A reassessment order is invalid if it completely ignores the taxpayer's detailed reply to the show-cause notice.

A reassessment order is invalid if it completely ignores the taxpayer’s detailed reply to the show-cause notice.

Issue

Is a reassessment order legally valid if the Assessing Officer passes it without considering or even referring to the detailed reply and documentary evidence that was submitted by the taxpayer in response to the show-cause notice?

Facts

The Assessing Officer (AO) reopened the assessee’s completed assessment. During the reassessment proceedings, the AO issued a show-cause notice (SCN) proposing to make an addition for an alleged unexplained investment under Section 69 of the Income-tax Act, 1961.
In response to this SCN, the assessee filed a detailed submission. In this reply, they explained that the underlying share transactions were genuine and provided all the necessary supporting documentary evidence.
However, the AO went ahead and passed the final reassessment order, making the proposed addition, but did so without even bothering to consider or discuss the detailed reply and the evidence that the assessee had filed.

Decision

The court ruled in favour of the assessee.

It held that the AO’s action of completely ignoring the assessee’s reply was a clear and fundamental breach of the principles of natural justice.
The very purpose of issuing a show-cause notice is to give the taxpayer a chance to present their case. This purpose is completely defeated if the reply to the notice is not even considered.
The court therefore set aside the impugned reassessment order and remanded the matter back to the AO. The AO was directed to pass a fresh order, but only after properly considering the assessee’s submissions.

Key Takeways

The Right to Be Heard is a Substantive Right: The principle of audi alteram partem (the right to be heard) is not just about being given a chance to file a piece of paper. It includes the crucial right to have that submission or reply actually considered by the person making the decision.
An Order Must Show Application of Mind: A valid assessment order, especially one that makes an addition to a taxpayer’s income, must show that the Assessing Officer has applied their mind to the facts, evidence, and arguments presented by the assessee. An order that simply ignores the taxpayer’s entire defense is considered a non-speaking or arbitrary order and is not valid in law.
A Hearing Cannot Be an “Empty Formality”: The process of issuing a notice and asking for a reply cannot be reduced to a mere procedural checkbox that the officer ticks off. The law requires it to be a meaningful process where the taxpayer’s perspective is genuinely taken into account.
Remand is the Standard Remedy for Such a Breach: When an order is passed in such a blatant violation of natural justice, the standard judicial remedy is to set that order aside and send the case back for a fresh and fair hearing, where the taxpayer’s reply will be properly considered.

HIGH COURT OF GUJARAT

J N Tekrawala Construstion Ltd.

Income-tax Officer

BHARGAV D. KARIA and Pranav Trivedi, JJ.

R/TAX APPEAL NO. 930 of 2008

AUGUST 6, 2025

Ms. K.J. Brahmbhatt and Ms. Varsha Brahmbhatt for the Appellant. Karan G Sanghani for the Respondent.

JUDGMENT

Bhargav D. Karia, J. – Heard learned advocate Ms. Varsha Brahmbhatt for the appellant and learned Senior Standing Counsel Mr. Karan Sanghani for the respondent.

2. This Tax Appeal is filed under Section 260A of the Income Tax Act, 1961 (For Short “the Act”) challenging the order dated 16.03.2007 passed by the Income Tax Appellate Tribunal, Ahmedabad Bench-A, (For short “the Tribunal”) Ahmedabad in ITA No. 1421/Ahd/2006.

3. This Court by order dated 11.08.2008 has admitted the Tax Appeal on the following substantial question of law :-

“(A) Whether in the facts and circumstances of the case, the Tribunal was right in confirming the addition of Rs.14,13,745/- being 8% of the contract value in respect of contract with GTEC when the appellant following the project completion method had disclosed the entire profit of the project for the A.Y. 2003-04, after applying the proviso to Section 44AD of the Income Tax Act 1961?”

4. Brief facts of the case are as under :-

4.1. The appellant assessee was engaged in the business of civil construction on contractual basis for the Assessment Year 1998-99. The appellant filed return of income declaring income of Rs.5,98,413/- for Assessment Year 1998-99 on 29.05.2002 which is beyond time limit prescribed under the Act and therefore the same is treated as not filed. During the year under consideration, the appellant carried out contract works for Essar Steel Limited and Gujarat Torrent Energy Corporation Ltd., (For Short “GTEC”). In respect of the contract receipts from the Essar Steel Limited, the appellant followed percentage completion method of accounting and income is shown year to year basis. However, the appellant followed the project completion method in respect of the contract receipts from GTEC.

