Rakesh Kumar Khare Vs ITO (ITAT Jabalpur)
Books Rejected, but Profit Cannot Be Picked at Will: ITAT Orders Five-Year Average Instead of Ad Hoc 8%
Rejection of Books Does Not Justify an Arbitrary Rate
The Jabalpur Tribunal upheld rejection of the assessee’s books because essential stock and trading records were not produced. However, it rejected both the 14.72% profit rate adopted by the Assessing Officer and the 8% rate sustained by the CIT(A) for want of a reasoned basis.
The Tribunal directed a fresh computation using the simple average of the assessee’s net-profit percentages for the immediately preceding five assessment years.
It also restored a separate ₹32,50,800 addition relating to an unexplained change in opening creditors for verification. The assessee therefore obtained reconsideration of both additions, while the rejection of books remained intact.
Missing Records Lead to Rejection of Accounts
The assessee, engaged in liquor trading and property development, filed his return on 5 September 2017, declaring income of ₹13,40,980.
His case was selected for complete scrutiny under CASS. The relevant business turnover was ₹7,21,37,618, against which the assessee declared a net-profit rate of 1.93%.
To verify the trading results, the Assessing Officer sought shop-wise stock or inventory registers, sales and purchase records, and expense ledgers.
The assessee failed to produce these essential records. The Assessing Officer consequently rejected the books under section 145(3) and estimated net profit at 14.72%, resulting in an addition of ₹92,24,675 over the declared profit.
The CIT(A) upheld rejection of the books but reduced the estimated net-profit rate to 8%.
Stock Records Were Substantial to Income Determination
The Tribunal examined whether the accounts were sufficiently incomplete or incorrect to warrant rejection.
It held that stock and inventory records formed a significant part of the accounts, capable of materially influencing determination of taxable income. Their absence, together with non-production of sales, purchase and expense records, justified the action under section 145(3).
The Tribunal referred to Dhondiram Dalichand v. CIT, 81 ITR 609, Bastiram Narayandas v. CIT, 210 ITR 438, and Kachwala Gems v. JCIT, 288 ITR 10 (SC).
On the facts before it, the Tribunal upheld the rejection of both the books and the trading results derived from those incomplete records.
Neither 14.72% nor 8% Had Adequate Support
The next question was whether the profit estimates could be sustained.
Although the Assessing Officer had referred to a third-party case within his jurisdiction, the Tribunal found that the necessary rationale, supporting material and basis for adopting 14.72% had not been adequately brought on record.
The CIT(A)’s reduction to 8% suffered from the same problem: the appellate order did not explain why that particular rate represented the assessee’s likely profit.
There were no meaningful findings showing consideration of industry standards, the assessee’s operational size, local market conditions or competition during the relevant year.
The Tribunal therefore declined to sustain either percentage merely because the books had validly been rejected.
Assessee’s Own Five-Year History Provides the Basis
Relying on Vrajlal Manilal & Co. v. CIT, 92 ITR 287 (MP), the Tribunal observed that earlier assessment records could provide relevant material for estimating income after rejection of books.
It considered the simple average net-profit percentage earned by this assessee in the five immediately preceding assessment years an acceptable basis in place of the unsupported estimates.
The matter was restored to the Assessing Officer to determine the rate strictly according to that direction and apply it to the declared turnover.
The Tribunal also directed that the assessee receive three effective opportunities before the assessment was framed accordingly.
Addition Limited to the Differential Profit
The Tribunal prescribed a clear safeguard for the recomputation.
If the net-profit percentage calculated using the five-year average fell below the assessee’s declared rate, no addition would be permissible.
Otherwise, the addition could not exceed the difference between the profit computed at the revised rate and the profit already declared.
The order therefore did not approve taxation of the entire estimated profit afresh. It confined any addition to the excess over the profit already accounted for.
The final amount remained dependent on the historical figures and the resulting computation.
