ORAL JUDGMENT:

1) Rule, by consent made returnable forthwith. Counsel for the respondents waives service. With the consent of counsel, all the petitions are taken up for final hearing.

2) The sole business which the petitioner carries on is of life insurance. A certificate of registration was granted to the petitioner on 24 November, 2000 by the Insurance Regulatory and Development Authority of India (IRDA) under Section 3(2) (a) of the Insurance Act, 1938. The petitioner is by the mandate of law required to maintain its accounts in accordance with the provisions of the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditors Report of Insurance Companies) Regulations, 2002 read with Section 211 of the Companies Act, 1956.

3) The three petitions under Article 226 of the Constitution relate to the reopening of assessments for assessment years 2002-03, 2003-04 and 2004-05. The facts, as they pertain to assessment year 2003-04 are representative, and can be narrated. The difference in so far as the notices for the reopening of assessments are concerned is that for assessment years 2002-03 and 2003-04, the assessments have been sought to be reopened beyond a period of four years of the expiry of the relevant assessment year. The reopening of the assessment for assessment year 2004-05 is within four years.

4) During the course of assessment year 2003-04, the petitioner filed a return of income on 27 November, 2003 reporting a net loss of Rs.98.70 crores. The statement of the computation of profits and gains from business shows an actuarial deficit of Rs.158.37 crores. After excluding a deficit of Rs.48.47 crores, arising out of pension schemes exempt under Section 10(23AAB), the deficit in the policyholders account stood at Rs.109.90 crores. The Petitioner had an income surplus in the share -holders account of Rs.11.20 crores. As a result, the deficit from the insurance business was Rs.98.70 crores.

5) Section 44 of the Income Tax Act, 1961 provides that notwithstanding anything contained to the contrary in the provisions of the relating to the computation of income chargeable under the head interest on securities, income from house property, capital gains or income from other sources or in section 199 or in sections 28 to 43B the profits and gains of any business of insurance shall be computed in accordance with the rules contained in the First Schedule to the. Rule 2 of the First schedule provides as follows:-

"The profits and gains of life insurance business shall be taken to be the annual average of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made in accordance with the Insurance Act, 1938, in respect of the last inter-valuation period ending before the commencement of the assessment year, so as to exclude from it any surplus or deficit included therein which was made in any earlier inter-valuation period.

6) Before 1999, Companies engaged in the business of life insurance were required to prepare one consolidated account. Section 11 of the Insurance Act, 1938 was amended so as to include sub-sections 1A and 1B. Sub-section 1A to Section 11 provides that every insurer, on or after the commencement of the IRDA Act, 1999, in respect of insurance business transacted by him and in respect of shareholders funds, shall, at the expiration of each financial year, prepare with reference to that year, a balance-sheet, a profit and loss account, a separate account of receipts and payments, and revenue account in accordance with the regulations made by the Authority. Section 13(1) provides that every insurer carrying on life insurance business shall inter alia in respect of the life insurance business transacted in India, cause an investigation to be made each year by an actuary into the financial condition of the life insurance business carried on by him, including a valuation of his liabilities and shall cause an abstract of the report of such actuary to be made in accordance with the regulations laid down in Part I of the fourth schedule and in conformity with the requirements of Part II of that schedule. The fifth proviso to Section 13 stipulates that on or after the commencement of the IRDA Act, 1999 every insurer shall cause an abstract of the report of the actuary to be made in the manner specified by the regulations made by the Authority.

7) In exercise of the powers conferred by Section 114A of the Insurance Act, 1938, IRDA notified the Insurance Regulatory and Development Authority (Actuarial Report and Abstract) Regulations, 2000. Regulations 3 and 4 stipulate the procedure for preparation of actuarial reports and abstracts and the requirements applicable. Under Regulation 3(4)(v) each abstract and statement is to be accompanied by a certificate signed by the appointed actuary inter alia stating that in his opinion, the mathematical reserves are adequate to meet the insurers future commitments under contracts and the reasonable expectation of policyholders. Each insurer is required to prepare statements which are to be annexed to the abstract and a list of those statements is set out in Regulation 4(2). Regulation 8 provides that a statement showing the total amount of surplus arising during the inter-valuation period and allocation of such surplus, shall be furnished separately for participating business and for non participating business, together with the particulars as mentioned in the Regulation. The composition of surplus inter alia includes the surplus shown by Form I, interim bonuses, loyalty additions and sums transferred from shareholders funds during the inter-valuation period.

