Practical Aspects in Income Tax Scrutiny proceedings

• ​We are in month of November and the due date of completion of assessment i.e. 31st December is fast approaching. There are many issues which my professional colleagues ignores while appearing for assessment proceedings before Assessing Officer [AO]. In this article, I tried to highlight some of those issues.

Scrutiny assessment refers to the examination of a return of income by giving an opportunity to the assessee to substantiate the income declared and the expenses, deductions, losses, exemptions, etc. claimed in the return with the help of evidence.

Selection of Cases for Scrutiny Assessment:

Presently the returns of income filed by the tax payers are accepted by the Income Tax Department without any questions. Only a small percentage of cases are getting selected for scrutiny.

The cases are mostly selected through the process of computer assisted scrutiny selection (CASS) and there is no element of subjectivity in this process.

In addition to the above CASS system, the cases where there is information about concealment of income, which may be based on an enquiry report, survey report or any other source, can also be selected for scrutiny.

Only deserving cases are identified for scrutiny assessment in this manner. The selection in this manner is made by the AO only with the approval of higher authorities so that the selection is fair and proper.

There is yet another category of cases in which scrutiny assessment is framed under section 143(3) of the Act. There is a provision in the Income Tax Act which enables the reopening of cases where there is reason to believe that any income has escaped assessment.

This reopening can be resorted to even in cases which had been subjected to scrutiny assessment earlier. A case can be reopened within a period of six years from the end of the relevant assessment year.

Further if any person has undisclosed Income / assets and he has not disclosed the same in the recently concluded Income Declaration Scheme, in that case the case of the assessee can be reopened beyond six years. Section 197 of the Income Tax Act deals with the same, which says that
“Where any income has accrued, arisen or received or any asset has been acquired out of such income prior to commencement of this Scheme, and no declaration in respect of such income is made under this Scheme,—

1. such income shall be deemed to have accrued, arisen or received, as the case may be; or
2. the value of the asset acquired out of such income shall be deemed to have been acquired or made,

in the year in which a notice under section 142, sub-section (2) of section 143 or section 148 or section 153A or section 153C of the Income-tax Act is issued by the Assessing Officer, and the provisions of the Income-tax Act shall apply accordingly.”

Category of Assessment:

CBDT has classified the assessments in two categories namely:
(A) Limited Scrutiny (B) Detailed Scrutiny

(A) Limited Scrutiny:

• Central Board of Direr Taxes vide instruction no. 7/2014 dated 26.09.2014 (applicable for cases selected for scrutiny during FY 2014-15 via CASS), has provided instructions regarding method of scrutiny in specific cases:

• Therefore, for proper administration of the lncome-tax Act, 1961 (‘Act’), Central Board of Direct Taxes, by virtue of its powers under section 119 of the Act, in supersession of earlier instructions/ guidelines on this subject, here by directs that the cases selected for scrutiny during the Financial Year 2014-2015 under CASS, on the basis of either AIR data or CIB information or for non re-conciliation with 26AS data, the scope of enquiry should be limited to verification these particular aspects only. Therefore, in such cases, an Assessing Officer shall confine the questionnaire and subsequent enquiry or verification only to the specific point(s) on the basis of which the particular return has been selected for scrutiny.”

• This circular is mainly speaking about cases where scrutiny is called for on the basis of either AIR data or CIB information & non reconciliation with 26 AS or directed the AO to confine in those issues only. But further the circular says that

• In case, during the course of assessment proceedings it is found that there is potential escapement of income exceeding Rs. 10 lakhs (for non-metro charges, the monetary limit shall be Rs. 5 lakhs) on any other issue(s) apart from the AIR/CIB/26AS information based on which the case was selected under CASS requiring substantial verification, the case may be taken up for comprehensive scrutiny with the approval of the Pr. CIT/DIT concerned. However, such an approval shall be accorded by the Pr. CIT/DIT in writing after being satisfied about merits of the issue(s) necessitating wider and detailed scrutiny in the case. Cases so taken up for detailed scrutiny shall be monitored by the Jt. CIT/Addl. CIT concerned.”

