2023 (10) TMI 1525 - AT - Income Tax

Rejecting the books of account of the assessee - estimating the profit @ 8% of the revenue recognized - HELD THAT - AO has nowhere given a finding of fact that the assessee has not regularly followed the method of accounting specified u/s 145(1) of the Act. It is also not the case of the AO that the assessee has not computed the income in accordance with the standard notified u/s 145(2). AO s satisfaction that the accounts are not correct or complete cannot be accepted merely because there was inadvertent mistake in the TAR which was explained by the assessee as inadvertent error while entering the date which fact is seen supported by auditor who has accepted the mistake by filing an affidavit. And it also noted that assessee filed the rectified TAR which is found placed at page no. 96 of PB. Therefore the action of the AO to reject the books cannot be accepted and the Ld. CIT(A) has rightly reversed his action on this issue and accepted the books of account of the assessee and we confirm the impugned action of CIT(A). Having upheld the action of the CIT(A) and accepted the books of account the action of AO to have estimated the income of the assessee is legally unsustainable. And therefore we confirm the action of the Ld. CIT(A) deleting the estimated addition made by the AO. Appeal of the revenue stands dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal were:

(a) Whether the Assessing Officer (AO) was justified in rejecting the books of account of the assessee under section 145(3) of the Income Tax Act, 1961, on the ground of discrepancies between the turnover figures reported in the audited accounts and the tax audit report (TAR), and alleged improper maintenance of stock records?

(b) Whether the AO was justified in estimating the income of the assessee at 8% of the revenue recognized, after rejecting the books of account?

(c) Whether the explanation and evidence furnished by the assessee regarding the alleged discrepancies, including the data entry error in the TAR and the method of accounting adopted (percentage completion method), were sufficient to uphold the correctness and completeness of the books of account?

(d) Whether the AO erred in treating the closing provision of expenses as closing stock and in comparing the assessee's real estate development activity with trading/manufacturing activities?

2. ISSUE-WISE DETAILED ANALYSIS

Issue (a): Justification for rejection of books of account under section 145(3)

Relevant legal framework and precedents: Section 145(3) of the Income Tax Act empowers the AO to reject the books of account if they are found to be incorrect or incomplete. The burden lies on the AO to demonstrate that the accounts are not reliable. The Courts have held that mere discrepancies or errors do not justify rejection unless they are material and unexplainable.

Court's interpretation and reasoning: The AO rejected the books primarily because of a mismatch between the turnover figures shown in the audited accounts (Rs. 25,52,69,395) and the TAR where turnover was shown as zero, and because of alleged improper maintenance of stock records. The AO also noted a discrepancy in closing stock figures, comparing Rs. 43,49,47,272 claimed by the assessee with Rs. 1,14,63,282 as per ICDS disclosure in the audit report.

The Tribunal noted that the assessee explained that the zero turnover in the TAR was a data entry error, as the same auditor audited both the accounts and the TAR, and the error was rectified by filing a corrected TAR along with an affidavit from the auditor. The Tribunal accepted this explanation as credible and supported by documentary evidence.

Regarding stock maintenance, the assessee followed the percentage completion method for revenue recognition in real estate development, which involves recognizing revenue based on the proportion of project cost incurred. The Tribunal observed that the AO erred in comparing the assessee's activity with trading or manufacturing businesses where stock is maintained physically. The closing provision of Rs. 1,14,63,282 was a closing provision for expenses, not closing stock, as reflected in the balance sheet and audit report.

Key evidence and findings: The corrected TAR filed by the assessee, affidavit of the auditor admitting the data entry error, explanation of the percentage completion method, and the balance sheet showing the nature of closing provision.

Application of law to facts: The Tribunal held that the AO's rejection of books was not justified as the discrepancies were explained satisfactorily and were not indicative of incorrect or incomplete accounts. The AO failed to appreciate the accounting method adopted and misinterpreted the nature of closing provision.

Treatment of competing arguments: The revenue argued that the mismatch and stock discrepancies warranted rejection of books. The Tribunal rejected this, holding that the explanation provided was sufficient, and the AO's approach was legally unsustainable.

