Estimated Gross Profit Additions From Stock Shortages Do Not Attract Penalty Under Section 271AAB

ORDER

Prakash, Accountant Member.- This appeal by the Assessee is directed against the order of the learned Commissioner of Income Tax (Appeals) [hereinafter referred to as “the learned CIT(A)”] dated 27.01.2026 arising out of the penalty order dated 26.03.2022 passed by the Assessing Officer (hereinafter referred to as “the AO”) under section 271AAB(1A)(b) of the Income Tax Act, 1961 (hereinafter referred to as “the Act”) for the assessment year 2020-21.

2. The grounds of appeal raised by the Assessee before us in the memorandum of appeal in Form No. 36 read as under:

“1 . The Ld. CIT(A) has erred on facts and in law in confirming the levy of penalty of Rs.1,20,170/- u/s 271AAB of IT Act, 1961.

2. The appellant craves to alter, amend and modify any ground of appeal.

3. Necessary cost to be awarded to the assessee.”

3. Briefly stated, the facts of the case are that a search and seizure action under section 132(1) of the Act was carried out on 23.01.2019 in the case of the Goyal Group, Neem Ka Thana, to which the Assessee belongs. The Assessee is an individual and is the proprietor of M/s Global Industries, which is engaged in the manufacturing and trading of minerals. For the year under consideration, the Assessee filed her return of income on 21.01.2021 declaring a total income of Rs 7,95,900. In the course of the search, the stock of M/s Global Industries was physically verified and inventoried at Rs 5,17,350 as per Annexure SF, whereas the stock as per the books of account stood at Rs 17,20,285. The AO treated the resultant difference of Rs 12,02,935 as representing unrecorded sales, estimated the profit thereon by applying the gross profit rate of 16.65% declared by the Assessee in her audited accounts and, accordingly, made an addition of Rs 2,00,289 while completing the assessment under section 143(3) read with section 153B(1)(b) of the Act on 28.09.2021 at a total income of Rs 9,96,190. Penalty proceedings under section 271AAB(1A)(b) of the Act were initiated in the said assessment order.

4. The reasoning on the basis of which the AO made the addition is contained in paragraph 4 of the assessment order and reads as under:

“It has been noticed that in search short stock of Rs. 12,02,935/-[(Rs.17,20,285/- (as per books) minus Rs.5,17,350/- as per physical verification)] was found. The above short stock found on physical verification represents unrecorded sales of assessee for the year under consideration and profit is estimated by applying GP rate of 16.65%. Since, the assessee has not disclosed the above sales, therefore, the above income of the assessee is required to be estimated by applying correct gross profit ratio to covers up all leakages of revenue on account of non-disclosure of true turnover in the audited accounts. The assessee has shown gross profit rate @ 16.65% in audited account statement, therefore, above GP rate of @ 16.65% is applied on unrecorded sales. In view of above undisclosed profit of Rs.2,00,289/- (@ 16.65% of Rs.1202935/-) is hereby added to income of assessee.”

5. The Assessee did not carry the assessment order in appeal. In the penalty proceedings, a show cause notice dated 20.01.2022 was issued to the Assessee, in response to which the Assessee filed a reply contending that the addition had been made on an estimate basis without bringing any concrete finding on record and that estimation of income is neither a case of addition nor of disallowance but a case of substitution of income, on which penalty under section 271AAB of the Act is not leviable. The AO did not accept the said reply and, by the penalty order dated 26.03.2022, levied a penalty of Rs 1,20,170, being the penalty computed at the rate of 60% of the sum of Rs 2,00,289, under section 271AAB(1A)(b) of the Act. The relevant finding recorded in paragraph 5 of the penalty order reads as under:

“The reply filed by the assessee has been examined but not found acceptable as the addition of Rs.2,00,289/- is made to the total income of the assessee on the basis of stock found short during the search proceedings. Thus the claim of the assessee that stock was properly recorded in the books of account is not correct. Since, the assessee couldn’t rebut the fact that why penalty shouldn’t be levied despite the fact that addition was made to the total income of the assessee. It is pertinent to mention here that had there been no search and seizure action being carried out in this case; this amount of undisclosed income could not be brought to tax. Thus, it is a clear case of undisclosed of income. From the above discussion, it amply clear that penalty u/s 271AAB(1A)(b) of the I.T. Act, 1961 is applicable in this case.”

