Messrs. Lalchand Bhagat Ambical Ram vs The Commissioner Of Income-Tax, Bihar and Orissa

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 679 and 680 of 1957

Decision Date: 14 May 1959

Coram: Natwarlal H. Bhagwati, M. Hidayatullah

The case was titled Messrs Lalchand Bhagat Ambical Ram versus The Commissioner of Income-Tax, Bihar and Orissa, and the judgment was delivered on 14 May 1959 by the Supreme Court of India. The opinion was authored by Justice Natwarlal H Bhagwati, who sat on the bench together with Justice M Hidayatullah. The petitioner was the Hindu undivided family operating a grain-trading business, while the respondent was the Commissioner of Income-Tax for the two provinces. The judgment was recorded under the citation 1959 AIR 1295 and also appears in the 1960 Supreme Court Reporter (1) 301. The matters under consideration involved the assessment of income tax where the assessing authority had based its finding on conjecture, and the question of whether a court could interfere where the authority acted without evidence. The factual backdrop featured the High Denomination Bank Notes (Demonetisation) Ordinance of 1946, also known as Ordinance III of 1946.

The appellant maintained its accounts according to the mercantile system and kept two separate cash-book entries: one for ordinary daily cash balances and a second called the “Almirah account” where large sums that were not needed for day-to-day operations were held. On 12 January 1946, the date on which the High Denomination Bank Notes (Demonetisation) Ordinance was promulgated, the cash balances recorded were Rs 29,284 in the ordinary cash book and Rs 2,81,397 in the Almirah account. For the assessment year 1946-47 the appellant filed its income-tax return showing a loss of Rs 46,415 from the business. During the assessment, the Income-Tax Officer observed that on 19 January 1946 the appellant had encashed high-denomination notes amounting to Rs 2,91,000. The appellant explained that these notes formed part of its overall cash balances, including the amount held in the Almirah account. The Officer rejected this explanation and relied upon several circumstances: (1) the appellant’s licence for dealing in food grains had been cancelled for the accounting year because of improper stock accounts; (2) the appellant had been prosecuted under the Defence of India Rules but had been acquitted on the basis of reasonable doubt; (3) the appellant was described as a speculator who could easily have earned sums far exceeding the value of the notes encashed; (4) despite a period that was favourable to grain traders, the appellant declared a loss for the assessment year 1944-45 up to 1946-47 while possessing substantial capital; and (5) the appellant was identified as one of the leading grain merchants in Sahibganj, a location that had acquired a reputation for grain smuggling. Concluding that the appellant possessed various probable sources from which it could have generated the Rs 2,91,000, the Officer treated that amount as secreted profits from the business and included it in the appellant’s total taxable income. The Appellate Tribunal, after accepting the account books produced by the appellant, examined the cash book and, taking into account the circumstances highlighted by the Income-Tax Officer, proceeded to assess the amount in question.

Considering every circumstance that the Income-tax Officer had pointed out, the Tribunal formed the opinion that the appellant could be expected to have held, as part of its ordinary business cash balance, at least Rs 1,50,000 in the form of high-denomination notes on 12 January 1946, the date when the Ordinance had been promulgated. However, the Tribunal was not satisfied with the explanation offered for the source of the remaining fourteen high-denomination notes, each bearing a value of Rs 1,000, and therefore found that the origin of those notes remained unexplained. On that basis the Tribunal reduced the amount that it treated as secreted profits from the earlier figure of Rs 2,91,000 to a lower sum of Rs 1,41,000. When the matter was referred to the High Court, that court held that the Tribunal’s finding was a factual determination and could not be challenged on the ground that it was unsupported by evidence. The High Court therefore affirmed that the Tribunal’s conclusion, being a finding of fact, was valid so long as it rested on some material evidence.

