ITAT Hyderabad Quashes Assessment for Breach of Limited Scrutiny Jurisdiction

Overview of the Decision

The Hyderabad Bench of the Income Tax Appellate Tribunal (ITAT) in Krishna Constructions Vs ITO has held that an assessment framed in a limited scrutiny case becomes invalid when the Assessing Officer (AO) exceeds the prescribed scope without following the mandatory procedure laid down by the CBDT. Since the AO, in this case, made additions on issues beyond the original scrutiny parameter of cash deposits, and no prior approval for conversion to full scrutiny was obtained, the Tribunal declared the entire assessment order as void and unsustainable in law.

The ruling is significant for all assessees facing limited scrutiny under CASS, particularly in situations where the AO tries to widen the scope of examination without adhering to CBDT instructions.

Background and Grounds of Appeal

The appeal arose from an order dated 03.07.2025 passed by the CIT(A) – National Faceless Appeal Centre (NFAC), Delhi for Assessment Year 2017-18.

The assessee, a partnership firm engaged in construction contracts, challenged the assessment framed under Section 143(3) on several legal and factual grounds. The prominent grounds included:

  • The assessment order was bad in law as it travelled beyond the scope of limited scrutiny for which the case was selected.
  • The AO made additions relating to all bank credits and partner contributions, although the scrutiny was confined only to verification of cash deposits during demonetization.
  • CBDT Instructions, specifically F.No. 225/402/2018/ITA.II dated 28.11.2018, were ignored, which categorically bar the AO from expanding the scope of limited scrutiny without meeting specified conditions.
  • The AO treated the total bank deposits of Rs. 2,17,54,080/- as income of the assessee and further treated Rs. 2,20,45,610/- as business receipts, effectively taxing the entire gross inflow instead of only the profit element.
  • The CIT(A) was alleged to have erred in confirming these additions and in holding that the assessee violated Section 44AB by not maintaining books and not getting them audited.

The assessee also raised additional legal grounds under Rule 11 of the Income Tax (Appellate Tribunal) Rules, 1963, focusing on the jurisdictional error in expanding limited scrutiny without approval.

Admission of Additional Grounds – Pure Question of Law

The Tribunal first addressed whether the additional grounds regarding jurisdiction could be admitted at the appellate stage.

  • The assessee’s authorised representative argued that the issue was purely legal, arising from material already on record, and did not require fresh investigation.
  • Reliance was placed on the Supreme Court judgment in National Thermal Power Co. Ltd. vs. CIT [1998] 229 ITR 383 (SC), which permits raising a pure question of law at any stage before the Tribunal.

The Departmental Representative opposed admission but could not rebut the fact that the case was originally picked only for limited scrutiny on cash deposits, whereas the AO had proceeded to examine and tax all bank credits and partner contributions.

The Tribunal, noting that:

  1. The nature of the dispute was purely legal, and
  2. All necessary facts were already on record,

admitted the additional grounds relating to lack of jurisdiction and violation of CBDT instructions.

Facts of Selection Under Limited Scrutiny

It was undisputed that the assessee’s return was picked up under Computer Assisted Scrutiny Selection (CASS) for limited scrutiny, restricted to the issue of “cash deposits during the year”.

  • The notice under Section 143(2) clearly indicated that the case was a limited scrutiny case and specified the issue of verification of cash deposits.
  • During assessment, the assessee furnished bank statements, computation of income, and explanations for cash deposits.

However, while framing the assessment, the AO:

  1. Did not confine the enquiry to cash deposits of Rs. 8,22,000/- in the two bank accounts.
  2. Examined the entire credits in the bank accounts.
  3. Treated all deposits, including partners’ capital contributions, as income of the firm.
  4. Characterised gross receipts of Rs. 2,20,45,610/- as the assessee’s business turnover and invoked applicability of Section 44AB.