INCOME TAX OFFICER-WARD-30(1), KOLKATA, KOLKATA vs. M/S LEATHER POINT, KOLKATA

2.1. The brief facts of this issue is that the assessee is a partnership firm engaged in the business of manufacturing and selling of tanned leather and leather goods. The ld AO observed that the assessee appeared on different occasions to explain the return and filed various details and documents in support thereof which were test checked during

2 M/s Leather Point. A.Yr.2009-10 the course of assessment proceedings. The ld AO observed that assessment has been framed after examination of the return, audited accounts, supporting details / documents and written submissions filed in course of assessment proceedings on the points which emerged for specific discussion. The ld AO observed that the modus operandi of the assessee was to purchase raw hides from different parts of the country and get the same processed in various tanneries so as to get tanned leather and sell the said tanned leather to leather manufacturing exporters. The audited profit and loss account of the assessee for the year ended on 31.03.2009 was credited with the following:

(a) Sales : Rs. 2,69,35,288.75 (b) Closing Stock : Rs. 73,22,171.00 • Finished Leather : Rs. 43,25,298/- • Raw Hide : Rs. 29,96,873/- Total : Rs. 3,42,57,459.75 4.02. Against the above, the assessee claimed purchase of raw hides to the tune of Rs. 1,49,46,679/- and chemicals amounting to Rs. 37,03,484/-. Since col. No. 28(b) and (B) of the Tax Audit Report in Form No. 3CD (quantitative details of finished products/ by products) did not mention anything at col. No. 28(b) and (B) about the finished products and by-products, the requisite details of raw materials and finished products were called for vide notice u/s 142(1) of the Act dated 11.07.2011. After analyzing the accounts and details/documents furnished by the assessee, three major issues, inter alia, were observed, namely, (i) The cost of production of finished leather per sq. ft increased from Rs. 39.22 for the financial year 2007-08 to Rs. 51.23 in the financial year 2008-09, thus, indicating a more than 30% increase over that of the immediately preceding previous year (the working of the cost production is given in the show cause letter reproduced below). 2

3 M/s Leather Point. A.Yr.2009-10 (ii) Expense under the head “Cutting & Stitching Charges” increased disproportionately over those of the preceding previous year. (iii) The assessee declared disproportionately huge sundry creditors in the balance sheet as at 31.03.2009.

2.2. The ld AO issued a show cause notice to the assessee by referring to quantitative details and value of raw materials and finished goods and arrived at the cost of production per square feet of finished goods. He compared the same with that of the previous year and found that the cost of production per square feet of finished goods had increased from Rs 39.22 to Rs 51.23 (registering an increase of 30% ) which appears to be abnormal. He found that the assessee had debited huge amount towards cutting and stitching charges in the sum of Rs 47,21,760/- when compared to that of earlier year and subsequent year, which in his opinion, had contributed to the increase in cost of production. Accordingly the assessee was asked to justify the incurrence of cutting and stitching charges during the year under appeal. The assessee explained that during the year under appeal, the assessee was also engaged in the sales of leather and leather goods for which the cutting and stitching charges had to be paid to the fabricators. This business was admittedly not there in earlier year as well as in subsequent year. Due to global recession, the funds of the assessee got blocked in the export market and in view of untimely realization of the same and huge exchange loss, the assessee chose to stop the export of leather and leather goods from subsequent year. In other words, it was submitted that the export of leather and leather goods was done only in the year under appeal which had contributed to increased expenditure towards cutting and stitching charges which in turn had contributed to the increase in cost of production per square feet of finished goods. It was also explained that the cutting and stitching charges were paid to individuals / casual workers who are involved in such type of works and who come from remote corners of the state. They are basically daily 2.3. The ld AO observed that the assessee was engaged in manufacture and sale of tanned leather from raw hides by applying chemicals ; and that the selling of tanned leather cannot, by any stretch of imagination, mean selling of leather goods like wallets, leather bags, purses etc as claimed by the assessee on 22.11.2011. No quantitative details of this leather goods were furnished by the assessee and there was no opening or closing stock in this regard in the details furnished by the assessee. Accordingly he disbelieved the version of the assessee and sought to examine the fabricators to whom the cutting and stitching charges were paid by the assessee during the year under appeal.

