Transaction with sister concerns at a comparatively low price not sufficient ground to reject Books

IN THE ITAT BANGALORE BENCH ‘C’

Deputy Commissioner of Income-tax

Versus

Sphoorti Machine Tools (P.) Ltd.

IT APPEAL NO. 928 (Bang.) of 2011
[ASSESSMENT YEAR 2007-08]

SEPTEMBER  28, 2012

ORDER

N. V. Vasudevan, Judicial Member 

This is an appeal by the Revenue against the order dated July 11, 2011 of the Commissioner of Income-tax (Appeals)-III, Bangalore, relating to the assessment year 2007-08.

2. The grounds of appeal of the Revenue reads as follows :

“1.          The order of the learned Commissioner of Income-tax (Appeals) is opposed to law and facts of the case.

2.            The Commissioner of Income-tax (Appeals) erred in deleting addition of Rs. 54,39,297 to the net profit declared by the assessee, without appreciating that the Assessing Officer rejected the books of account and estimated the profits as pricing of some of the items products sold to Pragathi Automation P. Ltd., which is the sister-concern of the assessee, as discussed in the assessment order, was less than the cost to the assessee.

3.            The Commissioner of Income-tax (Appeals) erred in not appreciating the fact that it was unusual that the assessee incurred loss on certain sales transactions with its related company and such loss not being genuine, the Assessing Officer was justified in rejecting the books of account and estimating the profits of the business.

4.            For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the Commissioner of Income-tax (Appeals) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored.”

3. The assessee is a private limited company. It is engaged in the manufacture of CNC machine parts. For the assessment year 2007-08, the assessee filed return of income declaring taxable income of Rs. 20,72,668. In the course of assessment proceedings, the Assessing Officer noticed that the assessee sold to M/s. Pragathi Automation P. Ltd., (M/s. PAP), which is a sister-concern of the assessee, at a price which was much less than the price at which similar products were sold by the assessee to the third parties. The assessee submitted before the Assessing Officer that the assessee-company was promoted by ex-employees of M/s. Pragathi Automation P. Ltd. and they hold shares to the extent of 50 per cent. The assessee further submitted that since the major customer of the assessee was M/s. Pragathi Automation P. Ltd. they have to sell to them at a lower price. The assessee further submitted that as a businessman, the assessee is free to decide the price at which the products were to be sold to a particular customer. The assessee also submitted that it cannot be presumed that the price at which the assessee sells products to outsider is a standard price and that products which were sold to sister-concerns at a price less than the price at which the products were sold to outsider is done with an intention to suppress income. The assessee also gave detailed calculation of costs and demonstrated before the Assessing Officer that the price charged to M/s. Pragathi Automation P. Ltd. was also profitable to the assessee.

4. The Assessing Officer was of the view that he had the power to investigate and find whether the transaction have been arrived in such a way whereby, the assessee incurs notional loss. The Assessing Officer thereafter, found that 50 per cent. of the products manufactured by the assessee are exported and 70 per cent. of the 50 per cent. so exported is sold to M/s. Pragathi Automation P. Ltd. which in turn various products sold by the assessee to M/s. Pragathi Automation P. Ltd. and to outsiders. These are given in pages 5 to 7 of the assessment order. Thereafter, the Assessing Officer arrived at the following percentage of profits derived by the assessee on it various products generally and such products sold to outsider and to M/s. Pragathi Automation P. Ltd.

“However, on examination of ‘costing’ of the above products and sale price to Pragathi and others, one more startling fact came to the notice of the undersigned. The assessee-company before this office, furnished product-wise all inclusive cost on October 20, 2009. This is evident if we refer to the above chart. The assessee-company in its submission, besides, raw material and process cost, has apportioned per unit employee cost, administration cost along with interest and depreciation and arrived at total cost per unit and hence total cost to the items produced and sold thereafter. The product-wise sale price and profit thereon is also indicated by the chart above discussed. From the above, the following conclusions can be drawn.

