 2021-2022]

SEPTEMBER 8, 2025

Hem Chhajed, AR for the Appellant. Rignesh Das, CIT-DR for the Respondent.

ORDER

Makarand V. Mahadeokar, Accountant Member.- This appeal by the assessee is directed against the order passed by the Principal Commissioner of Income Tax, Ahmedabad – 3 [hereinafter referred to as “the PCIT”] under section 263 of the Income Tax Act, 1961 [hereinafter referred to as “the Act”], dated 30.03.2025, in relation to the assessment year 2021-22. The PCIT sought to revise the order dated 08.12.2022 passed under section 143(3) r.w.s. 144B by the Assessment Unit of the Income Tax Department [hereinafter referred to as ” Assessing Officer or AO”].

2. Facts of the Case

2.1 The brief facts, as emanating from the assessment records, are that the assessee, M/s Kesar Buildcon Private Limited, filed its return of income for the assessment year 2021-22 on 30.10.2018 declaring total income at a loss of Rs. (-) 27,49,550. Subsequently, the case of the assessee was selected for scrutiny assessment under the E-Assessment Scheme, 2020 with the reason “Very Low PBDIT (Profit before Depreciation, Interest and Taxes) as compared to business turnover.” Pursuant thereto, notices under section 143(2) dated 28.06.2022 and 142(1) dated 11.08.2022, 08.10.2022, 24.11.2022 of the Act were issued to the assessee calling for details in relation to its return of income, profit and loss account, and other supporting documents.

2.2 Despite initial non-compliance, the assessee eventually furnished replies electronically through the e-filing portal along with supporting documents in response to centralised communication dated 11.11.2022, show cause notice dated 13.11.2022, and notice under section 142(1) dated 24.11.2022.

2.3 The Assessing Officer recorded in the order that on the basis of details and evidences furnished, no variation was found in the returned income. Accordingly, the returned loss of Rs. (-) 27,49,550 was accepted in full as assessed income and the assessment was completed under section 143(3) r.w.s. 144B of the Act without any addition or disallowance.

2.4 Subsequently, on examination of assessment records, the PCIT, Ahmedabad-3, invoked revisionary jurisdiction under section 263 of the Act by issuing a show cause notice to the assessee on 18.03.2025. The PCIT observed that during the course of assessment proceedings, the Assessing Officer had failed to examine certain issues which rendered the assessment order both erroneous and prejudicial to the interests of the Revenue. The principal issue identified by the PCIT was in respect of the loan transaction of Rs.1,35,00,000/- received by the assessee company from M/s Kesar Built Systems Private Limited during the year.

2.5 The PCIT recorded that as per MCA website, both the assessee company and M/s Kesar Built Systems Pvt. Ltd. had common management, and two directors, namely Shri Rajendra Joshi and Smt. Vishakhaben Joshi, were holding 20% shares each in M/s Kesar Built Systems Pvt. Ltd. It was therefore observed that these directors were beneficial owners of shares with substantial interest in the lending company. The PCIT further recorded that the tax audit report in Form 3CD did not report this transaction under clause 31(a) pertaining to loans or deposits exceeding the limit specified in section 269SS, though such disclosure was required. According to the PCIT, the Assessing Officer failed to verify whether the loan received was out of accumulated profits of the lending company, and whether the provisions of section 2(22)(e) of the Act, relating to deemed dividend, were attracted. It was noted that the loan amount of Rs. 1.35 crore remained unexplained and not examined for the purpose of section 2(22)(e), and that even the peak amount of Rs. 20,16,470 /- during the year was not subjected to proper verification.

2.6 The assessee, in response to the show cause notice issued by the PCIT, submitted that it was not a shareholder in M/s Kesar Built Systems Pvt. Ltd., and hence the provisions of section 2(22)(e) were not applicable in its case. The assessee also pointed out that it had in fact advanced loans to the said company in earlier years and there existed opening and closing balances, and the receipt of Rs. 1.35 crore represented repayment or adjustment of those loans. It was further contended that the PCIT had proceeded on erroneous factual assumption regarding availability of tax audit report.