4.2. The case of the petitioner was reopened under Section 147 of the Act after recording reasons thereof and notice under Section 148 of the Act was issued on 31.03.2005. The petitioner was accordingly assessed under Section 143(3) read with Section 147 of the Act vide order dated 29.12.2005. The Assessing Officer noticed that the appellant received payment from GTEC on the basis of RA bills raised from time to time and for the Financial Year 1997-98 there were total receipts of Rs.1,76,71,807/-. The Assessing Officer therefore estimated the profit @ 8% on receipts of Rs.1,76,71,807/- and made an addition of Rs.14,13,745/- to the total income of the appellant. The Assessing Officer also found various defects in the Books of Account maintained by the appellant including the method of accounting as well as the vouchers of the labour payments.

5. Being aggrieved by the Assessment Order, the appellant preferred an appeal before the CIT (Appeals) who vide order dated 23.02.2006 confirmed the addition made by the Assessing Officer.

6. The appellant therefore, filed an appeal being ITA No. 1421/Ahd/2006 before the Tribunal. The Tribunal by impugned order dated 16.03.2007 dismissed the appeal by observing as under :-

“8. We have heard the Id. representative of parties and record perused. The first issue as per facts of the case is in respect of method of accounting to follow for contract receipts from GTEC. Two methods of account for contracts commonly followed by contractors are the percentage of completion method and complete contract method.

Under the percentage of completion method, revenue is recognized as the contract activity progresses based on the stage of completion reached. The costs incurred in reaching the stage of completion are matched with this revenue, resulting in the reporting of the results which can be attributed to the proportion of work completed. Although (as per the principle of prudence) revenue is recognized only when realized, under this method, the revenue is recognized as the activity progresses even though in certain circumstances it may not be realized.

Under the completed contract method, revenue is recognized only when the contract is completed or substantially completed; that is, when only minor work is expected other than warranty obligation. Costs and progress payments received are accumulated during the course of the contract but revenue is not recognized until the contract activity is substantially completed.

The choice for following a particular method depends upon accrual or revenue recognition. The principles to determine as to when the income is said to have been accrued or arisen are already well-settled by a catena of decisions of the Supreme Court and need no reiteration. It is well settled that the income is held to accrue only when the assessee acquires a right to receive that income. In other words, or to say it differently, income can be said to accrue on a date when the debt becomes due. As observed by the Supreme Court in CIT v. Ashokbhai Chimanbhai (1965) 56 ITR 42.

9. In the case under consideration admitted facts are that contract receipts received to the assessee on the basis of R.A. Bills Rs.71,63,010/- is received in financial year related to Asst. Year 1997-98. Rs.13,14,187/- in Asst. Year 1999-2000 and Rs.55,81,493/- in Asst. Year 2003-04. Asst. Year 2003-04 said to be year of completion of contract works. The details of RA bills noticed from reasons recorded at the time of reopening of assessment are as under :-

GTEC Ltd.

1997-98 i.e. 1998-99

Date	RA No.	Gross amount	TDS	Deductions		Net amount
Date	RA No.	Gross amount	TDS	Security deposit	Sales Tax	Ele. exp.
08.04.1997	3rd	40,74,637	87, 605	2,03,732	–	3,595	37,79,705
27.05.1997	4th	40,40,591	86, 872	2,02,030	_	_	37,51,689
18.06.1997	5th	52,80,651	1,13,534	2,64,033	3,88,675	–	45,14,409
27.01.1998	7th	15,77,739	31, 555	78, 887	_	_	14,67,297
		1,49,73,618	3,19,566	7,48,682	3,88,675	3, 595	1,35,13,100

10. After considering discussion on principle of revenue recognisation and above noted facts we find that the assessee has failed to establish that how project completion method is applicable in case of assessee. Generally project completion method is being followed in case of assessee’s own project and not in case where assessee is to execute civil contract works obtain from awarder for execution under an agreement. In such cases there is agreement between contractor and awarder having terms and conditions including terms and condition of payments on the amount received to assessee through RA Bills are periodically, out of TDS is made deduction made on account of security and sales-tax etc. That means the receipts are in accordance with agreement between parties. Receiving contract receipts against bills means there is accrual of receipts, once income/receipt is accrued same is subject to tax in the year in which it accrued. Accrual receipts/income cannot be postponed for taxation in future date. In case of project completion method income/receipt is not accrued, but in the case under consideration income/receipts has been accrued therefore project completion method is not applicable. We find that the Assessing Officer has rightly rejected the assessee’s contention and method followed. We therefore confirm the action of the Assessing Officer. Further, we find that under the facts and circumstances, defects in books of accounts as pointed out by the Assessing Officer including following incorrect method of accounting we find that Assessing Officer is fully justified in rejecting books of account and in estimating GP by applying 8% profit rate. The rate applied is fortified by section 44AD. The assessee failed to point out any convincing reasons against application of that rate of profit as such rate is applicable in cases where turnover of 40 lakh why not same is applicable to where turnover is more than 40 lakh.

