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Income Tax Appellate Tribunal, MUMBAI BENCHES “D”, MUMBAI
Before: SHRI JOGINDER SINGH & SHRI ASHWANI TANEJA (ACOUNTANT MEMBER)
O R D E R Per ASHWANI TANEJA, AM:
These cross appeals have been filed against the order of Commissioner of Income-Tax (Appeals)-27, Mumbai [hereinafter called Ld.CIT(A)] passed against the assessment order dt 05-12-2011 u/s 143(3) for the assessment year 2009-10.
First, we shall take up the revenue’s appeal in . The revenue has raised the following grounds of appeal:
1. “Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the addition of Rs 8,83,56,806/- on account of suppression of safes which was based on auditor's report filed by the assessee.
2. Whether in the facts and circumstances of the case and in law, the Id. CIT(A) has erred in deleting the addition of Rs 1,85,83,340/- on account of unaccounted stock of polished diamonds. 3. Whether in the facts and circumstances of the case and in law, the Id. CIT(A) has erred in deleting the addition of Rs 2,14,67,740/- on account of unaccounted stock of rough diamonds.”
4. Both the parties made exhaustive submissions on the respective grounds.
5. In ground No.1, the revenue has challenged the action of Ld. CIT(A) in deleting the addition of Rs.8.83 crores made by the AO on account of suppression of sales.
The brief facts of the case as culled out from the orders of lower authorities are that during the year under consideration, the assessee, a partnership firm was engaged in the business of import of rough diamonds, manufacturing, polishing and export of polished diamonds. The impugned year is the first year of business of the firm. The AO in the assessment order passed u/s 143(3) made assessment at Rs. 13,98,99,900/- against the returned income of Rs.16,12,060. In the assessment order, the AO noted following information gathered from the audit report filed by the assessee in Form 3CD:
Rough Diamond Quantity Value Rate (In carats) (in Rs.) (in Rs.) Purchases 27,139.46 61993269 2284.25 Sales 00 00 00 Used in manufacture 17,640.46 -- -- Transfer to Rejection 9,499.00 227976 24 Rough (treated as closing Stock) Polished Diamond Quantity Value Rate (in carats) (in Rs.) (in Rs.) Purchases 00 00 00 Sales 5013.59 51670565 1036.10 Closing stock 953.29 28408042 29800
The yield of polished diamonds 5,966.88 carats The % of yield 33.82% Being aggrieved, assessee filed an appeal before Ld.CIT(A) wherein detailed submissions were made and it was submitted that the AO had misunderstood the facts. There was no basis to substitute the sale price on the basis of average price of the stock. It was also submitted that assessee was ready to produce all the books of account, stock register, etc. Ld. CIT(A) considered in detail the submissions and evidence produced by the assessee. He partly agreed with the findings of the AO and estimated the sales of the assessee by applying gross profit @3.9% on the sale of 2543 cts of diamonds at Rs.10521 per carat. The findings recorded by the Ld.CIT(A) are reproduced hereunder, for the sake of ready reference: “3.1. I have carefully considered the contents of the assessment order and the appellant's submissions made before me. At the outset, this is the first year of business for the appellant firm, and therefore, there is no opening stock of either rough or polished diamonds. Appellant has imported rough diamonds of 27139.46 carats from one of the related parties covered u/s 40A(2) of the Act and the impugned transaction was subjected to scrutiny by the Transfer Pricing Officer (TPO) and no adjustment was made thereof. In other words, the purchase price has been accepted to be reasonable. Secondly, the imports were also subjected to customs appraisal and thus there is nothing unusual to suspect anything about the purchases. Now, entire stock of 27139.46 carats of rough diamonds was put to manufacturing process, out of which, 9499 carats were considered as not makeable rough and thus rejected at the threshold level. The balance of 17640.46 carats rough diamonds were worked upon, which resulted in polished diamonds of 5966.88 carats. Thus, the rejection in terms of unmarketable rough diamonds was about 35% and the final yield of polished diamonds was of 34%. The relevant information was placed before the AO, and apparently the AO, has no complaint against these yield ratios and no adverse comment thereof is made anywhere in the assessment order. The only observation made by the AO in this regard was that the wastage generated in the process of cutting, cleaving, sawing and polishing will have certain marketable