2.7 The PCIT, however, was not satisfied with the explanation furnished. In the impugned order dated 30.03.2025, the PCIT held that since the directors of the assessee company were beneficial owners of shares in the lending company, the transaction of loan of Rs. 1.35 crore received by the assessee squarely fell within the definition of deemed dividend under section 2(22)(e) of the Act. It was further held that the Assessing Officer had failed to conduct necessary inquiries and verification, and that the order passed was erroneous in so far as it was prejudicial to the interests of the Revenue. The PCIT placed reliance on the judgment of the Hon’ble Gujarat High Court in the case of Katlary Kariyana Merchant Sahkari Sarafi Mandali Ltd. v. Assistant Commissioner of Income-tax 602 (Gujarat)as well as the decision of the Hon’ble Supreme Court in CIT v. Paville Projects (P.) Ltd. 453 ITR 447 (SC), besides other precedents, to emphasise that failure to conduct proper inquiry renders an assessment order erroneous and prejudicial. The PCIT also invoked clause (a) of Explanation 2 to section 263 inserted by the Finance Act, 2015, which deems an order passed without inquiries or verification, which should have been made, as erroneous in so far as it is prejudicial to the interests of the Revenue. On these findings, the PCIT set aside the assessment order dated 08.12.2022 and directed the Assessing Officer to frame a fresh assessment after proper examination of the loan transaction and applicability of section 2(22)(e), within the limitation prescribed under section 153(3) of the Act.

3. Aggrieved by the aforesaid revisionary order, the assessee has preferred the present appeal before us raising following grounds of appeal:

The Order passed U/S 263 of the Act by the Ld. PCIT is in against law, equity & justice.

Revision proceedings initiated by PCIT-3 is void & illegal as same has been without independent application of mind.

Proceedings U/S 263 of the Act is void & illegal s same has been initiated on the basis of audit objection.

The Order passed by PCIT U/S 263 of the Act is void and illegal as revision order passed for the issue which is not selected under CASS.

The Order passed by PCIT is void and illegal as section 2(22)(e) of the Act is not applicable to the assessee company as it is not a shareholder in M/S kesar built Systems Private Limited

The Ld. PCIT has erred in law and on facts in passing the order without correctly appreciating facts more particularly there is no tax audit report.

The Ld. PCIT has erred in law in assuming the jurisdiction U/S 263 of the Act as assessment order is passed after obtaining approvalU/S 153D of the Act.

The appellant craves liberty to add, amend, alter or modify all or any grounds of appeal before final appeal.

4. During the course of hearing before us, the learned Authorised Representative (AR) of the assessee drew our attention to the notice issued under section 143(2) of the Act dated 28.06.2022 and the subsequent notice issued under section 142(1) dated 11.08.2022. It was pointed out that the notice under section 143(2) is in a standard format and does not record any specific reasons for the selection of the case for scrutiny. However, the notice under section 142(1) clearly mentioned that the case was selected for scrutiny assessment under CASS on the parameter of “Very Low PBDIT (Profit before Depreciation, Interest and Taxes) as compared to turnover.” It was thus argued that the scope of scrutiny was confined only to the said parameter, and the Assessing Officer, having issued detailed questionnaires in line with the said notice, examined the matter, called for supporting evidences and completed the assessment after being satisfied with the explanations tendered by the assessee.

4.1 It was submitted by the AR that the Assessing Officer did conduct inquiries as warranted by the reason for selection, and after due consideration of the material on record, accepted the returned income of the assessee. In such circumstances, it was contended that the Principal Commissioner was not justified in invoking section 263 of the Act to travel beyond the scope of CASS selection and to substitute his own opinion in place of that of the Assessing Officer. It was further submitted that the PCIT cannot enlarge the scope of scrutiny by taking recourse to section 263, especially when the Assessing Officer has acted within the confines of the reason recorded in the notice under section 142(1) and completed the assessment after inquiry.

