2016 (7) TMI 943 - AT - Income Tax

Invocation of section 144 - estimation of income - Held that - It is not disputed that assessee failed to produce books of account. It could not furnish various details called for by the AO. Assessee had filed its balance sheet and profit & loss account along with the return of income. Once the assessee, despite notices, failed to produce books of account for verification, AO is left with no choice but to proceed with a best judgment assessment. We cannot find any fault with the AO in this regard - Decided against assessee Interest expenditure disallowed for the reason that it was expenditure pertaining to work-in-progress and had to be capitalized - Held that - It is clear from clause 12 of the Accounting Standards 2 that normal interest and borrowing costs cannot form part of cost of inventory. When an assessee is following method of valuation of inventory which is in accordance with the Accounting Standards prescribed by ICAI, in our opinion, Revenue cannot step into the shoes of assessee and foist on it a different method, unless there is a clear statutory edict allowing a departure from such accepted standards. We cannot say that assessee had understated its work-in-progress or inventory by not charging interest relating to working capital loan to its valuation. Assessee was well justified in considering interest as a period cost and debiting in its profit & loss account. We do not find any merit in the additions made by the AO - Decided in favour of assessee Rejection of books of account and estimation of business income at 8% - Held that - Scrutiny assessments were done for AYs 2006-07 & 2007-08 and the net profit rate accepted were much lower than 8%. Submission is that such rates came to 1.7% for AY 2007-08 and 2.21% for AY 2006-07. We, therefore, set aside the orders of authorities below in so far as it relates to the estimation of profit and direct the AO to take the average of net profit of the above two years and apply it to the gross receipts of the assessee and determine its income from business for the impugned assessment year Addition u/s 41(1) - Held that - AO in his remand report has stated that assessee was unable to give ledger extracts from the books of creditors for proving the credit. But this by itself would not show that liabilities had ceased to exist; when the liabilities were appearing in the books of account. AO had not issued any summons on the creditors or obtained any statements from them which would show that liabilities were not existing and had ceased. In any case, we find that assessment was completed u/s. 144 of the Act. When an assessment is completed u/s. 144 of the Act by applying the net profit rate on the turnover, addition u/s. 41(1) of the Act, in our opinion, cannot be made. When books of account as such are rejected, the question whether creditors appear in such books were there or had ceased to exist, would become irrelevant. We are of the opinion that ld. CIT(Appeals) was justified in deleting such addition.- Decided in favour of assessee

Issues Involved:
1. Invocation of Section 144 of the Income-tax Act, 1961.
2. Disallowance of interest expenditure.
3. Capitalization of interest expenditure related to work-in-progress.
4. Rejection of books of account and estimation of business income.
5. Addition under Section 41(1) of the Income-tax Act, 1961.

Detailed Analysis:

1. Invocation of Section 144 of the Income-tax Act, 1961:
The assessee challenged the invocation of Section 144 by the Assessing Officer (AO) and the best judgment assessment confirmed by the CIT(Appeals). The AO invoked Section 144 due to the assessee's failure to produce books of account and other required details during the assessment proceedings. The Tribunal upheld the AO's decision, stating that the assessee's non-compliance left the AO with no choice but to proceed with the best judgment assessment. Thus, the Tribunal dismissed the assessee's ground on this issue.

2. Disallowance of Interest Expenditure:
The AO disallowed ?55,95,000 of interest expenditure, arguing that the assessee had advanced interest-free loans to various parties while incurring interest on borrowed funds. The CIT(Appeals) upheld this disallowance. However, the Tribunal found that the assessee had sufficient interest-free funds to cover the loans advanced. Citing the Bombay High Court's decision in CIT v. Reliance Utilities and Power Ltd., the Tribunal held that a presumption arises that interest-free funds were used for the advances. Consequently, the Tribunal deleted the disallowance of interest expenditure.

3. Capitalization of Interest Expenditure Related to Work-in-Progress:
The AO disallowed ?1,78,91,526 of interest expenditure, arguing it should be capitalized as it pertained to work-in-progress. The CIT(Appeals) confirmed this disallowance. The Tribunal, however, noted that the work-in-progress was part of the assessee's current assets and not capital assets. Referring to Accounting Standard AS-2, which excludes interest and borrowing costs from inventory costs, the Tribunal ruled that the interest should be charged to the profit & loss account as a period cost. Thus, the Tribunal deleted the addition made by the AO.

4. Rejection of Books of Account and Estimation of Business Income:
The AO rejected the assessee's books of account due to non-production and estimated the business income at 8% of total contract receipts. The CIT(Appeals) confirmed this estimation. The Tribunal noted that in the assessee's previous assessment years, the net profit rates accepted were much lower (1.7% and 2.21%). Citing the Karnataka High Court's decision in Deluxe Roadlines Pvt. Ltd. v. DCIT, the Tribunal directed the AO to take the average net profit rate of the preceding two years and apply it to the gross receipts for the current assessment year, thus partly allowing the assessee's ground.

5. Addition under Section 41(1) of the Income-tax Act, 1961:
The AO added ?1,14,31,582 under Section 41(1), arguing that certain sundry creditors had ceased to exist. The CIT(Appeals) deleted this addition, stating that the mere non-payment did not imply cessation of liability. The Tribunal agreed, noting that the AO had not provided sufficient evidence to prove that the liabilities had ceased. Furthermore, the Tribunal held that once profits were estimated under Section 144, no further addition under Section 41(1) could be made. Thus, the Tribunal dismissed the Revenue's appeal on this ground.

Conclusion:
The Tribunal partly allowed the assessee's appeal by deleting the disallowances related to interest expenditure and directing a revised estimation of business income. The Tribunal dismissed the Revenue's appeal, upholding the deletion of the addition under Section 41(1).

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