Books of account can be rejected either for default of ‘incomplete books’ or for ‘inaccurate books’

ITAT PUNE BENCH ‘A’

Honeywell Automation India Ltd.

v.

Deputy Commissioner of Income-tax

IT APPEAL NOs. 401& 402 (Pune) of 2007

[Assessment years 2001-02 & 2002-03]

Date of Decision – September 7, 2011

ORDER

D. Karunakara Rao, Accountant Member –

There are two appeals under consideration for the AYs 2001-02 and 2002-03. The issues are common and therefore, with the consent of the parties, we have decided to take up the appeal no 401/PN/2007 for adjudicating both the appeals as the grounds, facts, and the arguments of the parties are essentially common. Appeal no 401/PN/2007 is filed by the assessee against the impugned order of the CIT(A)- III, Pune dated 29-12-2006 for the A.Y. 2001-02. The grounds of the appeal with the concise ground 1, read as under:

(1)  Whether the lower authorities were justified in rejecting the books of accounts and in estimating the amount of deduction under Section 10A to Rs 5,69,99,894 being 50% of the cost as against the amount claimed by the assessee of Rs. 11,95,79,294/-.

(2)  The Ld CIT(A) has further erred in upholding disallowance of provisions of Rs 51,53,103 towards leave encashment.

(3)  That interest u/s 234D of the Act is chargeable for the period beginning from 1.6.2003.

2. Briefly stated relevant facts of the case for the AY 2001-02 are that the assessee formerly called Tata Honeywell Ltd and being a listed company, has been jointly promoted by Honeywell Inc., USA and Tata group in India, each of whom held 40% of the paid-up share capital of the company in the relevant financial year and the balance 20% was held by the public. Assessee has multiple segments of the business. One segment of the business carried on by the assessee is of designing, supply/erection of automation equipments mainly to the customers in India. The revenues derived from this segment are not eligible for exemption/deduction under Section 10A. The other segment of business is provision of engineering/designing services relating to industrial/business automation systems to overseas customers (substantially to Honeywell associates) from set-up in Software Technology Parks (STP) in Pune and in Chennai. The revenues from this segment of business are claimed exempt under Section 10A of the Act. Assessee filed the return of income on 31.10.2001 declaring the total income of Rs 4,24,16,268 after claiming exemption under section 10A for the STP units amounting to Rs 11,95,79,294/-. Assessee revised the income to Rs 5,41,17,010/- by filing revised return of income. During the scrutiny proceedings, AO noticed certain errors in the books of accounts with reference to the allocation of expenses to the STP units and others and thus, AO invoked the provisions of section 145 of the Act.

3. Relevant questionable parameters for the AO are given in this following table as under:

Segment wise turnover and profits for the year (Rs. In crores)

	Domestic	STP Unit	Total
Turnover	258.80	17.09	Rs 275.89
Profits as per computation of income	5.41	11.95	Rs 17.36
Percentage of profit on sales	2.09%	69.92%	6.29%
Percentage of profit on cost	2.13%	232.49%	6.71%

Resultantly, the AO made assessment of its income by determining the total income at Rs 15,05,05,103/- as against the revised income of Rs 5,41,17,010/-. Thus, the rejection of the books of accounts and revising of the income of the STP units and consequent effects are the areas of disputes.

4. Regarding the rejection of the books of the assessee, AO found various discrepancies in them that has an effect of increasing of the profits of the eligible undertakings. The facts brought out by the AO for concluding the books are not reliable are discussed in para 2.3 of the assessment order and the same are extracted below.

2.3

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Wrong allocation of Manpower costs:

2.3.1 It was also noticed in the Profit and Loss account submitted for the STP units that the total salary, wages, etc. For the two units amounted to Rs.4.65 crores out of which only 45.7% amounting to 2.12 crores was allocated to the STP units and remaining was taken to the domestic business of the assessee. The assessee was, therefore, asked to explain this discrepancy and the basis of allocation of manpower costs to STP units.

2.3.2 In response the assessee has filed letter dt.26-2-2004 in which it was stated as under.

“The total expenditure on salaries and wages for both Chennai and Pune units are rs.465 lacs. As explained to you during the course of our hearings, in this financial year, in order to ensure a greater synergy and sharing of best business practices, etc., the domestic engineering group was also physically sitting along with export engineering group. The intention was to share the best practices between domestic and global engineering services. However, we were not very successful in this experiment, resulting in a large customer dissatisfaction issue, due to which this group was de-merged from F.Y.2001-02 onwards. In the financial accounting system for Salary, this group was given one common department code. In order to cope the expenses attributable for the export of services, we have identified the total man-hours that were billed by this group for both domestic and export services. The salary expenses pertaining to STP1 wee taken in this ratio. We have a primavera software package which is basically used for project scheduling and time tracking. Based on the primavera data, the man-hours attributable to STP1 were computed. The details are attached in Annexure VII.

While doing this, supervisory and idle time man-hours were not captured. Hence, the allocation of salary to the extent of this has been understated. We believe that idle time/supervisory man-hours are around 10% to 151% of the total man-hours available. Hence, it would be far to assume that the salary costs attributable to STP1 are understated to the extent of 15% and what should have got charged to STP1 was around 54% of the same, which translates approximately to Rs.38 lacs.”

2.3.3. It was thus admitted that salary cost to the extent of 15% was not allocated to STP units which amounted to approximately to Rs.38 lacs. Although, vide order sheet entry dt.17-2-2004, Shri Sowni had admitted that around 75% of the total salary cost would be a fair allocation to the STP units-difference working out to Rs.1.36 crores.

2.4 Wrong figures of man-hours taken:

2.4.1. The extract of data from Primavera Software for F.Y.2000-01 submitted by the assessee is as under.

	Total CEE employees (Incl. Contracts)	169
	Total available MH for per week	373490
	Billable MH for exports	177741
	Billable MH for domestic	150931
	Total Billable MH	3328672
	Non Billable MH	44666
	Non Billable – Default Activities	52
	Total Non Billable MH	44818

 2.4.2. From the above, it is seen that the total billable hours for exports were shown at 1,77,741 whereas in the profit and loss account for the STP units, thee hours were taken at 1,71,000 as per Note No.4. The other figures regarding the number of employees and total number of man hour were the same. It is thus noticed that the percentage of man hours spent on STP work for the cost allocation to STP units was understated in the profit and loss account at 45.7%. Vide order sheet entry dt. 11-3- 2004, Shri Sowani accepted that this was a mistake and by adopting the correct an hours as per primavera Software i.e. 1,77,741 hours, the salary cost allocable to the STP units would go up.

2.5. Wrong allocation of Hi Spec Salaries:

2.5.1. In Annexure II to the profit and loss account of the STP Pune units, it is seen that the salaries relating to employees working on High Spec jobs amounting to Rs. 31,57,109 were also divided between the STP units and domestic business in the ratio 45.7% to 54.3%. The assessee was asked why this salary cost was apportioned when the employees relating to the High Spec jobs were engaged only for the STP units and not for the domestic business of the assessee in response, vide letter dt.10-3-2004, the assessee admitted the mistake and stated as under.

“In the salary and wages grouping, the total High Specs salary cost is Rs.31.57 lacs. Erroneously, this amount has also got apportioned at 45.7% only to the STP unit. The entire amount needs to be charged to the STP unit and as such, the different of Rs.17.14 lacs needs to be further debited to the STP profit and Loss account.” It is thus admitted by the assessee that the STP profits are over stated by Rs.17.14 lacs.

2.6 Wrong claim of exemption u/s 10A for profit on reimbursement of travel expenses.

Vide letter dt.26-2-2004, the assessee has submitted detailed revenue breakup of the STP units for A.Y.2001-02. In this it is noticed that the revenue of Rs.17.10 crores includes a sum of Rs.54 lacs by way of “Debit Note”. Vide order sheet entry dt.4-3-2004, it was explained by Shri Sowani that this represented the discount given by the travel agent on the foreign travel undertaken by the employees of the company, which was fully reimbursed by Honeywell Inc. At the original bill price of the travel agent. However, by letter dt.10-3-204, it as submitted as under.

“In our submission dt.26-2-2004, we had stated that the amount of Rs.54 lacs is received towards the reimbursement of expenses and included in the total revenue. As explained to you, the debt notes for reimbursements are raised by us completion of individual tours as of 31st arch every year. There are unfinished tours for which debit notes are not raised as a matter of consistent accounting practice. The company treats the expenditure as costs incurred and does not classify such cots as pre-paid expenses. In the subsequent year when the debt notes are raised, the income gets accounted. This phenomena does not result in any excess income/costs in any particular year as this happens every year and the same practice is followed consistently every year.”

2.6.2. It was thus claimed that the sum of R.54 lacs was not a discount given by the travel agent as explained earlier, but it represented he difference between the ravel costs debited to the STP Profit and Loss A/c and the reimbursements credited. Thus, it as the excess of reimbursements over the travel costs incurred by the company for the year. It was a profit relating to the STP unit but it was not a profit derived by the undertaking from the export of computer software for which exemption u/s 10A is available. In other words, exemption on his profit was not allowable u/s 10A as it is not derived from the export of computer software. Shri Sowani accepted this fact vide order sheet entry dt.11-3-2004. Consequently, the profit allowable for exemption u/s 10A for the year would get reduced by Rs.54 lacs.

