The Commissioner of Income Tax-II vs. m/S.M.Ventakteswara Rao AND Others

* THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN

INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003; INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005

% 21.6.2011

# The Commissioner of Income Tax, Rajahmundry ... Appellant VERSUS

$ M/s.R.Narayanarao & others, Mg. Pr. Sri R.Dasaradha Ramaiah Goud, Kakinada And others ... Respondents

< GIST:

> HEAD NOTE:

! Counsel for Appellants: M/s.S.R.Ashok and V.R. Badri

^Counsel for Respondents: M/s.Y.Ratnakar, A.V.Krishna Koundinya

? Cases referred THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN

INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003;

INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005

June 21, 2011 Between: The Commissioner of Income Tax, Rajahmundry … Appellant AND M/s.R.Narayanarao & others, Mg. Pr. Sri R.Dasaradha Ramaiah Goud, Kakinada And others

… Respondents

THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003; INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005

COMMON JUDGMENT: (Per Hon’ble Sri Justice V.V.S.Rao) This group of Income Tax Tribunal Appeals is filed under Section 260A of the Income-tax Act, 1961 (the Act) by the Commissioner of Income Tax (CIT), Rajahmundry against different common orders passed by the Income Tax Appellate Tribunal, Visakhapatnam Bench. The learned Tribunal passed various common orders in all the appeals filed by the assessees as well as the Revenue. The appeals by the assessees were partly allowed and those of Revenue were dismissed. The issue, in these appeals, is whether the best judgment assessment made by the

Income Tax Officer, Kakinada estimating the gross profit from the assessees’ arrack business at 40% of the purchase value is sustainable in law and if not what would be the estimate of gross profit as per the principles of best judgment assessment?

The fact of the matter is not in serious dispute. The respondent asseessees (the arrack contractors), at the relevant point of time, were engaged in the business of selling arrack. For the assessment years 1993-94 and 1995-96 these assessees, assessed either as individuals, partnership firms or Association of Persons (AoPs), filed their returns of income admitting a net loss. The assessing officer did not accept the returns. He took up assessment under Section 143(3) of the Act. Objections were invited with regard to the nature of the concern – whether it is a firm or AoP; justification for the expenditure claimed; and profit/loss shown in the return. The assessees filed their explanation. They contended that, due to prohibition on the sale of arrack introduced from 30th September, 1993 by the Government, the whereabouts of the partners were not known; it was not possible to maintain or issue sale bills; there was no practice at any time to maintain the books of complete accounts; and the expenses claimed were nominal. The assessing officer rejected the books of accounts wherever they were produced and estimated the gross profit at 40% of the purchases.

In the appeals, before the CIT (Appeals), it was inter alia contended that the additions/disallowance of expenditure made by the assessing officer, after computing gross profit at 40% of the purchase price of arrack, were arbitrary and excessive. It was urged that arrack business suffered unforeseen set back due to State wide agitation which preceded imposition of prohibition of sale of arrack in the State. In addition it was also contended that arrack business in agency areas and other places, where extremist activities were at the peak, the arrack contractors suffered loss.

The CIT (Appeals) upheld adoption of gross profit at 40% of the purchase price taking into consideration the agitation which preceded introduction of prohibition in the State as well as disturbance in certain areas due to extremist activities. He also took into consideration the question of loss due to agitation. The Commissioner agreed with the assessing officer in restricting the expenditure claimed at 50% on the ground that the assessee did not place any evidence on both the aspects. The purchase value, rental payments, licence fee and bank commission were accepted and allowed as deduction. Addition made to bank interest was also deleted. Thus the assesses got some relief before the CIT (Appeals).

As already noticed supra, there were a number of assessments of arrack contractors in East Godavari District by the same assessing officers and orders by the same CIT (Appeals). Various groups of appeals were filed before the Tribunal. In all these matters the assesses contended that taking 40% of the purchase price as the gross profit is without any basis. Reliance was placed on a consolidation order dated 30.5.2001 of the learned Tribunal in the case of Anakapalle Municipal Units Arrack Shop and others (ITA Nos.1418 to 1424/Hyd/1996 and batch), wherein the Tribunal held that estimation of turnover at eight (8) times of the purchase price and 1% thereon as profit would be reasonable. Indeed there is no dispute that this order was followed in all the other common orders by which the appeals of the assesses were allowed and those of the Revenue were dismissed. The Senior Standing Counsel, Sri S.R.Ashok, submits that, when estimation of income under Section 145 of the Act was held to be justified by the Tribunal, interference with the estimation of gross profit by the assessing officer as confirmed by the CIT (Appeals) is uncalled for. The Senior Counsel would further submit as follows. The best judgment assessment involves an element of guess

