1. This appeal is directed against the order under Section 263 of the Income-tax Act, 1961 ("the Act"), passed by the Commissioner in respect of the assessment year 1976-77. The facts of the case may be noted first to appreciate the arguments of the learned counsel whereby he assailed the order of the learned Commissioner as wholly unsupportable in law.
2. The assessee was an individual and was carrying on business in the name and style of Arun Steel Industries at 17/1C, Alipore Road. On 9-3-1976 His residential and business premises were searched under an authorisation issued by the Commissioner, West Bengal. In that search jewellery and lockers were discovered. The jewellery discovered was valued at Rs. 4,26,073. In proceedings under Sub-section (5) of Section 132 of the Act, the assessee explained vide his written explanation dated 26-4-1976 that the jewellery in question belonged to his wife, his daughter-in-law, Smt. Uma Devi Agarwalla, and his mother Smt. Manna Devi Agarwalla. The aforesaid three ladies also supported the assessee's claim and asked for the return of their jewelleries. A part of the jewellery valuing Rs. 35,129 was claimed by the assessee as his personal property.
3. The WTO verified the claims lodged by the aforesaid persons with reference to their wealth-tax records and accepted the assessee's explanation to the extent of Rs. 2,74,826. The remaining value of the jewellery amounting to Rs. 1,51,247, rounded up to Rs. 1,51,250, was treated by him an unexplained income of the assessee. The aforesaid order under Sub-section (5) of Section 132 was passed by the ITO on 4-6-1976 with the prior approval of the IAC. Against the aforesaid order, the assessee filed an appeal with the competent authority in terras of Sub-section (11) of Section 132. The said competent authority happened to be the Commissioner himself. We understand that the said appeal is still pending for disposal with the Commissioner.
4. In course of time, the ITO took up the regular assessment of the assessee in respect of the assessment year 1976-77. The proceedings for the regular assessment commenced on 11-1-1978 and ended on 16-2-1978.
In all five hearings were given to the assessee.
5. We have gone through the order sheet entries pertaining to these hearings made by the ITO from time to time and strangely enough we noted from them that the ITO had not put even one question to the assessee with regard to the jewellery which had been discovered from his business and residential premises and bank lockers and in respect of which the addition of Rs. 1,51,250, referred in above, was made at the time of provisional assessment under Sub-section (5) of Section 132. He made the routine inquiries from the assessee and completed the assessment after applying the gross profit rate of 14.1 per cent to the turnover of the assessee and after disallowing certain expenses. The assessment in question was completed on 16-2-1978.
6. The assessee appealed against the aforesaid assessment order to the AAC and raised two grounds of appeal before him in respect of (1) addition of Rs. 20,000 to the trading account, and (2) the disallowance of various expenses made by the ITO. The learned AAC, after considering the submission of the assessee in respect of the aforesaid points, granted to him a relief of Rs. 33,000 and allowed the assessee's appeal.
7. Sometime in 1979, it appears that the Commissioner called for the assessment records of the assessee and noted therefrom that "while passing the assessment order under Section 143(3) of the Act, the concerned ITO did not take into account the income of Rs. 1,51,250 held by him as income from undisclosed sources under Section 132(5).
Thereupon, he issued a notice under Sub-section (1) of Section 263 to the assessee requiring him to explain as to why he should not set aside the order of the ITO so far as the aforesaid subject-matter was concerned. The assessee's counsel pleaded before him that (7) he bad no jurisdiction to attract the provisions of Section 263 of the Act, because the assessment order of the ITO had, in the meanwhile, merged with the order of the AAC, and the Commissioner had no jurisdiction to revise under Section 263 the order passed by the AAC, and (it) that the order under Section 132(5) passed by the ITO was erroneous and that appeal against the said order was pending with the notified authority and that the said appeal had not yet been disposed of.
