Excess Business Stock Taxable as Business Income, Not Section 69: ITAT Ahmedabad

Fashion World Vs ACIT (ITAT Ahmedabad)

Summary: The Ahmedabad Bench of the Income Tax Appellate Tribunal examined whether excess stock discovered during an income-tax survey under Section 133A should be assessed as unexplained investment under Section 69 of the Income-tax Act, 1961, or treated as undisclosed business income. The assessee, M/s Fashion World, was engaged in trading readymade garments. During a survey conducted on 15 February 2002, discrepancies were detected in its stock and other assets. The Assessing Officer assessed ₹10,06,250 separately as unexplained investment, while computing a loss from the regular business. The assessee challenged this treatment on the ground that the excess stock was inseparably connected with its existing trading activities.

The assessee contended that the additional stock had no separate physical identity and represented undisclosed receipts arising from its garment business. The Revenue relied upon Fakir Mohmed Haji Hasan v. CIT, (2002) 247 ITR 290 (Gujarat High Court), to argue that deemed income under Section 69 could not be adjusted against business losses. The Tribunal examined the distinction between unexplained investments and business receipts, observing that the nature and source of the asset must be considered before applying the deeming provisions. The decision is consistent with the distinction discussed in judicial decisions concerning excess stock and undisclosed business income.

The Tribunal held that where an allegedly unexplained asset does not possess an independent physical identity and forms an integral part of existing business stock, the difference between recorded stock and physically verified stock may represent undisclosed business receipts rather than a separately identifiable unexplained investment. The entire stock of ₹25,14,306 was held and dealt with uniformly in the assessee’s business. The excess stock of ₹8,10,011 was not distinguishable from the recorded stock, and the Revenue had not established any independent asset corresponding to that difference. The Tribunal therefore directed that the amount be assessed under the head “Profits and gains of business or profession”. A comparable principle is discussed in Excess Stock is Business Income, Not Unexplained Investment.

However, the Tribunal distinguished investments in furniture, fixtures and air conditioners because those assets had separate physical identities. Such investments were to be considered under Section 69. The Assessing Officer was directed to recompute the assessee’s business income, including the application of Section 40(b) concerning partners’ remuneration. The Tribunal restored the matter to the Assessing Officer and allowed the assessee’s appeal for statistical purposes.

The decision clarifies that an Assessing Officer must examine the identifiable source and business nexus of an undisclosed asset before invoking Sections 69, 69A, 69B or 69C. Where excess stock is inseparable from regular trading stock and represents undisclosed business receipts, the amount should not automatically be treated as deemed income. The distinction between regular business stock and independently identifiable unexplained investments remains important in survey assessments, as also reflected in subsequent judicial consideration of intermingled excess stock.

Cases Discussed:

1. Fakir Mohmed Haji Hasan v. CIT, (2002) 247 ITR 290; 120 Taxman 11 (Gujarat High Court) — Examined and distinguished. The Tribunal explained that the Gujarat High Court decision concerned unexplained gold whose acquisition and source were not satisfactorily established. The principle did not prevent the assessee from establishing a business nexus for excess trading stock. The precedent is also discussed in Section 80IB Deduction Available on Income Disclosed During Survey.

2. CIT v. Margarets Hope Tea Co. Ltd., (1993) 201 ITR 747 (Calcutta High Court) — Cited by the assessee in support of its contention concerning the business character of receipts.

3. Abhaysing Nathubhai Chauhan (ITAT Rajkot Bench; further case particulars not specified in the order) — Referred to in the assessee’s grounds concerning denial of set-off of business losses against deemed income.

4. Lakhmichand Baijnath v. CIT, (1959) 35 ITR 416 (Supreme Court) — Cited for the proposition that credits found in business accounts may reasonably be inferred to represent business receipts.

5. Daulatram Rawatmull v. CIT, 64 ITR 593 (Calcutta High Court) — Cited by the assessee in support of its submissions concerning business receipts.

FULL TEXT OF THE ORDER OF ITAT AHMEDABAD

This is an appeal by the assessee raising following grounds :-

1. The learned CrI.T(A) erred in law and on facts in upholding the action of learned in including the income disclosed during the course of survey on the basis of statement of the partner of the appellant in its total income. It is submitted that entire exercise of eliciting the statement from the appellant being contrary to the letter and spirit of CBDT instructions in this regard, the addition made to the income on this count be deleted.

