According to section 145(3) of Income Tax Act,1961(herein short referred to as ‘the Act’), where the Assessing Officer(AO) is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1)[to section 145] has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under sub-section (2)[to section 145], the AO may make an assessment in the manner provided in section 144 of the Act.
Manyatimes, AO increases the gross profit rate as declared by an assessee, for one reason or another, which becomes the point of litigation.
In CIT vs. Vijay Constructions [(2007) 213 CTR All 105], the Allahabad High Court has held that the rate of profit cannot be assumed, merely on assumptions or surmises and conjectures. It is the first liability of the assessee to produce such records, evidence/material so as to substantiate its plea about the rate of profit that he claims and in case the books of account have been rejected, then the onus shifts upon the AO to determine the rate of profit on consideration of the material which may be brought before him or even on making such enquiry, which may be necessary, which may include the requirement of having any information from the assessee also during the course of determination of such rate of profit, namely, during the assessment proceedings.
Recently, in Pharmalab Engineering India Private Limited vs. ACIT [I.T.A. No. 999/Mum/2014, decided on 22.06.2016], it has been held by Mumbai ITAT that mere fall in the gross profit ratio, in the absence of any cogent reasons could not be a ground to hold that the proper income could not be deduced from the audited accounts maintained by the assessee and the book results ought to be rejected, and consequently gross profit margin rate of preceding years be applied to the sales of the instant assessment year under appeal.
In ACIT vs. Sitalamata Oil Mill Pvt. Ltd. And Vice-Versa [I.T.A No.2317/Kol/2013,decided on 1 January, 2015], the Kolkata ITAT has held that when the books of accounts are not available and estimating the gross profit is to be resorted to, the situation prevailing in the industry has to be taken in account.
In CIT vs. Smt. Poonam Rani [(2010) 326 ITR 223 (Delhi)], it has been held that the fall in gross profit ratio, in the absence of any cogent reasons could not, by itself, have been a ground to hold that proper income of the assessee cannot be deduced from the accounts maintained by her and consequently, could not have been a ground to reject the accounts invoking Section 145(3) of the Act.
The fall in gross profit ratio could be for various reasons such as increase in the cost of raw material, decrease in the market price of finished product, increase in the cost of processing by the assessee etc.
The Chandigarh ITAT has held in Universal Woollen Mills vs. CIT, Ludhiana [ITA No. 616/Chd/2013] that mere fact that the profits were low as compared to the earlier year, by itself is no ground to make addition against the assessee.
In CIT vs. Jas Jack Elegance Exports [(2010) 324 ITR 95 (Delhi)], the respondent/assessee filed return showing income of Rs.49,40,500/- for the A.Y.2004-2005. The return was picked up for scrutiny and notice under section 143(2) of the Act was issued to the assessee. The assessee firm was engaged in the business of manufacturing and export of readymade garments and had declared gross profit @ 12.08% during the A.Y.2004- 2005 as against gross profit of 12.37% declared by it for the A.Y. 2003-2004 and gross profit of 17.58% declared for the A.Y.2002-2003. The assessee claimed that the fall in gross profit ratio was due to reduction in margin, in order to increase sales. The assessee was asked to produce Books of Account and relevant registers. The Books of Account as well as certain vouchers were produced, but, the stock register was not produced, claiming that no such register was being maintained. The assessee had claimed fabrication charges amounting to Rs.37,54,215, finishing & dyeing charges amounting to Rs.25,00,989 and embroidery expenses of Rs.55,85,683/-, details of which were furnished to the AO. It was asked to produce the parties to whom charges amounting to Rs.20,000/- or more were paid on account of fabrication, embroidery, finishing & dyeing. The assessee, however, did not produce any of those parties on the ground that it had closed down its business and was not in contact with any of them. The AO rejected the Books of Account produced by the assessee and computed income of the assessee, taking the gross profit ratio at 17.58%, which was the gross profit percentage declared for the A.Y.2002-2003. Addition of Rs.24,40,898/- was, accordingly, made by the AO.
On first appeal for CIT(Appeals) filed by the assessee, it was pointed out that no defect in the accounts books was found by the AO and the gross profit rate for the assessment year in question was almost similar to the gross profit rate declared in the immediate preceding year. CIT(A) noted that the Books of Account of the assessee were audited and no discrepancy in those books had been pointed out by the AO. He held that the gross profit ratio assumed by the AO was vitiated, since the Department itself had accepted gross profit ratio of 12.37% in the immediate preceding year and the principle of continuity and consistency had been ignored. Relying upon the decision of Punjab & Haryana High Court in CIT vs. Om Overseas (2008) 173 Taxman 185 (P&H) and CIT vs. Ludhiana Steel Roll Mills (2007) 295 ITR 111 (P&H), it was held that estimation of gross profit on the basis of gross profit ratio declared by the assessee two years ago, was not justified. Accordingly, the addition made by the AO was deleted.
On further appeal, while dismissing the appeal filed by the Revenue against the order of CIT(A), the Tribunal noted that the AO had not found any defect in the books of accounts maintained by the assessee. The Tribunal was of the view that maintenance of Stock Register, which shows consumption of raw material and production of finished goods by applying the same measurement was not feasible, considering the nature of the business of the assessee. It was further noted that the fabric was measured in meters and was thereafter stitched to make garments which have to be counted in pieces. The Tribunal also pointed out that the AO had not been able to point out any difference in the consumption of raw material and production of finished goods, when compared to the earlier years. The Tribunal, therefore, concluded that the finding recorded by CIT(Appeals) was on the right footing.
On appeal before the Delhi High Court, it observed that as regards failure of the assessee to produce the persons to whom payments were made by the assessee for fabrication, embroidery and dyeing & finishing, etc., the AO was at liberty to summon any or all of them in case he wanted to verify the genuineness of the payments made to them. No such course of action was, however, adopted by him. Failure of the assessee to produce those persons could not have been a ground for rejecting the accounts under Section 145(3) of the Act. The AO did not point out any difference in the consumption of raw material and production of finished goods when compared to earlier years. The AO did not say that after comparing the raw material consumed and finished goods produced in the previous years with the raw material consumed and the finished goods produced in the year in question, he had found that the number of finished goods pieces actually produced by the assessee should have been more than the number of pieces declared in the account books produced before him. Admittedly, the gross profit percentage declared by the assessee in the assessment year 2003-2004 which was the immediate preceding year, was more or less the same as was declared in the assessment year 2004-2005, to which this appeal pertains. However, the AO, instead of applying the gross profit ratio declared in the immediate preceding year, applied the gross profit ratio declared in the assessment year 2002-2003, thereby failing to maintain the accepted principle of continuity and consistency. No ground at all has been given by the AO for deviating from this accepted principle of assessment. The Delhi High Court held that, in any case, the question whether fall in gross profit stood explained by the assessee or not is a question of fact. Both, the ITAT as well as CIT (Appeals) have accepted the explanation given by the assessee. The High Court cannot disturb finding of fact unless some perversity is pointed out in the finding of the Tribunal which is otherwise the final authority on facts.
The issue is of immense importance and in the light of above an assessee can take help where there is enhancement of gross profit rate.