Full Judgment Text
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PETITIONER:
GANGA SARAN AND SONS PVT. LTD. CALCUTTA
Vs.
RESPONDENT:
INCOME TAX OFFICER & ORS.
DATE OF JUDGMENT23/04/1981
BENCH:
BHAGWATI, P.N.
BENCH:
BHAGWATI, P.N.
VENKATARAMIAH, E.S. (J)
CITATION:
1981 AIR 1363 1981 SCR (3) 564
1981 SCC (3) 143 1981 SCALE (1)883
CITATOR INFO :
R 1987 SC1897 (31)
ACT:
Income Tax Act 1961, S. 147-Income Tax-Escaped
assessment-Duty of assessee to disclose fully and truly all
material facts necessary for his assessment for that year-
Meaning of.
Director in sole charge of management of business of
assessee-Paid remuneration for services-Utilisation of the
remuneration by director-Assessee whether under obligation
to disclose to the Income Tax Officer in the course of its
assessment.
HEADNOTE:
The assessee was incorporated as a Private Limited
Company in March, 1947 with G as its Managing Director and
it took over the business of the trading company carried on
by ’D’ in Delhi. D was the brother-in-law of G and was
placed in charge of the management of the business of the
Delhi Branch of the assessee and he was paid a salary of Rs.
1000 per month, commission at the rate of 1 per cent on the
sales of the Delhi Branch and bonus equivalent to three
months salary.
The assessments of the assessee for the years 1949-50
to 1959-60 were finalised on the basis of the decisions of
the Income-Tax Tribunal and the amounts paid to the Managing
Director and the other Directors including D by way of
salary, commission and bonus were allowed in full as
permissible deductions and so was the interest paid on the
credit balances in their respective accounts.
On the 28th March, 1968, the Income Tax Officer issued
a notice under Section 148 of the Income Tax Act, 1961
seeking to reopen the assessment of the assessee for the
assessment year 1959-60 on the ground that the income of the
assessee had escaped assessment at the time of the original
assessment. The Income Tax Officer, however, did not state
the reasons which had led to the belief that the income of
the assessee had escaped assessment by reason of omission or
failure to disclose material facts nor did he give any
reasons though requested by the assessee.
The assessee’s writ petition challenging the validity
of the notice was allowed by a Single Judge and the notice
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issued by the Income Tax Officer was quashed. It was held
that there was no omission or failure on the part of the
565
assessee to disclose material facts relating to his
assessment and that there was no reason to believe that any
part of the income of the assessee had escaped assessment at
the time of the original assessment by reason of wrong
allowance of the remuneration paid to D as a permissible
deduction.
The Division Bench allowed the appeal, holding that the
Income Tax Officer had reason to believe that the
remuneration paid to D had been wrongly allowed as a
permissible deduction by reason of omission or failure on
the part of the assessee to disclose the material facts and
the notice issued by the Income Tax Officer was justified.
Allowing the appeal to this Court,
^
HELD: 1. (i) Neither of the two conditions necessary
for attracting the applicability of Section 147(a), was
satisfied. The notice issued by the Income Tax Officer is
therefore without jurisdiction. [574 G]
(ii) It is not possible to sustain the conclusion that
the assessee omitted or failed to disclose fully and truly
any material facts relating to his assessment.
