2019 (5) TMI 1997 - AT - Income Tax

Reopening of assessment u/s 147 - Reason to believe - mandation to get Add. CIT approval - invocation of provisions of Section 145(3) - addition made with reference to under valuation of closing stock included in the finished goods - HELD THAT - As per section 151(2) before the AO issues notice u/s 148 satisfaction is to be recorded by the concerned higher authority which is a sine qua non. Such satisfaction does not mean merely agreeing and approving to what the AO has said rather the concerned higher authority should record a proper satisfaction applying his mind as to why it is a fit case giving proper reasoning. The courts have time and again held that just noting the word Yes or it is a fit case or Yes I am satisfied and affixed his signature thereunder cannot be considered to be a proper or valid sanction as contemplated by law. However in the present case this mandatory precondition has not been fully and properly satisfied in as much as the ld. Add. CIT while granting approval has not recorded his satisfaction. Addition made by rejecting the valuation of closing stock in respect of rejected goods and also on account of goods sent and lying with the job work units at the end of year - AO picked up an agreement and considered the same to be universally applicable and drawn an inference that every rejected item shall be destructed and that too with immediate effect. It is a matter of record that the primary condition of every agreement is restriction on sale of rejected goods. Whether to destroy or not is a secondary requirement which will be based upon certain conditions and under certain circumstances. However some agreements are having condition of destruction which was duly complied with. If a particular item has been classified as rejected and no further sale has been made of that item then conditions of agreement has been fulfilled. It is not the case that the assessee is selling these rejected goods in the grey market neither the AO nor the ld CIT(A) made any such allegation. Hence if a particular item has been classified as rejected and simply lying in the factory with no further sale then it is beyond any understanding that how will it fetch a value of Rs.355/- per piece for valuation purpose. Allegation of the AO that these goods are not destroyed is baseless. He might be confining the word destruction to some form of burning only which is nowhere included in the definition. The meaning of destruction in readymade garments is to make them unsaleable/unusable. For the assessee it was a dump/wastage having no realizable value at all. Even then the assessee to be on a very fair side valued such rejected goods @ of Rs.25 per piece though was not at all required. Undisputedly the assessee has no legal right to sell these rejected/destructed goods in the open market due to condition of agreement hence the value of these goods was Nil for the assessee. To account for the rejected goods/destructed goods in the financial account and for the purpose of internal controls only these goods were valued on a symbolic value of Rs.25/- per piece. The allegation of the AO that no documentary evidences were submitted to support this price is completely wrong on the facts. The assessee filed Quality Control Audit Report mentioning complete details of Goods in defect along with description of defects. Having admitted the binding agreement its legal effect could not be ignored. AO has alleged that percentage of rejection claimed by the assessee at 2.16% of total production was on higher side - Since the assessee has no right to sale these goods hence to minimize the losses reusable accessories (buttons zips etc.) were extracted from these items. This extraction work is carried out in very rough and speedy manner and after this it is totally impossible to sale these items. After this operation they got converted into a scrap items (also known as Chindi) and this was sold on kilogram basis. The bills of Chindi items sold were also submitted before the lower authorities. The AO did not deny from this fact but merely suspected that it did not show the sale of chindi resulting from the rejection goods which however was an impractical and almost impossible task. Further the regular labourer engaged by the assessee was also engaged in the destruction of the rejection goods but to evidence such activity was not humanly practical and possible. Hence there remains no doubt that the assessee had rejected items which were not as such open for sale in the open market and to minimize the losses these were sold as Chindi. In view of the above facts and circumstances we hold that the A.O. was not justified in making addition on account of under valuation of rejected goods which was included in the list of closing stock. Undervaluation of the stock lying with job units - We had verified the sheets containing complete details of Fabric lying at Job Units. The Number of Piece have also been shown in the same sheet apart from showing the Raw Fabric in Meter which are expected to be prepared out of such Raw Fabric sent to these job units. Thus whether it is number of pieces shown or fabric in meter is shown the ultimate valuation shall remain the same and is not going to make any difference. However this was not properly understood by the AO. Therefore the allegation of avoidance of taxes is baseless more particularly when otherwise also any enhancement in the valuation of closing stock of this year will enhance the value of opening stock of the next year leaving a tax neutral effect. As per our considered view in case of business of manufacturing of readymade garments there are certain scientifically evolved conversion formula based on which one can ascertain the number of pieces desired/expected of a particular design type of that particular garment say a shirt consuming a particular amount of Meter of fabric. To put it differently one can ascertain the number of particular type of shirt to be obtained out of the given quantity of the fabric. Surprisingly the AO neither required any such conversion formula to be furnished nor he made any enquiry on his own from the experts of readymade garment industry. Therefore there is no valid point behind the AO raising this issue merely to suspect that something may be wrong. In the entire exercise the AO has proceeded merely on suspicion suspicion and there is absolutely no iota of material brought in support. We observe that the allegation of the undervaluation of the stock lying with job units of Rs. 2.03 Crores is imaginary in as much as the AO had no iota of evidence showing even remotely that the assessee incurred some cost after delivering the fabric to the job units so as to enhance the valuation from the mere cost of fabric to include some overheads. Admittedly no bills were raised by the job units up to the year-end so as to be taken into the account while valuing the closing stock. Therefore such valuation was also highly imaginary without any evidence. Once the AO himself admits that the assessee has incurred this cost and therefore only the valuation of the closing stock of such raw fabrics has been enhanced by him to the extent of the cost of the finished goods i.e. @ Rs. 355/-. By his own admission it has to be accepted that the assessee has incurred the cost to the extent of Rs.355. Thus on one hand the AO had enhanced the valuation of the closing stock but at the same time he has to allow the revenue expenditure (job charges/stitching charges) to this extent resulting into no tax effect. In other words the entire exercise to enhance the value of the raw fabric is completely tax neutral in this year itself. Thus we do not find any merit in the addition made by the A.O. in respect of raw material lying with the job worker unit by treating the same as finished goods.

