Chandan Sewing Machine Repairs Vs ITO (ITAT Lucknow)
Best Judgment Assessment Cannot Rest on Conjectures: ITAT Reduces Profit Rate from 20% to 12.5%
Summary: The Income Tax Appellate Tribunal, Lucknow Bench, has reduced the profit rate applied to a sewing machine manufacturing and repair business from 20% to 12.5% of gross receipts, holding that the Assessing Officer’s estimate was excessive and unreasonable. The Tribunal observed that a best judgment assessment must rest on relevant material and cannot be based merely on whims, conjectures or surmises.
Vice President Kul Bharat nevertheless rejected the assessee’s challenge to reopening, finding that information regarding substantial cash deposits warranted verification. The appeal was partly allowed, balancing the assessee’s past profit history against its failure to furnish complete sales-party details.
Background of the case
The assessee, Chandan Sewing Machine Repairs, is a partnership firm engaged in manufacturing and repairing sewing machines. It filed its return of income, along with the tax audit report, on 30 October 2018, declaring total income of ₹28,440 for assessment year 2018-19.
The assessment was subsequently reopened under Section 147 through a notice under Section 148 dated 25 March 2022. The reopening arose from information that the assessee had deposited ₹1,41,76,810 in cash in its bank account during the relevant year.
During reassessment, the Assessing Officer sought details of the parties to whom the assessee claimed to have made sales. According to the assessment findings, complete particulars, including PAN and addresses, were not furnished. Parties whose PAN or GST details were available also failed to respond to notices under Section 133(6).
The AO consequently treated the sales as unverifiable and questioned the correctness and completeness of the books.
Books rejected and income estimated at 20%
The Assessing Officer issued a show-cause notice proposing rejection of the books and completion of assessment on a best judgment basis. The assessee was also asked why income should not be estimated at 20% of total sales or receipts.
The AO considered the reply insufficient to establish the reliability of the sales records. The books were rejected under Section 145(3), and the assessment was completed under Section 144.
Applying 20% to gross receipts of ₹1,83,66,190, the AO estimated income at ₹36,73,238. The CIT(A), National Faceless Appeal Centre, upheld the estimate through an order dated 23 May 2025.
The assessee challenged both the validity of reopening and the profit estimation before the Tribunal.
Assessee’s arguments
The assessee argued that the reopening concerned bank deposits, whereas the eventual assessment involved estimation of income on gross sales. It questioned the legal basis of the proceedings and maintained that the 20% rate had no supporting foundation.
In its grounds, the firm stated that it maintained regular audited books and that the cash deposits represented recorded business receipts. It also referred to evidence concerning customers and contended that cash sales alone did not establish defects in the accounts.
Counsel drew attention to the assessee’s past profit rates, arguing that there was no justification for departing so sharply from its business history.
The Revenue defended the assessment, submitting that sufficient opportunities had been provided but complete sales-party details remained unavailable.
Reopening upheld
The Tribunal rejected the contention that reopening was without any reason. It noted that the Department possessed information regarding substantial cash deposits, the nature and source of which required examination.
Accordingly, the assessee’s objection to reopening failed. The Tribunal then separately examined whether the profit rate adopted by the AO was reasonable.
Past history could not be ignored
The Tribunal found that the AO adopted the 20% rate without examining the assessee’s past history or bringing comparable cases on record.
It explained that the authority conducting a best judgment assessment must exercise judgment judiciously and reasonably. An estimate must have a reasonable nexus with the material available and should reflect relevant considerations.
These considerations may include the assessee’s past performance, the nature of its business, prevailing market conditions and comparable cases. The Tribunal found that no such exercise appeared to have preceded the adoption of 20%.
The material showed profit rates of approximately 9.5% in preceding assessment years, with the historical average worked out at approximately 9.10%. The AO had not produced adverse material justifying a 20% rate in light of the business and its past performance.
Profit rate restricted to 12.5%
The Tribunal also recognised that the assessee had failed to furnish complete sales details despite several opportunities. This prevented verification of the transactions and had to be considered when fixing a reasonable rate.
Balancing these circumstances, the Tribunal directed the AO to recompute income at 12.5% of gross receipts, replacing the 20% rate sustained by the CIT(A).
The ruling confirms that shortcomings in sales verification may justify estimation, but the rate selected must still have a reasoned basis. The assessee secured a reduction in the estimated profit rate, while its challenge to reopening was rejected.