work. When the assessee has not proved the correctness of the books of accounts, or has not produced any record to support his claim as to the taxable income, it is always open to the assessing officer to estimate the income and profit therein as per similar business data. In arrack business the profit margin is very high and the expenditure and facilities are minimal. The assessing officer is justified in disallowing the expenditure claimed to the extent of 50%.

S ri Y.Ratnakar and Sri A.V.Krishna Koundinya made submissions for the assesses. They would contend that estimation of 40% of the purchase price as gross profit is unreasonable, arbitrary and without any basis. The Tribunal was, therefore, correct in estimating the sales turnover at eight (8) times of the purchase price and then estimating the net profit at 1% of such estimated sales. They would point out that in all the cases the assesses had filed returns showing the price for the purchase of arrack which were verifiable and non-variable, and the assessees had also admitted certain amount as total sales. The total sales were found to be approximately eight (8) times the purchase price.

In the background facts and, in view of the rival submissions, the only question that would arise for consideration is whether the learned Income-tax Appellate Tribunal is justified in holding that profit shall be adopted at 1% of the total sale value? There is no dispute that in all the cases the assessees had shown the turnover sales without producing books of accounts. Even when the books of accounts were produced they were not verifiable. The maximum retail price of arrack was not fixed by the government and it was for the arrack contractor to sell the liquor at whatever price the contractor would get. After receiving assessments in all the cases the assessing officer issued show cause notice; the assessees filed their objections and produced books of accounts. When they were not produced the assessing officer disbelieved the turnover of sales as they were not supported

by vouchers or books of accounts and, wherever the books of accounts were produced, they were rejected. The assessing officer then, indisputably, took up best judgment assessment under Section 145(3) read with 144(1) of the Act. The best judgment assessment resorted to by the assessing officer is not challenged either before the learned Tribunal or before us. Therefore, what is required to be examined are the principles of best judgment assessment. Provisions and Precedents As per the charging Section of the Act, income shall be charged at any rate or rates as per the Central Act for that year. Section 2(24) defines ‘income’ inclusively and elaborately. As per Section 2(43) tax means the income tax chargeable under the provisions of the Act for the relevant assessment year in determining the income tax liability of an assessee who is liable to pay tax under the Act. In computing the income, Sections 5 and 7 and the provisions in Chapter IV of the Act provide the modalities. While doing so, deductions to be made in computing the total income are enumerated in Chapter VIA. Chapter VIII deals with rebates and reliefs to be allowed in computing income tax. The law mandates that every person shall furnish a return of the total income if it exceeds the maximum amount which is not chargeable to income tax. Chapter XIV contains the procedure for assessment, and Chapter XIVB contains the procedure for block assessment pursuant to search and seizure taken in cases of tax evasion. Besides these provisions, the Income Tax Act contains the machinery provisions for Collection and Recovery of Tax (Chapter XVII), Refunds (Chapter XIX), Settlement of Cases (XIXA), Appeal/Revision System (Chapter XX) and Penalties imposable under the Act (Chapter XXI).

In determining the income tax liability of a person, computation of the total income of the assessee is the first stage

