2020 (8) TMI 7 - AT - Income Tax

Rejection of books of account u/s 145(3) - non maintenance of stock register and the incorrect method of valuation of stock adopted by the assessee - estimation of gross profit earned - CIT(A) who upheld the rejection of books of account but at the same time reduced the estimation of GPR from 18% to 16% - contention of Assessee that merely because stock registers were not maintained by the assessee it could not be the reason for rejecting the books of accounts and when the assessee had explained that since it was manufacturing large number of small items it was not feasible and was not in the practice of maintaining stock register for each items - HELD THAT - As for the non maintenance of stock register the assessee has explained the non feasibility of maintaining it considering the fact that it was dealing in a large number of small items. It was also explained that the assessee was consistently following the method of physically verifying its stock at the end of the year. We are not in agreement with the Revenue that the non maintenance of stock register was sufficient for exercising the power of rejecting the books of the assessee. It is not unusual for businesses dealing in large number of small items and operating at a small or medium scale to do away with the maintenance of any stock register since it is not feasible maintaining movement of stock of every such item. Such businesses usually verify physically their stock at the end of the year and all wastages, pilferages and other losses therefore get automatically accounted for in the process, reflecting thus the true profits earned by the assesses. As assessee has been doing the same consistently, following the method of determining its stock at the end of the year by physically verifying the same and not maintaining any stock register since it was dealing in a large number of small items. We fail to understand how the non maintenance of stock register has affected the determination of true and correct profits of the assessee in the circumstance. The Revenue has found no other defect in the books of the assessee. Therefore in our opinion the mere fact of non maintenance of stock register cannot be the basis for rejection of books of accounts. Method of valuation adopted for determining the value of the stock - Merely because of adoption of an incorrect method of valuation or merely on account of non compliance with the prescribed accounting standard, the books of accounts cannot be rejected. In fact in such cases the correct accounting standard or the correct method of accounting should be applied by the Revenue and the true and correct profits determined. Such defects, relating to method of valuation of stock, do not render the books of accounts unreliable, incorrect or incomplete, in which circumstances alone the Books of accounts can be rejected. On the contrary such defects can be cured and the taxable profits determined by applying the correct method of accounting/valuation. We set aside the order of the Ld. CIT(A) upholding the rejection of books of accounts of the assessee under section 145(3) of the Act. We further direct the AO to determine the value of stock after applying the correct method of valuation and thereafter determine the taxable profits earned by the assessee. For this limited purpose the issue is restored back to the AO. - Decided in favour of assessee.

Summary

Issues Involved:
1. Rejection of books of account under Section 145(3) of the Income-tax Act, 1961.
2. Estimation of Gross Profit Rate (GPR).

Issue-wise Detailed Analysis:

1. Rejection of Books of Account under Section 145(3):

The primary issue in this appeal is the rejection of the books of account of the assessee under Section 145(3) of the Income-tax Act, 1961. The Assessing Officer (A.O.) rejected the books on the grounds that the assessee did not maintain a stock register and used an incorrect method for valuing stock. The A.O. applied an 18% Gross Profit Rate (GPR) to estimate the profit, which the CIT(A) later reduced to 16%.

The assessee argued that the non-maintenance of a stock register alone should not be a reason for rejecting the books, especially when no other discrepancies were found. The assessee explained that due to the large number of small items manufactured, it was not feasible to maintain a stock register. Instead, the assessee used physical verification at the year-end to determine the value of closing stock, a method consistently followed in previous years.

The Revenue countered that the method of applying the GPR of the year for stock valuation was incorrect and did not conform to accepted accounting standards. They emphasized that the correct method should be at cost or market value, whichever is less. The Revenue also relied on statements from the assessee's employees and partners during a survey, which confirmed the non-maintenance of stock registers and the method of applying the GPR for stock valuation.

The Tribunal observed that the power to reject books of account should be exercised only when the books are found incorrect or incomplete for determining true profits. In this case, the only defects noted were the non-maintenance of a stock register and the incorrect method of stock valuation. The Tribunal found that non-maintenance of a stock register, given the nature of the business, was not sufficient grounds for rejection. Moreover, while the method of valuation was incorrect, this alone did not render the books unreliable. Instead, the correct method of valuation should be applied to determine the true profits.

The Tribunal set aside the CIT(A)'s order upholding the rejection of books and directed the A.O. to determine the value of stock using the correct method of valuation and then ascertain the taxable profits.

2. Estimation of Gross Profit Rate (GPR):

The second issue was the estimation of the Gross Profit Rate. The A.O. initially applied an 18% GPR, which the CIT(A) reduced to 16%. The assessee contended that the CIT(A) erred in confirming the GPR estimation and argued that the books of accounts were properly maintained and audited, with no specific discrepancies found.

Since the Tribunal set aside the rejection of the books of accounts, the estimation of GPR became redundant. The Tribunal noted that with the rejection of books being set aside, there was no need to estimate the GPR.

Conclusion:

The Tribunal allowed the appeal of the assessee, setting aside the rejection of books of accounts and directing the A.O. to apply the correct method of stock valuation to determine the taxable profits. Consequently, the issue of GPR estimation was rendered infructuous.