Karnataka High Court affirms that assessment order ignoring DRP directions is invalid and time-barred

Background of the dispute

The Revenue filed an appeal before the Karnataka High Court challenging the order dated 31.12.2018 passed by the Income Tax Appellate Tribunal, Bengaluru (ITAT) in IT(TP)A No.832/Bang/2017 relating to Assessment Year 2012-13 in the case of PCIT Vs Flextronics Technologies (India) Pvt. Ltd.

The ITAT had quashed the final assessment order on two principal grounds:

  1. The assessment was not in compliance with the mandatory procedure laid down in Section 144C of the Income Tax Act 1961.
  2. The final assessment order was barred by limitation in the context of the special time limits applicable under Section 144C(13).

The Revenue brought the matter to the High Court, contending that the Assessing Officer (AO) had passed the assessment order within the general time limit and that the ITAT erred in law by annulling the assessment.

Questions of law framed by the High Court

The Karnataka High Court admitted the appeal to examine four specific questions of law:

  1. Whether, in the facts and circumstances, the ITAT was correct in holding that the entire assessment order was time-barred when both the draft assessment order and the final assessment order had been passed within the general limitation period?
  2. Whether the ITAT was justified in law in declaring the final assessment order invalid on the ground that the AO failed to adhere to the directions issued by the Dispute Resolution Panel (DRP)?
  3. Whether the ITAT erred in not applying the decision of the Punjab and Haryana High Court in Des Kul Bhushan (47 Taxmann 79 (P&H)), where it was held that when an assessment is set aside, the limitation extends under Section 153(3)?
  4. Whether the ITAT was justified in holding that an assessment order passed under Section 143(3) read with Section 144C(13) was bad in law even though, according to the Revenue, it was passed within the parameters of those provisions?

These questions placed in issue not only compliance with DRP directions but also the interplay between the special timeline under Section 144C(13) and the broader limitation framework under Section 153.

Facts leading to the assessment

Transfer pricing adjustment and draft order

During the assessment proceedings for AY 2012-13, the AO proposed transfer pricing (TP) adjustments aggregating to Rs.40,11,77,583. The draft assessment order under Section 144C was issued on 29.03.2016, reflecting this TP adjustment.

As required under the DRP mechanism:

  • The assessee filed objections against the draft assessment order before the DRP on 29.04.2016.
  • The matter involved transfer pricing issues and therefore attracted the special assessment procedure under Section 144C, which mandates the draft order–DRP–final order sequence.

DRP directions

The DRP, after considering the assessee’s objections, issued its directions on 28.12.2016 under Section 144C(5) read with Section 144C(8). In those directions, the DRP granted relief to the assessee in respect of the TP adjustments initially proposed in the draft assessment order.

Under the statutory scheme of Section 144C:

  • The directions of the DRP are binding on the AO by virtue of Section 144C(10).
  • The AO is obligated under Section 144C(13) to pass the final assessment order in conformity with the DRP’s directions within one month from the end of the month in which those directions are received.

Final assessment order dated 31.01.2017

The AO subsequently passed the final assessment order on 31.01.2017 under Section 143(3) read with Section 144C(13).