Revenue loses appeal: No incriminating material found in search to justify tax addition

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Case Name

Principal Commissioner of Income Tax vs Jaypee Financial Services Ltd.(High Court of Delhi)

ITA 42/2021 & CM No.6138/2021

Date: 20th July 2021

Key Takeaways

1. Search-based assessments require incriminating material: Tax additions under Section 153A (of Income Tax Act, 1961) can only be made if they’re based on incriminating documents or evidence actually found during the search operation.
2. Burden of proof on Revenue: The tax department must clearly identify and produce the specific incriminating material that justifies any additions to income.
3. Factual findings are rarely overturned: High Courts will not interfere with concurrent findings of fact by lower tax authorities unless they are clearly perverse.

Issue

Can the tax department make additions to a taxpayer’s income under Section 153A (of Income Tax Act, 1961) without establishing that such additions are based on incriminating material actually found during a search and seizure operation?

Facts

• 2007: Jaypee Financial Services Ltd., a company trading in equity shares and securities, filed its tax return showing income of Rs. 86,67,680/-
• 2009: The return was processed normally
• March 30, 2012: A search and seizure operation was conducted under Section 132 (of Income Tax Act, 1961) as part of investigations into the Jaypee Group. Computer data was cloned and documents were seized
• August 5, 2013: A notice under Section 153A (of Income Tax Act, 1961) was issued for post-search assessment
• Assessment: The tax officer found evidence of “Client Code Modifications” by related companies and appointed a Special Auditor under Section 142(2A) (of Income Tax Act, 1961) to investigate
• Final Assessment: Based on the auditor’s report, the officer added Rs.14,97,45,205/- to income, claiming profit and loss shifting through code modifications, plus Rs.22,242/- under Section 40A(3) (of Income Tax Act, 1961) for excess cash expenditure

Arguments

Revenue’s Position:

• Incriminating documents and evidence were found during the search operation
• Computer data was cloned and seized along with physical documents
• The assessment officer didn’t need to provide complete details of incriminating material since the CIT vs. Kabul Chawla decision wasn’t available at the time

Taxpayer’s Position:

• No assessment was pending when the search took place, so no assessment was abated
• The additions weren’t based on any incriminating material actually found during the search
• The tax officer failed to establish a clear link between seized material and the additions made

Key Legal Precedents

The court relied heavily on CIT vs. Kabul Chawla, 2015 SCC OnLine Del 11554. This precedent established that:

• If no assessment is pending on the date of search, no assessment gets abated
• Additions under Section 153A (of Income Tax Act, 1961) must be based on incriminating material found during the search
• The tax department must clearly establish this connection

The court noted that both the CIT(A) and ITAT followed this precedent, and their decision was “squarely covered by the aforesaid judgment”.

Judgement

Winner: Jaypee Financial Services Ltd. (Taxpayer)

Court’s Reasoning:

The Delhi High Court dismissed the Revenue’s appeal for these key reasons:

1. Lack of Incriminating Material: Both CIT(A) and ITAT found that the additions weren’t based on any incriminating material found during the search
2. Revenue’s Failure to Prove: The tax department couldn’t explain or indicate what specific incriminating material supported their additions, despite multiple opportunities
3. Concurrent Findings: The court noted that “findings of facts returned by CIT(A) and ITAT are not to be interfered with lightly”
4. No Substantial Question of Law: Since the case was covered by existing precedent, no substantial legal question arose for consideration

Orders: The appeal was dismissed along with pending applications.

FAQs

Q1: What does this mean for future search and seizure cases?

A: Tax officers must clearly establish that any additions to income are based on specific incriminating material found during the search. Vague references to “incriminating documents” won’t suffice.

Q2: Can the tax department still make additions after a search?

A: Yes, but only if they can prove the additions are based on incriminating material actually found during the search operation under Section 132 (of Income Tax Act, 1961).

Q3: What if no assessment was pending when the search happened?

A: Following the Kabul Chawla precedent, if no assessment was pending on the search date, no assessment gets abated, and stricter standards apply for making additions.

Q4: Why couldn’t the Revenue provide details of incriminating material?

A: The court found that despite multiple opportunities - before CIT(A), ITAT, and even the High Court - the Revenue failed to identify or produce any specific incriminating material that justified the additions.

Q5: What’s the significance of the Client Code Modification issue?

A: While the auditor found evidence of code modifications, the court’s focus was on whether this evidence came from incriminating material found during the search, which the Revenue couldn’t establish.

