2008 (1) TMI 646 - AT - Income Tax

Summary

Issues Involved:
1. Adherence to Accounting Standards.
2. Rejection of Books of Account.
3. Estimation of Net Profit.
4. Application of Section 145(3) of the Income-tax Act.

Issue-wise Detailed Analysis:

1. Adherence to Accounting Standards:
The primary issue was whether the assessee followed the correct accounting standards, specifically Accounting Standard 7 (AS-7) prescribed by the Institute of Chartered Accountants of India. The Assessing Officer (AO) argued that the assessee did not prepare books based on the percentage completion method or the completed contract method, resulting in an inability to compute the correct income as envisaged under the Income-tax Act. The AO noted that the assessee did not indicate the specific percentage of completed work in its financial statements, which was a requirement under AS-7. However, the CIT(A) observed that AS-7 was not mandatory for the assessment year 2001-02 as it had not been notified under section 145(2) of the Income-tax Act. Therefore, the results shown in the accounts could not be rejected merely because the assessee did not strictly follow AS-7.

2. Rejection of Books of Account:
The AO rejected the books of account on the grounds that the assessee had not quantified the excluded profit from the project and had not furnished the exact percentage of completion of the project. The AO presumed that every contract has an inbuilt profit element and rejected the books without pointing out any specific defects. The CIT(A) held that the AO did not provide any finding that he was not satisfied with the correctness or completeness of the accounts. The CIT(A) emphasized that the AO had not pointed out any defects in the books of account, and the assessee was regularly following the mercantile system of accounting. Consequently, the rejection of books was deemed unjustified.

3. Estimation of Net Profit:
The AO estimated the net profit at 10% of the gross receipts, amounting to Rs. 1,55,58,117, based on the assumption that every contract has an inbuilt profit element. The CIT(A) found no basis for applying a flat rate of 10% and noted that the AO did not bring any material on record to support this estimation. The CIT(A) referenced the fact that the assessee had incurred losses in all three years of the project, which were accepted by the department for the preceding and succeeding years. The CIT(A) concluded that the real income must be determined from the transactions and activities of the assessee with reference to the books of account, records, and documents maintained by the assessee.

4. Application of Section 145(3) of the Income-tax Act:
The AO invoked section 145(3) to reject the books of account and estimate the net profit. The CIT(A) observed that section 145(3) could only be invoked if the AO was not satisfied with the correctness or completeness of the accounts, if the method of accounting provided under sub-section (1) was not regularly followed, or if the accounting standards notified under sub-section (2) were not regularly followed. Since none of these conditions were met, the CIT(A) held that the AO was not justified in invoking section 145(3). The CIT(A) emphasized that the rejection of books and estimation of net profit should be based on cogent reasons and material evidence, which was lacking in this case.

Conclusion:
The CIT(A) concluded that the AO was not justified in rejecting the books of account and estimating the net profit at 10% of the gross receipts. The CIT(A) deleted the addition made by the AO, and the appellate tribunal upheld this decision, dismissing the departmental appeal. The tribunal found no infirmity in the CIT(A)'s order, which was based on a detailed analysis and adherence to the principles of accounting and taxation law.