2. The learned A.O. erred in taking statement on oath u/s. 133A of the Act of the appellant and adding the income disclosed by the appellant pursuant to such statement. It is submitted that the statement recorded u/s. 133A do not have evidential value end hence the income disclosed pursuant to such declaration be not considered as undisclosed income of the appellant. The learned CIT(A) erred in rejecting the above ground of the appellant. It is submitted that it be so held now.

3. Without prejudice to above, the learned A.O. as well as learned CIT(A) erred in treating the amount of Rs10,06,250/- disclosed by the appellant in its statement recorded u/s. l33A and which was credited in its business books of accounts as unexplained investment/income and consequently, erred in taxing them u/s 69 of the Act. It is submitted that income/investments representing this amount of Rs.10,06,250/- having already been entered in the books of accounts of the appellant and arising from the only source being business of the appellant cannot be considered and taxed as deemed income representing unexplained investment u/s. 69 and have to be considered as business income to be taxed as business income of the appellant. It is submitted that it be so held now and the income/investment representing Rs.10,06,250/- be taxed as business income of the appellant.

4. The learned CIT(A) erred in holding that the income representing unexplained stock which was declared by the appellant during survey proceedings was earned m earlier year. It is submitted that such finding has no basis.

5. The learned CLT(A) erred m confirming the action of learned A.O. in segregating the income of the appellant in two ports namely income disclosed during survey u/s. 133A and other regular income and also erred in taxing the entire declared income of Rs. 10,06,250/- without setting it off against the loss incurred or reducing ft by the Joss suffered in its regular business under the head business income at Rs. 4,47,580/- subject to the appeal effect order. It is submitted that it be so held now and the loss incurred under the head business income without considering the declared income be allowed to be set off against or deducted from such declared income of Rs. 10,06,250/-

6. The learned CIT(A) grossly erred in confirming the action of learned A.O. in computing total income of the appellant at Rs. 10,06,250/- and allowing carry forward of normal business loss to the Succeeding assessment year without setting off or granting deduction of such business loss against the declared income of Rs. 10,06,250/-. It i5 submitted that such treatment is in clear violation of the provisions of sections 70 to 72 of the Act. It is submitted that it be so held now and set off/deduction as claimed be allowed to the appellant

7. The learned CIT(A) grossly erred in facts and in low in applying the ratio of Jurisdictional Gujarat High Court in Fakir Mohmed Haji Hasan 247 ITR 290 and of ITAT Rajkot Bench in case of Shri Abhaysing Nathubhai Chauhan and denying benefit of set off or deduction of business loss against the declared income of RS. 10,06,250/- taxed u/s. 69 of the Act. Your appellant submits that in the facts and circumstances of the appellant the said decisions are not applicable to the appellant and hence the same be not applied to the facts of the appellant and benefit of set off or deduction of normal business .loss incurred by the appellant be granted to it against the declared income of Rs. 10,06,250/-.

8. Without prejudice to any of the fore-goings, the learned A.O. and CIT(A) erred in not considering the alternative claim of the appellant to grant higher remuneration to the partners subject to ceiling u/s. 40(b) in respect of such deemed income taxed by them.

2. The facts of the case are that the assessee is dealing in ready made garments. A survey under section 133A was carried out at the business premises of the assessee on 15.2.2002. During the course of survey certain discrepancies in the stock and documents were found. Statement of the partner Shri Sunil P. Agrawal was recorded on that date. The authorised officer required Shri Sunil P. Agrawal to furnish stock position as on 31.1.2002. This was worked out by him by considering GP rate of 20% and sales and purchases upto 15.2.2002. Accordingly, stock as per books was determined at Rs.9,87,718/-. On physical verification the stock was valued at Rs.25,14,306/-. However, stock as per books was reworked after applying GP margin of 28.5%. The difference between stock as per books and that physically found was finally determined at Rs.8,10,011 In addition to this the AO found unaccounted investment in furniture and fixtures at Rs.91,000/-. It was also found that four air conditioners were fitted in the premises in which unexplained investment of Rs.1,06,250/- (1,20,000 – 13,750/- was worked out. Thus total undisclosed investment of Rs.10,06,250/- (Rs.8,10,011 + 91,000 + 1,12,250) was determined. The assessee subsequently while filing return for the Asst. Year 2002-03 declared total income of Rs.5,58,670/-. There was no independent declaration of any undisclosed investment found during course of survey. On being asked to explain, it was stated by the assessee that sales in the last two months i.e. February & March were made at very low rates as it is decided to close the business due to recession in the market. The AO did not agree with this explanation and made addition of Rs.10,06,250/- separately under section 69 to the income computed as per profit and loss account. In fact what the AO did was that he worked out income from business separately and made addition under section 69 separately. His working for the sake of convenience is given below :-

