Rajmoti Industries Vs ACIT (ITAT Rajkot)
Summary: Estimation of gross profit cannot be made merely because the gross profit ratio has declined, unless the Assessing Officer first rejects the books of account under section 145(3) by identifying specific defects. Further, in a Limited Scrutiny assessment, an addition on an issue outside the approved scope, without following the prescribed procedure for conversion into Complete Scrutiny, is unsustainable.
Facts
The assessee was engaged in manufacturing and trading of edible oils and returned a loss of Rs. 7,08,02,914 for AY 2018-19. The case was selected under Limited Scrutiny through CASS for verification of default in deduction/deposit of TDS and allowability of business loss arising from such default. The assessee furnished the required details in response to notices under sections 143(2) and 142(1). The AO made a disallowance of Rs. 3,21,351 under section 40(a)(ia). He further noticed that the assessee’s gross profit ratio had declined from 10.42% in the preceding year to 3.64% in the year under consideration. Without rejecting the books of account, the AO estimated gross profit at 11.08% of turnover of Rs. 125,79,07,800 and made an addition of Rs. 9,35,43,196.
AO / CIT(A) Finding
The AO considered the substantial fall in the gross profit ratio as sufficient justification for estimating the assessee’s profit. He determined gross profit at Rs. 13,93,76,184 as against Rs. 4,58,32,988 disclosed by the assessee and made the consequential addition of Rs. 9,35,43,196.
The CIT(A) confirmed the additions. The assessee contended before the Tribunal that the AO had neither rejected the books under section 145(3) nor identified any specific defect in them. It was also contended that the AO had travelled beyond the scope of the Limited Scrutiny without converting the case into Complete Scrutiny or obtaining the requisite approval.
ITAT Finding on Estimation of Gross Profit
The Tribunal found that the AO had nowhere recorded any finding rejecting the books of account, nor had he pointed out any specific defect therein. Invocation of section 145(3) was also not discernible from the assessment order.
The Tribunal held that before resorting to estimation of profits, the AO must first reject the books by recording cogent reasons and identifying material defects. A mere decline in the gross profit ratio compared with the preceding year cannot, by itself, justify estimation of profit when the books have not been rejected.
The assessee had satisfactorily explained the decline in gross profit by referring to adverse market conditions, reduction in production and sales and the continuing burden of fixed overheads. The Tribunal also noted that the subsequent taking over of the assessee’s business premises by Union Bank of India under the SARFAESI Act and the subsequent auction of the property corroborated the assessee’s financial distress and supported its explanation for the fall in profitability.
Limited Scrutiny
The Tribunal further accepted the assessee’s contention that the AO had travelled beyond the approved scope of Limited Scrutiny. The case had been selected only for verification of TDS deduction/deposit defaults and the allowability of business loss arising therefrom.
The AO had examined and made an addition on the gross profit issue without following the prescribed procedure for converting the case from Limited Scrutiny into Complete Scrutiny. Therefore, the addition made beyond the approved scope of Limited Scrutiny was held to be unsustainable in law.
Outcome
The ITAT held that the estimation of gross profit and consequential addition of Rs. 9,35,43,196 were unsustainable. The additions made in the assessment order were directed to be deleted, with consequential relief to be granted to the assessee in accordance with law. The appeal was allowed.
Ratio
A fall in gross profit ratio, without rejection of the books of account under section 145(3) and identification of specific defects, cannot justify estimation of profit. Further, an Assessing Officer cannot make additions on issues falling outside the scope of Limited Scrutiny unless the prescribed procedure for conversion into Complete Scrutiny is duly followed.
FULL TEXT OF THE JUDGMENT/ORDER OF ITAT RAJKOT
Captioned appeal filed by the assessee, pertaining to Assessment Year (AY) 2018-19, is directed against the order under section 250 of the Income-tax Act, 1961 [hereinafter referred to as ‘the Act’] passed by the National Faceless Appeal Centre [hereinafter referred to as ‘NFAC’], dated 23.04.2026, which in turn arises out of an order passed by assessing officer u/s. 143(3) of the Act, dated 16.05.2021.
02. Brief facts of the case are that the assessee is engaged in the business of manufacturing and trading of edible oils. The assessee filed its return of income for the assessment year 2018-19 declaring a loss of Rs.7,08,02,914/-. The case was selected for Limited Scrutiny under CASS for verification of the following issues;
i. Default in deduction/deposit of TDS; and
ii. Allowability of business loss on account of such default.
