Income Tax Department cannot reopen an assessee's assessment under Section 147/148 merely because a third party with whom the assessee had transactions did not cooperate with the investigation

The Hon'ble High Court of Gujarat (Division Bench) in M/s. R.D. Diamond v. The Income Tax Officer, Ward 2(3)(4), Surat [R/Special Civil Application No. 12270 of 2025, 2025:GUJHC:70547-DB] dated December 9, 2025 held that proceedings under Section 148 of the Income Tax Act, 1961 cannot be initiated against an assessee merely on the basis of non-cooperation by a third party during investigation and information available on the portal, when the assessee has itself made full and true disclosure of all its transactions including those with the said third party in its Income Tax Return. The Court held that the Assessing Officer must have reason to believe that income of the assessee has escaped assessment, and reliance on the conduct of a third party without any independent material establishing escapement of the assessee's own income amounts to a fishing and roving inquiry not sanctioned by Section 147 of the Act. The said judgment has since been affirmed by the Hon'ble Supreme Court of India in Income Tax Officer Ward 2(3)(4) Surat v. M/s. R.D. Diamond [Special Leave Petition (Civil) No. 15400/2026] dated April 27, 2026, wherein the Special Leave Petition filed by the Revenue was dismissed.

FACTS OF THE CASE

The Petitioner, M/s. R.D. Diamond, is a partnership firm engaged in the business of trading of rough diamonds as well as cut and polished diamonds, and has been regularly filing its Income Tax Returns since its incorporation. For Assessment Year 2019-20, the Petitioner recorded a total turnover of Rs. 16,28,25,185/-, which was subjected to a tax audit under the provisions of the Income Tax Act, 1961, and filed its Income Tax Return on October 18, 2019, declaring its net income and paying the tax thereon. The Petitioner maintains regular books of account, gets them audited every year within time, and uploads the same on the IT portal. All transactions, including those with one Shree Vasudev Babubhai Kapadia, were duly disclosed by the Petitioner and reflected in the profit and loss account.

Pursuant to information received by the Respondent authority under the Risk Management Strategy formulated by the Central Board of Direct Taxes on the portal, it was found that there were suspicious transactions reported in the case of one Shree Vasudev Babubhai Kapadia, who had allegedly carried out huge transactions through an undisclosed bank account not commensurate with his Income Tax Return for AY 2019-20. On further verification, it was found that the said Vasudev Babubhai Kapadia had filed GSTR-1 showing purchases of Rs. 23,98,17,548/- and total sales of Rs. 23,15,57,996/-, and did not furnish documentary evidence to prove the genuineness of his sales and purchases during the course of inquiry proceedings. The Investigating Officer treated the unaccounted purchases of Vasudev Babubhai Kapadia as his unaccounted income for AY 2019-20.

On the basis of this investigation, a Show Cause Notice dated March 29, 2025 under Section 148A(1) of the Act was issued to the Petitioner, alleging that the Petitioner had entered into bogus transactions of Rs. 5,66,44,146/- and that income to that extent had escaped assessment. The Petitioner replied vide its letter dated April 10, 2025, denying all allegations and furnishing a detailed explanation that the transactions pertained to sales made by it which were duly offered to tax. The Petitioner dealt with the information threadbare, compared it with its books of account, and categorically clarified that the amount of Rs. 73,31,671/- does not figure in its books of account, while the amount of Rs. 1,73,89,827/- pertained to sales of rough diamonds to Vaibhav Enterprise, proprietor Janakbhai Vasudev Kapadia, during AY 2018-19, for which all details were offered. Upon receipt of this reply, the Respondent authority merely noted that the same would be looked into during assessment proceedings, without articulating any reason to believe that the Petitioner's income had escaped assessment.

Thereafter, the Respondent authority passed the impugned Order dated June 29, 2025 under Section 148A(3) of the Act and issued the impugned Notice dated June 29, 2025 under Section 148 of the Act for AY 2019-20, holding that income of Rs. 5,66,44,146/- chargeable to tax had escaped assessment, on the sole basis that Vasudev Babubhai Kapadia did not cooperate with the investigation and did not furnish details having a direct nexus with the Petitioner. Aggrieved by the impugned Notice and Order, the Petitioner filed the present writ petition before the Gujarat High Court.

