Insignificant mistakes cannot justify rejection of books of accounts

ACIT Vs Sanjay Agrawal (ITAT Raipur)

Insignificant mistakes in the accounts cannot justify rejection of books of accounts of the assessee under Sec. 145(3) of the Act.

Facts- The case of the assessee was selected for scrutiny assessment u/s. 143(2). Accordingly, A.O directed the assessee to substantiate its claim for deduction of expenses under the various heads by producing its cash book a/w supporting bills and vouchers.

In fact, it was admitted by the assessee before the A.O that though the bills/vouchers supporting its claim for deduction of certain administrative expenses may not be as per the decorum and level of presentation which he would have expected, but for the said standalone reason the same could not be dubbed as unauthentic. However, the A.O was not persuaded to subscribe to the contentions advanced by the assessee.

Observing that the books of account of the assessee were not fully reliable for determining its correct profit from construction business the A.O triggered the provisions of Sec.145(3) of the Act and rejected its books of account. Although, it was observed by the A.O that the turnover of the assessee from construction business was more than the limit provided u/s. 44AD of the Act, however, considering the facts and circumstances of the case he estimated its income @ 8% of its gross receipts and vide his order passed u/s.143(3), dated 10.03.2016 assessed the same at Rs.10,71,67,261/-

Aggrieved, the assessee carried the matter in appeal before the CIT(Appeals). CIT(Appeals) on the basis of his aforesaid observations computed the business income of the assessee at Rs. 5,79,34,562/-. Being aggrieved, the matter is before the Tribunal.

Conclusion- Our aforesaid conviction that insignificant mistakes in accounts cannot lead to rejection of books of accounts u/s 145(3) is supported by the judgment of the Hon’ble Supreme Court in the case of CIT Vs. Padamchand Ramgopal (1970) 76 ITR 719 (SC). In its aforesaid order, it was, inter alia, observed by the Hon’ble Supreme Court that insignificant mistakes in the accounts cannot justify rejection of books of accounts of the assessee under Sec. 145(3) of the Act. Accordingly, in the backdrop of our aforesaid observations, we are of the considered view that in the absence of pointing out of any specific defect in the books of accounts of the asseseee there was no justification for the AO to have rejected the same by triggering the provisions of Sec. 145(3) of the Act. We, thus, in terms of our aforesaid observations and deliberations qua the facts involved in the case before us read in light of the aforementioned judicial pronouncements set-aside the rejection of the books of accounts of the assessee by the AO.

FULL TEXT OF THE ORDER OF ITAT RAIPUR

The present appeal filed by the department is directed against the order passed by the CIT(Appeals)-1, Raipur, dated 22.02.2018, which in turn arises from the order passed by the A.O under Sec.143(3) of the Income-tax Act, 1961 (in short ‘the Act’) dated 10.03.2016 for assessment year 2013-14. Also the assessee is before us as a cross-objector. Before us the Revenue has assailed the impugned order on the following grounds of appeal:

“1. Whether on points of law and on facts & circumstances of the case, the Ld. CIT(A) was justified in restricting the addition made on account of income computed @ 8% of gross receipt to 7% giving a significant relief to the assessee.

2. Whether on points of law and on facts & circumstances of the case, the Ld. CIT(A) was justified in allowed extra relief beyond the AO on account of bank interest & finance cost to Rs.2,36,58,670/- as a deduction out of the NP estimated.

3. Whether on points of law and on facts & circumstances of the case, the Ld. CIT(A) was justified in stating that the NP of 3.75% has been accepted for AY 2014­15 (page 9, last para, 10th line) when in reality the AO has estimated the NP @ 8% u/s 143(3), thus rendering the order of ld. CIT (A), perverse.”

4. The order of Ld. CIT(A) is erroneous both in law and on facts”.

5. Whether on points of law and facts & circumstances of the case, the Ld.CIT(A) was justified in giving a decision in favour of the assessee and against the revenue though there is no nexus between the conclusion of fact and primary fact upon which conclusion is based?

