ACIT, CIRCLE - 1, GORAKHPUR vs. BAJRANG BAHADUR SINGH, GORAKHPUR

PER SUDHANSHU SRIVASTAVA, J.M.: This appeal has been preferred by the Assessee against the order dated 28.06.2018, passed by the Learned Commissioner of Income Tax (Appeals), Gorakhpur [Ld. CIT(A)] for Assessment Year 2012-13.

2.0 The brief facts of the case are that the assessee was a Civil Contractor. The assessee filed his return of income for the year under consideration on 29.09.2012, declaring a total income of Rs.64,87,970/-. The assessment was completed by the Assessing Officer (AO) under section 143(3) of the Income Tax Act, 1961 (hereinafter called 'the Act’), assessing the total income

ITA No.49/VNS/2018 Page 2 of 32

of the assessee at Rs.67,43,840/-, vide assessment order dated 29.09.2012, wherein certain expenses were disallowed by the AO.

2.1 Subsequently, the Leaned Principal Commissioner of Income Tax (hereinafter called 'Ld. PCIT’), Gorakhpur by invoking the revisionary powers under section 263 of the Act, set aside the assessment order dated 29.09.2012 passed by AO under section 143(3) of the Act by treating the same as erroneous in so far as it was prejudicial to the interests of the Revenue and directed AO to frame fresh assessment, vide revisionary order dated 29.03.2017 passed under section 263 of the Act, by observing as under:

"From the above it clear that assessment was completed without due proper and adequate enquiries, making the order erroneous and prejudicial to the interest of revenue, and he also did not cooperate in the assessment proceedings as noted by the AO in his order and, therefore, I set aside to the file of the AO to be done afresh.” 2.2 During the second round of proceedings before the Assessing Officer, the assessee had filed Ledger Account before the Assessing Officer, who, after considering the details furnished by the assessee, passed an order under section 263/143(3) of the Act, disallowing certain expenses claimed by the assessee. The AO completed the assessment under section 263/143(3) of the Act, computing the income of the assessee as under, vide order dated 12.12.2017:

ITA No.49/VNS/2018 Page 3 of 32

Net income as per P&L account 6287969 Add: Disallowance made on account of 520799.00 expenses Add: Disallowance made on account of 35072.00 personal expenses Add: On account of disallowance u/s 40A(3) 51357520.00 on account of material consumed

Add: On account disallowance u/s 40A(3) on 18747450.00 account of labour payment Add: On account of disallowance of 337200.00 depreciation 77286010.00 Less: Deduction allowed under chapter VI-A 100000.00 Net taxable Income 7,71,86,010.00

2.3 Aggrieved by the order of the AO, the Assessee preferred an appeal before the ld. CIT(A), who partly allowed the appeal of the assessee. The relevant portion of the order of the Ld. CIT(A) is reproduced as under:

“In view of the above discussion I find that the additions made by the AO are unjustified. However, since the payments were not verified and the appellant has also not discharged its onus of verifying the genuineness and necessity of making payments in cash. I find that the books of account of the appellant are unreliable and should have been rejected u/s 145(3). Looking of the facts and circumstances of the case net profit @ 6% of the gross receipts of Rs.10,18,28,011/- would be fair and judicious.

ITA No.49/VNS/2018 Page 4 of 32

The business income of the appellant is directed to be assessed at Rs.61,09,680/-. This does not includes 'miscellaneous income of Rs.11,45,654/- disclosed by the appellant In his P&L account for the year under consideration.” 2.4 Aggrieved by the impugned order of the Ld. CIT(A), the Revenue has approached this Tribunal, challenging the order of the Ld. CIT(A), by raising the following grounds of appeal:

ITA No.49/VNS/2018 Page 5 of 32

2.5 The Tribunal, vide its order dated 31.05.2022, decided the appeal of the Revenue ex-parte qua the assessee-respondent and partly allowed the appeal of the Revenue by reversing the impugned order of the Ld. CIT(A) and restoring the order passed by the AO with regard to the addition under section 40A(3) of the Act and allowing Grounds No.2 and 3 of the appeal of the Revenue. The Tribunal also partly allowed Ground No.4 of the Revenue by rectifying the amount of disallowance of deprecation at Rs.3,37,520/-, which was erroneously typed as Rs.33,75,200/- in the impugned order of the Ld. CIT(A).

2.6 Against the ex-parte order of the Tribunal dated 31.05.2022, the assessee moved a petition under section 254(2) of the Act, bearing M.A. No.02/VNS/2022 with a request to recall the order of the Tribunal dated 31.05.2022, which was dismissed by the Tribunal vide order dated 27.10.2022 passed in M.A No.02/VNS/2022.