Upon further appeal to the Supreme Court, the appellant contended that although the Tribunal’s conclusion was indeed a finding of fact, it was nevertheless tainted by the Tribunal’s reliance on conjecture, suspicion and surmise, and that no material had been placed before the Tribunal to substantiate the finding. The appellant further argued that the conclusion was perverse, in the sense that no reasonable body of men could have arrived at it on the basis of the record. The Supreme Court held that the Tribunal had been unduly influenced by the unsubstantiated suspicions and conjectures freely expressed by the Income-tax Officer, and that it had arrived at its conclusion in a manner akin to a rule-of-thumb judgment, lacking proper material evidence. The Court observed that, having accepted the appellant’s books of account, the Tribunal could not accept the appellant’s explanation for the Rs 1,50,000 portion of cash while rejecting the same explanation for the remaining Rs 1,41,000. The Court relied upon the authorities Messrs Mehia Parikh & Co. v. The Commissioner of Income-tax, Bombay [1956] S.C.R. 626 and Kanpur Steel Co. Ltd. v. Commissioner of Income-tax, Uttar Pradesh [1957] 32 I.T.R. 56. It further noted that where a Tribunal acts without any evidence or bases its view on facts that could not reasonably be entertained, or where the facts found are such that no person acting judicially and properly instructed in the relevant law could have reached that conclusion, the court is entitled to intervene. Accordingly, the Court cited Dhirajlal Girdharilal v. Commissioner of Income-tax, Bombay [1954] 26 I.T.R. 736; Dhakeswari Cotton Mills Ltd. v. Commissioner of Income-tax, West Bengal [1955] 1 S.C.R. 941; Messrs Mehta Parikh & Co. v. The Commissioner of Income-tax, Bombay [1956] S.C.R. 626 and Meenakshi Mills, Madurai v. Commissioner of Income-tax, Madras [1956] 1 S.C.R. 691. The judgment was delivered in the civil appellate jurisdiction for Civil Appeals Nos. 679 and 680 of 1957, which were special leave appeals from the Patna High Court judgment and decree dated 5 January 1955 (M.J.C. Nos. 374 & 375 of 1952). The counsel for the appellant were R. J. Kolah and R. Patnaik, while the counsel for the respondent were A. N. Kripal and D. Gupta. The judgment was pronounced on 14 May 1959.

Delivered by Justice Bhagwat, the judgment concerned two related appeals that had been granted special leave by this Court under Article 136 of the Constitution. Both appeals arose from the assessment made against the appellant for income tax for the assessment year 1946-47 and from an assessment made under the Excess Profits Tax for the chargeable accounting period running from 9 January 1945 to 2 February 1946. The appellant was a Hindu undivided family engaged in a large-scale grain trade, acting both as merchants and as commission agents. It was recognised as one of the leading grain merchants and wholesalers operating in Sahibganj, a town situated in the Santhal Parganas district of Bihar. In addition to its principal place of business at Sahibganj, the family maintained branch establishments at Nawgachia in the Bhagalpur district and at Dhulian in the Murshidabad district of West Bengal. For the assessment year 1946-47 the appellant submitted its income-tax return showing a loss of Rs 46,415 arising from its trading operations.

The assessing officer of the Patna Income-Tax Office, while conducting the assessment, observed that the appellant had lodged high-denomination bank notes totalling Rs 2,91,000 on 19 January 1946. The officer therefore required the appellant to explain the source of those notes. The appellant replied that the notes were part of its cash holdings, which also included cash kept in an Almirah account. On 12 January 1946—the date on which the High Denomination Bank Notes (Demonetisation) Ordinance, 1946, had been issued—the appellant’s cash balances were recorded as Rs 29,284-3-9 in the regular cash drawer (referred to as the “Rokhar”) and Rs 2,81,397-10-0 in the Almirah account. The Almirah account was described as a repository for money that had been withdrawn from the regular cash drawer and kept at the appellant’s residence.

To substantiate its claim that the high-denomination notes formed part of its cash balances, the appellant relied on certain entries in its books that indicated receipt of money in such notes. The assessing officer, however, examined those entries and concluded that portions of them had been inserted after the fact. The officer held that these interpolations were made by the appellant in order to strengthen the argument that the cash balances contained the high-denomination notes that had been encashed. Further investigation revealed that the appellant’s licence to trade food grains at Nawgachia had been cancelled for the relevant accounting year because the licencee had failed to maintain proper stock accounts. In addition, the appellant had been prosecuted under the Defence of India Rules, although the prosecution had resulted in an acquittal on the ground of doubt.

The assessing officer also considered the appellant’s character as a speculator in the grain market. The officer reasoned that a speculator could readily generate profits far exceeding the value of the Rs 2,91,000 in high-denomination notes. Even taking into account the volume of business disclosed for the head office and the two branches during the year under review, the officer found that the appellant could have earned a substantial sum, yet the return showed a net loss of approximately Rs 46,000. Moreover, the officer noted that the period in question was unusually favourable to grain dealers, yet the appellant nonetheless reported a loss for the assessment year 1944-45 through 1946-47.