Opening Creditors Also Sent for Verification
The second dispute concerned ₹32,50,800 shown as opening sundry creditors, although the immediately preceding year’s closing balance was nil.
The assessee had failed to furnish confirmations or satisfactorily explain the nature and source of this change. The Assessing Officer added the amount under section 68, and the CIT(A) confirmed it.
Referring to CIT v. Jansampark Advertising & Marketing (P.) Ltd., 231 Taxman 384, the Tribunal granted another opportunity to furnish evidence and explain the change in audited figures.
This issue too was restored for verification. The appeal was partly allowed for statistical purposes.
Author’s Comments
The ruling separates rejection of accounts from selection of a profit rate. Defective books justified estimation, but each percentage still required a defensible basis.
The assessee’s own history supplied that basis in this case. The direction is fact-specific and does not prescribe a universal five-year averaging formula for every business.
The creditor issue also requires careful attention. This was an unexplained mismatch between the previous closing balance and the current opening balance, rather than a finding that an established carried-forward liability automatically attracted section 68. The assessee must now reconcile that mismatch with evidence.
Cases Discussed / Relied Upon
- Dhondiram Dalichand v. CIT, [1970] 81 ITR 609 (Bombay High Court) — Rejection of books in the absence of quantitative records relating to purchases, sales and stock.
- Bastiram Narayandas v. CIT, [1994] 210 ITR 438 — Rejection of books where relevant stock and manufacturing records were not produced.
- Kachwala Gems v. JCIT, [2007] 288 ITR 10 (Supreme Court) — Rejection of incomplete books where stock records were not maintained.
- Vrajlal Manilal & Co. v. CIT, [1973] 92 ITR 287 (Madhya Pradesh High Court) — Earlier assessment records as relevant material for estimating income.
- CIT v. Jansampark Advertising & Marketing (P.) Ltd., [2015] 231 Taxman 384 — Opportunity for evidence and verification of the disputed credit.
FULL TEXT OF THE ORDER OF ITAT JABALPUR
This appeal is filed by the assessee challenging DIN & Order No. ITBA/APL/S/250/2024-25/1072848582(1) dt. 03/02/2025 passed u/s 250 of the Income-tax Act, 1961 [‘the Act’ in brief] by first appellate authority [‘Ld. CIT(A)/NFAC’ in brief] which in turn arisen out of order of assessment dt. 29/12/2019 passed by Income Tax Officer, Ward-Tikamgarh [‘Ld. AO’ in brief] u/s 143(3) of the Act anent to assessment year 2017-18 [‘AY’ in brief]
2. We have heard rival party’s submission and subject to rule 18 of ITAT-Rules (supra) perused material placed on record, considered the facts in the light of settled legal position.
3. We briefly note that, the assessee is an individual and engaged in the trading business of liquor & property developers, who filed his return of income on 05/09/2017 declaring total income of ₹13,40,980/-. The said return of the assessee was selected for complete scrutiny under CASS and consequential assessment u/s 143(3) of the Act was completed whereby books of accounts of the assessee for the want of stock records, ledgers of purchases/sales & expenses etc., were rejected u/s 145(3) of the Act and in consequence thereof the net profit [‘NP’ in brief] was estimated @14.72% as against the NP of 1.93% declared by the assessee. The resultant difference of NP of ₹92,24,675/- was thus added along-with the addition of ₹32,50,800/- towards change in audited opening balance of sundry creditor which remained unexplained by the assessee. The aforestated additions & assessment was challenged in first appeal before the Ld. CIT(A), which was partly allowed whereby the % of NP was restricted to 8% and addition towards change in opening balance of sundry creditors was confirmed.
4. Still aggrieved by the impugned order and relief granted thereby the assessee came in present appeal challenging both ad-hocly restricting the NP to 8% of declared turnover and confirming the addition on account of change in audited opening balance of sundry creditors.