5. Thereafter, the Assessing Officer has drawn the following conclusion :

“From the elaborate discussion above, the following issues become obvious ;

(a)          The assessee-company is the sister-concern of M/s. Pragathi Automation P. Ltd.

(b)          The assessee-company sells more than half its produce to M/s. Pragati and sometimes it sells at price lesser than the cost itself. For example, profit of BTH/ATH range of products, when sold to others is 28 per cent. whereas when sold to M/s. Pragati is 1.1 per cent. In some items, there is loss also as per the work sheets provided. All the tables, cost work sheets are part of the assessment record.

(c)          M/s. Pragati Automation P. Ltd., has disclosed profit of 12.5 per cent.

(d)          When this anomaly was enquired into the assessee vide letter dated September 25, 2009 sought to question the authority of the sister-concern to determine the actual business profits. Further, with regard to price differential to M/s. Pragati and others, the assessee sought to state that as the orders from M/s. Pragati are always higher than by others, the price charged to them is less than others.

(e)          As the undersigned was not satisfied by the vague replies of the assessee, the assessee was asked to furnish in table format, the cost per product, the price to M/s. Pragati and others and profit thereon. In response, the accountant of the assessee-company, has furnished the same on October 20, 2009. They are duly signed and are part of the assessment record, the gist of the above is already furnished above.

(f)           The workings so furnished include raw material cost, process cost, and proportionate indirect expenses being employee cost, administration cost, depreciation and interest (financial cost). The cost and profitability product wise as furnished are part of the assessment record.

(g)          The assessee vide letter dated November 11, 2009 sought to dispute, the above costing and has furnished reworked cost sheet and profit thereof. Even this is much more than the profit offered by the assessee in the return of income. No explanation with substantiating evidence is furnished for the variation.

(h)          Instead, the assessee has sought to argue that, cost sheets are prepared based on past experience and with the information available estimates are prepared. But estimates are prepared for future. What is asked herein is actual cost based on the details for the year which has already been over. Thus, what is asked for the assessee is actuals. The assessee is contradicting itself in this regard. Because vide letter dated September 25, 2009, the assessee has stated that it maintains detailed cost sheets and relied on them to explain the profitability. But, in letter dated November 11, 2009 the assessee states that cost sheets are not totally reliable but are estimates only.

(i)           The assessee argues that it is not feasible to determine the profit made on each and every transaction and law does not require the assessee to do so. But the assessee has not been asked to furnish profitability of each and every transaction but only on products. The profitability of product is very vital for the very survival of any business and assessee cannot state that it cannot furnish the same.

(j)           As per profit and loss account schedule 7 income, the assessee has shown raw material sales of Rs. 2,74,36,365 blackening sales of Rs. 9,26,654 and labour charges sales of Rs. 3,18,86,679 totalling to Rs.6,02,49,968. Whereas on October 20, 2009, the accountant submitted details of total sales of Rs. 3,85,63,300 vide letter dated November 11, 2009, the assessee has arrived at sales including labour charges at Rs. 5,96,48,000. Thus, no there is no clarity in the figures submitted by the assessee and the books of account.

(k)          Despite sufficient opportunities, the assessee has in writing, expressed its inability to give accurate statements as to cost and profitability. It only means that books of account of the company do not reflect the true income of the assessee and caste a shadow of doubt on correctness and completeness of the accounts of the assessee.

(l)           Though the assessee has furnished workings on October 20, 2009 and revised working on November 11, 2009, it states that nothing therein is indicative or has any bearing on the final taxable income. In that case, what is indicative of the final taxable income? The assessee has not clarified/answered the questions raised by this office, instead, it is doubting its statements filed before this office.

(m)         Vide letter dated November 11, 2009, the assessee requested for a questionnaire in writing. As per the assessee’s request on November 13, 2009, a questionnaire, was issued and dispatched to the assessee on November 13, 2009 itself, requiring it to clarify/ answer the issue raised thereon on or before November 23, 2009. It is important to note that the said letter was sent to the address as given by the assessee itself, but no reply has been received till date of the order and hence it is presumed that the assessee has nothing more to say in this regard.”