2.7 No allocation of Learning and Development expenses:

In the Compensation revision Proposal submitted by the assessee to Honeywell Inc. on Page No.3, it is seen that the assessee company has claimed that “to continue delivering greater value to Honeywell, Tata Honeywell has been investing considerably on learning and development and continuous skills upgradation.” A bar graph on the same page showed approximately 975 an days spent on “learning and development”. However, in the Profit and Loss account relating to STP units, no costs relating to learning and development have been debited/allocated. Vide order sheet entry dt.4-3-204, Shri Sowani accepted that “learning and development” costs have not been allocated to the STP units which was a mistake. Vide order sheet entry dt.11-3-2004, it was stated by Shri Sowani that approximate learning and development costs allocable to the STP units would be Rs. 6.52 lacs out of Rs.56.57 lacs of learning and development expenses incurred for the entire company. This allocation is in the ratio of manpower employed in the STP units to the total man power employed in the company, which is 98 out of 850. Thus, the STP profits would come down further by Rs.6.52 lacs.

2.8. No allocation of manpower costs towards “Sale Through Physical”.

In the detailed revenue breakup submitted by the assessee vide letter dt.26-2-2004, it is seen that out of the total revenue of Rs.17.10 crores, revenue of Rs.27 lacs is due to “Sale through Physical”. Against this sale no manpower costs have been allocated as the number of hours taken for allocation were based on the offshore and on-site work only. Vide order sheet entry dt.11-3-2004, Shri Sowani accepted that some salary/manpower cost should further be allocated to the STP Units against the “Sale through Physical”, the quantification of which was not possible at this stage. It is similarly seen that the manpower costs relating to the NODCO sales of Rs.1.79 crores and “others” Rs. 42 lacs, is similarly not been debited/allocated in the STP Profit and Loss account.

2.9 Discrepancy between Annual Reports to STP1 and P&L account:

As stated earlier, the assessee company in the “Compensation revision Proposal” submitted to Honeywell Inc. USA had stated the manpower costs incurred during F.Y.2001-02 to be 28.62% of the turnover, according to which, for the current turnover of 17.10 crores, the manpower costs should be approximately Rs.4.89 crores. However, the manpower costs shown in the Profit and Loss account, are at only Rs. 2.96 crores. In this connection, the assessee was asked to provide details of the information/periodical reports submitted by them to the Software Technology Parks of India, the governing body of the Government of India, running the scheme under which the assessee has claimed exemption u/s 10A. Copies of Annual Reports submitted by the company for the Pune unit and the Chennai Unit are annexed o the assessment order as Annexure – 3

2.9.2 In this Report, the wage bill (for export activity only) is stated to be as under.

Wage Bill ( for export activities only)

	STP Pune unit	Rs.438.69 lacs
	STP Chennai unit	Rs. 12.62 lacs
	Total	Rs. 511.31 lacs

2.9.3. It is thus seen from the Reports, which are duly certified by a Chartered Accountant, that the man-power costs relating to the “export Activities Only” are stated to be Rs. 5.11 cr for the current year against the manpower costs of Rs. 2.96 cr shown in the Profit and Loss account. This figure of Rs. 5.11 cr works out to 29.8% of Turnover, which tallies with the manpower costs of 28.62% stated by the assessee company Honeywell Inc. In the “Compensation Revision Proposal” referred to earlier….

2.9.4 In this connection, the assessee’s explanation was called for vide order sheet entry dt.4-3-204. In response, the assessee filed letter dt.10-3-2004, in which it is stated that:

“At the end of each financial year, a return in the prescribed format is submitted to the Software Technical Park of India, stating out certain details. The data for this return is complied from the accounting system. As explained to you, during the financial year 200-01, the entire engineering group was assigned one Business Unit Code in the accounting system. The total costs attributable to this Business Unit Code have been considered by the Chartered Accountant for the STP1 return. The mistake in the return has been that salary costs towards domestic engineering should have been excluded which was not done. As such, there is a difference between the Profit and Loss account and the STP1 return as in the former, only salary costs for export engineering has been taken into account.”

2.9.5. It is thus claimed that the wage bill or the manpower costs of the STP units has been wrongly reported to the Software Technology Park of India in the annual Returns submitted by the assessee company.

2.10. Allocation of manpower costs and no DTA Sales:

It is also noticed that the total Salaries and Wages shown in the Annexure II to the Profit and Loss account of the STP units, come to Rs.4.65 cr. Out of this only 45.7% has been allocated o the SATP units and remaining salary expenses have been allocated to the domestic business of he assessee company. It was stated by Shri Sowani that such an allocation has never been done n the past nor in future, after the A.Y.2001-02. In this connection, it is also seen that the STP units are required to be Custom Bonded and he sales made from the STP units in the domestic tariff area should be reported Software Technology parks of India. In the current F.Y. the assessee company has not reported any domestic tariff area sales to the Software technology parks of India.

2.11. Admission by the assessee company:

2.11.1. From all the above, it is seen that the assessee has admitted the following errors/mistakes with respect to the manpower costs allocated to the STP units:

	Sn	Particulars	Amount(Rs.)
	1.	Non allocation and Idle time and supervisory costs	38.0 lacs
	2.	Wrong adoption and billable man hours	8.38 lacs
	3.	Wrong allocation of High Specs salaries to Domestic TO	17.14 lacs
	4.	Wrong claim of exemption u/s 10A on profits due To excess reimbursement of travel expenses	54.0 lacs
	5.	No allocation of learning and development costs	6.52 lacs
	6.	No allocation of manpower costs towards “sale through physical”
		Total	124.04 lacs

 2.11.2 Thus, the assessee company has admitted to have allocated less expenses of STP units by Rs. 124.04 lacs or that exemption u/s 10A has been claimed excess to the extent of Rs. 124.04 lacs. Besides, the assessee company claimed o have reported wrong “Wage Bills” in their Annual Report to the STPI at Rs.5.11 crores against manpower cost of Rs. 2.96 cr shown in Profit & Loss account.

5. Thus, para 2.22 and its paragraphs indicate that there are mistakes in the books maintained by the assessee, who admitted the same during the assessment proceedings. The quantity of such inflation of the exempt profits is undisputedly kept by the AO at 124.04 lakhs. Thus, the AO rejected the books of accounts with which the assessee is now aggrieved before us and therefore, the first limb of the ground 1 of this appeal. We shall take up this ground 1, which has two limbs (i) rejection of the books and (ii) assessment of the correct and eligible profits of the STP units u/s 10A of the Act. The issue wise analysis and adjudication in the succeeding paragraphs.

6. Rejection of books of Accounts: On finding that the assessee has both domestic and exports segments, the AO compared the profit percentages of the both the segments and found that the profits margins of the export segments (STP unit) are exorbitantly high vis a-vis the domestic results. Consequently, the AO examined the books of accounts and made enquiries and found certain mistakes in the accounts of the assessee which led to the incorrect results of the profits of the STP units. These mistakes revolve around (i) non allocation of idle time/supervisory cost; (ii) wrong adoption of billable man hours; (iii) wrong allocation Hi Spec salaries; (iv) Learning & Development costs; (v) allocation of manpower costs towards sale through physical (vi) non consideration of the reimbursement of the expenses to the extent of Rs 54 lakhs etc. Thus, as per the AO, failure to make proper debit of the correct expenditure, the profits of the STP units are inflated. In response to the same, the assessee admitted the same and submitted that these mistakes are inadvertent and due to software deficiencies. Assessee made written submission in this regard as detailed in para 4.18 and 4.19 of the impugned order. These are extracted as under for completeness of the order. They are:

“4.18 Pursuant to the enquiry made by me regarding the manner in which the assessing officer came to ascertain the exact amounts of mistakes in the allocation of expenses and the causative factors thereof, following submissions have been filed before me in the course of appellate proceedings.

a. Non-allocation of idle tie/supervisory costs (page 5 of the assessment order, para 2.3)

In the Profit & Loss account of the STP unit, the salary cost was charged off at 45.7% of the total salary cost in proportion to the man hours worked for the STP unit, as in the financial accounting system, one common department code came to be allotted to the employees working for STP and non-STP units.

The working for the same as already placed before your Honours vide our submission dt.18th June 2004, page 9, is reproduced below.

	Particulars	Nos/Amount
	Total number of employees in Exports Department	169
	Total man-hours	3,73,490
	(8.5 hrs/days × 5 days/week x 52 weeks) Man hours worked for STP	1,71,000
	STP Man hours percentage to total Man hours	45.7

Accordingly, 15% idle/supervisory hours are added to the actual billed hours of 1,71,000 to arrive at total hours for the STP unit which is 1,96,650. The revised proportion of STP man hours to Total Man Hours is then 52.65% instead of 45.7% as reported in the Profit and Loss account. The said revised ratio in the order is accepted to be 54% on conservative basis. The total salary costs are Rs. 4.65 crores, out of which Rs. 2.12 crores were allocated to STP unit based on the original ratio of 45.7%. By applying the revised ratio of 54% the allocable salary would be 2.50 crores (i.e. Rs.4.65 crores × 54%) leading to an addition of Rs. 38 lacs ( Rs.2.50 crores les Rs.2.23 crores)

b. Wrong adoption of billable man-hours ( page No.6 of the assessment order, para 2.4)

The man hours considered for STP unit were 1,71,000, whereas man hours based on the Prima Vera software used for the purpose of tracking the man hours were 1,77,741 hours. Thus man hours considered short while allocating the salary were 6,741 hours. The salary allocated to STP unit is Rs.2.12 crores based on 1,71,000 hours worked for STP. The proportionate salary for additional 6,741 hours works out to Rs.8.38 lacs.

c. Wrong allocation of Hi Spec salaries (page 6 of the assessment order, para 2.5)

As explained in clause (a) above, the ratio of 45.7% was applied to the salary costs of the STP unit, as in the financial accounts the salaries of employees working for STP unit and non-STP unit came to be clubbed together. During the year under consideration, the Company had also provided high end services to its customers through Hi Spec division. The employees for this division were identified separately and their salary of Rs.31.57 lacs was considered in total salary correctly. However, while applying the proportion of 45.7%, the same was erroneously applied to the Hi Spec division’s salaries of Rs.31.57 which resulted into understatement of Hi Spec salaries by 54.3% (i.e. 100% less 45.7%) which resulted into lower cost allocation off Rs.17.14 lacs (i.e.311.57 lacs × 54.3%)

d. Learning & Development costs (page 8 of the assessment order, para 2.7)

Total learning and development costs during the year under consideration were Rs.556.57 lacs, which comprises of

	(i) Foreign Trainings Expenses	Rs.3.39 lacs
	(ii) Inland Training Expenses	Rs.53.18 lacs

As all training facilities/programs area arranged by one of the support departments, i.e. Human Resources and Administration, the accounting for the same does not happen separately for each business unit. As such these expenses were not captured in the profit & loss account. For the purpose of estimating the amount of learning & development expenses to be apportioned to the STP unit, the same is considered on an power basis. During the year under consideration, the total number of employees working for the Company are 850, out of which a list of 98 employees was placed before the assessing officer for employees working for STP unit. So, the entire learning & development expenses were bifurcated in the proportion of manpower, which amounted to Rs. 6.53 lacs.

e. Allocation of manpower costs towards “sale through physical” (page 8 of the assessment order, para 2.8)

In this regard it is submitted that the salary cost debited to Profit & Loss account as reported in Annexure – I enclosed herewith, is in excess of the excess of the actual salary costs of the employees working for the STP unit.