2.7 In the meantime, the assessee filed a writ petition before the Hon'ble High Court of Allahabad against the ex-parte order of the Tribunal dated 31.05.2022, vide Income Tax Appeal No.5 of 2023, raising the following substantial questions of law:

(i) Whether the impugned ex-parte order dated 31.05.2022 passed by the Income Tax Appellate Tribunal deserves to be set aside and quashed as it results in an impossible

ITA No.49/VNS/2018 Page 6 of 32

determination of income of the assessee/appellant which would be in excess of approximately 75% of the gross receipts of business? (ii) Whether the impugned order of the Tribunal is sustainable in law, inasmuch as, once the Assessing Officer treats the Books of Accounts maintained by the assessee as unreliable then for the purposes of causing a technical disallowance, under section 40(3) of the Income Tax Act, 1961, reliance on those very books of account or entries recorded therein, can be made; the issue is conclusively decided by this Hon'ble Court in the case of Commissioner of Income Tax vs. Banwari Lal Banshidhar reported in (1998) 229 ITR 229? (iii) Whether the impugned order of the Tribunal is sustainable in law as it has ignored the ration of decision of Hon'ble the Supreme Court in the case of Attar Singh Gurmukh Singh vs. State of Haryana and the Circular dated May 31, 1977 [(1977) 108 ITR (St.) 8] granting exemption from application of section 40A(3) of the Act, if the genuineness of the expenses incurred is not doubted? (iv) Whether the impugned order of the Tribunal is sustainable in law, inasmuch as, the grounds of appeal taken by the Revenue before the Tribunal did not challenge the order of Commissioner of Income-Tax(Appeals) on the issue of invocation of provisions of Section 145(3) of the Act and applying a best judgment assessment? 2.8 The Hon'ble High Court, vide order dated 23.11.2024 decided the first question referred to in affirmative, i.e., in favour of the assessee and remanded the matter to the Tribunal with a

ITA No.49/VNS/2018 Page 7 of 32

direction to grant an opportunity of hearing to the assessee and to decide the matter preferably within a period of three months, by holding as under:

“9. Since we have answered the first question in favour of the assessee, we are not going into any other substantial question of law raised by the assessee. 10. The matter is remanded to the Tribunal with a direction to grant an opportunity of hearing to the appellant and the appellant is also directed not to seek any adjournment in the said matter and the same may be decided preferably within a period of three months from today. 11. We have also been informed by learned counsel appearing on behalf of the appellant that an attachment order has been passed on 13.09.2024. 12. Since we have remanded the matter to the Tribunal, the attachment order is vacated. 13. The appeal stands disposed of.” 3.0 Consequent to the directions of the Hon'ble Jurisdictional High Court, vide order dated 23.11.2024, the appeal was fixed for hearing on various dates and the final hearing was concluded on 02.07.2026.

4.0 The Ld. CIT(DR) submitted that the present appeal preferred by the Department is against the order of the Ld. First Appellate Authority, vide which he has allowed substantial relief to the assessee by invoking the provisions of section 145(3) of the

ITA No.49/VNS/2018 Page 8 of 32

Act and, thereafter, estimating the net profit @ 6% of the gross contract receipts of Rs.10,18,28,011/- which amounted to Rs.61,09,680/- as against the total income of Rs.7,71,86,010/- assessed as per the assessment order passed under section 143(3) read with section 263 of the Act which included mandatory disallowance under section 40A(3) of the Act out of the payments towards material consumed and towards labour payments to the tune of Rs.5,13,57,520/- and Rs.1,87,47,450/- respectively besides the disallowance of depreciation to the tune of Rs.3,37,200/-. The Ld. CIT(DR) submitted that the initial original assessment proceedings were concluded on 31.03.2015 by making routine disallowances out of some heads of expenditures and subsequently proceedings under section 263 of the Act were initiated and, thereafter, order under section 263 of the Act was passed on 29.03.2017 as a remedial measure to an audit objection raised by the Revenue Audit Party which had pointed out to an omission of the AO to make disallowance under section 40A(3) of the Act out of material consumed. The order passed under section 263 of the Act attained finality, as the assessee had not filed any appeal against the order passed under section 263 of the Act.

