2012 (8) TMI 1244 - HC - Income Tax

Summary

The core legal questions considered by the Court are as follows:

(i) Whether the tribunal was justified in law in restoring the disallowance of business expenditure of Rs. 52,21,367/- incurred by the appellant for car hire, printing, hire of manpower, and sampling and display of goods, which was deleted by the Commissioner of Income Tax (Appeals), and whether the tribunal's findings in this regard were arbitrary, unreasonable, and perverse.

(ii) Whether the said disallowance was made by the Assessing Officer in violation of the principles of natural justice by:

a) Relying on enquiries conducted from banks regarding parties to whom payments were made, without disclosing such enquiries to the appellant or affording it an opportunity to rebut or deal with the same;

b) Relying on enquiries conducted in respect of sampling and display of goods without disclosing such enquiries or affording the appellant an opportunity to rebut;

c) Not providing copies of reports relating to local enquiries conducted about the entities to whom payments were made and not affording the appellant an opportunity to cross-examine the persons interrogated.

Regarding the disallowance of business expenditure, the relevant legal framework includes the principles under the Income Tax Act, particularly the necessity to establish the genuineness and commercial expediency of claimed business expenses under section 37(1). Precedent decisions emphasize the burden on the assessee to prove the legitimacy of deductions claimed. The Court also considered the principles of natural justice as developed in administrative and tax proceedings, including the requirement of fair hearing and opportunity to rebut adverse material.

The Court examined the factual matrix wherein the appellant had claimed a substantial increase in advertisement and sales promotion expenses, which was scrutinized by the Assessing Officer due to the disproportionate rise compared to previous years and the fall in net profit. The appellant was asked to produce confirmations from its principal, ITC Ltd., which clarified that wholesale dealers were not obliged to incur such expenses. The Assessing Officer then conducted enquiries, including inspection reports and bank enquiries, which led to disallowance of the claimed expenses on grounds of inadequate substantiation and suspicious identities of parties receiving payments.

The appellant contended that the Assessing Officer violated natural justice by relying on undisclosed enquiries and reports without providing copies or opportunities for cross-examination. The Court analyzed the procedural conduct of the assessment proceedings, noting that the Assessing Officer communicated the substance of the inspector's report to the appellant by letter dated 12.03.1997 and invited responses. The appellant was granted adjournments and responded by furnishing all information in its possession, emphasizing payments made by account payee cheques and explaining the nature of sampling and display expenses.

The Court held that principles of natural justice were substantially complied with. The appellant was informed of the material against it, given opportunity to respond, and did not request copies of the inspector's report or cross-examination of witnesses during the assessment. The Court observed that the failure to avail such opportunities at the assessment stage precluded raising the issue belatedly at the appellate stage. The Court underscored that natural justice is flexible and must be applied in light of the facts and circumstances, ensuring fairness but not imposing undue procedural formalities.

On the enquiry into bank accounts of entities receiving payments, the Court found that such enquiries were made to ascertain the addresses of those entities for issuing notices under Section 131 of the Income Tax Act, after the appellant failed to disclose their identities. The Court held that these enquiries did not violate natural justice nor cause prejudice to the appellant, given the appellant's initial burden to establish the identity and genuineness of the payees.

Regarding the sampling and display expenses, the appellant admitted it did not maintain records of individual shops where cigarettes were distributed. The Court held that remanding the matter for production of such evidence after nearly two decades would be futile. The failure to discharge the initial onus to establish the claim justified disallowance without further enquiry. The Court emphasized that the question of commercial expediency under section 37(1) arises only after prima facie establishment of the claim, which was not done here.

The Court also referred to precedent where payments made through account payee cheques were not accepted as conclusive proof of genuineness when the identity of the payees was doubtful. The Court agreed with the learned third member of the tribunal that the appellant failed to discharge its burden of proof and that the disallowances were justified.

In treatment of competing arguments, the Court rejected the appellant's claim of violation of natural justice as belated and an afterthought, noting that the appellant did not suffer prejudice and had ample opportunity to rebut the material. The Court also rejected the argument that mere payment by account payee cheque sufficed to establish the claim, emphasizing the necessity of establishing identity and genuineness of the payees.

The Court concluded that the tribunal's restoration of the disallowances was justified, there was no violation of natural justice, and remand was unnecessary. The appeal was dismissed accordingly.

Significant holdings include the following verbatim excerpts capturing the Court's reasoning:

"Natural justice is no unruly horse, no lurking land mine, nor a judicial cure-all. If fairness is shown by the decision-maker to the man proceeded against, the form, features and the fundamentals of such essential processual propriety being conditioned by the facts and circumstances of each situation, no breach of natural justice can be complained of."

"From the aforesaid correspondence, we have no doubt in our mind that the principles of natural justice have been substantially complied with in the instant case."

"If the assessee felt that cross-examining of any person was necessary for establishing its case it was incumbent upon the assessee to make such prayer before the Assessing officer during the assessment proceeding. If a party fails to avail of the opportunity to cross-examine a person at the appropriate stage in the proceeding, the said party would be precluded from raising such issue at a latter stage of the proceeding."

"Non-supply of the copy of the inspector's report did not cause any prejudice to the assessee inasmuch as the contents thereof were in fact substantially communicated to the assessee by the aforesaid letter of the Assessing Officer dated 12.07.1997 to which the assessee was given adequate opportunity to respond."

"When the identity of the entities though whom such expanses were made were doubtful and the assessee had failed to dispel such doubt by discharging its initial onus, mere fact that payments were made through account payee cheques would not be the sole criteria to accept the genuineness of such transaction."

"In view of its failure to produce adequate and cogent material to establish the claim of expenses on sampling and display, the learned accounting member had rightly held disallowance can be made on that ground itself without even considering the inspector's report."

"The question as to whether such expenses were necessary or not in terms of the commercial expediency under section 37 (1) of the Income Tax Act would arise only after the assessee had discharged its initial onus to prima facie establish such claim."

Core principles established include:

- The burden lies on the assessee to establish the genuineness and commercial expediency of claimed business expenses.

- Mere payment by account payee cheque is insufficient to discharge the burden if the identity of the payee is doubtful.

- Principles of natural justice require that the assessee be given fair opportunity to know the case against it and to respond, but do not mandate formal production of inspection reports or cross-examination unless requested at the assessment stage.

- Failure to seek cross-examination or copies of reports during assessment precludes raising such issues at appellate stages.

- Enquiries made by the Assessing Officer to ascertain identities of payees after failure of the assessee to disclose such information do not violate natural justice.

- Remand of assessment proceedings is unnecessary where the assessee has failed to produce evidence despite repeated opportunities and where such evidence is unlikely to be forthcoming.

Final determinations on each issue were:

1. The tribunal was justified in restoring the disallowance of the claimed business expenditure, as the appellant failed to discharge its initial burden of proof and the Assessing Officer's findings were neither arbitrary nor perverse.

2. The disallowance was not made in violation of principles of natural justice, as the appellant was adequately informed of the materials against it, given opportunity to respond, and did not suffer prejudice.

3. Enquiries conducted by the Assessing Officer, including bank enquiries, were legitimate investigative steps and did not violate natural justice.

4. The appellant's belated claim of denial of opportunity to cross-examine witnesses and obtain inspection reports was untenable.

5. The appellant's failure to maintain records or produce evidence regarding sampling and display expenses justified disallowance without remand.