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Thursday, 23 June 2016 14:35

Mere Fall in the Gross Profit Ratio, in the Absence of any Cogent Reasons Could Not be a Ground to Reject Audited Accounts and Estimate GP - Mumbai Tribunal

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Estimation of GP u/s 145 Estimation of GP u/s 145

Rejection of Books of Accounts u/s 145(3) and Estimation of GP

1. Merely because gross profit margin is lower in the instant assessment year under appeal vis-à-vis preceding assessment year cannot be a ground of additions to the income of the assessee unless the Revenue points out particular defect or discrepancies in the books of accounts

2. Mere fall in the gross profit ratio , in the absence of any cogent reasons could not be a ground to hold that the proper income could not be deduced from the audited accounts maintained by the assessee and the book results ought to be rejected

FactsFacts of Case

1. Assessee company is engaged in the business of manufacturing of equipments/machineries which are used by Pharmaceuticals and allied industries

2. The A.O. observed from the Profit and Loss Account for the previous year relevant to the assessment year 2007-08 that the assessee company has sales of Rs.20.58 crores and gross profit of Rs.6.55 crores , whereas for the previous year relevant to the assessment year 2008-09, the assessee has sales of Rs.19.01 crores and gross profit of Rs.2.6 crores

3. The gross profit ratio of the assessment year 2007-08 worked out to be 31.82% , while for the assessment year 2008-09, it worked out to be 13.67% and hence there was a drastic fall in GP ratio for assessment year 2008-09 vis-à-vis for assessment year 2007-08

4. The details were called by the AO from the assessee to enquire about this drastic fall in GP ratio

5. The assessee submitted details and the AO observed from the details submitted by the assessee that out of sales of Rs.19.01 crores, the sales to the tune of Rs.9.67 crores were made to the sister concern M/s Pharmalab India Private Ltd

6. The assessee was called upon to submit complete details of transactions with sister concern for the entire year to verify that the same were made at arms length price

7. The assessee submitted details on which the AO observed from purchase and sale register that the assessee has shown sale price inclusive of excise duty, freight and transport charges with respect to the sales made to sister concern whereas, in respect of the sales made to outside parties , the assessee has only shown the sales figure exclusive of excise duty, freight and transport charges to show that the assessee has sold at a higher price to its sister concern and at a lower price to outside parties. Thus, from the details submitted by the assessee, the AO observed that the assessee has sold items to its sister concern at a discount of around 30-50% as compared to outside parties. It was also observed by the AO that the assessee has manipulated the sales prices in the last quarter of the previous years to nullify the profits made in first three quarters. The assessee has made sales of Rs.7.22 crores in the last quarter to its sister concern to make the stock NIL while purchases are Rs.72.02 lacs during the last quarter of the previous year. The assessee has booked sales of Rs.7.22 crores to sister concern excluding Rs.13 lacs as sale of ‘spares’ without giving description about the details of the spares it constituted. Thus it was observed by the AO that a net loss of Rs 41 lacs was shown for the entire assessment year by manipulating the sales made to sister concern

8. In response, the assessee submitted before the AO that some of the sales to outside parties were inclusive of accessories as well in respect of some items of sales to outside parties were of different specification than the one sold to its sister concern and hence prices were higher. The assessee also contended that in respect of some items, the sale price to outside parties is inclusive of installation and commissioning whereas in the case of sister concern, the installation and commissioning was carried on by the sister concern itself

9. The AO rejected the contentions as the same were not based upon documentary evidences. It was also held by the AO that with respect of sales of spare parts at the fag-end of the previous year to its sister concern , thereby reducing the stock to Nil, the details were not available in the stock register and the assessee did not furnished the details before the AO

10. It was also observed by the AO that the assessee booked sales commission of Rs 99 lacs on sales of Rs 19.01 crores during the previous year relevant to the impugned assessment year, while in the immediately preceding assessment year the sales commission was only Rs.1.08 lacs on sales of Rs.20.58 crores. Further it was observed by the AO that it is pertinent that in the impugned assessment year under appeal, the sales to sister concern was Rs.9.67 crores on which no sales commission would be payable

11.  It was observed by the AO that the assessee has claimed commission of Rs.99 lacs on sales of Rs. 9.34 crores to outside parties . No details of sales commission were submitted by the assessee including the names and address of the parties to whom sales commission is payable, nor the assessee paid sales commission during the previous year and the said sale commission of Rs. 99 lacs was shown as payable as at 31-03-2008. The AO held that this claim of Rs.99 lacs towards sales commission is a bogus claim made by the assessee and it is an attempt by the assessee to manipulate the accounts to deflate the profits and consequently reduce the tax payable

