2025 (5) TMI 818 - AT - Income Tax

Rejection of books of accounts - AO concluded that the genuineness of the purchases could not be verified - CIT(A) rejecting the observation of the AO to invoke the provisions of section 145(3) - HELD THAT - Factual and legal findings of the Learned NFAC could be controverted by the revenue before us. Hence we do not find any infirmity in the order of the learned NFAC. Accordingly the grounds raised by the revenue are dismissed.

Summary

The core legal questions considered in this appeal pertain primarily to the validity of the Assessing Officer's (AO) invocation of section 145(3) of the Income-tax Act, 1961, which authorizes rejection of the books of accounts maintained by the assessee, and consequential estimation of income under section 144 of the Act. Specifically, the issues include:

1. Whether the AO was justified in rejecting the books of accounts of the assessee under section 145(3) on the ground of unverifiable purchases from certain suppliers whose tax filings were suspicious or who failed to respond to notices under section 133(6).

2. Whether the AO's estimation of net profit at 10% of turnover after rejecting the books of accounts was reasonable and supported by cogent material.

3. Whether the assessee had discharged its onus of proving the genuineness and veracity of business transactions and the reliability of its books of accounts and audit report.

4. The legal standards and judicial precedents governing the exercise of discretion by the AO under section 145(3) regarding rejection of books of accounts.

Issue-wise Detailed Analysis

1. Justification for Rejection of Books of Accounts under Section 145(3)

Legal Framework and Precedents: Section 145(3) of the Income-tax Act empowers the AO to reject the books of accounts maintained by the assessee if they are found to be incorrect or incomplete. However, the exercise of this power is not arbitrary and requires a clear and cogent basis. Judicial precedents, including the Karnataka High Court decision in Karnataka State Forest Industries Corporation Ltd. vs. CIT and rulings by the Supreme Court, have emphasized that before invoking section 145(3), the AO must bring on record material evidencing the incorrectness or incompleteness of the accounts or the method of accounting employed.

Precedents cited by the Tribunal include Commissioner of Income Tax vs. Das's Friends Pvt. Ltd., ACIT vs. ITD Cementation India Ltd., and Drillcon (Raj)(P.) Ltd. vs. Addl. CIT, all underscoring the necessity for the AO to exercise judicial discretion and provide clear findings before rejecting books.

Court's Interpretation and Reasoning: The AO initiated the assessment proceedings by scrutinizing the genuineness of purchases from four suppliers identified as suspicious due to either non-filing of income tax returns, showing of lower turnover in ITRs compared to GST returns, or non-response to notices under section 133(6). The AO expanded the scope to other suppliers, noting discrepancies in the tax audit report and relying on Supreme Court rulings to conclude that the transactions were artificially structured to evade taxes. Consequently, the AO rejected the books and estimated profits at 10% of turnover.

However, the appellate authority (NFAC) carefully examined the materials and submissions, including additional evidence furnished by the assessee such as purchase invoices, transportation bills, bank statements, ledger accounts, and export documents. The NFAC noted that the assessee had substantially discharged its onus to prove the genuineness of transactions despite difficulties posed by the Covid-19 pandemic.

The NFAC found the AO's rejection of books to be based on "flimsy grounds," highlighting that the auditor had not expressed any adverse opinion regarding the books, and no specific defects or inflated purchases/suppressed sales were identified. The AO also failed to provide a rationale for selecting the 10% net profit rate for estimation.

The NFAC emphasized that the AO's powers under section 145(3) must be exercised judicially and not arbitrarily, requiring clear findings supported by material evidence, which was lacking in this case.

Key Evidence and Findings: The assessee submitted comprehensive documentary evidence including:

• Complete purchase invoices and ledger accounts with PAN details.
• Bank statements evidencing payments to suppliers.
• Transportation bills and movement of goods details.
• Export invoices and export incentives documentation.
• Details of closing stock, sundry creditors and debtors, and commission payments.
• Tax audit report without adverse remarks on books or accounting methods.

The AO did not controvert the genuineness of these documents but expressed doubts in the remand report. The NFAC held that the documents were not self-serving and contained sufficient details to establish genuineness.