4.19 Regarding the alleged error concerning reimbursement of expenses of Rs.54 lacs it as submitted before the assessing officer as also before e that the Debit notes were raised during the year towards the reimbursable expenses which were incurred in A.Y.2000-01. It has been argued that since the profits of that year were diminished to this extent, the reimbursement claim credited to the profit & Loss account of the year under consideration should not be excluded from the eligible profits u/s 10A.”

7. Thus, the books of accounts of the assessee were audited and assessee followed a method of accounting i.e (a) Direct revenues and expenses are accounted on actual basis; (b) Common operating salaries are allocated in the ratio of man hours; (c) Facility Common expenses are allocated in the ratio of occupation of building area and (d) The other common expenses are apportioned in the ratio of turnover; (e) The AO did not find any defect in the method of accounting employed for drawing up the accounts. However, the AO did not accept the correctness of the accounts for the following reasons: (Refer para 2.11.1 / Pg10 , Para 2.9.1 / Pg 8 and Para 2.12.2 / Pg 11 of the assessment order). (a) Mistakes in the allocation of salary due to non- consideration of idle time, learning and development costs etc as discussed above. (b) The assessee had included an amount of Rs. 54 lacs, being the reimbursement of travel claims, as income of the undertaking in A Y 2001-02 though the same pertained to A Y 2000-01; (c) There were errors in the returns filed with the STP authorities, as stated by the AO; (d) The profit/costs percentage in the compensation revision proposal for F Y 2001-02 relevant to A Y 2002-03 was 40% as against profit ratio of 232.49% in A Y 2001-02. Finally, the AO invoked the provisions of section 145 of the Act. Aggrieved with the above, the assessee raised this issue before the CIT(A) and made various submissions. The case of the assessee in their own words on this issue are enlisted as under: (Para 4.18 Page 11/17, Para 4.19/Pg 13 of CIT(A) order are relevant.

(1)  The errors were caused due to inadvertent errors due to sheer human fallibilities in applying the allocation principles.

(2)  Regarding travel costs reimbursement of Rs. 54 lacs, it was urged that there was no dispute about the eligibility of exemption thereof; the only issue was that the though the claim was increased to that extent in A Y 2001-02, there was corresponding understatement of claim in A Y 2000-01. In other words, it was timing difference only.

(3)  Regarding the returns filed with the STP authorities, clarifications were provided to the CIT (A) as per paras 4.21 to 4.24 on page 14 of the order of CIT (A).

(4)  In particular, it was pointed out that the AO had erred in recording the finding that the salary costs had declined despite the increase in the number of employees, as clarified in para 20 on page 13 of the appellate order. The finding of the AO was incorrect as per the facts on record.

(5)  Regarding the dichotomy between the profits/costs percentage in the compensation revision proposal for F Y 2001-02 vis-a vis the actual numbers for that year, viz: A Y 2002-03, a reconciliation was provided to the CIT(A) explaining that the calculation in the revision proposal was based on gross costs without considering the reimbursements of expenses incurred in the course of rendering on-site services and further that the revenues were considered therein at USD 17 dollars per hour for standard services as against the actual revenue of USD 23.58 per hour. The CIT(A) was pleased to call for a remand report from the AO in respect of this explanation and the reconciliation is placed at page 28 of the paper book. The CIT(A) was pleased to record the finding in para 4.42 on page 22 of the appellate order that the AO did not find any flaw with the explanation filed.

8. On hearing above submissions of the assessee, the CIT(A) considered the same and held that the AO rightly invoked the provisions of section 145 of the Act. Relevant discussion is available in paragraph 4.43 of the impugned order of the CIT(A). From the said paragraphs, it is evident that the CIT(A) rejected the arguments relating inadvertence in view of the plethora of errors and discrepancies, which rendered the books unacceptable.

9. Aggrieved with the above order of the CIT(A), the assessee raised before us, this issue in the first limb of the ground 1 of this appeal. During the proceedings before us, Ld Counsel for the assessee made various submissions and in short they are:

(1)  The errors in the allocation of salary costs were mere 6.19% of the total claim for exemption.

(2)  Overstatement of claim of Rs 54 lacs towards reimbursement of salary costs was neutralised by understatement of claim by the corresponding amount in immediately preceding year.

(3)  In response to the queries raised by the Honourable Members in the course of the hearing, written clarifications dated 7th July, 2011 have been filed and placed on the records.

(4)  The nature and extent of errors are overwhelmingly suggestive of human fallibilities and the probability of inadvertence combined with the absence of allegation of fudging of accounts by the lower authorities should extricate the case of the assessee from the provisions of Section 145(3) of the Act.

(5)  The lower authorities have not refuted the correctness of the clarifications submitted in respect of STP returns and other related issues.

(6)  The AO did not find any flaw, in the course of remand proceedings, regarding the clarifications, explanations and reconciliation provided with reference to the alleged dichotomy between the profits/costs percentage as calculated in the compensation revision proposal for F Y 2001-02 vis-a-vis actual numbers for that year relevant to A Y 2002-03, as noted by the CIT (A).

(7)  The appellant is a public limited company quoted on the stock exchange whose accounts are audited by statutory auditors. The company has drawn up its accounts by adopting well recognised method of accounting and the accounting standards notified. In working out the claim for deduction u/s 10A some insignificant errors and that too regarding allocation of common expenses came to occur. The accounts of appellant company as a whole were complete and correct and there were no omissions in the said accounts. Provisions of Sec. 10A do not require maintenance of separate set of accounts and sub section 5 thereof only requires that the deduction claimed be certified. The working of profits of 10 A undertaking was based on the information culled out from the accounts maintained. The learned A.O. or CIT Appeals have nowhere stated that the accounts of the appellant company were incomplete and incorrect or that the appellant had not followed recognised method of accounting or accounting standards notified. In the light of the said facts the accounts of the appellant ought not to have been rejected. The book results being substantially accurate and complete, they should not be rejected; rather, the claim of the assessee should only be adjusted for the admitted errors. Reliance is placed on the principles laid down by the Supreme Court in the case of H M Essufali (90 ITR 271, 276). Reliance is also placed on the following precedents for the proposition that the book results should not be rejected on account of minor errors. Citation relied on are: Uttamchand Chuna Pathar Udyog– 65 ITD 460- Ra; Padmachand Ramgopal- 76 ITR 719- SC; Badshah Construction Company- 127 Taxman 153 (Indore)etc.

10. Per contra, Ld DR for the revenue relied heavily on the orders of the both AO and the CIT(A) and argued vehemently in favour of confirming the order of the CIT(A). Further, Ld DR made various submissions and they are: 1.The errors of allocation of expenses were not trivial; rather, they were horrible; 2. The profits from the taxable source of income were barely 2% of the costs as against 232% of costs in respect of exempt source of income; 3. The observations of the Supreme Court in the case of CST v. H M Esufali M. Abdulali [1973] 90 ITR 271 on which reliance is placed by the AR are out of context; 4. The finding of the Supreme Court in the case of H M Esufali M. Abdulali (supra) was against the assessee. Moreover, this finding was based on the transactions of just 19 days of the financial year which led to the rejection of the books of accounts which was confirmed by the Supreme Court. In other words, omission to enter the sales invoices of just 19 nineteen days led to the rejection of the books of account. Therefore, the plea of the assessee that the extent and effect of the errors were trivial which did not warrant rejection of the books of account was not acceptable; 5) The details (of reimbursements) were never filed before the A.O. during the course of assessment proceedings for A.Y. 2001-02 which is the lead year of investigation on the issue; 6) In the remand report (page 29 to 36 of the paper book filed by the assessee), the A.O submitted that the same cannot be treated as profit derived by the undertaking on which exemption/deduction u/s 10A of I.T.; 7) It is inconceivable that such a proposal was prepared and sent by the marketing department without the concurrence of account department in a reputed organization; 8) The learned CIT(A) has accepted the details filed before him on the issue but does not seem to have verified and adjudicated upon the issue; 9) The learned counsel of the assessee has also stated that since learned A.O. has not commented adversely in respect of reconciliation during the course of reassessment proceedings for A.Y. 1999-2000, it can be said that the A.O. has accepted the reconciliation in respect of debit notes. This argument has no basis as stand of the A.O. is always clear that debit notes do not represent income of the undertaking from export of articles or thing or computer software. Merely because the A.O. at any given point of time that too in a different assessment year has not commented adversely does not lead to the conclusion that he has accepted the reconciliation. The issue needs to be examined in totality and not on the basis of alleged silence of the AO in a different Assessment year; 10) It is not correct to state that only profit margin of revision statement being 40% on cost was considered by the A.O. while estimating the profit margin of cost plus 50% in the assessment order. In this regard para 2.12.6 of Page 13 of the Assessment Order may kindly be referred to. In the above quoted Para the AO has made the following remarks “It is thus seen that companies of good standing and repute engaged in similar work have been earning profit margin of 20-25% during A.Y. 2001-02 against the assessee claiming profit margin of approximately 70%.” The learned CIT(A) has also discussed the comparable two cases and has come to the finding that that the AO has already given heavy discount after discussing comparable cases and arriving at the profit of cost plus 50% in the Assessment Order. The concluding remark of the Ld. CIT(A) (last line on page 27) is worth mentioning which reads as under: “It is vitally important to consider that the Assessing officer has already given sufficient set off for reasons of high profit by restricting the profits @ 50% as against 20-25% in other comparable cases which is more than enough to take care of any reason given by assessee in general for earning higher profits. Such a heavy discount having already allowed by the Assessing Officer, in my opinion no further relief is deserved by the Appellant on this score.” Therefore, while deciding the issue besides examining the issue of reimbursable expenses finding on the issue of two comparable cases which also happen to be the basis for arriving at the profit margin of cost plus 50% by the AO and also approved by the learned CIT(A) is a must. Further, the submissions of Ld DR are as under:

  •  Books of accounts were rejected after finding a number of defects in allocation of various expenses which were intended to artificially inflate the exempted profit of the undertaking u/s 10A of the Act.

