2025 (5) TMI 1069 - AT - Income Tax

Rejection of books of accounts u/s 145(3) - estimated addition based on Net Profit (NP) rate - inflated purchases were found - HELD THAT - Due to non-inclusion of items coming to knowledge of the AO from any mode/source yet he can make assessment based on such accounts without rejecting the books of accounts u/s 145(3) of the Act and going ahead with making specific disallowances/additions under section 28 to 44DB 68 to 69D of the Act as the case may be. This can never be the purpose of the statute to propagate the mischief which is otherwise sought to be plugged under that section of the Act. It is trite law that the statutory provisions must be interpreted in to further the intent and purposes of Act and avoid absurdity. All such absurdities can be averted only if the invocation of powers under 145(3) of the Act is held to be discretionary due to use of the word may instead of shall . As per section 145 of the Act it is for the AO to be satisfied about the correctness or completeness of the accounts of the assessee or the assessee has not followed regular method of accounting provided in section 145(1) of the Act or the assessee has not computed his income in accordance with the standards notified under section 145(2)of the Act. In the present case neither the CIT(A) nor the AO has held that the assessee s books of accounts are incorrect/incomplete or the assessee has not maintained his books of accounts as per regular followed method of accounting or the assessee s income cannot be worked out in accordance with the notified standards. Before the Ld. CIT(A) books of accounts were not produced for examination. The Ld. CIT(A)has not recorded his categorical satisfaction about the incorrectness or incompleteness of the books of accounts of the assessee or failure of the assessee to maintain his books of accounts as per the method of accounting provided in section 145(1) of the Act or the assessee has not computed his income in accordance with the standards notified under section 145(2) of the Act. It is for the AO to be satisfied about the correct income; (i) either by making specific disallowances/additions only if possible or (ii) by estimating income after rejecting the books of accounts. In the present case the AO chose the first option and made specific disallowances/additions over the second option of the average Gross Profit rate addition after rejection of books of accounts under section 145(3) of the Act. CIT(A) is not justified in applying NP rate after rejecting the books of accounts under section 145(3) of the Act particularly when the AO on same sets of facts has categorically held that the assessee as tactical move has requested for application of average Gross Profit rate after rejection of books of accounts under section 145(3) of the Act to avoid specific disallowances. Rejection of books of accounts of the assessee by the Ld. CIT(A) therefore is held unjustified. Unverifiable/unexplained purchases - The assessee has not brought any material on the record to contradict the finding of the AO. The genuineness of purchases was not established/demonstrated either before us or authorities below. We therefore find no infirmity in the AO s order in this regard. Therefore the impugned order is set aside and the disallowance of purchases is sustained. Disallowances u/s 40(a)(ia) and 40A(3) - It cannot be ruled that the payments made in contravention to the provisions of sections 40(a)(ia) and 40A(3) of the Act might have not been done/embedded for/in such purchases. Accordingly the impugned order is set aside in this regard. We also delete disallowance made in the assessment order for contravention to the provisions of sections 40(a)(ia) and 40A(3) of the Act.

Summary

Issues Presented and Considered

The core legal questions addressed in this appeal are:

1. Whether the Commissioner of Income Tax (Appeals) erred in deleting the addition of Rs. 2,12,26,191/- on account of unsubstantiated purchases by treating it as subsumed within an estimated addition based on a Net Profit (NP) rate.

2. Whether the CIT(A) was correct in invoking the provisions of section 145(3) of the Income Tax Act, 1961 (the Act) to reject the books of accounts, despite the facts not mandating such rejection, especially when purchases were found to be inflated.

3. Whether the CIT(A) erred in deleting the addition of Rs. 96,94,500/- under section 40(a)(ia) of the Act for admitted failure to deduct tax at source (TDS) on labour charges.

4. Whether the CIT(A) erred in deleting the addition of Rs. 2,40,000/- for admitted violation of section 40A(3) of the Act, relating to cash payments exceeding prescribed limits.