6. Any other ground that may be adduced at the time of hearing.”

On the other hand the assessee has objected to the order passed by the CIT (Appeals) on the following revised ground:

“1. On the facts and in the circumstances of the case, the learned AO has erred on facts and in law in rejecting the books of accounts of the assessee without pointing out specific defect, discrepancy or infirmity n the books of accounts or bills and vouchers and he Learned CIT(A) has erred in upholding the rejection of books of accounts and estimation of income, more particularly, when the Learned AO did not mention any specific instance of bogus claim of expenditure in the body of the assessment order.

Relief sought : It is prayed that the rejection of books of accounts by invoking Section 145 of the Income-tax Act, 1961 may kindly be held as bad in law, improper, illegal and consequential enhancement made to the total income by resorting to estimation may kindly be directed to be deleted..”

As the issue involved in the departments appeal and the cross-objection filed by the assessee are inextricably interlinked or in fact interwoven, therefore, the same are being take up and disposed off together.

2. Succinctly stated, the assessee firm which is engaged in the business of construction activities had filed its return of income for the assessment year 2013-14 on 29.09.2012, declaring an income of Rs.5,19,81,710/-. Subsequently, the case of the assessee was selected for scrutiny assessment u/s. 143(2) of the Act.

3. During the course of assessment proceedings, the A.O, inter-alia, directed the assessee to substantiate its claim for deduction of expenses under the various heads, viz. repair & maintenance, printing & stationary, travelling expenses, telephone expenses, office expenses and postage & telegram expenses by producing its cash book a/w supporting bills and vouchers. As is discernible from the assessment order, the assessee is stated to have not produced all the bills and vouchers before the A.O. In fact, it was admitted by the assessee before the A.O that though the bills/vouchers supporting its claim for deduction of certain administrative expenses i.e., printing & stationary expenses, office miscellaneous expenses, repairs & maintenance expenses and transport & hire charges may not be as per the decorum and level of presentation which he would have expected, but for the said standalone reason the same could not be dubbed as unauthentic. However, the A.O was not persuaded to subscribe to the contentions advanced by the assessee. Observing that the books of account of the assessee were not fully reliable for determining its correct profit from construction business the A.O triggered the provisions of Sec.145(3) of the Act and rejected its books of account. Although, it was observed by the A.O that the turnover of the assessee from construction business was more than the limit provided u/s. 44AD of the Act, however, considering the facts and circumstances of the case he estimated its income @ 8% of its gross receipts and vide his order passed u/s.143(3), dated 10.03.2016 assessed the same at Rs.10,71,67,261/-.

4. Aggrieved, the assessee carried the matter in appeal before the CIT(Appeals). It was observed by the CIT(Appeals) that the AO had rejected the audited books of accounts of the assessee on the basis of vague observations and without pointing out any substantial lapse which would have justified triggering of the provisions of Sec. 145(3) of the Act. It was noticed by the CIT (Appeals) that the assessment order suffered from certain contradictory observations of the AO, wherein, on the one hand she while framing the assessment had though observed that the books of account of the assessee were produced before her and were test checked, but then in contradiction of her own observation she had thereafter stated that the assessee was asked to produce its books of accounts alongwith vouchers to support its claim for deduction of expenses. It was further observed by the CIT(Appeals) that the AO had not only failed to point out any specific defect which would have justified the rejection of its books of accounts, but had also not stated as to on what basis the same were to be held as unreliable. Also the CIT(Appeals) was of the view that the claim of the assessee that its many supporting bills may not match with the decorum and level of presentation that would be expected by the AO would not have on such standalone basis formed a justifiable reason for rejection of its books of accounts. Apart from that, the CIT(Appeals) did not concur with the adoption of the Net profit rate @ 8% by the AO. It was observed by the CIT(Appeals) that the AO had not brought on record any data which would have justified taking of its Net profit rate @8% by her. Referring to the NP rates of the assessee for AY 2011-12 and AY 2014-15, the CIT(Appeals) was of the view that going by the rule of consistency the profit rate in the case of the assessee for the year under consideration could safely be taken @7% out of which deduction for depreciation, finance charges and partners remuneration and interest on capital may be further allowed. Accordingly, the CIT(Appeals) on the basis of his aforesaid observations computed the business income of the assessee at Rs. 5,79,34,562/-. For the sake of clarity the relevant observations of the CIT(Appeals) are culled out as under :

