2008 (9) TMI 867 - AT - Income Tax

Valuation of closing stock - Rejection of books of accounts - Addition of Enhancement of Net profit @ 3 percent of the total turnover - Polished diamonds - sales of superior quality of diamond and cost of inferior diamond having lower value than the average manufacturing cost of the year - assessee is engaged in the manufacturing as well as trading and export of diamonds - HELD THAT - In the instant case it is observed that the trading result shown by the assessee compares favourably with the past accepted position in the case of the assessee itself. Therefore merely rejecting the book result on the ground that quality-wise details of diamonds has not been maintained will not empower the AO to add any income to the income shown by the assessee. We also observe that no material could be brought on record by the Revenue to show that the value of closing stock of diamonds shown by the assessee was incorrect or the method of valuation consistently adopted and followed by the assessee was incorrect. Further it is observed that none of the lower authorities have found that the various expenses claimed by the assessee in its profit and loss account were not supported by vouchers or not verifiable or were not genuine. In the above circumstances the ld CIT (A) was not justified in rejecting various expenses disclosed by the assessee s day-to-day maintained books of account. Merely because the profit disclosed by the other businessmen in terms of the turnover of its business differs from the rate of profit disclosed by the assessee in terms of its turnover will not by itself empower the ld CIT (A) to add any amount to the income of the assessee. We are confident that the Revenue authorities must have come across the case of other assessees whereby securing similar or more turnover the assessee suffers a loss in the business or secured lesser profit than the assessee. In the instant case as no specific defect in the various expenses claimed by the assessee in the profit and loss account could be pointed out by the Revenue the ld CIT (A) was not justified in arbitrarily applying the rate of net profit of 3 percent in making addition. As the addition on account of valuation of closing stock and addition of enhancement of net profit are found to be not based on cogent and relevant material and are based merely on the surmises and conjectures the same are found unsustainable on the facts of the instant case. We therefore delete the additions. In view of our decision in respect of grounds taken with the memo of appeal the entire addition made by the lower authorities stands deleted. In the result the assessee s appeal stands allowed.

Issues Involved:
1. General nature of the appeal.
2. Addition of enhancement of net profit by Rs. 2,19,33,591/-.
3. Addition of Rs. 53,07,218/- on account of valuation of closing stock of polished diamonds.

Detailed Analysis:

General Nature of the Appeal:
The first ground taken by the assessee was of a general nature and required no adjudication.

Enhancement of Net Profit:
The second ground of appeal challenged the addition of Rs. 2,19,33,591/- to the net profit, which was enhanced by the Ld. CIT(A) based on an ad-hoc presumption. The assessee contended that the enhancement was made without appreciating the facts related to selling, administrative, and financial expenditures, as well as the different nature and circumstances of the business compared to other cases.

Valuation of Closing Stock:
The third ground of appeal contested the addition of Rs. 53,07,218/- on account of the valuation of the closing stock of polished diamonds. The assessee argued that the valuation disregarded the quality of diamonds sold and the cost of inferior diamonds, which had a lower value than the average manufacturing cost of the year.

Combined Analysis of Both Grounds:
Since both grounds were interconnected, they were disposed of together for convenience. The A.O. observed that the quantitative details of diamonds were not produced, which made the closing stock unverifiable. Consequently, the books of account were rejected, and an addition of Rs. 53,07,218/- was made to the closing stock valuation.

In appeal, the Ld. CIT(A) upheld the A.O.'s decision, emphasizing that accounting should include a tally of goods handled in the business. The CIT(A) noted that in the diamond business, quality is inherently linked to the price, and the lack of quality-wise records hampered the verifiability of sales and cost valuation. The CIT(A) also observed that the net profit shown by the assessee was lower compared to similar businesses, justifying the enhancement of income.

The CIT(A) proceeded to estimate the taxable income by comparing the net profit rates of other similar businesses. The average net profit rate was around 4.53%, but the lowest rate was 3.08%. Given the assessee's higher turnover, a net profit rate of 3% was deemed fair, resulting in an addition of Rs. 2,19,33,591/-.

Assessee's Arguments:
The assessee argued that the lower net profit was due to the absence of export exchange difference and increased financial expenditure. The assessee also contended that the comparison with other businesses was not justifiable due to differences in business activities, management, and other factors. The assessee maintained that the gross profit rate had improved compared to the previous year and that the net profit percentage should not be the sole criterion for comparison.

Tribunal's Findings:
The Tribunal found that the book results were rejected solely because quality-wise details of diamonds were not maintained. The addition was made on an estimate basis without any material evidence. The Tribunal emphasized that additions must be based on material evidence and not on arbitrary estimates. The Tribunal noted that the gross profit disclosed by the assessee compared favorably with the previous year, and no specific defects in the purchases or expenses were pointed out by the Revenue. The Tribunal concluded that the CIT(A) was not justified in applying a 3% net profit rate and making the additions.

Additional Grounds of Appeal:
The assessee also raised additional grounds of appeal, challenging the jurisdiction and basis of the enhancement of income. However, the Tribunal deemed these grounds academic in nature and refrained from adjudicating them.

Conclusion:
The Tribunal deleted the additions of Rs. 53,07,218/- and Rs. 2,19,33,591/-, finding them unsustainable and based on surmises and conjectures. The appeal was allowed in favor of the assessee.

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