Conversion of case from limited scrutiny to complete scrutiny prior to receipt of approval from Pr. CIT is invalid – ITAT

When the income tax department selects a return for scrutiny (they have an internal basis or use the computer-assisted scrutiny selection process), a notice could be issued under Section 143(2) of Income-tax Act, 1961. The objective of the scrutiny notice is to initiate a revenue audit on the tax return filed by the taxpayer so as to ensure the taxpayer has not underpaid tax in any way

In the case of income tax assessment there are two types scrutiny’s – ‘Limited Scrutiny’ and ‘Complete Scrutiny’. The assessee’s concerned are intimated about their cases falling either in ‘Limited Scrutiny’ or ‘Complete Scrutiny’ through notices issued under section 143(2) of the Income-tax Act, 1961.

Limited scrutiny is a computer-assisted scrutiny selection (CASS) where cases are selected based on set parameters. The scrutiny will be limited to the particular area of return mentioned in the notice.

A complete scrutiny will be undertaken on the return filed and all supporting documents. The cases will be flagged based on CASS. As the scope of scrutiny is not limited, the Assessing Officer (AO) can verify various aspects of the tax return filed for a particular assessment year along with supporting documentation.

The procedure for handling ‘Limited Scrutiny’ cases shall be as under:

• In ‘Limited Scrutiny’ cases, the reasons/issues shall be forthwith communicated to the assessee concerned.
• The Questionnaire under section 142(1) of the Act in ‘Limited Scrutiny’ cases shall remain confined only to the specific reasons/issues for which case has been picked up for scrutiny. Further, the scope of enquiry shall be restricted to the ‘Limited Scrutiny’ issues.
• These cases shall be completed expeditiously in a limited number of hearings.
• During the course of assessment proceedings in ‘limited Scrutiny’ cases, if it comes to the notice of the AO that there is potential escapement of income exceeding Rs. 5 lakhs (for metro charges, the monetary limit shall be Rs. 10 lakhs) requiring substantial verification on any other issue(s), then, the case may be taken up for ‘Complete Scrutiny’ with the approval of the Pr. CIT/CIT concerned.
• However, such an approval shall be accorded by the Pr. CIT/CIT in writing after being satisfied about merits of the issue(s) necessitating ‘Complete Scrutiny’ in that particular case

Let us refer to the case of Manju Kaushik Vs DCIT (ITAT Jaipur), where the issue under consideration is whether the conversion of case from limited scrutiny to complete scrutiny prior to receipt of approval from Pr. CIT is justified in law?

Submissions by both the Parties

• The Ground of the assessee was regarding validity of assessment framed by the AO by taking up the issue of disallowance of deduction u/s 54B without having necessary approval of conversion of limited scrutiny to complete scrutiny.
• The assessee filed her return of income and the case of the assessee was selected for limited scrutiny under CASS.
• The AO issued notice along with questionnaire on the issue of increase in capital.
• Subsequently vide notice u/s 142(1), the AO proposed to disallow the claim of deduction u/s 54B.
• The assessee submitted that assumption of the jurisdiction by the AO to scrutinize the claim of deduction u/s 54B without approval of the competent authority to convert the case from limited scrutiny to complete scrutiny was invalid.
• The assessee further contended that there was nothing in the assessment order to show that the AO sought any approval for conversion of limited scrutiny to complete scrutiny.

• Therefore, the initiation of proceedings by the AO for complete scrutiny by issuing notice u/s 142(1) was without jurisdiction and authority.
• It was further contended that even otherwise the said initiation of proceedings for full scrutiny was not permissible when the notice u/s 143(2) was issued only for the purpose of conducting limited scrutiny and the subsequent initiation of proceedings by the AO for full scrutiny was after the limitation period for issuing notice u/s 143(2).
• Thus, the proceedings initiated by the AO for full scrutiny was invalid and liable to be quashed.
• CBDT Instruction No. 5/2016 dated 14-07-2016 was referred and it was submitted that CBDT had issued specific instruction that the case selected for limited scrutiny cannot be taken up for full scrutiny without prior approval of the competent authority.
• These instructions were repeated by the CBDT vide Instruction Nos. 7/2014 dated 26-09-2014, 20/2015 dated 29-12-2015 and 5/2016 dated 14-07-2016 that the AO shall intimate the tax payers concerned regarding conducting complete scrutiny in the cases where the AO proposed to convert the limited scrutiny to complete scrutiny.
• It was contended that the assessee came to know about this fact only through the assessment order that the AO converted her case from limited scrutiny to complete scrutiny.
• Therefore, there was a gross violation of instructions CBDT which rendered the assessment order null and void.

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• The respondent submitted that the AO converted the limited scrutiny to complete scrutiny only after taking the approval from the Pr. CIT. The notice issued u/s 142(1) was only after approval accorded by the Pr. CIT.
• Thus, the respondent submitted that once the approval was accorded by the Pr. CIT then the conversion was in accordance with the provisions of law and initiation of proceedings by the AO for full scrutiny was valid.
• In rejoinder, the assessee submitted that the alleged proposal and approval accorded by the Pr. CIT was an afterthought and pre-dated.
• The AO had not mentioned anything in the assessment order regarding any proposal for conversion of limited scrutiny to full scrutiny and the assessee was also not intimated about the said proposal of conversion of limited scrutiny to full scrutiny.
• Therefore, these proposal and approval are nothing but afterthought documents prepared by the department.
• Therefore, initiation of proceedings by issue of notice u/s 142(1) for full scrutiny was without the alleged approval communicated and in the knowledge of the AO.