which is sometimes complex. The next stage is determination or computation of the sum payable by the assessee on the basis of such assessment towards income tax. While determining the sum payable, it might become necessary for the assessee, or the competent assessment officer, to take into consideration the income received or is deemed to be received keeping in view the definition of income. While doing so, the deductions to be made and rebates and reliefs to be allowed cannot be ignored. The last and ultimate exercise is only the determination of the tax on the total income as per the Central Act for the relevant assessment year read with Section 4 of the Act. In CIT v Suresh N.Gupta[1], the Supreme Court considered the charging Section and made observations which are apt to quote below. The rate at which a charge on the total income of the previous year is imposed under Section 4(1) of the 1961 Act is not laid down in the Income Tax Act and, therefore, the said section provides that the charge has to be fixed by the Central Act. It is because of this, that income tax is levied at different rates under the Finance Act. ... ... It must be borne in mind that the Income Tax Act deals with tax on income and nothing else. Therefore, in order that the charge should be a legal charge under Section 4, it must be a tax on the income of the assessee. If the charge is the tax on anything else, then it would not be a valid charge. This is the only limitation upon the power or authority of Parliament to fix any rate it pleases. So long as the charge is on “total income” of the previous year, there is no limitation upon the power or authority of Parliament to fix any rate it pleases. However, if “rate” is understood to mean the fixing of the tax irrespective of “total income” and unconnected with “total income”, then, in our view, Parliament would be travelling outside the ambit of Section 4(1). The Income Tax Act, therefore, contains an elaborate machinery for ascertaining “total income” of an assessee. If Parliament has power to fix tax at a rate which has no connection with the “total income”, then the machinery set up under the 1961 Act becomes infructuous. In our view, Section 4(1) prescribes the subject-matter of the tax and the rate of that tax is prescribed by the legislature, either under the Act as in the case of Section 113 or vide the Finance Act. As long as the charge is on “total income” of the previous year and so long as the rate relates to the subject-matter of the tax, there is nothing to prevent Parliament from fixing the rate. But the rate must be applied to

the “total income” and the tax that an assessee has to pay must be at the rate in respect of total income of the previous year.

The term ‘assessment’ is an inclusive definition. ‘Assessment’ includes re-assessment (Section 2(8) of the Act). The understanding of the scope of ‘assessment’ is necessary as, in these cases, we are concerned with the computation of income for the purpose of determining or assessing income tax payable by the respondent – assessees. In C.A.Abraham v I.T.Officer[2], the Supreme Court quoted with approval the observations of the Privy Council in Commissioner of Income Tax v Khemchand Ramdas,[3] to the effect that “the word ‘assessment’ is used as meaning sometimes the computation of income, sometimes the determination of the amount of tax payable and sometimes the whole procedure laid down in the Act for imposing liability upon the tax payer”. The word “assessment”, as used in the Income Tax Act, 1922 (the 1922 Act), includes a proceeding for imposition of penalty (CIT v Kirkend Coal Company[4]).

Asst. Collector of Central Excise v National Tobacco Co. Ltd[5] is a case which arose under the Central Excise Rules, 1944. It was argued that there would be no ‘levy’ in the eye of law unless there is ‘assessment’ for the purpose of determining the value of excisable goods. While observing that Article 265 of the Constitution makes a distinction between ‘levy’ and ‘collection’, it was held that the term ‘levy’ does not extend to ‘collection’ although ‘levy’ is wider than ‘assessment’. The Supreme Court also held that, “the term ‘assessment’ is generally used for the actual procedure adopted in fixing the liability to pay a tax on account of particular goods or property or whatever may be the object of the tax in a particular case and determining its amount”.

Section 35 of the 1922 Act conferred power on the Commissioner or the Appellate Commissioner to suo motu rectify

any mistake apparent on the record, appeal, revision, assessment or refund within four years from the date of such order. I n I.T. Commissioner v J.K. Commercial Corporation[6], the Supreme Court was required to consider whether the expression ‘assessment order’ in Section 35 of the 1922 Act includes an order made under Section 23A which authorized the Income Tax officer to levy super tax at specified rates. Referring to Khemchand Ramdas as approved in C.A.Abraham, the Supreme Court held that, “the word ‘assessment’ is capable of bearing a very comprehensive meaning; it can comprehend the whole procedure for ascertaining and imposing liability on the tax payer and literally speaking … … the assessment is of the total income of the assessee and then in the same order sum payable by the assessee is determined which would include income tax, surcharge, super tax etc”. On this reasoning, the Apex Court ruled that the expression ‘assessment order’ occurring in Section 35(1) of the 1922 Act would include an order made under Section 23A of the said Act.