4.1 Referring to the present appeal, the Ld. CIT(DR) submitted that during the course of assessment proceedings, the

ITA No.49/VNS/2018 Page 9 of 32

assessee was required to explain that as per the ledger account, labour charges to the tune of Rs.1,81,38,750/- were made in cash exceeding Rs.20,000/- and the assessee was required to explain as to why these payments should not be disallowed under section 40A(3) of the Act and the assessee’s contention was that the cash payments were not exceeding Rs.20,000/- in one single day to any labour and copies of Muster Rolls were produced for ready reference. Similarly, on being required to explain why disallowance should not be made with respect to purchase of raw material, it was the assessee’s submission that the purchases related to Grit, Sand, Soil and Morang which had been made to various truck drivers, who neither had any bank account nor would they accept any cheque and further the said payments were made to various truck drivers but no single payment to one truck driver exceeded Rs.20,000/- in a single day. The Ld. CIT(DR) submitted that all the same, the assessee did not produce any bills and vouchers during the course of fresh assessment proceedings. It was further submitted that the assessee had failed to make out a case under the first proviso to section 40A(3) of the Act read with Rule 6DD of the Rules during the course of fresh assessment proceedings and, therefore, the AO had rightly made disallowances under section 40A(3) of the Act with respect to the material consumed and labour payments.

ITA No.49/VNS/2018 Page 10 of 32

4.2 The Ld. CIT(DR) also argued that the Ld. First Appellate Authority had not insisted upon the assessee to produce all the bills and vouchers before providing the impugned relief to the assessee. It was argued that the Ld. First Appellate Authority had not carried out any kind of enquiry into the genuineness of the expenses claimed to have been incurred in cash on account of material and labour charges. It was submitted that the Ld. First Appellate Authority had made a wrong observation that the AO should have rejected the books of account under section 145(3) of the Act and that the AO should have estimated the income on account of un-verifiability of the expenses. It was submitted that the Ld. First Appellate Authority had invoked the provisions of section 145(3) of the Act on his own, rejected the book results and had estimated the net profit rate @6% of the gross receipts contrary to the facts on record.

4.3 It was further argued that as per provisions of section 40A(3) of the Act read with Rule 6DD of the Rules, it is mandated that this provision is of overriding nature and irrespective of the impact on the overall quantum of profits or tax, the same will have to be given full effect wherever payments, otherwise than by specified mode, are noticed. It was submitted that provisions of section 40A of the Act are mandatory provisions because of the use of word “shall” used in its various sub-sections and, further,

ITA No.49/VNS/2018 Page 11 of 32

sub-section (1) contains a non-obstante clause, i.e., it applies notwithstanding anything to the contrary contained in any other provisions of the Act relating to the computation of income under the head “profits and gains of business or profession”.

4.4 It was further pointed out by the Ld. CIT(DR) that the assessee has been assessed to income tax during the last fifteen years or so and has multiple bank accounts at different places and, therefore, the payments being made in cash inspite of having numerous bank accounts is not suitably explained. It was further submitted that as per CBDT Circular 6P dated 06.07.1968, the object and scope of section 40A(3) of the Act was to ensure that expenses in cash are not claimed in such a way so as to frustrate proper investigation as to the identity of the payee and the reasonableness of the payment.

4.5 It was further argued that while provisions of section 40A(3) of the Act are mandatory, the provisions of section 145(3) of the Act, i.e., relating to rejection of the books of account, are only discretionary and not mandatory and, therefore, the Ld. First Appellate Authority had grossly erred in not taking into consideration the effect of the mandatory provisions and resorting to the discretionary provisions and thereby granting relief to the assessee in a manner not valid in terms of law. It

ITA No.49/VNS/2018 Page 12 of 32

was submitted that the Ld. First Appellate Authority’s decision, to be guided by only one factor, i.e., disallowances under section 40A(3) of the Act, would result into business profits being computed approximately at 75% of the gross receipts, was not tenable in view of the judgment of the Hon'ble Apex Court in the case of Attar Singh Gurmukh Singh vs. ITO reported in [1991] 191 ITR 667 (SC) wherein it was held that there would be little merit in the contention that if the price of purchased material is not allowed to be adjusted against the sale price of the material sold, then the income tax levied will not be on the income but will be on an assumed income. It was submitted that as per Hon'ble Apex Court, genuine and bona fide transactions are not taken out of the sweep of section 40A(3) of the Act and it is always open to the assessee to furnish to the satisfaction of the AO the circumstances under which the payment in the manner prescribed in section 40A(3) of the Act was not practicable or would have caused genuine difficulty to the payee.

4.6 The Ld. CIT(DR) submitted that in the facts and circumstances of the present appeal, it was evident that the Ld. First Appellate Authority’s order was totally unjustified on facts as well as in law and it deserved to be set aside and that the order of the AO deserved to be restored by upholding mandatory provisions of section 40A(3) of the Act.

ITA No.49/VNS/2018 Page 13 of 32

4.7 The Ld. CIT(DR) also drew our attention to the compilation of case laws placed in the paper book in support of various arguments by the Department and prayed that the same may be taken on record and should be considered while adjudicating the issue.

