2023 (10) TMI 1269 - AT - Income Tax

Estimation of Net Profit before remuneration at 5.206% - rejection of books of accounts of the assessee u/s 145(3) - AO alleged that the assessee has lowered his profits by manipulating its books of accounts by deflating partners' remuneration and inflating other expenses to artificially compensate for the income surrendered by the assessee on account of survey done in the month of October 2014. HELD THAT - There is no error in the findings of Ld. CIT(A) that the books of accounts were rejected without cogent reasons. There is no allegation of change of any accounting practice by the assessee. There was no enquiry about the transactions reported in financials to corroborate there was any significant irregularity which made books inaccurate. It is a settled law held that in the absence of any material pointing towards falsehood of the books of accounts and no particular defect or discrepancy being pointed in the books of accounts, resort could not be made to rejecting the books of accounts by invoking Sec. 145(3), specially where same were duly audited by a statutory auditor. It is a settled law, that merely because the Net Profit has declined, the AO cannot resort to rejecting the books of accounts. The discretion exercised about how much remuneration shall be paid to the partners is upon the discretion of the assessee firm cannot be basis to doubt the net profit itself. It is a settled position of law that revenue cannot sit into the armchair of the businessman and question the reasonableness of expenditure. We are of considered view that ad-hoc addition of Net Profit has not been sustained by Ld. CIT(A) on the basis of additional evidences before it. Prudent approach is needed to examine the explanation given by an assessee for decline in profits and statistical examination of financial of past years alone cannot be basis of gearing up the Net Profit. Ld. CIT(A) has appreciated the transactions leading to lower Net profit and accepted explanation of assessee for fall in Net Profit while Ld. AO had examined the issue only on statistical parameters, which is not sustainable. The grounds raised by Revenue have no substance. The appeal of Revenue is dismissed.

Summary

Issues Involved:
1. Rejection of Books of Accounts u/s 145(3) of the Income Tax Act, 1961.
2. Addition of Rs. 2,05,29,361/- by estimating Net Profit before remuneration at 5.206%.
3. Justification of the decline in Gross Profit (GP) and Net Profit (NP).

Summary:

Rejection of Books of Accounts u/s 145(3):
The Revenue appealed against the CIT(A)'s order deleting the additions made by the AO by rejecting the books of accounts of the assessee under section 145(3). The AO alleged that the assessee manipulated its books by deflating partners' remuneration and inflating other expenses to compensate for the income surrendered during a survey. The AO also noted discrepancies in stock and cash balance during the survey. However, the CIT(A) held that the rejection of books was not justified as the AO did not find any defect in the correctness and completeness of the accounts or any deviation from the accounting method. The Tribunal upheld this view, citing that the books were duly audited and no specific defects were pointed out by the AO.

Addition of Rs. 2,05,29,361/- by Estimating Net Profit:
The AO's addition of Rs. 2,05,29,361/- was based on an estimated Net Profit rate of 5.206%. The CIT(A) deleted this addition, stating that profits and gains from business should be taxed on an actual basis, and there was no evidence of falsehood in the profit declared by the assessee. The Tribunal agreed, emphasizing that in the absence of any material pointing towards falsehood or specific defects in the books of accounts, the AO's estimation was unwarranted.

Justification of the Decline in Gross Profit and Net Profit:
The assessee provided detailed explanations for the decline in GP and NP, including discontinuation of institutional sales, reduced commission income, increased bank charges and interest, charity and donation expenses, bad debts, and interest to partners. The CIT(A) accepted these explanations, noting that every year has different facts and circumstances, and it is unreasonable to expect the same profit margin each year. The Tribunal supported this view, highlighting that the AO's observations were based only on statistical parameters without considering the actual business transactions and explanations provided by the assessee.

Conclusion:
The Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s order that the rejection of books of accounts and the addition made by estimating Net Profit were not justified. The Tribunal emphasized the need for a prudent approach in examining explanations for profit decline and upheld the principle that revenue cannot question the reasonableness of business expenditures.