2012 (10) TMI 855 - AT - Income Tax

Rejection of the books of accounts - invoking the principles of best judgment - Held that - The provisions of sec. 145(3) invoked by the AO, lay down that if the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the AO may make an assessment in the manner provided in section 144. As is apparent from the facts narrated in the impugned order, the AO nowhere recorded any finding that the books of accounts maintained by the assessee for Koldam project were incorrect, rendering it impossible to deduce the profit and despite that he proceeded to invoking the principles of best judgment. There is no deviation in the method of accounting employed by the assessee in the previous year from the accounting standards prescribed u/s 145 of the Act while the auditor s observations did not affect the taxable income of the assessee, the assessee having provided detailed explanations against each of the observations of the auditors along with the supporting documents - as decided in CIT Vs. Amitbhai Gunwantbhai 1980 (6) TMI 10 - GUJARAT HIGH COURT if there is no challenge to the transactions represented in the books then it is not open to Revenue to contend that what is shown by the entries is not the real state of affairs. Secondly, even if for some reason, the books are rejected it is not open to the AO to make any addition on estimate basis or on pure guess work. As there being no explanation in respect of claim of expenditure of Rs.3,20,656/- mentioned in observation (f) the amount is required to be added back. As assessee did not raise any objection if the said amount is added back. To that extent impugned order is modified and AO is directed to disallow the claim of these expenses - As regards other observations of the auditors, since there is no challenge to the transactions represented in the books in the light of these observations, then it is not open to Revenue to contend that what is shown by the entries is not the real state of affairs - partly in favour of assessee.

Issues Involved:
1. Rejection of Books of Accounts
2. Additions Made by Assessing Officer
3. Observations of Auditors
4. Method of Accounting
5. Internal Controls and Documentation
6. Estimation of Income

Issue-wise Detailed Analysis:

1. Rejection of Books of Accounts:
The primary issue revolves around the rejection of the assessee's books of accounts under section 145(3) of the Income-tax Act, 1961. The Assessing Officer (AO) rejected the books due to several defects highlighted by the auditors, including discrepancies in reconciliation and confirmation of balances, non-recording of certain expenses, and improper estimation of project costs. The AO concluded that the books were not reliable and proceeded to complete the assessment under section 144 of the Act.

2. Additions Made by Assessing Officer:
The AO determined the income at 10% of the total receipts from the NTPC, Koldam project, resulting in an addition of Rs.9,25,82,275. This was contested by the assessee, who argued that the observations of the auditors did not affect the correctness of the accounting methodology adopted. The CIT(A) deleted the addition, concluding that the AO was not justified in rejecting the books of accounts based on the auditors' observations.

3. Observations of Auditors:
The auditors made several observations regarding the Koldam project, including non-reconciliation of account balances, non-recording of reimbursement claims, overstatement of contract revenue, and inadequate documentation for certain expenses. The AO relied heavily on these observations to reject the books of accounts. However, the CIT(A) and ITAT found that these observations did not materially affect the correctness of the books or the taxable income of the assessee.

4. Method of Accounting:
The assessee maintained their books of accounts as per Accounting Standard-7, and there was no change in the method of accounting from the previous year. The CIT(A) noted that the AO did not point out any deviation from the prescribed accounting standards and that the auditors' observations did not impact the taxable income.

5. Internal Controls and Documentation:
The auditors highlighted weaknesses in internal controls and documentation, particularly regarding inventory records and fixed assets. The AO used these observations to question the reliability of the books. However, the CIT(A) and ITAT concluded that these weaknesses did not justify the rejection of the books, as the auditors did not doubt the authenticity of the purchases or the expenses incurred.

6. Estimation of Income:
The AO estimated the income at 10% of the total receipts without providing a basis for this estimation. The CIT(A) and ITAT found this approach unjustifiable, especially since similar additions in the preceding year had been deleted by the ITAT. The ITAT noted that the AO did not provide any comparable instances or evidence to support the estimation.

Conclusion:
The ITAT upheld the CIT(A)'s decision to delete the addition of Rs.9,25,82,275, except for an amount of Rs.3,20,656 related to unsupported expenses. The ITAT emphasized that the AO's rejection of the books was not justified without pointing out specific defects affecting the accuracy of the accounts. The ITAT also noted that the auditors' observations did not materially impact the taxable income, and the method of accounting was consistent with the prescribed standards. The appeal was partly allowed, with the disallowance of Rs.3,20,656 being upheld.

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