2.4. The assessee replied before the ld AO that the sales made on account of leather goods such as wallets, ladies bags etc were duly reflected in the total sales disclosed already and the same had also been duly disclosed in the VAT returns filed by the assessee. The assessee also disputed the method of arriving at the cost of production per square feet of finished goods as worked out by the ld AO by pointing out the mistakes in the said workings. It was pointed out that the ld AO had applied the combined cost i.e cost for processing of leather and cost for making leather goods to find out the cost of finished leather conjointly. It was also pointed out that the ld AO had considered the number of pieces of raw hides in financial year 2007-08 uniformly as full size of cow hides, whereas from the way bills and suppliers invoices filed already, it could be seen that a portion of the materials comprised hides of cow head cuttings (1/10 of full size) and hides of cow half & buffalo calf (normally ½ of full size). In the financial year 2008-09, all the materials were full size. Accordingly, the assessee furnished the cost statement of finished leather for financial years 2007-08 and 2008-09 in a tabular form as under:-

5 M/s Leather Point. A.Yr.2009-10 B: Cost Statement of Finished Leather F.Y. 2007-08 F.Y. 2008-09 Raw Hides Pcs Amount Pcs Amount Op. Stock- R/Hides .. .. .. .. Purchase R/H (Eqv. Full Size) 20050 12249710 24941 1494679 Less: Closing Stock .. .. 5645 2996873 Consumption of R/Hides 20050 12249710 19296 11952806 Purchase of Chemicals .. 3989030 .. 3703485 Carriage Inward .. 83743 .. 74823 Processing Charges .. 1363120 .. 1254240 Production Pcs/ Total cost 2050 17685603 19296 16985354 Cost Per Pcs 882.07 880.25 Cost per Sq. Ft. (1Pc=22sq.ft) 40.09 40.00 Accordingly it was submitted that there were no material variation in the cost per sq.ft of finished leather in the year under appeal when compared to the earlier year. (i) It was also pointed out that while determining the total cost of chemicals and other materials amounting to Rs 40,35,624/- for the year under appeal, the ld AO had included the sums of Rs 3,06,440/- and Rs 25,700/- incurred for purchase of cloth lining and materials respectively which constituted the cost for making leather goods. (ii) Similarly from the determination of other expenses forming cost of materials amounting to Rs 61,39,573/- by the ld AO, the delivery charges of Rs 28,750/- , cutting & stitching charges of Rs 47,21,760/- and rent & electric (factory) Rs 60,000/- should have been considered separately in ascertaining cost per sq.ft of finished leather. While delivery charges is part of selling and distribution expenses and does not form part of cost of production , cutting & stitching charges and rent & electric expenses constitute cost for making leather goods to which they relate, but not in the cost of finished leather. (iii) It was also pointed out that in the Tax Audit Report, the nature of business was duly mentioned as ‘Manufacturing & Processing of Leather & Leather Goods’. It was submitted that the sales reflected in the profit and loss account includes sale of leather goods also. 5 2.5. The ld AO however disbelieved the fact of assessee involved in the sale of leather goods in the year under appeal. He observed that the assessee failed to furnish the details of persons / parties including their names and addresses to whom cutting and stitching charges were paid by the assessee . He observed that the payments were made to them only in cash and it is the duty of the assessee to prove the genuineness of the same with supporting documents, which the assessee failed and accordingly disallowance to that effect is warranted. He also observed that for manufacturing and sale of tanned leather, no expenditure need to be incurred towards fabrication work on finished leather. The ld AO also brought some comparable instances engaged in the similar line of business and observed that the ratio of direct expenses to the total cost of manufacturing incurred by the assessee was 22.19% whereas the comparable cases were in the range of 5% to 10% and concluded that it is very reasonable to infer therefrom that the fictitious claim of cutting & stitching charges had contributed largely to this abnormally high ratio of direct expenses in the case of the assessee. Moreover, the identity of the parties to whom the said charges were paid were not proved by the assessee. Accordingly he disallowed a sum of Rs 47,21,760/- representing entire cutting & stitching charges in the assessment.

2.6. The ld CITA appreciated the contentions of the assessee but restricted the disallowance to 5% of total cutting & stitching charges. Aggrieved, the revenue is in appeal before us on the following ground:- 1. On the facts and circumstances of the case, the Ld. CIT(A) erred in not considering the fact that the assessee failed to discharge his onus by not supplying party details of cutting and stitching charges payment and hence A.O. was justified in treating the same as bogus expenditure.

