Reassessment Cannot Be Sustained Where Reduction

Reassessment Cannot Be Sustained Where Reduction in Work-in-Progress Decreases Taxable Profit Without Escapement

Issue

Whether reassessment proceedings under Section 147/148 are legally sustainable when an alleged higher valuation of closing Work-in-Progress (WIP) actually increases taxable income rather than causing income escapement, and whether the Assessing Officer can introduce new grounds while disposing of objections.

Facts

The assessee, a partnership firm in the real estate development business, filed its return of income for AY 2015-16, which was processed under Section 143(1).
The assessee submitted audited accounts under Section 44AB, maintaining a consistent method of accounting followed since AY 2013-14, with WIP valued at the cost of completion.
The Assessing Officer (AO) issued a notice under Section 148, alleging that closing WIP was valued at Rs. 13.72 crores instead of Rs. 13.08 crores, resulting in an inflation of WIP by Rs. 63.88 lakhs and consequent escapement of income.
The assessee filed objections stating that reducing closing WIP would decrease its reported profit, thus proving there was no income escaping assessment.
While disposing of the objections, the AO introduced a new allegation regarding suppression of sales/income—a ground absent from the original reasons recorded for reopening.

Decision

No Escapement of Income: The High Court held that reducing closing WIP by Rs. 63.88 lakhs would lower the profit shown by the assessee, meaning no income had escaped assessment to justify reopening under Section 147.
Impermissible New Grounds: The Court ruled that the AO cannot introduce new allegations (such as suppression of sales) in the order disposing of objections when such grounds were not part of the original reasons recorded for reopening.
Reassessment Quashed: The notice issued under Section 148 and the order rejecting the assessee’s objections were quashed and set aside in favour of the assessee.

Key Takeaways

Core Requirement of Income Escapement: Reassessment under Section 147 requires a demonstrable escapement of income; an adjustment that reduces profits or increases income reported by the taxpayer cannot form the basis of reopening.
Scope Limited to Reasons Recorded: The Assessing Officer is bound strictly by the reasons recorded prior to issuing a Section 148 notice and cannot introduce fresh grounds at the stage of disposing of objections.
Consistency in Accounting Method: A consistent method of valuing Work-in-Progress followed across assessment years without challenge cannot be arbitrarily disturbed in a subsequent year without valid legal grounds.

HIGH COURT OF GUJARAT

Siddhivinayak Buildcon

Assistant Commissioner of Income-tax

A.S. Supehia and Ms. VAIBHAVI D. NANAVATI, JJ.

R/SPECIAL CIVIL APPLICATION NO. 19277 of 2019

JUNE 22, 2026

Manish J Shah for the Petitioner. Maunil G Yajnik for the Respondent.

JUDGMENT

Vaibhavi D. Nanavati, J.- Issue Rule, returnable forthwith. Learned Standing Senior Counsel Mr. Maunil Yajnik, waives service of Rule for and on behalf of the respondent.

2. With the consent of the learned counsel appearing for the respective parties, matter is taken-up for final hearing.

3. Heard learned advocate Mr. Manish J. Shah appearing for the petitioner and Learned Standing Senior Counsel Mr. Maunil Yajnik appearing for the respondent.

4. By way of present petition, the petitioner herein is aggrieved by the issuance of the impugned notice under Section 148 of the Income Tax Act, 1961 (for short ‘the Act’) dated 13.03.2019 for the Assessment Year (for short ‘A.Y.’) 2015-16 as well as order dated 27.09.2019 passed by the respondent, rejecting the objections filed by the petitioner. The same having been issued without valid reasons, and prayed for the following reliefs:

“10. In the premises aforesaid, the petitioner prays that:-

A) this Hon’ble Court be pleased to call for the records of the proceedings, look into them and be pleased to issue a writ of certiorari or any other appropriate writ, order or direction quashing the impugned 148 notice at Annexure-C and the order disposing the objections at Annexure-J.

B) this Hon’ble Court be pleased to issue a writ of mandamus or any other appropriate writ, order or direction asking the respondent not to proceed further in pursuance of section 148 notice at Annexure-C and the order rejecting the objections at Annexure-J.

C) Pending the hearing and final disposal of this application, this Hon’ble Court be pleased to stay any further proceedings in pursuance of section 148 notice at Annexure-C.