7. Learned advocate Ms. Varsha Brahmbhatt for the appellant submitted that it is not in dispute that the appellant was having composite contract of storm water drainage from GTEC which was completed in the Financial Year 2002-03 (Assessment Year 2003-04). It was submitted that the project had proceeded for some time but had to be kept pending as the appellant was not receiving funds and the amount was shown as work in progress by the appellant and finally on completion of the contract, the entire income was offered to tax in the Assessment Year 2003-04.

7.1. It was submitted that the appellant had followed two different methods. The percentage method for the contract of construction of residential houses of Essar Steel Limited and project completion method for the composite contract of storm water drainage in case of contract of GTEC. It was pointed out by learned advocate Ms. Brahmbhatt that the appellant did not offer to tax the amount received from GTEC from the Assessment Year 1997-98 to 2003-04 and the entire amount of Rs.2,60,38,029 was offered to tax in Assessment Year 2003-04.

7.2. It was submitted that during the assessment of the Assessment Year 2002-03, the Assessing Officer has raised an issue regarding the receipts from GTEC being shown on project completion method and no addition was made by the Assessing Officer as the entire profit was shown in the return of income filed for the Assessment Year 2003-04. It was, therefore, submitted that once the Revenue has accepted the project completion method employed by the petitioner for the receipts from GTEC in Assessment Year 2002-03, the Assessing Officer could not have made any addition in the year under consideration as it would amount to double taxation as the same income is already taxed in Assessment Year 2003-04.

7.3. Learned advocate Ms. Brahmbhatt also invited attention of the Court to the notes forming part of the accounts in the audited accounts wherein in the significant accounting policy it was disclosed by the appellant that the company follows project completion method as per Accounting Standard-7 in respect of the construction work of GTEC. Reference was also made to the settlement agreement arrived at between the appellant and the GTEC in arbitration proceedings, when the GTEC disputed the claims raised by the appellant as per the award rendered by the Arbitrators [Hon’ble Ex-Chief Justice Mr. B.J. Diwan and Shri B.T. Unwala] and Shri M.S. Julundwala as the Presiding Arbitrator. During the course of arbitration proceedings, Deed of Settlement dated 31.05.2002 was executed and accordingly the entire income was offered to tax for the Assessment Year 2003-04.

7.4. Learned advocate Ms. Brahmbhatt has refer to and relied upon the decision of this Court in case of CIT v. Advance Construction Co. (P.) Ltd. 61/275 ITR 30 (Gujarat) to submit that this Court in the facts of the said case has held that when the Tribunal has categorically found that the assessee has followed the standard accounting method as it being the first year of the business it was the sole choice of the assessee to adopt a particular method of accounting contemplated under Section 145 of the Act. After referring to the decision of the Hon’ble Apex Court in case of Badridas Daga v. CIT [1958] 34 ITR 10 (SC), it was held by this Court that when the assessee has followed the method of accounting which is well recognized and is in consonance with the standard accounting practice, in such cases on the basis of accepted commercial principle, it cannot be held that the receipt which was required to be charged to income tax for the year under consideration has to be on different accounting method.

8-9. On the other hand, learned Senior Standing Counsel Mr. Karan Sanghani for the respondent relied upon the orders passed by the Tribunal and submitted that the substantial work has been completed for the year under consideration and therefore, the Tribunal has rightly upheld the findings of the CIT (Appeals) to hold that the project completion method is rightly not applied by the Assessing Officer and as the appellant has received the payment and the TDS is also deducted for the year under consideration from RA bills and deduction on account of security and sales tax etc. are also made and therefore, the receipts are in accordance with agreement between the parties and resulting into approval of the receipts and therefore, the Assessing Officer was justified in applying profit @ 8% in consonance with the provisions of Section 44AD of the Act to tax the income for the year under consideration.

10. Having heard the learned advocates for the respective parties and considering the facts of the case, it is not in dispute that the appellant has offered entire income of the composite project of storm water drainage with GTEC in the Assessment Year 2003-04. The appellant has followed the project completion method since 1992 in respect of project with GTEC. Moreover, during the year 2002-03 the appellant has brought to the notice of the Assessing Officer about offering the entire income on completion of project with GTEC in the Assessment Year 200304 which was accepted.

