ITAT Quashes Assessments for Procedural Lapses: Limited Scrutiny Breached and Mandatory Draft Order Skipped

Bangalore, Karnataka – The Income Tax Appellate Tribunal (ITAT), Bangalore 'B' Bench, comprising Shri Laxmi Prasad Sahu (Accountant Member) and Shri Keshav Dubey (Judicial Member), has delivered a significant ruling, allowing two appeals filed by assessee Anantula Vijay Mohan against the Deputy Commissioner of Income Tax (DCIT), Bangalore. The Tribunal quashed assessment orders for Assessment Years (AY) 2016-17 and 2017-18, citing critical procedural failures by the Assessing Officer (AO) concerning the scope of 'limited scrutiny' and the mandatory issuance of a draft assessment order under Section 144C of the Income Tax Act, 1961.

The orders, pronounced on May 7, 2025, highlight the binding nature of CBDT instructions on AOs and the non-curable nature of failing to issue a draft assessment order to eligible assessees.

Case Background and Core Disputes

The appeals, ITA Nos. 2059 & 2060/Bang/2024, pertained to two distinct assessment years with different procedural challenges:

AY 2016-17 (ITA No.2059/Bang/2024): Expansion of 'Limited Scrutiny'

Mr. Anantula Vijay Mohan , a resident individual, reported substantial short-term capital gains (STCG) and set off a significant short-term capital loss (STCL) from transactions in Bharat Electronics Limited (BEL) shares.

His case was selected for 'Limited Scrutiny' focusing on: (i) justification of refund claim, and (ii) disclosure of investment and income relating to foreign bank accounts.

However, the AO expanded the scrutiny to the BEL share transactions, recharacterizing them as an "adventure in the nature of trade," disallowing the STCL, and computing a business loss. The AO alleged an artificial arrangement to generate capital loss.

The Commissioner of Income Tax (Appeals)/NFAC partly upheld the AO's view on the nature of the transaction but modified the computation.

AY 2017-18 (ITA No.2060/Bang/2024): Non-issuance of Draft Assessment Order u/s 144C

For this year, Mr. Mohan , then a non-resident, reported long-term capital gains (LTCG) from the sale of BEL bonus shares, claiming exemption under Section 10(38).

The AO initiated reassessment proceedings under Section 147 and recharacterized the LTCG as business income, denying the exemption.

Crucially, the AO passed the final assessment order on March 29, 2022, without first issuing a draft assessment order as mandated by Section 144C(1) of the Act, applicable to 'eligible assessees' including non-residents (post-amendment effective April 1, 2020).

The CIT(A)/NFAC upheld the AO's action.

Arguments Before the Tribunal

Assessee's Contentions (Represented by Sri Padma Khincha, A.R.):

AY 2016-17: The AO unlawfully expanded the scope of 'limited scrutiny' without obtaining the mandatory prior approval from the Principal Commissioner/Commissioner of Income Tax (PCIT/CIT), as required by CBDT instructions. This rendered the variations in the assessment order without jurisdiction.

AY 2017-18: As a non-resident, the assessee was an 'eligible assessee.' The failure to issue a draft assessment order under Section 144C(1) before passing the final order was a fatal flaw, making the entire assessment void ab initio and not a curable defect.

Revenue's Contentions (Represented by Sri Sridhar E., D.R.):

AY 2016-17: Verification of a refund claim inherently allows the AO to examine all items in the income computation that contribute to the refund, effectively permitting a broader scrutiny.

AY 2017-18: The non-issuance of a draft assessment order was merely a procedural irregularity that could be cured by remitting the matter back to the AO.

Tribunal's Findings and Rulings

The ITAT meticulously examined the arguments and records, allowing the additional legal grounds raised by the assessee in both appeals.

On Expansion of 'Limited Scrutiny' (AY 2016-17):

The Tribunal found it undisputed that the case was selected for limited scrutiny with specific issues. The AO, however, delved into the BEL share transactions, which were not part of the initial scope.

> "The AO has over stepped his jurisdiction without duly recording the reasons for expanding the scope of ‘Limited Scrutiny’. The same also not placed before the Pr. CIT/CIT concerned for his approval & the assessee had also not been intimated that additional issue would also be considered..."

The Bench emphasized that CBDT instructions (Instruction No. 20/2015, Instruction No. 5/2016, and F.No.225/402/2018/ITA.II) clearly mandate that an AO cannot expand the scope of limited scrutiny without prior PCIT/CIT approval. It rejected the DR's argument that refund verification justifies a complete scrutiny, stating such an interpretation "will completely frustrate the very objective of 'limited scrutiny'."

The Tribunal concluded: > "The AO has exceeded his jurisdiction in inquiring into those issues which are beyond the scope of 'limited scrutiny' which is clear violation of mandate given by the CBDT... and accordingly without jurisdiction & bad in law. ...we set a-side the order of the AO being without jurisdiction & bad in law."

On Non-Compliance with Section 144C (AY 2017-18):

The Tribunal noted that the assessee was a non-resident and thus an 'eligible assessee' under Section 144C(15)(b) from April 1, 2020. The assessment order was passed on March 29, 2022, well after this provision became effective.

The Bench held that Section 144C, which requires the AO to first issue a draft assessment order to an eligible assessee if proposing any variation prejudicial to their interest, is a mandatory provision, not merely procedural. > "Failure on the part of AO to follow procedure u/s 144C(1) is not merely a procedural or inadvertent error but a breach of a mandatory provision."

Citing several High Court judgments, including CIT v. Cisco System Services B.V. (2023) 456 ITR 50 (Kar) , S.H.L. (India)(P) Ltd. Vs. DCIT (2021) 128 taxmann.com 426 (Bombay) , CIT, Vadodara 2 Vs. C-SAM (India) (P) Ltd. (2017) 84 taxmann.com 261 (Guj.) , and Gigabyte Technology (India) (P) Ltd. (2020) 317 CTR 585 (Bom HC at Goa) , the Tribunal affirmed that non-compliance with Section 144C(1) is an incurable illegality rendering the assessment order void.

The Tribunal stated: > "As the order passed by the AO is without jurisdiction, the assessment order dated 29.3.2022 is without jurisdiction, null and void."

Final Decision and Implications

Appeals Allowed: Both appeals (ITA No. 2059/Bang/2024 for AY 2016-17 and ITA No. 2060/Bang/2024 for AY 2017-18) were allowed in favor of the assessee based on these preliminary legal grounds.

Merits Not Adjudicated: Consequently, the Tribunal did not adjudicate the other grounds of appeal concerning the merits of the case, leaving them open.

Stay Petition Dismissed: The stay petition (SP No.67/Bang/2024) for AY 2017-18 was dismissed as infructuous.

This ruling reinforces the critical importance of procedural adherence by tax authorities. It underscores that AOs must strictly confine their inquiries within the scope of 'limited scrutiny' unless proper approval for expansion is obtained. Furthermore, it reiterates that the procedure under Section 144C for eligible assessees, including the issuance of a draft assessment order, is a substantive right, and its violation can nullify the entire assessment.