5.0 Per contra, the Ld. Authorized Representative for the assessee (Ld. A.R.) submitted that proper books of account were maintained by the assessee, which were duly subjected to audit by the Auditor and the Audit Reports along with final accounts and balance sheet, etc. were filed before the AO. It was also submitted that with respect to purchase of material, the assessee being a Civil Contractor, most of the purchases were of Grit, Sand, Soil and Morang, etc., the payment of which has to be made to the truck drivers, who neither have any bank account nor accept cheques. Similarly, in the case of payment towards labour charges, the assessee was carrying out work at four different sites during the year under consideration and it was practically impossible for a Contractor to engage labour for each and every site and, therefore, the labour was engaged through a Labour Incharge and the payments were made to the said Labour Incharge but again no payment exceeding Rs.20,000/- to one single labour was made under any circumstances. It was argued that this is the normal practice adopted by the Contractor,

ITA No.49/VNS/2018 Page 14 of 32

specially engaged in Civil Contract. It was argued by the Ld. A.R. that the impossibility of making payments through bank account stemmed from the fact that neither the truck drivers nor the Labour Incharges would accept payments except in cash and, therefore, this would essentially be covered by the exception provided under rule 6DD(j) of the Income Tax Rules and would, therefore, rigors of section 40A(3) of the Act would not be applicable in the present case.

5.1 It was further submitted by the Ld. A.R. that as per the CBDT Circular dated 31.05.1977 on the interpretation of section 40A(3) of the Act and Rule 6DD(j) of the Rules, it has been specified that though all the circumstances in which conditions laid down under rule 6DD(j) of the Rules would be applicable, cannot be spelt out, some of them which would meet the requirements of the said rule would include: (1) the purchaser is new to the seller; or (2) the transactions are made at a place where either purchaser or seller does not have a bank account; or (3) the transactions are made on a bank holiday; or (4) the seller is refusing to accept payment by way of crossed cheque or draft and the purchaser’s business interest would suffer due to non-availability of goods; or (5) the seller, acting as a commission agent, is required to pay cash in turn to the persons from whom he has purchased goods; or (6) specific discount is given for

ITA No.49/VNS/2018 Page 15 of 32

purchase in cash. The Ld. A.R. submitted that the above narrated circumstances are not exhaustive but only illustrative and the object of Rule 6DD(j) of Rules is to relax the rigors of sub-section (3) of section 40A of the Act to avoid hardship and harassment in genuine and bona fide cases and further the practicability for the purpose of Rule 6DD(j) of Rules has to be judged from the point of view of businessman and not the Revenue. The Ld. A.R. submitted that section 40A(3) of the Act must not be read in isolation or exclusion of Rule 6DD of the Rules and it is very much apparent that the provisions of section are not intended to restrict the business activities.

5.2 It was further submitted that subsequent to the original assessment proceedings, the AO was mandated under section 263 of the Act, vide order dated 29.03.2017, to make assessment order afresh and a perusal of this fresh assessment order would reveal that the AO was unable to verify the books of account, as the same were not produced before him and photocopies of some ledgers were submitted which were not supported by bills or vouchers. It was submitted that, admittedly, the assessee was at fault for not having submitted the relevant details but all the same the impugned additions under section 40A(3) of the Act could not have been made under the circumstances. The Ld. A.R. submitted that, therefore, in view of factual matrix, the Ld.

ITA No.49/VNS/2018 Page 16 of 32

First Appellate Authority had acted in most logical and legally tenable manner by proceeding to reject the books of account and estimating the income of the assessee which, the AO should have done in the first place. The Ld. A.R., while placing reliance on the order of the Ld. First Appellate Authority, also submitted that as far as the Department’s reliance in the case of Attar Singh Gurmukh Singh vs. ITO (supra) is concerned, the facts are distinguishable and the same was rendered prior to the amendment to Rule 6DD(j).

5.3 The Ld. A.R. further submitted that the powers of the Ld. First Appellate Authority are coterminous with the powers of the AO in the matter of making assessment and, therefore, when the AO had found that the books of account were highly unreliable, the Ld. First Appellate Authority was within his right to reject the books of account under section 145(3) of the Act and had, therefore, proceeded to assess the income by applying the net profit rate. The Ld. A.R. further submitted that the provisions of section 40A(3) of the Act contemplate disallowance of expenditure incurred in cash and question of disallowance would obviously arise when deduction is claimed, whereas if estimation of profit is made on a percentage, no deduction of expenditure incurred in cash can be said to have been claimed, considered or allowed.