value, which requires a further addition to appellant's income, and however, the very fact of occurring of wastage was not questioned at all. Thus, the facts on record rule out any undisclosed stocks dealt outside the books resulting in any unaccounted sales. Therefore, the only question to be considered is whether there is any possibility of understatement of sale value. Apparently, AO has applied the closing stock value of polished diamonds to the entire sales made by the appellant, without assigning any reason thereof. It is a matter of common ,knowledge that all minerals/stones are formed naturally, which includes diamonds, therefore all the rough diamonds will not have the same qualities and it is also not possible to assort the same based on exact qualities that they can be assumed to give equal quality of final product. In fact, AO has no dispute with this proposition while accepting the yield ratios. The only logical corollary of this fact is that the polished diamonds sold will also be of different sizes and different qualities. If this is so, there is no good reason for the AO to arrive at the conclusion that the entire sales are to be considered at the closing stock value. However, from the materials placed on record, I note that the entire purchase cost through imports remained unpaid at the end of the year requiring the appellant to recast the sundry creditors as on balance sheet date and the appellant has debited an amount of Rs. 11017829 to its P&L A/C towards cost of purchases on this count. If this amount is also taken into account, appellant's average cost of production works out to Rs.10521 per carat. As against this, examination of the sales affected during the year reveals that at 35 instances appellant has sold stocks of 2543 carats out of total sales of 5013 carats, at a value lower than the average cost and such sales amount to Rs.18431118 out of the total sales of Rs51670565, which is approx.51% of the quantity sold and 36% of the total sate value. In this regard, it is also noted that the goods sold by the appellant are of multiple grade and vide variety, and not identified on FIFO method. In such a situation where goods are sold in mixed lots, any ordinary prudent business man will keep in mind the average cost incurred in bringing them to market and would like to avoid any uncertainties and would like to recover the cost at minimum with a decent profit margin. It is also pertinent to note that all the sales were made locally and there was no control established by any authorities on sale price unlike in the case of purchases by way of customs appraisal or through transfer pricing adjustments. In my considered opinion, there is no good reason for selling more than 50% of the stock at a value lower than its cost price. During the proceedings before me, despite a specific query on this issue, appellant failed to offer any explanation for sale below the cost price, leave alone a valid one, In this background, I hold that the possibility of understating the sale value cannot be entirely ruled out and therefore the books of accounts maintained by appellant are not reliable and to be rejected requiring a certain portion of the addition made by the AO to be upheld. Having said so, I hold that the impugned sale of 2543 carats is to be considered at average cost price of Rs.10521 and the difference in sale needs to be added to appellant's income apart from a reasonable GP addition. In respect of the GP earned by the appellant, I note that but for the cost of purchases and the foreign exchange fluctuation added to the cost of purchases, there are no other major expenses debited to P&L A/C. These two items stand verified through transfer pricing scrutiny and exchange rate prevailing on balance sheet date. Labour expenses of Rs.5292138 works out to Rs.300 per carat of rough diamonds worked upon, which appears to be reasonable. Therefore, I note that it would meet the ends of justice if the declared GP of 3.9% is loaded to the sale of 2543 carats considered at the sale price of Rs. 10521. In such a case the addition confirmed is worked out as follows:
Sale of 2543 carats at Rs. 10521 per carat Rs.26764898 Add: GP at 3.9% thereon Rs. 1043831 Total sale value of 2543 carats Rs. 27808729 Less: sales shown in books Rs.18431118 Addition confirmed Rs. 9377611
3.1.5 Accordingly, I direct the AO to adopt the addition of Rs.9377611 in the place of Rs.97734417 the head suppression in sales. Appellant gets part relief on this issue.”
Being aggrieved with the order of the Ld. CIT(A), the assessee as well as the revenue have filed appeal before the Tribunal.