[574 F]
2. (i) Before the Income Tax Officer can assume
jurisdiction to issue notice under Section 147(a), two
distinct conditions must be satisfied. First, he must have
reason to believe that the income of the assessee has
escaped assessment and secondly, he must have reason to
believe that such escapement is by reason of the omission or
failure on the part of the assessee to disclose fully and
truly all material facts necessary for his assessment. If
either of these conditions is not fulfilled, the notice
issued by the Income Tax Officer would be without
jurisdiction. [571 F]
(ii) The important words under Section 147(a) are "has
reason to believe" and these words are stronger than the
words "is satisfied.". The belief entertained by the Income
Tax Officer must not be arbitrary or irrational. It must be
reasonable or in other words it must be based on reasons
which are relevant and material. The Court, cannot
investigate into the adequacy or sufficiency of the reasons
which have weighed with the Income Tax Officer, in coming to
the belief, but the Court can examine whether the reasons
are relevant and have a bearing on the matters in regard to
which he is required to entertain the belief before he can
issue notice under Section 147(a). If there is no rational
and intelligible nexus between the reasons and the belief,
so that, on such reasons, no one properly instructed on
facts and law could reasonably entertain the belief, the
conclusion would be inescapable that the Income Tax Officer
could not have reason to believe that any part of the income
of the assessee had escaped assessment and such escapement
was by reason of the omission or failure on the part of the
assessee to disclose fully and truly all material facts and
the notice issued by him would be liable to be struck down
as invalid. [571 G-572 C]
3. Even a close relative who is in management and
charge of a business on a full time basis is entitled to be
paid remuneration and, in fact, it would be wholly
unreasonable to expect him to work free of charge. [573 C]
566
In the instant case D was the brother-in-law of G the
Managing Director of the assessee but this circumstance
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cannot lead to an inference that the payment of remuneration
to D who was solely managing and looking after the business
of the Delhi Bench of the assessee was sham and bogus. There
is nothing unusual in D giving a loan to his brother-in-law,
the Managing Director or making gifts to the son, wife and
daughter-in-law of the Managing Director who were his close
relatives. Any inference that the payment of remuneration to
D was sham and bogus cannot be drawn merely from the manner
in which he expended the amount of remuneration received by
him, particularly when the persons to whom he gave a loan
and made gifts were his close relatives.
[573 E-574 B]
4. The statements of account of D with the assessee for
the relevant accounting year as also the previous years were
with the Income Tax Officer at the time of the original
assessment and these statements of account clearly showed
that out of the amount of remuneration credited to his
account, he had made gifts to the sons of G on 31st July,
1957 and given a loan to G on the 25th August, 1958 and the
Income Tax Officer was fully aware that G was the Managing
Director of the assessee. The assessee could not therefore
be said to be under an obligation to disclose to the Income
Tax Officer in the course of its assessment as to how the
director who was in sole charge of the management of the
business of the assessee, and who was being paid
remuneration for the services rendered by him to the
assessee, had utilised the amount of remuneration received
by him. [574 C-F]
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1146 of
1973.
From the judgment and order dated the 1st, June 1972 of
the Calcutta High Court in Appeal No. 150 of 1971 arising
out of Matter No. 262 of 1968.
Debi Pal, A.K. Verma and K.J. John for the Appellant.
V.S. Desai, Champat Rai and Miss A. Subhashini for the
Respondents.
The Judgment of the Court was delivered by
BHAGWATI, J. This appeal by certificate is directed
against an order passed by a Division Bench of the High
Court of Calcutta allowing an appeal against a decision of a
Single Judge which quashed and set aside a notice dated 28th
March 1968 issued by the Income Tax Officer under section
148 of the Indian Income Tax Act, 1961 seeking to reopen the
assessment of the assessee for the assessment year 1959-60.
The facts giving rise to the appeal are a little important
and they may be briefly stated as follows.
567
Prior to March 1947, one Deo Datt Sharma carried on
business in Delhi in the name of Sharma Trading Company. The
business was quite a prosperous one and the record shows
that Deo Datt Sharma was making an average profit of about
Rs. 36,000 per year. In March 1947, the assessee was
incorporated as a private limited company with Ganga Saran
Sharma as its managing director and it took over the
business of Sharma Trading Company as a going concern in
consideration of allotment of 1703 shares in the share
capital of the assessee to Deo Datt Shrama. The share
capital of the assessee consisted of 8500 shares out of
which 1703 shares were allotted to Deo Datt Sharma, 5 shares
were held by Ganga Saran Sharma and 3500 shares, by a
company called Narendra Trading Company controlled by Ganga
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Saran Sharma and his wife. It may be pointed out at this
stage that Deo Datt Sharma was the brother-in-law of Ganga
Saran Sharma. When business of Deo Datt Sharma was taken
over by the assessee, Deo Datt Sharma was appointed Director
of the assessee along with two other persons. Deo Datt
Sharma was placed in charge of management of the business of
Delhi Branch of the assessee and he was paid a salary of Rs.