8) The authority has also notified the Insurance Regulation and Development Authority (Preparation of Financial Statements and Auditors Report of Insurance Companies) Regulations, 2002. Part V deals with the provision of financial statements. Every insurer is required to prepare

(i) a revenue account which is also described as a policyholders account; and (ii) a profit and loss account, which is also described as a shareholders account, apart from a balance sheet. The statutory forms are prescribed by the regulations. Form A-RA is prescribed for the preparation of the Revenue account or policyholders account. Form A-RA reflects the surplus or, as the case may be, the deficit generated in the revenue account for the year ending 31 March.

9) As a result of the regulations, the petitioner which is engaged in the business of life insurance is required to prepare and maintain two accounts namely (i) A Revenue account of policyholders and (ii) A Profit and loss Account of shareholders. For the previous year which ended on 31 March, 2003, the Policyholders account reflected a deficit of Rs.158.37 crores. This deficit was made good by the transfer of an amount of Rs. 158.37 crores from the Shareholders account to the Policy- holders account. This was essentially an internal transfer of funds. Form I which has been prepared by the petitioner in pursuance of the IRDA Regulations of 2000 reflected a Nil deficit consequent upon the transfer of an amount of Rs.158.37 crores from the Shareholders account to the Policyholders account. The source for making a transfer of Rs.158.37 crores from the shareholders account originated in the infusion of capital from shareholders during the course of the previous year relevant to the assessment year in question.

10) During the course of the assessment proceedings for assessment year 2003-04, the petitioner furnished a note to the computation of income. The salient aspects which were highlighted in the note were as follows:-

(i) The erstwhile format for the presentation of surplus / deficit required each insurance company to aggregate the results relating to shareholders operations and policyholders operations. The impact of the consolidated revenue account was transferred to the actuarys valuation balance-sheet in form I which disclosed the surplus / deficit for the year;

(ii) The format for presentation of the insurance accounts was amended by the Regulations of 2000 and by the revised format, the impact of the actuarial valuation was transferred to the revenue account relating to the policyholders for the year and the surplus / deficit was disclosed therein;

(iii) The Profit and loss for shareholders and the surplus / deficit for policyholders are since segregated into two separate accounts after the amended regulations;

(iv) For the financial year ending 31 March, 2003, the actuarial valuation as disclosed in Form I shows a Nil surplus / deficit as regards the business of policyholders. The actual deficit of Rs.158.37 crores in the Policyholders account (form A-RA) was made good by a transfer of an equivalent sum from the Shareholders account. Hence the figures showing a Nil deficit in form I were subsequent to the transfer;

(v) The total deficit in the Policyholders account for tax purposes was Rs.109.90 crores (Rs.158.37 crores less an amount of Rs.48.47 crores on account of exempt pension schemes);

(vi) In the Shareholders account, there was a net surplus of Rs.11.19 crores;

(vii) Consequently, while there was a net surplus in the Shareholders account of Rs.11.19 crores, there was a net deficit in the Policyholders account of Rs.109.90 crores;

(viii) Consequently, in determining the profits and gains under Section 44 read with Rule 2, the loss was computed at Rs.98.70 crores by aggregating the surplus in the Shareholders account with the deficit in the Policyholders account for the purposes of taxation.

11) During the course of the assessment proceedings, letters were addressed to the Assessing Officer specifically in order to clarify the position of the deficit in the Policyholders account. By its letter dated 27 December, 2005, the petitioner clarified that the deficit in the Policyholders account as reflected by form A-RA had been met by a transfer from the Shareholders account. The figures relating to surplus / deficit in Form I were subsequent to the internal transfer of funds. The assessee contended that the transfer from the Shareholders to the Policyholders account was an internal adjustment and was tax neutral. Before the assessment proceedings came to be concluded for assessment year 2003-04, an audit query was raised with reference to assessment year 2002-3. The audit report dated 4th May, 2005 specifically raised a question as to whether the petitioner should have been allowed to claim a deficit in the Policyholders account since the deficit disclosed by the actuarial valuation in form I was shown to be Nil. In response to the audit query, the petitioner addressed a letter dated 29 December, 2005 contending that the First schedule to the Income Tax Act did not refer to any particular form for calculating the taxable surplus and instead mentions that the actuarial surplus calculated under the provision of the Insurance Act, 1938 has to be considered. The petitioner reiterated its position that form I showed a zero surplus because, it has already considered inter alia the transfers made from the Shareholders account to the Policyholders account to nullify the deficit as per IRDA regulations. The same position has been reiterated by a letter dated 30 December, 2005 to the Assessing Officer.

