Mumbai ITAT: Books Cannot Be Rejected Solely for Non-Maintenance of Qualitative Stock Records

Sparkle Diam Pvt. Ltd. Vs DCIT (ITAT Mumbai)

Mumbai ITAT: Books Cannot Be Rejected Solely for Non-Maintenance of Qualitative Stock Records

The Mumbai ITAT held that non-maintenance of qualitative stock details, by itself, is not a valid ground for invoking section 145(3) where the assessee has maintained complete books of account, inventory records, purchase and sales registers, stock registers, tax audit records and stock valuation reports, and the Assessing Officer has not pointed out any specific defect in those records. The Tribunal noted that the assessee had consistently followed the same accounting system over the years, which had been accepted by the Department in earlier as well as subsequent scrutiny assessments.

The Assessing Officer had rejected the books solely because the assessee, engaged in the diamond and jewellery business, did not maintain stock records based on qualitative attributes such as size, clarity, colour and shape of diamonds, and consequently estimated the net profit at 3% of turnover, resulting in an addition of ₹3.16 crore. The Tribunal held that, in the absence of any other defect in the books or evidence showing that the accounts were incorrect or incomplete, such rejection was unsustainable and the estimation of profit had no rational or scientific basis.

Relying on the decisions of the Bombay High Court in Swananda Properties Ltd. and Time and Space Haulers and the Rajasthan High Court in Bhawani Silicate Industries, the Tribunal deleted the addition, holding that books of account cannot be rejected merely because qualitative stock records are not maintained when no other material defect is found.

Cases Discussed

• PCIT v. Swananda Properties Ltd. (Bombay HC), (2019) 111 taxmann.com 94 (Bom.)
• PCIT v. Time and Space Haulers (Bombay HC), ITA No. 52 of 2016, decided on 04.07.2018
• PCIT vs Bhawani Silicate Industries (Rajasthan HC), (2016) 65 taxmann.com 106 (Rajasthan)
• Sage Infrastructure (P.) Ltd. v. ACIT (Gujarat HC), [2013] 37 taxmann.com 32 (Guj.)
• Neena Mahajan v. CIT (Punjab & Haryana HC), [2011] 14 taxmann.com 88 (P&H)

FULL TEXT OF THE ORDER OF ITAT MUMBAI

The instant appeal of the assessee filed against the order of the NFAC, Delhi [for brevity ‘Ld. CIT(A)’], order passed under Section 250 of Income Tax Act, 1961 (for brevity ‘the Act’) for Assessment Year 2022-23, date of order 24.11.2025. The impugned order emanated from the order of the Assessment Unit Income Tax Department (for brevity ‘Ld. AO’), order passed under Section 143(3) r.w.s. 144B of the Act, date of order 23.03.2024.

2. The brief facts of the case are that the assessee is engaged in the business of manufacturing and export of studded gold Jewelry and sale of polish diamonds. The assessee filed the return and the books of accounts are duly audited as per provision of section 44AB of the Act. The assessee has been associated with gem and jewelry industries over three decades and engaged in business of manufacturer and export of cart and polish diamonds. The assessee’s case was selected for scrutiny mainly because there were differences in opening and closing stock, very high turnover with low profit, noncompliance with Ind-AS, larger loans squared up during the year and high liabilities compare to income. The assessee submitted that it maintains complete books of accounts including inventory register and purchase register and sale register etc. The assessee submitted the details of maintaining of books of accounts in Tax Audit Report (TAR) duly filed u/sec. 44AB of the Act in Form No. 3CA. The list of books of accounts maintained by the assessee is reported by the Charted Accountant in TAR which is enclosed in APB page 7. The list is reproduced as below:

But the Ld. AO rejected the books of accounts of the assessee on the grounds that the assessee has failed to maintain “quality wise” particulars such as size, clarity, color and shape of diamonds and components which are mandatory for determining the valuation of stock. Without this attributes, the correctness of opening and closing stock cannot be verified. Accordingly, the Ld. AO rejected the books of accounts of the assessee u/sec. 145(3) of the Act and estimated to net profit at the rate of 3% on turnover amount to Rs.1,79,37,37,589/- which comes amount to Rs.5,38,12,128/-. After deduction of the net profit declared by the assessee the balance amount to Rs.2,21,40,797/- is added back with the total income of the assessee. The aggrieved assessee filed an appeal before the Ld. CIT(A). The Ld. CIT(A) uphold the impugned assessment order. Being aggrieved assessee filed an appeal before us.

