There are large number of decisions which say in unison that AO cannot estimate gross profit rate without rejection of books and without showing defects. In CIT v. Paradise Holidays  325 ITR 13 (Delhi), the hon’ble Delhi High Court has held that if accounts which are regularly maintained in the course of business and are duly audited, free from any qualification by the auditors, should normally be taken as correct unless there are adequate reasons to indicate that they are incorrect or unreliable. The onus is upon the Revenue to show that either the books of account maintained by the assessee were incorrect or incomplete or that the method of accounting adopted by him was such that true profits of the assessee cannot be deduced therefrom. For rejection of books of accounts, the AO is required to demonstrate specific defects in the books of accounts produced by the assessee and also as to how the books of accounts produced by the assessee is not giving clear picture of the profit earned from the business activity. In the absence of such finding, the books of accounts cannot be rejected and the addition cannot be sustained on the basis of such rejection of books of accounts. Even where the books are rejected, the discretion must be used by the AO judiciously. We also find considerable substance in the plea of the assessee for not indulging estimates of such whopping nature particularly when lesser net profit rates of 2.19% and 1.10% declared in A.Y. 2016-17 and A.Y. 2017-18 has been endorsed by the Revenue itself in regular assessments.
Hence, on giving due weightage to the peculiar facts and circumstances of the case, we find merit in the plea of the assessee for reversal of its consequent substitution by the actual income as per books as offered. Thus, we reverse the action of the lower authorities and restore the position of the assessee.
FULL TEXT OF THE ORDER OF ITAT RAIPUR
The captioned appeal has been filed at the instance of the assessee against the order of the Commissioner of Income Tax (Appeals)-I, Raipur (‘CIT(A)’ in short), dated 01.08.2016 arising in the assessment order dated 30.03.2015 passed by the Assessing Officer (AO) under s. 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2012-13.
2. The grounds of appeal raised by assessee read hereunder:
“1. On the facts and in the circumstances of the case, the Learned A.O has erred on facts and in law in determining the income from construction activities by applying 8% to enhanced gross contract receipts i.e. Rs. 102,71,69,868/-, ignoring the audited financial statements, without any basis which is wholly arbitrary and unjustified and the Learned CIT(A) has erred on facts and in law in confirming the said arbitrary estimation of income.
2. On the facts and in the circumstances of the case, the Learned A.O has erred on facts and in law in enhancing the Gross Receipts of the assessee from construction contracts by Rs.7,67,46,776/- i.e. from Rs.95,04,23,092/- to Rs.102,71,69,868/- merely on the basis of figures appearing in Form 26AS which is wholly arbitrary and unjustified and the Learned CIT(A) has erred on facts and in law in confirming the said enhancement of gross receipts.
3. Without prejudice to the above, on the facts and in the circumstances of the case, the Learned A.O has erred on facts and in law in making separate addition of Rs.99,90,703/- on account of interest and Rs.1,46,250/- on account of Miscellaneous Income already appearing in Profit & Loss A/c which is wholly arbitrary and unjustified and the Learned CIT(A) has erred on facts and in law in confirming the said enhancement to the total income.
4. Without prejudice to the above, on the facts and in the circumstances of the case, the Learned A.O has erred on facts and in law in not allowing deduction on account of depreciation allowance of Rs.94,17,716/- as prescribed by binding CBDT Circular No. 29D(XIX-14), dt. 31st Aug., 1965.
5. Without prejudice to the above, on the facts and in the circumstances of the case, the Learned A.O has erred on facts and in law in not allowing deduction of Rs. 1,27,17,564/- on account of Finance cost which is wholly arbitrary and unjustified and the Learned CIT(A) has erred on facts and in law in confirming the said enhancement to the total income.”