1000 per month, commission at the rate of 1 per cent on the
sales of the Delhi Branch and bonus equivalent to three
months’ salary. Ganga Saran Sharma and the other two
directors were also paid salary, commission and bonus but it
is not necessary to set out the quantum of the emoluments
paid to them, because in this appeal we are concerned only
with the emoluments paid to Deo Datt Sharma and not with the
emoluments paid to other directors.
The Income Tax Officer while assessing the assessee to
tax for the assessment year 1949-50 disallowed the claim of
the assessee for deduction in respect of payments made to
the managing director and other directors on account of
commission and bonus. On appeal by the assessee the
Appellate Assistant Commissioner disagreed with the view
taken by the Income Tax Officer and allowed the entire
amount paid to the managing director and other directors by
way of commission and bonus. So far as Deo Datt Sharma is
concerned, the Appellate Assistant Commissioner observed
that having regard to the fact that this very business was
carried on by Deo Datt Sharma prior to its taking over by
the assessee and it was a prosperous business earning on an
average about Rs. 36,000 per year and after taking over of
the business by the assessee, Deo Datt Sharma continued to
be in sole management of the
568
business of the Delhi Branch, the aggregate amount paid to
him could not at all be regarded as excessive and was
allowable as a permissible deduction. Thus the entire amount
paid by the assessee to the managing director and other
directors was allowed by the Appellate Assistant
Commissioner as a deduction in computing the taxable income
of the assessee. The assessee had thereafter no difficulty
in claiming deduction of the amount paid to the managing
director and other directors on account of salary,
commission and bonus, but again in the assessment year 1956-
57, the Income Tax Officer disallowed a substantial portion
of the remuneration paid to the managing director and the
assessment made by the Income Tax Officer was confirmed in
appeal by the Appellate Assistant Commissioner and in
further appeal by the Income Tax Tribunal. This led to the
making of a reference and the High Court answered the
question referred to it in favour of the assessee and held
that the disallowance of a portion of the remuneration paid
to the managing director was not justified. While making the
assessment for the assessment year 1957-58, the Income Tax
Officer once again disallowed a part of the remuneration
paid to the managing director as also the amounts of
interest paid to the directors on the balances lying to the
credit of their respective accounts with the assessee on
account of undrawn remuneration. The Appellate Assistant
Commissioner in appeal held that the interest paid to the
directors on the balances lying to the credit of their
respective accounts was an allowable expenditure but he
sustained the disallowance of a portion of the remuneration
paid to the managing director. The assessee thereupon
preferred a further appeal to the Tribunal and after
considering all the facts and circumstances of the case, the
Tribunal came to the conclusion that the remuneration paid
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to the managing director as also to the other directors was
not at all excessive and no portion of it could justifiably
be disallowed. The result was that not only was the
remuneration paid to the managing director and the other
directors allowed in full as a permissible deduction but
also the amount of interest paid on the credit balances in
their respective accounts was allowed to be deducted as a
permissible expenditure. Obviously, and this could not be
disputed on behalf of the Revenue, the accounts of the
managing director and other directors including Deo Datt
Sharma showing the amount of remuneration credited and the
withdrawals debited in each year were produced before the
Income Tax Officer and he was aware that only a very small
amount was withdrawn by Deo Datt Sharma out of the
remuneration credited in his account. The
569
record also shows that on a query made by the Income Tax
Officer the assessee furnished inter alia the assessment
file number of Deo Datt Sharma who was being assessed in
Delhi. The assessment for the assessment year 1958-59 also
followed the same course upto the stage of appeal before the
Income Tax Tribunal and ultimately the amount of interest
paid to the directors on the credit balances in their
respective accounts was allowed as a permissible deduction
to the assessee. The assessment of the assessee for the
subsequent year 1959-60 was thereafter completed on the
basis of the decision of the Income Tax Tribunal for the two
earlier assessment years and the amounts paid to the
managing director and other directors including Deo Datt
Sharma by way of salary, commission and bonus were allowed
in full as permissible deductions and so was the interest
paid on the credit balances in their respective accounts.