It may, therefore, be taken as well settled that the word ‘assessment’ used in various provisions of the Act connotes different meanings, namely, the computation of income, the determination of the amount of the tax payable and some times the whole procedure laid down in the Act for imposing liability upon the tax payer. The word ‘assessment’ would certainly take within its fold, “computation of income as well as determination of tax payable thereon”. The immediate question, therefore, would be on what basis income is computed although the determination of the tax liability would depend on the Finance Act passed by the Parliament to be applicable for each assessment year. The computation of income, unless specifically provided for by the Act, is ordinarily left to the choice and option of the person liable to pay the income tax. Every tax payer is expected to disclose all types of income contemplated under the Act, namely, income from salary,

income from other sources etc. If any assessee fails to disclose various types of income truthfully or the assessing officer comes to a conclusion that the income is either not fully disclosed or improperly computed, he can then himself compute the income of a person liable to pay the tax. Sections 144 and 145 of the Act are relevant and are quoted hereunder. 144. Best judgment assessment. (1) If any person—

(a) fails to make the return required under sub-section (1) of Section 139 and has not made a return or a revised return under sub-section (4) or sub-section (5) of that section, or (b) fails to comply with all the terms of a notice issued under sub- section (1) of Section 142 or fails to comply with a direction issued under sub-section (2A) of that section, or (c) having made a return, fails to comply with all the terms of a notice issued under sub-section (2) of Section 143, the Assessing Officer, after taking into account all relevant material which the Assessing Officer has gathered, shall, after giving the assessee an opportunity of being heard, make the assessment of the total income or loss to the best of his judgment and determine the sum payable by the assessee on the basis of such assessment: Provided that such opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the assessment should not be completed to the best of his judgment : Provided further that it shall not be necessary to give such opportunity in a case where a notice under sub-section (1) of section 142 has been issued prior to the making of an assessment under this section. (2) The provisions of this section as they stood immediately before their amendment by the Direct Tax Laws (Amendment) Act, 1987 (4 of 1988), shall apply to and in relation to any assessment for the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year and references in this section to the other provisions of this Act shall be construed as references to those provisions as for the time being in force and applicable to the relevant assessment year.

(1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any

class of assessees or in respect of any class of income. (3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in Section 144.

The above two provisions empower the assessing officer to make assessment of the total income to the best of his judgment and determine the tax payable by the assessee. If a case falls under any of the three categories under Section 144(1) of the Act, it is mandatory for the assessing officer to make a best judgment assessment. In a case falling under Section 145(3) of the Act, discretion is given to the assessing officer to make a best judgment assessment in the manner provided under Section 144 of the Act. For more clarity, we shall indicate different situations herein below. The mandatory best judgment assessment is to be made in any of the four cases. (a) If any person fails to make the return under Section 139(1) of the Act and has not made a return or a revised return under Section 139(4) or (5) of the Act; (b) if any person fails to comply with all the terms of a notice issued under Section 142(1) of the Act; (b) if any person fails to comply with a direction issued under Section 142(2A) of the Act; or (d) if a person having made a return fails to comply with all the terms of a notice issued under Section 143(2) of the Act. Section 145(2) of the Act confers discretionary power on the assessing officer to make a best judgment assessment in two situations, namely, where the assessing officer is not satisfied about the correctness or completeness of the accounts of the assessee; and where the assessee has not followed regularly any method of accounting provided in subsection (1) of Section 145 of the Act (cash system or mercantile system of accounting).

“What is the scope of best judgment assessment”? The mandatory and discretionary best judgment assessment under

Sections 144(1) and 145(3) of the Act provide some guidelines. As per Section 144(1) of the Act, the assessing officer has to take into account all relevant material which he has gathered and should make assessment after giving the assessee an opportunity of being heard. Therefore the best judgment assessment is not to be an arbitrary assessment. Whatever the computation of income and tax thereon, it shall have some bearing with reference to the material gathered by the assessing officer and, if there is no material, the question of best judgment assessment would not arise. The availability of material or availability of material gathered by the assessing officer is crucial for making a best judgment assessment. It is not the ipse dixit of the assessing officer to compute the income of an assessee either under Section 144(1) or 145(3) of the Act. Nor the computation and determination can be as per the whims and fancies of an assessing officer. The language of Section 144(1) and 145(3) of the Act indicate that the computation of total income should be by adopting an objective method, and subjectivity in arriving at the taxable income is not contemplated under law. The word ‘assessment’ is, therefore, to be understood in each Section with reference to the context in which it has been used. In some Sections it has a comprehensive meaning and in some Sections it has a restrictive meaning (A.N. Lakshman Shenoy v I.T.Officer[7]). The power to make best judgment assessment is not an arbitrary power. These principles of law are well settled.

As observed by the Supreme Court in State of Orissa v Maharaja Shri B.P.Sing Deo[8], the scope of the best judgment assessment power has been explained by the Supreme Court in number of decisions. In Raghubar Mandal Harihar Mandal v State of Bihar[9], the assessee was engaged in bullion business. It was assessed to sales tax for seven quarters under the Bihar Sales Tax Act, 1944. For three quarters the assessee did not file returns.

