Section 263 IT Act | Revisionary Order Without Verification of Expenditure Claim Violates Natural Justice : ITAT Bangalore

In a significant ruling on the scope of revisionary powers under Section 263 of the Income Tax Act, 1961, the Income Tax Appellate Tribunal (ITAT), Bangalore, has quashed an order passed by the Principal Commissioner of Income Tax (PCIT) on the ground that the assessee had not claimed the impugned expenditure at all. The Tribunal held that when no expenditure is claimed or allowed, the assessment order cannot be deemed erroneous or prejudicial to revenue merely on suspicion, reinforcing the necessity of factual verification before invoking revisionary jurisdiction.

Background & Facts

The Dispute

The appellant, M/s. Khoday India Limited, a company engaged in the manufacture and sale of India Made Foreign Liquor (IMFL), was subjected to a search action under Section 132 of the Income Tax Act on 09.02.2021. Pursuant to this, assessment proceedings were initiated under Section 153A of the Act. The assessee filed its return of income for the Assessment Year (AY) 2020-21 on 31.12.2020, declaring a total loss of ₹30,622,529. The assessment was completed on 31.03.2023, with an addition of ₹727,023.

Key Facts

• 09.02.2021: Search action conducted under Section 132 at the assessee’s premises.
• 31.12.2020: Assessee filed original return of income under Section 139(1), declaring a loss of ₹30,622,529.
• 13.10.2021: Notice under Section 153A issued to the assessee.
• 27.08.2022: Assessee responded to the notice, filing a return showing Nil income.
• 31.03.2023: Assessment completed under Section 153A read with Section 143(3), with an addition of ₹727,023.
• 27.02.2020: During a separate search action on Tuteja, Bhatia and Dhand group, information emerged suggesting that the assessee had paid ₹18,84,425 as commission for IMFL sales.
• 27.01.2023: DCIT, Central Circle 8, Delhi, forwarded a satisfaction note to the Assessing Officer (AO) based on the search findings.
• 19.08.2024: AO submitted a proposal to the PCIT for initiating revisionary proceedings under Section 263.
• 30.08.2024: PCIT issued a show cause notice to the assessee, alleging that the commission payment of ₹18,84,425 was illegal and not allowable under Section 37(1) of the Act.
• 08.01.2025: PCIT issued a second notice, reiterating the allegations and referring to the search findings.
• 20.02.2025: PCIT passed an order under Section 263, holding that the AO had not verified the commission payment, rendering the assessment order erroneous and prejudicial to revenue.

Procedural History

• 31.12.2020: Return of income filed under Section 139(1).
• 09.02.2021: Search action under Section 132.
• 13.10.2021: Notice under Section 153A issued.
• 27.08.2022: Assessee filed return under Section 153A showing Nil income.
• 31.03.2023: Assessment order passed under Section 153A.
• 30.08.2024: Show cause notice issued by PCIT under Section 263.
• 08.01.2025: Second show cause notice issued by PCIT.
• 20.02.2025: Revisionary order passed under Section 263.
• 23.03.2026: Appeal filed before ITAT, Bangalore (ITA No. 770/Bang/2025).

The Parties' Positions

For the Appellant (Assessee):

• The assessee contended that it had not claimed any expenditure of ₹18,84,425 as commission during the assessment year.
• The PCIT’s order was based on mere suspicion without any factual basis or verification.
• The assessee sought cross-examination of the alleged payees and details of the source of information, but none were provided.
• The revisionary proceedings were initiated based on a proposal by the AO, which lacked independent verification by the PCIT, rendering the order jurisdictionally defective.
• Reliance was placed on the decisions in ITA No. 466/Bang/2020 and Alpha Laval Lund AB v. CIT (ITA No. 1287/Pun/2017).

For the Respondent (Revenue):

• The Revenue relied on a satisfaction note forwarded by the DCIT, Central Circle 8, Delhi, based on search findings in the case of Tuteja, Bhatia and Dhand group.
• It was alleged that the assessee had made illegal payments disguised as commission, which were not allowable under Section 37(1) of the Act.
• The AO had failed to verify the nature of the expenditure, rendering the assessment order erroneous and prejudicial to revenue.

Relief Sought

The assessee sought quashing of the revisionary order dated 20.02.2025 passed under Section 263, contending that the order was passed without factual basis, in violation of principles of natural justice, and without establishing that the expenditure was either claimed or allowed.

The Legal Issue

The central question before the ITAT was whether a revisionary order under Section 263 of the Income Tax Act can be sustained when:

1. The assessee did not claim the impugned expenditure in its return or during assessment proceedings.
2. The PCIT failed to verify whether the expenditure was even allowed by the AO.
3. The revisionary proceedings were initiated based on third-party information without affording the assessee an opportunity to cross-examine or rebut the allegations.