12) The Assessing Officer issued an order of assessment under Section 143(3) on 30 December, 2005 for assessment year 2003-04. The assessment order accepts that there was a loss to the extent of Rs.98.70 crores and that it was allowed to be carried forward. After the order of assessment, the provisions of Section 263 were invoked by the Commissioner of Income Tax on 25 August, 2008. While invoking Section 263, the Commissioner was of the view that it needed to be examined as to whether the income shown in Shareholders account was liable to be taxed under the head of business or from other sources. Aggrieved by the invocation of Section 263, the assessee filed an appeal to the Tribunal which was allowed on 22 January, 2009. During the course of its judgment, the Tribunal noted hat it was not disputed by the Commissioner that there is a deficit in the Policyholders account. The Tribunal noted that the assessee had adjusted the income in the Shareholders account against the deficit. The Tribunal observed that even assuming that the Commissioner was correct in holding that the income from the Shareholders account is assessable under the head of other sources, in that case, the set off of the current years income in the Shareholders account against the deficit in the Policyholders account was permissible under Section 71. Hence according to the Tribunal, there was no prejudice to the interest of the Revenue. The Tribunal also noted that the Assessing Officer had examined the case of the assessee before the completion of the assessment; the return filed by the assessee contained various details and an audited report; and that written submissions were filed on 27, 29 and 30 December, 2005 in response to the queries of the Assessing Officer. The invocation of the jurisdiction under Section 263 was consequently held to be unwarranted. The judgment of the Tribunal was carried in appeal to this Court. On 14 December, 2009 a Division Bench of this Court dismissed the appeals filed by the Revenue (Income Tax Appeal No.1345 of 2009 with Income Tax Appeal (L) No.1625 of 2009).

13) The Assessing Officer has purported now to reopen the assessment for assessment year 2003-04. As already noted earlier, the assessments which have been completed for assessment years 2002-03 and 2004-05 have also been reopened. The reasons which have been furnished in support of the reopening of the assessments are that, under Section 44 read with Rule 2 of the First schedule to the, income of life insurance business assessable under the Income Tax Act has to be as per the surplus declared in an actuarial valuation made in accordance with the Insurance Act, 1938. Form I which constitutes a part of the actuarial report, declares the surplus to be Nil, whereas, the returned income as well as the assessed income show a loss. The Assessing Officer has hence opined, that the assessee had filed an incorrect computation of total income along with the return and an assessment has been made on the basis of the incorrect computation of total income filed by the assessee. According to the Assessing officer, the loss which is reflected in the Policyholders account is not in accordance with the actuarial report; whereas, the income / loss according to the actuarial report in form 1 is Nil. The assessee, according to the Assessing Officer, has made a misleading statement for computing the total income. The assessments for all the three years have been reopened on these grounds.

14) In assailing the grounds on which the assessment is sought to be reopened, Counsel appearing on behalf of the petitioner submitted that (i) The reopening of the assessment is bad in law because, there was no failure on the part of the assessee to disclose fully and truly all material facts relevant to the assessment for the assessment years 2002-03 and 2003-04; (ii) As a matter of fact, there is no escapement of income, because an internal transfer from the Shareholders account to the Policyholders account does not result in any income to the assessee; (iii) Though this is merely an internal transfer, the Revenue still wants to treat it as income and which the Revenue asserts will reduce the extent of loss in the Shareholders account; (iv) The Assessing Officer has by reopening the assessment sought to reduce the loss not by expenditure which has been disallowed but by setting off the capital receipts comprising Shareholders funds in the shareholders account. Counsel submitted that this submission would govern the reopening of the assessment for assessment years 2002-03 and 2003-04 which, admittedly is beyond the period of four years from the end of the relevant assessment year. For assessment year 2004-05, where the power under Section 147 has been invoked within a period of four years of the end of the relevant assessment year, it is urged that the reasons asserted by the Assessing Officer constitute only a change of opinion which is not permissible in view of the law laid down by the Supreme Court in Commissioner of Income Tax V/s. Kelvinator of India Ltd. [2010] 320 ITR 561 (S.C.) Counsel submitted that specific questions were raised during the course of the assessment by the Assessing Officer to which the assessee had responded in its several replies and the assessment order was passed after the replies were considered. Hence there was no tangible material before the Assessing Officer to reopen the assessment.