2.7. We have heard the rival submissions and perused the materials available on record. We find that the assessee had duly countered the contentions of the ld AO by making

7 M/s Leather Point. A.Yr.2009-10 detailed written submissions before the ld CITA. We find from the Tax Audit Report in response to Question No. 8a) in Form 3CD with regard to ‘Nature of Business’ , it is duly mentioned by the Tax Auditor as ‘Mfg. & Processing of Leather & Leather Goods’. It is not in dispute that the assessment has been framed u/s 143(3) of the Act after examining the books of accounts and various details filed before the ld AO which is also acknowledged by the ld AO. The logical inference would be that the books of accounts along with sales bills which were produced by the assessee before the ld AO were examined by the ld AO. The sales bills would show that the assessee had indeed made sale of leather goods such as wallets, ladies bags etc . It is not in dispute that the assessee had made sales in the year under appeal as under:- Sales of leather - Rs 85,64,599/- Sales of Leather Goods - Rs 1,83,70,690/- We find that the assessee had engaged in sale of leather goods only during the year under appeal which is more than the sales of leather and that itself would justify the increase in cutting & stitching charges during the year under appeal. It is not in dispute that the cutting & stitching charges were indeed incurred by the assessee in the earlier as well as in subsequent year. Hence there is no case for disallowance of 100% of cutting & stitching charges by the ld AO. We find that the assessee had duly demonstrated the cost of production per square feet of finished goods for the year under appeal which is almost similar to that of the previous year. It is also not in dispute that the quantitative details were furnished before the ld AO during the course of assessment proceedings. The ld CITA had observed that it is not the case of the ld AO that the assessee is indeed warranted to deduct tax at source in terms of section 194C of the Act as there is no finding in the assessment order to the effect that the assessee had made single payment exceeding Rs 20,000/- and aggregate payments in a year exceeding Rs 50,000/- to a single party. However, it cannot be ruled out that certain cutting & stitching charges could be accounted in excess as admittedly no evidence has been produced by the 7

8 M/s Leather Point. A.Yr.2009-10 assessee before the ld AO to justify the claim of expenses. Hence there is nothing wrong in the action of the ld CITA confirming the disallowance thereon @ 5% of total cutting & stitching charges. Given the fact that the cost of production per square feet of finished goods remaining more or less similar to that of earlier year and given the fact that the assessee had made payments in cash to various fabricators but had not provided the details of the parties before the ld AO and more importantly given the fact that the books of accounts filed by the assessee were not rejected by the ld AO, we find that the disallowance @ 5% of total cutting & stitching charges had been rightly made in the instant case and hence the order of the ld CITA does not require any interference. Accordingly, the Ground No. 1 raised by the revenue is dismissed.

3.1. The brief facts of this issue is that the assessee paid processing charges of Rs 12,54,240/- to 34 persons. The names and addresses of all such persons were furnished by the assessee at the time of assessment proceedings. The ld AO sought to verify the said parties and observed that the identity of the persons was not established by the assessee in as much as no such persons were found in the given address. Moreover, the assessee had failed to produce even one out of 34 persons for examination. Secondly, since the payments were admittedly made in cash, no credible documentary evidence could be adduced by the assessee to prove the genuineness of transactions. The ld AO finally concluded that the assessee had violated the provisions of section 40A(3) of the Act by making cash payments to tanners / tanneries and accordingly disallowed a sum of Rs 12,54,240/- in the assessment. The ld AO also observed that tax was not deducted at source in respect of said payments and in any case, the expenditure is required to be disallowed u/s 40(a)(ia) of the Act. 8 3.2. The assessee submitted that there is no dispute that the assessee is in the leather trade. There is also no dispute that in the leather trade, one has to purchase raw hides, which are required to be treated / processed in the tanneries, for which processing charges have to be paid. The assessee submitted the details of the persons who were paid processing charges along with copy of their ledger accounts before the ld CITA (which were already filed before the ld AO). It was submitted that it is well known fact that the leather trade operates in an unorganized sector and the payments are also required to be paid in cash as per the norms of the trade. Infact purchase of raw hides in cash falls under the exception provided in Rule 6DD of the Rules. It was submitted that the assessee made payments towards processing charges were made in cash but within the permissible limits u/s 40A(3) of the Act. It was submitted that the assessee had brought to the notice of the ld AO vide letter dated 3.8.2011 , that the assessee purchased raw hides from different parts of country against waybills issued by the West Bengal Commerical Taxes Authorities. The raw hides along with leather chemicals purchased from registered dealers, whose genuinity has not been disputed, were delivered to small tanneries who processed the same against cheap rates. The payments to them were made through vouchers, which were submitted before the ld AO. The owners of the small tanneries are illiterate and men of meager means and have very meager income. They are mostly not assessed to tax and are reluctant to appear before the tax authorities. Hence the assessee was not able to produce them before the ld AO. It was submitted that the ld AO had not disallowed the processing charges on account of genuinity and reasonableness in as much as there is no whisper in the assessment order that he did not find any element of unreasonableness in the amount spent towards the same. The only grievance of the ld AO is payments were made in cash in violation of section 40A(3) of the Act without deduction of tax at source.