3. The Ld. AR further filed a paper book comprising pages 1 to 342, which has been taken on record. It was contended that the assessee has consistently disclosed a net profit ranging between 1.20% and 1.98% on its turnover during the AYs 2017-18 to 2024-25, demonstrating consistency in its business results. In support of this contention, the Ld. AR placed on record a comparative chart showing the ratio of net profit to turnover for the Assessment Years 2017-18 to 2024-25, which is reproduced below:

During the relevant previous year, the assessee disclosed a net profit of 1.23% on its turnover. The Ld. AR submitted that all the relevant books of account and supporting documentary evidence were furnished before the Ld. AO as well as the Ld. CIT(A). The same documents have also been placed before us in the APB at pages 115 to 311. The Ld. AR further contended that the following books of account, ledgers, and supporting documents had been duly furnished before the revenue authorities in support of the assessee’s claim, which are as follows:

“(i) Statement of details of Trade Payables as on 31.03.2022

(ii) Copy of relevant statement from TAR-closing stock

(iii) Statement of party wise details of sales

(iv) Statement of party wise details of purchase of raw materials polished diamonds and gold and others.

(v) Statement of details of Trade Receivables as on 31.03.2022

(vi) Matrix of profit & Loss account for year ended 31.03.2022 in percentage of 31.03.20221 and 31.03.2020.

(vii) Statement of party wise details of sales to new customers.

(viii) Copy of stock valuation report in respect of closing stock as on 31.03.2021 and copy of stock valuation report in respect of as on 31.03.2022 obtained from a register valuer.

(ix) Relevant extract from Tar-statement of quantitative details of stock.

(x) Relevant extract from TAR –stock register

(xi) Daily stock register for the impugned financial year.”

4. The Ld. AR further contended that there is no specific lacuna was found by the Ld. AO during the rejection of book of accounts. Even, during the rejection of books of accounts, only the lacuna was found that the assessee is not maintaining “quality wise” stock. Admittedly, the assessee is not maintaining the “qualitative records” in any of the assessment years. The Ld. AR stated that the scrutiny assessments of the assessee were completed for A.Y. 2021-22 and 2023-24 u/sec. 143(3) of the Act, date of order 20.12.2022 and 01.03.2026 respectively. Where the revenue has accepted the assessee’s accounts and stock details, and no such rejection of books of accounts was done in respective scrutiny assessments. He further contended that in arbitrary manner, the Ld. AO had rejected the books of the assessee and calculated the net profit at the rate of 3% which has no basis. He respectfully relied on the order of Hon’ble Rajasthan High Court in the case of PCIT vs Bhawani Silicate Industries reported in (2016) 65 taxmann.com 106 (Rajasthan) where the Hon’ble Court has considered that the books of accounts could not be rejected merely because qualitative records was not maintained. The observations of the Hon’ble Court contended in paragraph no.9 is reproduced as below:

“9. We have heard and considered the arguments advanced by counsel for the Revenue and in our view, the Tribunal, which is the ultimate final fact finding authority, after analyzing the material again placed before it and having gone into the issue once again has come to the conclusion that merely because qualitative record was not maintained and on this premise, the books of account could not have been rejected. It is also an admitted fact that mustard seed is only single commodity used by the assessee for manufacturing of mustard oil and the Tribunal noticed that the assessee filed yield percentage for two months before the AO in which no discrepancy was found by the AO. The Tribunal has found that the production of mustard oil is a continuous process and the seeds are put into the milling for continuous oil production. The Tribunal has further found that 80% of its mustard oil is by way of trading sale and neither discrepancies were noticed by the AO in either purchase or sale nor any sale or purchase, found unrecorded. The Tribunal also found that the books of account had been maintained in the same manner as in the past and the assessee cannot be expected to stop the plant as and when the new lot of mustard seed is subjected to crushing as manufacturing of mustard oil is a continuous process. The Tribunal has also found as a finding of fact that except quality, quantitywise stock details has been maintained but no other defect was noticed by the AO in the quantitative details and after noticing the above fact, has come to the conclusion that the books of account ought not to have been rejected. In our view, such a finding of fact which has been reached by the Tribunal is after appreciating the material and evidence on record and such a finding has been arrived at by the Tribunal after analyzing the material and in our view, no substantial question of law can be said to arise out of the order of the Tribunal. Once the stock register has been held to be properly maintained and has been held to be proper, no trading addition could have been made and rightly so, even otherwise, minor discrepancies cannot result into rejection of books of account.”

