2025 (6) TMI 565 - AT - Income Tax

Exemption u/s 10(26) - income arising from scheduled areas specified in the Act - contract income and the deposit added the exemption was denied - HELD THAT - We are of the view that adequate opportunity of being heard needs to be provided to the assessee to explain the claim of exemption before the Ld. CIT(A). Therefore the order of the CIT(A) is set aside and the appeal is restored to him to be decided afresh after considering the submission of the assessee and after providing a reasonable opportunity of being heard to the Ld. AO as per Rule 46A of the Rules. Hence all the grounds of appeal raised by the assessee are allowed for statistical purposes.

Summary

The core legal questions considered in this appeal include:

1. Whether the income earned by the assessee, a member of a Scheduled Tribe residing in the Sixth Schedule area of Meghalaya, is exempt from income tax under Section 10(26) of the Income Tax Act, 1961, particularly income derived from contract work and interest on bank deposits situated within the specified area.

2. Whether the addition of Rs. 68,00,000 as unexplained investment under Section 69 of the Act, representing fixed deposits made by the assessee, is justified, given the claim that the funds originated from exempt income within the Scheduled Area.

3. The validity of the Assessing Officer's estimation of business income and addition of cash expenditure under provisions such as Sections 40A(3), 40(a)(ia), and 37(1) of the Act, as well as the correctness of the partial disallowance of exemption on contract receipts from certain parties.

4. The procedural propriety of the assessment order passed under Sections 147 and 144B of the Act, especially considering the assessee's claim of exemption and the late filing of the return following a notice under Section 148.

Issue-wise Detailed Analysis

1. Exemption under Section 10(26) of the Income Tax Act, 1961

The legal framework centers on Section 10(26), which exempts income of a member of a Scheduled Tribe residing in areas specified in Part I or II of the Table appended to paragraph 20 of the Sixth Schedule to the Constitution of India, from income tax. The exemption applies to income accruing or arising from any source within those areas or by way of dividend or interest on securities.

The assessee claimed exemption on business income earned from contract works within the Sixth Schedule area of Meghalaya and interest income from fixed deposits held in a local bank branch. The assessee supported this claim with caste and residential certificates, and documentary evidence of contract payments and bank statements.

The Assessing Officer (AO) acknowledged that the bank transactions and income arose within the Sixth Schedule area but rejected the exemption claim on business income, citing lack of documentary proof for some contracts and non-compliance with audit provisions under Section 44AB. The AO estimated income from contracts at 8% of receipts for certain parties and disallowed cash expenditure additions under various sections, treating the fixed deposits as unexplained investments under Section 69.

The Commissioner of Income Tax (Appeals) partly allowed the exemption for interest income under Section 10(26) but upheld the addition of Rs. 68,00,000 as unexplained investment and the estimated income on certain contract receipts. The CIT(A) noted the absence of audited accounts and incomplete documentation, which justified the AO's reliance on estimation and addition under Section 69.

The Tribunal noted that the exemption under Section 10(26) requires three conditions: (i) the individual must belong to a Scheduled Tribe, (ii) the income must accrue or arise from a source within the specified area, and (iii) the individual must reside in the specified area. The assessee fulfilled these conditions as per documentary evidence and AO's acknowledgment.

However, the Tribunal emphasized the need for the assessee to provide a reasonable explanation and documentary evidence to substantiate the source of income and investments, especially for the fixed deposits and contract receipts. The Tribunal observed that the AO and CIT(A) did not fully consider the assessee's submissions and evidence, particularly regarding the source of the fixed deposits and the nature of contract work within the Sixth Schedule area.

The Tribunal referred to the official Income Tax North East awareness campaign guidelines, which reiterate the exemption criteria under Section 10(26), highlighting the importance of residence, tribal status, and source of income within the Scheduled Area.

2. Addition of Rs. 68,00,000 as Unexplained Investment under Section 69

Section 69 treats unexplained investments as income if the assessee fails to satisfactorily explain the nature and source of such investments. The AO treated the fixed deposits amounting to Rs. 68,00,000 as unexplained investment due to the assessee's failure to provide adequate explanation or supporting documents during assessment and appellate proceedings.