3. Briefly stated, the assessee is a partnership firm registered under the provisions of Indian Partnership Act, 1932 and its accounts have been audited under the provisions of Section 44AB of the Act. The assessee is engaged in civil and road construction work and filed the return of income for AY 2012-13 in question declaring total income at Rs.3,34,95,914/-. The case was selected for scrutiny through CASS. In response to the queries raised, the assessee attended the case from time-to-time and filed written submissions. Books of accounts were also produced and were test checked as per para 2 of the assessment order. The AO inter alia observed that the gross receipts declared by the assessee stands at Rs.95,04,23,092/-, interest on FDRs. Rs.99,90,703/- and miscellaneous income of Rs.1,46,250/- totaling to Rs. 96,05,60,045/-. On perusal of 26AS, it was found by the AO that gross receipt of the assessee was shown to be Rs. 1,02,87,55,059/-. Consequently, the assessee was asked to explain the difference and mis-match. In response, the assessee vide written submissions stated that the difference was due to deduction of TDS by the payer on advances which did not crystalize into income in the relevant financial year. The AO, however, did not agree with the explanation offered by the assessee in this regard and substituted the total receipt at Rs.1,02,71,69,868/- after granting deduction of interest income. The AO further applied net profit @8% on the aforesaid figure without rebuttal of the submissions of assessee and without citing any reasons whatsoever in its very brief and cryptic order. The income was eventually assessed at Rs.8,10,16,240/-.
4. Aggrieved by the substitution and adoption of receipts as appearing in Form 26AS in place of entries shown as per audited book and estimation of net profit thereon @ 8% discarding the book results, the assessee preferred the appeal before the CIT(A).
5. The CIT(A), however, was not persuaded by the submissions made by the assessee and sustained the addition without granting any relief by way of a brief and laconic order.
6. Further aggrieved, the assessee preferred appeal before the Tribunal on both the counts i.e. (i) substitution of gross receipts as per annual statement in Form 26AS generated by the department; & (ii) estimation of business income by applying @8% at net profit rate.
7. When the matter was called for hearing, the learned counsel for the assessee reiterated the facts submitted before the lower authorities and pointed out that the assessee firm is engaged in civil contract business as a Government Contractor carrying out construction work on behalf of the Government department and PSUs. In this background, the learned counsel firstly submitted that the difference in the gross receipts between the books of accounts and the annual statement of the department (26AS) is on account of timing difference in recognition of income.
7.1 The learned counsel pointed out that the assessee has recognized the income when the ‘right to receive’ the income has accrued to the assessee and the amount has become legally due to the assessee. The deductor/payer, on the other hand, deducts TDS on every payment either by way of advance or by way of final payment unconcerned with of its accrual as income in the hands of the deductee (assessee). It was submitted that mere receipt by way of advance would naturally be shown as liability of assessee and will be recognized as income only at the point of time when the income is accrued and due to the assessee in reality. The assessee is liable to return the advance if the work is not performed and thus cannot be recognized as income merely on the event of its inward receipts. The annual statement of the department, however captures all transactions of receipts where TDS has been deducted without recognising the factum of accrual of income. Notwithstanding receipt of money, the tax liability would arise in law only when the income has accrued in real sense in contrast to a mere receipt by way of advance which is only a contingent income till the time corresponding work is performed to the satisfaction of the corresponding party.
7.2 It was thus submitted that such difference would always arise in almost all cases of the assessees owing to the reasons of outstanding work remaining against the advances. To support such contention, the learned counsel submitted that past history would indicate that higher amount has been recognized in the books on account of such contract receipts whereas the actual receipts in these years as per Form 26AS were comparatively lesser following the ongoing accounting practices. The situation is disadvantageous to assessee. However, income has been recognized as and when advance of the earlier years materialized as income in the subsequent years. Page No. 492 of paper book-2 showing year-wise comparison of gross receipts as per books qua turnover as 26AS was referred to demonstrate the point in issue. Further, on facts, it was submitted with reference to page nos. 496 & 497 of paper book that when seen cumulatively for A.Y. 2011-12, 2012-13 & 2013-14, the income reported due to such policy has exceeded the income as per 26AS by Rs.12,92,345/- and thus action of assessee is prejudicial to him and not to the Revenue over a longer period. Similarly reference was made to elaborate submission made before CIT(A) in this regard. It was thus submitted that the amount received by way of advance would be reported in the year as income as and when the income accrues and becomes due as per accounting policy consistently followed and which is a perennial exercise. The accounts are audited and the amounts have been received from Government organizations which overriding fact should also be borne in mind.