“Income as per statement of income Rs.5,58,670/-
i.e. returned income

Less: The additional income as disclosed by the Assessee u/s 133A to be taxed separately (-) Rs.10,06,250/-

Balance Regular Total income subject to Adjustment as discussed in the preceding paras (-) Rs.4,47,580/-

16. Subject to the above remarks the total income of the assessee is computed as under :

III. INCOME FROM BUSINESS

This loss will be carried forward to the next year and will be adjusted against future profit if any and the income investment disclosed during the survey u/s 133A amounting to Rs.10,06,250/- is taxed u/s 69 of the Income-tax Act as under :

Total income u/s 69C as discussed in para 7 above Rs.10,06,250/-“

3. Ld. CIT(A) passed very detailed and reasoned order. He referred to the decision of Hon. Gujarat High Court in Fakir Mohmed Haji Hasan vs. CIT (2002) 120 Taxman 11,17 (247 ITR 290) and held that addition under section 69 has to be separately made as deemed income. There is one more issue. The assessee claimed partners’ remuneration u/s 40(b) considering that an addition of Rs.10,07,261/- is made by the AO. The ld. CIT(A) dismissed the related ground of the assessee on the ground that income determined from business is loss.

4. While upholding the addition of Rs.10,06,250/- as made by the AO, ld. CIT(A) observed that deemed income under section 69 does not need any head of income and, therefore, cannot be set off against business loss. Ld. CIT(A) also declined to give telescoping effect of either Rs.2 lacs being unexplained credit in the account of partner or of Rs.97,000/- being investment in furniture and fixtures out of Rs.10,06,250/- on the ground that this sum is already found invested in stock and, therefore, it will not be available for investing elsewhere.

5. Before us, assessee has raised several grounds as above. The ld. AR did not press ground Nos.1 & 2 and, therefore, they are rejected as not pressed.

6. Regarding addition of Rs.10,06,250/- under section 69 ld. AR submitted that this has to be considered as “business income” as what is found is “business stock”. It cannot have a different character than the business income. He submitted that in any case, tax has to be levied on total income after clubbing income under different heads including income under section 69. Therefore, there is no separate identity of addition under section 69 even if one follows the decision of Hon. Gujarat High Court in the case of Fakir Mohmed Haji Hasan vs. CIT (supra). He then claimed that once investment in stock is considered as business outgoing then partners of the firm are entitled for higher remuneration as per section 40(b). Ld. AR referred to the decision of Hon. Supreme Court in Lakhmichand Baijnath vs. CIT 35 ITR 416(SC) for the proposition that if credits are found in the business account of the assessee then the Income-tax authorities are entitled to treat the receipts as business receipts chargeable to tax and further that when amount is found credited in books maintained for business then it is not unreasonable inference to draw that it is a receipt from business. He then referred to the decisions of Hon. Calcutta High Court in the case of Daulatram Rawatmull vs. CIT 64 ITR 593 (Cal), and CIT vs. Margarets Hope Tea Co. Ltd. 201 ITR 747 (Cal) for the same proposition.

7. The ld. AR further submitted that if there is a positive figure under the head ‘business’ then it has to be necessarily aggregated with the deemed income under section 69A, 69B & 69C for working out gross total income from which allowable deductions under Chapter-VIA are reduced and thereafter total income is worked out for levy of tax. If positive income under the head ‘business’ is aggregated with deemed income then there is no reason why negative income i.e. loss be not aggregated with such deemed income. There is no provision under the Income-tax Act that loss under the head ‘business’ would be carried forward and tax has to be levied only on deemed income. In fact section 68, 69A, 69B & 69C fall under Chapter VI.

8. On the other hand, ld. DR submitted that addition under section 69 has to be separately made following the decision of Hon. Gujarat High Court in Fakir Mohmed Haji Hasan vs. CIT (supra) and no set off against business loss has to be allowed.

9. We have considered the rival submissions and perused the material on record. In our considered view there is some misunderstanding about the interpretation of decision of Hon. Gujarat High Court in the case of Fakir Mohmed Haji Hasan vs. CIT (supra). For the sake of convenience we reproduce the head notes from that decision as under :-