10 M/s Leather Point. A.Yr.2009-10 3.3. The ld CITA observed that from the perusal of the ledger accounts of each party, the payments towards processing charges were made within the permissible limits i.e below Rs 20,000/- and hence the same are directly outside the scope of provisions of section 40A(3) of the Act. He observed that the ld AO presumed that in order to avoid the rigour of tax deduction at source, the assessee had bifurcated the expenses into different persons. This allegation made is without any basis and there is no scope for making disallowance u/s 40(a)(ia) of the Act. Hence the ld CITA based on the verification of the ledger accounts observed that there is no scope for making any disallowance either u/s 40A(3) or u/s 40(a)(ia) of the Act towards processing charges in the facts and circumstances of the case and accordingly deleted the same. Aggrieved, the revenue is in appeal before us on the following ground:- 2. On the facts and circumstances of the case, the Ld. CIT(A) erred in not considering the fact that the assessee failed to discharge his onus by not producing party details of processing charges and also payment evidences of these expenditure and hence A.O. was right in invoking provision of section 40A(3) of the I.T. Act.

3.4. We have heard the rival submissions and perused the materials available on record. We find that the ld DR fairly agreed to the contentions of the ld AR by placing reliance on the order of the ld CITA. We find that the ld CITA had granted relief to the assessee after due examination of evidences available on record. Hence we do not find any infirmity in the order of the ld CITA in this regard. Accordingly, the Ground No. 2 raised by the revenue is dismissed.

4.1. The brief facts of this issue is that the ld AO observed that the sundry creditors in respect of raw hides were astronomically high ; that the assessee in the subsequent year, 10

11 M/s Leather Point. A.Yr.2009-10 did not make any purchase of raw hides from the persons standing as sundry creditors in the year under appeal ; that the sundry creditors standing in the balance sheet were fictitious as the assessee neither furnished confirmations from the parties nor produced the parties and that the payments made to the sundry creditors in the subsequent year were bogus since the creditors did not issue any receipts.

4.2. The assessee submitted that the ld AO disbelieved the existence of sundry creditors mainly on the ground that the same are abnormally high. In this regard, the assessee submitted that during the year , there were sundry debtors of Rs 2,00,85,091/- as against the sundry creditors of Rs 2,72,89,282/- . It was explained that due to delayed recovery of dues from the sundry debtors (overseas debtors) due to global meltdown of economy and recession set thereon, the sundry creditors could not be settled in time by the assessee. Hence both sundry creditors and sundry debtors were remaining outstanding in the balance sheet at the end of the year. Since the assessee had deferred the payment to these sundry creditors, they chose not to supply goods to the assessee on credit in the subsequent year. Hence the assessee had no choice but to keep such abnormally high sundry creditors at the end of the year.

4.2.1. With regard to the ld AO’s grievance as to non-furnishing of the confirmations or non-production of the parties, it was submitted by the assessee that the assessee is operating in an unorganized sector and as per the norms of the trade, their representative used to visit Kolkata to collect cash payments. Since the assessee delayed the payments of these parties for a long period, their co-operation was not forthcoming. Hence the said parties could neither furnish confirmations from these parties or produce them before the ld AO. However, the copies of purchase bills along with the way bills were duly furnished before the ld AO which were duly subjected to examination by the ld AO and which fact is also acknowledged by him in the assessment order. It was argued that 4.2.2. With regard to the payments made to these parties in cash in subsequent years, the assessee submitted the evidences together with the books of accounts of those relevant years. The assessee also produced a chart showing how the payments were made in the subsequent years liquidating the outstanding amounts. The ld CITA observed that the ld AO did not have any material to come to the conclusion that the entire payments were made by the assessee in the instant case out of its undisclosed income.

