Analysis on Rejection of book of accounts along with grounds and bases of addition allowable
Books of account of an assessee are a must for assessment proceedings. The Income Tax Act, 1961, The Income Tax Rules, 1962 contain elaborate provisions with respect to maintenance of books of account along with compliance of ICDS. The assessee as well as the Assessing Officer are bound to keep them in mind while completing their respective statutory duties in order to minimize rejection of books accounts and its consequences.
Section 145 of the Income Tax Act 1961, provides that income chargeable under the head “Profit & Gains of Business or Profession or Income from other sources“, subject to accounting standards as notified by the central government (i.e., Income Computation and Disclosure Standards or in short “ICDS”) shall be computed in accordance with either cash or mercantile system of accounting.
According to Section 2(12A) of the Income Tax Act, 1961, books or books of account, include ledgers, day-books, cash books, account-books and other books, whether kept in the written form or as electronic data. Section 145 does not specify any set of accounts to be maintained by an assessee. Also, Rule 6F of Income Tax Rules, 1962 prescribes certain set of books only for professionals and not for other assessees or businesses or traders.
In business or profession and in respect of income from other sources, the assessee is required to maintain certain accounts showing day to-day transactions either in cash or in mercantile system of accounting. The system of accounting adopted by the assessee for his dealing with outside world, say for public information would be adopted for the purpose of computing the profit or loss for tax purposes also. Section 145(1) Further, accounts are required to be audited and must be consistent with the chosen method.
Understanding Validity of Books Rejection on the bases of Landmark Judicial Judgements
Rules and Law has prescribed the methods, Yet the choice of selecting suitable method of accounting still remains with the assessee. The revenue cannot compel an assessee to adopt mercantile system of accounting. If the assessee chooses to adopt cash system under Section 56 of the Act, he cannot be assessed on the accrual basis. J.K Bankers case (supra)
Under Income Tax provisions, the Assessing officer has a discretionary power to reject books of account as assessed by an assessee and complete his assessment by “Best Judgment Assessment.” It is Assessing Officer’s duty to determine the method of accounting regularly employed by an assessee and assess the income, profit and loss in accordance with such method of accounting. Sub-section (3) of Section 143 empowers the Assessing Officer to make Best Judgment Assessment as provided under Section 144. There are three circumstances, which are –
As said above, the Assessing Officer has a discretionary power to reject books of account. The accounting method may be rejected by virtue of sub-Section (1) of Section 145. Further, books of account itself by virtue of said sub-section, read with Section 144 or under sub-section (3) of Section 143.
Instances of rejection of books of account –
Cases where Rejection was Justified
The Hon’ble Jharkhand High Court in Amitabh Construction (P.) Ltd. v. CIT (Addl.)  335 ITR 523/ 20 taxmann.om 385 held that where purchases are found not to be genuine, the books of account have been rejected rightly.
The Hon’ble Madras High Court in Abdul Khadar (P.) v. CIT 36 ITR 341 (sic.) held that presence of unexplained cash credits may justify rejection of books of account.
The Hon’ble Bombay High Court in Bastiram Narayandas v. CIT  210 ITR 438/74 Taxman 454 held that rejection of books of account justified under section 145 and best judgment assessment under section 144′ needed. As the the assessee, a manufacturer, has failed to produce relevant records of its day-to-day manufacture.
Cases where Rejection can be challenged
In Veeraiah Reddier v. CIT 385 ITR 152 (sic.) and Punjab Trading Co. Ltd. v. CIT  53 ITR 335 (Punj. & Har.), it was held that it is not for the assessee to prove that the method of accounting followed ought not to be rejected.
Before rejection of books of account, the Assessing Officer must record a clear finding that system of accounting followed by an assessee cannot deduce correct profit or income. Where the accounts are consistently maintained on a basis that has been accepted in the past and there is no material to indicate how it was defective the Assessing Officer cannot reject the books of account as per CIT v. Margadarshi Chit Funds (P.) Ltd.  155 ITR 442/ 19 Taxman 73 (AP).
Hon’ble Karnataka High Court, recently, in CIT v. Anil Kumar & Co.  386 ITR 702/67 taxmann.com 278 held that jurisdiction to estimate assessee’s income is not available when books of account have not been rejected.
The Hon’ble Supreme Court in CIT v. Padamchand Ramgopal  76 ITR 719 held that insignificant mistakes noticed in the books of account of one year, like one item of interest not brought into account or one item of receipt having been incorrectly recorded, cannot form the basis for rejection of books of account.
The Assessing Officer before resorting to reject books of account, is obliged to use his powers judicially without compromising on the principles of natural justice and also bring on record of material on which basis he concludes his assessment.
The Assessing Officer is required to analyse various other parameters which have the effect on the gross profit rate of the assessee for the relevant period, before drawing any conclusion on the merit of such claim. Thus in lines with that an case law favouring assess was passed, The Allahabad High Court, recently, in CIT v. Pashupati Nath Agro Food Products (P.) Ltd dated 4th May 2017 held that the Assessing Officer did not reject the books of account; it shows that the assessee has maintained the books of account as prescribed under Section 145 of the Act. If so, the Assessing Officer is not entitled to make any addition on account of sale of goods out of books or for investment in stock out of undisclosed sources.
The fall in G.P rate might be a symptom of malice with which the assesses account would be suffering. However, it is the duty of the Assessing Officer to pin point the malice and bring it out in the Assessment Order by marshalling the facts encompassing the same. In the case of low gross profit rate, there could be inflated purchases or unrecorded sales besides manipulation in the valuation of closing stock. Therefore, the Courts expect that the Assessing Officer shall bring on record specific defects in the books of account of the assessee before invoking the provisions of Section 145(3). The rejections of books of account simply on lower G.P rate in comparison to earlier years or with other assessees placed in similar circumstances would not suffice and will not stand the test of appeal.
ACIT, CIRCLE-11 (2) , KOLKATA VERSUS M/S. MACKINTOSH BURN LTD (VICE-VERSA) I.T.A. No.2139/KOL/2018, 1940/KOL/2018 held that : Audited books cannot be rejected in such a casual manner. Ad hoc disallowances are arbitrary and cannot be upheld.
However following observation are made by ITAT in this case
The assessee is a public sector company, audited by C&AG, Therefore, in view of the consistent accounting system followed by the assessee.
CIT(A) rejected the books of accounts. When the Assessing Officer has not rejected the books of accounts of the assessee, we find no proper reason recorded by the ld. CIT(A) for rejecting the books of accounts. No defects have been pointed out in the books of accounts, Such audited books cannot be rejected in such a casual manner.
Under the circumstances, we are of the considered opinion that the entire disallowance made by the Assessing Officer on the ground of cessation of unascertained liability as adhoc addition is made after rejecting which is not consistent with the law.
To enhance the effect of this judgement we can also refer the judgement of Akhtari Begum & Sons v. CIT  145 ITR 295/ 12 Taxman 79 (MP) where it was concluded that ,The Assessing Officer may consider to add certain omissions, defects, etc. Addition to an estimate of the gross receipts or only one of the additions depends on each case. Such addition may be based on estimate of turnover and profit rate or disallowance of claims, expenditure.
In conclusion we can denote that, The Assessing Officer before resorting to reject books of account, is obliged to use his powers judicially without compromising on the principles of natural justice and also bring on record of material on which basis he concludes his assessment and also determine an analytical methodology which is mathematically accurate and logically sound rather then making an adhoc /lump sum addition or disallowance in Income and expenditure of an assessee.