[1981] 130 ITR 1 (SC)

SUPREME COURT OF INDIA

Ganga Saran and Sons P. Ltd.

v.

Income-tax Officer

P.N. BHAGWATI AND E.S. VENKATARAMIAH, JJ.

CIVIL APPEAL NO. 1146 OF 1973

APRIL 23, 1981

 

JUDGMENT

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 ITO under section 148 of the I.T. 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.

Prior to March, 1947, one Deo Dutt 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 Dutt 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 Trading Company as a going concern in consideration of allotment of 1,703 shares in the share capital of the assessee to Deo Dutt Sharma. The share capital of the assessee consisted of 8,500 shares out of which 1,703 shares were allotted to Deo Dutt Sharma, 5 shares were held by Ganga Saran Sharma and 3,500 shares, by a company called Narendra Trading Company controlled by Ganga Saran Sharma and his wife. It may be pointed out at this stage that Deo Dutt Sharma was the brother-in-law of Ganga Saran Sharma. When the business of Deo Dutt Sharma was taken over by the assessee, Deo Dutt Sharma was appointed director of the assessee along with two other persons. Deo Dutt Sharma was placed in charge of management of the business of the Delhi branch of the assessee and he was paid a salary of Rs. 1,000 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 the appeal we are concerned only with the emoluments paid to Deo Dutt Sharma and not with the emoluments paid to other directors.

The ITO, 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 AAC disagreed with the view taken by the ITO and allowed the entire amount paid to the managing director and other directors by way of commission and bonus. So far as Deo Dutt Sharma is concerned, the AAC observed that having regard to the fact that this very business was carried on by Deo Dutt 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 the taking over of the business by the assessee, Deo Dutt Sharma continued to be in sole management of the business of the Delhi branch, the aggregate sale 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 AAC 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 ITO disallowed a substantial portion of the remuneration paid to the managing director and the assessment made by the ITO was confirmed in appeal by the AAC 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 ITO 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 AAC, 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 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 Dutt Sharma showing the amount of remuneration credited and the withdrawals debited in each year were produced before the ITO and he was aware that only a very small amount was withdrawn by Deo Dutt Sharma out of the remuneration credited to his account. The record also shows that on a query made by the ITO the assessee furnished, inter alia, the assessment file number of Deo Dutt Sharma who was being assessed in Delhi. The assessment for the assessment year 1958-59 also followed the same course up to the stage of appeal before the Income-tax Tribunal and ultimately the amount of interest paid to the directors on the credit balance 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 Dutt 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 ITO issued a notice under section 148 of the I.T. 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 ITO was based on section 147(a), and it could be justified only if it could be shown that the ITO had reason to believe that, by reason of omission or failure on the part of the assessee to disclose any material facts, the income of the assessee had escaped assessment. The ITO 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 ITO, possibly on service of the rule, addressed a letter dated 29th June, 1968, to the assessee stating that the notice was issued by him because he had reason to believe that the payment of remuneration to Deo Dutt Sharma was bogus and false. The ITO 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 up to 1963-64, the ITO came to learn that Deo Dutt Sharma was the brother-in-law of Ganga Saran Sharma, managing director, and that Deo Dutt Sharma had disposed of the income received by him by way of remuneration from the assessee, in the following manner:

 

Rs.

1. On 31st July, 1957, he made a gift to Shri Narendra Sharma, son of Shri Ganga Saran Sharma, managing director of the company

12,550

On 25th August, 1958, he made a loan to Ganga Saran Sharma

2,25,000

Total

2,37,550

and thereafter, out of the amount lying to his credit in the account with the assessee, he had made the following gifts:

 

Rs.

On 5th December, 1960, gift to Brahma Devi, wife of Ganga Saran Sharma

1,01,101

On 21st December, 1960, gift to Indu Sharma, daughter-in-law of Ganga Saran Sharma

15,101

On 26th December, 1961, gift to Hemlata Sharma, daughter-in-law of Ganga Saran Sharma,

56,101

The ITO stated that out of the total amount of remuneration of Rs. 3,51,000 received by Deo Dutt Sharma during the period up to 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. 4,000 per year. These facts, according to the ITO, showed that the remuneration paid to Deo Dutt Sharma was not genuine and was sham and bogus and the amount of such remuneration alleged to have been paid to Deo Dutt 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 Dutt Sharma as a permissible deduction. The writ petition was accordingly allowed by him and the notice issued by the ITO was quashed and set aside. The ITO 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 ITO had reason to believe that the amount of remuneration paid to Deo Dutt 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 ITO was justified. The assessee thereupon preferred the present 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 ITO 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 ITO 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 ITO 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 have weighed with the ITO in coming to the belief, but the court can certainly examine whether the reasons are relevant and have a hearing 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 ITO 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.

Now, here, on the facts as admitted or found, it is clear that Deo Dutt 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. 36,000 per year. When the assessee, on incorporation, took over the business as a going concern from Deo Dutt Sharma, it appointed Deo Dutt 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 Dutt 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 Dutt Sharma was paid salary at the rate of Rs. 1,000 per month, commission at the rate of one per cent. on the sales of the Delhi branch and bonus equivalent to three months' salary. The amount of remuneration paid to Deo Dutt Sharma was thus not without consideration; in fact, it was paid for valuable services rendered by Deo Dutt Sharma in solely managing the business of the Delhi branch of the assessee. Now, once it is conceded that Deo Dutt 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 ITO could not expect Deo Dutt Sharma to devote his full time and energy to the business of the Delhi branch of the assessee without any remuneration whatsoever. The actual remuneration paid to Deo Dutt Sharma was in fact found to be genuine and reasonable by the AAC 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 Dutt 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 Dutt 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 Dutt 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 Dutt Sharma was bogus and not genuine. It is an admitted fact that Deo Dutt Sharma was the brother-in-law of Ganga Saran Sharma and there is nothing unusual in Deo Dutt Sharma giving a loan to Ganga Saran Sharma or making gifts to the son, wife and daughters-inlaw 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 Dutt 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 Dutt 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 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 ITO could have no reason to believe that the payment of remuneration to Deo Dutt 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 statements of account of Deo Dutt Sharma with the assessee for the relevant accounting year as also the previous years were with the ITO 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 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 ITO 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 Dutt Sharma to the wife and daughters-in-law of Ganga Saran Sharma were not disclosed to the ITO 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 ITO. Moreover, it is difficult to appreciate how the assessee could be said to be under an obligation to disclose to the ITO 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 the 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 its 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 ITO 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 and setting aside the notice dated 28th March, 1968, issued by the ITO against the assessee. The revenue will pay the costs of the assessee throughout.