ITA No.49/VNS/2018 Page 17 of 32

5.4 The Ld. A.R. also placed reliance on various case laws in support of his contention (which have been compiled in the form of paper book) and prayed that the same may be taken on record and duly considered while adjudicating the issue.

6.0 We have heard the rival submissions and have also perused the material on record. We have also carefully considered the various judicial precedents cited by both the parties. The undisputed facts in this case are that the assessee was a civil contractor. The assessee filed his return of income on 29.09.2012 declaring a total income of Rs.64,87,970/-. The assessment was completed by Assessing Officer by assessing total income of the assessee at Rs.67,43,840/- in the original assessment proceedings conducted under section 143(3) read with section 143(2) of the Act, vide assessment order dated 29.09.2012 passed under section 143(3) of the Act, wherein certain expenses were disallowed by the AO . The ld. Pr. CIT, Gorakhpur invoked revisionary powers under section 263 of the Act, and set aside the assessment order dated 29.09.2012 passed by the AO under section 143(3) of the Act by treating the same as erroneous so far as being prejudicial to the interest of Revenue and directing the AO to conduct fresh assessment, vide revisionary order dated 29.03.2017 passed by ld. Pr. CIT under section 263 of the 1961 Act, by holding as under:

ITA No.49/VNS/2018 Page 18 of 32

“From the above it clear that assessment was completed without due proper and adequate enquiries, making the order erroneous and prejudicial to the interest of revenue, and he also did not cooperate in the assessment proceedings as noted by the AO in his order, and therefore, I set is aside to the file of the AO to be done afresh.” 6.1 The assessment order dated 12.12.2017 passed by the Assessing Officer in consequence to revisionary order passed by ld. Pr. CIT under section 263 of the Act, dated 29.03.2017, categorically records that the assessee did not produce books of account in the original proceedings as also that the assessee did not produce any books of account even during the assessment proceedings conducted by the Assessing Officer in consequence to the revisionary order passed by the ld. Pr. CIT under section 263 of the Act. The AO observed that the assessee has wrongly stated in his reply that books of accounts were produced before the AO during the original assessment proceedings, while no books of accounts were produced by the assessee before the AO in original assessment proceedings, as found mentioned in the order sheet entry dated 24.02.2015. The AO further observed that no books of accounts were also produced in the assessment proceedings conducted by AO in consequence of the revisionary order passed by ld. Pr. CIT under section 263 of the Act. The AO further observed that no bills and vouchers were produced by the

ITA No.49/VNS/2018 Page 19 of 32

assessee during assessment proceedings conducted by the AO in pursuance to revisionary order passed by ld. Pr. CIT under section 263, and it was noted by the AO in his order that except written submissions, nothing else was produced by the assessee. The AO observed that even in the original assessment proceedings, the assessee had merely filed photocopies of some ledger accounts, while no bills and vouchers were produced. The AO observed that the assessee had submitted ledger account of material purchases, and it was observed by the AO that the assessee has made payments to the tune of Rs.5,80,12,836/- towards material purchases which were paid in cash. The AO observed that the assessee has tried to bifurcate these cash payments to bring down below the threshold limit of Rs.20,000/- per day. The AO observed that the assessee has not produced cash book, receipt book, bills or voucher(s), so that the payments could be verified. The AO observed that the assessee has changed the ledger account of material consumed to bring down cash payments within threshold limit of Rs.20,000/- per day, in order to avoid being hit by provisions of section 40A(3) of the Act. The AO observed that in the material consumed ledger filed during assessment proceedings consequent to the revisionary order passed by ld. Pr. CIT, even names of the payees have been changed. Further, the AO observed that none of the cash

ITA No.49/VNS/2018 Page 20 of 32

payments towards material purchases made by the assessee were supported by vouchers. This led to the additions to the tune of Rs.5,13,57,520/- being made by the AO to the income of the assessee on account of such payments been made in cash otherwise than through account payee cheque, by invoking provision of section 40A(3) of the Act by the AO and the material consumed to the tune of Rs.5,13,57,520/- was added to the income of the assessee.

6.2 Similarly, the AO observed that the assessee has made payment to the tune of Rs.2,16,67,364/- towards labour charges. The AO observed from the ledger of labour payments, that cash payments in excess of Rs.20000/- in a day were made towards labour charges, to the tune of Rs.1,81,47,450/-. The details are extracted by AO in its assessment order dated 12.12.2017, at pages 4 and 5. The AO asked the assessee to explain these cash payments. The assessee submitted muster rolls before the AO, and it was observed by the AO that there are several inconsistencies in the muster roll and further the details of payees are not there. The AO further observed from the muster roll that it is an afterthought by the assessee.

