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2019 (4) TMI 2177 - AT - Income TaxDisallowance u/s 40A(3)(a) and u/s 40A(3)(b) - abnormal gross profit and net profit rate - assessee is engaged in the cloth business - HELD THAT - As books of accounts were not rejected by the AO as required under section 145(3) of the Act. Thus after disallowance under section 40A (3) of the Act the profit of the assessee exceeded by more than 8%. It has been claimed the gross profit margin in the case of the assessee is 7% and turnover is below Rs. 40 Lakh. The assessee shown income of Rs.1, 49, 160/- whereas after disallowance it comes to Rs.35, 22, 360/- which giving absurd result as held in the case of CIT v. S Mohammad Dhurabudeen 2007 (7) TMI 635 - MADRAS HIGH COURT categorically held that when disallowance under section 40A (3) is made the overall income should not exceed probable percentage of profit. The ratio of this decision is directly applicable to the case of the assessee. We are of the opinion that it would be interest of natural justice judicial pronouncements discussed and cited above by the learned counsel for the assessee 0and considering the turnover is below Rs. 40 lakhs the disallowance of all payments be restricted to 8% of total turnover. The AO is directed to recalculate the disallowance in respect of disallowance of Rs.18, 27, 989/- made under section 40A(3)(a) and disallowance of Rs.15, 45, 212/- under section 40A(3)(b) of the Act totaling to Rs.33, 73, 201/-. These grounds of appeal are therefore partly allowed.
ISSUES PRESENTED and CONSIDERED
The primary issues considered in this appeal were:
ISSUE-WISE DETAILED ANALYSIS 1. Disallowance under Section 40A(3)(a) and 40A(3)(b) Relevant Legal Framework and Precedents: Section 40A(3) of the Income Tax Act mandates that payments exceeding Rs.20,000 should be made through account payee cheques or drafts to be allowable as deductions. Exceptions to this rule are provided under Rule 6DD, which allows cash payments under specific circumstances. Court's Interpretation and Reasoning: The Tribunal noted that the Assessing Officer (AO) did not dispute the genuineness of the job work income and sales shown by the assessee. However, the AO disallowed the payments made in cash exceeding the prescribed limit, resulting in an abnormal gross profit and net profit rate. Key Evidence and Findings: The assessee argued that the payments were made out of business expediency, especially considering the nature of the business and the geographical location of the laborers, who were from areas lacking banking facilities. Application of Law to Facts: The Tribunal considered precedents where disallowance under section 40A(3) was not warranted if the overall income exceeded a probable percentage of profit. The Tribunal also noted that the AO had not rejected the books of accounts under section 145(3), which would have been necessary to question the genuineness of the accounts. Treatment of Competing Arguments: The Tribunal weighed the arguments regarding business expediency and the practical difficulties in adhering strictly to section 40A(3). The Tribunal also considered the argument that if the accounts were true, then the disallowance was unwarranted, and if not, the AO should have estimated the profit. Conclusions: The Tribunal concluded that the disallowance resulted in an unrealistic profit margin and was not justified. The Tribunal directed that the disallowance be restricted to 8% of the total turnover, considering the peculiar circumstances and judicial precedents. 2. Application of Section 145(3) Relevant Legal Framework and Precedents: Section 145(3) allows the AO to reject the books of accounts if they are not reliable or do not reflect the true income. Court's Interpretation and Reasoning: The Tribunal noted that the AO did not invoke section 145(3) to reject the books of accounts, which indicated that the AO accepted the accounts as true and correct. Key Evidence and Findings: The Tribunal observed that the AO did not make any specific mention of section 145(3) in rejecting the accounts. Application of Law to Facts: The Tribunal found that since the AO did not reject the accounts, the disallowance under section 40A(3) was not justified. Treatment of Competing Arguments: The Tribunal considered the argument that if the accounts were not believed, the AO should have estimated the profit, which was not done. Conclusions: The Tribunal concluded that the AO's failure to reject the accounts under section 145(3) further supported the assessee's case that the disallowance was unwarranted. SIGNIFICANT HOLDINGS Core Principles Established: The Tribunal emphasized the importance of considering the practicalities of business operations and the need for a realistic assessment of income. The Tribunal also highlighted that disallowances should not lead to absurd results, such as an unrealistic profit margin. Final Determinations on Each Issue: The Tribunal partly allowed the appeal, directing the AO to restrict the disallowance to 8% of the total turnover, considering the peculiar circumstances and judicial precedents. Verbatim Quotes of Crucial Legal Reasoning: "The disallowance made by the AO resulted in an abnormal gross profit and net profit rate, which comes to almost hundred percent, which is clearly manifested that such a result is impossible."
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