The assessee contended that the deposits were made out of exempt income earned within the Sixth Schedule area and supported this with bank statements showing the pattern of deposits and withdrawals. The assessee argued that since the interest income on these deposits was exempt under Section 10(26), the principal amount should also not be treated as taxable income.

The CIT(A) rejected this contention, holding that the addition under Section 69 is deemed income and not derived from a specific source; hence, it is not eligible for exemption under Section 10(26). The CIT(A) also noted the absence of a satisfactory explanation for the source of the deposits.

The Tribunal observed that the AO and CIT(A) did not adequately consider the documentary evidence submitted by the assessee to explain the source of the deposits. The Tribunal opined that the assessee should be given an opportunity to substantiate the claim that the deposits originated from exempt income within the Scheduled Area. The Tribunal thus set aside the order on this issue for fresh consideration after hearing the assessee.

3. Estimation of Business Income and Cash Expenditure Additions

The AO estimated the business income from contract works at 25% of receipts and added back cash expenditure of Rs. 65,69,700, citing non-compliance with provisions of Sections 40A(3), 40(a)(ia), and 37(1) relating to disallowance of certain expenses and payments made in cash beyond prescribed limits.

The CIT(A), while upholding the estimation of income on certain contract receipts at 8%, deleted the addition relating to cash expenditure, reasoning that once income is estimated on a presumptive basis under Section 44AB, no separate addition under Sections 40A(3) or 40(a)(ia) is warranted.

The assessee submitted bills and running account ledgers for certain contracts, particularly with SSK Infrastructure, claiming that the estimation of profit at 8% was incorrect and should be deleted. The AO and CIT(A) however found the documentary evidence insufficient for some contracts and upheld the estimation for those receipts.

The Tribunal noted the need for the CIT(A) to re-examine the documentary evidence submitted by the assessee and provide a reasoned decision on the quantum of income eligible for exemption under Section 10(26), including the correctness of the estimated profit and the treatment of cash expenditure additions.

4. Procedural Validity of Assessment under Sections 147 and 144B

The assessment was reopened under Section 147 read with Section 144B because the assessee had not filed a return of income before issuance of notice under Section 148. The return was filed only after the notice was issued.

The AO relied on discrepancies between the income declared in the return and the income reflected in Form 26AS and TDS claims to justify reopening and additions.

The assessee argued that as a member of a Scheduled Tribe residing in the Sixth Schedule area, he was not mandated to file a return for exempt income under Section 10(26), and the assessment order was passed without due application of mind to the exemption provisions.

The Tribunal, while not directly adjudicating on the validity of reopening, emphasized the need for the AO and CIT(A) to apply judicial mind and consider the exemption claim fairly. The Tribunal restored the appeal to the CIT(A) for fresh adjudication after providing the assessee with a reasonable opportunity of being heard as per Rule 46A of the Income Tax Rules.

Significant Holdings

"In computing the total income of a previous year of any person, any income falling within clause (26) of Section 10 shall not be included if the person is a member of a Scheduled Tribe residing in any area specified in the Sixth Schedule to the Constitution and the income accrues or arises from any source in such areas."

"The addition under Section 69 is a deemed income and does not arise from a specific source; therefore, it is not eligible for exemption under Section 10(26). However, the assessee must be given a reasonable opportunity to explain the source of such investment."

"Once income is estimated under presumptive taxation provisions, no separate addition under Sections 40A(3) or 40(a)(ia) is warranted for cash expenditure."

"The AO and CIT(A) are required to apply judicial mind and consider the exemption claim under Section 10(26) fairly, taking into account the documentary evidence submitted by the assessee."

"The appeal is restored to the CIT(A) to be decided afresh after considering the submissions of the assessee and after providing a reasonable opportunity of being heard to the AO as per Rule 46A."

The Tribunal's final determination was to set aside the CIT(A)'s order and remit the matter for fresh consideration, allowing all grounds of appeal for statistical purposes. The Tribunal emphasized the necessity of a fair hearing and proper examination of evidence regarding the exemption claim under Section 10(26), the nature and source of the fixed deposits, and the estimation of business income and related additions.