6.3 The AO further observed that as the assessee has not produced books of accounts, the availability of cash in hand

ITA No.49/VNS/2018 Page 21 of 32

cannot be verified. The AO observed that the payments have been made exceeding Rs.20000/- in cash on single day, and no explanation has been offered by the assessee, which led the AO to invoke provisions of section 40A(3) of the Act and cash payments to the tune of Rs.1,81,47,450/- towards labour payments, stood added to the income of the assessee , vide assessment order dated 12.12.2017 passed by AO under section 143(3) read with section 263 of the Act.

6.4 Thereafter, on appeal, the Ld. First Appellate Authority partly allowed assessee’s appeal by holding that invocation of provisions of section 40A(3) of the Act in the case of the assessee would result in abnormal increase in the profit of the assessee (almost 75% of the gross receipts) which could not be sustained. As an alternative, the Ld. First Appellate Authority proceeded to invoke the provisions of section 145(3) of the Act and rejected the books of account by observing that the AO should have also invoked the provisions of section 145(3) of the Act and should have estimated the profit rather than proceeding to make the disallowance under section 40A(3) of the Act. The Ld. First Appellate Authority estimated the net profit rate @ 6%.

6.5 Given this background, the essential question raised by the Department and due for consideration before us is as to

ITA No.49/VNS/2018 Page 22 of 32

whether the Ld. First Appellate Authority had erred in law and in fact in deleting the specific disallowances under section 40A(3) of the Act and, thereafter, proceeding to invoke the provisions of section 145(3) of the Act by holding that any addition made under any specific provisions of section 40A(3) of the Act can be substituted by general provisions of the Act.

6.6 It is seen that, undoubtedly, the provisions of section 40A(3) of the Act are mandatory in nature, as the use of word ‘shall’ signals an obligatory fiction. The Courts have consistently held that once its conditions are met, the deeming provisions operate irrespective of preference, convenience, or the existence of some other mechanism elsewhere in the statute that might also touch the same facts. A mandatory mechanism, once triggered, does not yield to a competing approach simply because a party would prefer the other one. The Hon'ble Apex Court in the case of CIT vs. S. Teja Singh reported in [1959] 35 ITR 408 (SC) has laid down that when a statute deems one state of affairs to be another, the Courts must also deem all facts and consequences that are logically indispensable for that deemed state to exist, meaning thereby that a fiction must be carried to its logical conclusion and not be read in truncated form. In this particular case of CIT vs. S. Teja Singh (supra), the assessee had never been assessed to tax before assessment year 1948-49. He

ITA No.49/VNS/2018 Page 23 of 32

filed voluntary returns in July, 1949 disclosing income for two assessment years, but he had not filed the advance-tax estimate required under section 18A(3) of the Income Tax Act, 1922, which obliged a person, not previously assessed, to send the Income-tax Officer an estimate of tax payable if his income was likely to exceed Rs.6,000. The Income Tax Officer treated this default as attracting penalty under section 28 read with section 18A(9) of the Act, and levied penalties for both years. At that point of time, section 18A(3) of the Act had no notice requirement at all, whereas the language of section 28(1)(a) of the Act presupposed a prior notice under sections 22/34 of the Act which was followed. The Appellate Tribunal and, on reference, the Hon'ble Punjab High Court, both held the penalty order ultra vires on the reasoning that section 28(1)(a) of the Act would be attracted only when there was a notice under sections 22 or section 34 of the Act to which the assessee had failed to comply and whereas, since no such notice could ever be issued in respect of section 18A(3) of the Act, estimate (which was due before assessment even begins), section 28 of the Act could not, on its plain wording, be applied to section 18A(3) of the Act default at all. However, the Hon'ble Apex Court reversed the judgment of the Hon'ble Punjab High Court holding that its error lay in not giving full effect to the deeming fiction in section 18A(9)(b) of the Act.

ITA No.49/VNS/2018 Page 24 of 32

While deciding the case, the Hon'ble Apex Court invoked the classic English authority on statutory fictions, Lord Asquith's observation in East End Dwellings Co. Ltd. v. Finsbury Borough Council, L.R. (1952) AC 109 that when a statute requires an imaginary state of affairs to be treated as real, one must also treat as real the consequences that would inevitably have flowed from that state of affairs had it actually existed, without letting imagination boggle at those inevitable corollaries. The Hon'ble Apex Court held that it was competent for the Income Tax authorities to impose a penalty under section 28 read with section 18A(9)(b) of the Act for a bare failure to comply with section 18A(3) of the Act, notwithstanding the absence of any actual notice under section 22 of the Act. Thus, as per the judgment of the Hon'ble Apex Court in CIT vs. S. Teja Singh (supra), once the fiction is created, Courts must assume all facts and consequences logically necessary to give it full effect. Therefore, at this juncture, we are in full agreement with the arguments of the Ld. CIT(DR) that deeming provisions of section 40A(3) of the Act have to mandatorily applied.