8. The learned Commissioner rejected the assessee's first objection by pointing out that "whether the impugned sum of Rs. 1,51,250 was or was not an income of the assessee was never before the AAC and there was no question of the merger of the order of the ITO with that of the AAC on this point'" and, therefore, held that the Commissioner was competent to take up this matter and revise the order of the ITO so far as it related to the assessability of the impugned sum. Regarding the second objection raised by the assessee, the learned Commissioner pointed out that, as he was setting aside the assessment order of the ITO, he could raise his objection on the merits of the additions before the ITO, who would give necessary opportunity of hearing to the assessee. After rejecting the assessee's objection as above, he set aside the assessment order passed by the ITO "with the limited object of assessing the income from undisclosed source detected as a result of the search..." He further clarified that, "while making the fresh assessment, he should give the assessee an opportunity of being heard and he should not disturb the assessment of particular item of income agitated before the AAC and decided upon by him".
9. It is this order of the Commissioner, which has been assailed before us by the learned counsel for the assessee. The main contention of the learned counsel for the assessee has been that the order of the ITO was appealed against by the assessee, and with the passing of the order of appeal by the learned AAC, the ITO's order of assessment ceased to have any independent existence ; it merged in the order of the ITO in accordance with the well known doctrine of merger enunciated by their Lordships of the Hon'ble Supreme Court in CIT v. Amritlal Bhogilal & Co.  34 ITR 131. As the powers of the AAC were coterminous and coextensive with those of the ITO, the AAC could do all that the ITO could do, and therefore, if an assessment order passed through the process of an appeal and was scrutinised by the AAC, the order of the ITO in all respects, whether raised before the AAC or not or whether considered by him or not, got merged in the order of the AAC.In this case, submitted the learned counsel for the assessee, it was open to the ITO to have submitted to the AAC that he had made certain omissions in his order, and that, therefore, the learned AAC should set aside his order so that he could make up the omission. This procedure had not been followed by the revenue and it allowed the order of the ITO to lose its identity. Such order could not be set aside by the Commissioner as it no longer existed. For the above proposition, he drew support from the Full Bench decision of the Allahabad High Court in the case of J.K. Synthetics Ltd. v. Addl. CIT  105 ITR 344 wherein their Lordships opined, inter alia, as follows : It is thus apparent that the appellate authority can look into and adjudicate upon findings recorded by the ITO not only against the assessee which may expressly be the subject-matter of the appeal but also those which may have gone in favour of the assessee and which may not have been challenged by the assessee....Simply because the department did not have a right to file an appeal, it cannot be said that the findings against the revenue were not capable of being challenged or being adjudicated upon in the appeal filed by the assessee. In view of the scope and nature of the appellate powers, the entire subject-matter of the assessment order was within the jurisdiction of the Appellate Assistant Commissioner. That being so, the entire assessment order will merge in the appellate order, irrespective of the points urged by the parties or decided by the appellate authority. (p 349) 10. He also drew our attention to the decision of the Full Bench of the Tribunal in the case of Dwarkadas & Co. (P.) Ltd. v. ITO  1 ITD 303 (Bom.) After going through the decisions of the various High Courts on the point, the said Full Bench (Bombay Special Bench 'B') concluded that "...the issues arising out of the assessment order which were decided by the ITO in the. assessee's favour over which the AAC had power to examine and pass appropriate order but did not actually do so, the AAC should be deemed to have examined these issues and agreed with the ITO and even that portion of the assessment order is merged with that of the AAC...." In view of the aforesaid position in law, the learned Commissioner had, according to the learned counsel for the assessee, erred in holding against the assessee that the order of the ITO had not merged with that of the AAC, and that he could revise the impugned order under Section 263. The assessment order of the ITO, as made by him, no more existed independently. The whole of it in the present case was subjected to the scrutiny by the AAC and as soon as he passed his order it engulfed the entire order of the ]TO. There was, therefore, nothing left to set aside. The order of the Commissioner was, as such erroneous, and according to the assessee, should be reversed and that of the ITO should be restored.