  •  The assessee had no option but to accept the defects.

  •  Once the defects in allocation to the tune of Rs.1.20 crores were noticed and admitted by the assessee the books of accounts automatically lost its sanctity.

  •  The learned counsel of the assessee states that the defects represented only 6% of total expenses and therefore, there was no reason for rejection of the books of accounts. He further submitted that the errors were unintended and it was not the case of the A.O that accounts were fudged or manipulated. He also submitted that these were arithmetical mistakes being of inadvertent nature.

  •  The submissions of the learned counsel are bereft of merit. The books of accounts of the assessee were audited and despite resource crunch and paucity of time the A.O was able to detect a number of defects in allocation of various expenses.

  •  The argument that the defect represented only 6 % of total amount and therefore trivial in nature is also needs to be rejected. In fact the defects are not trivial but horrible in nature. The learned counsel of the assessee is trying to trivialize the issue. In a blood test only 2 to 5 ml of blood sample is taken for analysis in a pathological laboratory in order to arrive at a conclusion. Entire blood of the body is not considered for analysis.

  •  Coming to the issue of mistake being inadvertent in nature, it is submitted that the learned counsel of the assessee could not throw any light on the issue despite repeated query of the Bench.

  •  As far as the contention of the learned counsel of the assessee that it is not the case of the A.O that the books of accounts were fudged or manipulated, it is submitted that there was no need to come to this type of conclusion by the A.O as he was concerned with verifying the correctness of allocation of various expenses between eligible and ineligible units. Therefore, the argument of the Learned AR is without any merit and needs to be rejected.

  •  Reliance on the decision of Hon’ble Apex court in the case of Commissioner of Sales tax v. H.M. Esufali H.M. Abdulali 90 ITR 271.

  •  The learned counsel of the assessee has strongly relied upon the observations of Hon’ble Apex court on Page 276 of the above quoted judgement which reads as under:

“Sometimes there may be innocent or trivial mistakes in the accounts maintained by the assessee. There may be even certain unintended or unimportant omissions in those accounts, but yet the accounts may be accepted as genuine and substantially correct.”

  •  The reliance on the above observation of Hon’ble Apex court is out of context and misplaced. The observations should be seen in the context in which it was made and then similarity of facts of the case should be clearly established before relying on the same. The Hon’ble Apex court in the case of Sun Engineering works 198 ITR 297(320) has made following remarks”

“It is neither desirable nor permissible to pick out a word or sentence. The decision takes colour from the question involved”

In this case exactly same has been done. Observations of the Hon’ble Apex court have been picked up out of context ignoring the subsequent paragraphs of the same judgment. In fact in the very same case the Hon’ble Apex court has approved the estimation of turnover for the entire year based upon evidence for 19 days only. In percentage term 19 days works out at 5.5 % of total 365 days in a year. The Hon’ble Apex court also awarded cost against the assessee. In fact the above quoted decision supports the case of the department.

Therefore, It is submitted that the there is no merit in the ground taken by the assessee. Strong reliance is also placed upon the order of A.O/CIT(A).

Submitted ……. “

11. Further, during the time of rebuttal, Ld assessee’s counsel filed the following issues wise replies to the issues raised by the DR in his arguments and the same are produced as under.

1. The errors of allocation of expenses were not trivial; rather, they were horrible.

Replies : The nature and effect of the errors should lead any authority to a fair and reasonable conclusion that they were caused by human fallibilities. Preponderance of probability weighs in favour of this conclusion rather than the proposition canvassed by the learned DR.

It is submitted that the appellant is a public limited company quoted on the stock exchange whose accounts are audited by statutory auditors. The company has drawn up its accounts by adopting well recognised method of accounting and the accounting standards notified. In working out the claim for deduction u/s 10A some insignificant errors and that too regarding allocation of common expenses came to occur. The accounts of appellant company as a whole were complete and correct and there were no omissions in the said accounts. Provisions of Sec. 10A do not require maintenance of separate set of accounts and sub section 5 thereof only requires that the deduction claimed be certified. The working of profits of 10 A undertaking was based on the information culled out from the accounts maintained. The learned A.O. or CIT Appeals have nowhere stated that the accounts of the appellant company were incomplete and incorrect or that the appellant had not followed recognised method of accounting or accounting standards notified. In the light of the said facts the accounts of the appellant ought not to have been rejected.

2. The profits from the taxable source of income were barely 2% of the costs as against 232% of costs in respect of exempt source of income.

Replies The reason for the percentage variation was explained to the CIT(A) and noted by him at para 4.11 on page 8 of the order. Moreover, the DR has not considered the relevant fact that in absolute terms, the book profits of the taxable sources of income were Rs 10.11 crores and those of the STP units were Rs 11.96 crores, as per page 3 of the paper book. The profits of STP undertakings were therefore not misaligned from the profits earned from taxable sources of income.

3. The observations of the Supreme Court in the case of H.M Esusufali (supra) on which reliance is placed by the AR are out of context.

Replies On the contrary, the observations of the Supreme Court are very much within the context. The Supreme Court was concerned with the conditions which empower the AO to make best judgement assessment. Even in the assessee’s case, this is precisely the issue. Without prejudice, even an obiter dicta pronounced by the Supreme Court is a binding precedent.

4. The finding of the Supreme Court in the case of H.M Esusufali (supra) was against the assessee. Moreover, this finding was based on the transactions of just 19 days of the financial year which led to the rejection of the books of accounts which was confirmed by the Supreme Court. In other words, omission to enter the sales invoices of just 19 nineteen days led to the rejection of the books of account. Therefore, the plea of the assessee that the extent and effect of the errors were trivial which did not warrant rejection of the books of account was not acceptable.

Replies

  a.  In the case decided by the Supreme Court, the flying squad of the sales tax department inspected the business premises of the assessee and found that sales invoices for a period of 19 days were not entered in the books of account.

  b.  The assessee, in that case, initially protested that the bill books did not belong to him but later admitted that that the sale invoices contained in the said bill books were not entered in the accounts.

  c.  Based on above, the authorities reached an uncontroverted finding that the assessee in that case had dealings outside the accounts and therefore, the accounts were rejected and finally, the Supreme Court confirmed this finding.

  d.  It is respectfully submitted that the facts of the case decided by the Supreme Court are materially distinct from the facts of the case before the Honourable Tribunal. By no stretch of imagination, the assessee could have contended, in that case, that the omissions in the accounts were unintended or unimportant. Admission of dealings outside the accounts can certainly not fall within these terms. However, the mistakes of allocation of expenses caused due to human failures do fall within the ambit of these terms used by the Supreme Court.

It is submitted that to place the facts in the present appeal of the assessee with the facts before the Supreme Court, on the same footing, will be grossly unfair and unreasonable.

(5) The details (of reimbursements) were never filed before the A.O. during the course of assessment proceedings for A.Y. 2001-02 which is the lead year of investigation on the issue.

Replies

 a.  The contention of the learned DR is contrary to the facts on the records.

 b.  The STP profit and loss account is at page 5 of the paper book which shows expenditure on selling, administration and other expenses of Rs 1,58,27,390. The break-up of this expenditure is at 7 of the paper book which clearly shows reimbursement of expenditure of Rs 2,28,92,718 from the gross expenses of Rs 3,87,20,108, resulting in the net charge of Rs 1,58,27,390. These accounts were already on the records of the AO which were also filed with the CIT(A).

 c.  Therefore, it is factually incorrect for the DR to aver that the details were never filed with the AO.

 d.  In the course of the remand proceedings before the AO, the copies of debit notes were filed only by way of corroborative material as noted by the AO in the remand report in para 4 which is placed at page 35 of the paper book.

Therefore, it is submitted the primary evidence was already on the records of the AO which was supplemented by corroborative material in the course of the remand proceedings. Even otherwise, the CIT(A) has provided cogent reasons for admission of additional evidence-if it is so regarded- in para 4.42 on page 22 of the appellate order read with para 4.37 of the appellate order.

(6) In the remand report (page 29 to 36 of the paper book filed by the assessee), the A.O ……….submitted that the same cannot be treated as profit derived by the undertaking on which exemption/deduction u/s 10A of I.T.

