Prashant S. Joshi vs. ITO (Bombay High Court)

Even if there is no assessment u/s 143 (3), reopening u/s 147 is bad if there are no proper “reasons to believe”. AO cannot go beyond the recorded reasons

The assessee was a partner in a firm. Upon retirement, he received an amount of Rs. 50 lakhs in addition to the balance lying to his credit in the books of the firm in full and final settlement of his dues. The assessee filed a return in which the said amount was not offered to tax on the ground that it was a capital receipt. No assessment order was passed. The AO issued a notice for reopening u/s 148 on the ground that as in the assessment of the firm the amount paid by it to the assessee had been allowed as a revenue deduction, the amount received by the assessee had to be assessed as income. Reliance was also placed on ss. 28 (iv) & (v). The assessee filed a Writ Petition to challenge the reopening. HELD allowing the Petition:

(i) The basic postulate which underlines s. 147 is the formation of the belief by the AO that income chargeable to tax has escaped assessment. The AO must have reason to believe that such is the case before he proceeds to issue a notice u/s 147. The reasons which are recorded by the AO for reopening an assessment are the only reasons which can be considered when the formation of the belief is impugned. The recording of reasons distinguishes an objective from a subjective exercise of power. The requirement of recording reasons is a check against arbitrary exercise of power. The validity of the reopening has to be decided on the basis of the reasons recorded and on those reasons alone. The reasons recorded while reopening the assessment cannot be allowed to grow with age and ingenuity, by devising new grounds in replies and affidavits not envisaged when the reasons for reopening an assessment were recorded;

(ii) The only reason recorded by the AO was that as the firm had been held eligible to claim a deduction of the amount paid to the assessee, the amount received by the assessee was chargeable to tax. However, this is unsustainable because the law is well settled that what the partner gets upon dissolution or retirement is the realization of a pre-existing right or interest which is not assessable to tax. Mohanbhai Pamabhai 165 ITR 166 (SC) followed. Even u/s 45 (4) (which applies only where there is a distribution of assets on dissolution or otherwise), the gains are taxable in the hands of the firm and not in the hands of the partner. The amount received by the assessee is also not chargeable u/s 28 (iv) {value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of profession} and 28 (v) {any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm}. A payment made to a partner on dissolution does not fall u/s 28 (v);

(iii) Though in Rajesh Jhaveri 291 ITR 500 (SC) the Supreme Court held that the passing of an Intimation u/s 143 (1) does not amount to an “assessment” and in the absence of an assessment, there was no question of a “change of opinion”, the Court also held that there must be “reason to believe” i.e. “cause or justification” that income had escaped assessment. There must be relevant material on which a reasonable person could have formed a requisite belief even though the material need conclusively prove the escapement;

(iv) Though Explanation (2) (b) to s. 147 creates a deeming fiction of income having escaped assessment in cases where an assessment has not been made, the act of taking notice cannot be at the arbitrary whim or caprice of the AO but must be based on a reasonable foundation. Though the sufficiency of the evidence or material is not open to scrutiny by the Court, the existence of the belief is the sine qua non for a valid exercise of power;

(v) On facts, it was impossible for any prudent person to form a reasonable belief that the income had escaped assessment. Consequently, the s. 148 notice was quashed.