6.7 However, as is apparent from the factual matrix of the case, although the AO invoked the provisions of section 40A(3) of the Act by disallowing payments with respect to materials purchased and the payments to labour, a perusal of the

ITA No.49/VNS/2018 Page 25 of 32

assessment order as well as the observations of the Ld. First Appellate Authority will show that the books of account or the vouchers were never produced before the AO and the assessee only produced Muster Rolls and self-made vouchers to support the claim of expenditure. Thus, apparently, the entire set of books of account were never produced before the AO and inspite of the entire set of books of account not being made available to the AO, the AO proceeded to make the impugned disallowances in absence of books of account, i.e. without verification.

6.8 Apparently, the AO only had some Ledger Accounts before him and also Muster Rolls and self-made vouchers, but for the purpose of making proper disallowance, in terms of the provisions of section 40A(3) of the Act, it was imperative on the part of the AO to have pointed out specifically which all payments in cash were made in excess of Rs.20,000/- to one single person on one single day. It was the assessee’s explanation before the AO that the purchase of materials were made from truck drivers from whom Grit, Sand, Soil and Morang, etc. were purchased and that these truck drivers neither had any bank account nor would they accept payments in any other form except in cash. Similarly, with respect to labour charges, it was submitted by the assessee before the AO that these payments were made through

ITA No.49/VNS/2018 Page 26 of 32

Labour Incharges at four different sites of the assessee and again no single payment was exceeding Rs.20,000/- to a single person on any given single day. It is true that the assessee did not co- operate during the course of assessment proceedings and for the reasons best known to him, did not furnish the required details. There is also an allegation against the assessee that the ledgers produced had been manipulated to show that all payments were below Rs.20,000/-. Thus, apparently, the books of account could not be trusted. All the same, it was imperative for the AO to have made disallowance under section 40A(3) of the Act only after proper verification and specifically pointing out all cases where payments exceeded Rs.20,000/- to a single person on a single day. However, the AO simply proceeded to reject the submissions of the assessee and made the impugned disallowances completely ignoring the fact that the provisions of section 40A(3) of the Act specifically require that each violation has to be specified and brought on record before disallowance can be made. The assessee should have been required to submit more details before the impugned disallowance could have been made.

6.9 In the alternative, the AO could have required the assessee to point out specifically those entries which would fall

ITA No.49/VNS/2018 Page 27 of 32

under the exception as provided under Rule 6DD(j) or 6DD(k) of the Rules which provide exception to section 40A(3) of the Act. Therefore, although we are in full agreement with the contentions of the Ld. CIT(DR) that the provisions of section 40A(3) of the Act are mandatory in nature and have to be applied, the said provision, all the same, has to be applied in such terms as laid down by the Act, i.e., by specifically pointing out each and every violation, which in the present case has not been done.

6.10 This brings us to another aspect of the appeal of the Department wherein the Department has castigated the observations of the Ld. First Appellate Authority wherein he has observed that if the provisions of section 40A(3) of the Act are to be applied, the same would result in abnormal profits which would be approximately 75% of the gross receipts. In our considered opinion, this observation of the Ld. First Appellate Authority lacks any legal backing as has been held in the case of CIT vs. S. Teja Singh (supra). The Courts cannot ignore a deeming provision or refuse to apply because it is absurd. It has been held in multiple cases, including CST v. Modi Sugar Mills, AIR 1961 SC 1047 that there is no room for intendment in a taxing provision and that the Court cannot supply a casus omissus just because the outcome seems unfair and, thus, the

ITA No.49/VNS/2018 Page 28 of 32

default in tax law calls for strict, literal construction. In a taxing statute, one looks only at what is clearly said, with nothing to be read in and nothing implied. Therefore, we are of the considered view that the observation of the Ld. First Appellate Authority, that if provisions of section 40A(3) are applied, the net profit percentage will be of more than 75% which is impossible in any line of business, cannot be held to be legally tenable.

6.11 All the same, the fact remains that the AO had made the disallowance without bringing any specific finding or pointing out specific violations and, therefore, the provisions of section 40A(3) of the Act, notwithstanding their mandatory nature, could not have been applied legally.