Replies

  a.  The learned DR has not noticed a specific clause no 4 in the service agreement which is on records at page 61 of the paper book.

  b.  This clause specifically provides that the assessee shall be reimbursed the expenses, at actual, incurred or arising out of the engineering services.

  c.  Without prejudice, the reimbursement of expenses is not of income character at all since it represents the recoupment of actual costs which reduce the expenses that are charged to the profit and loss account. The effect on the profits will be neutral in either case. Reliance in this behalf is placed on the decision of the Delhi High Court in the case of Perot Systems- 2010-TIOL- 672-HC-DEL-IT, a copy of which is enclosed herewith.

(7) It is inconceivable that such a proposal was prepared and sent by the marketing department without the concurrence of account department in a reputed organization.

Replies At the very initial stage before the AO the then CFO of the assessee company had made submission in writing that the compensation revision proposal was not validated or confirmed by the accounts department. Please see para 2.12.2 on page 11 of the assessment order.

(8) The learned CIT(A) has accepted the details filed before him on the issue but does not seem to have verified and adjudicated upon the issue.

Replies

Here again, the submission of the learned DR is not as per the finding on the records. In para 4.42 on page 22 of the appellate order, the learned CIT(A) has categorically rendered a finding that the Assessing Officer has not pointed out any flaw in the explanation of the appellant. In fact, this is the very grievance of the assessee that despite this finding, the learned CIT(A) rejected the case of the assessee.

(9) The learned counsel of the assessee has also stated that since learned A.O. has not commented adversely in respect of reconciliation during the course of reassessment proceedings for A.Y. 1999-2000, it can be said that the A.O. has accepted the reconciliation in respect of debit notes. This argument has no basis as stand of the A.O. is always clear that debit notes do not represent income of the undertaking from export of articles or thing or computer software. Merely because the A.O. at any given point of time that too in a different assessment year has not commented adversely does not lead to the conclusion that he has accepted the reconciliation. The issue needs to be examined in totality and not on the basis of alleged silence of the AO in a different Assessment year.

Replies

In fact, only because the AO did not render any finding on the reconciliation furnished by the assessee in the course of the proceedings for A Y 1999-00, the learned CIT(A) called upon the AO to submit the remand report of the AO in the course of the appellate proceedings for A Y 2001-02, as is evident from paras 4 and 5 of the requisition for remand report which is placed at pages 26 and 27 of the paper book.

Therefore, the submission of the leaned DR is not borne out from the records; indeed, the AO was accorded full opportunity to meet the contentions of the assessee.

(10) It is not correct to state that only profit margin of revision statement being 40% on cost was considered by the A.O. while estimating the profit margin of cost plus 50% in the assessment order. In this regard para 2.12.6 of Page 13 of the Assessment Order may kindly be referred to. In the above quoted Para the AO has made the following remarks “It is thus seen that companies of good standing and repute engaged in similar work have been earning profit margin of 20-25% during A.Y. 2001-02 against the assessee claiming profit margin of approximately 70%.” The learned CIT(A) has also discussed the comparable two cases and has come to the finding that that the AO has already given heavy discount after discussing comparable cases and arriving at the profit of cost plus 50% in the Assessment Order. The concluding remark of the Ld. CIT(A) (last line on page 27) is worth mentioning which reads as under: “It is vitally important to consider that the Assessing officer has already given sufficient set off for reasons of high profit by restricting the profits @ 50% as against 20-25% in other comparable cases which is more than enough to take care of any reason given by assessee in general for earning higher profits. Such a heavy discount having already allowed by the Assessing Officer, in my opinion no further relief is deserved by the Appellant on this score. Therefore, while deciding the issue besides examining the issue of reimbursable expenses finding on the issue of two comparable cases which also happen to be the basis for arriving at the profit margin of cost plus 50% by the AO and also approved by the learned CIT(A) is a must.

Replies

(a)  First, the concluding part of the contentions advanced by the learned DR need to be dealt with. It is respectfully submitted that the AO did not base his estimate on the profits of the alleged comparable cases. Rather, it needs specific emphasis that the AO based his estimate on the profit margin reflected in the flawed compensation revision proposal. Therefore, finding of the CIT(A) that the AO had given sufficient set-off with reference to the profit margins of comparable cases is contrary to the process of estimation employed by the AO.

(b)  Without prejudice, the flaws in the findings of the learned CIT(A), with respect, are as under.

(c)  The dissimilarities with the STP undertakings of the assessee with regard to functions, risks and resources employed have been brought on record as per pages 51 to 54 of the paper book. In particular, reference is invited to pages 53 and 54 of the paper book where the activity profiles of the alleged comparable cases of Wipro and Geometric Software are placed on the records. Both these enterprises are engaged in diverse activities whereas the assessee company is engaged in the limited segment of rendering engineering and designing services for industrial and building automation. There is neither any finding either by the AO or the CIT(A) nor any information has been provided by these enterprises in their responses to the AO pursuant to the enquiries conducted by him as to the amount of profits derived from the segment of activity, out of their diverse varieties of their activities, which could be fairly compared with the profits derived by the STP undertakings of the assessee which are engaged in the restricted activity field.

(d)  The CIT (A) has erred giving the finding in para 4.44 on page 24 of the appellate order that these dissimilarities cannot cause significant variations in the comparative profits. On the other hand, on the basis of settled principles applicable to theory of transfer pricing, such dissimilarities strike at the very root of the comparability and more so, when such fundamental differentials are also not amenable to compensatory adjustments.”

12. We have heard the parties and perused the orders of the revenue and the available papers before us. We have also perused the written submissions and the citations relied upon by both the parties. At the end, on this issue of invoking of the provisions of section 145 of the Act, we find that the case of the assessee’s counsel is that it is not a fit case for invoking of the said provisions and therefore, books should not have been rejected in this case considering the triviality of the errors etc. Thus, from the assessee’s point of view, the AO invalidly assumed jurisdiction u/s 145 of the Act and CIT(A) erred in confirming the same. On the other hand, the case of the revenue is that the books are not only incomplete but also inaccurate and thus the correct profits of the assessee/undertaking cannot be computed arrived at with the help of the books, which are full of mistakes. Therefore, it is a fit case for rejection u/s 145 of the Act. We need to sort out this deadlock and for this purpose, we have travelled to elucidate the scope of the provisions of section 145 of the Act. The amended provisions apply to this case and the said amended provisions read as under:

13. Section 145 relating to “Method of accounting’. Section 145 as applicable to AY 91-92 reads as under :

(1)  Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall be subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2)  The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.

(3)  Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where 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.

A. Sub-section and (3) above is same as the sub section (2) of the pre amended section 145 of the Income tax Act and it has following ingredients, namely: (a) AO being not satisfied about the correctness or completeness of the accounts of the assessee or assessee’s failure to to not to follow regularly the method of accounting/accounting standards; and (b) making of an assessment in the manner provided in section 145. The expressions the ‘correctness’ and ‘completeness’ of accounts are undefined here. Before analysing the expression i.e. (i) AO being not satisfied; (ii) the completeness of the accounts; (iii) correctness of the accounts’, it is necessary to elaborate on what constitutes the “accounts of the assessee” used in conjunction with the ‘correctness or completeness. The same has not been defined in the Act in that form. However, the Finance Act, 2001 introduced clause 12(A) of section 2 providing for an inclusive definition for “books or books of accounts”. The clause 12(1) reads as follows :-

“(12A) “Books or books of accounts includes” ledgers, day-books, cash books, account-books and other books, whether kept in written form or as print-outs of the data stored in a floppy, disc, tape or any other form of electromagnetic data storage device”.

B. The above definition provides the list of books to be kept and manner of keeping whether any print or electronic forms. The ‘day-books’ is not defined, nevertheless, it is in the common knowledge it refers to certain registrar’s to be maintained to contain the details of each day particulars with reference to raw materials received or issued or consumed or stock of raw materials remained in stores in respect of both manufacturing or/ and trading or any other day-to-day activities of the business. For this order, there is no need for explaining much on the definition of books of accounts as the present dispute in our opinion, relates to only on the completeness or correctness aspects. Therefore, we restrict the present discussion only on the meanings of expressions ‘correctness’ and “completeness” of assessee’s accounts.

C. Regarding the “completeness” of accounts, in our opinion, it not only refers to the list of the books of accounts to be maintained by the assessee as per the statute, but also to all the accounting entries for all the transaction done during the previous year. In other words, the failure of the assessee to maintain relevant registers or any other books described in the list “with all the transactions properly recorded in accordance with the set principles of accounting, makes the accounts of the assessee incomplete. Regarding the “correctness” of the accounts, in our opinion, it refers to the quality or accuracy or reliability of the accounts maintained by the assessee and it covers the reconcilable mistakes or errors in accounts. Thus, the completeness refers to list of books of accounts and entries therein and the accuracy refers to the quality/accuracy/reliability of the accounts of the assessee. Regarding the rejection of books of accounts, ‘accepting the books of accounts of the assessee is a rule and rejecting the same is an exception’. This is the principle in existence. In order to arrive at such conclusions by the AO, it must be shown that the AO has taken into consideration relevant factors and not omitted to consider the material before him.