During the course of hearing, it has been submitted by the ld. counsel of the assessee that there were no basis with the Ld. CIT(A) to sustain any addition. It was submitted that closing stock of 953.29 cts of diamonds has been sold in the next year at appropriate sales price. The diamonds of lower quality were sold in the year under consideration. Therefore, the average sale price of the same was Rs.10306.10. It was also submitted by the ld. counsel that if the methodology adopted by the CIT(A) is implemented, then, it results into an exorbitant overall gross profit rate of 18.87% which is not expected in the industry. Therefore, viewed in any manner, the addition sustained by the Ld. CIT(A) is unreasonable. 9. Per contra, the ld. DR submitted that the assessee is not maintaining proper stock register. It is very difficult to find out quality-wise break-up of the diamonds. There is no transparency in the system followed by the assessee. The assessee is enjoying liberty to value the closing stock as per its convenience and also adjust the sale price as per its needs so as to minimize the tax burden. Under these circumstances, addition made by the Assessing Officer was justified and, therefore, order of Ld. CIT(A) should be reversed and addition made by the Assessing Officer should be upheld. 10. We have gone through the submissions made by both the sides carefully. From the facts brought before us, we agree with the observations made by the Assessing Officer as well as the Ld. CIT(A) that complete records are not being maintained by the assessee so as to maintain transparency in its books of account especially with regard to valuation of its closing stock. In response to our query, ld. counsel was not able to demonstrate from any record from where any qualitative details of the inventory of diamonds could be obtained. Further the stock registers were never produced before the lower authorities. Thus, undoubtedly, the assessee has not been able to substantiate that the valuation done by the assessee with regard to its closing stock is correct as per facts. On the other hand, we also agree with the assessee that the sale price of the diamonds sold by the assessee during the year cannot be substituted without any contrary evidence available in the possession of the revenue. We also agree with the argument of the ld. counsel that the approach adopted by the Ld. CIT(A) for arriving at correct amount of profit by computing the suppressed amount of sales is not showing reasonable and acceptable results. It is evident, on the basis of a work sheet submitted by the assessee, that if the order of Ld.CIT(A) is implemented, then, it would give an overall gross profit rate of 18.87%, which, according to the assessee, is quite improbable in this industry. Our attention was drawn on the gross profit rates of the subsequent years, since the impugned year is the first year of business of the assessee. It is further noticed by us that the entire closing stock of the impugned year i.e. 953 carats was old in the subsequent year, i.e. A.Y. 2010-11. No fresh purchases have been made in A.Y. 2010-11 as is evident from the P&L account and other details submitted before us pertaining to A.Y. 2010-11. The ratio of G.P. to turnover of A.Y.2010-11 has been reported at 10.58%. Thus, with a view to reduce this controversy and to render justice to both the sides, we deem it appropriate to estimate the income of the assessee for the year before us at gross profit rate of 10.58%. The total sales shown by the assessee during the year for 5013.59 cts is aggregating to Rs.5,16,70,565. The Assessing Officer shall compute gross profit @10.58% on this amount which shall be further subjected to claim of all other expenses as have been claimed by the assessee in the P&L Account, as allowable under the law and as per facts. Thus, the Assessing Officer is directed to compute net profit of the assessee accordingly. The remaining amount of addition shall be deleted. The order of Ld. CIT(A) is modified accordingly. The ground raised by the revenue is partly allowed.
Ground 2 : In this ground, the revenue has challenged the action of Ld.CIT(A) in deleting addition of Rs.1,85,83,340 on account of unaccounted stock of polished diamonds.
The brief facts in this case are that the assessee in its appeal before the Ld. CIT(A) had made exhaustive submissions on the issue that the assessee had valued its closing stock of polished diamonds of 953.29 carats at Rs.29800 per carat and credited its P&L A/C with the closing stock value of Rs.28408042. AO at page 4 of his order noted that the closing stock was valued at a price higher than the sale price which is against the principle of valuation of inventories. In the opinion of the AO, sale price of polished diamonds which represent the market rate should have been applied by the appellant for valuing its closing stock. Accordingly, on applying the sale rate, AO worked out the closing stock value at Rs.9824702 as against the value reported by the assessee at Rs.28408042. Thereafter, the AO treated the difference amount of Rs. 18583340 as value of unaccounted stock and added the same to assessee’s income.
It was also submitted by the assessee before the Ld.CIT(A) that after I holding the value of closing stock to be on higher side, surprisingly the AO has taxed the said difference as income (as unaccounted stock of polished diamonds) instead of reducing the same from the income. It was illogical from point of view of as well as common sense, as to how higher stock value can be considered as unaccounted and the sales rate be applied to closing stock, especially when facts are on record that the sales out of the closing stock has been made subsequently and the attention of the AO was drawn that these very goods were sold for Rs. 285,96,255/- in the financial year 2010-11 for which the return was already filed on 30-09-2010 i.e. much prior to the assessment proceedings and order dt. 05.1 2.2011. If this addition is considered independently and as a sole item and proper effect given it should result in the reduction of the returned income by Rs. 1,85,83,840/-.