4.2.3. The ld CITA also examined the applicability of provisions of section 69C of the Act with regard to the purchases. It was observed that section 69C of the Act could be invoked only where expenditure has been incurred and no satisfactory explanation about its source is offered by the assessee. He observed that the assessee has submitted evidence before the ld AO to prove the genuinity of purchases, which has not been disputed by the ld AO. The ld CITA observed that the ld AO himself had given a finding that no further purchases were made from the said sundry creditors in subsequent years and in this regard, he agreed to the contentions of the assessee that a creditor would normally refrain from dealing with the party who delays the payments.

4.2.4. With regard to the applicability of provisions of section 40A(3) of the Act, the ld CITA appreciated the decision relied upon by the assessee before him on the decision of Hon’ble Calcutta High Court in the case of CIT vs CPL Tannery reported in 318 ITR 179 (Cal) wherein it was held that the suppliers of skins and hides are themselves the producers of skins and hides and therefore section 40A(3) of the Act cannot be applied.

13 M/s Leather Point. A.Yr.2009-10 4.2.5. Based on these observations, the ld CITA deleted the addition made towards sundry creditors in the sum of Rs 2,70,21,589/-. Aggrieved, the revenue is in appeal before us on the following ground:- 3. On the facts and circumstances of the case, the Ld. CIT(A) erred in deleting the addition of Rs. 2,70,21,589/-.

4.3. We have heard the rival submissions and perused the materials available on record. The ld DR vehemently relied on the order of the ld AO. At the outset, we find that there is absolutely no basis for the ld AO to come to a conclusion that the payments to the suppliers of materials were made in cash by the assessee out of unexplained sources during the year itself. The entire books of accounts were produced before the ld AO together with the requisite details called for and the same were also duly examined. The books of accounts were not rejected by the ld AO. While this is so, there is absolutely no basis for the ld AO to come to a conclusion that payments were settled by the assessee out of unexplained sources in cash to these sundry creditors thereby making them fictitious. It is not in dispute that the assessee had correspondingly huge piling of sundry debtors in its balance sheet. This has been duly explained by the assessee that due to global recession, the sale proceeds could not be recovered in time from the export market and which in turn had contributed to the delayed payment to sundry creditors by the assessee. It is in universal knowledge that during the relevant year, there was global recession which had a severe impact on the world market and India was also one of the country which got affected by it. Infact the assessee had even given details before the authorities below that its funds had been blocked substantially with two persons:- (i) Farinni Leather (P) Ltd Rs 22,19,511/- (ii) Acme Tanning Industries Rs 1,51,74,690/- The ld AR argued that the assessee was in a helpless situation that there was no option before it but to defer the payments due to the sundry creditors particularly when the bank finance was also not forthcoming due to low margin in the assessee’s trade , 13

14 M/s Leather Point. A.Yr.2009-10 negative industry profile and poor working capital ratio. It is quite common that the parties to whom payments were not made would not come forward to supply goods subsequently on credit to the very same defaulter in their own business interests. These facts have been duly appreciated by the ld CITA. We find that the copies of purchase bills along with the way bills were duly furnished before the ld AO which were duly subjected to examination by the ld AO . We find that the ld AO did not find any defects in the said documents and it is not the case of the ld AO that the purchases are ingenuine. The waybills were issued by the sales tax authorities and invoices bearing the stamp of the check post evidencing the entry of of materials in the State of West Bengal proved beyond doubt the genuinity of purchases. It is also not the case of the ld AO that provisions of section 41(1) of the Act are applicable to the instant case in as much as the said provision applies to the cessation of liability. Admittedly, the assessee had duly reflected the said parties as sundry creditors in its balance sheet and had also discharged the same in the subsequent years. The ld CITA had duly dealt with the applicability of provisions of section 69C of the Act and held that the same could not be invoked in the instant case. We do not find any infirmity in the same. We have also verified the details of payments made to the sundry creditors in the subsequent years which are enclosed in pages 80 & 81 of the paper book, wherein, we find out of sundry creditors as on 31.3.2009 in respect of the 19 parties amounting to Rs 2,70,21,589/-, the assessee had paid a sum of Rs 2,53,10,389/- in Asst Year 2010-11 and remaining sum of Rs 17,11,200/- in Asst Year 2011-12. In these circumstances, we find that the ld CITA had rightly deleted the addition made on account of sundry creditors in the sum of Rs 2,70,21,589/- and hence we do not find any justifiable reason to interfere with the same. Accordingly, the Ground No. 3 raised by the revenue is dismissed.

Order pronounced in the Court on 11.08.2017