On 28th March, 1968 the Income Tax Officer issued a
notice under section 148 of the Income Tax Act, 1961 seeking
to reopen the assessment of the assessee for the assessment
year 1959-60 on the ground that the income of the assessee
had escaped assessment at the time of the original
assessment. Since a period of four years had already elapsed
from the close of the assessment year 1959-60 and no notice
could be issued under section 147 (b), it was obvious that
the notice issued by the Income Tax Officer was based on
section 147 (a), and it could be justified only if it could
be shown that the Income Tax Officer had reason to believe
that, by reason of omission or failure on the part of
assessee to disclose any material facts, the income of the
assessee had escaped assessment. The Income Tax Officer
however did not indicate in the notice as to what were the
reasons which had led him to believe that the income of the
assessee had escaped assessment by reason of omission or
failure to disclose material facts nor did he give any
reasons though requested by the assessee to do so. The
assessee thereupon preferred a writ petition in the High
Court of Calcutta challenging the validity of the notice on
the ground that there was no omission or failure on the part
of the assessee to disclose any material facts at the time
of the original assessment and that in any event, there was
no reason to believe that any part of the income of the
assessee had escaped assessment by reason of such omission
or failure. The writ petition was admitted and rule was
issued by a single Judge of the Calcutta High Court. The
Income Tax Officer, possibly on service of the rule,
addressed a letter dated 19th June 1968 to the assessee
stating that
570
the notice was issued by him because he had reason to
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believe that the payment of remuneration to Deo Datt Sharma
was bogus and false. The Income Tax Officer also stated in
the affidavit filed by him in reply to the writ petition
that after the assessment of the assessee was completed for
the assessment years upto 1963-64, the Income Tax Officer
came to learn that Deo Datt Sharma was the brother-in-law of
Ganga Saran Sharma, managing director and that Deo Datt
Sharma had disposed of the income received by him by way of
remuneration from the assessee, in the following manner:
1. On 31st July 1957 he made a
gift to Shri Narendra Sharma
son of Shri Ganga Saran
Sharma, Managing Director
of the Company. Rs. 12,550.00
2. On 25th August 1958 he made
a loan to Ganga Saran Sharma. Rs. 2,25,000.00
---------------
Total 2,37,550.00
---------------
and thereafter, out of the amount lying to his credit in the
account with the assessee, he had made the following gifts:
On 5th December 1960 gift to
Brahma Devi wife of Ganga
Saran Sharma Rs.1,01,101.00
On 21st December 1960 gift to
Indu Sharma daughter-in-law of
Ganga Saran Sharma Rs. 15,101.00
On 26th December 1961 gift to
Hemlata Sharma daughter-in-law
of Ganga Saran Sharma. Rs. 50,101.00
The Income Tax Officer stated that out of the total amount
of remuneration of Rs. 3,51,000 received by Deo Datt Sharma
during the period upto 31st March 1962, he had paid tax in
the sum of about Rs. 65,000/- and spent a total sum of Rs.
2,37,550 on account of gifts and loan as aforesaid and the
withdrawals made by him for his own purposes thus did not
amount to more than Rs. 4000 per year. These facts,
according to the Income Tax Officer, showed
571
that the remuneration paid to Deo Datt Sharma was not
genuine and was sham and bogus and the amount of such
remuneration alleged to have been paid to Deo Datt Sharma
was wrongly allowed as a permissible deduction and hence the
assessment of the assessee was liable to be reopened by
issue of a notice under section 147 (a).
The learned single Judge of the Calcutta High Court who
heard the writ petition took the view that there was no
omission or failure on the part of the assessee to disclose
any material facts relating to his assessment and that in
any event, there was no reason to believe that any part of
the income of the assessee had escaped assessment at the
time of the original assessment by reason of wrong allowance
of the remuneration paid to Deo Datt Sharma as a permissible
deduction. The writ petition was accordingly allowed by him
and the notice issued by the Income Tax officer was quashed
and set aside. The Income Tax Officer thereupon preferred an
appeal before a Division Bench of the Calcutta High Court
and the learned Judges constituting the Division Bench
allowed the appeal, holding that the Income Tax Officer had
reason to believe that the amount of remuneration paid to
Deo Datt Sharma had been wrongly allowed as a permissible
deduction by reason of omission or failure on the part of
the assessee to disclose the material facts set out above
and the notice issued by the Income Tax Officer was
justified. The assessee thereupon preferred the present
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appeal in this Court after obtaining a certificate of
fitness from the High Court of Calcutta.
