VIP Road Chartered Accountants Association

Best Judgement and Protective Assessments

Introduction

For the last two to three years Tax Practitioners and their clients have lost touch with the process of assessments and the problems and issues arising therefrom. This is on account of the fact that for a period of nearly five years, returns filed by assesses have, by and large, been accepted and only a very limited number have been selected for scrutiny. In and around September’02, the Central Board of Direct Taxes issued instructions to scrutinize a large number of returns. We will now, therefore, have high-pitched assessments, best judgement assessments, re-assessments and last but not the least protective assessments. This article proposes to discuss two of these categories, viz, Best Judgement and Protective Assessments.

Best Judgement Assessments

A Best Judgement Assessment is normally framed under Section 144 and will be passed if any person:

fails to make a return required under Section 139(I); or

fails to comply with terms of a notice issued under Section 142(1); or

fails to carry out a special audit as directed under Section 142(2A); or

fails to comply with the terms of a notice issued under Section 143(2).

It will be apparent from the above categories that a best judgement assessment is the consequence of a failure on the part of the assessee. Such a failure may be deliberate, may have arisen out of ignorance or circumstances beyond the control of an assessee. In any of these eventualities, the Assessing Officer is entitled, on the basis of all relevant material which he has gathered and after giving an opportunity to the assessee of being heard, make an estimate of the total income or loss of an assessee and determine the sum payable by him.

Courts, including the Apex Court, in a number of judgements have laid down the principles, which an Assessing Officer must follow in framing a best judgement assessment. Experience, however, shows that these are rarely followed and we have totally arbitrary and ad-hoc assessments. As aforementioned, Courts have very lucidly explained the principles of best judgement assessment. Some observations of the
Courts are reproduced herein for ready reference.

In CIT vs. Laxminarian Badridas: (1937) 5 ITR 170(PC)

"The officer is to make an assessment to the best of his judgment against a person who is in default as regards supplying information. He must not act dishonestly or vindictively or capriciously because he must exercise judgment in the matter. He must make what he honestly believes to be a fair estimate of the proper figure of assessment, and for this purpose he must, their Lordships think, be able to take into consideration local knowledge and repute in regard to the assessee’s circumstances, and his own knowledge of previous returns by and assessments of the assessee, and all other matters which he thinks will assist him in arriving at a fair and proper estimate; and though there must necessarily be guesswork in the matter, it must be honest guesswork. In that sense, too, the assessment must be, to some extent, arbitrary."

In State of Kerala vs C.Velkutty (1966) 60 ITR 239(SC) – A decision under the Travancore ST Act.

"The limits of the power are implicit in the expression ‘ best of his judgment’. Judgment is a faculty to decide matters with wisdom truly and legally. Judgment does not depend upon the arbitrary caprice of a judge, but on settled and invariable principles of justice. Though there is an element of guesswork in a ‘best judgment assessment’, it shall not be a wild one, but shall have a reasonable nexus to the available material and the circumstances of each case."

From the above, it will be apparent that though judicial authorities have accepted that the assessment under Section 144 is an estimate, it would be the estimate of an honest and fair man who applies his well-reasoned judgment to the material on record and, therefore, not only should the judgment be fair and honest but the judgment should have a reasonable nexus with the material. If that is not so, Courts are inclined to set aside the said assessment.

To summarise, a best judgement assessment must be an honest estimate on the basis of:

material including record pertaining to past assessments;

local knowledge and repute.

This would mean that when profit is estimated the officer must consider comparable instances of other assessees in similar circumstance.

Apart from the above, Section 144 contemplates that an opportunity is to be given to an assessee to show cause as to why the assessment ought not to be framed under Section 144. The proviso, therefore, contemplates that an assessee should be confronted with the material with Assessing Officer on the basis of which an adverse conclusion will be drawn. This would enable an assessee to meet the conclusions which the Assessing Officer seeks to draw.

The second proviso states that it would not be necessary to give such an opportunity if a notice under Section 142(1) has been issued prior to making of the assessment. Practically, an assessee and his representative are well advised to place all material available with him to substantiate his case. Experience shows that sensing the adversarial nature of the Assessing Officer the assessee does not place on record even material, which could help the assessee’s case. It must be pointed out that once material is on record, the Assessing Officer is bound to consider that material in framing the assessments. Therefore, even though the entire requirements specified in a notice under Section 142(1)/143(2) may not be available with an assessee, he should proceed to place on record whatever is available. For e.g. if the Assessing Officer calls upon an assessee to prove credit-worthiness of a loan creditor, the assessee should furnish in the absence of a confirmation, name and address, the cheque numbers by which the money has been received and the cheque numbers and relevant dates on which the money has been repaid and bank statements in regard to the same. If the loan creditor does not respond to the request of the assessee to furnish confirmations, the assessee should request the Assessing Officer to send the necessary summons. This would establish that not only did an assessee undertake the requisite effort to comply with the notices, but also made the necessary request to the Assessing Officer to exercise his powers for collection of evidence.