D) This Hon’ble Court be pleased to grant any further or other relief as this Hon’ble Court deems just and proper in the interest of justice, and

E) This Hon’ble Court be pleased to allow this application with costs against the respondent.”

5. The brief facts leading to the filing of the present petition read as:

5.1. The petitioner herein is a partnership firm engaged in business of real estate development and sales thereof and an income tax assessee being assessed to tax at PAN: ACEFS0364H under the Act. The petitioner herein filed return of income on 29.09.2015 for A.Y. 2015-16 declaring total income of Rs.64,01,500/-. Thereafter, the said return was processed under Section 143(1) of the Act and accordingly, intimation dated 17.10.2015 was issued to the petitioner. The petitioner revised its return of income on 07.06.2016 declaring the same income.

5.2. The acknowledgment of original return of income and revised return of income alongwith intimation issued under Section 143(1) of the Act and computation of revised income are duly produced at Annexure A.

5.3. The petitioner being liable to get the books of account audited under Section-44AB of the Act, has furnished tax audit report in Form No.3CB alongwith audited financial statement of the firm for the period from 01.04.2014 to 31.03.2015. In the said audit report in Form No.3CB, the Chartered Accountant, who conducted the tax audit of the petitioner, in Column 13 A to D has mentioned that there is no deviation/change in method of accounting employed by the petitioner compared to the method employed immediately preceding year. In the audited financial statement, it was shown that the valuation of inventory on balance-sheet date, i.e. 31.03.2015 comes to Rs.30,01,00,538/-, which comprises of inventory of land Rs.3,39,94,650/-, material and hardware Rs.63,452/-, and work in progress of Rs.10,31,00,000/-. All the figures have specifically been shown in Schedule-4 of the financial statement.

5.4. The petitioner firm at Schedule-19, i.e. ‘significant accounting policies’, has specifically made a disclosure that closing stock of raw material, stores, spares, and packing materials are valued at cost and work in progress is valued at cost of completion worked out as on balance sheet date. The Chartered Accountant of the petitioner firm, who conducted the audit, has not found any fault with the method of valuation of closing stock and hence, he has not made any specific adverse observation or qualification with regard to valuation of closing stock.

5.5. The petitioner herein was issued Notice under Section-148 of the Act on 13.03.2019 (Annexure-C), for A.Y. 2015-16, stating that the respondent authority has reason to believe that income has escaped assessment and asking the petitioner to file its income tax return within 30 days from the receipt of the said notice. In response to the said Notice, the petitioner filed return of income on 10.04.2019 (Annexure-D), declaring the income as declared in return filed under Section-139 of the Act. On even date, the petitioner addressed a letter to the Assessing Officer informing him about filing of return and also asking for copy of reasons recorded in the order. The Assessing Officer supplied the copy of reasons recorded which are duly produced at Annexure-F. The petitioner herein filed objections against the reasons recorded for reopening of the assessment by communication dated 28.05.2019, which was submitted on 06.06.2019 (Annexure-G).

5.6. Thereafter, certain Notices under Section-142(1) of the Act are issued to the petitioner asking for certain information without disposing of the objections taken by the petitioner. The petitioner submitted its responses to the aforesaid. All the notices and replies thereto are duly produced at Annexure-H to the Petition (collectively). On even date, i.e. on 20.09.2019, the petitioner addressed a communication to the Assessing Officer reminding about the objections raised by the petitioner to the reopening of the assessment proceedings, by filing objections by letter dated 28.03.2019, submitted on 06.06.2019 which were not disposed of.

5.7. It was further submitted by the petitioner that to continue the proceedings without disposing of the objections raised by the petitioner, results in gross violation of principles of natural justice and requested the Assessing Officer, to dispose of the objections by passing a speaking order. The respondent passed the impugned order dated 27.09.2019 (Annexure-J), disposing of the objections of the petitioner, wherein, in the said order, it is stated that due to inflation of closing stock by Rs.63,88,466/-, the petitioner suppressed the sale and other income equivalent amounting to Rs.63,88,466/- and hence the reasons are correctly recorded by the Assessing Officer. Thereafter the petitioner by letter dated 02.10.2019 (Annexure-K) informed the respondent that it is contemplating to prefer a writ-petition before the High Court against the issuance of the allegedly illegal Notice under Section-148 of the Act and order rejecting the objections raised by the petition. The aforesaid has given rise to the filing of the present petition for the prayers as referred to herein-above.

