2006 (8) TMI 607 - HC - Income Tax

Determination of rate of profit - work of civil construction in Public Works Department - rejected books of account - exceeds turnover - whether the assessee was entitled to the benefit of section 40(b)( iv) and (v) - salary and interest paid to the partners - HELD THAT - In no case, simply because the turnover is more than ₹ 40 lakhs or the assessee is performing civil construction work for Public Works Department, neither the rate of profit could be determined nor it could be taken to be less nor it could be reduced nor could be arrived at on presumptions. Since the Assessing Officer as well as the CIT(A) as also the ITAT has not recorded any finding based on any material, and the findings recorded are merely on surmises and conjectures or, so to say, on purely guess work and imagination of the authorities, as it has not been brought to our notice that any such rate of profit can be assessed under the rules or any law in this manner, the findings of rate of profit, therefore, cannot be sustained and are liable to be set aside, and the matter deserves to be remanded to the assessing authority for re-determination thereof. It was the specific case that these partners were working partners and they were entitled to salary and interest, as per terms of the deed in accordance with section 40(b) of the Act. In the absence of any material having brought by the revenue in rebuttal and more so when no such plea was ever taken or raised in the appeal, as also no substantial question of law has been framed in this regard, the aforesaid plea is bound to fail. Even before the Tribunal, it appears that no such question was raised. We have been informed by the learned counsel for the parties that for the last two assessment years, the Assessing Officer himself has granted deductions treating the firm to be entitled for the same. Thus, we allow the appeals in part and remit the matter to the Assessing Officer for only recording findings on question (1) referred to above, namely, to determine the rate of profit on the basis of the evidence/material on record, after affording opportunity of hearing and also giving opportunity to the parties to lead such evidence, as may be necessary, in the light of the observations. The findings regarding availability of deductions u/s 40(b)( iv) and (v) stand concluded and this question shall not be opened by the Assessing Officer. All the appeals are disposed of accordingly.

Summary

Issues Involved:
1. Determination of the appropriate rate of profit for the assessee.
2. Entitlement of the assessee to the benefit of section 40(b)(iv) and (v) regarding salary and interest paid to partners.

Issue-wise Detailed Analysis:

1. Determination of the Appropriate Rate of Profit for the Assessee:
The primary issue was whether the determination of the profit rate at 5% by the Commissioner of Income-tax (Appeals) and further reduction to 4% by the ITAT was justified. The Assessing Officer initially applied an 8% profit rate based on section 44AD, which was not applicable to the assessee for the relevant assessment years. The Commissioner of Income-tax (Appeals) reduced the rate to 5% considering the nature of the assessee's work with the Public Works Department (PWD) and the turnover exceeding Rs. 40 lakhs, suggesting higher expenses. The ITAT further reduced the rate to 4%, citing the stringent specifications and supervision by PWD authorities.

The court found that the Assessing Officer's application of section 44AD was incorrect as it was not applicable. Neither the Commissioner of Income-tax (Appeals) nor the ITAT provided substantial material or reasoning for their profit rate determinations. The court emphasized that profit rates cannot be assumed based on conjectures or assumptions and must be substantiated with evidence. Consequently, the court set aside the findings and remanded the matter to the assessing authority for re-determination of the profit rate based on proper material and evidence.

2. Entitlement of the Assessee to the Benefit of Section 40(b)(iv) and (v):
The second issue addressed whether the assessee was entitled to deductions for salary and interest paid to partners under section 40(b)(iv) and (v) in the context of a best judgment assessment. The revenue argued that such deductions should not be available in cases where the books of account were rejected, and best judgment assessment was applied. The court examined sections 144 and 145 of the Income-tax Act, which outline the procedures for best judgment assessment and the method of accounting.

The court clarified that statutory deductions under sections 28 to 43, including section 40(b)(iv) and (v), are available to all assessees, regardless of whether the assessment is made under section 139(1), section 143, or section 144. The court found no provision in the Act or Rules that excluded these deductions for assessees assessed under best judgment assessment. The court also noted that section 44AD, which prescribes a flat profit rate, allows for deductions of salary and interest paid to partners, further negating the revenue's argument.

The court concluded that denying statutory deductions to assessees under best judgment assessment would lead to an anomalous situation and is not supported by the Act's scheme. The court also addressed the factual aspect, confirming that the assessee had established before the assessing authority that it was a registered partnership firm with working partners entitled to salary and interest as per the partnership deed.

Conclusion:
The court allowed the appeals in part, remanding the matter to the Assessing Officer to re-determine the rate of profit based on evidence and material on record. The court upheld the assessee's entitlement to deductions under section 40(b)(iv) and (v), concluding that this issue should not be reopened by the Assessing Officer.