5. The Ld. AR further contended that the Hon’ble Bombay High Court, in PCIT v. Swananda Properties Ltd. reported in (2019) 111 taxmann.com 94 (Bom.), has categorically held that where the revenue is unable to point out any specific defect or discrepancy in the books of account or other records regularly maintained by the assessee, the provisions of Section 145 of the Act cannot be invoked for rejecting the books of account. It was submitted that the ratio laid down in the said decision squarely applies to the facts of the present case. The relevant observations contained in paragraph 11 of the judgment are reproduced below:

“11. We note that the books of accounts of the Respondent were rejected by the CIT (A) under section 145(3) of the Act. However, the Tribunal found in the impugned order that the invocation of section 145(3) of the Act is unjustified as no defect was noted in the books of accounts to disregard the same. We note that CIT (A) in his order while rejecting the Books of Account does not specify the defect in the record. The basis of the rejection appears to be best judgment of assessment done by him. The rejection of books should precede the best judgment assessment. On facts, the Revenue has not been able to show any defect in the Respondent’s records which would warrant rejection of books and making a Best Judgment Assessment. Thus, on facts the view taken by the Tribunal is possible view. Therefore, no substantial question of law arises. Thus not entertained.”

The identical issue has also been considered by the Hon’ble Bombay High Court in PCIT v. Time and Space Haulers, ITA No. 52 of 2016, decided on 04.07.2018, wherein the Hon’ble High Court reiterated the settled principle that additions cannot be sustained merely on suspicion or presumptions in the absence of cogent material establishing the revenue’s allegations. The Ld. AR submitted that the ratio laid down in the said decision squarely applies to the facts of the present case.

6. The Ld. DR argued and contended that the assessee’s sale was abruptly increasing in impugned assessment year in comparison to the other years. Whereas the net profit was duly reduced. The assessee was unable to maintain the qualitative details which is duly essentially for the same type of industries. The Ld. DR invited our attention in impugned assessment order paragraph no.4.5 which is reproduced as below:

“4.5 Point-wise rebuttal of reply of the assessee including analysis of any case law relied upon:

Non-verification of Opening and Closing Stock

The reply of the assesse is not found acceptable for the reasons that the case of the assesse has been selected in scrutiny and one of the reasons for selection is large difference in the opening stock of current year (in Trading & Manufacturing account) and closing stock of previous year shown in P&L a/c as per Return of Income.

The assessee is engaged in the business of manufacturing and selling gold and polished diamonds. It is noticed that purchase register is maintained by the assessee according to quantity of the particular item but quality, shape, clarity, size is not taken into account whereas in such type of business, quality, shape, clarity and size of the items is very important for determination of price.

Further, during the course of VC proceedings, the assesse submitted that the decline in net profit in comparison to previous years is due to discount to the new customer. However, the assesse did not provide details of items sold to the new customers and also did not furnish the item wise rate to the new customers in comparison to old customers. Further, the assesse did not provide the quantum of discount which was given to the new customers during the year under consideration, along with supporting documentary evidences. Merely submitting list of new customers to whom discount were given is not justifiable.

Therefore, it is clear that the purchase records are not maintained totally and the value of closing stock declared is not verifiable.

Rejection of books of accounts

In view of the facts as mentioned above & judgments discussed supra, it is clear that books of the accounts of the assessee are unable to shown the clear picture of the business of the assessee nor they deduce correct profit of the business of the assessee. Therefore, books of the account of the assessee are rejected u/s 145(3) of I.T. Act 1961. Once of the books of accounts of the assessee are rejected the profit of the assessee is to be estimated, however this estimation should have the basis which is fare and scientific. One such basis for estimation of profit can be trading results shown by the assessee in the preceding years. This view is also supported by following case laws-“

7. The Ld. DR further argued and contended that the Ld. CIT(A) has made the observations and duly rejected the appeal of the assessee on the same grounds that assessee is not maintaining the qualitative details of the stock. He supported the orders of revenue authorities. The observations of Ld. CIT(A) in paragraphs no.5.1 to 5.2.10 are reproduced as below:

“5.1. Ground No.1. The appellant preferred appeal to contest the validity of the addition amounting to Rs.3,16,71,331/-.

