SUJATHA TRADERS ,BANGALORE vs. ACIT, CIRCLE-5(2)(1) , BANGALORE

PER WASEEM AHMED, ACCOUNTANT MEMBER:

The present appeal filed by the assessee is directed against the order under section 250 of the Income Tax Act, 1961 (hereafter the Act) passed by the learned Commissioner of Income Tax (Appeals) under the National Faceless Appeal Centre, Delhi (hereafter the Ld. CIT(A)) for A.Y. 2017-18 bearing DIN & Order No.: ITBA/NFAC/S/250/2025-26/1081838154(1).

5.1 The assessee contended that the AO had not pointed out any specific defect in the books of account or identified any particular entry or expenditure as incorrect. The books were maintained in Tally software. Due to a system crash in February 2017, the accounting data had to be reconstructed. This fact had been duly explained and the reconstructed accounts were also certified by the tax auditor. It was therefore submitted that the entire books could not be rejected merely on the basis of doubts regarding the cash balances.

5.2 The assessee further submitted that there was regular compliance during the assessment proceedings and the relevant explanations and documents were furnished both physically and electronically. It was accordingly contended that rejection of the books and estimation of profit at 3% of the turnover was without any proper basis. The AO had also failed to consider the nature of the assessee's business and the profit rates of similar concerns.

6.1 The Ld. CIT(A) further observed that merely because the books were audited would not prevent the AO from invoking section 145(3) of the Act where the accounts were found to be incomplete or unreliable. In this regard, reliance was placed on the decisions of the Hon'ble Supreme Court in CIT v. McMillan & Co. (1958) 33 ITR 182 (SC) and Kachwala Gems v. JCIT (2007) 288 ITR 10 (SC).

6.2 The Ld. CIT(A) also noted that even during the appellate proceedings, despite several opportunities, the assessee did not furnish any additional reconciliation, confirmation or independent documentary evidence to establish the correctness of the declared trading results. The HDFC Bank certificate showing deposits of SBN and non-SBN notes only established the fact of deposits. It did not independently establish the correctness of the reported turnover or trading results in the absence of corroboration from the underlying sales and purchase records.

6.3 Accordingly, the Ld. CIT(A) held that the AO was justified in rejecting the books of account u/s 145(3) of the Act. The estimation of income at 3% of the turnover was also considered reasonable having regard to the volume of turnover, the cash-intensive nature of the business and the volume of cash transactions. The action of the AO was therefore upheld and the grounds raised by the assessee were dismissed.

9.1 In this regard, we have carefully perused the assessment order. The reason the AO doubted the books was the manner in which cash was reflected and dealt with during the demonetisation period. As per the AO, the assessee maintained separate cash books for its Head Office and branch and had substantial cash balances comprising demonetised notes as on 09.11.2016. The AO questioned why such substantial cash was retained for several days while smaller amounts were being deposited into the bank, sometimes multiple times. On this basis, the AO concluded that the cash transactions and balances were not satisfactorily explained and that the books did not reflect the true picture of the assessee's affairs.

9.2 However, on a careful reading of the assessment order, we find that the AO has nowhere doubted the turnover disclosed by the assessee. The AO has also not pointed out any defect in the sales or purchase figures as such. No particular sale or purchase has been held to be bogus. No specific expenditure has been found to be false or unverifiable. The AO's concern was primarily with the cash balance and the manner in which cash, particularly demonetised currency, was deposited into the bank.

9.3 We also note that before the lower authorities, the assessee had furnished audited financial statements, Form 3CB-3CD, VAT returns, monthly sales and purchase summaries, stock statements and bank account details. The assessee had also furnished a certificate issued by HDFC Bank confirming deposits of Rs. 1,39,91,000/- in SBN and Rs. 95,30,260/- in non- SBN notes during the demonetisation period. The assessee further explained that its books were maintained in Tally and that the data had to be reconstructed due to a system crash in February 2017. The tax auditor also certified the reconstructed accounts.