15) On the other hand, counsel appearing on behalf of the Revenue supported the reasons on the basis of which the assessment was sought to be reopened by urging that (i) There was no discussion in the assessment order; (ii) The transfer from the Shareholders to the Policyholders account would be permissible only when a bonus was to be declared; (iii) The surplus / deficit in form I is declared to be Nil, whereas the assessee had returned a loss which was accepted by the Assessing Officer. Hence, the Assessing Officer was justified in reopening the assessment.

16) All the three petitions before the Court, which pertain to assessment years 2002-03, 2003-04 and 2004-05, have been heard together. The reasons on the basis of which the assessment is sought to be reopened are similar. The assessment is sought to be reopened on the basis that whereas Form I showed a Nil surplus / deficit, the assessee had in its computation of income, showed a loss for each of the relevant assessment years to which the petitions relate. In so far as assessment years 2002-03 and 2003-04 are concerned, the assessments have been reopened admittedly, beyond a period of four years from the end of the assessment years in question. The reopening of the assessment for assessment year 2004 -05 is within four years.

17) The condition precedent to the exercise of the power to reopen an assessment under Section 147 is the formation of a reason to believe by the Assessing Officer that income chargeable to tax has escaped assessment. By the proviso to Section 147, where an assessment under Section 143(3) has been made and it is sought to be reopened beyond a period of four years from the end of the relevant year, the exercise of power is subject to the condition that income should have escaped assessment by a failure of the assessee to disclose fully and truly all material facts necessary for assessment for that assessment year. For assessment years 2002-03 and 2003-04, the validity of the notice for reopening the assessments must, therefore, depend upon whether there was, as a matter of fact, a failure on the part of the assessee to disclose fully and truly all material facts necessary for the assessment.

18) The record before the Court shows that the assessee had in its computation of income disclosed that the Policyholders account showed that (i) There was a deficit of Rs.109.90 crores (comprising Rs.158.37 crores minus Rs. 48.47 crores arising out of exempt pension funds); (ii) There was a transfer of funds to the extent of Rs.158.37 crores from the Shareholders account to the Policyholders account; and (iii) That the deficit in the Policyholders account was adjusted only by an internal transfer of funds from the Shareholders account to the Policyholders account. By its letters dated 27 December, 2005 and 30 December, 2005, which were filed in response to queries raised by the Assessing Officer, the assessee disclosed (a) The manner in which the profits and gains under Section 44 read with the First schedule were arrived at, so as to reflect a loss of Rs.98.70 crores; (b) The fact that the Nil surplus shown in the report of the actuarial valuation in form I was subsequent to the transfer of funds from the Shareholders account to the Policyholders account. When the assessment proceedings pertaining to assessment year 2003-04 were pending, an audit query came to be raised in regard to a similar claim for loss during assessment year 2002-03. The petitioner responded to the audit query by its letter dated 29 December, 2005. The letters addressed by the petitioner, including the note appended to the computation of income clearly set out the fact that there was a surplus in the Shareholders account and that the deficit in the Policyholders account was met by a transfer from the Shareholders account to the Policyholders account. The petitioner disclosed that in Form I, the surplus / deficit was shown to be Nil and submitted that the position reflected in Form I was subsequent to the internal transfer of funds which took place from the Shareholders to the Policyholders account. It is after the petitioner had filed its explanation by several letters that the Assessing Officer passed an order of assessment under Section 143(3).