6. For all the above reasons, the Assessing Officer held that the books of account of the assessee are not correct and complete and he therefore, rejected the books of account. Thereafter, the Assessing Officer estimated the profit of the assessee as follows :

“The assessee has submitted original workings on October 20, 2009 and revised working on November 11, 2009. Even as per the revised working of the assessee itself, the average profits works out to be 11.96 per cent. It is important to note over here that this profit percentage is arrived at after considering raw material cost, process cost, employee cost, administration cost, interest cost and even depreciation. Even the profit percentage of M/s. Pragati Automation P. Ltd., which deals in same product purchased from the assessee-company is also 12.5 per cent. Considering these facts and circumstances, it is fair, just and proper to adopt profit rate of 11.96 per cent. in this case. In the result, the net taxable income is arrived at Rs. 74,84,427 as against Rs. 20,45,200 declared by the assessee.”

Aggrieved by the order of the Assessing Officer, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals), the assessee submitted as follows :

“(a)         The prices charged by the appellant to Pragati are in conformity with normal commercial practices, whereby the customer who places assured orders for larger quantities gets a better pricing structure.

(b)          The Assessing Officer exceeded his jurisdiction in putting himself in the shoes of the businessman and demanding that the assessee should supply his product at a price that the Assessing Officer finds satisfactory. While this exercise may be permitted in an international transaction, it is not so in case of a domestic one.

(c)          The Assessing Officer has not defined what he understands by the term ‘sister-concerns’ and his action of rejecting the books of account and determining the pet profit is bad in law, mechanical and without application of mind inasmuch as it was based on mere suspicion and a pre-conceived notion that the transactions between the parties were entered into in such a way as to divert the profits of the appellant to Pragati, without bringing on record any evidence for the same.

(d)          Notwithstanding the above, there was nothing to be gained by diverting he profits of the appellant to another company, since both are resident tax paying companies which were not claiming any tax-free or exempt incomes. Under these conditions, profits in the hands of either company would be tax neutral.”

8. The Commissioner of Income-tax (Appeals) after considering the submissions of the assessee held as follows :

“5. I have considered these submissions carefully and also perused the evidences and other documents filed. From the comparative table filed by the appellant, it is clear that the orders placed by Pragati in respect of majority of the products is substantially more than the quantity purchased by all other customers put together and have been given a higher trade discount on the list price as compared to others. As regards other customers too, I find that the appellant has allowed different rates of discount to different customers depending on the quantity of order placed by them. In respect of the product named TDS it is also seen that Pragati have been actually charged higher than other customers, since their off-take for this product has been lesser than the others. From this it is apparent that the appellant is following a ‘higher the order, higher the discount’ policy. The appellant has also submitted that it is seeking to gain entry in European and other overseas market wherein it has to compete with Chinese products. In order to achieve this, it has to perforce offer its components at a price which is very competitive, till such time it establishes its presence in the international market. Offering higher discounts for larger orders is neither uncommon nor an unreasonable business practice. Admittedly, every industry has its own market dynamics and it is best left to the businessman to take policy decisions.

5.1 From the assessment order, I also observe that it is not the case of the Assessing Officer that the appellant has suppressed its sales or has realised more than what it has accounted in its books. The Assessing Officer has proceeded on the assumption that something is amiss, only because the appellant has offered its products to different customers at different rates, which in my opinion cannot be justified. I also find the argument put forth by the authorised representative that the transactions between the appellant and Pragati is tax neutral convincing. The certificate provided by Pragati confirms that they are not claiming any tax exemptions and is in fact the bigger company. The various decisions relied upon by the appellant would also clearly show that in the absence of a specific finding by the Assessing Officer that the transactions were entered into defraud the Revenue, it is not permissible for the Assessing Officer to make additions on the basis of mere suspicion and assumptions. The decision cited by the authorised representative in Deputy CIT (Assessment) v. Microtex Separators Ltd. [2007] 293 ITR 451 (Karn) is by the Karnataka High Court which is the jurisdictional court in the case. Therefore, respectfully following the decision of the hon’ble Karnataka High Court along with the decisions of the hon’ble Supreme Court and the facts of the case, I hold that the action of the Assessing Officer in rejecting the books of account and determining the net profit ratio is unwarranted and accordingly, the addition made on this account is deleted.”