9.4 We are conscious that merely because the accounts are audited, this does not prevent the AO from invoking section 145(3) of the Act where the conditions prescribed therein are satisfied. However, the AO cannot reject the books merely on suspicion or because certain transactions appear unusual. There must be material defects in the accounts which render it impossible or unreliable to correctly determine the income of the assessee. In the present case, the principal doubt raised by the AO concerns the availability and movement of cash during the demonetisation period. In our view, such doubt, by itself, could have called for examination of the source and genuineness of the particular cash transactions. However, without pointing out defects in the trading account, purchases, sales, stock records or the method of accounting, the same cannot automatically lead to rejection of the entire books and substitution of the disclosed business results by an ad hoc percentage of turnover.

9.5 We also find a material inconsistency in the reasoning adopted by the Ld. CIT(A). On one hand, the Ld. CIT(A) observed that the assessee had failed to establish the correctness of the reported turnover and trading results in the absence of corroboration from the underlying sales and purchase records. On the other hand, the Ld. CIT(A) accepted the very same turnover as the basis for estimating the assessee's income at 3%. In our considered view, these two conclusions do not stand together. If the turnover itself was considered unreliable or unproved, there was no logical basis for adopting that very turnover as the foundation for estimation of income. More importantly, this doubt regarding the correctness of the turnover does not emerge from the assessment order itself. As noted above, the AO's objection was directed towards the cash balances and deposits during the demonetisation period and not towards the turnover disclosed by the assessee.

9.6 We further find that the estimation of income at 3% of the turnover has not been supported by any objective basis. The AO has not referred to the assessee's profit rate in the preceding or subsequent years. No comparable case from the same line of business has been brought on record. No industry profit rate has been referred to. The assessment order also does not demonstrate how the rate of 3% was arrived at. Therefore, even assuming defects existed in the books, income cannot be estimated at an arbitrary rate without any reasonable nexus to the material on record.

9.7 The Ld. CIT(A) justified the rate of 3% by referring to the volume of turnover, cash-intensive nature of the business and volume of cash transactions. In our view, these factors by themselves cannot determine the rate of profit. A high turnover or substantial cash transactions do not necessarily result in a particular percentage of profit. The estimate must have some reasonable foundation, such as the assessee's past accepted results, comparable cases or other relevant material. No such exercise has been carried out in the present case.

9.8 The decisions of the Hon'ble Supreme Court in CIT v. McMillan & Co. (1958) 33 ITR 182 (SC) and Kachwala Gems v. JCIT (2007) 288 ITR 10 (SC), relied upon by the Ld. CIT(A), lay down that audited accounts are not conclusive and that income may be estimated where the accounts are unreliable. There can be no dispute with this proposition. However, these decisions do not dispense with the requirement that rejection of books should be based on defects relevant to determining the true business results and that any subsequent estimation must have a reasonable and rational basis.

9.9 In view of the above discussion, we are of the considered opinion that the rejection of books of account u/s 145(3) of the Act and consequent estimation of income at 3% of the turnover in the given facts is liable to be quashed. We, therefore, set aside the finding of the Ld. CIT(A) and direct the AO to accept the business income as disclosed by the assessee in its books of account. Accordingly, the addition arising from estimation of income at 3% of the turnover is deleted, and the grounds raised by the assessee on this issue are allowed.

Sd/- Sd/- SANDEEP SINGH KARHAIL WASEEM AHMED JUDICIAL MEMBER ACCOUNTANT MEMBER Bangalore Dated: 7th October, 2026. Vms Copy to: SUJATHA TRADERS , NO. 42, III MAIN, NEW THARAGUPET,, 1 BANGALORE-560002, KARNATAKA

ACIT, CIRCLE-5(2)(1) , BMTC BUILDING, 80 FEET ROAD, 6TH 2 BLOCK, KORAMANGALA, BANGALORE-560095, KARNATAKA

3 THE PCIT / CIT, 4 THE D.R., ITAT, BANGALORE BENCH 5 GUARD FILE By Order ASSISTANT REGISTRAR / I.T.A.T., BANGALORE

P G Digitally signed by P G RAJANI RAJANI Date: 2026.10.22 15:48:18 +05'30'