6. Aggrieved by the levy of penalty, the Assessee carried the matter in appeal before the learned CIT(A). It was contended before the learned CIT(A) that the penalty proceedings are independent of the assessment proceedings, that the alleged shortage of stock had arisen on account of an incorrect physical inventory taken during the search and non-updation of the books of account up to the date of search, that no evidence of any sale outside the books was found in the search and that the addition, having been made on estimate by applying a gross profit rate, does not amount to undisclosed income within the meaning of section 271AAB of the Act. The learned CIT(A) did not accept these contentions and confirmed the penalty. The operative findings recorded in paragraph 4.2 of the impugned order read as under:

“It is an undisputed fact that a valid search u/s 132 was conducted in the present case and stock discrepancy was found during the course of search. The shortage of stock was not merely an estimate made during assessment proceedings but was directly based on physical inventory prepared during search suggesting unrecorded sales.

The contention that the stock discrepancy occurred due to improper stock taking or non-updating of books is not supported by any contemporaneous documentary evidence. The explanations regarding unaccounted purchases, production and alleged errors in physical inventory are general in nature and remain unsubstantiated.

The argument that the addition is merely an estimation is also not acceptable. While the gross profit rate was applied to quantify the income, the existence of unrecorded sales itself stands established on the basis of stock discrepancy. Quantification of undisclosed income by applying GP rate does not dilute the character of such income as “undisclosed income” within the meaning of section 271AAB.”

7. The learned Authorised Representative (hereinafter referred to as “the learned AR”) submitted before us that the amount of the addition made does not qualify to be undisclosed income so as to attract the penalty under section 271AAB of the Act. It was submitted that nothing in the nature of money, bullion, jewellery or other valuable article or thing was found in the course of the search, nor was any entry in the books of account or in any other document, or any transaction, evidencing a sale outside the books found in the search. What was found was a shortage in the physical inventory of stock when compared with the books of account, from which the AO inferred unrecorded sales and thereafter estimated the profit by applying a gross profit rate. It was further submitted that the Assessee had accepted the addition in the quantum proceedings having regard to the smallness of the amount and in order to put an end to litigation, and that such acceptance does not by itself establish the existence of undisclosed income for the purposes of section 271AAB of the Act.

8. The learned Departmental Representative (hereinafter referred to as “the learned DR”) supported the orders of the authorities below. It was submitted that the shortage of stock was detected on the basis of the physical inventory prepared in the course of the search, that but for the search this income would not have been brought to tax, and that the application of the gross profit rate was only a mode of quantification which does not alter the character of the income as undisclosed income.

9. We have heard the rival contentions and perused the material available on record. The short question for our consideration is whether the sum of Rs 2,00,289, being the gross profit estimated by the AO on the alleged unrecorded sales of Rs 12,02,935 inferred from the shortage of stock, constitutes undisclosed income within the meaning of section 271AAB of the Act, so as to sustain the penalty of Rs 1,20,170 levied under clause (b) of sub-section (1A) of that section.

10. Section 271AAB of the Act is a special provision which enables the AO to levy penalty where a search has been initiated under section 132 of the Act. The penalty is, however, not attracted by every addition made in an assessment framed consequent to a search. It is attracted only in respect of the undisclosed income of the specified previous year, and that expression carries the meaning assigned to it by the Explanation to the section. Clause (c) of the said Explanation reads as under:

“(c) “undisclosed income” means—

(i) any income of the specified previous year represented, either wholly or partly, by any money, bullion, jewellery or other valuable article or thing or any entry in the books of account or other documents or transactions found in the course of a search under section 132, which has—

(ii) any income of the specified previous year represented, either wholly or partly, by any entry in respect of an expense recorded in the books of account or other documents maintained in the normal course relating to the specified previous year which is found to be false and would not have been found to be so had the search not been conducted.”

11. Two requirements emerge from the above definition. First, the income must be represented, wholly or partly, either by money, bullion, jewellery or other valuable article or thing, or by an entry in the books of account or other documents or transactions, or by a false entry of an expense recorded in the books of account. Secondly, that which so represents the income must itself be something found in the course of the search. The definition therefore proceeds upon the existence of a tangible foundation, discovered in the search, to which the income can be traced. It is only such income which the Legislature has brought within the reach of the penalty under section 271AAB of the Act.

