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Income Tax Appellate Tribunal, G Bench, Mumbai
Before: Shri B.R. Baskaran & Shri Ravish Sood
This appeal filed by assessee is directed against the order dated 15.12.2016 passed by the CIT(A)-1, Thane and it relates to A.Y. 2013-14. The assessee is aggrieved by the decision of the CIT(A) in confirming the estimation of net profit made by the AO and also in not granting deduction towards depreciation, partners remuneration and interest on capital of partners.
The facts relating to the case are stated in brief. The assessee is a contractor undertaking road repair works for Government authorities like Konkan bhavan, Maharashtra Maritime Board and Kalyan Dombivili Municipal Corporation. It filed its return of income declaring total income of `16.15 lakhs. During the course of scrutiny proceedings the AO noticed that the assessee has recorded a turnover of `23.59 lakhs. The GP and NP ratios declared by the assessee worked out to 4.14% and 0.69% respectively. The assessee has booked various expenses and hence the AO asked the assessee to furnish evidences in support of the expenses claimed by the assessee.
M/s. Subhash Construction Co. Since the assessee did not furnish the details called for by the AO, he recorded a statement under Section 131 Income Tax Act, 1961 (hereinafter "the Act") from the partner named Shri Subhash D. Pawar. From the reply given to various questions, it was noticed that the assessee has been making payments to various parties by way of cash for various expenses. Hence the AO took the view that the books of account of the assessee are not reliable and accordingly he rejected the same. The AO noticed that provisions of Section 44AD of the Act has prescribee net profit rate of 8% of the total turnover, in the cases where the turnover does not exceed `1 crore for A.Y. 2013-14. Taking cue from the provisions of Section 44AD of the Act, the AO took the view that the income of the assessee should be estimated at 8% of the gross receipts. The AO also noticed that the Hon'ble Madras High Court in the case of CGT vs. A. Vajjram Bros. 326 ITR 551 has accepted the estimate of 8% in the case of gross receipts of income of the assessee. Accordingly the AO estimated the net profit @ 8% of the gross receipts determined the net profit of the assessee from contract works at `188.73 lakhs. Further, the AO also assessed the interest income of Rs.12.06 lakhs separately under the head income from other sources.
In the appellate proceedings, the assessee contended that the net profit ratio shown by the assessee in the earlier years was only in the range of 0.62% to 0.84% and hence the estimate of 8% made by the AO is on the higher side. The assessee also submitted that the books of accounts maintained by it have been audited and the auditors have not pointed out any defect. The assessee also submitted that it has furnished various details before the AO vide letters dated 03.08.2015, 10.08.2015, 23.10.2015 and 15.12.2015. It was also submitted that the major expenses incurred are expenses relating to fuel, materials and labour expenses. All these expenses are supported by proper vouchers. It was also submitted that the assessee was entitled for deduction on remuneration and interest payable to the partners subject to the limits prescribed under Section 40(b) of the Act. Accordingly it was contended that the net profit declared by the assessee should be accepted.
M/s. Subhash Construction Co.
The learned CIT(A) was not convinced with the explanations of the assessee. He noticed that the assessee has made a provision of `522.74 lakhs towards labour expenses and the assessee did not file details relating to the same. Accordingly, by placing reliance on the order passed by the Hon'ble Madras High Court in the case of A. Vajjiram Bros (supra) and the decision of the Hon'ble Delhi High Court in the case of Subodh Gupta in dated 09.12.2014 the learned CIT(A) confirmed the order passed by the AO. Aggrieved, the assessee has filed this appeal before us.
We heard the parties and perused the record. Though the Ld A.R contended that the rejection of books of accounts by AO was not on proper reasoning, yet we notice that the assessee appears to have not furnished full details that were called for by the AO. Hence we are of the view that the Ld CIT(A) was justified in confirming the rejection of books of accounts.
With regard to estimation of income, the Ld A.R submitted that the assessee is doing road repair works, which is labour intensive one. The assessee was constrained to engage local labourers and procure materials locally. Hence the assessee was constrained to make payments by way of cash, since the amount was payable then and there and also of small amounts. He further submitted that the accounts of the assessee were audited and the auditors have not found any defect either in the vouchers or in the accounts of the assessee. He submitted that the margin level in road repair works is low, when compared with civil construction works. He further submitted that the turnover of the assessee company has increased to Rs.23.59 crores during the year under consideration as against the turnover of Rs.8.60 crores in the immediately preceding year. He submitted that the assessee could win more contracts during the year under consideration due to competitive rates quoted by the assessee. Hence the net profit is bound to be lower during the year under consideration. He further submitted that the rate of net profit before partners’ payments and after depreciation was as under in the immediately preceding and succeeding years:-
M/s. Subhash Construction Co. Asst. Year Gross Turnover Rate of Profit 2010-11 12.65 crores 0.46% 2011-12 8.01 crores 1.93% 2012-13 8.60 crores 2.47% 2014-15 18.41 crores 1.24% 2015-16 22.12 crores 1.26% The Ld A.R submitted that the turnover of Rs.23.59 crores achieved during the year under consideration was comparable with the turnover achieved in AY 2015-16. He submitted that the rate of profit before partners’ remuneration and after depreciation was around 1.25%, when the turnover has increased and it was around 2% when the turnover was less. He submitted that the net profit shown by the assessee is inclusive of interest received from bank, which is connected with the business activities carried on by the assessee. Accordingly he submitted that the rate of net profit adopted by tax authorities, net of all deductions at 8% is very much on the higher side and is deviating from the facts available in the present case. He also contended that the interest income should not have been assessed separately and further the AO should have given deduction for depreciation, partners’ remuneration and interest from the estimate made by him.
