2025 (5) TMI 1595 - HC - Income Tax

Reopening of assessment u/s 147 - reason to believe - jurisdictional condition of the AO having reason to believe that the petitioner s income for AY 2011-12 has escaped assessment - HELD THAT - As petitioner had sold and purchased shares of DEL on the stock market would not lead to a reason that the transactions were fraudulent or that the petitioner had routed its own money. The said inferences are based on mere suspicion fuelled by the information that DEL is a penny stock and that the shares of DEL were concentrated in the hands of few shareholders which were either non-filers or had filed nominal returns. As apparent that the AO also did not examine whether there was any wide fluctuation in the price of shares of DEL during the previous year relevant to AY 2011-12. Petitioner had stated that during the relevant previous year the price of shares of DEL had gradually fallen from about Rs. 20 to Rs. 11 and there was no wide fluctuation. The AO does not contradict this claim. It is thus apparent that the AO had issued the impugned notice only on the basis of general information as reported by the Investigation Wing which may have required the AO to make some enquiries but did not furnish reasons to believe that the petitioner s income has escaped assessment for AY 2011-12. As explained in Lakhmani Mewal Das 1976 (3) TMI 1 - SUPREME COURT reasons to believe cannot be conflated with reasons to suspect that an assessee s income has escaped assessment. Whilst it is not necessary for the AO to arrive at a firm conclusion that the assessee s income for the relevant assessment year has escaped assessment that conclusion is to be drawn during the assessment proceedings it is necessary that the AO has reasons to believe based on tangible material that has a live nexus with the belief that income has indeed escaped assessment. Concluded and closed assessments cannot be reopened merely on suspicion. In the present case we find that there is no reason to believe that the petitioner s income has escaped assessment. Assessee appeal allowed.

Summary

The core legal questions considered in this judgment revolve around the jurisdiction and validity of reopening an assessment under Section 147 of the Income Tax Act, 1961. Specifically, the issues are:

1. Whether the Assessing Officer (AO) had "reason to believe" that the petitioner's income for Assessment Year (AY) 2011-12 had escaped assessment, thus justifying the issuance of a notice under Section 148 for reassessment.

2. Whether the reasons recorded by the AO for reopening the assessment were based on tangible material or merely on suspicion and surmises.

3. Whether the AO complied with the statutory requirements and judicially settled principles regarding the formation of "reason to believe" under Section 147 of the Act.

4. Whether the petitioner had disclosed true and full information in its original return, negating the applicability of the extended limitation period for reassessment.

Issue-Wise Detailed Analysis

Issue 1: Existence of "Reason to Believe" for Reopening Assessment under Section 147

The legal framework governing reopening of assessments under Section 147 mandates that the AO must have "reason to believe" that income chargeable to tax has escaped assessment. This belief must be founded on tangible material and not mere suspicion or conjecture. The expression "reason to believe" has been extensively interpreted by courts to require a rational nexus between the material in possession of the AO and the formation of the belief that income has escaped assessment.

Precedents such as Calcutta Discount Co. Ltd. v. Income Tax Officer elucidate that the AO's belief must be held in good faith, based on information that is more than mere suspicion. The AO must have reasons that induce this belief, and the existence of these reasons-not their sufficiency-is justiciable. The Supreme Court in Chhugamal Rajpal v. S.P. Chaliha emphasized that the AO must have prima facie grounds to issue a notice under Section 148, and mere vague feelings or calls for investigation do not suffice.

The Court also referred to the judgment in The Income-Tax Officer, I Ward, District VI, Calcutta v. Lakhmani Mewal Das, which underscores that the reasons for reopening must have a "live link" or "rational connection" with the belief that income has escaped assessment. The AO's power to reopen is not plenary; vague, indefinite, or remote information cannot justify reopening.

In the instant case, the AO's reasons for reopening were primarily based on information received from the Investigation Wing regarding suspicious trading in shares of a penny stock company, M/s DMC Education Ltd. (DEL). The AO noted that DEL's share price movements were not supported by its financial fundamentals, and that trading was concentrated among a few non-filers or nominal filers. The AO concluded that the petitioner's transactions in DEL shares were bogus and intended to evade tax.

However, the Court found that the information was of a general nature, lacking particulars linking the petitioner specifically to any tax evasion. The AO's reliance on the Investigation Wing's report was essentially a repetition without independent application of mind. The AO did not demonstrate a rational nexus between the material and the belief that the petitioner's income had escaped assessment. The petitioner's turnover in DEL shares was a minuscule fraction of its total turnover, and the petitioner had disclosed all material particulars in its return and during assessment proceedings.