During the course of assessment proceedings, notices under sections 143(2) and 142(1) of the Income-tax Act, 1961, were issued. In response thereto, the assessee furnished the requisite details and explanations. The Assessing Officer observed that the tax auditor had reported in Form No. 3CD that the assessee had deducted/collected tax but had failed to deposit the same into the account of the Central Government. Accordingly, the Assessing Officer made a disallowance of Rs.3,21,351/- under section 40(a)(ia) of the Act. The Assessing Officer further observed that the assessee’s Gross Profit ratio had declined from 10.42% in the preceding year to 3.64% during the year under consideration. Without rejecting the books of account, the Assessing Officer estimated the Gross Profit at 11.08% of the total turnover of Rs.125,79,07,800/-, determined the Gross Profit at Rs.13,93,76,184/- as against the Gross Profit of Rs.4,58,32,988/- disclosed by the assessee, and consequently made an addition of Rs.9,35,43,196/-. The assessment was completed by determining the total income at Rs.2,39,61,633/-.
03. Aggrieved, the assessee preferred an appeal before the Ld. Commissioner of Income-tax (Appeals), who confirmed the additions. The assessee is, therefore, in appeal before the Tribunal.
04. At the time of hearing, the Ld. AR submitted that the Assessing Officer has nowhere recorded any finding rejecting the books of account nor invoked the provisions of section 145(3) of the Act. No specific defect in the books of account was pointed out. The addition has been made merely because of a decline in the Gross Profit ratio, which is not a valid basis for estimating profits. It was further submitted that the assessee is engaged in the business of extraction and trading of edible oils, where profitability is highly dependent upon volatile market conditions. During the relevant year, production and sales declined substantially whereas the fixed overheads remained almost unchanged, resulting in a significant fall in the Gross Profit ratio. It was also submitted that the assessee had itself disallowed expenditure relating to TDS defaults in the return of income, which itself demonstrates that the assessee had suffered genuine business losses. The Ld. AR further contended that the addition under section 40(a)(ia) as well as the estimation of Gross Profit travelled beyond the scope of the Limited Scrutiny. The case was selected only for verification of issues relating to TDS defaults and allowability of business loss arising therefrom. The Assessing Officer neither converted the Limited Scrutiny into Complete Scrutiny nor obtained the requisite administrative approval before examining issues beyond the scope of the Limited Scrutiny, rendering the additions unsustainable. The Ld. AR also brought to our notice that on 13.03.2023, possession of the assessee’s business premises was taken over by the Union Bank of India under the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), and the property was subsequently auctioned. This clearly establishes that the assessee had been continuously incurring losses and the business ultimately came to a standstill.
05. The Ld. DR supported the orders of the authorities below and submitted that merely because the Assessing Officer has not specifically referred to section 145(3) of the Act, it cannot be inferred that the books of account were not rejected.
06. We have heard the rival submissions and perused the material available on record. We also find considerable force in the submissions advanced on behalf of the assessee. The Assessing Officer has nowhere recorded any finding rejecting the books of account nor pointed out any specific defect therein. No invocation of section 145(3) of the Act is discernible from the assessment order. It is well settled that before resorting to estimation of profits, the Assessing Officer must first reject the books of account by recording cogent reasons and identifying material defects therein. In the absence of such rejection, estimation of Gross Profit merely because the Gross Profit ratio has declined compared to earlier years is legally unsustainable. We also find that the assessee has satisfactorily explained the reasons for the decline in the Gross Profit ratio by placing reliance upon adverse market conditions, reduced production and sales, and the continued burden of fixed overheads. The subsequent events placed on record, namely, the taking over of the business assets by the secured creditor under the SARFAESI Act and the eventual auction of the property, further corroborate the financial distress of the assessee and lend credibility to the explanation furnished. We also find merit in the contention that the Assessing Officer travelled beyond the scope of the Limited Scrutiny without following the prescribed procedure for conversion into Complete Scrutiny. The additions made beyond the approved scope of Limited Scrutiny are therefore not sustainable in law. In view of the above discussion, we hold that the estimation of Gross Profit and the consequential addition of Rs.9,35,43,196/- are unsustainable. The additions made in
the assessment order are accordingly directed to be deleted. The Assessing Officer is directed to grant consequential relief to the assessee in accordance with law.
07. In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on this 9th day of September, 2026.