In this case the appellant, although possessing a substantial amount of capital, was judged by the Income-tax Officer to have been operating in locations that were known for illicit trade. The officer considered that Nawgachia and Dhulian were prominent commercial hubs and that Sahibganj, which was the appellant’s main place of business, had acquired a reputation for smuggling foodgrains and other commodities to Bengal using country boats. Dhulian, situated directly on the Bengal-Bihar border, was also reported to be a major receiving point for such smuggled goods. Taking all of these circumstances into account, the officer rejected the appellant’s claim that the high-denomination notes recovered by the officer formed part of the appellant’s legitimate cash balances. Instead, the officer treated the amount of Rs 2,91,000 as secret profits derived from the appellant’s business, added this sum to the appellant’s total income, and consequently assessed the appellant for the assessment year on a total income of Rs 1,39,117. In the parallel proceeding concerning the Excess Profits Tax, the officer held that the same amount was income arising from the appellant’s trade and therefore subject to excess-profits tax as well. The appellant appealed both assessment orders before the Appellate Assistant Commissioner. By order dated 28 February 1951 the Appellate Assistant Commissioner affirmed the Income-tax Officer’s findings and dismissed the appeals. The appellant then proceeded to the Income-tax Appellate Tribunal. By its order dated 29 April 1952 the Tribunal rejected the appellant’s contentions in both the income-tax and excess-profits tax matters, upholding the earlier assessments. Earlier, before the Income-tax Officer and the Appellate Assistant Commissioner, the appellant had maintained that the entries in its account books recording receipts of high-denomination notes were genuine and correct. However, before the Tribunal the appellant altered this position and asserted that those entries had been made in a state of nervousness after the High Denomination Bank Notes (Demonetisation) Ordinance, 1946, came into force on 12 January 1946, claiming that it had no specific proof that the high-denomination notes were actually part of its cash balances. The Tribunal examined this claim and concluded that there was no independent reason to doubt the authenticity of the account books in which the alleged interpolations appeared. It observed that if the entire set of books had been fabricated, there would have been no need for the appellant to insert entries between lines already written in a different ink in such a conspicuous manner that even a cursory review would highlight them. After scrutinising the cash book and considering all the factors highlighted by the Income-tax Officer, the Tribunal held that it was reasonable to expect the appellant to have possessed at least Rs 1,50,000 in high-denomination notes as part of its business cash balance on 12 January 1946, the date on which the dematerialisation ordinance was promulgated. The Tribunal also noted that the appellant had filed a statement showing large sums received from a single constituent, which was relevant to its assessment of the matter.

In the proceedings, the appellant had submitted a statement that showed a total of Rs. 5,04,713 had been received by it in large sums each exceeding Rs. 1,000 during the period from 6 February 1945 to 11 January 1946. Regarding the large payments that the appellant made, the appellant did not file any statement. Nevertheless, the Tribunal examined the appellant’s accounts in order to determine whether any of the payments could have been made using high-denomination notes. After examining the accounts, the Tribunal concluded that it could not satisfactorily explain the source from which the appellant obtained the remaining 141 notes of Rs. 1,000 each. Consequently, the Tribunal ordered that the additional amount of Rs. 2,91,000 previously added by the tax authorities should be reduced to Rs. 1,41,000. The Tribunal also directed the Income-Tax Officer to make the necessary consequential adjustment in the income-tax assessment, taking into account the result of the related Excess Profits Tax appeal. In relation to the Excess Profits Tax appeal, the Tribunal considered the earlier and later assessments, examined the nature of the appellant’s business, and evaluated the opportunities the appellant had to earn substantial profits outside the regular books. On that basis, the Tribunal held that an addition of Rs. 1,41,000 had to be made to the business profits that the appellant had disclosed. Accordingly, the Tribunal granted the corresponding relief in the Excess Profits Tax appeal as well. Following these orders, the appellant applied to the Tribunal seeking to have a case stated and to refer certain questions of law to the High Court. The appellant raised two specific questions: first, whether any material existed to justify the conclusion that Rs. 1,41,000 represented secreted profit for the purpose of assessment, noting that this amount formed part of the Rs. 2,91,000 and corresponded to the high-denomination notes encashed by the petitioner; and second, whether any material existed to support a finding that the sum of Rs. 1,41,000, being the secreted value of the high-denomination notes, should be treated as business income liable to excess profits tax.

By an order dated 15 August 1952, the Tribunal dismissed the appellant’s applications, holding that the finding of the taxing authorities was a pure finding of fact based on the evidence before them and that no question of law arose from that order. Thereafter, the appellant made applications to the High Court under section 66(2) for a direction that the Tribunal should state a case and refer the aforementioned questions of law to the High Court for its decision. By an order dated 21 January 1953, the High Court directed the Tribunal to state a case and to raise and refer the following question of law for its determination in both applications: whether any material existed to support the finding of the Appellate Tribunal that a sum of Rs. 1,41,000 was secreted profit liable to be taxed in the hands of the assessee under the Indian Income-Tax Act and under the Excess Profits Tax Act. The tribunal