The Court emphasized that the AO's observations were based on suspicion and generalizations about penny stocks, rather than tangible evidence implicating the petitioner. The AO failed to show that the petitioner's transactions were sham or that the petitioner had routed its own money through DEL shares. Consequently, the AO lacked "reason to believe" as legally required.

Issue 2: Sufficiency and Nature of the Reasons Recorded for Reopening

The statutory requirement under Section 147 is that reasons for reopening must be recorded in writing and must be based on tangible material. The Court referred to the decision in Meenakshi Overseas Pvt. Ltd., which held that reasons must demonstrate a live link between the material and the belief that income has escaped assessment. Mere repetition of investigation reports without independent application of mind is impermissible.

In the present case, the AO's reasons were largely a reiteration of the Investigation Wing's information on penny stock manipulation. The reasons lacked particulars such as the period of price fluctuations, the extent of price movements, or any direct evidence of the petitioner's involvement in tax evasion. The AO did not independently verify or analyze the information in relation to the petitioner's transactions.

The Court noted that the AO's conclusion that the petitioner's transactions were bogus and intended for tax evasion was not supported by any material beyond the general observations about DEL shares. The AO's failure to examine the petitioner's detailed turnover data, which showed a nominal trading loss in DEL shares, further weakened the reasons recorded.

Thus, the Court held that the reasons recorded were insufficient and did not satisfy the statutory requirement of being based on tangible material with a rational nexus to the belief of escapement of income.

Issue 3: Compliance with Jurisdictional Conditions for Reassessment

The jurisdictional conditions for reopening include the existence of "reason to believe" and compliance with limitation periods. The petitioner contended that there was no failure to disclose true and full information, negating the applicability of the extended six-year limitation period for reassessment.

The Court observed that the petitioner had filed a return declaring taxable income and had participated in scrutiny assessment proceedings, producing all relevant documents. There was no material to indicate non-disclosure or concealment.

The AO's reliance on general suspicion regarding penny stock trading did not amount to failure to disclose material facts. Hence, the AO could not invoke the extended limitation period under Section 147.

Issue 4: Treatment of Competing Arguments and Evidence

The petitioner submitted detailed data on its overall turnover and specific trading in DEL shares, showing that the turnover in DEL shares was an insignificant fraction of total turnover and that the petitioner had incurred a trading loss rather than gain. The petitioner also highlighted that it held shares of DEL as stock-in-trade and that there was no wide fluctuation in DEL's share price during the relevant period.

The AO did not effectively counter these submissions or provide contradictory evidence. The AO's reasons did not address the petitioner's data or explain how the petitioner's transactions were sham or intended for tax evasion beyond the general suspicion arising from the nature of penny stocks.

The Court found that the AO's failure to engage with the petitioner's evidence and the absence of independent analysis undermined the validity of the reassessment proceedings.

Conclusions

The Court concluded that the AO did not have any legally sustainable reason to believe that the petitioner's income for AY 2011-12 had escaped assessment. The reasons recorded were based on vague and general information, lacking a live nexus with the petitioner's transactions. The AO's conclusion of sham transactions was founded on suspicion rather than tangible material.

The reopening of assessment was therefore held to be without jurisdiction and liable to be quashed. The impugned notice under Section 148 and the order rejecting the petitioner's objections were set aside.

Significant Holdings

"The expression 'reason to believe' does not mean a purely subjective satisfaction on the part of the Income Tax Officer. The reason must be held in good faith. It cannot be merely a pretence. It is open to the court to examine whether the reasons for the formation of the belief have a rational connection with or a relevant bearing on the formation of the belief and are not extraneous or irrelevant for the purpose of the section."

"The reopening of the assessment after the lapse of many years is a serious matter. The Act contemplates reopening if grounds exist for believing that income has escaped assessment, but the reasons must not be vague, indefinite, farfetched or remote."

"The reasons so recorded have to be based on some tangible material and that should be evident from reading the reasons. It cannot be supplied subsequently either during the proceedings when objections to the reopening are considered or even during the assessment proceedings that follow."

"The AO must independently apply mind to the material and not merely repeat observations made by the Investigation Wing or other authorities."

"Reopening cannot be based on suspicion or surmises but must be grounded in tangible material that has a live nexus with the belief that income has escaped assessment."

"The mere fact that the petitioner traded in shares of a penny stock, which was generally regarded as suspicious, without more, does not furnish reason to believe that the petitioner's income has escaped assessment."

"The AO's failure to consider the petitioner's detailed turnover data and the nature of transactions further vitiates the reasons recorded for reopening."

"The impugned notice under Section 148 and the order rejecting objections are set aside as the AO lacked jurisdiction to reopen the assessment."