No Penalty Under Section 271AAA Based on Presumed Sales of Unfound Stock Without Search Evidence

ORDER

Vikram Singh Yadav, Accountant Member.- This is an appeal filed by the Assessee against the order of the Learned Commissioner of Income Tax (Appeals)- 50, Mumbai [‘Ld.CIT(A)’], dated 24.02.2026, pertaining to Assessment Year (AY) 2012-13, wherein the Assessee has taken the following grounds of appeal:

“1. The learned Commissioner of Income-tax (Appeals) erred in confirming validity penalty order dated 22nd June 2023 which was barred by limitation and is bad in law.

2. The learned Commissioner of Income-tax (Appeals) erred in confirming levy of penalty of Rs. 1,39,153/- under Section 271AAA of the Act in respect of alleged difference of 60.11 carat in physical stock of polished diamonds and as per the stock register, as on the date of search.

3. The Appellant reserves the right to add, to alter or to amend the grounds of appeal.”

2. Briefly, the facts of the case are that the assessee company is engaged in the business of manufacturing and export of rough and polished diamonds and trading in Commodity Derivatives. The return of income for AY 2012-13 was filed on 29.11.2012, declaring total income of Rs.57,41,72,566/-. Thereafter, a search and seizure action was carried out u/s 132 of the Act on 25.08.2011 at the residence of the Directors and business premises of Assessee Company. Consequent to search, the case was selected for scrutiny by issue of notice u/s 143(2) of the Incometax Act, 1961. The assessment was completed u/s.143(3) of the Act on 31.03.2015 assessing the total income at Rs.62,33,98,342/- and the amount of Rs.1,24,78,900/- on account of Diamond stock discrepancy was added by the AO to the total income of the assessee. During the course of search carried out at the office of assessee company on 25.08.2011, the total stock as per book was 307486.89 carats whereas the total physical stock found from various premises was 292461.95 carats. Before the Assessing Officer, assessee filed detailed reconciliation of stock at various premises and according to the assessee, only discrepancy was that physical stock was less by 60.11 carats as compared to stock as per books. Taking into account statements given at the time of search and seized documents, the AO found that entries related to goods received from Jhangad of Rs.872.11 carats and goods sent on consignment of 272.95 carats as included by the assessee in the stock reconciliation statement are not supported by documentary evidences. Hence these are excluded by the AO from the stock reconciliation statement. Therefore, during the course of assessment proceedings, the Assessing Officer worked out that stock of diamonds is excess by 539.05 carats at the rate of Rs. 23,149.80/-. Thus the Assessing Officer calculated the disallowance on account of stock discrepancy of Rs.1,24,78,900/-. Penalty proceedings u/s.271AAA of the Act was initiated separately for undisclosed income as a result of search action. Accordingly, a notice u/s 274 r.w.s 271AAA of the Act dated 31.03.2015 was issued to the assessee.

3. Aggrieved by the aforesaid Order u/s. 143(3) of the Act, the assessee filed appeal before the Ld.CIT(A)-50, Mumbai. The Ld.CIT(A) has partly allowed the assessee appeal vide order dated 26.03.2018. Before the Ld.CIT(A) the Assessee Company submitted that diamonds amounting 872.11 carats were duly recorded in the stock records of M/s Orra Fine Jewellery Pvt Ltd. The Jhangad (Delivery Memo) of M/s Orra Fine Jewellery Pvt Ltd confirming that goods were sent to Assessee Company were found during the course of search operation from the office of M/s. Orra Fine Jewellery Pvt Ltd and is a part of the seized papers. In these circumstances, it has been contended by the assessee that the goods amounting 872.11 carats found in the premises of the assessee stands duly explained and there is no reason to make an addition for the same. For shortage of 60.11 Ct., the Ld.CIT(A) observed that the assessee has given certain general reply that this is due to weighing errors such as calibration, human error due to handling of large quantities at a time etc, however, no documentary evidence has been produced by the assessee to support the contentions. The Ld.CIT(A) held that in the absence of any concrete evidence, the assessee’s contention cannot be accepted. The Ld.CIT(A) held that the A.O. has worked out the average value of diamonds at Rs.23.149.80 per carats Thus, only the addition in respect of un-reconciled stock of 60.11 carats @ Rs. 23,149.80/- amounting to Rs.13,91,534/- was upheld and confirmed and the balance addition of Rs.1,10,87,366/- was deleted by the Ld.CIT(A).

4. The assessee thereafter carried the matter in appeal before the Tribunal and in ground no.1, has challenged the upholding of addition of Rs.13,91,534/- on account of alleged shortage discrepancy of 60.11 carats of cut and polished diamonds between physical stock and book stock. The Coordinate Bench did not find any infirmity in the order of Ld. CIT(A) and upheld the same.

