THE ASSISTANT COMMISSIONER OF INCOME TAX, CENTRAL CIRCLE-2, GUNTUR vs. KHAN MOHAMMED DIAMONDS & JEWELRY PRIVATE LIMITED, GUNTUR

During appeal hearing, ld.DR submitted that AO found that profit of the assessee was sharply declined for the A.Ys. 2016-17 & 2017-18 and against the net profit 11.67% in the A.Y. 2011-12, net profit was decreased to (-)7.09% in the A.Y. 2016-17 and for the A.Y. 2017-18 it was (-)1.19%. Thus, the assessee declared huge losses for both the assessment years, therefore, the AO has sufficient reason to believe that the assessee has declared the losses to set off the additional income admitted by the assessee during the search to pre-empt the declarations made during the search operations. The ld.DR further argued that assessee himself has agreed for the addition to estimate the income @ 5.52% and accordingly admitted the income of Rs.3,32,36,244/- and Rs.3,14,09,432/- for the A.Ys. 2016-17 & 2017-18 respectively. The AO has considered the submissions of the assessee and found that there were no details of opening stock and closing stock and in absence of such details it is very difficult to ascertain whether the assessee has sold old items or new items, therefore viewed that gross profit and net profit ratio cannot be relied on. Thus, accepted the estimation of income as agreed by the assessee and completed the assessment. Ld.DR further submitted that addition 10 ITA Nos.183 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) was agreed by the assessee himself, therefore there is no reason to go back from the admission given by the assessee hence argued that the addition be sustained and requested to set aside the order of the ld. CIT(A).

On the other hand, ld.AR vehemently relied on the order of the ld. CIT(A) and argued that the admission given by the assessee was under mental pressure and lack of understanding and the AO made the addition without having any material solely on the basis of letter given by the assessee, therefore argued that there is no reason to interfere with the order of the ld. CIT(A) and the same required to be upheld.

We have heard both the parties and perused the material placed onrecord.

For the A.Y. 2016-17, the assessee filed return of income disclosing loss of Rs. 4,25,19,151/- u/s 139(1) and subsequently revised the loss to Rs. 2,96,32,471/- duly decreasing the loss to the extent of Rs.1,28,86,680/- which was admitted as undisclosed income during the course of search. Similarly, for the A.Y. 2017-18, the assessee filed return of income declaring loss of Rs.45,81,242/- and even in response to the notice issued u/sec. 153A the assessee filed return of income admitting the same loss and no change. A search u/sec. 132 was conducted in the case of 11 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) the assessee and during the course of search, no evidence was found with regard to concealment of income as seen from the assessment order. The assessee has incurred the loss of Rs.4,26,59,680/- for the A.Y. 2016-17 and Rs.67,47,869/- for the A.Y. 2017-18 as per the profit & loss account. For the sake of convenience and clarity, we extract the tabulation of gross turnover and the net profit declared by the assessee for the A.Y. 2011-12 to 2017-18 which is tabulated in assessment order at page No.2 and reads as under:-

The AO did not find any defect in the books of account and no evidence also was found during the search with regard to concealment of income. However, the AO observed that there was decline in profit, therefore arrived at the average profit at 8.51% taking the profits from the A.Ys. 2011-12 to 2015-16 ignoring the losses incurred by the assessee for the impugned assessment years and issued show cause notice to estimate the profit at 8.51%. In response to the notice the assessee explained the reasons for shortfall in the profit in detail which was discussed 12 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) earlier in this order. The AO found that the assessee could not furnish the details of closing and opening stocks and in the absence of such details the AO viewed that it is very difficult to verify whether the stock which was put to sale consists of old items or items purchased during the year. Thus, viewed that gross profit or net profit cannot be relied upon for the current year, therefore accepted the estimation of income at 5.52% as agreed by the assessee. Accordingly, completed the assessment estimating the income at 5.52% of the gross turnover.