14. In the light of the above scope of the provisions, we need to apply the above to the facts of the present case, where there is undisputed and excess mistakes in the accounts. It is a fact the said inaccuracy amounts to Rs 124.04 lakhs and works out to nearly 6% of the profits and the assessee describes the same as trivial and ignorable. Stand of revenue in this regard is that the AO has only to establish the inaccuracy in the books of accounts maintained by the assessee and the triviality of otherwise is not the issue. Further, they are of the view that the said supreme court judgment has not relevant to the post amended provisions of section 145 of the Act. Chronologically yes, it is true that the said judgment relates to the post amended period. The provisions are clear that in principle that the AO can assume jurisdiction u/s 145 of the Act either for the reasoning of the ‘incompleteness of the books or for the reasoning of the inaccuracy of the same. In the instant case, the inaccuracy is obvious and therefore, we have no problem in coming to the conclusion that the books are inaccurate. We have also considered the assessee’s argument whether the books can be reject for trivial inaccuracy as made out by the assessee with the help of the cited judgments. In our opinion, the said judgment does not relate the post amended period in time and amended provisions does not provide for any leverage to the quantify of inaccuracy in the books maintained by the assessee. Considering the fact that the AO has dug out multiple inaccuracies as detailed above, in our opinion, the assessee’s explanation has to be rejected and the impugned inaccuracies are unreasonable. Assessee must be careful in maintaining the books and the responsibility is more on the assessee when it has claimed exemption u/s 10A of the Act. What if the present is taken not taken up for the scrutiny u/s 143(2) of the Act? The assessee would have gone with the claim of higher and inflated exemptions u/s 10A of the Act. In alternative, if the present falls in the category of compulsory scrutiny, the assessee still guilty of not maintaining the books accurately. It is the law that the books can be rejected either for default of incomplete books or for inaccurate books. In our opinion, the triviality of the default is no excuse as per the amended provisions of section 145 of the Act. Further, the default, which is quantified to be around Rs 1.24 cr in our opinion, cannot described trivial in this case as it is the case of exemption u/s 10A of the Act and the assessee is expected to be extremely responsible in matters of maintenance of the books of such exempt undertakings. Without going into the reasons, whether bona fide or otherwise, we are of the considered opinion, the AO has rightly rejected the books as per the provisions of section 145(3) of the Act. Accordingly the relevant grounds of the appeal are dismissed.

Issue of Estimation of Profits of the STP Units

15. In the preceding paragraphs, we have upheld the AO’s decision in rejecting the books of the accounts for the detailed reasons mentioned therein. That leaves the issue of the ‘best judgment’ assessment in the manner prescribed in section 144 of the Act. At the end of the assessment, the AO held that only the sum of Rs 5,69,99,894/- is the allowable profits and the same is eligible for exemption u/s 10A of the Act. Otherwise claim of the assessee is Rs 11,95,79,294/-. The difference, being Rs 6,25,79,400/- is disallowed and added to the total income returned for the AY 2001-02. Whereas, for the AY 2002-03, the assessee’s claim of exemption u/s 10A is Rs 15.41 cr (rounded off) and the AO restricted the exemption claim to Rs 8.51 cr only. It resulted in making addition of Rs 6.9 cr for the AY 2002-03. Both these additions are contested by the assessee before us now. Assessee is aggrieved with the same and it is the second limb of the first concise ground. During the assessment proceedings, the AO having rejected the books of account asked the assessee to justify the very profit percentages of the STP units, whose profits are exempt u/s 10A of the Act. Referring to the profits percentages of exempt and non exempt units of the assessee for the relevant period, AO observed that the profit percentage of the STP units is 232.49% i.e. very high, whereas the profit percentage of domestic units of 2.31%. Further, AO not only referred to the blatant mistakes in arriving at the said huge profit percentages of the STP units but also referred to the Compensation Revision Proposal (CRP) submitted by the assessee himself to the Honeywell Inc, USA, an alliance partner. The CRP indicates that the profit margin @ 40% over the costs and the impugned STP units are prominently meant for this alliance partner of the assessee. The following tables confirm the above positions.

Table showing turnover & profits of various unit (Rs. In cr)

	Domestic	STP Unit	Total
Turnover	258.80	17.09	Rs 275.89
Profits as per computation of income	5.41	11.95	Rs 17.36
Percentage of profit on sales	2.09%	69.92%	6.29%
Percentage of profit on cost	2.13%	232.49%	6.71%

 Table showing profit margin @ 40% on the cost vide the CRP

Particulars	Costs -CRP	Cost -P&L A/c for FY 00-01
Sale	100%	100%
Total cost	74.53%	30.04%
Profit Margin @ 40% on cost	28.556%	69.96%
Total	100%	100%

16. AO asked the assessee to justify the above claims of the assessee and proposal to adopt the profit margins as per the CRP. In response, assessee contended that that the (i) the figures of CRP are supplied by the Marketing Department unconfirmed by the Finance& Accounts Department and therefore, they are not correct and credible figures; and (ii) CRP is meant for FY 2001-02 and not for the year under consideration. Further, the AO asked the assessee to confirm the cost analysis leading to 232.49% margin of the STP units. In response, the assessee filed the following response, i.e. “we confirm and reiterate that, as stated vide our submission dt 26.2.2004, the estimation given by our Marking Dept was incorrect and should not be treated as the base for financial year 2000-01”. Thus, the AO came to the conclusion that the said book results of the assessee are not credible and assessee has explanation to justify the same. Further, he came to the conclusion that the figures in the CRP are actual and not mere estimates as contended by the assessee. AO reasoned that the assessee, the alliance partner of such repute shall not submit the CRP in casual manner too. Further, the AO collected the book results of the comparable companies i.e. Wipro Technologies Ltd and Geometric Software Ltd and concluded that their profit margins vary from 20-25% only against the profit margin of 69.96%.

17.  Thus the AO considered the incongruous profit margins of various segments of the assessee i.e. domestic and STP unnits cum the high pitched margins of the STP units on one side and the lower profit margins of the comparable cases i.e. Wipro and Geometric Software companies on the other and rejected the book results of the assessee. Resultantly, keeping in tune with the provisions of section 145(3) of the Act the AO assumed the powers of the best judgment assessment and proceeded to in principle rely on the contents of the CRP. Thus, the AO is of the opinion that the estimation of the profit of the STP units @ 50% of the cost is proper. Relevant discussion is given in para 2.12 of the order of the AO and para 2.12.6 to 2.12.9 are reproduced as under:

“2.12.6 It is thus seen that companies of good standing and repute engaged in similar work have been earning profit margin of 20-25% during the AY 2001-02 against the assessee claiming profit margin of approximately 70%.

2.12.7 In view of the number of defects found and admitted by the assessee in the calculation of profits of the STP units and the exemption claimed under section 10A as reported in the CRP, the book results are rejected u/s 145(3) of the I T Act, 1961 and the income earned by the STP units is calculated as under:

	STP Turnover	17,09,99,684/-
	Profit estimated @ 50% of Cost:	5,69,99,894/-

 2.12.8 Profit as a percentage of cost is taken at 50% instead of 40% reported for AY 2002-03, allowing for a 10 percentage point variation in favour of the assessee. This is on the premise of increase in cost over successive years.

2.12.9 Thus the exemption u/s 10A is allowable at 5,69,99,894/- as against Rs 11,95,79,294/- claimed in the return of income. The difference, being Rs 6,25,79,400/- is disallowed and added to the total income returned. “

Thus, the AO made addition of Rs 6,25,79,400/- with which the assessee is aggrieved and filed an appeal before the CIT(A).

18. Assessee submitted that the profit margins of domestic and STP segments are incomparable as they are of different business activities and the turnovers. Further, the assessee argued that the AO failed to find any specific conceptual defects in the method adopted by the assessee in computing the profits of the STP units. Assessee further mentioned that the mistakes if any in allocation of expenditure amounts to only Rs 1.24 crores which is negligible. Further, the assessee found fault with the AO decision to rely on the so called comparable i.e. Wipro and Geometric Software companies and attempted to demonstrate that they are incomparable Para 4.44 to 4.48 of the impugned order are relevant.

19. Attempting to bridge the gap between the figures of CRP and the book results, the assessee submitted for factoring the same and mentioned that the AO failed to consider the amounts involved in the ‘reimbursement of expenditure’. Assessee got reimbursement of the expenditure amounting Rs. 2.29 cr incurred on their employees’ travel abroad. Of course, the said figure should be Rs. 54 lakhs for the AY under consideration as per the AO vide discussion on page 7 of the AO’s order. Actually, the assessee submitted additional evidence relating the said ‘debit notes’ relating to the said reimbursement of expenditure before the CIT(A) and the AO opposed the admission of the same in the remand proceedings. As per the AO the provisions of rule 46A does not permit admission of such additional evidence. On the other hand, the case of the assessee is that there is no role of 46A and it is merely a case of other explanation before the CIT(A) and pleaded for considering the said debit notes during the first appellate proceedings. As per the assessee, if these debit notes are considered, there will be hardly any difference between the CRP figures and the book results. As per the assessee, if these debit notes are to be factored in the working made by the Marketing division, the dichotomy between the profit margin worked out by it and that as per the P & L account of STP undertakings will be narrowed down considerably.

20. At the end of the first appellate proceedings, vide the para 4.42 of his order, the CIT(A) came to the conclusion that the impugned ‘debit notes’, the additional evidence must be admitted. Regarding the comparables of Wipro and Geometric software companies, as stated in para 4.44, CIT(A) was not satisfied with the explanation of the assessee and held that the assessee’s explanation in inconclusive in proving the variation of profits ie 20-25% of the comparables vis avis assessee’s 70% (rounded off). In the process, the CIT(A) rejected the hyper technical approach of the assessee in arguing in favour for the incomparability of the said cases to that of the assessee. Otherwise, the assessee’s submissions revolve around the ‘domain expertise’ of the STP units and therefore, higher profits of the STP units was also rejected by the CIT(A) holding that the assessee failed to demonstrate the same conclusively. Finally, the CIT(A) held that the AO is reasonable in granting relief of 10% over and above 40% proposed in the CRP of the assessee. Such huge discount already allowed by the AO, the CIT(A) refused to grant further relief to the assessee and at the end of the first appellate proceedings, the CIT(A) confirmed the disallowance of Rs 6,25,79,400/-. Aggrieved with the same, the assessee is in the appeal before us.