11. This Court in case of Advance Constructions Company Pvt. Ltd., (supra) has held as under :-

“13. The assessee was in receipt of total sum of Rs. 1,54,82,953/- comprised of certified work as well as uncertified work including reimbursements. As against such receipts, during the accounting period the assessee incurred expenses to the tune of Rs. 1,39,66,411/- leaving a difference of Rs.15,16,542/-. The assessee reduced the said figure by sum of Rs. 11,78,850/- on the basis of the method of accounting employed by the assessee viz. Percentage Completion Method by working out the said sum as more than one-forth but less than one-half of contract being completed and offered profit of Rs. 3,37,592/- as profit of the year. It becomes further clear from the calculation statement available on record that for the next accounting period i.e. year ended 30/6/1982 the assessee similarly reduced a sum of Rs. 44,440/- towards more than one-half of contract being completed. The said statement further shows that a sum of Rs. 9,43,160/- was written back for the subsequent year and offered for taxation. Similarly a further sum of Rs. 2,80,230/- was again written back in the third year i.e. accounting period ended on 30/6/1983. Therefore, it is apparent that a total sum of Rs. 12,23,390/- which was reduced in the year under consideration and the immediately succeeding year was offered for taxation in the immediately succeeding year and the year thereafter. Therefore, on facts it becomes apparent that by the time the contract was completed the total receipts had borne charge of tax and the assessee had derived no advantage as such.

14. However, apart from the aforesaid factual position, it is necessary to note that u/s.145 of the Act income chargeable under the head ‘Profits and Gains of Business or Profession’ shall be computed in accordance with the method of accounting regularly employed by the assessee. The only exception is : where the method employed is such that in the opinion of the assessing officer income cannot be properly deduced therefrom the assessing officer shall then compute the income upon such basis and in such manner as he may determine. The provision therefore specifically provides that the choice of method of accounting lies with the assessee, the only caveat being that it has to show that the chosen method has been regularly followed. The section is couched in mandatory terms and the department is bound to accept the assessee’s choice of method regularly employed, except for the situation, wherein the assessing officer is permitted to intervene, in case it is found that true income, profits and gains cannot be arrived at by the method employed by the assessee. The position of law is further well settled that a regular method adopted by an assessee cannot be rejected merely because it gives benefit to an assessee in certain years.

15. In the present case, the Tribunal has categorically found that “the assessee has followed the standard accounting method as this being the first year of the business it was the sole choice of the assessee to adopt a particular method of accounting contemplated u/s.145 of the Act”. It is further admitted by the learned Advocates appearing for the parties that the said method has been constantly followed by the assessee and in subsequent years the revenue has accepted the same.

16. In the case of Badridas Daga v. Commissioner of Income-Tax, (1958)34 ITR 10, the Hon’ble Supreme Court has enunciated the following propositions:

“While section IO(1) of the Indian Income-tax Act,1922, imposes a charge on the profits or gains of a business, it does not provide how these profits are to be computed. Section 10(2) enumerates various items which are admissible as deductions but they are not exhaustive of all allowances which could be made in ascertaining the profits of a business taxable under section 10(1). Profits and gains which are liable to be taxed under section 10(1) are what are understood to be such under ordinary commercial principles.

When a claim is made for a deduction for which there is no specific provision under section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and be incidental to it. The loss for which a deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it, and not any loss sustained by the assessee even if it has some connection with his business. If that is established, then the deduction must be allowed, provided that there is no provision against it, express or implied, in the Act.

Sections 28 and 29 of the Act are pari materia with Sections 10(1) & 10(2) of the Indian Income Tax Act,1922. Therefore, the same principles will be applicable to the case at hand. The Tribunal has found that the assessee has followed a method of accounting which is well recognized and is in consonance with standard accounting practice. In these circumstances, on the basis of accepted commercial practice it is not possible to hold that the amount of Rs. 11,78,950/- is a receipt which was required to be charged to income tax for the year under consideration in light of the facts which have come on record and the settled legal position.

17 Therefore, the order of the Tribunal does not suffer from any infirmity. The action of the Commissioner u/s. 263 of the Act is bad in law there being no error in the assessment order, much less an error which could be termed as an error prejudicial to the interests of revenue.”

12. In view of the above dictum of law when the appellant has followed method of accounting which is well recognized and is in consonance with the standard accounting practice more particularly as per the revenue recognition note forming part of the account placed on record which discloses that the appellant has followed the project completion method as per Accounting Standard-7 in respect of the construction work of GTEC.

13. Therefore, we are of the opinion that the Tribunal was not right in conforming addition of Rs.14,13,745 being 8% of the contract value in respect of the contract with GTEC when the appellant was following the project completion method and has disclosed the entire profit of the project in the year 2003-04. The substantial question of law therefore, is, answered in favour of the appellant – assessee and against the Revenue.

The Tax Appeal is accordingly allowed.