From plain reading of the assessment order we find that the AO has not applied his mind and did not give logical reasoning for resorting to estimation of income. In the instant case, a search u/sec. 132 was conducted in the business premises of the assessee as well as residential premises and the entire material is available with the Income-tax Department i.e. stock books, registers, books of accounts. No evidence was found with regard to understatement of income. The reason given by the AO for resorting to estimation of income is neither convincing nor logical. As per the affidavit filed by the assessee before the ld. CIT(A), Investigation Wing has seized the stock registers and the valuation was also done by the panel valuer with regard to stock 13 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) available in the business premises. Thus, the basis for resorting to estimation of income on non-identification of the items that was sold were old stocks or new stocks by the AO is unacceptable. In the instant case, the assessee has explained the reasons and circumstances for accepting the additional income in his affidavit filed before the ld. CIT(A) and the same was accepted by the Ld.CIT(A). The assessee placed number of decisions where it is viewed by the judicial precedents that mere admission cannot be basis for taxing the income which is not taxable. The department has to collect legitimate taxes and bring the material to support their case. In the instant case, the AO neither brought the material nor rejected the books of account and brought any material to resort for estimation of income. The profit of earlier years cannot be only indicator for estimation of income, since, there may be lot of changes financially in the business environment. The contention of the assessee is that the admission was given on pressure and under misapprehension. If the admission is given on misapprehension or pressure, the assessee is permitted to retract from the admission and the AO is bound to make the assessment on the material gathered. In the instant case, no defect was detected and purchases and sales were accounted and the expenditure was accounted and the AO did not 14 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) find any inflation of expenditure, suppression of sales, inflation of purchases. Thus, there is no case for estimation of income and the AO simply computed the average net profit of the earlier years and issued show cause notice for estimation of income, the assessee explained the reasons for declining profit. Without rejecting explanation offered by the assessee with cogent evidence/material, the AO simply resorted for estimation of income. In his explanation, the assessee stated that there is huge competition from the corporate players. The assessee further stated that to attract the customers they are forced to reduce the margins and from the F.Y. 2015-16 the turnover was reduced. The assessee further stated that due to introduction of Central Excise Act from the A.Y. 2015-16 shops were closed for 45 days and the assessee has paid excise duty on the stocks which was not collected from the customers and business was interrupted frequently due to separate state agitation during the F.Y. 2014-15. Demonetization is one of the reasons stated to be for reduction of turnover and the profit drastically. The assessee has stated that slow and obsolete items were sold reducing the prices from 1% to 4%per gram. The assessee further stated that gold prices fluctuated considerably and many a times gold was purchased at higher rates. The assessee has maintained regular books of 15 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) account and all the above contentions are verifiable facts. Since the books of account, stock registers were seized by the department, the AO ought to have verified the above facts and the items sold, instead of resorting for estimation of income. All the reasons for shortfall in profit appears to be reasonable. From the tabulation of turnover given in the Assessment order, it is seen that the turnover has reduced from Rs. 64.26 crores to Rs.60.21 crores for the A.Y. 2016-17 which was further reduced to Rs.56.33 crores for the A.Y. 2017-18 and the gross profit also reduced. Thus assessee’s sales have been decreased which resulted in huge losses since the fixed cost cannot be reduced. Further on going through the paper book page No.88 we find that on 16.11.2018, the AO had issued the notice u/s 142(1) along with show cause letter proposing to make estimation of income @8.51% and the case was posted for hearing on 27.11.2018 at 3.30PM. Simultaneously one more notice u/s 142(1) was placed in paper book page No.91 to 94 calling for various details vide notice dated 16.11.2018 posting the case for hearing on 27.11.2018 at 3.30 P.M. Thus, it is observed that the AO even without verifying the details prejudiced to estimate the income @8.51% and landed in wrong conclusion that the assessee had understated the income without any basis. On verification of the assessment order, it is 16 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) also seen that the last date of hearing was 15.12.2018 which shows that the assessment proceedings were completed by 15.12.2018. The assessee also placed copy of letter dated 15.12.2018 objecting for the proposed addition for estimation of income @8.51%. There was no indication of agreement for estimation of income in it’s letter dated 15.12.2018. It is also seen that the assessee has furnished the affidavit on 26.12.2018 before the AO, though there was no hearing. The above material placed in the paper book shows that there was undue pressure on the assessee as stated by him in the affidavit filed before the Ld.CIT(A) for agreeing the addition. Thus, we are of the considered opinion that the admission was given on undue pressure and the same cannot be basis for addition. In this connection we, extract the order of ld.CIT(A) in page No.22 from Para No.18.4 to 18.7 which reads as under:- 18.4) On careful consideration of the material facts, it is clear that the appellant vide the affidavit has agreed to disclose the regular income towards net profits based on immediate previous year's net profit ratio. This affidavit was filed on 26/12/2018, i.e., at the fag end of the time barring period. The appellant submitted that no addition was agreed as alleged by the AO in the assessment order. It was also contended that the affidavit filed does not give any right to the AO to estimate the income. The appellant also stated that no revised computation was filed before the AO, before finalizing the assessment, incorporating the estimated income. Having regard to these facts the issue has been examined. The appellant vide the affidavit has only agreed to disclose the income on estimate basis but not filed revised computation accepting the said estimated income. A bear reading of the affidavit show that the appellant has not agreed for the addition 17 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) as mentioned by the AO in his order. Considering the affidavit as a consent for the addition made by the AO, appears to be incorrect. Even in the remand report the AO considered the affidavit given by-the appellant as the basis for agreed addition, which also appears to be incorrect. In view of the above discussion, having regard to the material facts it is clear that the appellant has not given consent for the addition proposed by the AO. At any stretch of imagination the addition made by the AO cannot be construed as an addition made on agreed basis keeping in view the words/language used in the affidavit, which has been considered by the AO for completing the assessment. 18.5) On examination of the notice U/s 142(1), the Assessing Officer has not pointed out any defects in the Books of accounts and simply questioned about the reason for the loss incurred, and further asked as to why the net profit should not be adopted @ 5.52% when compared with the previous asst year. For questioning this estimation, the Assessing Officer should bring the defects in the Books for which he could not be able to deduce the profit from the Books of accounts produced. In normal situations, the assessees usually give affidavit to confirm the company in showing the loss. According to the human probability theory when the assessing officer has not shown the default, why the appellant company will come forward to admit the income which is prejudice to his own. On perusal of the assessment order and the notices issued in the course of assessment proceedings, it is found that the Assessing Officer has not found any fault in the Books of account. Hence without defects in the Books of accounts mere admission will not, have the evidentiary value. 18.6) During the course of assessment proceedings, books of account were examined in depth. The stock records were seized /impounded .and are very much with the Department. The Assessing Officer allegation that the appellant company could not specifically identify the closing and opening stock details is without jurisdiction because the details are available in Form 3CD annexed to the audit report and also in the seized record. The reason quoted by the Assessing Officer does not in any way come to his rescue to estimate the profit and also to take the admission in the form of letter and affidavit. 8.7) The Assessing Officer has not drawn any conclusion in the assessment order whether any material has been seized which shows that the appellant company has siphoned the profit out of the company books. The appellant contended that on the date of search itself i.e. 20.09.2016, which as per the Books of account there is a loss which was also taken note of by the Investigation Department was examined. In such a case, there is no scope to allege that the appellant company has shown toss to mitigate the admission given during search proceedings. Assessing Officer has not disproved purchases and sales when comparing with Statutory records like VAT 18 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) returns. Hence the admission given by the appellant in the form of letter and affidavit is with misapprehension of law and fact.

