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Principles for Determination of Fair Income in case of Rejection of Accounts – A Judicial Analysis

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  • 2017-07-19

Rejection of books of account u/s 145(3) and making a best judgment assessment assessment u/s 144 is a powerful tool in the hands of the Assessing Officer. The Assessing Officer must notice specific defects in the books of accounts of assessee to be able to reject it & make an assessment on the basis of best judgment. One method of estimating income of assessee in case of rejection of accounts is taking gross profit rate by comparing the assessee with its counterparts' operating results. However, Assessing Officers must exercise this power prudently and not act arbitrarily.

This insight compiled by the editorial team of Taxsutra Database provides rulings on topics on rejection of books of accounts, disallowance when addition is made on the basis of gross / net profit rate, powers of AO to apply gross profit rate, Tribunal's approach while adjudicating an appeal on best judgment, scope of the term “to the best of his judgment" & more. We hope this compilation of 13 select rulings pronounced by SC, HC & ITAT will be helpful in your research work.

1. [TS-5062-SC-1965-O]: Scope of the term “to the best of his judgment : SC explains scope of the term “to the best of his judgment”, emphasises need for ‘relevant material’ for making a best judgment assessment – SC dismisses Revenue’s appeal against HC order holding the best judgment assessment by Sales Tax officer to be capricious; Holds that the best judgment assessment made was only a capricious surmise unsupported by any relevant material...read more

2. [TS-5236-HC-1992(Calcutta)-O]: Duty of Tribunal while adjudicating an appeal on best judgment: Tribunal, while adjudicating an appeal on best judgment assessment, cannot simply annul the assessment; It ought to either determine the quantum of income or loss, or set aside the assessments with a direction to the ITO to make fresh assessments – HC rules in favour of Revenue; Holds that while Tribunal came to correct finding that the ITO did not take into account all relevant materials in determining the quantum of assessee’s income, it was not correct in neither annulling assessments without determining quantum of income or loss, nor directing ITO to make fresh assessments on basis of material available on record…read more

3. [TS-5872-HC-2008(Rajasthan)-O]: Scope of powers of AO to apply GP rate : Upon rejecting books of accounts and invoking Sec.145, AO does not get unfettered powers to apply any GP rate of his choice – HC holds in favour of assessee for AY 2000-01; Accepts that GP rate of 2.51% declared and accepted for AY 1999-00 should be applied to current year as opposed to 15% applied by AO…read more

4. [TS-5881-HC-2009(Kerala)-O]: Rejection of books and estimation of income on basis of best judgment assessment: AO is justified in rejecting books of accounts by resorting to option u/s.145(3) of making assessment u/s.144 since the summons issued by him to various persons were either returned from non-existent parties, or parties gave a sworn statement that they have not received the amount from the assessee - ITAT rules in favour of Revenue; Holds that “when the cash payment of Rs.80.16 lakhs on a single day itself gave rise to doubt in the mind of the AO, he rightly cross-checked the genuineness of the payments by issuing summons to the persons whose names were shown in the vouchers prepared by the assessee. The result was that partly, vouchers were found to be bogus, and partly stand disproved.”…read more

5. [TS-5559-HC-2003(Rajasthan)-O]: Rejection of books: When there are discrepancies in the books of accounts and reasonable profits cannot be arrived by that system of accounting, book results can be rejected - HC rules in favour of Revenue; Holds that book results were rightly rejected by AO u/s.145; however when book results are rejected, there should be best judgment assessment whereby a reasonable income should be taxed…read more

6. [TS-5026-SC-2006-O]: Rejection of books: Rejection of books justified in case of defects such as failure to maintain quantitative details/ stock register, basis of valuation of closing stock, reduced gross profit rate etc., noticed - SC rules in favour of Revenue; Holds that cogent reasons have been given by IT authorities for rejection of the books, hence there is no reason to take a different view…read more

When a net profit rate is applied, no scope for further disallowance of any expenditure

7. [TS-5188-ITAT-2008(Kolkata)-O]: When NP rate applied, no scope for further disallowance of any expenditure: When income is assessed by estimating the profit, no disallowance can be made separately u/40A(3) - ITAT allows assessees’ appeals; Remands matter back to AO for verification of details for computing disallowance u/s.40A(3) r.w.Rule 6DD, whether or not the relevant clauses of rule 6DD as claimed by the assessees’ would be applicable to it; Separately, holds that when an NP rate is applied, there remains no scope for further disallowance of any expenditure, including that under Sec. 40A(3)…read more

8. [TS-5935-HC-2004(Gujarat)-O]: Addition of closing stock when addition is made on basis of GP margin: Separate addition on account of undisclosed closing stock cannot be made when AO has adopted GP margin to make an addition to the assessee’s income; Addition u/s.40A(3) deleted for payment in cash, keeping in mind the principle of practicability of payment in terms of Rule 6DD(j) - HC rules in favour of assessee; Holds that “gross profit margin disclosed in case of the assessee has been 15.3 per cent, 15.8 per cent and 15.1 per cent for asst. yrs. 1977-78, 1978-79 and 1979-80 respectively. If the addition of closing stock made by the AO is upheld, the gross profit in the adjusted trading account would get enhanced to 19.3 per cent, but as against that, the AO himself has found that gross profit in this type of cases, namely, carrying on construction activity, is around 16 per cent only.”…read more

9. [TS-5260-HC-1998(Andhra pradesh)-O]: Addition by relying on rejected books: When books are rejected by ITO u/s.145, then a specific item from the P&L A/c of interest and salary paid to partners cannot be added back by relying on the rejected books - HC rules in favour of assessee-firm; Holds that when an estimate of net profit is made, it is in substitution of income that is to be computed u/s.29, in other words, all deductions referred to u/s.29 are deemed to have been taken into account while making such an estimate, including interest and salary paid to partners…read more

10. [TS-5094-HC-2009(Rajasthan)-O]: Addition by relying on rejected books: AO having estimated higher profit rate on total contract receipts after rejection of books of account invoking Sec. 145(3), no separate additions can be made on account of unexplained cash credit u/s.68 - HC rules in favour of assessee; Holds that even if assessee has failed to discharge his onus of proof in explaining the cash credits shown in the books of account as "market outstanding", the AO cannot make addition of cash credits u/s.68 since he has made an addition by estimating higher profit rate on total contract receipts after rejecting books u/s.145(3)…read more

11. [TS-5385-HC-1997(Allahabad)-O]: Assessment made applying flat GP rate on sales - no disallowance possible invoking Sec. 40A(3) : When the assessee’s income is computed applying flat GP rate and when no deduction is allowed in regard to the assessee’s purchases, there is no need to look into Sec.40A(3) and the erstwhile Rule 6DD(j) - HC rules in favour of assessee; Holds that “When the gross profit rate is applied, that would take care of everything and there was no need for the AO to make scrutiny of the amount incurred on the purchases by the assessee”…read more

12. [TS-5141-ITAT-2013(Jaipur)-O]: Rejection of books - Estimation of profit - No separate disallowance u/s 40A(3): When income is assessed by estimating the profit after rejection of books of accounts u/s 145(3) then no disallowance can be made separately u/s 40A(3) - ITAT rules in favour of assessee; Upholds order of CIT(A) deleting addition u/s 40A(3) since the AO had made addition on the basis of gross profit margin after rejecting books of accounts of the assessee…read more

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