11. On behalf of the revenue, the order of the learned Commissioner was stoutly supported.
12. We have carefully examined the facts of the case and also have gone through the various judgments referred to by the learned counsel for the assessee. Their Lordships of the Hon'ble Allahabad High Court have rightly pointed out, basing themselves on the observations of their Lordships of the Hon'ble Supreme Court in the case of CIT v. Rai Bahadur Hardutroy Molilal Chamaria  66 ITR 443 that the appellate authority can look into and adjudicate upon all findings recorded by the ITO. The italicised words clearly go to show that in order to be a finding, the ITO is expected to have applied his mind to the problem and record his opinion in respect thereto. Similar is the observation in the Full Bench decision of the Tribunal referred to above. There too emphasis has been laid on the issues arising out of assessment order which were decided by the ITO. Such issues can be adjudicated upon by the AAC whether or not the assessee had made an issue of them. But where the ITO did not apply his mind to a problem and did not record a finding about it in his order nor did the problem arise out of the return of the assessee, the learned AAC could not have modified the order of the ITO in respect of the said subject-matter. The powers of the AAC, including his power of enhancement, came to be considered by their Lordships of the Hon'ble Supreme Court in the case of CIT v.Shapoorji Pallonji Mistry  44 ITR 891, wherein their Lordships held that the AAC had no power to enhance the assessment by discovering new sources of income, not mentioned in the return of the assessee or considered by the ITO in the order appealed against.
13. The aforesaid judgment of the Hon'ble Supreme Court came up for detailed review in the case of Rai Bahadur Hardutroy Motilal Chamaria (supra). In that case in proceedinas for the assessment for the assessment year 1952-53, the respondent claimed, on the basis of entries in the books of his Forbesganj branch, that he had borrowed three sums of Rs. 2,50,000, Rs. 1,50,000 and Rs. 30,000 from three parties. In considering the genuineness of these borrowings, the ITO noticed that the respondent had withdrawn at Calcutta, on 31-3-1952, a sum of Rs. 5,30,000 from a Calcutta Bank and had sent a sum of Rs. 5,85,000 to his Forbesganj branch on the same day to enable that branch to make payments including the repayment of the sum of Rs. 2,50,000.
The ITO discussed the impossibility of the amount having reached Forbesganj in Bihar on the very same day. He, therefore, treated the entries in the books as not genuine and added to the assessable income the sums of Rs. 2,50,000, Rs. 1,50,000 and Rs. 30,000. When the assessee took up the matter in appeal, the AAC considered that the amount of Rs. 5,85,000 should also be included in the total income of the assessee after giving a deduction of Rs. 1,80,000. This action of the AAC was the subject-matter of scrutiny before their Lordships of the Supreme Court and the problem considered was as to whether the AAC could have enhanced the income of the assessee by considering the above amount of Rs. 5,85,000. Their Lordships pointed out that the AAC had no jurisdiction under Sub-section (3) of Section 31 of the Indian Income-tax Act, 1922, to assess a source of income which is not disclosed either in the return filed by the assessee or in the assessment order. It is not, therefore, open to the AAC to travel outside the record, i.e., the return made by the assessee or the assessment order of the ITO, with a view to finding out new sources of income, and the power of enhancement under Section 31(3) is restricted to the sources of income which have been the subject-matter of consideration by the ITO from the point of view of taxability.
14. In this context, their Lordships clarified that "consideration" does not mean "incidental" or "collateral" examination of any matter by the ITO in the process of assessment. There must be something in the assessment order to show that the ITO applied his mind to the particular subject-matter or the particular income with a view to its taxability or to its non-taxability and not to any source of incidental connection.
The above observations of their Lordships of the Hon'ble Supreme Court have been duly taken note of by our learned brothers of the Bombay Bench of the Appellate Tribunal in the case of Dwarkadas & Co. v. ITO (supra). Their Lordships of the Calcutta High Court also noted them in Singho Mica Mining Co. Ltd. v. CIR  111 ITR 231 and pointed out that an order passed by the ITO which is not appeallable to the AAC could be revised by the Commissioner under Section 263-.