7.3 It was next contended that the action of the AO in substituting the turnover would result in double taxation of the same income once in the year of advance received and later when the receipt is recognized as income on performance of work.
8. The learned DR for the Revenue, on the other hand, relied upon the action of the lower authorities.
9. It may be in a fitness of things to address the issue at this stage itself. The assessee has demonstrated on facts that as per the method of accounting adopted by him accrual of income is the key for it be a taxable event. Accrual of income depends on realization and conversion of advance to income as may be legally due to it on completion of corresponding work. The mismatch is thus continuing right from A.Y. 2004-05 onwards as demonstrated in the tabular statement. In the light of factual demonstration of the accounting practices adopted by the assessee where advance receipts are recognized as income on execution of work, accounts being audited, receipts from government companies, etc., we find the reasons for mismatch to be quite convincing and in sync with the accounting practices as well as ground realities prevailing in this regard.
9.1 When the doctrine of real income theory is applied, the income would accrue to an assessee only when the right to receive the income gets crystallized. Mere receipt of money by way of advance does not automatically become the income of the assessee per se without doing the work for which the money was received. What should be considered is whether the income was realistically materialized or resulted to the assessee or not. Income Tax is tax as real income unless the position stands altered by a deeming fiction in the Act.
9.2 We thus see force in the plea of the assessee and hence set aside and cancel the actions of the AO and CIT(A) on this score. The receipts/sales taken by the assessee as per books overrides the annual statement (26AS) and is thus restored.
10. Second issue relates to estimation of net profit by applying 8% of the contract receipts. The learned counsel for the assessee, at the outset, submitted that there is no justification whatsoever for estimation of income by applying @ 8% as net profit arbitrarily and without any logical basis disregarding actual book results. The learned counsel for the assessee pointed out that the books of accounts of the assessee are audited and produced before the AO. The AO himself averred that the books produced were also test checked. However, there is no reference of any defect in the books whatsoever. The AO has simply substituted the net profit @ 8% as against the actual profit declared by the assessee without citing any reason for dislodging the actual book results.
11. Adverting further, the learned counsel for the assessee pointed out that while estimating the net income from the business, the AO totally disregarded the book results and was largely influenced by the outcome of search assessment proceedings which were completed in the case of the assessee involving A.Ys. 2005-06 to 2011-12. In rebuttal, it was submitted that while net profit @ 8% was offered in search assessment, the same cannot be applied mechanically & perfunctorily. It was contended that every assessment year is independent and self-contained and hence book results of one year cannot be applied to the other year without showing specific defects. It was contended that it is elementary that dynamics of business gets influenced by variety of factors peculiar to a business as also demand and supply environment. The broad argument raised on behalf of the assessee are listed hereunder:
(i) The principles of res judicata do not apply to the income tax proceedings and each assessment is a separate assessment as held in several decisions including Bharat Sanchar Nigam Ltd. and another V. Union of India (2006) 282 ITR 273 (SC); ITO v. Murlidhar Bhagwan Das  52 ITR 335 (SC).
