INCOME TAX OFFICER, WARD-1(8), BHAVNAGAR, BHAVNAGAR vs. MADHAV COPPER LIMITED, BHAVNAGAR

The assessee is a company engaged in the business of manufacturing and trading of copper products. For the relevant assessment years under consideration the assessee filed its return of income declaring profits from business.

In the assessment year 2018–19, the case was reopened under section 147 of the Act based on information received from the Investigation Wing of the Department, indicating that the assessee had entered into transactions with accommodation entry providers, including M/s. RCI Industries and Technologies Ltd. and others. It was further revealed during the proceedings that the assessee had made purchases from entities flagged in GST investigations as bogus suppliers. The Assessing Officer (AO) issued notice under section 148 and framed the reassessment under section 143(3) r.w.s.

On finding that the assessee had not satisfactorily discharged the onus of establishing the genuineness of purchases and the identity of the suppliers, the AO invoked the provisions of section 145(3), rejected the books of account, and applied a gross profit rate of 12.5%. In appeal, the CIT(A) upheld the rejection of books of account but found the GP rate adopted by the AO to be excessive. Considering the nature of business and submissions placed on record, the CIT(A) restricted the GP rate to 5% of the impugned purchases. The balance disallowance was deleted.

In assessment year 2020–21, the case was selected for complete scrutiny under CASS. The AO noted that the assessee had made purchases from parties whose details were flagged by the Insight portal and who had not filed their income tax returns or responded to verification notices. The AO treated the purchases as unverifiable, rejected the books of account under section 145(3), and estimated income by applying a GP rate of 12.5%. The assessee contested the assessment in appeal before the CIT(A), NFAC, reiterating the genuineness of purchases and the availability of supporting documentation. While concurring with the AO’s finding on unverifiability of suppliers, the CIT(A) considered a 6% profit rate to be reasonable and accordingly granted partial relief.

In the subsequent assessment year 2021–22, a similar pattern emerged. The AO, based on Insight data and field verification, concluded that the assessee had made purchases from parties whose existence or business activity could not be substantiated. The AO once again rejected the books of account under section 145(3) and applied a GP rate of 12.5%. The CIT(A), while affirming the rejection of books, accepted the assessee’s contention that the GP rate of 12.5% was on the higher side, and therefore scaled it down to 6% and deleted the balance.

Aggrieved by the orders of CIT(A) both Revenue, as well as assessee are in appeal before us raising following grounds of appeal:

Alternatively, and without prejudice, the estimation of profit at the rate of 5% is highly excessive and does not reflect the real income earned of the appellant.

The learned CIT(A) has erred in law and on facts of the case in confirming action of the ld. AO in initiating penalty u/s. 270A of the Act.

During the course of hearing before us, the learned Departmental Representative (DR) placed reliance upon the assessment orders passed by the Assessing Officer for all three assessment years under consideration.

The learned Authorised Representative (AR), appearing on behalf of the assessee, reiterated the factual matrix as recorded in the orders of the lower authorities. it was further submitted that the application of an arbitrary gross profit (GP) rate of 12.5% was excessive and without any basis in the business history of the assessee. The learned Authorised Representative (AR) also invited attention to the year-wise trend of gross profit (GP) and net profit (NP) ratios from A.Y. 2016–17 to A.Y. 2021–22 to contend that the GP ratios applied by the AO were wholly unjustified and excessive. It was submitted that the assessee has maintained consistent profitability over the years and that the impugned purchases were duly accounted for and supported by documentation. The AR emphasised that the average GP and NP ratios for the period A.Ys. 2016–17 to 2018–19 stood at 5.50% and 2.12%, respectively, whereas for the extended period A.Ys. 2016–17 to 2021–22, the average GP and NP ratios were 5.34% and 2.14%, respectively. These, according to the assessee, demonstrate consistency and rule out any unusual inflation or suppression. To further support this contention, the AR demonstrated the impact of the addition made by the AO for A.Y. 2018–19 on the profitability ratios. It was contended that if the addition of ₹11.61 crore made by the AO is factored in, the GP and NP ratios shoot up to 10.35% and 8.75%, respectively, which are abnormally high and uncharacteristic of the assessee’s line of business. This variation, the AR submitted, was a clear indication of excessive estimation made by the AO, warranting its moderation.

We have carefully considered the rival submissions, perused the orders of the lower authorities, and examined the material placed on record. In all three assessment years, the core issue pertains to the addition made by the AO towards alleged non-genuine purchases from certain flagged entities, based on third-party information and report from the Investigation Wing. The AO rejected the books of account under section 145(3) and applied a GP rate of 12.5%, resulting in substantial additions. The CIT(A), however, granted partial relief by restricting the GP rate to 6%, which has been challenged in cross appeals. Before the CIT(A), the assessee submitted that it is engaged in the business of manufacturing copper and copper-based products and had made purchases from suppliers after due verification, supported by copies of purchase invoices, ledger confirmations of parties, PAN and GST registration details, quantitative records of input/output, stock registers and evidence of payment through regular banking channels. The assessee pointed out that the purchases were duly accounted for in its books and that the sales arising therefrom were never doubted by the AO. It was emphasized that the purchases were subject to TDS where applicable, and that the quantitative tally of consumption and closing stock was fully maintained and verified by statutory auditors. The assessee also submitted comparative GP/NP ratios for past years and argued that the GP rate of 12.5% applied by the AO was wholly arbitrary and unsupported by historical data.