15. Bearing the above principles in mind, let us examine the facts of the present case and see whether the AAC could have suo motu made good the omission made by the ITO of not considering at all the question of addition of income from undisclosed source, represented by unexplained jewellery discovered from the premises of the assessee during the course of the search carried out in terms of Sub-section (1) of Section 132 referred to above. It is not the assessee's case that the income from the said source had been disclosed by the assessee in his return of income and the ITO had omitted to consider it.
It is also patent that in the assessment order the ITO makes no reference to this source of income of the assessee. There is not even incidental or collateral examination of the discovery of the jewellery from the residence of the assessee in the assessment order. From the order sheet entries, which were made by the ITO during the course of regular assessment proceedings, it is patent that the subject-matter of discovery of jewellery from the premises of the assessee and the bank locker was not at all the subject-matter of inquiry by him. In fact, it did not engage the attention of the ITO. On the face of it, therefore, it is to be held that the ITO did not apply his mind to this particular subject-matter or this particular source of income with a view to examine its taxability or non-taxability. The AAC could not, in the circumstances, have enhanced the income of the assessee in respect of this amount, even if he had applied his mind to it and he was so minded. The question of merger of the order of the ITO with that of the AAC in respect of the above subject-matter does not, therefore, arise.
16. The learned counsel for the assessee had, of course, contended that the same ITO, who had completed regular assessment, had earlier passed the order under Sub-section (5) of Section 132, and, therefore, according to him, it should be presumed that he was seized of the subject-matter and he did not make any addition with regard to it, as he was satisfied with the assessee's explanation. The finding given by the ITO though impliedly accepting the assessee's version, has to be treated as part of his order of assessment and its consideration by the AAC would amount to the merger of the order of the ITO, including the above implied finding, with the order of the AAC.17. The above contention does not, however, appeal to us as sound. The entries in the order sheet made by the ITO during the course of regular assessment proceedings, clearly go to show that he never applied his mind to this aspect and he never raised any question about the discovery of jewellery in respect of which he had earlier made addition under Sub-section (5) of Section 132. The proceedings under Section 132 are quite distinct and separate from the proceedings under Section 143.
The appellate channels for the two orders are also altogether different. No appeal against an order under Sub-section (5) of Section 132 lies to the AAC. The finding of the ITO in the order under Sub-section (5) of Section 132 cannot, therefore, be regarded as a finding given by him in the regular assessment proceedings. When a question with regard to the source of the discovery of the jewelleries was never raised in the course of regular assessment proceedings, there could hardly be an occasion for the ITO to have accepted the assessee's explanation even by implication. For an implied finding on the subject, there should be some material to show that the ITO has applied his mind to the problem and had accepted the assessee's explanation after considering it. In the regular proceedings, neither there is an explanation by the assessee on this subject nor there is any discussion of it either in the assessment order or on the order sheet. We are, therefore, unable to accept the assessee's plea that by implication the ITO had accepted the assessee's explanation and, therefore, the order of the ITO was confirmed by the AAC on this point and so, his order had merged in the order of the AAC.18. So far as the Commissioner was concerned, he saw that the ITO had given a certain finding in proceedings under Sub-section (5) of Section 132. Thereafter, there was nothing on record to show that any further explanation came from the assessee due to which the ITO might have changed his earlier finding given in the course of proceedings in terms of Sub-section (5) of Section 132. He, in fact, noted that the ITO made no inquiries on this point nor did he consider the subject-matter at all while completing the assessment. Not making the inquiries on the point on which he should have made the inquiries was itself an error prejudicial to the interests of the revenue, and, therefore, the learned Commissioner was, in our opinion, justified in holding that the order of the ITO deserved to be set aside in respect of this subject-matter. Reference may be made in this connection to the ratio of the decision of their Lordships of the Delhi High Court in the case of Gee Vee Enterprises v. Add. CIT  99 ITR 375.
19. In view of what we have stated above, we reject the assessee's appeal.