6. Mr. Manish Shah, learned advocate appearing for the petitioner, at the outset referred to the interim order dated 23.10.2019 passed in the present petition and reiterated the submissions that the reasons recorded for reopening of the assessment on the ground that petitioner had calculated the closing work in progress at Rs.13,71,58,102/- instead of Rs.13,07,69,637/- and resultantly inflated the closing work in progress by Rs.63,88,466/- and consequently income to that extent has escaped assessment. It is submitted that, issuance of notice under Section-148 of the Act can be invoked, if the income has escaped assessment. That condition precedent for issuing Notice under Section-148 of the Act is that there should be an escapement of income. In the facts of the present case, clearly, there cannot be said to be any escapement of income on the reasons recorded by the Assessing Officer. The reason states that the closing stock of the petitioner is required to be reduced, can never result into escapement of income. On the contrary, once the value of closing stock decreases, it directly reduces the taxable income, and hence assessment would have to be made at a lower figure than the existing one.

6.1. Placing reliance on the aforesaid submissions, it is submitted that in absence of any escapement of income, Notice issued under Section-148 of the Act by the Assessing Officer to reopen the assessment fails to fulfill the condition precedent of there being escapement of income for the concerned A.Y. 201516. It is submitted that, the Assessing Officer seeks to change the reason for reopening stating inflation of closing stock by an amount of Rs.63,88,466/-, resultantly, sale or other income has been suppressed by that amount. It is submitted that the aforesaid is nothing but change of opinion.

6.2. It is submitted that the assessing officer invoked Clause-(b) to explanation-2 of section-147 of the act to issue notice under section-148 of the act. The same being misplaced, as it can only be invoked, in case of understatement of income or any excess of claim of loss, deduction, allowance or relief in return. In the facts of the present case, none of the ingredients of Clause-(b) of Explanation-2 to Section-147 of the Act are present, as there is no understatement of income. On the contrary, in the facts of the present case, there is overstatement of income. Thus, invocation of Clause-(b) of Explanation2 to Section-147 of the Act has been erroneously invoked to issue reassessment Notice under Section-148 of the Act.

6.3. It is submitted that the petitioner herein consistently followed the method of valuing closing WIP (Work In Progress) since its incorporation in the A.Y. 2013-14 and has been never challenged in A.Y. 2013-14 and 2014-15. It is submitted that the aforesaid exercise is undertaken by following the Standard Accounting Method. It is submitted that, for the first time in A.Y. 2016-17, the Assessing Officer challenged the valuation of closing work in progress, which was found to be unsustainable by the CIT (Appeals), having deleted the additions made by the Assessing Officer in the Appeal, against the order of assessment in the A.Y. 2016-17. The said order has also attained finality. In view thereof also, the impugned order passed under Section-148 of the Act is unsustainable in the eye of law, and the same is required to be quashed and set aside.

7. Mr.Maunil Yajnik, the learned Senior Standing Counsel appearing for the respondent authority, submitted that the petition is filed at a premature stage, inasmuch as only notice under Section-148 read with Section 147 of the Act has been issued. In the event, the petitioner herein would be aggrieved by the reassessment, the petitioner would have statutory remedy by way of Appeal and thereafter Tribunal, as per the provisions of the Act. On the aforesaid ground alone, the present petition may not be entertained.

7.1. It is submitted that the impugned Notice is issued for A.Y 2015-16, the same is issued within a period of 4 years from the end of the relevant A.Y. No scrutiny assessment under Section-143(3) of the Act was undertaken and only an intimation under Section-143(1) of the Act was issued.

7.2. Pursuant to the information received, from the assessment proceedings for the subsequent year, i.e. 2016-17, it was noticed that for the year under consideration, i.e. A.Y. 2015-16, the assessee calculated the closing work in progress at Rs.13,71,58,102/- instead of Rs.13,07,69,637, which has resulted in inflating the closing stock in work in progress by Rs.63,88,466/-.

