The Judgment of the Court was delivered by

Irshad Hussain, J.:— The petitioner in this petition took exception to and questioned notices dated May 29, 2001 (annexures marked as Exts. 13 to 17) issued under section 147 read with section 148 of the Income-tax Act, 1961 (hereinafter for short “the Act”), in regard to the assessment years 1991-92, 1992-93, 1993-94 and 1994-95 and the challenge to the notices is mainly on the ground that these have been issued after the expiry of four years from the end of the relevant assessment year even though the conditions as contemplated under section 147 of the Act were not satisfied.

2. The relevant facts briefly stated are:

The petitioner is a public limited company incorporated under the Companies Act, 1956, and is the successor of the erstwhile Oil and Natural Gas Commission whose entire undertaking was transferred to the petitioner vide the “Oil and Natural Gas Commission (Transfer of Undertaking and Repeal) Act, 1993” with effect from February 1, 1994. The assessment for the relevant assessment years were completed under section 143(3) of the Act. The Assessing Officer made a disallowance of 10 per cent, of the tax free interest earned on bonds on the ground that it relates to the expenditure incurred by the petitioner in earning the said interest. The petitioner's appeal was decided by the Commissioner (Appeals) partly in its favour for the assessment years 1991-92, 1992-93 and 1993-94 and fully for the assessment year 1994-95. The Department preferred appeal before the Income-tax Appellate Tribunal. The impugned notices were issued on a mere change of opinion that a larger sum ought to have been disallowed under the original assessment.

3. The case of the petitioner is that it has huge capital reserves and profits out of which it makes the investment in tax free bonds and no part of the borrowed funds was utilised in the said investments. The interest on the said bonds is fully exempted from tax. The Assessing Officer in making the assessment for the relevant years was of the view that as the income from bonds is exempt the corresponding expenditure is disallowable and as no separate accounts were maintained by the assessee, 10 per cent, of such interest was considered fair and reasonable as allocable to such interest. The respondent-Assessing Officer now on May 29, 2001, issued the impugned notices on the belief that the income has escaped assessment within the meaning of section 147 of the Act and thereby proposed to reassess the income. The respondent resisted the petition mainly on the ground that in the original assessment the Assessing Officer considered the non-allowability of the expenditure attributable to the income which was not to be included in total income and on the reasonable estimate the disallowance of 10 per cent, of the tax free interest on P.S.U bonds were made. The assessee has not made a truthful disclosure of income in his original return as the petitioner paid interest on borrowing on the one hand and on the other hand investments were made to earn tax free income from bonds. Therefore, this is the reason for reopening of the case of the petitioner and the question for consideration is whether the interest paid on borrowing funds which were used for earning tax free income is allowable as business expenditure. In the circumstances, the Assessing Officer has jurisdiction to issue notices under section 148 of the Act and proceed for reassessment.

4. Heard Sri S.E Dastur, learned senior counsel for the petitioner, and Sri S.K Posti, learned counsel for the respondents.

5. At the outset it is desirable to reproduce section 147 of the Act which reads as below:

“147. Income escaping assessment.— If the Assessing Officer, has reason to believe that any income chargeable to tax has escaped assessment for any assessment year, he may, subject to the provisions of sections 148 to 153, assess or reassess such income and also any other income chargeable to tax which has escaped assessment and which comes to his notice subsequently in the course of the proceedings under this section, or recompute the loss or the depreciation allowance or any other allowance, as the case may be, for the assessment year concerned (hereafter in this section and in sections 148 to 153 referred to as the relevant assessment year):

Provided that where an assessment under sub-section (3) of section 143 or this section has been made for the relevant assessment year, no action shall be taken under this section after the expiry of four years from the end of the relevant assessment year, unless any income chargeable to tax has escaped assessment for such assessment year by reason of the failure on the part of the assessee to make a return under section 139 or in response to a notice issued under subsection (1) of section 142 or section 148 or to disclose fully and truly all material facts necessary for his assessment for that assessment year,

(emphasis1 supplied)

6. Explanation 1.— Production before the Assessing Officer of account books or other evidence from which material evidence could, with due diligence, have been discovered by the Assessing Officer will not necessarily amount to disclosure within the meaning of the foregoing proviso.