Issue-wise Detailed Analysis

1. Deletion of Addition on Account of Unsubstantiated Purchases

Legal Framework and Precedents: The Assessing Officer (AO) disallowed excess purchases of Rs. 2,12,26,191/- on the ground that the assessee failed to substantiate these purchases with adequate evidence such as invoices, GST returns, or bank statements. The AO's power to disallow unsubstantiated expenses is well established under the Act, ensuring that only genuine business expenses are allowed as deductions.

Court's Interpretation and Reasoning: The AO meticulously analyzed the purchases claimed by the assessee, distinguishing between GST and non-GST purchases and labour charges. The assessee was unable to provide sufficient documentary evidence for purchases exceeding Rs. 16.92 crores, leaving Rs. 2.12 crores unexplained. The AO held these purchases to be inflated and disallowed them accordingly.

The CIT(A) deleted this addition by applying a Net Profit rate of 3% on the premise of rejecting the books of accounts under section 145(3), thereby subsuming the disallowance within the estimated income. However, the Tribunal found that the CIT(A) did not record a categorical finding on rejection of books under section 145(3). The Tribunal emphasized that the assessee failed to rebut the AO's findings or produce evidence to establish the genuineness of the purchases. Consequently, the Tribunal sustained the AO's disallowance of Rs. 2,12,26,191/-.

Application of Law to Facts: The Tribunal applied the principle that unexplained or unverifiable purchases cannot be allowed as deductions. Since the assessee did not substantiate these purchases, the AO's disallowance was justified.

Treatment of Competing Arguments: The assessee's argument that the disallowance was subsumed in the NP rate applied by the CIT(A) was rejected on the ground that the CIT(A) had not validly rejected the books of accounts, and hence the addition could not be treated as subsumed.

Conclusion: The disallowance of Rs. 2,12,26,191/- on account of unexplained purchases is upheld.

2. Rejection of Books of Accounts under Section 145(3) of the Act

Legal Framework and Precedents: Section 145(3) of the Act empowers the AO to reject the books of accounts and make a best judgment assessment under section 144 if the AO is not satisfied about the correctness or completeness of the accounts, or if the method of accounting has not been regularly followed, or income has not been computed in accordance with notified standards.

Court's Interpretation and Reasoning: The Tribunal undertook a detailed textual and purposive interpretation of section 145(3). It noted the deliberate use of the word "may" in section 145(3), indicating discretionary power rather than mandatory obligation on the AO to reject books of accounts whenever discrepancies are found. This contrasts with the mandatory "shall" used in section 145(1) regarding the regular method of accounting.

The Tribunal reasoned that the AO's satisfaction must be specifically about the correctness or completeness of the books themselves, not merely about the correctness of claims or expenses under other provisions of the Act (such as sections 28 to 44DB). The Tribunal emphasized that the AO can make specific disallowances or additions based on unverifiable claims without necessarily rejecting the entire books of accounts.

Further, the Tribunal observed that the CIT(A) had only stated that the books were "liable" to be rejected but had not recorded a categorical finding rejecting the books under section 145(3). The CIT(A) applied an NP rate without formally rejecting the books, which the Tribunal found legally impermissible.

Application of Law to Facts: The AO did not reject the books but made specific disallowances for bogus purchases and violations of sections 40(a)(ia) and 40A(3). The CIT(A) erred in applying an NP rate without formally rejecting the books. The Tribunal held that the rejection of books of accounts must be a clear, categorical finding supported by the AO's satisfaction about the books' correctness or completeness.

Treatment of Competing Arguments: The Revenue's contention that the CIT(A) had rejected the books was negated by the lack of explicit findings. The Tribunal also rejected the argument that the application of an average NP rate was justified despite fluctuations in profit rates and absence of rejection of books.

Conclusion: The CIT(A) erred in applying the NP rate without a categorical rejection of books under section 145(3). The rejection of books of accounts by the CIT(A) is held unjustified.

3. Disallowance under Section 40(a)(ia) for Non-deduction of TDS on Labour Charges

Legal Framework and Precedents: Section 40(a)(ia) disallows expenditure where tax is required to be deducted at source but is not deducted. The AO disallowed 30% of Rs. 3.23 crores paid to labour subcontractors without TDS, amounting to Rs. 96,04,500/-.