An issue that often arises is that whether a best judgment assessment can be framed under Section 143(3). The answer seems to be in the affirmative. [Reference Addl. ITO vs. Ponkunnom Traders, 102 ITR 366 (Kerala)]. If the judgment made by an Assessing Officer is not caused on account of any infringement of the various clauses of Section 144, the Assessing Officer would be in his right to make an assessment under Section143(3). For e.g. in case whether the Assessing Officer rejects either books of account or does not accept the method of accounting of the assessee in terms of 145(2), the assessment is to be framed under 143(3) (Section 145 provides that in this case an assessment is to be framed in the manner provided in Section 144) and as a corollary, an opportunity has to be given to an assessee to meet the material which is adverse to him. Even otherwise, if the Assessing Officer seeks to make the best judgment assessment under Section 143(3), as long as he complies with the Principles of Natural Justice, such an assessment would be in order.

Since an assessment under Section 144 is basically an estimate, issues have been often arising as to whether depreciation has to be allowed independent of the estimate. The Courts are virtually unanimous in the conclusion that unless the order explicitly states that the allowance under Section 32 has been considered while making the estimate, depreciation has to be allowed from the income estimated. Further support can be drawn from a circular of the CBDT dated 31-8-1965 which explicitly states that depreciation has to be considered separately.

Out of this, an interesting issue would arise particularly with reference to the assessments pertaining to assessment year 2001-2002 and earlier years which are framed under Section 144. The issue is that whether in the absence of particulars, can depreciation be thrust on an assessee. The issue would be of significance because the consequences of transfer of a depreciable and non-depreciable assets are materially different. In my view, if the assessee does not make any specific averments stating that he does not wish to claim depreciation, then the Assessing Officer would be in his rights to allow depreciation because depreciation for determining commercial profit is a necessary allowance. However, the Supreme Court has held that depreciation is an allowance, which can be claimed at the option of the assessee. Therefore, if there is a specific statement in the return by an assessee that he does not wish to claim depreciation, then for assessment year 2001-2002 and earlier years depreciation cannot be thrust on an assessee.

One final aspect of the best judgment assessment is that section provides that the Assessing Officer shall determine total loss or income and determine sum payable by the assessee. The section does not contemplate issue of a refund. However, though a refund rarely arises in a best judgment assessment, the legal position would be that in the event that after a best judgment assessment a refund is actually due to the assessee, then it may be granted to him. This is on the basis of two factors, firstly, there cannot be any unjust enrichment of the state as against an assessee and one may also rely on the proposition laid down in LML Ltd. vs CIT 205 ITR 585.

Protective Assessment

Protective assessment is a concept which has been created by actions of the department, which have over a period of time received judicial recognition.

It may so happen that an Income Tax Officer is unable to determine during the course of assessment two aspects (1) the person in whose hands income should be taxed; (2) the year for which it should be taxed; and (3) the status in which a particular assessee should be assessed.

The law prescribes that the process of assessment has to be completed within a particular time frame. In order to ensure that the sword of damocles is not kept hanging permanently on an assessee, the law also prescribes a time limit within which an assessment can be re-opened or a re-assessment of income escaping assessment can be made. In these circumstances, we often find that an Assessing Officer charges the income in the hands of two different persons or taxes the same income for two different years or makes one assessment according to the status in which the assessee has filed its return and a second assessment in the status which in his view, is the correct status in law.

In all these cases, one of the assessments which in the opinion of the department is the correct assessment is treated as substantive. The other is treated as protective. The concept of protective assessment. is not explicitly contained in the act but it has been accepted as a necessary aspect, but by the courts and also by the department. The courts have held that if the authorities are convinced that the income is chargeable to tax then they may proceed to make protective assessments so that the interest of the revenue is not jeopardized by limitation coming into play. It is only to be ensured that – (1) the protective assessment seen only as the last alternative; (2) no recovery proceedings are commenced after a protective assessment has been made and (3) once one of the assessments becomes final, the other is cancelled by way of suo moto rectification proceedings under Section 154. There is a circular stating that once the substantive assessment becomes final, the protective assessment must be annulled suo moto by the Assessing Officer as a mistake apparent from record. The circular states that this action must be taken even if it is beyond the time frame envisaged by Section 154(7). (F.No.246/25/71.A & PAC dt. 24th December 1971). In my view, even though there is no specific provision in the law regarding protective assessments, in fairness to the revenue, in rare cases, the assessments of this nature are necessary to ensure that interests of the revenue are well protected.

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