The Ld. CIT(A) considered the submissions of the assessee and deleted the addition with the following observations : “3.2.2. I have carefully considered the appellant's submissions. In the notes to the accounts annexed to the audit report, the auditor has stated that the appellant valued the closing stock at the lower of the estimated cost being the likely sale price as reduced by gross profit or net realizable value, whichever is lower. Estimated cost arrived for this purpose was substantiated by the subsequent sales of the impugned stock as reduced by the gross profit. In such circumstances, I fail to understand the logic behind the AO's observation that the closing stock should be valued at market price of some other items and not that of the impugned stock itself. On one hand, AO made a huge addition of Rs.9.77 crs by holding that the closing stock value should applied to the sales affected during the year, and on the other hand, held that the closing stock should be valued at the sale price which was discarded by him as unreliable. It is lack of any accounting knowledge on the part of the AO which resulted in this dichotomy. Further, even for a moment AO is held to be correct, such a finding will only result in reduction of income and not an addition to the same. Even otherwise, there is no material brought on record to show that appellant has indulged in any transactions outside the books of account resulting in unaccounted closing stock. Secondly, even if such proposition is accepted to be true, the said value having been included in the books, no further addition is warranted. In view of the above discussion, I do not find any merit whatsoever in the impugned addition and I have no hesitation to delete the same Appellant succeeds on this ground.”
During the course of hearing before us, the ld. Ld. Departmental Representative relied upon the order of the Assessing Officer whereas ld. Counsel of the assessee submitted that addition was totally illegal and, therefore, it was rightly deleted by the Ld. CIT(A).
We have considered the submissions made by both the sides. It is noted that closing stock of this year has been taken as opening stock of the subsequent year and the same has been set off against the sales of this stock in the subsequent year. Under these circumstances, we do not find any justification to make revaluation of the closing stock and much less, the way it has been done by the Assessing Officer. Further, in any case, the gross profit of the assessee has been estimated on the basis of gross profit ratio of the subsequent year. Thus, any possible leakage or variation in the net profit reported by the assessee has already been taken care of. Under these circumstances, we do not find any logic or justification to make any addition on account of valuation of closing stock. Thus, we find that no interference is called for in the order of Ld.CIT(A) on this ground. Ground No.2 of the revenue’s appeal is dismissed.
Ground 3 : In this ground, the revenue has challenged the action of Ld.CIT(A) in deleting the addition of Rs.2,14,67,740 on account of unaccounted stock of rough diamonds. 18. Brief facts of this case are that it was noted by the Assessing Officer that the AO noted that apart from rough rejection at threshold level, further wastage of rough takes place during the manufacturing process as can be observed from the fact that the yield ratio of polished diamonds (5966 carats) to the rough actually worked upon (17640 carats) is of 33%. AO further observed that in this process small pieces of diamonds and dust are generated which are used in industrial blades and other uses. AO was of the opinion that out of the wastage of 11819 carats (17640 - 5966) at least 50% of the wastage will definitely have certain use and hence its own value, AO estimated such value at Rs.24 per carat and arrived at a total amount of Rs 141828/-. 19. Being aggrieved, assessee filed appeal before Ld. CIT(A) and made detailed submissions. It was submitted that rough diamonds as extracted from the mines are sold in lots to the customers who are in the business of cutting and polishing and only when they are analyzed at the time of cutting, the possibility of making a fine diamond is known and further it is the industry practice to sell the rough diamonds by the mine owners without any deep analysis thereof. It is further explained that non makeable rough rejection ranges from 5% to 35% depending on the size and quality of rough diamonds and the market value of such rejection is very negligible The AR further stated that the value of the rejected rough was adopted on the basis of its subsequent sale at Rs.30 per carat, which facts are placed before the Assessing Officer. 20. The Ld. CIT(A) considered the submissions of the assessee and agreed with the same. Accordingly, he deleted the addition made by the Assessing Officer with the following observations:
3.3.2. I have carefully considered the appellants submissions. The fact of rejection of rough at the time of cutting and polishing is not disputed by the AO. Once the rough diamonds are rejected as not capable of being made into a fine diamond, it is a matter of common sense that they cannot fetch the same value at which they were purchased. Thus, apparently, there is a self- contradiction in the stand taken by the AO. Secondly, the fact of rough rejection and its value being marginal is a fact supported by the industry practice and standards. Thirdly, appellant has substantiated its value by way data relating to its subsequent sale at Rs.30 per carat and the consistent practice of valuing the closing stock at estimated cost i.e., likely sale price as reduced by profit margin. Appellant also placed on record data relating to its sister concern M/S Ratnakala Exports, one of the largest firms engaged in imports, cutting& polishing and exports of diamonds, wherein the rejected rough was again exported in the price range of Rs 25 to Rs.35 per carat to buttress its submission that the value of rejected rough is marginal. Further, AO has not brought any material to contradict the appellant's submissions made before him. At any rate, enhancing the closing stock value will only result in increasing the opening stock value for the subsequent year, which is revenue neutral. In view of the above discussion I hold that there is no justification for valuing the rejected rough at the purchase price. Accordingly, the addition made by the Assessing Officer is deleted.”
During the course of hearing before us, it was submitted by the ld. DR that Assessing Officer had rightly made the addition and his order should be upheld.