“2.3 Facts being as above, the AO has computed income of the assessee by adopting NP rate of 8 percent. There is no finding about the basis for adopting this rate. The books of account has been rejected whereas the assessee has maintained books of account and has got these audited. The books of accounts cannot be rejected unless a substantial lapse on the major point is found as a result of investigation made by the AO. In this case the AO has simply made vague observation. The AO has examined some bills and the assessee was asked to furnish list of those expenses where cash payment exceeded Rs.20000/-. In para-3 of the assessment order the AO first notes that books of account were produced, and some bills were examined by text check. In the very next para she writes that assessee was asked to produce books of account along with vouchers. The statements are contradictory. Let alone bringing out any specific ground, AO has not even mentioned that why are the books not reliable. Just because “many supporting bills may not match with the decorum and level of presentation” the books, of accounts cannot be rejected. After rejection of books when GP/NP is estimated by adopting a certain percentage it is the profit of business before taking into account the factors such as finance charges, depreciations, partners interest and remuneration etc. because these items do not depend on the business results. For the same level of business activities NP will be depended on the interest payment on loans and depreciation on assets. Thus the reasons that counts for relied that after adopting NP by estimate the AO should debit interest and depreciation as per records. Books are rejected because due to keeping the books of ‘account not properly the profits shown is not likely to be true profit. However, interest expenses, depreciation, interest and remuneration of partner cannot be changed or manipulated and even if books are not relatable the figures of interest is relatable to the amount of loan raised and is verifiable from records. Similarly depreciation can be relatable to the opening WDV, and any additions made during the year can be verified from bills. In the case of Shri Ram Jhanwar Lal Vs ITI 177 Taxman 135 Hon’ble Rajasthan High Court has set aside order of the ITAT denying the depreciation. The High Court has held that ;

“Coming to question No.3, a bare reading of the provisions of S. 44AD does show that according to the proviso to sub-s. (1) nothing in sub-s. (1) applies in cases where : gross receipts exceed more than Rs. 40 lakhs. It is not in” that in the present case, the said amount exceeds Rs. 40 lakhs, obviously therefore, s. 44AD, as such, is not applicable. So far as the permissibility of adopting principle underlying therein is concerned, no legal authority has been shown to support the proposition that in this manner the principle underlying therein can be adopted. May be, that the learned Tribunal claims to be adopting this practice, but then, in our view, in taxing statutes, such adopting the principle underlying other sections cannot be said to be permissible, and sooner the practice is stopped, the better. Thus, question N. 3 is answered in favour of the Revenue, and against the assessee, and it is held, that the Tribunal was not justified in adopting the principle underlying s. 44AD, when it was not applicable, as such. Rather all the Tribunals are directed to stop this practice forthwith, if they are still continuing.

Since the impugned judgment of the learned Tribunal proceeds on the basis of adopting the principle underlying s.44AD, and also declines allowances of depreciation, contrary to law, we are constrained to set aside the order of the Tribunal.”

AO has not brought on record any data on the basis of which she has adopted the rate of 8 percent. The best judgment assessment should be honest estimate and fair and should have a like nexus with available material (Brij Bhaushan Lal Padkumar Vs CIT 197 CTR 134 SC). The rate of profit cannot be estimated merely on assumptions and there has to be some relevance to the facts on records (CIT Vs Vijay Construction 213 CTR 105 All). In case of the assessee in the AY 2011-12 assessee has shown turnover of 90.79 crores and NP of Rs. 6.7 crores. This NP was obtained after deducting finance cost of Rs. 76,95,747/-, Dep. 90,64,457/- and partners interest and remuneration Rs. 1,41,60,702/-. In the next AY 14-15 on the assessee’s turnover of Rs. 67,09,09,545/- a NP of 3.75 percent has been accepted. In this result depreciation of Rs. 1,40,31,509 and partners interest & remuneration Rs. 2,53,59,397/- have been allowed. Thus, to maintain consistency and also looking to the fact that complete compliance was not made by the assessee I find the rate of 7 percent will meet the justice on which depreciation, finance charges and partners’ remuneration an should be allowed.