According to the learned Authorised Representative, the assumption of jurisdiction by the PCIT under section 263 is therefore bad in law, as the order of the Assessing Officer cannot be branded as “erroneous” merely because the PCIT holds a different view on an issue which was never the subject matter of scrutiny selection.

4.2 On the merits of the addition proposed by the PCIT in the revisionary proceedings, the learned Authorised Representative further submitted that the provisions of section 2(22)(e) of the Act are wholly inapplicable to the facts of the present case. It was pointed out that the assessee company is not a shareholder in M/s Kesar Built Systems Pvt. Ltd., from whom the alleged loan of Rs. 1.35 crores was received. The learned Authorised Representative further contended that the amounts advanced represented inter-corporate deposits/loans in the ordinary course of business, which are outside the scope of section 2(22)(e).

5. We considered it appropriate to ascertain the exact scope of scrutiny assessment under the Faceless E-Assessment Scheme, 2020, particularly in cases selected through CASS parameters. We therefore directed the learned Departmental Representative (DR) to place on record any statutory notifications, CBDT circulars or administrative instructions which throw light on the ambit of inquiries to be conducted by the Assessing Officer while framing the assessment in such cases. In compliance, the learned Departmental Representative placed before us a copy of Instruction No. 1 of 2021 dated 17.05.2021 and copy of Instruction No. 1 dated 13.10.2021 issued by the CBDT, which lays down the modalities for conducting assessments under the Faceless Assessment Scheme and delineates the scope of limited scrutiny, complete scrutiny and compulsory scrutiny cases. Point No. 10, as reproduced from the Instruction, reads as under:

“Notice u/s. 143(2) in scrutiny cases contain the issue(s) identified for examination. The description of reasons for scrutiny visible to the AO may be different from the issues printed on the notices as the reason for selection visible to the AO contains detailed description related to the case. The screen for display of reasons for scrutiny display issue for examination printed on notice (visible to assessee), corresponding reason for scrutiny selection (visible to AO), underlying information element (visible to AO) and hyperlink for rationale for scenario (visible to AO).”

5.1 The learned Departmental Representative also placed on record a copy of the “Proceedings Feedback” from the ITBA system pertaining to the assessee’s case, which evidences the reason recorded for selection under CASS and the specific issues identified for verification by the Assessing Officer.

5.2 We have carefully considered the rival submissions and have perused the material available on record. We have also examined the statutory notifications, CBDT instructions and the ITBA proceedings feedback produced before us.

5.3 The notice under section 143(2) is in a standard format and does not mention any specific reasons for selection. However, the notice issued under section 142(1) specifically states that the case was selected for scrutiny under CASS for the parameter of “Very Low PBDIT as compared to turnover.” Thus, the scope of scrutiny was limited and confined only to that issue. The Assessing Officer, in line with the said parameter, issued questionnaires, sought replies and evidences, examined the matter and, being satisfied with the explanations offered, completed the assessment by accepting the returned loss.

5.4 The contention of the assessee that the Assessing Officer did conduct inquiries as warranted by the CASS reason is supported by the contemporaneous record. The ITBA “Proceedings Feedback” placed before us by the Departmental Representative also evidences that the inquiry was confined only to the said CASS parameter and that there was no conversion of the case into complete scrutiny with approval of the PCIT. This is also in conformity with the scheme of faceless assessment.

5.5 We have referred to Notification No. S.O. 2745(E) dated 13.08.2020, wherein paragraph 5(i) specifically provides that the National e-Assessment Centre shall serve a notice under section 143(2) specifying the issues for selection of the case for assessment. We have also referred to Instruction No. 1 relating to CASS 2020 dated 17.05.202, where Point No. 10 clarifies that the scrutiny notice itself contains the issue(s) identified for examination, and that the Assessing Officer is restricted by the system to those very issues. Thus, the statutory scheme and CBDT’s own instructions both emphasise that the scope of limited scrutiny is sacrosanct and cannot be enlarged except with prior approval of the competent authority.