5. Thereafter, a fresh show-cause was issued to the assessee u/s 274 r/w 271AAA. The submissions filed by the assessee were considered but not found acceptable to the AO. The AO referred to the findings of the ld CIT(A) and the Coordinate Bench in the quantum proceedings. It was further stated by the AO that the onus is on the assessee to substantiate its claim with adequate supporting evidences and to prove that the additions which have been made are not part of his income or the same does not constitute a willful concealment. It was held by the AO that in respect of the impugned issue, the assessee did not submit any satisfactory explanation either during the assessment proceedings, appellate proceedings or during penalty proceedings and owing to failure on the part of the assessee to discharge the onus of proving that the additions which have been made are not part of his income, it was held that this is a fit case for levy of penalty 271AAA of the Act. Therefore, penalty of Rs.1,39,153/- on the income of Rs.13,91,534/- in respect of which assessee has undisclosed income as a result of search action was imposed u/s.271AAA of the Act.

6. The assessee thereafter carried the matter in appeal before the ld. CIT(A), who has since sustained the levy of penalty. As per ld. CIT(A), the only addition (which had been sustained by the appellate authorities) in the income was of Rs.13,91,534/- on account of valuation of excess stock of polished diamonds found physically, which was not recorded in the books of account on the date of search. It is the contention of the assessee that the discrepancy in stock was due to weighing errors such as calibration, human error due to handling of large quantities at a time, etc. and in the assessee’s business line, such variances is a regular phenomenon. On the other side, the ld. CIT(A) while deciding the quantum appeal had observed that such explanation offered by the assessee is general and no documentary evidence has been furnished to support such contentions and confirmed the addition and which has been upheld by the Tribunal. It was accordingly held that in the light of observations made by two of the appellate authorities and more so the fact that during the present appellate proceedings, the assessee has not brought on record any documentary evidence to explain the impugned discrepancy in stock of polished diamonds; the assessee has failed to explain the excess stock of physical diamonds of 60.11 carats, valued at Rs. 13,91,534/-, which was for sure “undisclosed income” as per the provisions of seec.271AAA of the Act, since the same was not recorded in the books of account on or before the date of search in the books of account or other documents maintained in the normal course relating to such previous year and the assessee had no reasonable explanation for the discrepancy found in stock. Therefore, it cannot be said that the assessee had proper explanation to offer regarding the difference in stock. Further, the amount on which the penalty has been imposed was not an ad-hoc addition, since it was based upon the average rate of polished diamonds as recorded in the books of account of the assessee for the year under consideration and the assessee has not furnished any evidence to showcase that the average rate worked out by the AO was incorrect or to say excessive. Thus, the value of undisclosed stock of polished diamonds relates directly to the “undisclosed income” unearthed during the course of search. In such facts and circumstances, it was held that the AO was justified in imposition of penalty u/s 271AAA.

7. Against the said order and findings of the ld CIT(A), the assessee is in appeal before us.

8. During the course of hearing, the ld. AR reiterated the submissions made before the lower authorities. It was submitted that the assessee is engaged in the business of cutting and polishing rough diamonds and export of cut and polished diamonds. In accordance with the trade practice and accepted by the Department over a period of time, the assessee maintains complete and proper stock records at the respecting business places. It was submitted that consolidated stock records of cut and polished diamonds are maintained at the premises in Opera House. It was further submitted that the polished diamond business is carried out at five locations in Mumbai and one location in Indore and each location maintains separate stock records. On 25.08.2011, being the date of search, physical stock of polished diamonds computed by the Department was taken at all the premises. The physical stock found was 2,92,461.95 Carats whereas stock as per stock registers maintained by the assessee was 3,08,824.27 Carats. During the course of search assessee submitted a complete reconciliation of stock. As per the reconciliation statement, the discrepancy on that day between physical stock and the book stock was only 60.11 carats. It was explained that the difference is due to weighing errors such as calibration, human error due to handling of large quantities at a time, etc. It was submitted that it is an accepted trade practice that such variances is a regular phenomena in the trade and well accepted by the Department. It would be appreciated that as compared to the total cartage handled by the assessee of 11,53,004.39 carats, the difference on that day was only 0.005% which is due to calibration errors, human errors, etc. These facts were again explained to the Assessing Officer vide submissions dated 16.02.2015 and 04.03.2015. It was submitted that the addition was made due to alleged discrepancy in physical stock found on the date of search and the stock recorded in the books on such day. It was further submitted that the total income is computed for the year accepting the closing inventory as reported in the audited accounts and Tax Audit Report. The year-end stock has already taken into consideration the movement during the year and as such the discrepancy observed on a particular day has no relevance. It was submitted that it would be appreciated that the alleged addition is only 0.0043% of the turnover of the assessee and 0.005% of the total caratage handled by the assessee. Considering the facts and circumstances, the allegations of stock discrepancy is irrelevant to determine the income for the year and cannot tantamount to being an ‘undisclosed income’. It is only to buy peace and to avoid further litigation and considering the cost of litigation, the assessee has accepted the disallowance. It was submitted that any income to be subject to penalty u/s. 271AAA of the Act should be an ‘undisclosed income’, as defined in Explanation (a) to the said section, which is defined as under:

“undisclosed income” means –

9. It was submitted that income represented by an asset found during the course of search which has not been recorded on or before the date of search, in the books of account constitutes ‘undisclosed income’. In the present case, the stocks recorded in the books of account are higher than the stock found during the course of search. Further, clause (B) of sub-clause (i) and sub-clause (ii) of Clause (A) are not applicable to the facts in the present case. Accordingly, the finding of presence of ‘undisclosed income’ which is pre-requisite for levy of penalty under Section 271AAA is missing in the present case. Accordingly, in absence of such finding of ‘undisclosed income’, the Assessing Officer’s action in levying penalty of Rs. 1,39,153/-under Section 271AAA of the Act is contrary to the provisions of the Act. It was submitted that the Assessing Officer has estimated the value of alleged discrepancy and it is settled law that no penalty can be levied on an addition made on estimated basis. Thus, it is submitted that the addition though confirmed by the appellate authority cannot be a basis for levy of penalty under Section 271AAA of the Act as the said addition is only due to the alleged discrepancy in stock which is considered normal in the trade of the assessee and in any case is not in the nature of undisclosed income. In view of the above facts, it is submitted that the assessee has furnished detailed explanation on the alleged discrepancy of stock and as such cannot be treated as undisclosed income. In such circumstances, the penalty levied by the Assessing Officer under Section 271AAA is unwarranted and ought to be deleted.

10. Further, referring to the findings of the ld. CIT(A), wherein he has held that it is a case of excess stock of polished diamonds found physically which was not recorded in the books of accounts on the date of search. It was submitted that the same is factually incorrect finding recorded by the ld. CIT(A). In this regard, our reference was drawn to the assessment order and the detailed reconciliation statement submitted before the Assessing Officer wherein, it is clearly evident that the physical stock was less by 60.11 carats as compared to stock in the books of accounts. It was accordingly submitted that physically stock was found less as compared to stock recorded in the books of accounts and therefore, it cannot be termed as stock not recorded in the books of accounts on the date of search and therefore, on this ground itself, the addition so made, deserves to be deleted.

11. The ld. DR has been heard, who has relied on the order passed by the Assessing Officer. It was submitted that the additions have been confirmed by the Coordinate Bench in the quantum proceedings, wherein the Coordinate Bench has confirmed the findings of the ld. CIT(A), wherein he has stated that the assessee has given certain general reply that due to weighing errors such as calibration, human error due to handling of large quantity. However, no documentary evidence has been produced by the assessee to support the contention and in view of the same, the AO worked out the average value of diamonds at Rs. 23,149.80/- per carat and the addition of Rs. 13,91,534/- was made in respect of unrecorded stock of 60.11 carats and it was further submitted that it is clearly a case of a transaction which is represented by jewellery or other valuable article and income in respect of which has not been recorded on or before the date of search in the books of accounts and therefore, there is no infirmity in the order of the findings of the ld. CIT(A).

12. We have heard the rival contentions and perused the material available on record. Admittedly, it is a case where there is difference of 60.11 carats of cut and polished diamonds between physical stock and book stock as on the date of search. As per the reconciliation submitted by the assessee and finally accepted, physical stock of 60.11 carats was found less as compared to stock recorded in the books of accounts. In other words, stock quantity has been found recorded in the books of accounts, however, no corresponding sales or other credit has been found recorded in the books of accounts given that there was no physical stock found to that extent.

13. For the purposes of levy of penalty u/s 271AAA, what is relevant is to determine “undisclosed income” of the specified previous year which has been defined to mean 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 not been recorded on or before the date of search in the books of account or other documents maintained in the normal course relating to such previous year.

14. Where the books of accounts are found during the course of search wherein value of stock is found recorded, however, there is no corresponding sales so recorded, presumption can be drawn u/s 132(4A) to the extent that the contents of the books of accounts are true. However, the question in the instant case is whether the stock has been sold by the assessee (and the sale consideration not recorded in the books of accounts) or there is no sale and difference is merely on account of weighing errors such as calibration, human error due to handling of large quantities at a time, which represents 0.0043% of the turnover of the assessee and 0.005% of the total caratage handled by the assessee. To our mind, where the Assessing officer is negating the explanation so offered by the assessee, he has to lead some evidence, as found during the course of search, that the assessee has sold the aforesaid stock of diamonds and the sale consideration so derived has not been recorded in the books of accounts. However, we find that there is nothing on record which has been brought on record by the Assessing officer to this effect. Mere presumption that the stock not found physically must have been sold by the assessee cannot the basis for levy of penalty as the penalty provisions needs to be strictly construed. The facts and circumstances of each case needs to be appreciated and a general proposition applicable in all situations cannot be applied. The fact that the addition has been confirmed in the quantum proceedings cannot simpliciter form the basis for levy of penalty as the conditions specified therein needs to be satisfied and what has to be seen is determination of undisclosed income at the time of search independent of subsequent proceedings. Therefore, in absence of the same, the onus cast on the Assessing officer in terms of determining the same as undisclosed income found during the course of search is not satisfied in the instant case and the penalty so levied therefore deserve to be set-aside.

15. In the result, the appeal filed by the assessee is allowed.