Per contra, the ld. counsel of the assessee reiterated its submissions as were made with regard to earlier grounds and further submitted that this addition was absolutely incorrect on facts and law and, therefore, the same was rightly deleted by the Ld. CIT(A). It is noted by us that the Ld. CIT(A) has correctly appreciated the facts in this case, as we have observed in respect of ground 2 above that there were no basis to value the closing stock at a different rate by the Assessing Officer. Keeping in view these defects only, we have estimated the gross profit of the assessee so as to bury all the controversies. In any case, enhancing the closing stock value will only result in increasing the opening stock value for the subsequent year which would be revenue neutral. We find
the order of the Ld. CIT(A) to be justified and well reasoned and no interference is called for therein and, therefore, the same is upheld. This ground of revenue is dismissed. 23. Now we shall take up assessee’s appeal in filed is on the following grounds: “1. The learned CIT(A) (A) erred in upholding the action of the learned Assessing Officer whereby addition was made on account of alleged suppression in sale.
2. Without prejudice to Ground No. 1, the learned CIT (A) erred in directing the learned AO to adopt the sale value of Rs.2,78,08,729/- on the sale of 2543 cts of polished diamonds on the ground of alleged suppression in sale/understating of sale instead of actual sales realized of Rs. 1,84,31,118/-.
The learned CIT (A) erred in confirming the addition made by the learned AO of Rs. 1,41,828/- being the amount worked out as value of 11,819 Cts of Rough wastage allegedly generated during the process of cutting and polishing, which is purely based on surmises and conjectures.”
Grounds 1 & 2 deal with the addition sustained by the Ld. CIT(A) on account of suppression in sale value. These grounds have already been addressed by us while disposing of ground 1 of revenue’s appeal wherein income of the assessee has been computed at gross profit rate of 10.58% and order of Ld. CIT(A) has been directed to be modified accordingly. Under these facts, we find that grounds 1&2 become infructuous and dismiss as such.
Ground 3: In this ground, the assessee has challenged he action of Ld. CIT(A) in confirming the addition made by the Assessing Officer of Rs.1,41,828 being the amount worked out of rough wastage generated during the process of cutting and polishing.
The brief facts in this regard are that the AO noted that apart from rough rejection at threshold level, further wastage of rough takes place during the manufacturing process as can be observed from the fact that the yield ratio of polished diamonds (5966 carats) to the rough actually worked upon (17640 carats) is of 33%. AO further observed that in this process small pieces of diamonds and dust are generated which are used in industrial blades and other uses. AO was of the opinion that out of the wastage of 11819 carats (17640 - 5966) at least 50% of the wastage will definitely have certain use and hence its own value. Assessing Officer estimated such value at Rs.24 per carat and arrived at a total amount of Rs. 141828/-.
Being aggrieved, the assessee filed appeal before Ld.CIT(A) and submitted that it was a pure estimate and, therefore, could not be treated as income of the assessee. Ld. CIT(A) considered the submissions of the assessee but did not agree with the same and upheld the addition made by the Assessing Officer with the following observations: “I have carefully considered appellant's submissions. It is a fact that small diamonds of a few cents and dust is generated in the manufacturing process and it has certain market value. As seen from the stock statements and computation of income, appellant has not accounted for any income from this source, however small it may be. Even though AO's approach of valuing it at Rs.24 per carat has no valid basis, nevertheless, considering the overall volume of appellants business and the fact that certain marketable wastage is generated during the manufacturing process, I hold that the addition of Rs.141828 is reasonable in overall terms. Accordingly, the same is confirmed.””
During the course of hearing before us, the ld. counsel of the assessee submitted that this addition was purely on estimate basis and, therefore, should be deleted. It was further informed that there might be some generation of wastage but the same is retained by the karigars and is taken care of while negotiating the pricing of the labour charges with these karigars. It is because of this incentive that assessee is able to get the labour job done at economical pricing. In any case, nothing was found by the Assessing Officer showing that if some income has been earned by the assessee on account of sale of wastage.
Per contra, the ld. DR supported the orders of the lower authorities on this issue. 30. We have gone through the orders of lower authorities. It is noticed by us that no material has been brought on record by the lower authorities indicating if any wastage has been generated which has been sold or otherwise giving rise to any income which is escaped from tax. The addition has been made on purely estimate basis without bringing any material on record whatsoever. In our view addition cannot be made on pure estimate and, therefore, the same is directed to be deleted. Ground is allowed. 31. As a result, appeal of the assessee is partly allowed. Order pronounced in the court on this __22nd ______ day of July, 2016.