9. Aggrieved by the order of the Commissioner of Income-tax (Appeals), the Revenue has preferred the present appeal before the Tribunal.

10. We have heard the submissions of the learned Departmental representative, who reiterated the stand of the Revenue as reflected in the order of the Assessing Officer. Learned counsel for the assessee reiterated the submissions as were made before the Commissioner of Income-tax (Appeals). Reliance was also placed on the decision of the hon’ble Supreme Court in the case of CIT v. Glaxo Smithkline Asia (P.) Ltd. [2010] 195 Taxman 35. The hon’ble Supreme Court in the aforesaid decision expressed the view even in the case of domestic transaction between the related persons it was necessary to examine whether there was any motive to shift the profit making concern to a loss making concern. It was submitted that in the present case there was no motive to shift profits. It was also submitted that ultimately the exercise sought to be done by the Revenue will be revenue neutral in the sense that the profits of M/s. Pragathi Automation P. Ltd. should be reduced to the extent the assessee’s profits is sought to be increased.

11. We have given a careful consideration to the rival submissions. The primary condition for rejecting the book results as laid down under section 145 of the Income-tax Act, 1961 (the Act) is that the Assessing Officer should be satisfied that the books of account maintained by the assessee are not complete and correct. As can be seen from the findings given by the Assessing Officer in the order of assessment, the Assessing Officer has merely proceeded on a surmise that the profits of the assessee are sought to be reduced by selling its products to M/s. Pragathi Automation P. Ltd., the assessee’s sister-concern at a lesser price. There is no instance of falsity or incompleteness of the books of account pointed out by the Assessing Officer in the order of assessment. The books of account reflect the true state of affairs of the assessee. The fact that the assessee has sold its products to its sister-concerns at a price lesser than the price at which the same product is sold to the third parties, in our opinion, would not be a sufficient ground to come to a conclusion that the books of account of the assessee are not complete and correct. There is no evidence brought on record that over and above the price shown in the books of account, the assessee received something more from M/s. Pragathi Automation P. Ltd. As rightly contended on behalf of the assessee it is for the businessman to decide the price at which he has to sell its products to its customers. The law is well-settled that the Revenue cannot insist on the way in which businessmen should conduct his business. The Revenue cannot compel a businessman to sell its products at a particular price, so that the assessee derives maximum profit. The cost calculation, on which the Assessing Officer has placed reliance, has nothing to do with the completeness and correctness of the books of account of the assessee. There is one allegation by the Assessing Officer in the order of assessment (point j) that the sale of raw materials, blackening sales and labour charges sales not tallying with the books and details furnished by the assessee before the Assessing Officer in the course of assessment proceedings. This is a very vague allegation. The Assessing Officer has ultimately concluded that there is no clarity in figures submitted by the assessee and the books of account. This allegation on which the learned Departmental representative placed reliance, in our view, could not be sufficient to reject the book results. We agree with the conclusion of the Commissioner of Income-tax (Appeals) that the Assessing Officer has proceeded on the assumption that something is amiss, only because the assessee had offered its products to its different customers at different rates. The Commissioner of Income-tax (Appeals) found that M/s. Pragathi Automation P. Ltd. was not claiming any tax exemption which necessitates the assessee shifting profits to M/s. Pragathi Automation P. Ltd. In the circumstances, when there is no evidence regarding incompleteness and incorrectness of books of account or facts sufficient to come to a conclusion that the assessee has attempted to defraud the Revenue, we are of the view that the conclusion drawn by the Commissioner of Income-tax (Appeals) are correct and do not call for any interference. Consequently, the appeal filed by the Revenue is dismissed.

12. In the result, the appeal filed by the Revenue is dismissed.