On the contrary, the Ld D.R strongly placed reliance on the orders passed by tax authorities.
In the earlier paragraphs, we have confirmed the rejection of books of accounts of the assessee. Once the books of accounts were rejected, the profit from the business is required to be estimated. The AO should make a rational and reasonable estimate, while estimating income of the assessee. For this purpose, in our view, it is imperative to bring on record external comparable cases for determining the rate of profit. If no external comparable case is brought on record, then the past records should be taken help of. In this regard, we can gainfully take support from the M/s. Subhash Construction Co. decision rendered by Hon’ble Patna High Court in the case of Prasad Construction and Co. (368 ITR 579), wherein it was held that “....the Assessing Officer must be rational and reasonable while assessing the dealer to the best of his judgement and there is an element of guess-work in a best judgement assessment.
It has also been held in the judgments relied upon by both the parties that the Assessing Officer must take into consideration the materials which are in his possession, including previous assessment years. It is true that upon the failure of the assessee to maintain the account in the manner which led to the situation the best judgment assessment cannot wholly go to the assessee’s benefit but as a caution by the courts the fact that a best judgment assessment is being made cannot be a ground for fixing any unjustifiable figure of income or profit without reference to the same in the preceding assessment years......”
The AO as well as the Ld CIT(A) had placed reliance on the decision rendered by Hon’ble Madras High Court in the case of A Vajjiram & Bros (supra). The business of the assessee before Hon’ble Madras High Court is mentioned as civil contractor, while the assessee herein is engaged in road repairing works. Hence it is not clear as to whether the activities carried on both the parties are same or not, since the expression “civil contract” is a generic term encompassing different kinds of activities. The AO, in the above said case, worked out profit at 28%, which was found to be highly unreasonable. Hence the estimate of 8% made by the Ld CIT(A) was found to be reasonable by ITAT as well as Hon’ble High Court. Hence, in our view, the rate of 8% found to be reasonable in the above said case cannot be taken as a standard measure for determining profits of all types of civil contractors.
In the case of Subodh Gupta (supra), relied upon by Ld CIT(A), we notice that the Hon’ble Delhi High Court has also reiterated the importance of “comparables” by following observations:-
M/s. Subhash Construction Co. “The difficulty in the present case is that the Assessing Officer did not conduct any inquiry and ascertain the net profit rate of other comparable contractors...”.
The income, in the above said case, was estimated at 8% by the appellate authorities. The revenue challenged the same before the High Court. The Hon’ble Delhi High Court noticed that the AO himself had applied net profit rate of 8% on contractual receipts and net profit rate of 3% on supply receipts in another year. Further, the Hon’ble Delhi High Court also noticed that the revenue was not able to point out or state that the other contractors have a higher profit rate than 8%. Accordingly, in the facts prevailing in the above said case, the Hon’ble Delhi High Court confirmed the order passed by the Tribunal and dismissed the appeal of the revenue. Thus, we notice that the above said decision was also rendered in the facts prevailing in that case.
Now coming to the facts of the present case, we notice that the net profit declared by the assessee in the past and succeding years is consistently lower and is no where near the rate of 8% estimated by the AO, meaning thereby, the assessee is operating at lower profit level. The assessee has also pointed out that the net profit rate available with road repair works is low. We have noticed that the assessing officer has not brought on record any comparable cases in order to show that the net profit rate of 8% was justified in the facts and circumstances off the case. In the absence of external comparable cases, the results declared by the assessee in other years, which has been accepted by the assessing officer would be of great relevance. In the instant case, the Ld A.R has furnished the details of net profit rate declared by the assessee ‘after depreciation, but before allowing partners’ payments’. A critical analysis of the same would show that the average net profit rate was around 2% when the turnover was below ten crores of rupees. The average net profit rate was around 1.25%, when the turnover has exceeded ten crores. During the year under consideration, we have noticed that the assessee has achieved a M/s. Subhash Construction Co. turnover of Rs.23.59 crores. From the analysis furnished by the assessee, we notice that the assessee has declared net profit @ 1.41% during the year under consideration.
Considering the average rate of net profit shown by the assessee in various years, we are of the view that the rate of net profit adopted by the tax authorities @ 8% is very much on the higher side. The assessee has also contended that the interest income received from banks is connected with the business activities of the assessee. We also notice that the rate of net profit listed above has been computed after including the interest income. Accordingly we notice that the interest income has been assessed under the head business only in the past years. The assessee has also submitted that the depreciation should be allowed separately. In our view, the profit may be estimated either before allowing depreciation or after allowing depreciation. In the former method, the rate of net profit will be on the higher side and in the later method, it will be on the lower side.
Accordingly we are of the view that the net profit may be estimated net of depreciation. We have seen that the rate of net profit listed above is after allowing depreciation, but before allowing partners’ payments. Considering the average rate of net profit shown by the assessee in various years, we are of the view that the rate of net profit after allowing depreciation, but before allowing partner’s partners’ payments may be estimated @ 2% of gross receipts for the year under consideration, which is in fact higher than the average rate shown when the turnover is higher. Yet we are of the view that the above said estimate of 2% would meet the ends of justice. This estimate shall include the interest income also. From the income so estimated, the remuneration and interest payable to the partners, subject to the limits prescribed in sec.40(b) of the Act shall be allowed. We direct the assessing officer accordingly. The order passed by Ld CIT(A) would stand modified accordingly.
M/s. Subhash Construction Co. 14. In the result, the appeal filed by the assessee is partly allowed.