19) Hence, the record before the Court shows that the computation which was filed by the petitioner of the total income could not be regarded as either being incorrect or misleading. The computation discloses a nil surplus / deficit in form I. The petitioner set forth its case about how form I could not be regarded as being reflective of the correct position in regard to the loss sustained by the petitioner since it was after the internal transfer of funds from the Shareholders to the Policyholders account that the loss was effaced. There was thus, no failure on the part of the petitioner to set out fully and truly all the material facts necessary for the assessment for assessment years 2002-03 and 2003-04. The condition precedent to the exercise of the jurisdiction to reopen the assessments for assessment years 2002-03 and 2003-04, beyond a period of four years from the end of the relevant assessment year was, therefore, not fulfilled. The notices for the reopening of assessments for assessment years 2002-03 and 2003-04 will, therefore, have to be quashed on that ground. Parliament has made the invocation of the power to reopen an assessment beyond four years conditional on compliance with a statutory requirement. Once that requirement is not fulfilled, the invocation of the power has to be regarded as extraneous to the statute and hence, invalid.

20) For assessment year 2004-05, it would be necessary to note that during the course of the assessment proceedings, the petitioner submitted replies similar to those which were submitted during the course of the earlier assessment years. Since the nature of the explanation has already been set out while dealing with the previous assessment years, it would not be necessary to reiterate the contents of the replies, save and except to record that the disclosure by the petitioner was with reference to a query raised by the Assessing Officer on 27 November, 2006. By his query, the Assessing officer drew the attention of the petitioner to note 4 appended to the computation of income and specifically to Para 4.4 by which the petitioner had disclosed a Nil surplus / deficit in form I. The petitioner had stated in the note that the deficit in the Policyholders account as shown in form A-RA has been made good by a transfer of an equivalent amount from the Shareholders account and the figures that appear in Form I are subsequent to this transfer. The Assessing Officer called upon the petitioner to furnish an elaborate explanation on why the income should not be taken as Nil and as to why the transfer of funds from the Shareholders account to the Policyholders account, other than for the purpose of declaring a bonus would not amount to a violation of Section 49 of the Insurance Act. The petitioner submitted its replies on 11 December, 2006 and 18 December, 2006 following which an order of assessment was passed under Section 143(3) on 18 December, 2006. A loss, in accordance with the return of income, in the sum of Rs.174.23 crores was computed by the Assessing Officer.

21) While dealing with the reopening of the assessment for assessment year 2004-05, the principal question before the Court is as to whether there was any tangible material before the Assessing Officer to form a reason to believe that income chargeable to tax had escaped assessment. In the prefatory part of this judgment, a reference has been made to the relevant provisions of the Insurance Act, 1938 and to the Regulations of 2000 and 2002, which have a bearing on the formulation of the accounts, of an assessee like the petitioner who engages in the business of life insurance. Section 13(1) of the Insurance Act, 1938 which was inserted by the Insurance Regulatory Authority Act, 1999 requires every insurer upon the commencement of the to maintain separate accounts in respect of the insurance business transacted by the insurer and in respect of the shareholders funds. Regulations 3 and 4 of the Regulations of 2000 provide the procedure and requirements in the preparation of the actuarial report and abstract. Form I, it may be noted, is one of the summary statements that is required to be prepared by the insurer under regulation 4 (2). Part V of the 2000 Regulations deals with the preparation of the financial statement and requires the insurer to prepare: (i) A Revenue account, also called a Policyholders account; and (ii) A Profit & loss account, also called the Shareholders account. Form A-RA is the form in which the Policyholders account is to be filed. Form A-RA requires a disclosure of (a) Premiums earned, income from investments and other income; (b) Commission, operating expenses, provision for doubtful debts, debts written off, provision for tax and other than taxation; (c) Benefits, interim bonuses and change in valuation of liability in respect of life policies. The surplus / deficit is computed at the foot of the account by deducting the amounts computed under (b) & (c) above from the figures of income in (a).