7.3. In the objections raised by the petitioner, the assessee has contended that inflating closing WIP would decrease the profit. However, the Assessing Officer while disposing of the objections negated the stand, observing that due to reason of inflating of closing stock, sale or other income has been suppressed by that amount. It is submitted that the aspect of suppression of sale and other income by the assessee- petitioner is manifestly present in the reasons recorded and in view thereof, no interference is called for in the impugned order passed by the Assessing Officer.

7.4. It is further submitted that the present is not a case of change of stand by the Assessing Officer in the order disposing of the objections. It is submitted that, in the instant case, during assessment proceedings under Section-143(3) of the Act of A.Y. 2016-17, on perusal of working of WIP for the year 2015-16, the aforesaid was noticed and in view thereof, the reasons are valid for reopening the case of the petitioner.

7.5. Placing reliance on the aforesaid submissions, it is submitted that the present petition is required to be dismissed.

8. Having heard the learned advocates appearing for the respective parties, the facts as referred to herein-above are not in dispute and the same are not repeated.

8.1. On perusal of the impugned order passed by the Assessing Officer under Section 148 of the Act for A.Y. 2015-16, the reasons recorded for reopening the assessment are to the effect that the petitioner calculated the closing Work In Progress (WIP) at Rs.13,71,58,102/- instead of Rs.13,07,69,637/-, resultantly, inflated the WIP by Rs.63,88,466/-, and therefore, the income to that extent, has escaped the assessment. In our opinion, as submitted by Mr.Manish Shah, learned advocate, if the work in progress is reduced by Rs.63,88,466/-, the profit shown by the petitioner would stand reduced to that extent and hence, the question of any escapement of income would not arise. The reduction in closing stock of work in progress would not result into escapement of income.

8.2. Upon objections filed by the petitioner, bringing the aforesaid aspect to the notice of the Assessing Officer, it is held that due to inflation of closing stock by Rs.63,88,466/-, the petitioner has suppressed the sale or other income equivalent amounting to Rs.63,88,466/-. Such order and the reasons assigned by the Assessing Officer, in our opinion, are beyond the scope of the show cause notice, are unsustainable and impermissible in the eye of law.

8.3. It is pertinent to note that, the reasons assigned in the show cause notice under Section 148 of the Act dated 13.03.2019 for reopening of the assessment for A.Y. for 2015-16, having noticed that the petitioner has calculated the closing WIP at Rs.13,71,58,102/- instead of Rs.13,07,69,637/- and therefore the petitioner has inflated the closing WIP by Rs.63,88,466/-. The impugned order dated 27.09.2019 while disposing of the objections held that the objections raised by the petitioner are misplaced, wherein, only consequence of calculating closing stock by inflating it would not be a proportionate reduction in income. Due to the reasons for inflation of closing stock by an amount of Rs.63,88,466/-, the sale or other income has been suppressed by that amount.

8.4. The respondent has shifted his stand in his objection disposal order by taking all together a news stand, which was never the case of Assessing Officer at the time of recording the reasons. In the reasons recorded, it was never alleged by the Assessing Officer that the petitioner indulged in suppression of sales or any other income. On pointing out that reduction in closing stock of work-in-progress can never result into escapement of income and on the contrary, it results into decrease in income already assessed, held that reducing the value of closing WIP, the petitioner has suppressed the sale or other income.

9. At this stage, it is apposite to refer to the oral judgment dated 06.12.2017 passed in Special Civil Application No. 16171 of 2017, wherein, it is held that, the Assessing Officer, instead of dropping the assessment proceedings by order rejecting the objection, proceeded with the reassessment proceedings on a fresh ground, which did not find place in the reasons recorded in the show cause notice, was held to be impermissible. Relevant Paragraph nos.7 to 12 read thus:

“7. Besides, the facts of the present case are quite gross, inasmuch as, in the reasons recorded the Assessing Officer has based his belief on the fact that the assessee has not filed any return of income on account of which there is escapement of income on account of sale of the immovable property. After obtaining the reasons, the assessee has pointed out to the Assessing Officer that he had filed the return of income disclosing sale of the immovable property valued at Rs.40,00,000/, and the same had been duly accepted by the then Assessing Officer. However, the respondent Assessing Officer, instead of dropping the assessment proceedings, by the order rejecting the objections, seeks to proceed with the reassessment proceedings on a fresh ground which does not find place in the reasons recorded, viz. that “on perusal of copy of the assessment u/s 143(3) read with section 147 and computation of income, satisfaction of the AO while recording satisfaction is found based on fact as genuinity of deduction availed u/s 54 and discharge of liability of LTCG in the case is not found any reflection through the assessment order.