5. We have given out thoughtful consideration to the clinching facts of the case and noted that, the assessee for the year under consideration was engaged in trading business of liquor etc. which accounted total turnover of ₹7,21,37,618/-. In order to vouch the correctness of NP declared by the assessee in relation to turnover achieved by him, the Ld. AO summoned shop-wise stock/inventory register of the business, shop-wise ledger of sales, purchases & expenses. The appellant effectively failed to adduce any such stock/inventory register maintained by him for the purpose of his business, further also failed to adduce sales/purchase registers, ledgers of expenses etc. In view of this, the Ld. AO came to a conclusion that, stock/inventory is a key determinant in computing/arriving at real/true income for any business and in absence of such stock/inventory the residual profits/NP etc. declared by the assessee derailed trueness and correctness thereof.
6. The non-maintenance/production of former key records since constitutes a significant defect in the accounts/books therefore the resultant NP declared by the assessee was rejected by rejecting the books u/s 145(3) of the Act. In view thereof, the for the purpose of taxation the Ld. AO estimated the NP @14.72% of total reported turnover of the assessee taking third party’s case within his jurisdiction as basis. The resultant difference of NP over and above the declared NP was thus added to returned income. Echoing the findings and reasoning, the Ld. CIT(A) upheld the rejection of books and declared % of NP, however without further rationale restricted the NP to 8% instead of the % of NP estimated by the Ld. AO.
7. In this factual matrix let’s first deal with rejection of books, for which we deem it apt to reproduce provision in verbum to gather meaning & plain intent thereof;
Section 145 : Method of accounting.
(3) Where the Assessing Officer 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) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.’. (Emphasis supplied)
8. An austere reading of section 145(3) of the Act envisages existence of three situations where assessing officer can resort to rejection of books. And one of such situations with which we are concerned in the present appeal is satisfaction of the assessing officer about incorrectness or incompleteness of the books/accounts. The rejection on such ground however can only be triggered or considered when accounts are found substantially incorrect or incomplete. That is to say incorrectness or incompleteness of substantial accounts shall only form reasonable basis for rejection of books. The computation of taxable income is based upon books of accounts, where stock records inarguably forms substantial part of books/accounts. Hence determination of taxable income without reference to such stock/inventory records would be meaningless.
9. We note that, the Hon’ble Bombay High Court in ‘Dhondiram Dalichand Vs CIT’ [1970, 81 ITR 609] while upholding rejection of books categorically held that, absence of quantitative tally/figures regarding sales & purchases, opening & closing inventory/stock balances etc., was such that it was necessary to exercise powers available for rejection of books and determine the income to the best of judgement.
10. Equally in ‘Bastiram Narayandas Vs CIT’ [1994, 210 ITR 438] their Hon’ble Lordships have upheld rejection of books and framing of assessment to the best assessing officer’s judgment where the assessee Bidi manufacturer, failed to produce relevant inventory/stock records of its day-to-day manufacture of Bidis. An analogous view can be traced in ‘Kachwala Gems Vs Jt. CIT’ [2007, 288 ITR 10 (SC)] wherein the Hon’ble Apex Court also espoused the rejection of books for incompleteness owning to non-maintenance of stock/inventory records.
11. On a similar line the Hon’ble Jurisdictional High Court in ‘Vrajlal Manilal & Co. Vs CIT’ [1973 92 ITR 287 (MP)] held that once the books are properly rejected, the income has to be estimated and in making the estimate of such income, the previous assessment records can construe best & relevant material along with other things.
12. In the instant case, undisputedly non-maintenance/production of shop-wise item/product-wise trading/stock or inventory records and ledger accounts of purchases/sales, expenses etc., has formed solitary basis in holding accounts of the assessee was substantially suffered from incorrectness or incompleteness, which in turn triggered their rejection u/s 145(3) of the Act.