It is well settled as a result of several decisions of
this Court that two distinct conditions must be satisfied
before the Income Tax Officer can assume jurisdiction to
issue notice under section 147 (a). First, he must have
reason to believe that the income of the assessee has
escaped assessment and secondly, he must have reason to
believe that such escapement is by reason of the omission or
failure on the part of the assessee to disclose fully and
truly all material facts necessary for his assessment. If
either of these conditions is not fulfilled, the notice
issued by the Income Tax Officer would be without
jurisdiction. The important words under section 147 (a) are
"has reason to believe" and these words are stronger than
the words "is satisfied". The belief entertained by the
Income Tax Officer must not be arbitrary or irrational. It
must be reasonable or in other words it must be based on
reasons which are relevant and material. The Court, of
course, cannot investigate into the adequacy or sufficiency
of the reasons which
572
have weighed with the Income Tax Officer in coming to the
belief, but the Court can certainly examine whether the
reasons are relevant and have a bearing on the matters in
regard to which he is required to entertain the belief
before he can issue notice under section 147 (a). It there
is no rational and intelligible nexus between the reasons
and the belief, so that, on such reasons, no one properly
instructed on facts and law could reasonably entertain the
belief, the conclusion would be inescapable that the Income
Tax Officer could not have reason to believe that any part
of the income of the assessee had escaped assessment and
such escapement was by reason of the omission or failure on
the part of the assessee to disclose fully and truly all
material facts and the notice issued by him would be liable
to he struck down as invalid.
Now here on the facts as admitted or found it is clear
that Deo Datt Sharma was carrying on the same business prior
to the incorporation of the assessee as a private limited
company and this business was yielding him an average profit
of about Rs. 36000 per year. When the assessee, on
incorporation, took over the business as a going concern
from Deo Datt Sharma it appointed Deo Datt Sharma as a
director and placed him in sole charge of the management of
the Delhi Branch of the business. In fact, it could not be
disputed on behalf of the Revenue that Deo Datt Sharma was
looking after the business of the Delhi Branch of the
assessee in the same manner in which he was doing when he
was sole proprietor of the business and for this work done
by him, Deo Datt Sharma was paid salary at the rate of Rs.
1000 per month, commission at the rate of one per cent on
the sales of the Delhi Branch and bonus equivalent of three
months’ salary. The amount of remuneration paid to Deo Datt
Sharma was thus not without consideration; in fact, it was
paid for valuable services rendered by Deo Datt Sharma in
solely managing the business of the Delhi Branch of the
assessee. Now once it is conceded that Deo Datt Sharma was
in sole charge and management of the business of the Delhi
Branch of the assessee and was rendering full time service
to the assessee in that capacity, it is difficult to see how
any one could reasonably come to the belief that the payment
of remuneration made to him was sham and bogus. Surely, the
Income Tax officer could not expect Deo Datt Sharma to
devote his full time and energy to the business of the Delhi
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Branch of the assessee without any remuneration whatsoever.
The actual remuneration paid to Deo Datt Sharma was in fact
found to be genuine and reasonable by the Appellate
Assistant Commissioner
573
while disposing of the appeal of the assessee for the
assessment year 1949-50 as also by the Income Tax Tribunal
while disposing of the appeal for the assessment year 1957-
58. It is true that Deo Datt Sharma was the brother-in-law
of Ganga Saran Sharma, the managing director of the
assessee, but this circumstance cannot by any stretch of
imagination lead to an inference that the payment of
remuneration to Deo Datt Sharma who was solely managing and
looking after the business of the Delhi Branch of the
assessee was sham and bogus. Even a close relative who is in
management and charge of a business on a full time basis is
entitled to be paid remuneration and, in fact, it would be
wholly unreasonable to expect him to work free of charge.