Taking these figures as per audited account the income of the assessee is computed as under: –

5. The Revenue being aggrieved with the order of the CIT(Appeals) has carried the matter in appeal before us.

6. We have heard the ld. authorized representatives of both the parties, perused the orders of the lower authorities and the material available on record, as well as considered the judicial pronouncements that have been pressed into service by the ld. AR in order to drive home his contentions. On a perusal of the assessment order, it transpires, that the AO had rejected the books of account of the assessee, for the reason that not only the assessee in the course of the assessment proceedings had failed to produce all the vouchers for verification before him, but also by stating that the bills/vouchers supporting its claim for deduction of certain administrative expenses, viz. printing and stationary, office misc. expenses, repair and maintenance expenses, transport and hire charges may not match the decorum and level of presentation to which the AO may be accustomed, had thus admitted to lack of maintenance of proper records. On appeal the CIT(appeals) though concurred with the assessee that the AO had rejected the books of accounts of the assessee without pointing out any specific defect in its books of accounts, but despite so observing he had proceeded with the estimation of its income and by drawing support from the NP rates of the assessee for AY 2011-12 and AY 2014-15, held a conviction that going by the rule of consistency the profit rate for the year under consideration could safely be taken @7% subject to a further deduction of depreciation, finance charges and partners remuneration and interest on capital.

7. We have deliberated at length on the issue in hand and concur with the specific observation of the CIT(Appeals) that the AO had rejected the books results of the assessee not on the basis of any substantial lapse in its books of account, but rather on the basis of vague observations that were recorded by him in the body of the assessment order. As observed by the CIT(Appeals), and rightly so, the AO had not only failed to point out any specific defect in the books of account of the assessee, but in fact had not even given any reason as to why the book results of the assessee were to be held as unreliable. Before proceeding any further we deem it fit to cull out the provisions of Section 145 of the Act which reads as under:

“(1). Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, 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 assesses 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 the method of accounting provided in sub-section (1) or accounting standards as  notified under sub-section (2), have not been regularly followed by the  assessee, the Assessing Officer may make an assessment in the manner provided in section 144.”

(emphasis supplied by us)

As can be gathered from a perusal of sub-section (3) of Sec. 145, the same as per the law as was available on the statute during the year under consideration contemplated three conditions on satisfaction of either of which rejection of books of accounts of the assessee with a consequential framing of assessment in the manner provided in Sec. 144 would get triggered, viz. (i). where the assessing officer is not satisfied about the correctness or completeness of the accounts of the assessee; or (ii). where the method of accounting i.e cash or mercantile system of accounting have not been regularly followed by the assessee; or (iii). where the accounting standards notified by the central government in the official gazette for any class of assesses or in respect of any class of income have not been regularly followed by the assessee. Now, in the present case before us it is not the case of the department that the assessee had failed to regularly follow a specified method of accounting or the notified accounting standards as a result whereof the rejection of its books of accounts would get triggered resulting into framing of the assessment in a manner specified under Sec. 144 of the Act. In fact, the AO had based the rejection of the books of accounts of the assessee for the reason that he was not satisfied with the correctness of its accounts. As observed by us hereinabove, a perusal of the assessment order reveals that the AO had rejected the books of accounts of the assessee for the reason that it had in the course of the assessment proceedings not only failed to produce all the vouchers for verification before him, but also by stating that the bills/vouchers supporting its claim for deduction of certain administrative expenses, viz. printing and stationary, office misc. expenses, repair and maintenance expenses, transport and hire charges may not match the decorum and level of presentation to which the AO may be accustomed, had thus in a way admitted to lack of maintenance of proper records. In our considered view, as observed by the CIT(Appeals), and rightly so, the AO had rejected the books results of the assessee not on the basis of any substantial lapse in its books of account, but rather on the basis of vague observations that were recorded by her in the body of the assessment order. As per the settled position of law, in case an AO is not satisfied about the correctness or completeness of the books of accounts, then, irrespective of whether the accounting methods or accounting standards are being regularly followed by the assessee, he is obligated to demonstrate that there exists serious defects in the maintenance of accounts as a result whereof the profits cannot be correctly deduced there from. However, as in the present case before us the AO while framing the assessment had not pointed out any specific defect in either the books of accounts, bills or vouchers of the assessee, thus, the same in our considered view would go to the very roots of the rejection of the books of accounts of the assessee by him. Our aforesaid conviction that in the absence of pointing out of any specific defect in the books of accounts of the assessee there would be no justification for the AO to reject the same is supported by the judgment of the Hon’ble High Court of Punjab & Haryana in the case of CIT Vs. Om Overseas (2009) 315 ITR 185 (P&H). In its aforesaid order the Hon’ble High Court while upholding the order of the Tribunal, had observed, that the rejection of the books of accounts of the assessee without pointing out any specific defect could not be sustained and had rightly been vacated by both the lower appellate authorities. Also a similar view had been taken by the Hon’ble High Court of Gujarat in the case of CIT Vs. Vikram Plastics & Ors. (1999) 239 ITR 161 (Guj). In its said order the Hon’ble High Court had upheld the order of the Tribunal which had set-aside the rejection of the books of accounts of the assessee for two fold reasons, viz. (i) that the AO had not pointed out any specific discrepancies or defects in the books of accounts of the assessee which were regularly being maintained; and (ii). that no material was brought on record by the AO which would establish that either the purchases or expenses were inflated or sales were suppressed. On a similar footing the Hon’ble High Court of Allahabad had in the case of Dr. Prabhu Dayal Yadav Vs. CIT (2018) 253 Taxman 191 (All) observed, that as the assessee had maintained his accounts and recorded his professional receipts and there was no evidence to doubt the correctness or completeness of his books of accounts, therefore, the rejection of the same was unsustainable in the eyes of law.