13. Since the stock/inventory records/details forms significant part of accounts which severally capable of influencing the determination of taxable income of the assessee, hence the non-maintenance vis-à-vis non-production of stock/inventory records in our considered view is discretely capable of construing that accounts of the appellant were substantially incomplete & incorrect, thus valid reason for rejection of books and declared % NP. In view of the former judicial precedents (supra), we therefore upheld the action of tax authorities in rejecting the books for their incompleteness and in consequence thereof the declared % NP for non-maintenance/production of stock records etc.
14. Now next comes to estimation of net profit @14.72% of turnover by the Ld. AO and restricting the same by the Ld. CIT(A) to 8% as against NP of 1.93% declared by the appellant. In this context we observed that, after rejecting the books/NP in wholesome the Ld. AO simply estimated the gross profit at the rate 14.72% of turnover/sales achieved to have reported by the assessee and added differential amount of NP as the income of the assessee. We note that, while doing so the Ld. AO did dejectedly fail to bring on record (a) rationale applied in arriving the estimation and (b) basis or material founded in arriving such % of NP. Further the impugned order also failed to narrate justification in restricting the NP estimation to 8% and consequential addition made by the Ld. AO.
15. On the other hand, there is no material on record, or no findings & observation in the impugned order which could even remotely suggests that such estimations were made having regard to industry standards, operational size of the appellant, then usual local market conditions and level of competition prevailing during the respective assessment year under consideration etc. This ad-hoc estimation % of NP badly lacks the rationale hence could hardly be persuaded for the purpose of addition & consequential assessment, therefore we deem it fit to untie the former estimation made by the Ld. AO and the one arrived by the Ld. CIT(A)m thus the consequential addition sustained by the impugned order on this score.
16. Considering the totality of facts and circumstances, and judicial precedent laid in ‘Vrajlal Manilal & Co Vs CIT’ (supra) in our considered view, % of simple average NP earned by the appellant in five assessment years immediately preceding the assessment year under consideration could have formed an acceptable rationale and a profound basis in place of ad-hoc estimation arrived by both the tax authorities below.
17. In view thereof, we set-aside the impugned adjudication for determination % of NP to the file of Ld. AO who shall determine the same strictly in accordance with former direction with reference to declared turnover and framed the assessment accordingly after giving three effective opportunities to the appellant. Needless to mention that, no addition shall be permissible if the % of NP re-computed as per former direction falls below the % of NP declared by the assessee. In any other case the addition shall be not to exceed the differential amount of NP calculated with reference to % of NP re-computed on the basis of former direction. The ground of appeal thus stands partly allowed for statistical purposes.
18. Next comes to addition made u/s 68 of the Act. It shall suffice to note that, in the course of assessment proceedings it was observed that as against the immediately preceding assessment year NIL closing balance of sundry creditor, the corresponding opening balance of sundry creditors was shown at ₹32,50,800/- In the event of assessee’s failure to adduce letters of confirmation, explain nature & source of such change in credit balances, the Ld. AO treated the same as unexplained cash credit u/s 68 of the Act and made the addition while framing the assessment u/s 143(3) of the Act.
19. The assessee remained indifferent, as a result the said addition in the absence of persuading material and explanation was confirmed & upheld by the Ld. NFAC in first appellate proceedings. Since the addition was made & confirmed in absence of effective evidence in view of ‘CIT Vs Jansampark Advertising & Marketing (P) Ltd.’ [2015, 231 Taxman 384] we deem it fit accord one more opportunity to the assessee to adduce necessary evidences and prove his claim which would be possible only if we restore this issue as well for verification with evidences, satisfactory explanation about nature & source of change in audited figures. Ordered accordingly. The ground no 2 thus stand partly allowed for statistical purposes.
20. In result, the appeal of the assessee is partly allowed for statistical purposes in aforestated terms.
Adhering to the provisions of rule 34 of ITAT Rules, 1963 this order is pronounced on the day mentioned hereinbefore.