The Tribunal complied with the direction and formally stated a case, and it raised and referred the questioned point of law to the High Court. The High Court heard the reference and delivered its judgment on 5 January 1955, wherein it answered the referred question affirmatively. In its opinion, the High Court held that the burden of proving the source of the amount in dispute rested upon the appellant, a burden which the appellant failed to satisfy. The Court further observed that the Tribunal possessed evidence on record sufficient to support the conclusion that it had reached. Consequently, the Tribunal’s determination was characterized as a pure finding of fact, and it could not be contended that the finding was unsupported by any evidence. The High Court further held that the appellant claimed the sum of Rs 2,91,000 formed part of the cash balance of its business. Accordingly, those amounts were regarded as business profits and consequently liable to excess profits tax. Subsequently, the appellant applied to the High Court for a certificate under section 66A(2) of the Income-tax Act seeking leave to appeal to this Court. The High Court rejected the applications on 25 August 1955, noting that its answer to the question of law was grounded in the material available to the Income-tax authorities. It emphasized that the decision was not based on academic notions of onus but on the factual record that supported the authorities’ conclusion.

Thereafter, on 22 October 1955, the appellant applied to this Court for special leave to appeal the orders of the tribunal and the High Court. The Court granted special leave on 28 November 1955, allowing appeals against both the income-tax assessment and the excess profits tax assessment. These appeals, recorded as Civil Appeals Nos. 679 and 680 of 1957, are presently before this Court for determination. The principal issue to be decided in the two appeals is whether any material existed to support the Tribunal’s finding that the sum of Rs 1,41,000 represented secreted profits of the appellant’s business. If such material existed, the amount would be taxable under both the Indian Income-tax Act and the Excess Profits Tax Act. The Revenue has consistently contended that the Tribunal’s determination is a factual finding made by authorities competent to make such findings, and therefore this Court should not interfere with it. The Revenue argues that the Tribunal examined the documentary evidence and applied the statutory provisions correctly, and that any error, if present, is purely a matter of fact. Conversely, the appellant maintains that, although the finding is technically a factual one, it is tainted because the authorities relied on conjecture, suspicion, and surmise without any supporting material. The appellant further submits that the Tribunal ignored relevant documents and based its conclusion on speculative inferences, thereby violating the principle that factual findings must rest on admissible evidence. The appellant further argues that the finding is perverse, meaning that no reasonable body of men could have arrived at the same conclusion on the record before them. The appellant points out that the conclusion that the amount was secreted profit is inconsistent with the accounts and with the nature of the appellant’s commercial activities. Finally, the Court must consider the limits of its jurisdiction to intervene in factual findings of tribunals and courts, as established by its previous decisions. The Court must therefore balance the need to respect the tribunal’s expertise with the duty to ensure that factual findings are not based on unfounded speculation.

The Court explained that the principles governing findings of fact made by courts or tribunals have been set out in several of its own decisions. In the case of Dhirajlal Girdharilal v. Commissioner of Income-tax, Bombay (1) the Court observed that when a fact-finding court reaches its conclusion by considering material that is irrelevant to the enquiry, or by mixing material that is partly relevant with material that is partly irrelevant, and when it is impossible to determine the extent to which the irrelevant material influenced the decision, a question of law arises. The question is whether the finding is vitiated because the court relied on conjectures, surmises and suspicions that are not supported by any evidence on the record, or because it relied partly on evidence and partly on inadmissible material. The citation for this case is (1) [1954] 26 I.T.R. 736.

In Dhakeswari Cotton Mills Ltd. v. Commissioner of Income-tax, West Bengal (1) the Court held that an assessment made without disclosing to the assessee the information supplied by the departmental representative, without giving the assessee an opportunity to rebut that information, and while refusing to consider all the material that the assessee wished to produce, violates the fundamental rules of justice and therefore warrants interference by this Court. The Court further noted in Messrs. Metha Parikh and Co. v. Commissioner of Income-tax, Bombay (') that conclusions based on facts that have been proved or admitted may be conclusions of fact, but the question of whether a particular inference may be legitimately drawn from those conclusions is a question of law. Where the fact-finding authority acts without any evidence, or acts on a view of the facts that could not reasonably be entertained, or where the facts found are such that no person acting judicially and properly instructed in the relevant law could have reached them, the Court is entitled to intervene. The citation for this decision is (2) [1956] S.C.R. 626.