12. In view of the above , the AO rejected the book results shown by the assessee as the same do not reflect true and fair picture of the assessee’s profitability and the AO adopted gross profit rate of 31.82% on a total sales of Rs.19.01 crores i.e. the same gross profit rate shown by the assessee in the immediately preceding assessment year 2007-08

13. Thus, addition of Rs.3,45,63,127/- was made by the AO on sales of Rs.19,01,35,203/- after giving credit of Gross Profit of 13.67% declared by the assessee in the Profit and Loss Account, vide assessment orders dated 10.12.2010 passed by the AO u/s 143(3)(ii) of the Act

14. Aggrieved by the assessment order dated 10.12.2010 passed by the AO u/s 143(3)(ii) of the Act, the assessee filed first appeal before the learned CIT(A)

15. The learned CIT(A) called for remand report from the AO. The AO submitted remand report and accepted that the invoices raised to the sister concerns does not included excise duty and sales tax(for exports), whereas the invoice to outsiders included excise duty and sales tax as also sales to outsider contained additional specifications

16. The learned CIT(A) observed that there is a huge difference between the gross profit margin of the two years whereby gross profit margin in financial year 2006-07 was 31.82%, while for financial year 2007-08 it was 20.67% and there is a huge difference between these two on similar business on similar items of manufacturing activities of the assessee

17. The learned CIT(A) applied the difference between the two years gross profit margin i.e. 11.06% to the sales of products from manufacturing activities of Rs.12.52 crores during the impugned assessment year and added Rs.1,38,47,120/- to the income of the assessee and gave relief with respect to the balance addition made by the AO, vide appellate orders dated 23.12.2013 passed by learned CIT(A)

18.  Aggrieved by the appellate orders dated 23.12.2013 passed by the learned CIT(A) , the assessee filed second appeal with the Tribunal

19. Honb. ITAT decided the issue in favour of the Assessee 

Adjudication

Concealment Penalty u/s 271(1)(c)In our considered view, merely because gross profit margin is lower in the instant assessment year under appeal vis-à-vis preceding assessment year cannot be a ground of additions to the income of the assessee unless the Revenue points out particular defect or discrepancies in the books of accounts maintained by the assessee. The assessee is maintaining books of accounts which are audited. The assessee has duly met all the adverse reservations of the AO in remand report/appellate proceedings before learned CIT(A) as set out above. No cogent material has been brought on record to prove that the assessee has manipulated its accounts to suppress profits. Therefore, there are no reasons or justification in law to reject the explanation given by the assessee to support its contentions. Mere fall in the gross profit ratio , in the absence of any cogent reasons could not be a ground to hold that the proper income could not be deduced from the audited accounts maintained by the assessee and the book results ought to be rejected, and consequently gross profit margin rate of preceding years be applied to the sales of the instant assessment year under appeal. There is no averments that there is an deliberate attempt to inflate cost of material or other expenses on the part of the assessee or to suppress sale price of products sold by the assessee. The allegations of the AO were duly met by the assessee in remand report/appellate proceedings as set out above. The Revenue is not in appeal before the Tribunal with respect to the relief’s granted by the learned CIT(A). Our view is consistent with the decision of Hon’ble Delhi High Court in the case of CIT v. Smt Poonam Rani (2010) 326 ITR 223(Del.HC). In our considered view, the additions made by the learned AO as sustained/confirmed by the learned CIT(A) to the tune of Rs.1,38,47,120/- is not sustainable in law and we order deletion of the same. We order accordingly. 

Cases Referred to

CIT v. Poonam Rani (2010) 326 ITR 223(Del. HC)

Additional Info

Read 15747 times Last modified on Thursday, 05 January 2017 21:31
Amit

Amit is a Chartered Accountant and a part of Taxpundit's Support Team. He has experience in various industry sectors including manufacturing, power and utilities, financial services, alternative investments etc. He is a passionate blogger and keep writing articles on Income Tax for various publications.

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2 comments

  • Comment Link Amit Friday, 13 January 2017 17:29 posted by Amit

    Thank you Mr. Naveen

  • Comment Link CA Naveen Goyal Monday, 05 September 2016 14:24 posted by CA Naveen Goyal

    efforts of your blog is very nice and i appreciate your content.

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