(ii) Even where the best judgment assessment is framed, the same is to be done on some reasonable basis and cannot be done in a vindictive manner. For this proposition, following decisions were referred and relied upon:
(a) State of Kerala vs. C. Velukuty (1966) 60 ITR 239 (SC);
(b) Brij Bhushan Lal Parduman Kumar Vs. CIT 1978 CTR (SC) 134;
(c) Dhakeswari Cotton Mills Ltd. vs. CIT (1954) 26 ITR 0775 (SC);
(d) State of Orissa vs. Maharaja Shri B. P. Singh Deo (1970) 76 ITR 690(S C);
(iii) The net profit rate does not remain static with mathematical precession and findings reached and conclusions drawn in any preceding assessment cannot be the sole basis for subsequent assessment. In support of this proposition, following decisions were referred and relied upon:
(a) CIT vs. Winner Constructions Pvt. Ltd. (2012) 81 CCH 0091 HC Del.;
(b) ITO vs. Shri Srawan Kumar Arora ITA No. 144/BLPR/2011 (Raipur Tribunal);
(c) ACIT vs. Ramesh Steel Industries ITA No. 145/BLPR/2011 (Raipur Tribunal)
(d) M/s Shri Shakti Minerals Industries vs. ACIT ITA No. 67/BLPR/2 011 of Raipur Tribunal;
(iv) The co-ordinate benches have, at times, estimated the net income in case of similarly placed other assessee engaged in similar business at a much lower rate than what has been applied by the AO in the present case, despite instances of palpable defects. Following decisions were referred and relied upon:
(a) DCIT vs. M/s. A. P. Nirman Ltd. ITA No.139/RPR/2015 order dated 08.03.2018 A.Y. 2010-11 NP rate estimated at 1.85%
(b) DCIT vs. Shri Rajesh Makhijani ITA No.355/RPR/2014 order dated 17.01.2018 A.Y. 2010-11 NP rate estimated at 3.50%
(c) DCIT vs. Shyam Infratech ITA No.388/RPR/2014 order dated 18.01.2018 A.Y. 2010-11 NP rate estimated at 2.75%
(d) M/s. G. N. Construction vs. ITO ITA No.270/RPR/2014 order dated 16.04.2018 A.Y. 2011-12 NP rate estimated at 3.30%
(v) The turnover of the assessee firm is far more than the turnover of the comparable cases cited above and therefore, the profitability in higher volume ordinarily is lower and the profits ordinarily diminish with the increase in the turnover.
(vi) The outcome of the subsequent assessment proceedings in the case of assessee would show that the returned income of the assesse was accepted by the AO in the scrutiny assessment completed under s.143(3) of the Act for A.Ys. 2016-17 and 2017-18 wherein the net profit rate after all deductions on account of partners’ remuneration and interests, depreciation and finance cost has been accepted at 2.19% in A.Y. 2016-17 and 1.10% in assessment of A.Y. 2017-18. It was thus stated in concluding remarks that in the absence of any defects in the books despite its production before the AO, the book results could not have been discarded by the AO. The onus cast upon the Revenue in this regard is not discharged. The action of the Revenue in adopting the net profit @ 8% merely on account of declarations made in the search assessment in some earlier years is wholly unjustifiable and arbitrary. Such action is neither inconsonance with law nor in accord with the view taken by the AO in the subsequent assessment years. The learned counsel accordingly urged for restoration of book results as declared by the assessee.
12. We have perused the assessment order and the first appellate order. Both the orders are totally non-descript and has nothing worth to say for substitution of book results with estimated profits. Noticeably, in the assessment order, the AO has categorically made an averment to the effect that books of accounts have been produced by the assessee and test checked. The AO has not made mention of any material which could questions the correctness and bonafide of the book results declared. The AO is stoically silent on any kind of deficiency in books or excessive claim of any expenses etc. which could substantiate his action. It is incumbent upon the AO to record the inconsistency or incorrectness in the books which prevents the AO to ascertain true income chargeable to tax. The AO has neither rejected the books nor a single voucher was alleged to be unverifiable. In identically placed fact situation, the Hon’ble Calcutta High Court in M/s. Swadeshi Commercial Co. Ltd. vs. CIT ITA No. 219 of 2001 judgment dated 18th December, 2008 concluded that in the absence of rejection of books, the estimation of profit is arbitrary, unreasonable and perverse. In CIT vs. Anil Kumar & Co. (2016) 386 ITR 702 (Kar.), the Hon’ble High Court once again echoed the same view even while framing best judgment assessment. Identical view has been taken in large number of cases quoted on behalf of the assessee and many more. The pre-condition for estimating business income, where the assessee maintains books of account is that the books of assessee should be found to be unreliable or otherwise not realistically capable for demonstrating the income of assessee. Without this first step, the fact that the gross profit/net profit is low cannot by itself be a ground for taking a view that it is open to the AO to make good alleged deficiency in profits declared. Thus, the action of the AO requires to be cancelled and set aside on this score alone being devoid of any legitimacy.
