Key conclusions of the Gujarat High Court:

The High Court noted that the constitutional validity of search provisions under Income tax laws were upheld by a five-judge bench of the Supreme Court in Pooran Mal v Director of Inspection (Investigation), New Delhi, (1974) 1 SCC 345. Thus, the only issue that the High Court was required to examine in the context of legality of a search is whether the ‘satisfaction’ recorded by the relevant Income tax authority for the initiation of the search proceedings was justified. In the specific facts of this case, based on copies of the ‘satisfaction note’ as was prepared prior to the search by the authorizing senior income tax officer as well as copies of the seized materials/ documents from the petitioner’s premises, the Court concluded that it “is satisfied for the satisfaction recorded by the respondent authority for initiation of the search against the petitioner” and thus, the legality of the search was upheld.
The Court deprecated the high-handed and aggressive manner in which the search was conducted, especially the coercive manner in which the income tax authorities conducted themselves vis-à-vis a female colleague of the petitioner which came in for severe criticism from the court. However, the Court did not pass any specific directions in this regard “except a caution to the respondent authority to take care in future if such a situation arises” and directed the income tax authorities to send an apology letter to the said female colleague of the petitioner.
Having upheld the legality of the search, the Court held that attorney-client privilege will not apply in the present facts against seizure of documents/ data from the petitioner’s premises in light of clear legal provisions pertaining to search entitling the tax authorities to seize the materials available during the search.
However, as regards usage of the materials/ data so seized by tax authorities against third persons/ clients, the Court deliberated upon the nature and extent of the protection available under attorney-client privilege and held the following:

a. The Court held that tax authorities are entitled to use such material (if found incriminating) so far as it refers to the petitioner, as the petitioner, in the facts of this case, was searched as a taxpayer himself with potentially undisclosed income.

b. The Court took into account Supreme Court judgments in District Registrar and Collector, Hyderabad v. Canara Bank [(2005) 1 SCC 496], Department of Income Tax v. S.R. Batliboi & Co. [(2009) 17 SCC 767] in the context of search proceedings and noted that the question of law as to whether material seized from a professional during the course of search can be utilised against a third party has been left open by the Supreme Court in Batliboi (supra) and went on to answer the question of law as follows :-
- The doctrine of attorney-client privilege “is required to be applied to the facts of the case from the point of view of the petitioner and not from the point of view of the clients of the petitioner whom the petitioner wants to protect by preferring this petition."
- The protection of attorney-client privilege will be available to the documents/ data seized from the petitioner, subject to the exceptions to attorney-client privilege such as communications in furtherance of illegal purposes, etc.
- In order to ascertain which documents/ data will fall under the exception, the Court accepted the suggestion of the tax authorities that the tax authorities would bifurcate the seized documents/ data into incriminating and non-incriminating and save the documents/ data on two separate hard discs. The tax authorities agreed that the non-incriminating data will be “permanently sealed and shall not be accessed thereafter by the Income-tax Department." The tax authorities requested four weeks’ time to complete this entire exercise.
- As regards the incriminating documents/ data, further bifurcation would be made based on the illustrations appended to Section 126 of the Evidence Act. In essence:
  - “Where the petitioner is found to be in possession of any document of his clients which, according to the respondents are incriminating prior to the employment of the petitioner in his legal capacity, then no action can be taken against such documents.”
  
  - “Whereas, if it is found by the respondent authorities that the petitioner has come to the knowledge of fraud or illegal activity, if any, to be committed by the client during the course of his engagement as illustrated by Illustrations (b) and (c) to Section 126,” appropriate action can be taken by tax authorities against such third parties/ clients.
- The Court initially suggested the appointment of an independent agency for the above exercise which was vehemently opposed by the tax authorities (on the apprehension that it will set a wrong precedent prone to misuse). The Court ultimately decided to repose faith that the senior tax officers on whom the discretion has been placed to undertake the aforementioned exercise of bifurcation of the seized data would exercise their discretion judiciously, with the hope that “no further litigation would arise in the case of third parties whose documents were found during the course of the search."
- The Court went on to clarify that “it will be open for such third parties to raise all the contentions available under the law and observations made by this Court in the facts of the present case would not come in way if any action is taken by the respondent authorities against such third parties." Thus, the defence of attorney-client privilege may still be available to third parties/ clients of the petitioner if any action is initiated by the tax authorities based on data/ documents seized from the petitioner.

Former Bombay High Court judge Justice CV Bhadang appointed President of Income Tax Appellate Tribunal