8. In the case of GKN Driveshafts (India) Ltd. v. ITO, (2003) 1 SCC 72, the Supreme Court held that when a notice under section 148 of the Income Tax Act, 1961 is issued, the proper course of action for the noticee is to file return and if he so desires, to seek reasons for issuing notices. The Assessing Officer is bound to furnish reasons within a reasonable time. On receipt of reasons, the noticee is entitled to file objections and the Assessing Officer is bound to dispose of the same by passing a speaking order before proceeding further.

9. The filing of objections and passing an order thereon, is not an empty formality. The object behind the assessee filing objections and the Assessing Officer passing a speaking order thereon is to ensure that if the assessee is in a position to impress upon the Assessing Officer that there is no reasonable ground for reopening the assessment, the Assessing Officer may drop the proceedings and not proceed further. In the facts of the present case, despite the fact that the assessee had duly pointed out to the Assessing Officer that he had, in fact, filed his return of income, wherein this very issue had been gone into, instead of acting fairly and reasonably and dropping the proceedings, the respondent Assessing Officer seeks to proceed further for reasons which are alien to the reasons recorded for reopening the assessment. Thus, the very intent and purpose behind submitting objections and passing a speaking order thereon is frustrated.

10. As is apparent on a plain reading of the reasons recorded, the very basis for reopening the assessment is that the petitioner had not filed any return of income disclosing such sale of the immovable property valued at Rs.40,00,000/. The record of the case shows that earlier, pursuant to a notice under section 148 of the Act, the petitioner had, in fact, filed return on income disclosing the sale of such immovable property, and the Assessing Officer after duly applying his mind to the issue had accepted the return of income. Considering the fact that a return of income had been filed disclosing sale of the immovable property, the very foundation on which the reopening is based in the reasons recorded by the Assessing Officer for reopening the assessment, collapses. Therefore, on the reasons recorded, the Assessing Officer could not have formed the belief that income had escaped assessment, inasmuch as such belief had been formed on a factually incorrect premise. It is settled legal position, that the reopening of the assessment has to be maintainable on the reasons recorded for reopening the same, and that such reasons cannot be substituted. In the facts of the present case, when the original ground for reopening the assessment does not survive, the Assessing Officer seeks to proceed further with the assessment on totally different grounds, which is impermissible in law. Moreover, what the Assessing Officer now seeks to do is to sit in judgment over the assessment framed by his predecessor Assessing Officer, which again, is not permissible in law.

11. In the light of the fact that very basis for reopening no longer survives, the assumption of jurisdiction under section 147 of the Act by the Assessing Officer by issuing notice under section 148 of the Act is without authority of law and cannot be sustained.

12. For the forgoing reasons, the petition succeeds and is accordingly allowed. The impugned notice dated 31.03.2007 issued by the respondent – Income Tax Officer under section 148 of the Act is hereby quashed and set aside. RULE is made absolute accordingly with no order as to costs.”

10. Considering the position of law, as referred to herein-above and the facts of the present case, we have also noted that the petitioner herein has followed the method of closing WIP since its incorporation in A.Y. 2013-14 and has never been challenged in the A.Ys. 2013-14 and 2014-15. For the first time in the A.Y. 2015-16, the Assessing Officer challenged the valuation of closing WIP, which was found to be unsustainable, wherein, the CIT (Appeals) has deleted the additions made. On the aforesaid ground also, the aforesaid issue has attained finality which requires, no interference.

11. For the foregoing reasons, the impugned notice issued under Section 148 of the Income Tax Act, 1961 dated 13.03.2019 for the Assessment Year 2015-16 as well as order dated 27.09.2019 passed by the respondent, rejecting the objections filed by the petitioner, are required to be quashed and set aside and the same are hereby quashed and set aside. Accordingly, the present petition stands allowed. Rule is made absolute.