13. Adverting further, we find force in the other line of argument that gross profit rate/net profit rate cannot be estimated cursorily and in a routine manner without showing as to how the book results are superfluous. The AO has not brought any material which has any reasonable nexus to the estimation. As rightly stated on behalf of the assessee, even the best judgment assessment cannot be done in a vindictive manner and should be based on reasonable and fair estimations. Needless to say, low profit is neither the circumstance nor the reason to justify the estimation at some higher percentage. A higher profit in the earlier year or in the subsequent year could be deducible based on its own set of facts. An adoption of the net profit rate of some other years is only for the purposes of fair estimate for which objective reasons must be available with the AO. The AO in the instant case has not crossed the barrier to enable it to go into arena of estimation. The estimation is permissible only on showing that the books of accounts are so defective that it is not possible to ascertain the truthfulness of the profits arising therefrom.
14. The co-ordinate bench in ITO vs. Shri Shravan Kumar Arora ITA No. 144/BLPR/2011 has made interesting observation and recorded that ‘there is no rule that the gross profit ratio should followed as noted hereunder:
“There is no rule that the gross profit ratio should follow a constant ratio with mathematical precision. We further note that there has been a huge and over 100% increase in the turnover as compared to preceding year. Hence, the explanation that increase in turnover has affected margin cannot be brushed aside. In these circumstances, we uphold the order of the learned CIT(A) and delete the addition of 4.77 lakhs on account of low gross profit.”
15. In ACIT vs. Ramesh Industries Ltd., the co-ordinate bench has observed as under:
“The graph of the business profit is always not straight line but it fluctuates year to year. The reasons for fluctuations as given by the assessee that there was higher expenditure of electricity, stated to be main ingredient for the manufacturing of steel products & MS ingots. It is worth to mention that the AO has not given any specific reason for rejection of books of accounts. When the day to day consumption register was maintained and the sale/purchase were stated to be verifiable by supporting bills/vouchers, hence, invoking of the provisions of sec 145 that too in a cursive manner was not appreciable in the eye of law.”
16. To reiterate, there are large number of decisions which say in unison that AO cannot estimate gross profit rate without rejection of books and without showing defects. In CIT v. Paradise Holidays  325 ITR 13 (Delhi), the hon’ble Delhi High Court has held that if accounts which are regularly maintained in the course of business and are duly audited, free from any qualification by the auditors, should normally be taken as correct unless there are adequate reasons to indicate that they are incorrect or unreliable. The onus is upon the Revenue to show that either the books of account maintained by the assessee were incorrect or incomplete or that the method of accounting adopted by him was such that true profits of the assessee cannot be deduced therefrom. For rejection of books of accounts, the AO is required to demonstrate specific defects in the books of accounts produced by the assessee and also as to how the books of accounts produced by the assessee is not giving clear picture of the profit earned from the business activity. In the absence of such finding, the books of accounts cannot be rejected and the addition cannot be sustained on the basis of such rejection of books of accounts. Even where the books are rejected, the discretion must be used by the AO judiciously. We also find considerable substance in the plea of the assessee for not indulging estimates of such whopping nature particularly when lesser net profit rates of 2.19% and 1.10% declared in A.Y. 2016-17 and A.Y. 2017-18 has been endorsed by the Revenue itself in regular assessments.
17. Hence, on giving due weightage to the peculiar facts and circumstances of the case, we find merit in the plea of the assessee for reversal of its consequent substitution by the actual income as per books as offered. Thus, we reverse the action of the lower authorities and restore the position of the assessee.
18. While arriving at such conclusion, we also observe that interest income earned on FDR being inextricably linked to the business of the assessee and bearing direct nexus with the business where the FDR is used as security, the action of the AO in making separate addition on account of interest income is not sustainable in law. Similarly, separate addition on account of miscellaneous income which is already forming part of the P&L account is not sustainable.
19. In view of the above discussion, we find substantial merit in the grounds of appeal raised by the assessee. The additions made in the assessment order dated 30.03.2015 under challenge are thus quashed.
20. In the result, appeal of the assessee is allowed.
Order pronounced on 24/09/2021 by placing the result on the Notice Board as per Rule 34(5) of the Income Tax (Appellate Tribunal) Rule, 1963.