“The scheme of sections 69, 69A, 69B and 69C of the Income-tax Act, 1961, would show that in cases where the nature and source of investments made by the assessee or the nature and source of acquisition of money, bullion, etc., owned by the assessee or the source of expenditure incurred by the assessee are not explained at all, or not satisfactorily explained, then, the value of such investments and money or value of articles not recorded in the books of account or the unexplained expenditure may be deemed to be the income of such assessee. It follows that the moment a satisfactory explanation is given about such nature and source by the assessee, then the source would stand disclosed and will, therefore, be known and the income would be treated under the appropriate head of income for assessment as per the provisions of the Act. When the income cannot be so classified under any one of the heads of income under section 14, it follows that the question of giving any deductions under the provisions which correspond to such heads of income will not arise. The provisions of sections 69, 69A, 69B and 69C, treat unexplained investments, unexplained money, bullion, etc., and unexplained expenditure as deemed income where the nature and source of investment, acquisition or expenditure, as the case may be, have not been explained or satisfactorily explained. Therefore, in these cases, the source not being known, such deemed income will not fall even under the head “Income from other sources”. Therefore, the corresponding deductions which are applicable to the incomes under any of these various heads, will not be attracted in the case of deemed incomes which are covered under the provisions of sections 69, 69A, 69B and 69C of the Act in view of the scheme of those provisions :

Held, on the facts, that it was clear that when the investment in or acquisition of gold, which was recovered from the assessee was not recorded in the books of account and the assessee offered no explanation about the nature and source of such investment or acquisition and the value of such gold was not recorded in the books of account, nor the nature and source of its acquisition explained, there could arise no question of treating the value of such gold, which was deemed to be the income of the assessee, as a deductible trading loss on its confiscation, because such deemed income did not fall under the head of income “profits and gains of business or profession”. Therefore, the Tribunal was perfectly right in holding that the value of the gold was liable to be included in the income of the assessee as the source of investment in the gold or of its acquisition was not explained and that the assessee was not entitled to claim that the value of the gold should be allowed as a deduction from his income.”

If we closely examine above judgment we find that for invoking provisions of sections 69, 69A, 69B & 69C two conditions are required to be satisfied. They are (i) investment/expenditure are not recorded in the books of account of assessee & (ii) the nature and source of acquisition of assets or expenditure are not explained or not explained satisfactorily The expression “nature and source” used in this section should be understood to mean requirement of identification of source and its genuineness. To explain “Nature” it would require the assessee to explain what is description of investment or expenditure, period and the manner in which it was done. To explain the source it would require the assessee to explain the corpus or fund from where investment or expenditure has been met and also the head under which the investment or expenditure would fall such as whether investment/expenditure pertains to business or relates to acquisition of capital asset or to other source or to agriculture. Where the assessee is able to explain nature and source of investment/expenditure and also if they are recorded in the books of account then such investment/expenditure will not be treated as deemed income but where investment /expenditure is not recorded in the books of account and/or their nature and source is not explained or not satisfactory explained, deeming provision under these four sections can be invoked by the AO and investment/expenditure would be treated as deemed income of the assessee. Thus for invoking these deeming sections first condition has to be necessarily satisfied that they are not recorded in the books of account regularly maintained by the assessee. But for establishing nexus of such investment/expenditure with a head of income and to take the benefit of set off, assessee has to necessarily explain the nature and source of such investment/expenditure and establish its nexus with any head of income. Hon. Gujarat High Court further held that for claiming trading loss in respect of an asset whose investment was found unexplained, it was necessary for the assessee to explain the nature and source of its acquisition and on its failure to do so the trading loss on the confiscation of the asset could not be set off.

10. We notice that the set off of any trading loss against deemed income assessed under sections 69, 69A, 69B & 69C is not directly discernible from sections 72 to 79 falling in Chapter-VI. To summarily refer to these provisions we note that in Chapter VI, section 70 provides set off of loss from one source against income from another source under the same head of income. In other words, if under the head ‘business’ there are two businesses –one is resulting in income and the other is resulting in loss, they are to be set off against each other. Similarly, if there is a loss under the head capital gains in respect of short-term capital gains and there is income in respect of other capital assets then that can be set off as per section 70. Section 71 provides set off of loss from one head against income from another head. Thus where there is a loss under one head being loss other than loss under the head capital gains then it can be set off against any income assessable under another head. Section 71A and section 71B provide for carry forward of set off of loss from house property. Section 72 provides for carry forward of business loss. According to this section if loss under the head business, other than speculation loss, cannot be set off against income under any other head in accordance with section 71, then it has to be carried forward to the following Asst. Years. Section 72A provides provisions of carry forward and accumulated loss and unabsorbed depreciation allowance in amalgamation or demerger. Similarly section 72AA provides such set off and carry forward in the case of banking company and sec.72AB provides set off in the case of Co-op. banks. Section 73 provides for treatment of loss in speculation business. Section 74 provides for treatment of loss under the head capital gains and section 74A provides for treatment to loss arising from sources under the head ‘income from other sources’. Section 75 provides for losses in case of firm and section 78 in respect of carry forward and set off of loss in case of change in constitution of the firm and section 79 provides for carry forward and set off of loss in the cases of certain companies. Thus treatment of loss arising under the head business is provided only under section 72 which directs to carry forward the unabsorbed loss to the next year unless it is otherwise provided in any other section of Chapter –VI. We have gone through all the sections under Chapter –VI and we do not find any provision for setting off of business loss against deemed income under sections 69, 69A, 69B & 69C.