Conclusion: The books of account were properly maintained and accepted by the Tribunal; the AO's rejection was set aside.

Issue (b): Legality of estimating income at 8% of revenue after rejection of books

Relevant legal framework and precedents: Section 145(3) allows the AO to estimate income if books are rejected. However, if books are accepted, estimation is not warranted. Estimation must be reasonable and based on cogent material.

Court's interpretation and reasoning: Since the Tribunal upheld the books of account, the foundation for estimation by the AO fell away. The AO's estimate of 8% profit on turnover was arbitrary and not based on any material or evidence. The Tribunal held that the estimation was legally unsustainable once books were accepted.

Key evidence and findings: The acceptance of books by the Tribunal and lack of any independent basis for the 8% estimation.

Application of law to facts: The estimation was invalid because it was premised on rejected books, which were subsequently accepted.

Treatment of competing arguments: Revenue maintained that estimation was justified due to discrepancies. Tribunal rejected this view.

Conclusion: The estimated addition was rightly deleted by the CIT(A) and confirmed by the Tribunal.

Issue (c): Sufficiency of explanation regarding discrepancies and accounting method

Relevant legal framework and precedents: The percentage completion method is a recognized accounting method for real estate projects, consistent with accounting standards and ICDS. Errors in tax audit reports can be rectified by corrected filings and auditor affidavits.

Court's interpretation and reasoning: The Tribunal accepted that the turnover figure discrepancy was a bona fide data entry error, rectified by the assessee with supporting affidavit. The percentage completion method was properly applied to recognize revenue and closing stock (work-in-progress). The AO failed to understand this method and wrongly compared it to trading stock maintenance.

Key evidence and findings: Assessee's reply to show cause notice, corrected TAR, auditor's affidavit, and explanation of accounting method.

Application of law to facts: The explanation and documentary evidence sufficiently demonstrated that the accounts were correct and complete.

Treatment of competing arguments: Revenue's contention that discrepancies warranted rejection was rejected as the explanation was reasonable and credible.

Conclusion: The explanation was sufficient and accepted by the Tribunal.

Issue (d): Treatment of closing provision and comparison with trading/manufacturing activities

Relevant legal framework and precedents: Accounting standards and ICDS require proper classification of provisions and inventory. Real estate projects have distinct accounting practices compared to trading/manufacturing.

Court's interpretation and reasoning: The AO wrongly treated the closing provision of Rs. 1,14,63,282 as closing stock. The Tribunal noted that this amount was a provision for expenses, not inventory. The AO's comparison of the assessee's real estate activity with trading/manufacturing was erroneous and showed lack of appreciation of the accounting method.

Key evidence and findings: Balance sheet and audit report disclosures, explanation of percentage completion method.

Application of law to facts: The AO's approach was flawed and led to incorrect conclusions.

Treatment of competing arguments: Revenue's argument was rejected.

Conclusion: The AO's treatment was incorrect and set aside.

3. SIGNIFICANT HOLDINGS

"The AO's satisfaction that the accounts are not correct or complete cannot be accepted merely because there was inadvertent mistake in the TAR which was explained by the assessee as inadvertent error while entering the data which fact is seen supported by auditor who has accepted the mistake by filing an affidavit."

"The AO could not appreciate the computation of the closing stock as per such method and misdirected himself to compare the activity of assessee with trading/manufacture which was erroneous."

"The action of the AO to reject the books cannot be accepted and the Ld. CIT(A) has rightly reversed his action on this issue and accepted the books of account of the assessee."

"Having upheld the action of the Ld. CIT(A) and accepted the books of account, the action of AO to have estimated the income of the assessee is legally unsustainable."

Core principles established include that rejection of books under section 145(3) requires cogent material and cannot be based on inadvertent errors or misunderstandings of accounting methods; percentage completion method is a valid accounting practice for real estate projects; and estimation of income is not justified once books are accepted.

Final determinations:

- The books of account of the assessee were correctly maintained and accepted.

- The AO's rejection of books and consequent estimation of income was set aside.

- The addition of Rs. 1,73,36,141/- made by AO was deleted.

- The appeal of the revenue was dismissed.