The Sales Tax Officer (STO), in exercise of the power under Section 10(4) of the said Act, assessed the tax applying the principle of best judgment assessment. In respect of four quarters, though returns were filed, the STO rejected them and passed separate assessment orders. The assessee lost the appeal and, therefore, moved a revision before the Board of Revenue. The same was dismissed observing that the books of accounts filed by the assessee were not dependable and, therefore, the assessing officer was bound to assess the tax. At the assessee’s instance, the case was referred to the High Court of Patna. The High Court upheld the contention of the State that the STO is entitled to make an assessment on any figures of gross turnover. Before the Supreme Court, the issue was whether the assessing officer had assessed the tax amount due arbitrarily without basing the assessment on any material whatever. The Supreme Court referred to Section 23 of the 1922 Act, which was substantially similar to Section 10 of the Bihar Sales Tax Act. The issue was held in favour of the assessee and the relevant observations are as follows. Sub-section (3) of Section 23 of the Indian Income Tax Act requires the Income Tax Officer to assess the total income of the assessee and determine the sum payable by him on the basis of such assessment, by “an order in writing”; but clause (b) of sub-section (2) of Section 10 of the Act requires the Commissioner to assess the amount of tax due from the dealer and does not impose any liability as to “an order in writing”. In spite of these differences, the two provisions are substantially the same and impose on the assessing authority a duty to assess the tax after hearing such evidence as the dealer may produce and such other evidence as the assessing authority may require on specified points.

The Supreme Court pointed out that the best judgment assessment cannot be made rejecting the books of account by indulging in pure guess work without any evidence or material at all. The Supreme Court relied on the following observations of Lord Russel Killoven in CIT U.P. & C.P. v Badridas Ramrai Shop,

Akola[10] held as follows. The officer is to make an assessment to the best of his judgment against a person who is in default as regards supplying information. He must not act dishonestly, or vindictively or capriciously, because he must exercise judgment in the matter. He must make what he honestly believes to be a fair estimate of the proper figure of assessment, and for this purpose he must, their Lordships think, be able to take into consideration local knowledge and repute in regard to the assessee’s circumstances, and his own knowledge of previous returns by and assessments of the assessee, and all other matters which he thinks will assist him in arriving at a fair and proper estimate: and though there must necessarily be guess-work in the matter, it must be honest guess-work.

I n Commissioner of Sales Tax v H.M.Esufali[11] the Supreme Court considered the question whether it is the duty of the assessing officer to adduce proof in support of his estimate. After reviewing the case law, the Supreme Court did not agree with the view taken by the High Court that the assessing authority must have material before it to prove the exact turnover suppressed. It was held that if there is a reasonable nexus between the basis adopted by the assessing authority and the estimate of escaped income, it would suffice the test of validity of best judgment assessment. It is apt to quote the following relevant observations. The task of the assessing authority in finding out the escaped turnover was by no means easy. In estimating any escaped turnover, it is inevitable that there is some guess- work. The assessing authority while making the “best- judgment” assessment no doubt should arrive at its conclusion without any bias and on rational basis. That authority should not be vindictive or capricious. If the estimate made by the assessing authority is a bona fide estimate and is based on a rational basis, the fact that there is no good proof in support of that estimate is immaterial. Prima facie, the assessing authority is the best judge of the situation. It is his “best- judgment” and not of any one else’s. .... If the basis adopted is held to be a relevant basis even though the courts may think that it is not the most appropriate basis, the estimate made by the assessing authority cannot be disturbed.

I n S.M.Hasan, S.T.O v New Gramophone House[12] a

Division Bench of the Supreme Court held that, “if the conditions for the best judgment assessment are present, the assessing officer will make it not on speculative or fanciful grounds, but on reasonable guess since the best judgment assessment does not negate the exercise of judgment on the part of the officer ... ... a Tax Officer who makes a best judgment assessment should make an intelligent well grounded estimate rather than launch upon pure surmises”. From the decisions referred to hereinabove, we may sum up the principles to be followed when best judgment assessment is undertaken by a Taxing Officer as follows. (1) The power to levy assessment on the basis of best judgment is not an arbitrary power. It is an assessment on the basis of best judgment of the officer; (2) When best judgment assessment is undertaken it cannot be as per the whims and fancies of the assessing officer and it should base on some material either produced by the assessee or gathered by the Taxing Officer. If for any reason the material like books of accounts produced by the assessing is rejected as unreliable or unsatisfactory, there should be some valid reasons for doing so; and (3) Whenever best judgment assessment is made, the Court would not call for proof from the officer if there is some nexus between the amount arrived at after some guess work and the facts of the case.