21. During the proceedings before us, Ld counsel for the assessee elaborately detailed all the arguments that were taken before the lower authorities and prayed that the book results must be accepted without any amendment. The written submission on the issue of estimation is reproduced as under:

Estimation of Income Exempt Under Section 10a

1)

**

**

**

(2) The submissions, in this behalf, are as under:

 (a)  The profit ratio of 40% of F Y 2001-02 stated in the compensation revision proposal is reconciled with the actual profits at 195% of costs for that year as per the finding of the CIT(A) in paras 4.31 to 4.39 on pages 17 to 21 of the appellate order and in para 4.42 on page 22 of the appellate order read with the working of reconciliation at page 28 of the paper book.

 (b)  Therefore, the very basis of the estimate made by the AO has been revised consequent upon the remand report of the AO and the finding thereon by the CIT (A).

 (c)  Though the AO did not base the estimate on the profit ratios of the alleged comparable cases, out of abundant caution, the dissimilarities with the STP undertakings of the assessee with regard to functions, risks and resources employed have been brought on record as per pages 51 to 54 of the paper book. In particular, reference is invited to pages 53 and 54 of the paper book where the variegated activity profiles of the alleged comparable cases of WIPRO and Geometric Software are placed on the records as distinguished from the restricted activity of the assessee. There is neither any finding either by the AO or the CIT(A) nor any information has been provided by these enterprises in their responses to the AO pursuant to the enquiries conducted by him as to the profits earned by these enterprises from the activities similar to those performed by the assessee.

 (d)  The CIT (A) has erred giving the finding in para 4.44 on page 24 of the appellate order that these dissimilarities cannot cause significant variations in the comparative profits. On the other hand, on the basis of settled principles applicable to theory of transfer pricing, such dissimilarities strike at the very root of the comparability and more so, when such fundamental differentials are also not amenable to compensatory adjustments.

 (e)  On page 27 of the appellate order, the CIT(A) has referred to the provisions of 80 IA(8) read with section 10A(7) and held that the STP units of the assessee has earned much more than the ordinary. This finding of the CIT (A) is not tenable on the basis of the facts on record. First, the CIT(A) has omitted to consider that the invoicing rate for the general services rendered to HONEYWELL group, holding 40% of the paid up capital was same as that charged to an enterprise in TATA group- which is not associated with the HONEYWELL group- which also held 40% of the paid up capital of the assessee company. More pertinently, the revenues earned from HONEYWELL group are exempt under Section 10A whereas the revenues earned from TATA enterprise in India are taxable. These facts have been stated on page 10 of the appellate order. Second, it is demonstrably untenable to invoke the provisions of Section 10A(7) in the facts of the assessee’s case since it will be inconceivable to allege the motive to a shareholder, holding 40% stake in the capital, of transferring excessive profits to the investee company from which 60% will be for the benefit of the non-associate shareholders.

Revised estimate of the profitability based on the reconciled ratio of profits in the compensation revision proposal:

(a)  If the estimate of the profits, as per AO’s stand, is to be reworked based on the reconciled profitability of the compensation revision proposal, the result will be as under.

(b)  Page 28 of the paper book may be referred to where the profits/costs ratio of 40%, as per the compensation revision proposal, has been reconciled to the actual ratio of 195% (pre-correction ratio), relating to A Y 2002-03, after considering the reimbursement of expenses and the actual billing rate. However, it bears notice that the costs considered in the said reconciliation are before the correction of allocation of expenses considered in the accounts of STP units in A Y 2002-03, as clearly mentioned in column 4 of the chart at page 28 of the paper book.

(c)  Post correction, the profits/costs ratio stands revised downwards to 153%- from 195% -as stated by the AO in para 3.2.3 on page 5 of the assessment order for A Y 2002-03.

(d)  In the premise, therefore, the revised estimate of profits will work to 163% (153%+10%) of costs in A Y 2001-02 as against 232% claimed in return of income and 50% allowed by AO.

From the arguments of the assessee, profits at 40% over the cost works out to STP profits @ 153% for the AY 2002-03. Similarly, for the AY 2001-02, the revised profits will work out to 163% including the 10% allowed by the AO for this year.

22. Per contra, Ld DR for the revenue vehemently supported the estimations of the AO and prayed for confirming the order of the CIT(A). On the issue of ‘debit notes’, Ld DR made the following written submissions and they are extracted as under:

  •  The details were never filed before the A.O during the course of assessment proceedings for A.Y 2001-02 which is the lead year of investigation on the issue.

  •  The details were submitted before the learned CIT (A) as additional evidence which was admitted by him after obtaining the remand report of the A.O.

  •  In the remand report dated 6/11/2006 (page 29 to 36 of the paper book filed by the assessee), the A.O not only objected to admission of additional evidence but also submitted that that the same cannot be treated as profit derived by the undertaking on which exemption/ deduction u/s 10A of I.T.Act can be claimed.

  •  Section 10 A benefit is available to the undertaking on the profit and gains derived from the export of articles or thing or computer software.

  •  Claim of reimbursement by way of alleged debit notes amounting to Rs.2,28,92,718/- was over and above invoice price.( kindly refer 8th line on page 9 of CIT(A)’s order for A.Y 2001-02. This being so it cannot be said that it is in connection with installation of software which is the subject matter of export. In fact there is no connection between export invoice of software and reimbursement of expenses.

  •  Since reimbursement of expenses were over and above invoice rate the same cannot be considered for arriving at the profit margin based on billable man hours as stated on page 28 of the paper book filled by the assessee. In fact due to very same reasons reimbursement of expenses was not considered by the assessee while sending the revision proposal where profit was worked out at 40 % plus cost.

  •  It is inconceivable that such a proposal was prepared and sent by the marketing department without the concurrence of account department in a reputed organization. Therefore, the theory of debit notes over and above what has been considered by the A.O is nothing but an afterthought and needs to be rejected.

  •  The learned CIT (A) has accepted the details filed before him on the issue but does not seem to have verified and adjudicated upon the issue. Had he verified and accepted the reconciliation he would have also accepted the computation submitted by the assessee in respect of profit margin. Since CIT (A) has dismissed the appeal on merit too, it can be safely concluded that the Learned CIT (A) has rejected the reconciliation in respect of Profit Margin submitted by the assessee.

  •  The learned counsel of the assessee has also stated that since learned A.O has not commented adversely in respect of reconciliation during the course of reassessment proceedings for A.Y 1999-2000, it can be said that the A.O has accepted the reconciliation in respect of debit notes. This argument has no basis as stand of the A.O is always clear that debit notes do not represent income of the undertaking which can be said to be derived by the undertaking from export of articles or thing or computer software. Merely because the A.O at any given point of time that too in a different assessment year has not commented adversely does not lead to the conclusion that he has accepted the reconciliation. The issue needs to be examined in totality and not on the basis of alleged silence of the AO in a different Assessment year.

  •  Proposal made by the assessee to Honeywell Inc, USA for revision of the terms of alliance agreement was made in August 2002.However ,the proposal was based on actual financial numbers for F.Y 2001-02. In a best judgment assessment the A. O was perfectly justified in taking the profit margin being 40 % plus cost as one of the base.

  •  It is not correct to state that only profit margin of revision statement being 40% on cost was considered by the A.O while estimating the profit margin of cost plus 50% in the assessment order. In this regard para2.12.6 of page 13 of the Assessment Order may kindly be referred to. In the above quoted Para the A.O has made the following remarks “It is thus seen that companies of good standing and repute engaged in similar work have been earning profit margin of 20-25% during A.Y.2001-02 against the assessee claiming profit margin of approximately 70%.” The learned CIT (A) has also discussed the comparable two cases and has come to the finding that that the AO has already given heavy discount after discussing comparable cases and arriving at the profit of cost plus 50% in the Asstt. Order. The concluding remark of the Ld. CIT(A) (last line on page27)is worth mentioning which reads as under: “It is vitally important to consider that the Assessing officer has already given sufficient setoff for reasons of high profit by restricting the profits@ 50% as against 20-25 % in other comparable cases which is more than enough to take care of any reason given by assessee in general for earning higher profits. Such a heavy discount having already allowed by the Assessing officer, in my opinion no further relief is deserved by the Appellant on this score.

  •  Therefore, while deciding the issue besides examining the issue of reimbursable expenses finding on the issue of two comparable cases which also happen to be the basis for arriving at the profit margin of cost plus 50 % by the A.O and also approved by the learned CIT (A) is a must.

  •  Since reimbursements are claimed to be based on actual, there cannot be profit element and in order to arrive at the real profit of the undertaking eligible for benefit under section 10 A of the I.T.Act , the same needs to be excluded.

  •  Without prejudice to the above even if there is any profit element the same cannot be said to be profit derived by the undertaking and still needs to be excluded for the purpose of benefit u/s 10A.

  •  Profit margin @195% plus cost as claimed by the assessee on page 28 of paper book filed by the assessee and which is being requested to be considered by the learned counsel of the assessee is too high to be adopted in assessee’s case in view of comparative cases discussed by the A.O as well as revision proposal sent by the assessee itself.

  •  Strong reliance is placed on the order of A.O as well as CIT (A) on the issue.

  •  Therefore, in view of the above submissions and totality of facts it is submitted that the appeal of the assessee be dismissed for both the years. Submitted”

23. We have heard the parties and perused the orders of the revenue, papers available before us and the written submissions of the parties in the dispute. From the data tabulated in the preceding paragraphs for the AY 2001-02, we find that the turnover is 17.09 cr and profits works out to Rs 11.95 cr i.e. works out to 69.92%. Considering the cost as per the assessee, the % of profit of the STP units on Cost works out to 232.49%. Whereas the assessee’s data of the % of profit of the STP units on Cost work as per the CRP is only 40%. Further, the assessee’s rejected books advocates for 69.96% over the cost. However, rejecting above claims, the AO allowed the % of profit of the STP units on Cost at Rs 50% for the AY 2001-02. All these data worked out without considering the reimbursement of the expenditure, which is the subject matter of dispute before us. AO considered the comparable cases, which are other are not accepted by the assessee as comparables on many grounds. With regard to these ‘reimbursed expenses’, the case of the assessee is that if the same are considered the gap in the profits margins are greatly reconcilable and consequently, the unreconciled gap works out to negligible one and it should be ignored and consequently, the book results should be accepted. Further, the assessee is of view that the AO accepted the need for considering such ‘reimbursed expenditure’, which of course the DR rejects such an understanding of the assessee. Otherwise, the DR raised various submissions before us stating that these reimbursed expenditure has no profit component, these are outside the scope of the exemption provisions u/s 10A of the Act etc as extracted in the preceding paragraphs of this order. On the contrary, the assessee raised various other counter submissions and in favour of the assessee.