We note that the CIT(A) while giving partial relief, relying on various judicial precedent, has noted that complete disallowance of purchases is not sustainable when corresponding sales are accepted and stock position is not disturbed. The CIT(A) also held that the books may be rejected u/s 145(3) due to failure to conclusively prove supplier identity, but reasonable estimation should follow. Applying an industry-consistent GP rate of 5% and 6% was considered fair in light of past performance, industry margin trends, and judicial tolerance. The relevant paras from the order of CIT(A) for the A.Y. 2018-19 are reproduced as under: 6.1 This is a fact on record that the AO has not rejected the sales affected by the appellant. In fact, AO has taken into account the net profit declared on sales, even after rejecting the books of accounts, and has made the GP rate addition thereto relating to alleged bogus purchase. As such, it is only logical to conclude that without corresponding purchases being made, the appellant could not have affected the sales. In view of the contemporaneous evidence brought on record by the appellant, the entire purchase transaction cannot be treated as unexplained expenditure. This is a case where the payment to the concerned suppliers has been made through proper banking channel, and there is no evidence on record thatthe payments made were again routed back to the appellant company. In such a situation, the only logical view that can be taken is that the appellant company could have obtained the accommodation bills for the material purchased locally. In other words, the seller entities may not be the actual suppliers, but may have provided the bills for the material purchased locally. This is not a case wherein the signed blank cheque books etc. have been found with the buyer (the appellant company) to indicate that the purchase of material was not at all made, or the purchases were inflated, and the purchase consideration, in full or in part, was routed back to the appellant company. As such, the decision of the Supreme Court in the case of N K Proteins Ltd (250 Taxman 22) (SC) would not apply to facts of the instant the case. 6.2 In the case of Pr. CIT Vs Surya Impex (2023) (148 taxmann.com 154) (Gujarat), AO had received report from Investigation Wing that assessee-firm received accommodation entries in form of bogus purchases from Shri Bhanwarlal Jain Group. However, assessee filed detailed evidence consisting of details of purchase, PAN and addresses of parties, purchase invoice, stock register, etc. On these facts, Hon’ble Gujrat High Court has upheld the findings of Tribunal in limiting addition in hands of assessee at the rate of 6 per cent of impugned purchases, taking note of the fact that sales was not disputed by the Assessing Officer and books of accounts were not rejected. 6.3 Hon’ble Bombay High Court in the case of Pr. CIT Vs S. V. Jiwani (2022) (145 taxmann.com 230) (Bombay) has held that where assessment was reopened on the basis of information received from Sales Tax Department that assessee had made purchases which seemed to be accommodation entries, entire purchase made by assessee could not be added back as income, but only profit element embedded therein was to be treated as income of assessee. 6.4 Hon’ble Gujrat High Court in the case of Pr. CIT Vs Rakesh Kailashchand Jain (2023) (156 taxmann.com 82) (Gujarat) has held that where Assessing Officer received report from Investigation Wing that assessee was beneficiary of accommodation entries in form of bogus purchases from a group and made 100 per cent addition with respect to said purchases, Tribunal was justified in limiting addition in respect of bogus purchases at the rate of 6 per cent of total purchases considering only income component of disputed transaction. 6.5 Hon’ble Bombay High Court in the case of Pr. CIT Vs Tirupati Earth Neerprima JV (2023) (154 taxmann.com 197) (Bombay) where Assessing Officer treated purchases made by assessee as bogus and made addition in respect of same, since assessee had maintained inventory of stock and payments for such purchases were made by account payee cheques and tax invoices were obtained, such purchases could not be rejected and addition to be restricted to the extent of profit element. 6.6 Hon’ble Bombay High Court in the case Pr. CIT Vs Hiren Parekh (2023) (153 taxmann.com 470) (Bombay) has held that where Assessing Officer added entire amount of purchases to income of assessee on ground that same were bogus purchases, since it was not disputed that purchases were actually made and payments for same were made through account payee cheque and further, assessee

We also noted that the CIT(A) considered the trend of profit rates as under:

The CIT(A) observed that the assessee’s gross profit (GP) rate has historically ranged between 3.47% and 7.91%, with an average falling between 4% and 6%. For the year under consideration, the GP rate was noted at 3.47%, while the three- year average stood at 4.64%. Considering these trends, the CIT(A) found it fair and reasonable to estimate profit by applying a 5% GP rate (for A.Y. 2018-19) on the aggregate purchases from the five flagged suppliers and accordingly restricted the addition to that extent.

In view of the foregoing discussion, we find no infirmity in the well-reasoned and judicious findings recorded by the Learned CIT(A), for the assessment years under consideration. The CIT(A), while sustaining the rejection of books of account under section 145(3), has correctly applied a fair and industry-consistent gross profit (GP) rate after appreciating the nature of the assessee’s business, the consistency in profitability ratios over the years, and the evidentiary material placed on record. The CIT(A) has also drawn support from multiple binding judicial precedents, including those rendered by the Hon’ble Gujarat and Bombay High Courts, to hold that full disallowance of purchases is not justified when corresponding sales are accepted and no discrepancy is found in the stock records or turnover. We further note that the additions sustained by the CIT(A) at 5% (for A.Y. 2018–19) and 6% (for A.Ys. 2020–21 and 2021–22) are in line with past adjudications in similar cases and take into account the profit element embedded in disputed purchases. The application of an inflated GP rate of 12.5% by the AO, in our considered view, lacks justification and fails to account for business realities and past profit margins of the assessee. Accordingly, we uphold the orders of the CIT(A) for all three years.

In the result, all six appeals, three by the Revenue and three by the assessee, stand dismissed.