22) During the course of the assessment, the assessee had set out the computation in the Policyholders account and in the Shareholders account. According to the assessee, the net result of the operations is reflected in the Policyholders account which has been made good by transfer from the Shareholders account. A circular has been issued on 23 March, 2004 by the Insurance Regulatory Development Authority, to specify the conditions which are required to be fulfilled where an insurer intends to declare a bonus when there is a deficit in the life fund. The condition which is prescribed in the circular is that the accumulated deficit in the Policyholders account must be made good by a transfer of funds from the Shareholders account to the Policyholders account. The circular clarifies that the transfer from the Shareholders account can be out of the profit and loss account, balance or reserves in the Shareholders account or by drawing upon the paid up capital of the insurer. The transfer of funds made from the Shareholders account to the Policyholders account is to be irreversible. What the circular emphasises is that an insurer who intends to declare a bonus has to ensure, in the event that there is a deficit in the Policyholders account, that the deficit is effaced by a transfer of funds from the Shareholders account. In the present case, the petitioner has not declared a bonus and there was, therefore, no compulsion under the circular to transfer funds from the Shareholders account to the Policyholders account. The submission of the petitioner is that this was taken recourse to as a matter of good business practice. The important aspect of the matter which needs to be emphasised is that all along, during the course of the assessment proceedings, the petitioner reiterated that this was in the nature of an internal transfer of funds involving a transfer from the Shareholders account to the Policyholders account and that this transfer would not effect the income of the petitioner for the purposes of the Income Tax Act, 1961. The Assessing Officer, evidently called upon the petitioner to explain as to why the Nil surplus / deficit as reflected in Form I should not be treated as the basis for rejecting the claim of the petitioner that it had sustained a loss during the course of the assessment year in question. The fact that Form I disclosed a Nil deficit / surplus was, hence present to the mind of the Assessing Officer and consequent thereto the petitioner was called upon to file an elaborate explanation. The petitioner did so. The Assessing Officer, while reopening the assessment has not put forth any tangible material on the basis of which he could have formed a reasonable belief that income chargeable to tax has escaped assessment. He has merely altered or changed the opinion which was formed during the assessment proceedings.

23) Though the power to reopen an assessment within a period of four years of the expiry of the relevant assessment year is wide, it is still structured by the existence of a reason to believe that income chargeable to tax has escaped assessment. The Supreme Court, in a recent judgment in Kelvinator of India Ltd. (supra) while drawing upon the legislative history of Section 147 held that the expression reason to believe needs to be given a schematic interpretation in order to ensure against an arbitrary exercise of power by the Assessing Officer. The judgment of the Supreme Court emphasises that the power to reopen an assessment is not akin to a power to review the order of assessment and a mere change of opinion would not justify a recourse to the power under Section 147. Unless the Assessing Officer has tangible material to reopen an assessment, the power cannot be held to be validly exercised. The Supreme Court has held thus:-

...Therefore, post-1st April, 1989, power to re-open is much wider. However, one needs to give a schematic interpretation to the words reason to believe failing which we are afraid Section 147 would give arbitrary powers to the Assessing Officer to re-open assessments on the basis of mere change of opinion, which cannot be per se reason to re-open. We must also keep in mind the conceptual difference between power to review and power to reassess. The Assessing Officer has no power to review; he has the power to re-assess. But re-assessment has to be based on fulfillment of certain pre-condition and if the concept of change of opinion is removed, as contended on behalf of the Department, then, in the garb of re-opening the assessment, review would take place. One must treat the concept of change of opinion as an in-built test to check abuse of power by the Assessing Officer. Hence, after 1st April, 1989, Assessing Officer has power to re-open, provided there is tangible material to come to the conclusion that there is escapement of income from assessment. Reasons must have a link with the formation of the belief.

24) In the present case, for all the assessment years in question, and a fortiorari for assessment year 2004-05, what the Assessing Officer has purported to do is to reopen the assessment on the basis of a mere change of opinion. That the Assessing Officer had no tangible material is evident from the circumstance that the reasons which have been disclosed contain a reference to the same basis, namely the existence of a nil surplus / deficit in Form I which was drawn to the attention of and was present to the mind of the Assessing Officer during the assessment proceedings under Section 143(3). Consequently, it is evident that there is an absence of tangible material before the Assessing Officer.

25) In the circumstances, for the reasons indicated earlier, the notices by which assessments for assessment years 2002-03, 2003-04 and 2004-05 have been reopened will have to be quashed and set aside. All the notices under Section 148 impugned in these petitions are accordingly quashed.

26) Rule is made absolute in the aforesaid terms. There shall be no order as to costs.