Observations of ITAT on the facts of the present case and applicability of CBDT instructions

• There was no dispute that the case of the assessee was selected for limited scrutiny whereby the AO initiated proceedings by issue notice u/s 143(2) only on the issue of introduction of capital/ increase in the capital.
• Subsequently, the AO converted the limited scrutiny into complete scrutiny and issued notice u/s 142(1) whereby the AO proposed to disallow the claim of deduction u/s 54B.
• There was no dispute that scope of enquiry in case selected for limited scrutiny under CASS was only to the extent of the issue for which case was selected for scrutiny under CASS.
• CBDT had issued instructions from time to time in this respect and has specifically instructed the taxing authorities that scope of enquiry should be limited to verification of all the particulars for which limited scrutiny was taken up under CASS.
• However, in a case during the assessment proceeding if the AO was of the view that substantial verification of other issue was also required then the case may be taken up for comprehensive scrutiny with the approval of the Pr.CIT/DIT concerned.
• It was also instructed that such an approval shall be accorded by the Pr.CIT/DIT in writing after being satisfied about the merits of the issue (s) necessitating wider and detailed scrutiny in the case.
• In Instruction No. 5/ 2016 dated 14-07-2016, CBDT laid down that while proposing to take up ‘Complete Scrutiny’ in a case which was originally earmarked for ‘Limited Scrutiny’, the AO shall be required to form a reasonable view that there was possibility of under assessment of income if the case was not examined under ‘Complete Scrutiny’.

• In this regard, the monetary limits and requirement of administrative approval from Pr. CIT/CIT/Pr. DIT/DIT, as prescribed in the Instruction dated 29.12.2015, shall continue to remain applicable.
• Further, while forming the reasonable view, the Assessing Officer would ensure that:
  1. there exists credible material or information available on record for forming such view
  2. this reasonable view should not be based on mere suspicion, conjecture or unreliable source and
  3. there must be a direct nexus between the available material and formation of such view.
• It was further clarified that in cases under ‘Limited Scrutiny’, the scrutiny assessment proceedings would initially be confined only to issues under ‘Limited Scrutiny’ and questionnaires, enquiry, investigation etc. would be restricted to such issues.
• Only upon conversion of case to ‘Complete Scrutiny’ after following the procedure outlined above, the AO may examine the additional issues besides the issue(s) involved in ‘Limited Scrutiny’.
• Thus, the AO was duty bound to follow the instructions in case limited scrutiny assessment proceeding were proposed to be converted into complete scrutiny and without following said procedure and necessary approval of the competent authority conducting an enquiry on the issue which was outside the limited scrutiny would be beyond the jurisdiction of the AO.

Reference to previous cases by ITAT

• ITAT had taken the consistent view on this issue in the series of decisions that if the AO had taken up the issue of scrutiny without converting the limited scrutiny to complete scrutiny by taking a prior approval from the competent authority then the said order passed by the AO will be in nullity and beyond his jurisdiction
• In case of M/s CBS International Projects Pvt Ltd vs CIT, ITAT vide its order considered the relevant instruction issued by the CBDT on this issue and held that a perusal of the CBDT instruction showed that the AO can widen the scope of scrutiny even if it was selected for scrutiny assessment under CASS.
• However, the condition precedent for such action of the AO was that he had to seek prior approval of the higher authorities.
• A perusal of the assessment order showed that the AO had not mentioned as to when the permission from the PCIT was sought to make further enquiries in the case of the assessee.
• Considering the facts of the case in totality, in the light of the CBDT Instructions mentioned hereinabove, qua notice u/s 143(2), we are of the considered opinion that the assessment order so framed by the AO was not in consonance with Instruction of the CBDT and, therefore deserved to be quashed.
• The order of the CIT(A) was accordingly set aside

Observations of ITAT on current case

• In the case in hand, though the AO mentioned that approval was accorded by the Pr.CIT on 24-11-2016 and consequently he initiated proceedings of complete scrutiny by issuing notice dated 25-11-2016. However, the said approval was communicated by the AO only on 29-11-2016.
• Therefore, the notice u/s 142(1) issued on 25-11-2016 for initiation of complete scrutiny assessment proceeding was prior to the receipt of the approval accorded by the Pr.CIT and thus it was apparent that AO had initiated the proceedings for full/ complete/ comprehensive scrutiny in anticipation of approval to be accorded by the Pr.CIT.
• It was also mandated by CBDT Instructions that competent authority had to grant approval only after satisfying itself about the requirements of comprehensive scrutiny of the case.
• Further the AO was also required to intimate the assessee regarding conversion of limited scrutiny to the complete scrutiny in such cases.
• It was pertinent to note that in the proceedings for limited scrutiny the AO was satisfied with the source of increase in the capital of the assessee and did not proceed further after the reply and documents filed by the assessee in response to the notice u/s 142(1) dated 4-07-2016.
• Only after dropping the said notice, the AO issued fresh notice u/s 142(1) on 25-11-2016.
• The AO has finally made addition only on account of disallowance of deduction u/s 54B.
• Therefore, at the time of initiating the complete scrutiny, the issue under limited scrutiny was not pending with the AO as he was satisfied with the reply and documentary evidence on the said issue.
• In the case in hand, the AO has not intimated the assessee about the conversion of limited scrutiny to complete scrutiny which was a serious violation of the instructions issued by the CBDT.

• Hence, ITAT found that the AO had taken up the issue and initiated proceedings for complete scrutiny without necessary approval.
• Therefore, the issue taken up by the AO regarding disallowance of deduction u/s 54B was prior to the necessary approval communicated to the AO and therefore, in the absence of communication in writing to the AO about the approval, the assumption of jurisdiction by the AO was invalid.
• The addition made by the AO by denying the deduction u/s 54B was not sustainable and the same was deleted.

In simple words, conversion of case from limited scrutiny to complete scrutiny prior to receipt of approval from Pr. CIT is invalid and not justified in law.

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