12. Tested on this touchstone, the record before us does not disclose the existence of any such foundation. No money, bullion, jewellery or other valuable article or thing referable to the sum of Rs 2,00,289 was found in the course of the search. Neither the AO nor the learned CIT(A) has referred to any entry in the books of account, to any other document, or to any transaction found in the search which evidences a sale outside the books. What was found in the search was a shortage, that is to say, the absence of stock which the books of account showed to be there. A shortage is not an asset found in the search; it is a conclusion drawn from a comparison of the physical inventory with the books of account.

13. The manner in which the addition itself came to be made bears this out. In paragraph 4 of the assessment order, extracted above, the AO has recorded that the short stock found on physical verification represents unrecorded sales and that profit is estimated by applying the GP rate of 16.65%, and further that the income of the Assessee is required to be estimated by applying the correct gross profit ratio to cover up all leakages of revenue. The sum of Rs 2,00,289 is not the value of anything found in the search. It is a figure arrived at by applying a percentage to a figure which is itself the product of an inference. Such a sum cannot be said to be income represented by money, bullion, jewellery or other valuable article or thing, or by any entry, document or transaction found in the course of the search.

14. We are conscious of the reasoning of the learned CIT(A) that the application of the gross profit rate was only a mode of quantification which does not dilute the character of the income. That reasoning would hold good where the existence of the undisclosed income is otherwise established by material found in the search and it is only the quantification which is estimated. In the present case, however, it is not merely the quantum but the very existence of the unrecorded sales which rests upon an inference drawn from the physical inventory. The distinction is material, because the definition in the Explanation to section 271AAB of the Act attaches to what is found, and not to what is inferred from what is not found.

15. The explanation offered by the Assessee before the AO was that the stock as per the books had been taken from the tally data which was not complete on the date of search, the purchases and production for the period from 10th May till the date of search not having been incorporated, that the stock of plastic bags of the value of Rs 11,55,141 as per the books was not inventoried in the physical stock, and that the physical inventory had been taken in the presence of the guard at the factory gate. This explanation was rejected in the quantum proceedings as being general in nature and, before the learned CIT(A), as being unsubstantiated. The rejection of an explanation as unsatisfactory, however, is not the same thing as a finding that the explanation is false. Neither the AO nor the learned CIT(A) has recorded any finding that the reconciliation furnished by the Assessee was false, and no material found in the search has been brought on record to displace it. The rejection of the explanation therefore does not, by itself, supply the foundation which the definition of undisclosed income requires.

16. It is also relevant that the assessment proceedings and the penalty proceedings are distinct proceedings. The findings recorded in the assessment are good evidence in the penalty proceedings, but they are not conclusive of the question that arises under a penal provision. The Assessee accepted the addition of Rs 2,00,289 and did not prefer any appeal against the assessment order. Having regard to the smallness of the amount involved, that course of conduct is as consistent with a desire to avoid protracted litigation as it is with an admission of undisclosed income. It cannot, therefore, be read as an admission that the amount answers the description contained in the Explanation to section 271AAB of the Act.

17. We may finally observe that the levy under section 271AAB of the Act is not automatic. Sub-section (1A) provides that the AO may direct that the assessee shall pay by way of penalty a sum computed at the rate specified therein, and the exercise of that power is conditioned upon the income in question being undisclosed income as defined. Being a penal provision, section 271AAB of the Act has to be construed strictly, and the burden of establishing that the conditions for its application are satisfied lies upon the Revenue. On the material placed before us, that burden has not been discharged.

18. In view of the foregoing discussion, we hold that the sum of Rs 2,00,289 does not constitute undisclosed income within the meaning of the Explanation to section 271AAB of the Act and that the penalty of Rs 1,20,170 levied under section 271AAB(1A)(b) of the Act is not sustainable. We accordingly set aside the order of the learned CIT(A) on this issue and direct the AO to delete the penalty. Ground No. 1 of the appeal is allowed.

19. Ground No. 2 is general in nature and does not call for any separate adjudication. Ground No. 3, by which the Assessee has sought award of costs, was not supported by any submission or material and no case for award of costs has been made out. Ground No. 3 is accordingly rejected.

20. In the result, the appeal filed by the Assessee is partly allowed.

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