It means subject to incriminating evidences & approval of higher Authority, Limited scrutiny can be converted in to details scrutiny. A sample of notice u/s 143(2) of Limited Scrutiny is given below for understanding:

“Notice under section 143(2) of the Income Tax Act, 1961

Limited Scrutiny
This is for your information that return of income for assessment year 2015-16 filed on 24/01/2016 has been selected for scrutiny. Following issues have been identified for examination

(i) Derivative (Future) transactions
(ii) Salary Income Mismatch.

I view of the above, we would like to give you an opportunity to produce or cause to be produced, any evidence which you feel is necessary in support of the said return.”

(B) Detailed Scrutiny Assessment:

In this proceeding, AO makes a detailed inquiry on each and every aspect of the Return of Income.
The procedure begins with a Notice u/s 143(2) which is the key to open the door of scrutiny proceedings. It needs to be “Served” on an assessee prior to expiry of six months from the end of the financial year in which the return is furnished. Assessment framed u/s 143(3) without serving notice u/s 143(2) shall be void-abinitio. It was held by the Supreme Court in case of Hotel Blue Moon that “Omission on the part of the assessing authority to issue notice under section 143(2) cannot be a procedural irregularity and is not curable.

• It is followed by a notice u/s 142(1) calling for various information by AO for carrying out the assessment.
• AO shall consider all the information furnished by an assessee at the assessment stage in response to his notices or queries raised vide order sheet entries.
• AO shall issue a Show Cause Notice (SCN) intimating the assessee about the additions which he proposes to make in the assessee’s case.
• Assessee shall furnish a reply in response to such SCN which shall be considered by AO prior to making the additions.
• AO can use some special powers in assessment proceedings like:

1. As per section 131(3), AO may impound and retain books of accounts or any other document produced before him during the assessment proceedings.As per section 133(6),
2.  AO may call for information from third parties.
3. As per section 131(1), AO may issue “Summons” to any person for discovery and inspection, enforcing attendance and for compelling production of books of accounts.

• Finally, an Asst Order shall be passed u/s 143(3).

Precaution to be taken in assessment proceedings:

• Assessment proceedings commences with the issue of notice under Section 143(2). The assessee takes it lightly that it is a formal notice. This is not a correct approach since when the question whether adequate opportunity is given or not, the formal notice is also considered. In reply to the first notice, there should be some written communication with the AO.

• Preparation of details in response to Notice of AO

1. On receipt of Notice a detailed list of documents required from the assessee should be prepared and should be immediately inform to the assessee with date of hearing so as to enable its timely compliance.
2. The reply should be prepared point wise as per notice / questionnaire received from AO.
3. A proper index of papers should be prepared and all the papers in the file should be numbered so as to help the assessing officer to locate the papers easily. All supporting documents regarding the explanations given in the submission should be duly attached with reference page no. This helps in completion of security assessment in smooth manner.
4. Any document which are not being submitted at the time of hearing should be specifically noted and informed that those will be submitted in due time or those cannot be submitted.
5. A proper covering letter should always accompany the submission.
6. Even if no documents are ready or able to be produced on the date of hearing, at-least a letter stating that it should be submitted to the department informing the inability.

• Whenever difficult query is raised, the assessee at times either gives vague reply or avoids to give reply. This is very risky. In fact, the assessee should try to find out the proper reply and should give the reply with adequate evidences. This is because it is difficult to produce additional evidence before the appellate stage. Non-compliance of notices under Sections 142(2) and 143(2) attracts penalties as per law.

• Before making any addition in the assessment, the AO normally issues final show cause notice or makes entry in the order sheet and inform the Authorised Representative about the same. Assessee should make sure about timely compliance of this notice because the AO will not wait for the reply after the specified date of the compliance and will make the addition. It will be more difficult to defend these types of additions in appellate proceedings.