In Meenakshi Mills, Madurai v. Commissioner of Income-tax, Madras (3) the Court, after reviewing various authorities, laid down that a finding on a question of fact is open to attack under Section 66(1) as erroneous in law when there is no evidence to support it or when the finding is perverse. The citation for this case is (3) [1956] S.C.R. 691. The most recent pronouncement of the Court in Omar Salay Mohamed Sait v. Commissioner of Income-tax, Madras (4) summarises the position as follows: the Income-tax Appellate Tribunal is a fact-finding tribunal, and if it arrives at its own conclusions of fact after due consideration of the evidence before it, this Court will not interfere. However, it is essential that every fact for and against the assessee must be considered with due care, and the Tribunal must express its findings in a manner that clearly identifies the questions that arose for determination, the evidence pro and contra for each question, and the conclusions reached on that evidence. The Tribunal’s conclusions must not be coloured by irrelevant considerations, prejudice, or by reliance on suspicions, conjectures or surmises. Moreover, the Tribunal must not base its findings on no evidence at all, on an improper rejection of material, or on a mixture of evidence and conjecture. If any of these deficiencies occur, the Tribunal’s findings, even though they relate to questions of fact, will be liable to be set aside by this Court. The citation for this decision is (4) C.A. No. 15 of 1958 decided on March 5, 1959.

In this case, the Court reiterated that a tax tribunal must set out clearly the matters it needed to decide, explain the evidence both for and against each issue, and then state the conclusions it reached after considering that evidence. The tribunal’s conclusions were required to be free from any irrelevant considerations or bias, and whenever a fact required the assessee to give an explanation, the assessee had to be afforded a proper opportunity to do so. The Court stressed that the tribunal could not base its findings on mere suspicion, conjecture or surmise, nor could it rely on an absence of evidence, on an improper dismissal of material and relevant documents, or on a mixture of evidence and unfounded speculation. If the tribunal engaged in any such improper method, its factual findings would be vulnerable to being set aside by this Court. It was further required that the tribunal set out the reasoning it used, identify each issue that arose, and explain how the evidence addressed that issue. A departure from this careful method would make the tribunal’s decision open to being overturned on review. Consequently, the tribunal had to ensure that its record was complete, logical, and free from any hidden bias.

Applying these principles, the Court examined the material on record concerning the appellant’s method of maintaining its books of account. The appellant had adopted the mercantile system of accounting and, according to the records, kept two separate cash-book accounts. One account recorded the ordinary daily cash balances, while the other, labelled the ‘Almirah account’, was used to hold large sums that were not required for the ordinary day-to-day operations of the business. The records showed that, although the appellant also maintained sizable bank deposits and securities, cash was sometimes needed at short notice at various branches of the firm. In addition, the appellant collected money from a number of Beoparies or merchants and received funds for carrying out grain-purchase work on behalf of the Government. All such receipts were posted to the Almirah account, which therefore displayed substantial cash balances at various times. In earlier years the appellant’s books contained detailed entries for high-denomination notes, specifying the distinctive numbers of the notes received or paid, or at least providing a description such as ‘so many notes of Rs 1,000 each’. However, in the assessment year that is the subject of the present appeal, the appellant ceased to provide such particulars. Nevertheless, entries continued to be made for monies received from banks, branches, Beoparies and other sources, but without the accompanying details that had formerly been recorded. A statement of the cash balances, showing both the balance in the ‘Rokar’ and the balance in the Almirah, was submitted to the income-tax authorities for the period from 1 September 1945 to 31 January 1946. The statement indicated that, aside from the fluctuating Rokar balance, the Almirah balance increased from Rs 1,36,397-10-0 on 1 September 1945 to Rs 1,97,397-10-0 on 30 September 1945, to Rs 2,23,397-10-0 on 13 October 1945, to Rs 2,65,397-10-0 on 27 November 1945, to Rs 2,91,397-10-0 on 29 December 1945, and then stood at Rs 2,81,397-10-0 on 10 January 1946. The Rokar balance varied considerably, but on the relevant date of 10 January 1946 it was Rs 26,092-10-9; it was Rs 24,976-13-3 on 12 January 1946, and Rs 29,284-3-9 on 13 January 1946.