The ld. CIT(A) deleted the addition observing that the AO is not permitted to make the addition without rejecting the books of account. For the sake of clarity and convenience we extract the relevant part of the order of the ld. CIT(A) in para No.28 which reads as under:- “I have carefully considered the facts of the case, assessment order passed by the AO and the submissions/judicial pronouncements filed by the Authorised Representative of the appellant and also gone through the reply to the remand report furnished by the AO and also the counter comments given by the Authorised Representative of the appellant against the remand report. The issue to decide here is that whether the AO is justified in making the addition on estimate basis without rejecting the books of account and without pointing any defects in the books of account or method of account followed by the appellant is correct or not. I am of the view that even in the cases of disclosure made by the appellant at the time of search proceedings, it is necessary for the Assessing Officer to justify such admission with facts and figures and with proper verification of the documents filed by the appellant as required u/s.145(3)of the Income tax Act, 1961. It is more pertinent to mention here that this being a case of estimation of profit, the responsibility is cast upon the Assessing Officer to establish with proper evidence that the books of account of the appellant are defective and hence deserve to be rejected u/s.145(3)of the Income-tax Act, 1961 before estimation of profit. As submitted by the appellant, A.O.'s observation that the appellant failed to substantiate the valuation of opening and closing stocks, is found to be acceptable as the valuation has been reflected in Form 3CD of audit report and also in the Trading account. In order to fulfill the Assessing Officer could have carried proper verification/examination of the books of account on the basis of the information furnished by the appellant. The most essential requirement for the Assessing Officer before resorting to estimation of net profit, profit, is to reject the books of account, point out the defects in the books 19 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) of account u/s. 145(3), irrespective of the fact that whether the appellant made case, the Assessing Officer's action in making the addition of Rs. 3,32,36,244/- by estimating the net profit @ 5.52% on the gross of Rs.60,21,05,879/- could have gained some strength. Further, it is an undisputed fact that the appellant furnished Audit Report as required u/s. 44AB enclosing thereto the details of sales and purchases, closing stock etc. Except estimating the net profit @ 5.52% on the gross turnover of Rs.60,21,05,879/- as per the consent given by the Authorised Representative of the appellant by way of an affidavit filed during the course of assessment proceedings, the Assessing Officer has not made any worth-mentioning effort/independent verification and pointed out any defects in the appellant's books of account. The Assessing Officer simply gathered the particulars of turnover, gross profit and net profit from the records for the preceding five years i.e. AYs 2011-12 to 2015-16 (11.64 + 10.14 + 10.40 + 4.82+ 5.52 = 42.55/5 = 8.51), declared by the appellant in the return of income filed prior to date of search, and arrived at the average net profit 8.51% which was proposed to apply to the appellant's case, was also not adopted but a profit ratio of 8.51% was taken into consideration with the consent of the Authorised Representative of the appellant by way of an affidavit, but has not made any other worth mentioning exercise. The above exercise does not itself lead to estimation of income, as it is inevitable for the A.O. to reject the books of account u/s.145(3), if the profit is to be estimated, in other words, estimate of profit by comparing the profit admitted in the year under consideration with that of the earlier years, is not permissible as per law, as before resorting to such estimate of profit the A.O. should reject the books of account u/s 145(3) of the Income-tax Act, 1961 pointing out certain defects. As regards the A.O's observation that rejection of books of account of the appellant is not necessary as the profit was estimated as per the appellant's own admission, I am in disagreement with the A.O's observation as the provisions of sec.145 have not provided any such clause thereby making the intention of Legislature is crystal clear that rejection of books of account is mandatory in all the cases including the cases where the profit is to be estimated as per the admission given by the appellant.”