FULL TEXT OF THE ORDER OF ITAT LUCKNOW
This appeal, by the assessee, is directed against the order of the Learned Commissioner of Income-tax (Appeals)/National Faceless Appeal Centre (NFAC), Delhi dated 23.05.2025 pertaining to the assessment year 2018-19. The assessee has raised the following grounds of appeal: –
“01. Because the entire proceedings Initiated under section 148 are devoid of reasons, without any basis, being without jurisdiction, the order passed under section 148/143(3) be quashed.
02. Because the ground on which the proceedings u/s.148 were Initiated having found to be not in existence, the addition of Rs.36,73,238/- made is bad in law, the entire assessment be quashed.
03. Because the CIT(A) has erred on facts and In law in upholding the addition of Rs.36,73,238/-, which addition is contrary to facts, bad in law be deleted.
04. Because the CIT(A) has failed to appreciate that the assessee is a partnership firm carrying on business of manufacturing and repair of sewing machines, maintaining regular books of account, the details of the cash received being all business receipts having been maintained, there was no occasion to disbelieve the same and applying a gross profit rate of 20% on the gross sale, thereby making an addition of Rs.36,73,238/-, which addition is contrary to facts, bad in law be deleted.
05. Because complete evidence with respect to sale proceeds realized having been furnished supported by Aadhar Cards of the persons making the payments, the authorities below were not justified in rejecting the same and made the addition of Rs.36,73,238/-, which addition is contrary to facts, bad in law be deleted.
06. Because in any case keeping in view the past records, there being no change in the system of accounting, there was no justification of rejecting the explanation and applying gross profit rate of 20% on the total sales, the addition made of Rs.36,73,238/- Is bad in law be deleted.
07. Because merely the sales have been made in cash, It does not necessarily mean that the accounts are not properly maintained, especially when audited and no defect in the same having been pointed out, resulting in double taxation, in as much as, the cash deposited in bank being part of sales, coming out of the regular books of account, the addition made of Rs.36,73,238/- is bad in law be deleted.”
2. The facts in brief are that the assessee is a partnership firm carrying on business of manufacturing and repairing of sewing machines, filed its return of income along with Tax Audit Report (TAR) for A.Y. 2018-19 on 30.10.2018, declaring total income of Rs.28,440/-. Thereafter, the assessment was reopened u/s 147 of the Income Tax Act, 1961 (“Act”, for short), by issuing notice u/s 148 of the Act on 25.03.2022. The reopening was based upon information available with the Assessing Authority that the assessee had deposited cash amounting to Rs.1,41,76,810/- in its bank account during the year under consideration. During the course of reassessment proceedings, the Assessing Officer (“AO”, for short) issued a show-cause notice to the assessee requiring it to explain as to why its books of account should not be rejected and the assessment should not be framed on best judgment basis u/s 144 of the Act. The AO further called upon the assessee to explain as to why its income should not be estimated at 20% of the gross receipts, in view of its failure to furnish complete details of the parties to whom sales were claimed to have been made. The explanation furnished by the assessee did not find favour with the AO, who proceeded to reject the books of account and estimate the income at 20% of the gross receipts. Consequently, the AO made an addition of Rs.36,73,238/- and assessed the income accordingly. Aggrieved, the assessee preferred an appeal before the Ld. CIT(A) who dismissed the appeal of the assessee and confirmed the income as estimated @ 20% of the gross receipt. Now, the assessee is in appeal before this Tribunal.
3. The assessee has taken multiple grounds with regard to the addition made on merit and adopting the gross income @ 20% of the gross receipt. The assessee has also raised ground validity of the proceedings. Apropos to the grounds of appeal, the Ld. Counsel for the assessee contended that the assessment was re-opened on the ground of deposit made in the bank account and culminated into making addition by estimating income on the basis of gross sales. He further submitted that the action of the lower authorities is bad in law. He submitted that the rate as adopted by the Assessing Officer is without any basis the addition is made purely on the basis of whims and fancies.
4. On the other hand, the Ld. Departmental Representative (DR) opposed the submission and supported the orders of the lower authorities. The Ld. DR contended that the assessee was given sufficient opportunity to furnish the details of the parties to whom the assessee had claimed to have made sales despite that the assessee grossly failed to furnish the details so sought.
Hence, the AO was justified in estimating the income on the basis of the gross receipt.