Assessment by the department officials The ITO, Ward-3, Kakinada rightly rejected the loss return of income filed in most of the cases by the arrack contractors. Presumably opining that the arrack business is highly profitable, he rejected the book results disclosed by the assessees and estimated the gross profit at 40% of the purchase price. The license fee and bank commission were totally allowed as expenses. Out of the expenses claimed, the interest paid to partners was disallowed relying on the decision of the Supreme Court in Bihari Lal Jaiswal v CIT[13]. The assessing officer, however,

allowed 50% of the expenses claimed even though they were unvouched and unverifiable. The method adopted for allowing expenses has some rationality, but estimating the gross profit at 40% of the purchases is utterly unreasonable and arbitrary, and does not fit into any of the known principles of best judgment assessment. Even a microscopic examination of the assessment order in all the cases does not even give a clue as to how an arrack contractor would be able to reap profit at 40% of the purchase price of arrack.

The CIT (Appeals) affirmed the findings of the assessing officer treating the assessee as an AoP following the decision of the Supreme Court in Bihari Lal Jaiswal. The estimation of gross profit at 40% of the purchase price of arrack was also affirmed observing that there is nothing wrong as the books of accounts were rejected on account of non-substantiation of the turnover, and all major expenses. The reasons for adopting such a method of estimation of profit at 40% of the purchase price are not forthcoming even from the appellate authority. The rejection of books of accounts and non-substantiation of the turnover as well as the major expenses appears to be the reason for adopting 40% as the gross profit. The disturbance of business in extremist areas, and the general agitation demanding prohibition did not weigh with the CIT (Appeals) and, therefore, he affirmed the assessment order disallowing 50% of the expenditure claimed although some relief was given by deleting the addition made towards bank interest by the assessing officer.

The adoption of 40% as gross profit of purchase price of arrack, in our considered opinion, is arbitrary and irrational. Our finding also receives support from the decision of the Division Bench of this Court in A.Sanyasi Rao v Government of Andhra Pradesh[14] which was affirmed by the Supreme Court in Union of India v A.Sanyasi Rao[15]. These decisions dealt with the

constitutional validity of Sections 44AC and 206C of the Act[16]. Section 44AC of the Act inter alia stipulated that the profits and gains of purchaser of goods in the nature of alcoholic liquor for human consumption shall be deemed to be equal at 40% of the purchase price. The Division Bench of the High Court of Andhra Pradesh read it down holding that the provision was intended to check evasion of tax as guidance for deduction of tax at source. The Division Bench also held that it is irrational. The relevant observations are as follows. Once the tax is collected, based upon the purchase price of the specified goods, it is really immaterial whether the business is carried on in the names of dummies, in fictitious names, or in the names of faceless persons, or persons of on means. The tax collected is already with the State. An assessment can be made in accordance with the provisions of law. If the tax assessed is more than the tax already collected, may be there is little likelihood of such collection; but, even with these provisions, the situation is the same. There is no reason behind saying that even where a person actually earns less profit than the specified one, or incurs loss, even then his profits and gains should be arbitrarily fixed at 40% of the purchase price, or that he should not be allowed to establish his real income from the said business or trade. May be these persons do not maintain the books properly; but that is not an insuperable difficulty. If the books are not properly maintained, or are suspicious or unacceptable otherwise, they can away be rejected and a best judgment assessment made. The level or profits in such trade in a given area, region or State can always be kept in mind while making a best judgment assessment and/or while determining the truth or genuineness of accounts. The existence of some honest traders even in the specified good cannot be ruled out.

The Supreme Court while affirming the High Court judgment observed that Section 44AC of the Act denies equality of treatment, unfair and arbitrary as the arrack contractors are denied the reliefs under Sections 28 to 43C of the Act, which contain the procedure for computation of income from business.