8. Adverting to observation of the AO that the assessee had in the course of the assessment proceedings not only failed to produce all the vouchers for verification before him, but also by stating that the bills/vouchers supporting its claim for deduction of certain administrative expenses, viz. printing and stationary, office misc. expenses, repair and maintenance expenses, transport and hire charges may not match the decorum and level of presentation to which the AO may be accustomed, had thus admitted to lack of maintenance of proper records, the same in our considered view is nothing better than a vague observation which by no means could have justified triggering the provisions of Sec. 145(3) of the Act for rejecting the books of accounts of the assessee. We, say so, for the reason that there is neither any whisper in the body of the assessment order of even a single instance of any such claim of expenditure of the assessee which is not found to be supported by corresponding bills/vouchers, nor is there any mention of any such bill/voucher which not being as per the expected decorum and level of precision could be dubbed as unauthentic or bogus. In sum and substance, though the AO had tried to justify the rejection of the books of accounts of the assessee for the reason that there was a lack of maintenance of proper records by the assessee, but except for his general observations there is nothing discernible from the records which would evidence pointing out of any specific defect in the books of accounts of the assessee which would render them unreliable for deducing its correct income. Apart from that, the mere fact that the bills/vouchers supporting the assessee’s claim for deduction of expenses not being as per the expected decorum and level of precision as would be expected by the AO, not being in the nature of a serious infirmity would not suffice for subjecting its book results to the rigors of Sec. 145(3) of the Act. Our aforesaid conviction that insignificant mistakes in accounts cannot lead to rejection of books of accounts u/s 145(3) is supported by the judgment of the Hon’ble Supreme Court in the case of CIT Vs. Padamchand Ramgopal (1970) 76 ITR 719 (SC). In its aforesaid order, it was, inter alia, observed by the Hon’ble Supreme Court that insignificant mistakes in the accounts cannot justify rejection of books of accounts of the assessee under Sec. 145(3) of the Act. Accordingly, in the backdrop of our aforesaid observations, we are of the considered view that in the absence of pointing out of any specific defect in the books of accounts of the asseseee there was no justification for the AO to have rejected the same by triggering the provisions of Sec. 145(3) of the Act. We, thus, in terms of our aforesaid observations and deliberations qua the facts involved in the case before us read in light of the aforementioned judicial pronouncements set-aside the rejection of the books of accounts of the assessee by the AO. Accordingly, the order of the CIT(Appeals) is modified in terms of our aforesaid observations and the addition to the extent sustained by him by embarking on the process of estimation of the income of the assessee is herein directed to be vacated.

9. Resultantly, the appeal filed by the revenue is dismissed while for the cross-objection of the assesssee is allowed in terms of our aforesaid observations.

Order pronounced in open court on 9t^h day of June, 2022.