On 12 January 1946 the High Denomination Bank Notes (Demonetisation) Ordinance, 1946, was promulgated. The entries in the appellant’s books of account showed that on that day the appellant possessed a total cash amount of Rs 3,10,681-13-9, and it was highly probable that this amount included the high-denomination notes totalling Rs 2,91,000. The only challenge to the appellant’s books of account concerned the interpolations relating to the number of Rs 1,000 high-denomination notes that the appellant had evidently inserted in the accounts for the assessment year under consideration. Even regarding these interpolations, the explanation offered by the appellant was accepted by the Tribunal. Although the Income-Tax Officer treated the interpolations and subsequent insertions as fabricated evidence and therefore questioned the appellant’s explanation of the source of the high-denomination notes, the Tribunal was of the firm opinion that there was no other basis to doubt the authenticity of the account books containing those interpolations. Consequently, the Tribunal accepted the books of account as genuine and based its reasoning on the entries recorded therein. The Tribunal also had before it a statement showing that the appellant had received large sums from banks, various branches of the appellant, and its Beoparees or merchants, amounting to more than Rs 1,000 each and aggregating to Rs 5,04,713 between 6 February 1945 and 11 January 1946. Although the appellant may have paid out large amounts during that period, the balances recorded in the Rokar and the Almirah demonstrated that on 12 January 1946 the Rokar balance was Rs 26,234-3-9 and the Almirah balance was Rs 2,81,397-10-0, together constituting the total cash balance of Rs 3,10,681-13-9. No one could have foreseen the promulgation of the High Denomination Bank Notes (Demonetisation) Ordinance, 1946, on that date, and given the appellant’s usual business practices, it was not surprising or unlikely that the appellant kept its large cash balances in Rs 1,000 high-denomination notes. If the appellant needed to disburse substantial sums on short notice to its various branches, Beoparees, and also to finance the Government’s grain-purchase operations, handling those sums in high-denomination notes would have been most convenient, and the natural course would have been to retain as many high-denomination notes as possible. The Tribunal fully considered this position in its assessment.

After considering all circumstances, the Tribunal concluded that the appellant could be expected to have held at least Rs. 1,50,000 in notes as part of its balance on 12 January 1946, when the Ordinance was promulgated. The Tribunal held that this conclusion could be reached only if the entries in the books of account showing balances in Rokar and Almirah were correct and reflected true situation despite interpolations or later insertions. The Tribunal considered whether any record could show source of the 141 notes of Rs. 1,000 each was unexplained, given books indicated a balance of least Rs. 1,50,000 in Rs. 1,000 notes on that date. Assuming entries concerning Rokar and Almirah balances were genuine, the Tribunal found no way to avoid concluding that the appellant had provided an explanation for source of the 291 Rs. 1,000 notes encashed on 19 January 1946. The Tribunal held that it could not accept the authenticity of the books of account for part of the amount, Rs. 1,50,000, while rejecting the explanation for the remaining sum of Rs. 1,41,000-0-0. Accordingly, the Tribunal should have accepted the appellant’s explanation for the entire amount of Rs. 2,91,000 and concluded that the encashment of the 291 high-denomination notes on 19 January 1946 was satisfactorily explained.

Nevertheless, the Tribunal appeared to be swayed by the suspicions, conjectures and surmises expressed by the Income-Tax Officer and the Appellate Assistant Commissioner regarding the appellant's financial position. It is noted that the Tribunal adopted approach, holding without material that the appellant might be expected to possess at least Rs. 1,50,000 in notes on 12 January 1946, a mere conjecture lacking basis in the record. The Income-Tax Officer supported his view by citing surrounding circumstances, specifically that the appellant was a premier Arhatdar and grain merchant of Sahibganj with branches at Nawgachia and Dhullian, both major trading hubs. The Tribunal’s reliance on these allegations, rather than on the documentary evidence in the books of account, led it to reject the appellant’s full explanation of the cash held and the source of the notes. The Tribunal also ignored the authenticated books of account that were before it, despite their relevance to the issue. No documentary evidence was offered to substantiate the suspicion that the appellant possessed cash beyond the amount shown in the books of account. Consequently, the Tribunal’s order was based on conjecture rather than on the verified financial records that had been submitted. Such an approach conflicted with the established principle that judicial conclusions must be drawn from substantive evidence presented in the case.