1. The hearing has been conducted through video conferencing.

2. The present appeal under Section 260A (of Income Tax Act, 1961) is directed against the

order dated 05th September, 2019 passed by Income Tax Appellate

Tribunal, in ITA No. 4262/Del/2016 for the Assessment Year 2007-08

whereby the appeal of the Revenue has been dismissed.

3. Briefly stated, the assesse is a company engaged in trading of

equity shares, securities and commodities through recognized

exchanges. It filed its return of income on 31.10.2007 declaring total

income of Rs. 86,67,680/-. The return was processed on 21.02.2009.

Subsequently, on 30.03.2012, a search and seizure operation under

Section 132 (of Income Tax Act, 1961) was initiated in the case of the assesse, as part of Jaypee

Group. During search, data of the computers found at the premises

was cloned and seized along with certain documents. Thereafter, on

05.08.2013, a notice under Section 153A (of Income Tax Act, 1961) was issued.

Pursuant thereto, the assessee filed its return of income reiterating the

return of income filed by them. During the course of post search

proceedings, the assessing officer found evidence of Client Code

Modifications done by M/s Jaypee Capital Services Ltd. and Futurz

Next Services Ltd, companies registered with NSE, MCX, and

NCDEX and United Stock Exchange. A Special Auditor was

appointed u/s 142(2A) (of Income Tax Act, 1961) and directed to file a report on the aspect of

Client Code Modifications done by the afore-noted companies as well

the assessee company. On the basis of the Auditor Report and the

response of the assessee, the AO concluded that in the case of member

(broker) group companies of the assessee, the Client Code

Modification is by and large not for genuine reasons and is rather for

extraneous considerations. The net effect of profit and loss shifting in

the code of assessee-company has been suppressed in its books of

accounts. Accordingly an amount of Rs. 14,97,45,205/- was added to

the income on account of Client Code Modification. Further, a sum of

Rs. 22,242/- was also disallowed under section 40A(3) (of Income Tax Act, 1961) and

added to the income of the assessee for expenditure incurred in cash

by the assessee beyond the limit prescribed under the Income Tax Act.

The total income was assessed as Rs.15,84,35,130/-.

4. In appeal preferred by the assessee, the CIT(A), following the

dicta of this court laid down in CIT Vs. Kabul Chawla, 2015 SCC

OnLine Del 11554, held that no assessment/reassessment proceedings

were pending on 30.03.2012 when search action took place and hence

no assessment was abated. The addition made by the AO is not based

on any incriminating document/seized material found during the

course of search and seizure action u/s 132 (of Income Tax Act, 1961) and accordingly

the same were deleted. In further appeal preferred by the Revenue

before the ITAT, the findings of the CIT(A) were confirmed.

5. Before us, Mr. Ajit Sharma, learned senior standing counsel for

the Revenue, further submits that findings of the ITAT are perverse in

as much as the incriminating material was in fact found during the

course of search and therefore additions were justified. In support of

his submissions, he refers to para 2 of the assessment order which

records that “during the course of search incriminating documents and

evidences have been found and seized. The data in the computer was

also cloned and seized along with physical documents”. Mr. Sharma

further submits that at the stage of passing of the assessment order, the

decision of CIT Vs. Kabul Chawla (supra) was not available and

therefore, assessing officer did not consider it necessary to give a

complete description of the incriminating material by recording the

details of the panchnama.

6. We have perused the record. Both the CIT(A) as well as the

ITAT have held in the instant case that the addition is not based on

any incriminating material found during the course of search and the

assessment was not pending on the date of search. The observations of

the assessing officer relied upon by Mr. Sharma do not give us any

insight or clue about the ‘incriminating material’ which is claimed to

be in existence. In the proceedings before the CIT(A) as well as the

ITAT, the Revenue has not made any attempt so as to disclose the

incriminating material. Even in the present appeal, the revenue is

unable to explain or give us any indication about the same.

7. The findings of facts returned by CIT(A) and ITAT are not be

interfered with lightly. The view taken by the tax authorities based on

the decision of CIT Vs. Kabul Chawla (supra) cannot be held to be

perverse. The questions of law proposed by the Revenue are squarely

covered by the aforesaid judgment.

8. In view of the above, no question of law, much less a

substantial question of law, arises for our consideration. Accordingly,

the present appeal, along with pending application, is dismissed.

9. The order be uploaded on the website forthwith. Copy of the

order be also forwarded to the learned counsel through e-mail.

MANMOHAN, J

NAVIN CHAWLA, J

JULY 20, 2021