Application of Law to Facts: The NFAC applied the legal principles requiring cogent material before rejecting books and found that the AO failed to meet this threshold. The assessee's evidence was sufficient to discharge the burden of proving the genuineness of transactions. The AO's reliance on non-response from suppliers and discrepancies in their filings without direct evidence against the assessee was inadequate to reject the books.

Treatment of Competing Arguments: The revenue's argument rested on suspicion of accommodation entries and non-response by suppliers, supported by the AO's observations and Supreme Court precedents on artificial transactions. The assessee argued that it had furnished all relevant documents and that adverse inference could not be drawn merely on the basis of suppliers' conduct or discrepancies in their returns. The NFAC sided with the assessee, noting the lack of specific findings or defects in the books and the absence of cogent reasons for rejecting the accounts.

Conclusion: The rejection of books under section 145(3) was unjustified and the AO's estimation of profits was arbitrary. The books of accounts were to be accepted as genuine and reliable.

2. Reasonableness of Profit Estimation at 10% of Turnover

Legal Framework: Section 144 allows the AO to estimate income if the books are rejected or not maintained properly. However, the estimation must be based on reasonable grounds and not be arbitrary. The AO must provide a basis for the percentage or method used for estimation.

Court's Reasoning: The AO estimated net profit at 10% of turnover without providing any basis or analysis of the assessee's historical profit trends or industry standards. The NFAC noted that the assessee's net profit margins for preceding years were significantly lower (0.02% to 0.24%), which contradicted the AO's assumption.

Application of Law to Facts: The NFAC held that the AO's estimation was not supported by any cogent material or rationale and was therefore arbitrary. The estimation did not reflect the assessee's actual business performance or accounting records.

Conclusion: The profit estimation at 10% turnover was unjustified and was set aside.

3. Discharge of Onus by the Assessee

Legal Framework: The burden lies on the assessee to prove the identity, creditworthiness of creditors, and genuineness of transactions as per CIT vs. Precision Finance Pvt. Ltd. The assessee must produce reliable evidence to substantiate the books of accounts.

Court's Reasoning: The assessee provided extensive documentation including invoices, bank statements, ledgers, and export documents. Despite the pandemic constraints, the assessee cooperated and submitted additional evidence during appellate proceedings.

Conclusion: The assessee successfully discharged the onus of proving the genuineness and veracity of its business transactions and books of accounts.

4. Exercise of Discretion Under Section 145(3)

Legal Framework: The AO's discretion under section 145(3) is judicial and not arbitrary. The AO must record clear findings supported by material evidence before rejecting books.

Court's Reasoning: The AO's rejection lacked specific findings on defects in books or accounting methods and was based on suspicion and non-response by suppliers rather than direct evidence against the assessee. The NFAC emphasized that such discretion must be exercised judiciously, referencing authoritative judicial pronouncements.

Conclusion: The AO's exercise of discretion was improper and the rejection of books was set aside.

Significant Holdings

"The books of accounts of the assessee were audited and the auditor had not given any adverse comments in the maintenance of the books of accounts. It is seen that no specific defect in the books of accounts or method of accounting consistently followed by the assessee and no inflated purchases or suppressed sales or expenses not incurred for business purposes were found during the course of assessment proceedings by the Ld. AO."

"The Assessing Officer's powers under the Section are not arbitrary and he must exercise his discretion and judgment judicially. A clear finding is necessary before invoking the Section 145(3) of the Act."

"In view of the documents submitted by the appellant, this onus has been duly discharged. The Ld. AO has not controverted the genuineness of the documents submitted by the assessee."

"The Ld. AO has not provided the basis or cogent reasons for taking the net profit ratio of 10% while recalculating the income of the appellant. Hence there was no reason for the Ld. AO to disturb the trading results of the appellant."

"The additional documents submitted by the appellant are hereby admitted and the matter is being adjudicated accordingly as per the submissions and the additional evidence thereof after considering the reply of the Ld. AO."

The final determination was that the AO's rejection of the books of accounts under section 145(3) and the consequent estimation of income under section 144 were unsustainable. The additional evidence furnished by the assessee was admitted, and the genuineness of the transactions was accepted. The appeal filed by the revenue was dismissed, upholding the order of the National Faceless Appeal Centre in favor of the assessee.