7. Explanation 2.— For the purposes of this section, the following shall also be deemed to be cases where income chargeable to tax has escaped assessment, namely:—

(a) where no return of income has been furnished by the assessee although his total income or the total income of any other person in respect of which he is assessable under this Act during the previous year exceeded the maximum amount which is not chargeable to income-tax;

(b) where a return of income has been furnished by the assessee but no assessment has been made and it is noticed by the Assessing Officer that the assessee has understated the income or has claimed excessive loss, deduction, allowance or relief in the return;

(c) where an assessment has been made, but—

(i) income chargeable to tax has been underassessed; or

(ii) such income has been assessed at too low a rate; or

(iii) such income has been made the subject of excessive relief under this Act; or

(iv) excessive loss or depreciation allowance or any other allowance under this Act has been computed.”

8. The above proviso to section 147 of the Act provides that reopening of the assessment after the expiry of four years from the assessment year would be permissible only when there is failure as prescribed on the part of the assessee. Learned counsel for the petitioner vehemently argued that there is no material as may in any way indicate or suggest that there was failure on the part of the petitioner of the kind envisaged in the proviso. Exts. 2 to 6 annexed to the petition are the copies of the assessment orders for each of the relevant assessment years. These reveal that every material fact relating to the interest earned on tax free bonds was fully and truly disclosed and the Assessing Officer on considering the material on record and the submission of the assessee estimated the expenditure and made the disallowance to the extent of 10 per cent. Learned counsel also argued that it was nowhere stated that the assessee failed to make a return or that full and true disclosure of all the material facts was not made.

9. On the other hand learned counsel for the respondents submitted the justification of the impugned notices on the ground that the respondent-Assessing Officer has cogent reason to believe that the income has escaped assessment in view of the fact that the assessee has invested substantial amount in PSU bonds for which assessee had to use funds borrowed on high rate of interest and in a situation like this the expenditure incurred on the exempt income is not allowable expenditure under the provisions of the Act. Learned counsel also submitted that this aspect was neither examined by the Assessing Officer at the time of the original assessment nor the assessee, has made a truthful disclosure in his original return of income as such. The reference was made to the notice under section 148 of the Act, annexure 2 to the counter affidavit, also reproduced in the petition by the petitioner. For all the assessment years similar notices were given. We find it expedient to reproduce the same here:

“Reasons for issue of notice under section 148 in the case of Oil and Natrual Gas Commission for the assessment year 1991-92

The assessee filed its return of income of Rs. 439,49,86,580 and assessment under section 143(3) was completed at income of Rs. 812,37,78,325.

It was noticed from the computation of income that the assessee has earned interest from tax free PSU bonds which has been claimed exempt under section 10(15)(iv)(h) at Rs. 152,30,68,966. On the other hand the assessee has claimed deduction on account of interest on loans from the Government of India/banks and others. In order to earn the tax free interest the assessee has invested substantial amount in PSU bonds for which assessee had to use borrowed funds at higher rate of interest. If the ONGC had not invested into the PSU bonds, there would not have been that much necessity for such borrowings. This view finds support from the ratio of the judgment of the Allahabad High Court in the case of Commissioner Of Income-Tax v. H.R Sugar Factory Pvt. Ltd., [1991] 187 ITR 363. The disallowance of interest on this point had been made by the Assessing Officer after detailed discussion in the assessment order in the case of ONGC from the assessment year 1996-97 onwards and the same has been partly confirmed in appeal by the Commissioner of Income-tax (Appeals). Now the matter is pending before the learned Income-tax Appellate Tribunal. With the insertion of section 14A by the Finance Act, 2001, with effect from April 1, 1962, the action taken by the Assessing Officer stood confirmed.

In view of the above, I have reason to believe that income to the tune of Rs. 109,43,12,086 has escaped assessment within the meaning of the Explanation 2(c)(i) of section 147 of the Income-tax Act. Accordingly, notice under section 148 is to be issued.

(Sd.) H.C Jain,

Addl. Commissioner of Income-tax,

Special Range, Dehradun.”