24. Thus, ground 1 has two limbs and first one relates to the validity of the invoking of the provisions of section 145 of the Act and we have upheld the decision of the AO in this regard. The second limb of the ground relates to the best judgment in the manner of the provision of section 144 of the Act. As per the revenue, profit percentage @ 232.49% is too high and they held that the % of profit of the STP units on COST @ 50% is reasonable. This is against the 40% as per the CRP made by the assessee during the AY 2002-03. Further, the AO relies on the comparable cases of Wipro and Geometric Software companies, of course, the CIT(A) summarily rejected without proper analysis or reasoning. Per contra, the case of the assessee is that the said comparable cases are in fact not comparable ones considering the services, product lines etc. Further, as per the assessee, the profit % of 232.49 has to be adjusted downwards, if the ‘reimbursement of expenditure’ is considered. In that case, the gap is reduced marginally. Considering the above divergent positions, we have perused the order of the CIT(A) and find that the same has not met various arguments of the assessee. Even during the proceedings before us, the parties have failed to demonstrate various aspect relating to the said reimbursements and its impact on the profit margin of Rs 232.49%. Thus, so far as the ‘reimbursed expenditure’ is concerned, we find there is lack of factual clarity. It is not clear why only Rs. 54 lakhs were mentioned n the books initially, which was subsequently revised to Rs. 2.29 crores. Why the ‘debit notes’ were available for only Rs. 2.09 cr against the claim of Rs. 2.29 cr? What exactly is the nature of these reimbursements and whether they are discounts allocated by the principle company to the STP units of the assessee or otherwise?. If they are not discounts which is in the nature of the profit, how they are profits, derived from the assessee’s eligible undertakings and eligible for exemption? CIT(A) has not attended to this part of the arguments raised before him despite the matter remanded by him to the assessing officer during the first appellate proceedings. What are the facts of these reimbursed expenditure, whether these reimbursements of the travel expenditure of the employee of the company have profit element, at all if such profits and if the answer is positive, if such profits, unrelated to the export activity per se, constitutes ‘profits and gains derived from the undertaking from the export of such article or things or computer software‘ and therefore eligible profits for claim of exemption u/s 10A of the Act etc. CIT(A) has not dealt with relevant submissions before rejection of the assessee’s submissions.

25. So far as the admission of the additional evidence is concerned, we find there is no error on part of the CIT(A) in both admitting, remanding and considering the same while deciding the issue. However, we object the order of the CIT(A) in his failure to reason out as to how such reimbursements are taken care of by the 10% set off allowed by the AO over above the profit @ 40% over the cost. His order is silent on this issue.

26. Therefore, on this issue of best judgment of the profits for both the AYs, in the interest of the justice and for want of fact on these impugned reimbursement expenditure, we are of the opinion, this limb of the ground must be set aside to the files of the AO for bringing factual clarity on (i) what are these reimbursements; (ii) if these reimbursements have profit elements at all; (iii) if there is profits element, if they fall in the scope of the provisions of section 10A of the Act; (iv) what is the role of these profits elements when comes to computation of profit% on the cost etc. (iv) there is no clarity on the profit margins of 69.96% over the cost vis a vis the profit margins of 232.49%, which is discussed in the preceding paragraphs. (v). In adopting the figure of 50% over the cost, neither of the revenue authorities has giving reason for granting the leverage of 10% over the 40% mentioned in the CRP in the best judgment assessment. What is the justification for the said 10% margin and for what it is given to the assessee? Will this margin granted by the AO quantitatively accounts for (i) the defects or inaccuracies found in the books or (ii) set off claims of ‘reimbursed expenditure’ of the assessee? Why this 10% of additional relief must be granted to the assessee, when AO has resorted to the cost plus profit principle? There is no convincing reply from the revenue before us. In alternative, the orders of the revenue are also deficient on the reasoning on these queries. Whether the principles of best judgment permit the AO grant such unjustified reliefs ignoring the principles of consistency? In that case, why the figures of the comparable cases ei Wipro and Geometric Software companies, were not considered after making reasonable adjustments based on the sound logic? Therefore, in our opinion, the AO and the CIT(A) have not done the best judgment in the manner provided in section 144 of the Act. There are large number of judicial precedents in operation on the issue of ‘best judgment’ referred to in section 144 of the Act. In principle, the best judgment does not mean wild and unreasonable estimations. The very expression ‘best judgment assessment’ imply the judgment of the AO and the said judgment must be supported by the material or data gathered by him for this purpose both from internal as well as the external sources. Thus, we can not approve the ‘best judgment assessment’ made by the AO and sustained by the CIT(A) in the present form. Therefore, we are of the considered opinion, the AO must make ‘best judgment assessment’ as per the manner provided in section 144 of the Act and for this we have decided to set aside the order of the CIT(A) for this limited purpose. It goes without saying that the AO must grant reasonable opportunity of being heard to the assessee. Assessee is directed to furnish any and every relevant information to advance his case for making of the best judgment as per the provisions of section 145(3) of the Act. CIT(A) is also directed to consider the existing supreme court judgment in the case of the Liberty India Ltd. v. CIT [2009] 317 ITR 218/183 Taxman 349. in the set aside proceedings at the time of deciding the issue relating to if the said reimbursed receipts constitutes ‘profits and gains derived from the undertaking from the export of such article or things or computer software’ ones and eligible for exemption u/s 10A of the Act. Accordingly, the second limb of the ground 1 relating to the best judgment assessments in both the appeals are set aside.

27. Ground 2 relates to allowing of the provision towards ‘leave encashment’. On facts, the assessee created a actuarial basis centric provision and AO did not allow the said claim in routine manner following his decision in earlier years. However, he ignored the fact that the CIT(A) have allowed the claim of the assessee in the appellate proceedings. During the first appellate proceedings, the assessee submitted that claim of the assessee was allowed consistently in favour of the assessee since ay1998-99 onwards as discussed in para 6.2 of the impugned order. However, in this year, CIT(A) confirmed the disallowance mechanically relying on the order of the AO. Para 6.3 is relevant.

28. During the proceedings before us, Ld Counsel for the assessee demonstrated that this addition is confirmed by the CIT(A) for the first time ignoring the fact of actuarial-basis-centric creation of the provision and the ruling Apex Court’s judgment in the case of Bharat Earth Movers Ltd. v. CIT [2000] 112 Taxman 61/245 ITR 428 SC. On the other hand, Ld DR relied on the order of the CIT(A). We have heard the parties on this issue and perused the relevant material on record. It is a fact that the assessee’s provision is created based on the actual method. The same is not disputed by the AO. AO and the CIT(A) have routinely distinguished the said apex court’s judgment. We have perused the said judgment and the apex court has on facts dealt with the issue of ‘leave encashment’ and upheld the case of the assessee and the following held portion is extracted as under.

“The law is settled. If the business liability has definitely arisen during the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a later date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty although the actual quantification may not be possible. If these requirements are satisfied, the liability is not a contingent one. The liability in presenti though it will be discharged at a future date. It does not made any difference, if the future date, the liability shall have to be discharged, is not certain.”

29. From the above, it is self-explanatory that the incurring of liability should be certain during the year and such liability should be capable of estimation with reasonable certainty. Actual method of estimation was accepted by the Apex Court as the capable one. Therefore, we find no reason to interfere with the claim of the assessee. Consequently, the decisions of the revenue authorities on this disallownce are reversed. Accordingly, the ground 2 of the assessee’s appeal for the AY 2001-02 is allowed.

30. Ground 3 of the appeal for the AY 2001-02 relates to the provisions of section 234D of the Act. The is common ground to the assessee’s appeal for the AY 2002-03. Assessee is of the opinion, the amended provisions of this section are applicable to the impugned AYs. On the other hand, the AO/ CIT(A) are of the view that they are operative from 1.6.2003 prospectively. Before us, both parties mentioned that the issue is now settled at the level of the Special Bench of the Tribunal Mumbai Bench in the case of ITO v. Ekta Promoters [2008] 113 ITD 79. We have heard the parties and perused the said citation and find that the ratio of the same covers the case under consideration. In view of the importance, the conclusion part of the said order is reproduced as under.

“Section 234D inserted in the Income tax Act, 61, by the Taxation Laws (Amendment) Act, 2003 w.e.f 1st June, 2003, being substantive in nature, has no retrospective effect, hence applicable from the AY 2004-05 only; interest u/s 234D is chargeable from the AY 2004-05 only and it could not be charged for earlier Assessment years even though regular assessments for such earlier assessment years are framed after 1st June, 2003 or refund is granted for those years after the said date.”

31. The decision is unambiguous in stating that the interest on the excess refund could not be charged for earlier Assessment years even though the regular assessments for earlier assessment years i.e. earlier to the AY 2004-05, are framed after 1st June, 2003 or the refund is granted for those years after the said date. The impugned AYs being 2001-02 and 2002-03 i.e. earlier to 2004-05, fall outside the scope of the provisions of section 234D of the Act and therefore, the AO is unjustified in levy of interest on the excess refund and hence the assessee is entitled to relief. Accordingly, the relevant grounds in both the appeals of the assessee are allowed.

32. In the result, both appeals of the assessee are partly allowed pro tanto.