Arguments Presented

For the Appellant

• The assessee argued that the PCIT’s order was devoid of merit as it proceeded on the erroneous assumption that the expenditure of ₹18,84,425 was claimed and allowed.
• The assessee never transacted with the parties named in the show cause notice, and no such expenditure was reflected in its books of account.
• The PCIT failed to provide any evidence linking the assessee to the alleged payments, violating principles of natural justice.
• The revisionary proceedings were initiated based on a proposal by the AO, which lacked independent application of mind by the PCIT, rendering the order jurisdictionally unsustainable.
• Reliance was placed on the decision in Alpha Laval Lund AB v. CIT, where it was held that Section 263 proceedings cannot be initiated on mere suspicion.

For the Respondent

• The Revenue contended that the AO failed to verify the nature of the commission payment, which was allegedly illegal and not allowable under Section 37(1).
• The PCIT acted within jurisdiction by setting aside the assessment order and directing the AO to conduct further inquiries.
• The satisfaction note based on search findings in the Tuteja, Bhatia and Dhand group case provided sufficient basis for initiating revisionary proceedings.

The Court's Analysis

The ITAT undertook a detailed examination of the scope of Section 263 and the principles governing revisionary jurisdiction. The Tribunal observed:

"The core issue is whether, as claimed, the assessee has claimed deduction of the impugned expenditure at all. If not, then the issue arises whether the same was allowed by the AO with due verification or without."

The Tribunal noted that the assessee had categorically stated that no such expenditure was claimed or allowed during the assessment proceedings. The financial statements submitted by the assessee did not reflect any payment of ₹18,84,425 as commission. Despite this, the PCIT proceeded to pass the revisionary order on the assumption that the expenditure was allowed without verification.

The ITAT held that Section 263 empowers the PCIT to revise an order only if it is erroneous and prejudicial to the interests of revenue. For an order to be erroneous, it must be factually incorrect or legally unsustainable. In this case, the PCIT failed to establish that the expenditure was either claimed or allowed, rendering the revisionary order devoid of factual basis.

The Tribunal further observed that the PCIT’s reliance on third-party information without affording the assessee an opportunity to cross-examine the alleged payees or rebut the allegations violated the principles of natural justice. The assessee had repeatedly sought details of the source of information, but none were provided.

The ITAT also noted that the revisionary proceedings were initiated based on a proposal by the AO, which lacked independent verification by the PCIT. This procedural infirmity further vitiated the order under Section 263.

Relying on the decision in Alpha Laval Lund AB v. CIT, the Tribunal held that revisionary jurisdiction cannot be exercised on mere suspicion or without establishing that the assessment order is erroneous and prejudicial to revenue.

The Verdict

The ITAT allowed the appeal of the assessee and quashed the revisionary order dated 20.02.2025 passed under Section 263 of the Income Tax Act. The Tribunal held that:

1. The PCIT’s order was unsustainable as it proceeded on the erroneous assumption that the expenditure of ₹18,84,425 was claimed and allowed.
2. The absence of any claim or allowance of the impugned expenditure rendered the assessment order neither erroneous nor prejudicial to revenue.
3. The failure to provide an opportunity for cross-examination and lack of independent verification by the PCIT violated principles of natural justice.

What This Means For Similar Cases

Revisionary Jurisdiction Requires Factual Verification

This judgment reinforces that Section 263 proceedings cannot be initiated on mere suspicion or without establishing that the assessment order is factually erroneous and prejudicial to revenue. Practitioners must note:

• The PCIT must verify whether the impugned expenditure was actually claimed or allowed before setting aside an assessment order.
• Third-party information cannot form the sole basis for revisionary proceedings unless the assessee is afforded an opportunity to rebut the allegations.
• The burden of proof lies on the PCIT to establish that the assessment order is erroneous, failing which the order is liable to be quashed.

Principles of Natural Justice Are Non-Negotiable

The ITAT’s decision underscores the importance of adhering to principles of natural justice in revisionary proceedings. Key takeaways include:

• The assessee must be given an opportunity to cross-examine witnesses or rebut allegations based on third-party information.
• The PCIT cannot rely on undisclosed information or satisfaction notes without providing the assessee access to the same.
• Failure to provide details of the source of information or alleged transactions renders the revisionary order unsustainable.

Procedural Compliance Is Critical

The judgment highlights the procedural requirements for invoking Section 263:

• The PCIT must independently apply mind to the facts and cannot merely rely on a proposal by the AO.
• Revisionary proceedings initiated on the AO’s proposal alone suffer from jurisdictional deficit and are liable to be quashed.
• The onus is on the Revenue to establish that the assessment order is erroneous, and mere suspicion is insufficient to sustain a revisionary order.