In the instant case, it is clear from the discussion that there was no material and no defects were pointed out by the AO. Even 20 & 184/VIZ/2020 C.O.Nos. 18 & 19/VIZ/2020 (M/s. Khan Mohammed Diamonds & Jewellery Pvt. Ltd.) though search was conducted no evidence was found by the AO evidencing the suppression of income or the inflation of purchase or inflation of expenditure. The assessee has maintained regular books of account which are duly audited. A search u/sec. 132 was conducted but no evidence was found indicating concealment of income. The assessee relied on the decision of ITAT, Rajkot Bench in the case of ACIT Vs. Rushabh Vatika (2013) 35 taxmann.com 383 wherein the coordinate bench has held that without rejection of books of account question of application of net profit does not arise. In the case of Pr.CIT Vs. Marg Ltd. (2017) 84 taxmann.com 52 the Hon'ble Madras High Court held that profits of the assessee cannot be estimated without rejection of books of account. In the case of Dhakeswari Cotton Mills Ltd. Vs. CIT(1954) 26 ITR 775 the Hon'ble Supreme Court held that AO is not entitled to make a pure guess work or suspicion without any reference or without any material at all. Taking into consideration of all the above aspects, in the instant case, there is no basis for estimation of income, therefore, estimation of income without having any seized material or any material is bad in law, Hence, we uphold the order of the ld. CIT(A) and dismiss the appeal of the Revenue.