The Court noted that the appellant’s principal place of business, located in Sahibganj, had become well known for smuggling foodgrains and other commodities to BenLal by country boats, and that Dhulian, which lay just on the Bihar-Bengal border, was reported to be a major receiving centre for such commodities. It was further observed that the appellant’s licence for foodgrains at Nawgachia had been cancelled during the relevant accounting year because the appellant had failed to keep proper stock accounts. The appellant had been prosecuted under the Defence of India Rules, but the prosecution had given the appellant the benefit of doubt and the appellant had been acquitted. The Court added that the accounting year in question, the year preceding it, and the year succeeding it were all very favourable for foodgrain dealers, yet the appellant, despite having large capital in hand, had declared losses in every year from the 1944-45 assessment year through the 1946-47 assessment year. According to the appellant’s books, the loss for the year under consideration amounted to about Rs 46,000. The Court further recorded that the appellant was in circumstances that could have permitted it to earn a considerable amount in the year under consideration. It was pointed out that the appellant had also engaged in speculation, showing a loss of about Rs 40,000 in the Nawgachia branch (recorded in the Kalai account), and that a profit from a single transaction or a chain of transactions could have exceeded the amount represented by the high-denomination notes. Moreover, the disclosed volume of business at the Head Office and at the branches could have generated a substantial sum, even though the books showed a net loss of roughly Rs 45,000. Consequently, the Court held that the appellant possessed probable sources from which it could have earned the sum of Rs 2,91,000 represented by the high-denomination Rs 1,000 notes. The Appellate Assistant Commissioner emphasized this aspect but based his conclusion mainly on the proposition that the appellant had failed to demonstrate that the high-denomination notes originated from capital rather than from profit, and he held that the Income-Tax Officer was justified in treating the sum of Rs 2,91,000 as secreted profits. This background formed the basis on which the Tribunal arrived at its own conclusion. Although the Tribunal recognised that it was not improbable that when very large sums, for example in excess of Rs 10,000 at a time, were received, a fair portion of those sums would consist of high-denomination notes, and that such notes were valid tender and could not have been foreseen to be demonetised suddenly in January 1946, it nevertheless found nothing unusual in persons dealing with tens of thousands of rupees and whose balances ran into lakhs to hold a substantial proportion of their balances in the form of high-denomination notes. While acknowledging this probability of the appellant possessing a fair proportion of its balances as high-denomination notes, the Tribunal, albeit perhaps unconsciously, erred when it held that the appellant might be expected to possess at least Rs 1,50,000 in the shape of high-denomination notes as part of its cash balance, thereby treating the remaining Rs 1,41,000 of such notes as outside the scope of those cash balances.

The Tribunal concluded that the appellant must have possessed at least Rs 1,50,000 in the form of high-denomination notes as part of its cash balance, and therefore treated the remaining Rs 1,41,000, represented by 141 notes of Rs 1,000 each, as being outside those cash balances. The Tribunal’s conclusion could have been reached only if it had kept in mind the various probabilities cited by the Income-tax Officer, such as the likelihood that a substantial portion of very large receipts—say, amounts exceeding Rs 10,000 at a time—would consist of high-denomination notes, which were lawful tender and could not have been foreseen to be demonetised in January 1946. If the entries in the books of account were genuine and if the cash on hand in the Rokar and the cash stored in the Almirah on 12 January 1946 together amounted to Rs 3,10,681-13-9, then there was no basis for concluding that the appellant had adequately explained the possession of Rs 1,50,000 in Rs 1,000 notes while leaving the balance of the remaining 141 notes unexplained. Either the Tribunal failed to apply its mind to the situation, or it arrived at its conclusion merely by applying a rule-of-thumb approach, producing a factual finding that no properly instructed judicial authority could have reached. The Tribunal may also have been influenced by irrelevant considerations or have indulged in conjectures, surmises, or suspicions, all of which would render its finding untenable. Referring to the probabilities considered by the Income-tax Officer, the Tribunal observed that the notoriety attached to smuggling foodgrains and other commodities to Bengal by country boats operating from Sahibganj, and the reputation of Dhulian as a major receiving centre, constituted merely a background of suspicion. The appellant could not be painted with the same brush as every Arhatdar or grain merchant allegedly involved in smuggling absent any evidential support. The cancellation of the food-grain licence at Nawgachia and the appellant’s prosecution under the Defence of India Rules were of no consequence because the appellant was acquitted of the charge and the licence was later restored. The mere possibility that the appellant might have earned considerable sums during the year under consideration was a pure conjecture on the part of the Income-tax Officer, and the fact that the appellant engaged in speculation in the Kalai account could not legitimately lead to the inference that profit from a single transaction or a chain of transactions could exceed the amounts involved in the high-denomination notes. Such inference, therefore, rested on speculation rather than on proven fact.

In the present case the Revenue authority raised the possibility that the appellant had obtained a large sum of money by means of high-denomination currency notes, yet the assessment relied on mere conjecture. The Income-tax Officer suggested that the appellant might have earned a considerable amount, even though the accounts for the year showed a net loss of approximately Rs 45,000. He further attempted to indicate a probable source from which the appellant could have derived Rs 2,91,000, but the conclusion that this amount represented undisclosed profits was based solely on speculation and surmise. No factual evidence was produced to substantiate that the appellant had actually earned such a sum, and the record of the proceedings contained no proof of the alleged hidden income. Consequently, the Court observed that if the officer’s conclusion was perverse or tainted by unfounded suspicion, then the finding of the Tribunal, which accepted those speculative probabilities, was likewise perverse. The Tribunal had, by what the Court described as a “rule of thumb,” accepted the appellant’s explanation for the possession of 150 high-denomination notes of Rs 1,000 each while denying the explanation for the remaining 141 notes, without any logical or evidential basis for treating the two groups differently.