The Revenue, however, relied strongly on the fact that
out of the total amount of remuneration of Rs. 3,51,000
received by Deo Datt Sharma and credited to his account with
the assessee, he had not withdrawn more than Rs. 4,000 per
year for himself and an aggregate sum of Rs. 2,37,550 was
expended by him in giving a loan to Ganga Saran Sharma and
making gifts to the son, wife and daughters-in-law of Ganga
Saran Sharma on diverse dates between 31st July, 1957 and
26th December 1961. We fail to see how this fact can lend
itself to the inference that the payment of remuneration to
Deo Datt Sharma was bogus and not genuine. It is an admitted
fact that Deo Datt Sharma was the brother-in-law of Ganga
Saran Sharma and there is nothing unusual in Deo Datt Sharma
giving a loan to Ganga Saran Sharma or making gift to the
son, wife and daughters-in-law of Ganga Saran Sharma who
were his close relatives. It is indeed difficult to
appreciate how any inference can reasonably be drawn that
the payment of remuneration to Deo Datt Sharma was sham and
bogus merely from the manner in which he expended the amount
of remuneration received by him, particularly when the
persons to whom he gave a loan and made gifts were his close
relatives. It is possible that Deo Datt Sharma had other
financial resources apart from the remuneration derived by
him from the assessee and he therefore decided to give a
loan and make gifts to his close relatives out of the
remuneration received by him for valuable services rendered
to the assessee. In fact, if he had no other financial
resources, it is extremely difficult-one might say, almost
impossible-to believe that he worked for the assessee and
managed and looked after the business of the Delhi Branch on
a full time basis without any remuneration or in any event
on a
574
paltry remuneration of Rs. 4,000 per year when the managing
director and other directors who were working like him were
getting much more from the assessee and as the proprietor of
the business prior to its taking over by the assessee, he
was earning an average profit of about Rs. 36,000/- per
year. We are clearly of the view that on these facts the
Income Tax Officer could have no reason to believe that the
payment of remuneration to Deo Datt Sharma was sham and
bogus and that the amount of remuneration paid to him was
wrongly allowed as a permissible deduction.
We may point out that, in fact, the statement of
account of Deo Datt Sharma with the assessee for the
relevant accounting year as also the previous years were
with the Income Tax Officer at the time of the original
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assessment and these statements of account clearly showed
that out of the amount of remuneration credited to his
account, he had made a gift of Rs. 12,550 to the son of
Ganga Saran Sharma on 31st July 1957 and given a loan of Rs.
2,25,000 to Ganga Saran Sharma on 25th August, 1958 and the
Income Tax Officer was fully aware that Ganga Saran Sharma
was the managing director of the assessee. It is possible
and we may assume it in favour of the Revenue, that the
subsequent gifts made by Deo Datt Sharma to the wife and
daughters-in-law of Ganga Saran Sharma were not disclosed to
the Income Tax Officer at the time of the original
assessment, but these gifts being subsequent to the relevant
accounting year, the assessee was not bound to disclose the
same to the Income Tax Officer. Moreover, it is difficult to
appreciate how the assessee could be said to be under an
obligation to disclose to the Income Tax Officer in the
course of its assessment as to how a director who was in
sole charge of the management of the business of the
assessee and who was being paid remuneration for the
services rendered by him to assessee, had utilised the
amount of remuneration received by him. We do not think it
possible to sustain the conclusion that the assessee omitted
or failed to disclose fully and truly any material facts
relating to his assessment.
We must in the circumstances hold that neither of the
two conditions necessary for attracting the applicability of
section 147(a) was satisfied in the present case and the
notice issued by the Income Tax Officer must be held to be
without jurisdiction.
We accordingly allow the appeal, set aside the judgment
of the Division Bench and restore that of the learned single
Judge quashing
575
and setting aside the notice dated 28th March 1968 issued by
the Income Tax Officer against the assessee. The Revenue
will pay the costs of the assessee throughout.
N.V.K. Appeal allowed
576