Limited Scrutiny Cannot Be Expanded Without Pr.CIT Approval: Madras High Court Rules in Favour of Charitable Society

1. Background and Context

Madras Craft Foundation Society, a charitable organisation registered under Section 12AA of the Income Tax Act, 1961, filed its return of income electronically for Assessment Year 2016–17 on 27.09.2016, declaring nil income and reporting gross receipts of ₹2,50,80,909. The case was subsequently picked up under the Computer Aided Scrutiny Selection (CASS) system for limited scrutiny, with the sole issue identified being whether depreciation had been correctly claimed in the return of income.

A notice under Section 143(2) of the Act was duly issued on 27.07.2017, followed by a notice under Section 142(1) on 04.05.2018 seeking specific particulars. The assessee's authorised representative complied with these requisitions on multiple occasions. However, during the course of proceedings, the Assessing Officer issued a further notice under Section 142(1) dated 09.05.2018 calling for additional information that extended well beyond the depreciation issue originally identified for limited scrutiny.

2. What the Assessing Officer Actually Did

When the assessment order dated 09.11.2018 was passed under Section 143(3), the Assessing Officer had gone considerably beyond the scope of the limited scrutiny notice. Instead of confining the inquiry to the correctness of the depreciation claim, the order ventured into an examination of the assessee's claim for exemption under Section 11(2) of the Act.

The Assessing Officer found that a sum of ₹26,86,786 represented accumulation during the relevant financial year, and since the assessee had not filed Form No. 10 electronically, the claim for exemption on that accumulated amount under Section 11(2) read with Rule 17 was rejected. Further, the assessee had sought to adjust excess expenditure incurred in earlier years against the shortfall in the current year. The Assessing Officer denied this adjustment as well, relying on the following reasoning extracted from the assessment order:

"3.2. Set off of excess expenses over income incurred in earlier years can be adjusted against the income of the current year. It is explicitly clear that, the excess expenditure over and above the income means that excess expenditure over and above the total revenue receipts during the year. It is noticed from the accumulation schedule that, there is no excess application in any of the earlier years. The assessee trust has taken expenditure in excess of 85% of the gross receipts, for the purpose of carry forward of excess application of funds and adjustment. Only when the total application of income exceeds 100% of the gross receipts, the excess application of income is allowed to be carried forward and adjusted from the shortfall in the subsequent years. In the instant case, there is no question of excess application in any of the earlier years and hence, no adjustment of excess application against the shortfall is possible during this year."

As a consequence of these findings, the assessee's income was determined at ₹32,72,038 for Assessment Year 2016–17, a figure that stood in sharp contrast to the nil income originally returned.

3. Challenge Before the Revisional Authority Under Section 264

Aggrieved by the assessment order dated 09.11.2018, the assessee filed a petition under Section 264 of the Act before the Commissioner (Exemptions) on 12.02.2020. The core argument advanced was that the Assessing Officer had acted without jurisdiction in expanding the scope of scrutiny from the limited issue of depreciation to the entirely distinct question of exemption under Section 11(2), and that this expansion had been undertaken without obtaining the prior written approval of the Principal Commissioner or Commissioner as mandated by CBDT Instruction No. 20/2015 dated 29.12.2015 and Instruction No. 5/2016 dated 14.07.2016, both issued under Section 119 of the Act.

The revisional authority, however, rejected this contention. Its reasoning, as captured in the impugned order under Section 264, was:

"the assessing officer has reworked the computation part at the time of completion of the scrutiny assessment. As per Circular No.5/2016, the approval is required wherein potential escapement of income is noticed by the assessing officer on the basis of information and not for computation of income. Hence this ground of the assessee is not acceptable and the stand of the assessing officer is correct."

Dissatisfied with this rejection, the assessee approached the Madras High Court by way of W.P. No. 10673 of 2021.