5. I have heard the rival submissions and perused the material available on record. So far as the objection of the assessee regarding the validity of the reopening is concerned, I find that the Assessing Officer has categorically stated in the assessment order that information was available with the Department regarding substantial cash deposits made by the assessee in its bank account during the relevant period. The nature and source of such deposits required verification by the Assessing Authority. Therefore, the contention of the assessee that the re-opening was without any reason is devoid of any merit. Accordingly, the objection raised by the assessee in this regard is hereby rejected. Now, coming to the merits of the addition, I find that the Assessing Officer rejected the books of account and proceeded to estimate the income of the assessee at 20% of the gross receipts by observing as under: –
“3.4 Reasons for Inference Act the assessee was asked to furnish detail No. PAN, complete address etc of the parties to whom sales have been claimed to be made by the assessee. However, the assessee utterly failed to provide the details called for. Furthermore, the parties, whose PAN or GST Number have been furnished by the assessee firm, have not responded to the notices issued under section 133(6) of the Act. Therefore, in these circumstances, the claim of sales made by the assessee remains unverifiable due to non-furnishing of complete detail of parties by the assessee and non-response from the parties to whom notice u/s 133(8) were issued. In view of the above facts and circumstances, the correctness/completeness of sales data maintained/furnished by the assessee is not established and accordingly, the books of accounts maintained by the assessee for the year cannot be relied upon.
Thereafter, final show cause notice was issued to the assessee to show cause as to why the books of accounts maintained by the assessee for the year under consideration may not be rejected within the meaning of section 145(3) of the Act and why the assessment in the case may not be completed as per best judgment under section 144 of the Act. Accordingly, the assessee was required to show cause as to why its income for the year may not be estimated @ 20% of total sales/receipts.
As mentioned above, in response to the show cause notice, the assessee filed reply on 25.03.2023. The reply so furnished has been perused and duly considered. The assessee has pleaded in its submission that his Income is not to be considered @ 20% of the gross sales but has failed to put forth any supporting documentary evidence to establish the correctness/completeness of sales data maintained/furnished by the assessee. The onus to substantiate the claim so made was lying with the assessee which it has utterly failed to discharge. Hence the reply of the assessee in response to the show cause notice dated 24.03.2023 found to be not tenable.
In view of the above facts, the books of accounts maintained by the assessee for the year under consideration are rejected within the meaning of section 145(3) of the Act and the assessment in the case is completed as per best judgment under section 144 of the Act. Accordingly, the income of the assessed for the year under consideration is estimated 20% of total sales/receipts i.e. Rs. 36,73,238/- (Gross receipts-Rs. 1,83,66,190 x 20%).”
6. The aforesaid finding of the AO is affirmed by the Ld. CIT(A). During the course of hearing, the Ld. Counsel for the assessee drew my attention to the past history of the assessee and the profit rates declared in the preceding assessment years. I find that the AO, without examining the past history of the assessee or bringing any comparable instances on record, proceeded to estimate the income at 20% of the gross receipts. It is a settled principle of law that, while framing an assessment u/s 144 of the Act, the Assessing Authority is under a statutory obligation to exercise its best judgment judiciously and reasonably. Such assessment cannot be based merely upon the whims, conjectures or surmises of the Assessing Authority. The estimation of income must have a reasonable nexus with the material available on record and should be founded upon relevant considerations. For this purpose, the AO may take into account the past history of the assessee, the nature of its business, prevailing market conditions, comparable cases and other relevant factors. However, in the present case, no such exercise appears to have been undertaken by the AO before adopting the profit rate of 20%. Looking to the material placed before me, the assessee had declared a profit rate of approximately 9.5% in the preceding assessment years and the average profit rate, as worked out on the basis of its past history, comes to approximately 9.10%. The AO has not brought any adverse material on record to demonstrate that the profit rate of 20% adopted by him was justified having regard to the nature of the assessee’s business and its past performance. Therefore, the estimation of income at 20% of the gross receipts, in my considered view, is excessive and unreasonable. However, at the same time, it cannot be lost sight of that despite various opportunities afforded by the AO, the assessee failed to furnish complete details of the parties to whom sales were claimed to have been made. Thus, the AO was not in a position to verify the correctness and completeness of the transactions recorded in the books of account. This aspect also deserves due consideration while determining a reasonable rate of profit.
7. Considering the totality of the facts of the case, the nature of the business carried on by the assessee, its past history, the average profit rate declared in the preceding assessment years and the failure of the assessee to furnish complete details of the sales transactions, I am of the considered view that the ends of justice would be met if the profit rate is restricted to 12.5% of the gross receipts, as against 20% adopted by the AO and sustained by the Ld. CIT(A). Accordingly, the AO is directed to recompute the income of the assessee by applying the profit rate of 12.5% to the gross receipts instead of 20%. The addition is, therefore, restricted to the extent of 12.5%. The grounds raised in the appeal are partly allowed in the terms indicated hereinabove.
8. In the result, the appeal of the assessee is partly allowed.
Order pronounced in the open Court on 28/10/2026.