10. At the outset it needs to be mentioned that in the reasons for reopening of assessment which have been reproduced above it has not been alleged that there has been omission or failure on the part of the assessee to disclose fully and truly all the material facts necessary for assessments. The reasons itself, in fact, indicate that the assessee has disclosed full and true facts about the borrowings of funds as well as investments made in tax free public sector undertaking bonds. The reason to believe that income has escaped assessment was that the Assessing Officer has, in fact, not given conscious consideration to the aspect that if the assessee had not invested in tax free bonds there would not have been necessity for borrowing of funds by the assessee and by mistake underestimation of the income was made. It is, thus, obvious that the reasons shown do not satisfy the conditions as envisaged under the proviso to section 147 for reassessment.

11. On behalf of the petitioner reliance was placed on the apex court decision in Parashuram Pottery Works Co. Ltd. v. ITO, [1977] 106 ITR 1, in support of the contention that for failure of the Assessing Officer in assessing the taxable income recourse to section 147 of the Act cannot legally be taken. The apex court in the reported decision has observed (page 7) that: “The duty which is cast upon the assessee is to make a true and full disclosure of the primary facts at the time of the original assessment. Production before the Income-tax Officer of the account books or other evidence from which material evidence could with due diligence have been discovered by the Income-tax Officer will not necessarily amount to disclosure contemplated by law. The duty of the assessee in any case does not extend beyond making a true and full disclosure of primary facts. Once he has done that his duty ends. It is for the Income-tax Officer to draw the correct inference from the primary facts. It is no responsibility of the assessee to advise the Income-tax Officer with regard to the inference which he should draw from the primary facts. If an Income-tax Officer draws an inference which appears subsequently to be erroneous, mere change of opinion with regard to that inference would not justify initiation of action for reopening assessments”.

12. The principles laid down squarely apply to the facts of the instant case and on the pretext that there was no conscious consideration of the pointed facts at the time of the assessment, reopening of the assessment is not legally permissible by virtue of the proviso to section 147 of the Act.

13. In McDermott International Inc. v. Addl. CIT, [2003] 259 ITR 138 (Uttaranchal) to which one of us (Hussain J.) was a party, this court has recently held that an assessment could not be reopened when there was no failure on the part of the assessee to make a full and true disclosure of all material facts. It was reiterated that a reassessment cannot be initiated on the basis of a change of opinion and that Explanation 2 to section 147 of the Act permits reassessment within the permissible period under section 147 whereas to carry reassessment beyond a period of four years, the conditions under the proviso have to be fulfilled. It was thus observed (page 142) : “According to learned counsel, the information as envisaged under the Explanation would also be decision of superior authorities and includes true and correct state of law and also information as to judicial decision. He sought to support this proposition by citing various authorities. We need not discuss the case law, even accepting the position of law as an information for reopening of assessment. It could be for invoking the provisions under section 147 of the Act. The proviso to section 147 of the Act as discussed casts exemplary burden for satisfaction that the assessment escaped only due to failure on the part of the assessee for the contingency either of the description. In our view, information relating to the position of law available through the verdict of the higher authority could not be such failure on the part of the assessee which authorises the assessing authority to reopen the assessment.”

14. Further, the decision of the Allahabad High Court referred to by the assessing authority has no bearing on the facts of the case. The reasons are that, firstly, the decision does not relate to the legal proposition as contained in section 147 of the Act and, secondly, the decision was referred to as supportive of the changed opinion of the assessing authority, which as stated above would not justify reassessment. Even otherwise in the said case the assessee-company had advanced loans to its directors for non-business purposes. In the instant case details of cash profits, free reserves and investments in PSU bonds as at the end of the relevant financial periods referable to the assessment years in question, as set out in annexure Ext. 1 to the petition, reveal that the petitioner had huge reserves and cash profits facilitating investments in PSU bonds. Ext. 1, for the sake of convenience is also reproduced below:

Details of cash profits, free reserves and investment

in PSU bonds as at the end of financial periods

(Rupees in crores)

Financial year Assessment year Cash profits Free reserves Total of cash profits and free reserves Balance of investments in tax free PSU bonds 1990-91 1991-92 2,553.11 10,367.43 12,920.54 1,546.42 1991-92 1992-93 1,651.52 10,849.03 12,500.55 1,525.65 1992-93 1993-94 1,837.78 11,655.52 13,493.30 1,592.14 1993-94 1994-95 2,459.32 13,349.01 15,808.33 1,592.14 (commission) 1993-94 1994-95 589.60 13,763.20 14,352.80 1,592.14 corporation