Summary

Issues Involved:
1. Validity of action taken under Section 147 read with Section 148 of the Income Tax Act, 1961.
2. Addition on account of alleged under-valuation of closing stock by showing finished goods of readymade garments as rejection.
3. Addition on account of alleged under-valuation of closing stock by considering fabrics as readymade garments in the closing stock lying with job units.
4. Charging of interest under Sections 234A, 234B, 234C, and 234D of the Act and withdrawal of interest under Section 244A of the Act.

Issue-Wise Detailed Analysis:

1. Validity of Action Taken Under Section 147 r.w.s 148:
The assessee argued that the action taken under Section 147 was without jurisdiction and void ab-initio, as there was no reason to believe that income had escaped assessment. It was contended that the reopening was based on suspicion and not on tangible material. The assessee cited several judicial pronouncements to support the argument that the belief must be honest and reasonable, based on reasonable grounds, and not a mere pretence. The assessee also argued that the approval for reopening was mechanical and lacked proper application of mind by the higher authorities. The Tribunal noted that the reasons recorded by the AO were based on the same material available during the original assessment and there was no new tangible material. The Tribunal found that the initiation of proceedings under Section 147 was not justified.

2. Addition on Account of Alleged Under-Valuation of Closing Stock by Showing Finished Goods as Rejection:
The AO made an addition of Rs. 2,13,67,830/- by revaluing the rejected goods at Rs. 355 per piece instead of Rs. 25 per piece as shown by the assessee. The assessee argued that the rejected goods were valued at a nominal rate due to contractual obligations prohibiting the sale of such goods. The Tribunal observed that the assessee had provided detailed explanations and documentary evidence to support the valuation of rejected goods. The Tribunal found that the AO's method of valuation was not based on any recognized accounting principles and that the assessee's valuation was reasonable and consistent with past practices. The Tribunal held that the addition made by the AO was not justified.

3. Addition on Account of Alleged Under-Valuation of Closing Stock by Considering Fabrics as Readymade Garments in the Closing Stock Lying with Job Units:
The AO made an addition of Rs. 2,03,36,304/- by revaluing the fabric lying with job units at the rate of finished goods. The assessee argued that the stock lying with job units was valued at cost as no further cost was incurred by the year-end. The Tribunal noted that the assessee had provided detailed charts and documentary evidence showing the fabric sent to job units and the expected number of pieces. The Tribunal found that the AO's assumption that the fabric should be valued as finished goods was not justified as no further cost was incurred. The Tribunal held that the addition made by the AO was not justified.

4. Charging of Interest Under Sections 234A, 234B, 234C, and 234D and Withdrawal of Interest Under Section 244A:
The assessee argued that the interest charged and withdrawn was contrary to the provisions of law and facts. The Tribunal did not specifically address this issue as the primary additions made by the AO were deleted.

Conclusion:
The Tribunal allowed the appeal of the assessee, holding that the reopening of the assessment under Section 147 was not justified and the additions made on account of alleged under-valuation of closing stock were not warranted. The Tribunal emphasized the importance of having tangible material and reasonable grounds for reopening assessments and making additions. The Tribunal's decision was based on the detailed examination of facts, documentary evidence, and adherence to established legal principles.