The Court compared this situation with the earlier decision in Messrs Mehta Parikh & Co. v. Commissioner of Income-tax, Bombay. In that precedent the assessee was required to explain possession of 61 notes of Rs 1,000 each; the Tribunal concluded that the assessee had satisfactorily explained 31 of the notes but not the remaining 30. The High Court treated the Tribunal’s conclusion as a finding of fact, relying on the entries in the cash-book and the affidavit supporting the explanation, which were binding on the Revenue and could not be contradicted. The Supreme Court held that those records clearly showed that it was within the realm of possibility for the assessee to possess the 61 notes on the relevant date, and that the Revenue’s purely imaginary calculations could not defeat the explanation. Moreover, the Court found that the Tribunal erred by accepting the explanation for a portion of the notes while arbitrarily excluding the rest without any evidence that the excluded notes represented profit from undisclosed sources. Because the assessee had provided a reasonable explanation, the Tribunal could not, by applying a vague rule of thumb, disregard the remaining notes on mere speculation.

In this case, the Court observed that a rule of thumb could not be used to discard the remaining items and to act on mere speculation. While forming its decision, the Court referred to the earlier authority of Chunilal Ticamchand Coal Co. Ltd. v. Commissioner of Income-tax, Bihar and Orissa (1) and expressed that the matter before the Court should likewise have been decided by the High Court in favour of the assessee. The Court also noted a decision of the Allahabad High Court reported in Kanpur Steel Co. Ltd. v. Commissioner of Income-tax, Uttar Pradesh (') as relevant to the discussion. In the Kanpur Steel case, the assessee had encashed thirty-two currency notes of one thousand rupees each on 12 January 1946, which was the date on which the High Denomination Bank Notes (Demonetisation) Ordinance, 1946, came into force. When the Income-tax Officer required an explanation for the possession of those notes, the assessee asserted that the notes formed part of its cash balance, which on that date amounted to Rs 34,313. The Income-tax Officer rejected this explanation and assessed Rs 32,000, the value of the notes, as income suppressed from undisclosed sources. The Tribunal examined the sales statements for the few days preceding the encashment and observed that the largest single transaction recorded was only Rs 399. It also considered another statement showing the daily cash balances of the assessee from 20 December 1945 to 12 January 1946 and noted a steady increase in the cash balance. Nevertheless, the Tribunal estimated that only high-denomination notes to the value of Rs 7,000 could plausibly be included in the cash balance, and consequently upheld the assessment to the extent of Rs 25,000. On further reference to the High Court, the Court held that (i) the burden of proof lay with the Department to demonstrate that the sum of Rs 32,000 represented suppressed income from undisclosed sources, and the burden was not on the assessee to prove how it had received the high-denomination notes; until the Demonetisation Ordinance became effective, such notes could be used as freely as lower-denomination notes, and nobody was obliged to explain their possession, so the assessee had naturally not kept any record of their receipt, and only on 12 January 1946, when the Ordinance took effect, did a requirement arise to explain their possession; and (ii) the explanation offered by the assessee, that the notes were part of a cash balance of roughly Rs 34,000, was satisfactory and was not found by the Tribunal to be false, the sales statement was of little relevance to the issue, and the Department’s reliance on it was misplaced.

The Court noted that the Tribunal had erred in relying on the entries relating to the daily bills, observing that those entries contained a mistake and that no logical inference could be drawn from them. It further held that even though each individual transaction did not exceed Rs. 399, this fact did not exclude the possibility that the payment for such a transaction could have been made with high-denomination notes. Consequently, the Tribunal had rejected the assessee’s explanation on the basis of surmises, and there was no material on record for the Tribunal to conclude that the amount of Rs. 25,000 represented suppressed income from undisclosed sources. In reaching that conclusion the High Court had referred to the decisions in Mehta Parikh & Co. v. Commissioner of Income-tax, Bombay (1) and Chunilal Ticamchand Coal Co., Ltd. v. Commissioner of Income-tax, Bihar and Orissa (2). The Supreme Court found that the Tribunal, in arriving at its decision, had indulged in suspicions, conjectures and surmises, had acted without any evidential basis, and had adopted a view of the facts that could not reasonably be entertained. The Court described the finding as perverse and held that it was proper for this Court to intervene. Accordingly, the Court concluded that the High Court had erred in answering the referred question in the affirmative; the correct answer, having regard to all the circumstances, should have been negative. The appeals were therefore allowed, the judgment and order of the High Court were set aside, and the referred question was answered in the negative. The appellant was awarded costs of the reference in the High Court and of these appeals against the respondent, and the appeals were allowed.