15. On behalf of the petitioner with reference to the above financial position reliance was placed on the reported decision of the Madras High Court in the matter of Commissioner Of Income-Tax v. Hotel Savera, [1999] 239 ITR 795, wherein the assessee-firm lent money to the private limited company and the money borrowed by the firm was mixed with its own funds and finding that the firm had sufficient funds to cover advance the presumption drawn was that the advance had been made with firm's own funds. In the case of Shree Digvijay Cement Co. Ltd. v. CIT, [1982] 138 ITR 45, the Gujarat High Court held that where the material on record showed that the assessee had a common fund it cannot be predicated that the money lent came only out of borrowed funds. Considering that the petitioner-company had huge cash profits and reserves it has to be accepted that no part of the borrowed funds has in fact been invested in PSU bonds. The reported decision also fortifies this conclusion.

16. Learned counsel for the petitioner has submitted that even on the merits the impugned action has no legal sanctity as there was no bar against the allowance of expenditure incurred on tax free income and in support thereof reliance was placed on the decisions of the apex court in Commissioner Of Income Tax, Madras v. Indian Bank Limited, Madras, [1965] 56 ITR 77 and Rajasthan State Warehousing Corporation v. Commissioner Of Income Tax, [2000] 242 ITR 450. In the first mentioned case the assessee-bank was held entitled to claim the deduction of the entire interest paid by it on fixed deposits and whereas in the later case it had been held that if the assessee's business is one and indivisible, expenditure cannot be apportioned and part related to income which is exempt cannot be disallowed. In our opinion these decisions support the argument of learned counsel that even on bare facts the assessing authority has no reason to believe that income had escaped assessment and the re-opening proceedings are without jurisdiction. The observation so made with reference to the argument of learned counsel for the petitioner and the reported decision, however, has been made to question the factum of the existence of the grounds for the belief and in any case, it is not in relation to the adequacy of the grounds of such belief. As things stand the facts of the case are glaring enough to show that the reasons or ground for reopening of the assessment as envisaged by the proviso to section 147 of the Act are totally non-existent.

17. Learned counsel for the respondents submitted that non-disclosure of any fact which has a material bearing on the question of assessment confers power on the assessing authority to exercise jurisdiction under sections 147 and 148 of the Act and since in the instant case the petitioner has failed to disclose fully and truly the material facts with regard to the investments in tax free bonds which had necessitated borrowing of funds by it the assessing authority has reason to believe that the income has escaped assessment. In support of his contention, learned counsel referred to Indo-Aden Salt Manufacturing and Trading Co. P. Ltd. v. CIT, [1986] 159 ITR 624 (SC); Kantamani Venkata Narayana and Sons v. First Addl. ITO, [1967] 63 ITR 638 (SC); CIT v. Miss Esther P. Carvalho, [1999] 237 ITR 549 (Bom); Zohar Siraj Lokhandwala v. M.G Kamat, [1994] 210 ITR 956 (Bom); CIT v. T.S.P.I.P Chidambaram Chettiar, [1971] 80 ITR 467 (SC) and Seth Kishori Lal Babulal v. Commissioner Of Income-Tax, U.P, [1963] 49 ITR 502 (All).

18. Having gone through the above decisions we feel no need to discuss the facts of these cases because in the totality of facts and peculiar circumstances of these cases, the two conditions which are required to be satisfied before assuming jurisdiction under the provisions of section 147 read with section 148 of the Act were found to exist and whereas in the instant case the facts and circumstances conclusively show that the reasons or ground for reopening of assessment in terms of the proviso to section 147 are totally non-existent. In short, the above reported decisions are of no help to the cause of the respondents. In the reasons disclosed the Assessing Officer also relied upon the provisions of section 14A of the Act. Since in the counter affidavit it has been averred that the reopening of the assessment was not based on section 14A of the Act we need not enter into any discussion about the import of the said provision. Likewise in the face of the above conclusion we do not find it necessary as to whether or not the sanction to issue notices under section 151 of the Act is bad in law.

19. For the reasons stated above, the impugned notices dated May 29, 2001, issued under section 147 read with section 148 of the Act are without jurisdiction as the conditions precedent to reopen the assessment in terms of the proviso to section 147 are totally non-existent and, therefore, we allow the petition and quash the impugned notices.