Income Tax | Tax Commissioner Cannot Revise Assessment On Wrong Assumption Of Amalgamation: Madras High Court

The Madras High Court has held that the Income Tax Department cannot invoke its revisionary powers under Section 263 of the Income Tax Act by proceeding on an incorrect assumption about the nature of a transaction. The court ruled that such powers cannot be exercised where a demerger is wrongly treated as an amalgamation.

Dismissing the revenue's appeal, a bench of Justices Anita Sumanth and Mummineni Sudheer Kumar said the Commissioner had failed to first establish any error in the assessment order before ordering a revision.

“It was thus incumbent upon the CIT to have identified the 'error' in the order of assessment prior to directing intervention by the assessing officer. Alternatively, and assuming that he still harboured a doubt in regard to the arrangement qua the parties, he ought to have articulated those doubts in the order u/s 263 instead of which the matter was simply placed before the assessing officer for enquiry,” the court said

Section 263 allows the Commissioner of Income Tax (CIT) to revise an assessment only if two conditions are satisfied. The order must not only be be erroneous it must also be prejudicial to the interests of the revenue. If either condition is missing, the power cannot be exercised.

In this case, the Eastman Exports Global Clothing Pvt Ltd, the taxpayer, filed its return of income for Assessment Year 2007-8, in which an assessment order was passed. Prior to the assessment, the High Court had sanctioned schemes of demerger under which the manufacturing divisions of a few companies were transferred to the assessee.

The Commissioner of Income Tax (CIT) issued a show cause notice under Section 263 of the Income Tax Act on the ground that the company had wrongly carried forward unabsorbed depreciation and business losses of the demerged entities, treating the arrangement as an amalgamation and invoking Section 72A(2) of the Income Tax Act.

Thereafter, an order was passed by the CIT under Section 263 merely remitting the issue to the assessing officer for examination.

The taxpayer-company then filed an appeal before the Income Tax Appellate Tribunal challenging the CIT order, which was allowed.

Counsel for the company argued that the transaction was a demerger and not an amalgamation, and that the tax department had applied the wrong provision of the Income Tax Act.

He pointed out that the provision relied upon by the Commissioner applies only to amalgamations (Section 72A(2)) and allows companies to carry forward past losses and depreciation only if certain conditions are met. This includes a minimum period of existence.

In contrast, he submitted, the provision that applies to demergers (Section 72A(4)) does not impose any such requirement regarding how long the demerged companies must have been in existence.

Since the transaction in this case was a demerger approved by the High Court, the company was entitled to carry forward the losses and depreciation, and the assessment could not be revised on that basis.