11. But this does not mean that loss computed under any of the five heads mentioned in section 14 – (i) ‘salary’, (ii) ‘income from house property’, (iii) ‘profits and gains from business or profession’, (iv) ‘capital gains’ and (v) ‘income from other sources’ – cannot at all be adjusted against unexplained investment or expenditure. What is necessary as per Hon. Gujarat High Court is that source of acquisition of asset or expenditure should be clearly identifiable. In the case before Hon. Gujarat High Court the source of gold confiscated was not identifiable and hence adjustment was not permitted.

12. Thus the important aspect that emerges from the entire discussion is that for invoking deeming provisions under sections 69, 69A, 69B & 69C there should be clearly identifiable asset or expenditure. In the present case we find that entire physical stock of Rs.25,14,306/- was part of the same business. Both kind of stock i.e. what is recorded in the books and what was found over and above the stock recorded in the books, were held and dealt uniformly by the assessee. There was no physical distinction between the accounted stock or unaccounted stock. No such physical distinction was found by the Revenue either. The assessee has repeatedly claimed that unaccounted business income is invested in stock and there is no amount separately taxable under section 69. The department has ignored this claim of the assessee and sought to tax the difference between book-stock and physical-stock as unaccounted investment under section 69 without considering the claim of the assessee that first the business receipt has to be considered and then investment should be treated as coming out of such unaccounted income. The difference in stock so worked out by the authorities below had no independent identity of its own and it is part and parcel of entire lot of stock. The difference between declared stock in the books and what is physically found would only be a mathematical expression in terms of value and not a separate independent identifiable asset. Therefore, it cannot be said that there is an undisclosed asset existed independently. Once this is so then what is not declared to the department is receipt from business and not any investment as it cannot be co-related with any specific asset.

13. Thus in a case where source of investment/expenditure is clearly identifiable and alleged undisclosed asset has no independent existence of its own or there is no separate physical identity of such investment/expenditure then first what is to be taxed is the undisclosed business receipt invested in unidentifiable unaccounted asset and only on failure it should be considered to be taxed under section 69 on the premises that such excess investment is not recorded in the books of account and its nature and source is not identifiable. Once such excess investment is taxed as undeclared business receipt then taxing it further as deemed income under section 69 would not be necessary. Therefore, the first attempt of the assessing authority should be to find out link of undeclared investment/expenditure with the known head, give opportunity to the assessee to establish nexus and if it is satisfactorily established then first such investment should be considered as undeclared receipt under that particular head. It is only where no nexus is established with any head then it should be considered as deemed income under section 69, 69A, 69B & 69C as the case may be. It is because when assessee fails to explain satisfactorily the source of such investment then it should be taxed under section 69, 69A, 69B & 69C as the case may be. It should not be done at the first instance without giving opportunity to the assessee to establish nexus. Therefore, there is no conflict with the decision of Hon. Gujarat High Court in the case of Fakir Mohmed Haji Hasan (supra) where investment in an asset or expenditure is not identifiable and no nexus was established then with any head of income and thus was not available for set off against any loss under any other head. Therefore, we hold that where asset in which undeclared investment is sought to be taxed is not clearly identifiable or does not have independent identity but is integral and inseparable (mixed) part of declared asset, falling under a particular head, then the difference should be treated as undeclared business income explaining the investment.

14. To conclude sum of Rs.8,10,011/- being difference in stock is represented by undeclared business income. It does not have a separate physical identity. It is to be only taxed under the head ‘business’. Other assets have separate physical identity being furniture and fixtures, air conditioners etc. They cannot have a direct nexus with business and therefore investment therein has to be considered under section 69 only.

15. In view of the above, AO is directed to consider the sum of Rs.8,10,011/- as undisclosed business income assessable under the head ‘business’ and other two sums under section 69. The business income including application of section 40(b) has to be considered accordingly.

For calculation of income in view of our above observations, we restore the matter to the file of AO.

16. In the result, appeal of the assessee is allowed for statistical purposes.

Order pronounced in Open Court on 12/2/2010