5.1.1. The Appellant, being in the diamond and studded jewellery sector, is required to maintain complete and verifiable quantitative and qualitative details. The Appellant has failed to maintain essential quality-wise particulars such as size, clarity, colour and shape of diamonds and components, which are mandatory for determining true valuation of stock. Without these attributes, the correctness of opening and closing stock cannot be verified. It is noticed that the Assessing Officer has correctly identified serious defects in the appellant’s books of account. The appellant has not produced any item-wise billing, item-wise costing, or item-wise sale and consumption records to substantiate its claim of lower margins or discounts to new customers. The Assessing Officer has therefore rightly concluded that the declared profit does not reflect the true income of the appellant. The addition made by estimating profit at 3% is reasonable based on proper material. Hence, ground No. 1 raised by the appellant is dismissed.

5.2. Ground No.2. With regard to relates to Rejection of Books of Account for invoking the provisions of section 145(3) of the I.T.Act, 1961.

5.2.1. On perusal of the submissions of the appellant, the assessment order and the material available on record, it is evident that the Assessing Officer has correctly invoked the provisions of section 145(3) of the Income-tax Act, 1961. Although the appellant has emphasised that the accounts are audited under the Companies Act and tax audit provisions, such audit cannot substitute the statutory requirement under section 145(3). The AO must independently be satisfied about the correctness and completeness of the books of account and documents maintained by the appellant.

5.2.2. In this case, the appellant’s books lack critical qualitative particulars—such as size, clarity, colour and shape of diamonds and jewellery components which are indispensable for accurate valuation in the gem and jewellery industry. The appellant has only maintained broad quantitative figures without the requisite quality-wise bifurcation. In a business where value depends entirely on qualitative attributes, absence of submissions and other details renders both the opening and closing stock unverifiable, which makes the trading results unreliable and raises doubt about whether the profit shown in the books is correct or not.

5.2.3. The appellant’s argument is that the method of accounting has been accepted by the AO and that Ind-AS compliance has been followed does not prevent rejection of books.

5.2.3.1. Section 145(3) empowers the AO to reject books even where the method of accounting is not disputed, if the accounts are not complete or correct. Audit under the Companies Act or section 44AB does not automatically validate the books of account for income-tax purposes when essential stock details are missing. Consistency in following an accounting method in earlier years similarly cannot override factual defects identified in the year under consideration. Thus, despite regular accounting methods being followed, the fundamental defect of non-verifiable stock remains unaddressed.

5.2.3. It is also noted that the appellant failed to furnish any item-wise or qualitywise reconciliation of stock, any documentary evidence supporting the claim of discounts to new customers, or any industry benchmark to justify the decline in net profit rate despite a substantial increase in turnover. The AO has brought on record clear deficiencies—absence of quality-wise stock records, absence of item-wise discount evidence, failure to reconcile stock at attribute level, and a fall in margins without any cogent explanation. This constitutes adequate grounds for invoking section 145(3).

5.2.4. Once the books of accounts are validly rejected, the Assessing Officer is authorised to estimate the income in a reasonable manner. In this case, application of a net profit rate of 3% on turnover of Rs.1,79,37,37,589/-, as against the declared rate of 1.23%, is found reasonable considering business realities, past results and the pattern of declining profitability. The appellant has not produced any comparable industry data or scientific basis to dispute the AO’s estimation.

5.2.4. Section 145(3) reads as under:

“Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the Appellant, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2) have not been regularly followed by the Appellant, the Assessing Officer may make an assessment in the manner provided in section 144.”

5.2.5. The Assessing Officer is empowered to reject books when discrepancies such as improper accounting, non-production of records, absence of stock register or other defects are noticed. In the present case, I fully agree with the AO that the absence of quality-wise stock registers and other vital details forms a valid ground for rejection. The Assessing Officer is not bound to accept the system of accounting merely because it was accepted in earlier years. It is both the right and the duty of the Assessing Officer to examine whether the books are reflected in the true state of accounts or not.

5.2.6. It is also noticed that turnover increased substantially by 11% in AY 2021-22 over AY 2020-21 and further by 68% in AY 2022-23 over AY 2021-22. However, during the same period, the net profit rate continuously declined. The appellant has not furnished any reliable justification for such a trend. This also supports the AO’s conclusion that the declared results do not reflect true profits.