6.12 This brings us to the doctrine of co-terminus powers of the Ld. First Appellate Authority. In the case of CIT v. Kanpur Coal Syndicate reported in (1965) 53 ITR 225 (SC), a three-judge Bench of the Hon'ble Apex Court held that the appellate authority (then AAC, now CIT(A)) has plenary powers in disposing of an appeal, and that the scope of that power is co-terminous with that of the Assessing Officer, i.e., he can do what the AO can do, and can also direct the AO to do what he failed to do. This was reaffirmed in the case of Jute Corporation of India Ltd. v. CIT, (1991) 187 ITR 688 (SC), and many other cases. In practical

ITA No.49/VNS/2018 Page 29 of 32

terms, this means that the Ld. First Appellate Authority can examine and decide any matter connected with the assessment even without a specific ground being raised; can admit an additional legal ground not urged before the AO, provided the relevant facts are already on record; can direct further inquiry, or call for a remand report from the AO on facts or evidence produced in appeal; can admit additional evidence in the limited circumstances which Rule 46A of the Income Tax Rules permits; can enhance the assessment or penalty and not merely reduce it. Thus, it flows from this that the Ld. First Appellate Authority has the power to decide any matter arising out of the proceedings, whether or not raised by the assessee within the record of the assessment actually made and the Ld. First Appellate Authority functions almost as a substitute AO, to revisit, correct, enhance or reverse what the AO did. The doctrine is best understood not as unlimited delegated authority, but as full substitutive power over the same subject-matter the AO already had before him. Therefore, it flows from this that where the AO had applied the provisions of section 40A(3) of the Act incorrectly and the books of account were neither verifiable nor dependable, in view of the co-terminous powers of the Ld. First Appellate Authority, in the present appeal, the Ld. First Appellate Authority chose to reject the books of account in terms of section 145(3) of the Act and

ITA No.49/VNS/2018 Page 30 of 32

proceeded to apply the net profit percentage of 6%. Undoubtedly, section 145(3) of the Act as well as Best Judgment machinery of section 144 of the Act, are the tools which the AO himself could have used, and since the Ld. First Appellate Authority can do what the AO can do, the action of the Ld. First Appellate Authority, on the peculiar facts of this case in invoking the provisions of section 145(3) of the Act, cannot be said to be bad in law. We are of the considered view that in the present case, since the deeming provision of section 40A(3) of the Act had wrongly been applied by the AO, intervention of the Ld. First Appellate Authority, by rejecting the books of account, cannot be said to be downgrading the harsh provisions of section 40A(3) of the Act, because the AO did not have necessary details which could trigger the provisions of section 40A(3) of the Act and, therefore, the deeming fiction of section 40A(3) of the Act never actually came into operation in the facts of the present case.

6.13 Although the reasoning given by the Ld. First Appellate Authority might be legally unsound, the approach cannot be faulted with. Therefore, it flows from the facts that in the present case, an improperly invoked deeming provision (section 40A(3) of the Act) had no legal foundation to stand on and, therefore, the arguments of the Department have to fail on the merit part of it.

ITA No.49/VNS/2018 Page 31 of 32

This connects directly to CIT vs. S. Teja Singh (supra) and East End Dwellings Co. Ltd. v. Finsbury Borough Council (supra) principle that fiction requires certain underlying facts to exist before it can operate at all. If a deeming provision's own statutory conditions, the specific facts, figures, or procedural steps mandated by the section, were never actually established because the AO lacked the necessary details, the fiction simply did not come into operation and, accordingly, the resulting disallowance is not a defensible exercise of the provision applied somewhat imperfectly, but rather it is an addition/disallowance with no valid statutory basis at all.

6.14 Therefore, on an overall view of the facts of the case and in view of our observations in the preceding paragraphs, we have reached a conclusion that given the facts and circumstances of this case, the Ld. First Appellate Authority’s act of rejecting the books of account and applying the net profit rate of 6% on the gross receipts cannot be faulted with and the same is upheld.

6.15 As far as ground No.4 pertaining to non-adjudication of the ground relating to disallowance of Rs.3,37,520/- with respect of depreciation is concerned, no arguments were advanced by either of the parties on this ground before us and, therefore, the same is liable to be dismissed as not pressed.

ITA No.49/VNS/2018 Page 32 of 32

7.0 In the final result, the appeal of the Department stands dismissed.

Order pronounced in the open Court on 24/09/2026.

Sd/- Sd/- [NIKHIL CHOUDHARY] [SUDHANSHU SRIVASTAVA] ACCOUNTANT MEMBER JUDICIAL MEMBER

DATED:24/09/2026 JJ: Copy forwarded to: 1. Appellant 2. Respondent 3. CIT(A) 4. CIT 5. DR By order

Assistant Registrar/DDO