Impugned order of the Income Tax Appellate Tribunal

In all the orders impugned in these appeals, the learned Tribunal followed its earlier decision in the case of Anakapalle

Arrack Shops. In some of the cases, the Tribunal followed the order dated 31.8.2001 in ITA No.17/H/1997 against which ITTA No.253 of 2003, which is one of the cases in this batch, is filed. It is, therefore, necessary to notice the Tribunal’s decision in Anakapalle Arrack Shops. Though a copy of the same is not placed before us, the sum and substance of the order is found in the impugned order in ITTA No.172 of 2003 and other appeals. After coming to the conclusion that estimation of profits at 40% of the purchase price is without reason and arbitrary, the Tribunal observed as follows. On the very identical facts and circumstances as in the present case, this Bench in its consolidated order dated 30.5.2001 had the occasion to consider the issue of estimation of profit in the cases of assessees engaged in the arrack business in the case of Anakapalle Municipal Units Arrack Shop & Others in ITA No.1420/HYD/1996 (series) as referred to above and relied on by the learned AR of the assessee, wherein after considering the various orders passed by the Revenue authorities and also the orders passed by the ITAT, Hyderabad in which different yardsticks had been adopted for estimating profit and also after considering the sales shown by the assessees vis-à-vis purchase price, it was held fair and reasonable to first estimate sales at eight times of purchases and then to estimate the net profit at 1% of such estimated sales or declared sales whichever is more after considering all kinds of deductions and allowances. The very same view has also been taken by this Bench in the group cases M/s.K.Bhaskar Rao & others in ITA Nos.17/H/97 series (consolidated order dt.31.8.2001) and also in another batch of cases in ITA No.467/HYD/1997 (series) in the case of GRK Prasad & others disposed of to-day. We find that in the cases under consideration the facts are almost identical and therefore, the decision taken in our earlier orders referred to above (i.e., 30.5.2001, 31.8.2001 and 31.1.2002) is also applicable to the present cases at hand under Group ‘A’ and Group ‘B’. No worthwhile material or fact was also brought in record by the learned DR to justify a different finding. Therefore, following the same, under the circumstances we hold that though the AO was justified to reject the book results, estimate of gross profit @ 40% of purchase price and disallowances of expenditure is arbitrary and excessive. We further hold that sales, which are admittedly unverifiable should be estimated at eight times of purchase price and net profit should be estimated at 1% of such estimated sales or declared sales whichever is more clear of all deductions and allowances, and if the profit so estimated is less than the profit

declared should be accepted.

From the above observations, we are convinced that the Tribunal considered (i) the sales shown by the assessees vis-à-vis the purchase price for estimating the sales at eight (8) times the purchase price; (ii) various orders passed by the Revenue authorities as well as ITAT, Hyderabad; and (iii) estimated the net profit at 1% of the estimated sales or declared sales whichever is high, after considering all kinds of deductions and allowances. There is no dispute before us that the Revenue did not choose to file an appeal against the consolidated order dated 30.5.2009 in Anakapalle Arrack Shops. Be that as it is, for the reasons infra, we are of considered opinion that estimation of net profit at 1% in arrack business is certainly on the lower side and, therefore, it needs to be re-estimated. As these cases pertain to the assessment years 1989-90, 1992-93 and 1993- 94, we are, however, not inclined to remand the matters. While agreeing with the submission of the Counsel for the assessees, we may also take judicial notice of the fact that under the relevant provisions under the Andhra Pradesh Excise Act, 1968, a retail license for vending arrack was given for a period of one year renewable every year for a period of five years. It is also not uncommon that most of the arrack contractors, due to heavy competition for procuring license, may not either seek continuation of license after expiry of the initial period of five years or some of them may call it a day and leave the arrack business. We may further take judicial notice of the fact that preceded by general agitation for imposing prohibition, the State of Andhra Pradesh enacted the Andhra Pradesh Prohibition Act, 1995 barring manufacturing, possession, sale and consumption of arrack or country-made liquor or illicitly distilled liquor, making the contravention a cognizable offence. Therefore, from September,

1994, the arrack business of the assessees was abruptly closed. As rightly pointed out by the Counsel, most of them might be untraceable. These are certainly relevant in the best judgment assessment of income-tax.