5.2.7. The rejection of books is also supported by judicial precedents. In Sage Infrastructure (P.) Ltd. v. ACIT [2013] 37 taxmann.com 32 (Guj.), the Hon’ble Gujarat High Court upheld rejection of books under section 145(3) where the assessee failed to maintain essential details and the correctness of the trading results could not be verified. The Court emphasised that mere audit of accounts cannot prevent the Assessing Officer from invoking section 145(3) when fundamental defects exist.

5.2.8. Similarly, in Neena Mahajan v. CIT [2011] 14 taxmann.com 88 (P&H), the Hon’ble Punjab & Haryana High Court held that when the assessee fails to maintain proper stock records or reconcile discrepancies, the Assessing Officer is justified in rejecting the books and estimating income. The High Court observed that past acceptance of the method of accounting does not bar the AO from rejecting books when defects are detected in the relevant year.

5.2.9 . These judicial pronouncements directly apply to the present case, where the appellant failed to maintain quality-wise stock registers, item-wise valuation details, and furnish reconciliation of stock, resulting in unverifiable trading results. Therefore, invocation of section 145(3) and estimation of profit at 3% of turnover is justified.

5.2.10. Considering all the above facts and circumstances of the case, I find no reason to interfere with the Assessing Officer’s action. The rejection of books under section 145(3) is upheld. Consequently, the estimation of income by applying net profit rate of 3% on turnover is also confirmed. Accordingly, the addition of Rs.3,16,71,331/- is upheld and the Ground of Appeal relating to this issue is dismissed.”

8. We have heard the rival submissions and carefully considered the material available on record. It is an undisputed fact that the assessee has been engaged in the business of manufacturing and export of studded gold jewellery and sale of polished diamonds for nearly three decades. During the year under consideration, the assessee declared a turnover of Rs.1,79,37,37,589/- and a net profit of Rs.2,21,40,797/-, resulting in a net profit ratio of 1.23%. The books of account were rejected by the Ld. AO solely on the ground that the assessee had not maintained qualitative details of stock such as size, clarity, colour and shape of diamonds. Based on such rejection, the Ld. AO estimated the net profit at 3% of the turnover, which resulted in an addition of Rs.3,16,71,331/-. We find that except for the alleged absence of qualitative stock records, no specific defect or discrepancy has been pointed out either in the books of account, purchase register, sales register, inventory records, stock register, vouchers, or other primary records maintained by the assessee. The assessee had furnished complete books of account, inventory records, statutory audit report, Tax Audit Report under section 44AB, stock valuation reports and other supporting documents before the revenue authorities. The method of accounting followed by the assessee has remained consistent over the years and the same has been accepted by the Department in earlier as well as subsequent scrutiny assessments, including AYs 2021-22 and 2023-24, wherein no rejection of books under section 145(3) was made. The comparative chart placed on record also demonstrates that the assessee’s net profit ratio has consistently ranged between 1.20% and 1.98% over several years, and there is no material brought on record to justify estimation of profit at an arbitrary rate of 3%.

We further find that the Hon’ble Rajasthan High Court in Bhawani Silicate Industries (supra) has held that books of account cannot be rejected merely because qualitative records are not maintained when no other defect is found in the books. Similarly, the Hon’ble Bombay High Court in Swananda Properties Ltd. (supra) has held that in the absence of any specific defect in the books of account, invocation of section 145(3) is unsustainable. The same principle has also been reiterated by the Hon’ble Bombay High Court in Time and Space Haulers (supra). The ratio laid down in the aforesaid decisions squarely applies to the facts of the present case. In the absence of any material establishing that the books of account are incorrect or incomplete, rejection of the books merely for non-maintenance of qualitative stock details cannot be sustained. Consequently, the estimation of net profit at 3% also lacks any rational or scientific basis. Respectfully following the binding precedents of the Hon’ble Bombay High Court and the persuasive decision of the Hon’ble Rajasthan High Court, and applying the doctrine of consistency, we hold that the invocation of section 145(3) is unsustainable. Accordingly, we set aside the impugned order of the Ld. CIT(A) and direct the deletion of the addition of Rs.3,16,71,331/-made by the Ld. AO. Thus, the grounds raised by the assessee are allowed.

9. In the result, the appeal of the assessee bearing ITA No.243/Mum/2026 is allowed.

Order pronounced in the open court on 31th day of July 2026.