The Punjab & Haryana High Court has quashed an income-tax demand and penalty proceedings after finding that the Income Tax Department had sought to enforce a draft assessment order as though it were a final assessment order.
The bench of Justice Deepak Sibal and Justice Rupinderjit Chahal has observed that a draft assessment order cannot by itself create a tax liability or support a demand under Section 156 of the Income-tax Act, 1961, when no final assessment determining the amount payable has been passed.
The bench found that the assessee was not an “eligible assessee” under Section 144C(15)(b) because the Transfer Pricing Officer had not proposed any variation to the returned income. Consequently, the statutory mechanism for passing a draft assessment order under Section 144C was itself not applicable.
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The petitioner/assessee, a software development company and subsidiary of a US-based entity, had filed its revised return declaring total income of approximately ₹62.14 crore.
Since the return contained international transactions with associated enterprises, the Assessing Officer referred the matter to the Transfer Pricing Officer. The TPO examined the transactions and, taking note of an Advance Pricing Agreement entered into with the Central Board of Direct Taxes, found no adverse variation in the international transactions. The TPO consequently did not recommend any adjustment to the returned income.
Despite the absence of any transfer-pricing variation, the Assessing Officer subsequently issued an order dated December 28, 2019, styled expressly as a “Draft Order u/s 144C of the Income-tax Act, 1961.”
The proposed adjustment was substantial. The Assessing Officer proposed to disallow ₹13,73,32,347 towards foreign travelling expenses incurred by the assessee. The department consequently proposed to increase the assessee’s returned income by the same amount.
The draft order ultimately computed the assessed income at approximately ₹75.87 crore, after adding the proposed foreign travel expenditure of ₹13.73 crore.
A crucial feature of the case was the language used by the Assessing Officer himself.
The order was headed “Draft Order u/s 144C” and expressly stated that the addition was only a proposal. More importantly, the order specifically recorded that because it was a draft assessment order, no demand notice or penalty notice was being issued at that stage.
The assessee was also informed of its statutory right under Section 144C(2) to either accept the variations or file objections within 30 days.
The High Court therefore found little scope to accept the department’s subsequent contention that the order was actually intended to be a final assessment order under Section 143(3).
According to the Court, the document itself demonstrated that the Assessing Officer had treated it as a draft order, that the proposed addition was not a final determination, and that the assessee was specifically given an opportunity to object before a final assessment could be made.
The controversy intensified after the draft order.
When the assessee initially challenged the December 28, 2019 order before the High Court, the revenue informed the Court that the order was actually intended to be a final assessment order under Section 143(3) and that the reference to Section 144C had occurred because of an error.
The department indicated that it was in the process of correcting the mistake. The earlier writ petition was accordingly disposed of with liberty to the assessee to challenge any subsequent order.
However, instead of a fresh final assessment order, the assessee received a Section 156 demand notice dated February 28, 2020, requiring payment of approximately ₹4.37 crore. A separate notice under Section 274 read with Section 271(1)(c) was also issued for initiating penalty proceedings.
The assessee was subsequently informed that a final assessment order dated February 28, 2020 had allegedly been passed. When the assessee sought a copy of that order, the revenue later clarified that no such order had actually been passedand maintained that the earlier December 28, 2019 draft assessment order was the final assessment order.
The central question before the High Court was whether the revenue could treat the December 28, 2019 draft assessment order as a final assessment order and recover tax on that basis.
The Court answered the question in the negative.
It observed that the order dated December 28, 2019 was unmistakably a draft assessment order. The proposed addition of ₹13.73 crore was merely a proposal and there had been no final determination of the income-tax payable by the assessee.
The Court emphasised the requirement under Section 143(3) that the Assessing Officer must make an assessment of the total income or loss and determine the sum payable by the assessee.
The Court noted that before a demand under Section 156 can be raised, there must be a final assessment determining the amount payable. In the present case, that essential step was missing.
Thus, the demand raised on the basis of the draft order could not survive.
The department argued that the reference to Section 144C and the characterization of the order as a draft were the result of a human error, allegedly caused by the Assessing Officer selecting the wrong tab while uploading the order on the ITBA portal.
The department also relied upon Section 292B of the Income-tax Act to contend that such an error should not invalidate the assessment proceedings.
The High Court rejected the argument.
The Bench observed that the alleged mistake could not simply be characterized as an uploading error because the order repeatedly and substantively described itself as a draft order under Section 144C. It also expressly stated that the proposed addition was only a proposal and that no demand or penalty notice was being issued because the order was a draft.
The Court further held that even assuming there had been an error, the department should have corrected, modified or clarified it by passing an appropriate subsequent order after acknowledging the mistake.
That was never done.
Accordingly, the Court held that Section 292B could not rescue the department’s action in the circumstances of the case.
The High Court identified an additional and independent defect in the department’s action.
Section 144C provides a special procedure for certain categories of assessees, including cases where a variation arises as a consequence of the Transfer Pricing Officer’s order.
In the present case, the TPO had made no adjustment or variation to the assessee’s international transactions. The TPO’s order specifically recorded that no adverse inference was being drawn, principally because the assessee’s international transactions were covered by an Advance Pricing Agreement with CBDT.
The High Court therefore held that the assessee was not an “eligible assessee” within the meaning of Section 144C(15)(b).
As a result, there was no occasion for the Assessing Officer to pass a draft assessment order under Section 144C(1)in the first place.
The Bench drew support from several earlier decisions dealing with the scope of Section 144C.
The Court referred to the Delhi High Court’s decision in Honda Cars India Ltd., where it was held that when the TPO does not propose any variation, an assessee does not fall within the relevant definition of “eligible assessee” for purposes of Section 144C.
The Court also relied upon Pankaj Extrusion Ltd. of the Gujarat High Court and Classic Legends (P) Ltd. of the Bombay High Court, which similarly recognized that where there is no variation arising from the TPO’s order, the Section 144C draft-order procedure does not apply.
The Bombay High Court precedent was particularly relevant because it held that where there is no TPO-related variation, the assessee cannot be treated as an eligible assessee and the Assessing Officer is not competent to issue a draft order under Section 144C(1).
The assessment order had also referred to earlier years in which similar foreign travelling expenditure had been examined.
The department pointed out that additions concerning foreign travel expenses had arisen in earlier assessment years and that some proceedings remained pending. It also noted that certain earlier favourable decisions had not been challenged because the tax effect was below the applicable monetary limits.
The High Court’s decision, however, turned on the legal validity of the assessment procedure, rather than merely on the underlying allowability of the foreign travel expenditure.
The Court therefore did not sustain the demand merely because the department had disputed the deductibility of the expenditure in the assessment proceedings.
The Punjab & Haryana High Court set aside the draft assessment order dated December 28, 2019, the demand notice and the notice initiating penalty proceedings.
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