5.6 We also examined the “Proceedings Feedback” from the ITBA system placed on record. This feedback mechanism is an integral part of the Faceless Assessment Scheme and requires the Assessing Officer to mandatorily record (as per the said Instruction No.1) the outcome of verification on the identified CASS issues. The format of feedback contains standardised queries such as whether the case was limited scrutiny, whether the assessment was confined to the identified issues, whether additional issues were examined, and whether any additions were made on issues other than those for which the case was selected. Against each of these queries, the responses have to be recorded by selecting “Yes,” “No” or “N.A.” In the present case, the Assessing Officer has recorded the response as “N.A.” (not applicable) against the queries pertaining to limited scrutiny, including whether additional issues were examined. This contemporaneous record supports the assessee’s submission that the assessment remained confined strictly to the parameter of “Very Low PBDIT as compared to turnover,” and that no other issues were taken up or examined. The use of the expression “N.A.” by the Assessing Officer clearly denotes that questions relating to examination of other issues did not arise in this case.

5.7 Therefore, the allegation of the PCIT that the Assessing Officer failed to carry out inquiry on the issue of deemed dividend under section 2(22)(e) is misplaced. The Assessing Officer was never required, within the statutory framework of limited scrutiny under the Faceless Assessment Scheme, to travel beyond the CASS parameter, unless the case was formally converted into complete scrutiny with prior approval of the competent authority. No such conversion is shown to have been done. In such circumstances, the order passed by the Assessing Officer cannot be termed erroneous merely because he did not make inquiries on an issue which was outside the scope of CASS selection.

5.8 The action of the PCIT in invoking section 263 of the Act on an altogether different issue, namely applicability of section 2(22)(e) to the inter-corporate loan of Rs.1.35 crore received from M/s Kesar Built Systems Pvt. Ltd., amounts to enlarging the scope of assessment beyond the CASS parameter. This is impermissible in law. It is a settled position that once the Assessing Officer has raised queries on the issue for which the case is selected, considered the replies and taken a view, the order cannot be termed as “erroneous” merely because the PCIT has a different view on another issue which was never the subject matter of scrutiny. The Hon’ble Supreme Court in Malabar Industrial Co. Ltd. v. CIT 243 ITR 83 (SC)) and the Hon’ble Bombay High Court in CIT v. Gabriel India Ltd. 203 ITR 108 (Bombay)) have laid down that for section 263 to be invoked, the twin conditions of error and prejudice must co-exist, and that a mere change of opinion or suspicion of inadequate inquiry does not confer jurisdiction.

5.9 On merits also, the assessee’s contention is well founded. The assessee company is not a shareholder in M/s Kesar Built Systems Pvt. Ltd. (List of shareholders is placed on page No.56 of the paper book) and therefore, the provisions of section 2(22)(e) are not attracted in its case. The law on this point is no longer res integra. The Hon’ble Delhi High Court in CIT v. Ankitech (P.) Ltd. 340 ITR 14 (Delhi)) has categorically held that deemed dividend can be taxed only in the hands of a shareholder of the lending company, and not in the hands of a concern in which such shareholder is interested. This view has been affirmed by the Hon’ble Supreme Court in CIT v. Madhur Housing & Development Co.401 ITR 152 (SC)/ (Civil Appeal No. 3961 of 2013, dated 05.10.2017). The advances in question, as stated by the assessee, are in the nature of inter-corporate deposits in the ordinary course of business and do not bear the character of dividend. Thus, even on merits, the foundation of the PCIT’s order fails.

5.10 In light of the above discussion, we are of the considered view that the assessment order cannot be regarded as erroneous and prejudicial to the interests of the Revenue. The assumption of jurisdiction by the PCIT under section 263 is, therefore, unsustainable both on procedural grounds as well as on merits.

Accordingly, we set aside the order passed by the PCIT and restore the assessment order passed by the Assessing Officer. The appeal of the assessee is thus allowed.