Court's Interpretation and Reasoning: The AO found admitted failure to deduct TDS on substantial payments to self-help group heads for subcontract labour. The assessee conceded non-deduction during video conference. The CIT(A) deleted this disallowance on the basis that the income was estimated by applying an NP rate, thereby subsuming this disallowance.

The Tribunal, however, held that since the disallowance under section 40(a)(ia) relates to a specific statutory violation, it cannot be subsumed unless the books are validly rejected. Given the rejection of the CIT(A)'s approach on rejection of books, the disallowance under section 40(a)(ia) must be restored unless it is subsumed within the disallowance on purchases.

Application of Law to Facts: The Tribunal found that the disallowance under section 40(a)(ia) is embedded in the disallowance of purchases, as the payments in violation are likely included in the inflated purchases. Hence, the Tribunal deleted the separate disallowance under section 40(a)(ia) to avoid double taxation.

Treatment of Competing Arguments: The Revenue argued for restoration of the disallowance, while the assessee relied on the CIT(A)'s order. The Tribunal balanced these by recognizing the overlap between the disallowances.

Conclusion: The disallowance under section 40(a)(ia) is deleted as subsumed within the disallowance on purchases.

4. Disallowance under Section 40A(3) for Cash Payments Exceeding Rs. 10,000/-

Legal Framework and Precedents: Section 40A(3) disallows expenditure where payments exceeding Rs. 10,000/- are made in cash. The AO disallowed Rs. 2,40,000/- on this ground.

Court's Interpretation and Reasoning: The AO found admitted cash payments for rent exceeding the prescribed limit without documentary proof to the contrary. The CIT(A) deleted this disallowance on the basis that the income was estimated by applying an NP rate, subsuming this disallowance.

The Tribunal held that similar to the section 40(a)(ia) disallowance, the section 40A(3) disallowance is also subsumed within the disallowance of inflated purchases and hence deleted the separate disallowance under section 40A(3).

Application of Law to Facts: The Tribunal reasoned that since the payments violating section 40A(3) are likely part of the inflated purchases, separate disallowance would amount to double counting.

Conclusion: The disallowance under section 40A(3) is deleted as subsumed within the disallowance on purchases.

Significant Holdings

"The powers of the AO to invoke section 145(3) of the Act is merely declaratory/discretionary and not mandatory, where the legislature had no intention to prescribe the mandatory rejection of books of accounts in each & every case where some specific entry in accounts have been found to be bogus/inflated or unverifiable but largely the accounts maintained as per mandate of section 145(1) r/w 145(2) of the Act."

"The expression correctness/completeness of accounts is in context of maintenance of accounts by the assessee, entries made in it and being presented to the AO, whereas correctness of the claim of expenditure is all about testing such claim under various provisions of the Act."

"Any expenditure incurred and claimed in accounts but not allowable under the Act due to lack of corroboratory evidence, cannot by itself render the accounts as incorrect/incomplete, necessarily requiring rejection of books of accounts under section 145(3) of the Act."

"The rejection of books of accounts of the assessee by the CIT(A) therefore, is held unjustified where the AO had made specific disallowances/additions and had not rejected books of accounts."

"Disallowances under sections 40(a)(ia) and 40A(3) of the Act are subsumed in purchases of Rs. 2,12,26,191/- as it cannot be ruled that the payments made in contravention to the provisions of these sections might have not been done/embedded for/in such purchases."

Final Determinations

1. The disallowance of Rs. 2,12,26,191/- on account of unsubstantiated purchases is sustained.

2. The CIT(A) erred in applying a Net Profit rate after purported rejection of books under section 145(3) without recording a categorical finding of rejection; such rejection is held unjustified.

3. The disallowances under sections 40(a)(ia) and 40A(3) are deleted as they are subsumed within the disallowance on purchases.

4. The Revenue's appeal is partly allowed accordingly.