Additions not valid merely on the ground of fall in GP ratio, if books of account are accepted by AO

Brief Facts of the Case        

• Assessee, a partnership firm, was engaged in the business of manufacturing of enameled wire, submersible wire, bare copper wire etc.
• Assessee filed its return of income related to AY 2009-10 declaring gross loss of (-)3.65% against the total turnover of Rs.590703526/- with net loss of Rs.36385885/-
• Gross Profit ratio of assessee for immediately two preceding assessment years 2008-09 and 2007-08 was 5.48% and 5.47% respectively.
• AO computed income of the assessee estimating Gross profit at 3.65% (2/3^rd of preceding year GP) for the year under consideration as against the Gross loss of 3.65% and computed net taxable income at Rs.6755154/-.
• Aggrieved with the addition, assessee filed appeal with first appellate authority who has allowed the appeal and deleted the addition made by A.O.
• Aggrieve by order, Revenue is in appeal before the Tribunal.

Contention of Revenue

• Fall in rate of copper is not the acceptable reason for incurring loss.
• Monthly sales figure is higher than monthly purchase figure except in two months.
• Assessee was involved in sale –purchase of copper with its group concerns and has possibility of diversion of income.

Contention of Assessee

• Loss computed was mainly on account of continuous fall in the price of principal raw material i.e, copper which had an average cost of Rs.445 per kg at the beginning of the year and an average cost of Rs.233 per kg at the end of year.
• Heavy loss had been incurred on forward contract for purchase of copper too due to fall in prices at the time of delivery.
• Assessee is maintaining proper books of accounts based on actual state of affairs rather than any ad hoc G.P. rate basis. Besides accounts is duly audited u/s 44AB of I.T.Act. No books of account, records etc have been rejected by the A.O.
• Further records related to opening stock, purchase, sale and closing stock both quantity wise and amount wise is maintained which have furnished before A.O.
• Sale of Assessee increased in quantity from 1527065 Kgs to 1640902 Kgs but in value fell from Rs.644474892/- to Rs.590703526/- due to fall in price.
• A.O. has made the addition in an arbitrary manner without appreciating the fact of the case.

Held

• It is settled law that A.O. can-not make any addition based on estimated G.P., if the books of accounts have not been rejected by him.
• Assessee submitted a chart of monthly average rates prevailing at the London Metal Exchange , which shows that the average rate of April 2008 was USD 8684.93, which fell to USD 3717.00 in November 2008 and for the month of March 2009 was at USD 3749.75
• Loss incurred on forward contracts entered into for purchase of copper has also been verified with reference to the booking order placed and the corresponding purchase made.
• Observation of AO that profit may have been diverted to sister concerns is also found to be unsubstantiated as instances of sale of copper scrap are of different times of the year and prices are in accordance with prevailing market prices.
• Finding of the A.O. that monthly sales shows surplus over purchase inspite of fall in rate of copper ignores the value of opening and closing stock. Working of G.P. must necessarily take into account the opening and closing stock and direct expenses and not only be based on comparison of purchase price of raw material and sale prices of finished products.
• O. has based the addition entirely on fall in gross profit rate, without bringing any other material on record and without disputing the results. Mere fact that there was a less rate of gross profit declared by an assessee as compared to the previous years would not by itself be sufficient to justify the addition.
• After considering the evidences filed before Ld. CIT(A) regarding the continuous fall in the prices of copper, and after verifying the quantitative tally of consumption of raw material and manufacture of finished goods, the addition made on account of estimation of gross profit, has rightly been deleted by the Ld. CIT(A) and accordingly order of the Ld. CIT(A) was uphold .
• Appeal filed by revenue stands dismissed.

Compiled by CA G.M. Gupta