Bombay High Court Quashes Reassessment Against Royal Chains, Says 'Reason To Suspect' Not Enough

The Bombay High Court on 24 August quashed an Income Tax reassessment notice issued to jewellery manufacturer Royal Chains Pvt Ltd for Assessment Year 2016-17.

A Division Bench of Justices B.P. Colabawalla and Farhan P. Dubash noted that a completed Income Tax assessment cannot be reopened merely on the basis of suspicion about an investor's background, without material having a direct nexus with the particular transaction and the alleged escapement of income. It observed:

“The connection that is sought to be made appears to be purely on conjecture. It appears that since the Assessing Officer was convinced that Mr. Manoj Jain was involved in bogus and illegal cash transactions, the current transaction also should be painted with the same brush. We are afraid that is not the law. The law is that the material has to have a direct nexus to the belief formed by the Assessing Officer that income has escaped assessment. Having a 'reason to suspect' is not a ground on which the Assessing Officer can invoke his jurisdiction to reopen the assessment of an Assessee.”

Royal Chains had received foreign investment from Dubai-based Viren Jewellers LLC through the Foreign Direct Investment (FDI) route. Viren Jewellers initially invested around Rs.6.57 crore by subscribing to shares at a premium of Rs.5 per share. It subsequently invested another Rs.9 crore at a premium of Rs.59 per share, taking its shareholding in Royal Chains to 28.82%.

The Income Tax Department had examined the share premium during the original scrutiny assessment. The Assessing Officer had specifically examined the applicability of Section 56(2)(viib) of the Income Tax Act, which deals with the taxability of certain share premiums received by closely held companies. Royal Chains had furnished detailed documents relating to the share capital and valuation.

The assessment was subsequently reopened based principally on statements made by Sanjay Bhavishi concerning Manoj Jain of Viren Jewellers LLC. Bhavishi had allegedly stated that Jain was known in the trade for non-genuine business practices and illegal cash transactions.

The High Court found that Bhavishi's statements did not refer to Royal Chains, either directly or indirectly, or to Viren Jewellers' investment in Royal Chains. It therefore found no live link between the material relied upon by the Assessing Officer and the belief that Royal Chains' income had escaped assessment.

The Bench also examined the Survey Report relied upon by the Revenue. It noted that the report itself suggested that the Assessing Officer should undertake further verification and enquiries. It held that neither the Survey Report nor Bhavishi's statements provided a direct nexus for concluding that Royal Chains' share capital represented unaccounted money. The reopening on this ground was therefore held to be “wholly unsustainable.”

The Revenue also relied on the increase in share premium from Rs.5 to Rs.59 per share to support its suspicion. The Court rejected this argument even on the test of “human probabilities”. It observed that the Revenue's theory would mean that Royal Chains had used its own unaccounted cash to bring in a stranger as a 28.82% shareholder, thereby giving the investor substantial control in the company. The Bench found such a suggestion absurd.

The Revenue raised a second ground for reopening, alleging that Rs.21,636 towards employees' PF and ESIC contributions had been deposited beyond the due dates prescribed under the respective statutes.

The Bench noted that when the reassessment notice was issued in March 2021, the law prevailing under the Bombay High Court's ruling in Ghatge Patil Transports Ltd. permitted deduction where the contribution was deposited before the due date for filing the income tax return. It was undisputed that Royal Chains had deposited the amount within that period.

The judges observed that the Supreme Court subsequently took a different view in Checkmate Services (P) Ltd. in October 2022. However, they held that the subsequent Supreme Court judgment could not retrospectively create a “reason to believe” which did not exist when the reassessment notice was issued.

Accordingly, the High Court allowed Royal Chains' writ petition and quashed the notice issued under Section 148 of the Income Tax Act.

For the Petitioner (Royal Chains Pvt. Ltd.): Ms. Dinkle Hariya, with Ms. Sruti Kalyanikar, instructed by Ms. Rashmi Vyas.

For the Respondents/Income Tax Department: Mr. P.C. Chhotaray, with Ms. Sangita Choure.