ISSUE

Whether proceedings under Section 147 read with Section 148 of the Income Tax Act, 1961 can be validly initiated against an assessee who has made full and true disclosure of all its transactions in its Income Tax Return, solely on the basis that a third party with whom the assessee had transactions did not cooperate with the investigation and portal-based information flagging alleged bogus transactions, without any independent material satisfying the Assessing Officer's reason to believe that the assessee's own income chargeable to tax has escaped assessment.

HELD BY THE COURT

The Hon'ble High Court of Gujarat (Division Bench) in R/Special Civil Application No. 12270 of 2025 [2025:GUJHC:70547-DB] held that:

The Court held that the provisions of Section 147 of the Income Tax Act, 1961 are self-explanatory and can be invoked only if any income chargeable to tax has escaped assessment for any assessment year. It is a settled legal precedent that what is required from an assessee in the course of assessment proceedings is full and true disclosure of all material facts necessary for making the assessment for that year. All the requirements stipulated by Section 147 must be given due and equal weight, and none can be treated as a mere formality or bypassed on the strength of a third party's conduct.

The Court observed that in the present case, the Petitioner had categorically declared all its income including the profit and loss account, and all transactions with Vasudev Babubhai Kapadia, which were duly reflected and offered to tax. The Petitioner's reply to the Show Cause Notice was detailed, meticulous and supported by documentary reconciliation. The Petitioner had compared the figures flagged by the department with its books of account item by item, and had categorically explained the nature of each transaction. The Assessing Officer, instead of engaging with this reply substantively, merely noted that certain matters would be looked into during assessment proceedings, without recording any finding as to how the material constituted a reason to believe that the Petitioner's income had escaped assessment.

The Court further observed that the entire basis for the reopening notice was confined to the alleged bogus purchases of Vasudev Babubhai Kapadia and his non-cooperation with the investigation. The Respondent authority, on the pretext that Vasudev Babubhai Kapadia and Janakbhai Vasudev Kapadia had made alleged bogus purchases and had not offered their explanation, had roped the Petitioner into proceedings under Section 148 of the Act. There was nothing recorded in the order which would satisfy the statutory threshold that the Assessing Officer had reason to believe that the Petitioner's own income chargeable to tax had escaped assessment. The Court opined that the failure of a third party to cooperate with the revenue cannot, by itself, create the statutory precondition for reopening the assessment of an entirely different assessee who has disclosed its transactions fully and truly.

The Court accordingly held that the proceedings under Section 148 of the Act were uncalled for and amounted to a fishing and roving inquiry. The Respondents had misdirected themselves by conflating the alleged infirmities in the affairs of Vasudev Babubhai Kapadia and Janakbhai Vasudev Kapadia with the taxable income of the Petitioner. The writ petition was allowed, the impugned Notice dated June 29, 2025 under Section 148 and the impugned Order dated June 29, 2025 under Section 148A(3) for AY 2019-20 were quashed and set aside, and the Rule was made absolute.

The said judgment was subsequently challenged by the Revenue before the Supreme Court of India by way of Special Leave Petition (Civil) No. 15400/2026. The Supreme Court, by order dated April 27, 2026, dismissed the Special Leave Petition, observing that the reopening was founded on information from the portal and on alleged bogus transactions of a third party who did not cooperate in the investigation, that the Assessing Officer's order did not record material satisfying the statutory threshold, and that reliance on third-party non-cooperation and portal information without material showing escapement of the Petitioner's own income amounted to a fishing and roving inquiry. The Supreme Court held that it was not inclined to interfere with the impugned judgment and order of the High Court, though the question of law, if any, was kept open.

RELEVANT SECTIONS

Section 147 of the Income Tax Act, 1961 — "Income escaping assessment"

Section 148 of the Income Tax Act, 1961 — "Issue of notice where income has escaped assessment"

Section 148A of the Income Tax Act, 1961 — "Conducting inquiry, providing opportunity before issue of notice under section 148"

PARI MATERIA / CASES REFERRED

Apex Remedies Pvt. Ltd. v. Income Tax Officer, Ward-1(1)(1) [ Gujarat High Court, 2023] — Relied upon by the Petitioner. The Gujarat High Court in this case dealt with the scope of Section 147 and Section 148 and held that reopening of assessment is not permissible as a fishing and roving inquiry and must be based on tangible material establishing reason to believe that income has escaped assessment. The Court had set aside a reopening notice issued without such material.

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