How has the Tribunal arrived at 1% of estimates sales as gross profit? We may give an illustration. If the purchase price of one unit of arrack is ` 100/-, at eight (8) times of purchase price the estimated sales would be ` 800/-. 1% thereof would be `8/- or 8%. For arriving at the estimated sales at eight (8) times the purchase price, the Tribunal considered the actual purchase price and the actual sales as disclosed by the assessees. For instance in ITTA No.3 of 2003, admittedly, the purchase price of arrack was ` 21,16,276/- and the sales turnover was ` 1,41,63,666/-. In ITTA No.172 of 2003 as against the purchase price of ` 5,26,260/- the sales recovery was ` 32,17,544/-. In ITTA No.253 of 2003 the purchase price of arrack stood at ` 15,12,000/- and the admitted sale amount at `1,38,30,500/-. Thus the average estimated sale is about 7 or 8 times the purchase price. This aspect the assessees did not seriously dispute. But, according to them, given the nature of business and the expenses involved like cost of arrack paid to the Government, royalty paid to the Government, payment of taxes to the Government, rentals paid for setting of shops and all other miscellaneous expenses, estimation of net profit at 1% of the estimated sales is reasonable. The Senior Counsel for the Revenue, however, disputes this. What would be a reasonable estimate of the profit with reference to purchase and/or the total sale value? Section 44AD of the Act is a special provision for computing profits and gains in civil construction business. It mandates a sum equal to 8% of the gross receipts paid or total to the assessee in the previous year on account of construction business or a higher sum that may be

declared by the assessee in his return of income shall be deemed to be the profits and gains from the business. The Counsel would commend to us that, applying the principle in Section 44AD of the Act, the rate of percentage of profit assessed at 8% of the cost of purchase of arrack, as is done by the Tribunal, is reasonable. We are, however, not in agreement with this. Section 44AD of the Act does not put a ceiling at 8% of gross receipts as profit in a construction business. It could be higher as per the return of income. More often than not, contractors in civil construction business claim loss of profit arising out of diminution in turnover on account of delay in the matter of completion of work or breach of contract or illegal termination of contract. In such cases the Supreme Court has upheld award of 15% of the contract value or gross value of the contract towards loss of profit (see Mohd. Salamtulla v Government of Andhra Pradesh[17] and Brij Paul Singh v State of Gujarat[18]). Therefore, we are not inclined to accept the submission of the Counsel that 8% of the purchase value as profit would be reasonable. As seen from the purchase price and sales recoveries, there is a wide variation. In some cases, it is more than nine (9) times and in some other cases less than seven (7) times. Given the fact that there is no price fixed by the Government for sale of arrack and it is generally a seller’s market, to assume that the gross profit would be at 1% of the estimated sales, in our considered view, is low. Accepting the total sale price at eight (8) times of the purchase price, we feel it appropriate to hold that 2% of the estimated sale value, after considering all types of deductions mentioned hereinabove, would be reasonable. Indeed, the Division Bench of this Court in A.Sanyasi Raju found that in some cases the profit margin was higher in arrack business. Therefore estimating the net profit at 2% of the estimated sales or 16% of the purchase price (the Tribunal estimated at 8% of the purchase price) would not

be unreasonable. In the result, for the above reasons, we set aside the orders of the Income Tax Appellate Tribunal impugned in these appeals directing that the net profit be estimated at 2% of the estimated sales or 16% of the purchase value whichever is higher. All the appeals shall stand disposed of accordingly. In the facts and circumstances of the case, we make no order as to costs. _______________ (V.V.S.RAO, J)

______________________________ (RAMESH RANGANATHAN, J) June , 2011

NOTE: 1. L.R. Copy be marked. 2. Dispatch order copy in one week. (By order) YS

[1] (2008) 4 SCC 362 [2] AIR 1961 SC 609 [3] AIR 1938 PC 75 : (1938) 6 ITR 414 [4] AIR 1969 SC 1352 [5] AIR 1972 SC 2563 [6] AIR 1977 SC 459 [7] AIR 1958 SC 795 [8] (1971) 3 SCC 52 [9] AIR 1957 SC 810 [10] AIR 1937 PC 133 [11] AIR 1973 SC 2266 [12] AIR 1977 SC 1788 [13] (1996) 217 ITR 746 (SC) [14] (1989) 178 ITR 31 (AP) [15] (1996) 219 ITR 330 (SC) [16] These two sections were inserted by the Finance Act, 1988, w.e.f. 01.4.1989 and were omitted by the Finance Act, 1992, w.e.f. 01.4.1994. [17] AIR 1977 SC 1481 [18] AIR 1984 SC 1703