Estimation of Net Profit Based on Industry Standards Valid When

Estimation of Net Profit Based on Industry Standards Valid When Books Are Unavailable

Issue

Whether assessment orders passed under Sections 143 and 147 estimating net profit without formally rejecting returns under Section 143 can be treated as invalid best judgment assessments under Section 144.
Whether the Assessing Officer is justified in estimating an assessee’s net profit using industry standards when books of account are not produced due to loss in floods and expenses claimed are disproportionate to turnover growth.

Facts

Business Operations: The assessee operated as a distributor of LPG cylinders and filed income tax returns for AY 2011-12 to 2015-16 and AY 2017-18.
Profit & Expenses Reported: The Profit and Loss accounts submitted alongside the returns reflected a net profit rate of approximately 0.7% on turnover.
Non-production of Books: During assessment proceedings, the assessee failed to produce books of account, asserting that they were destroyed/lost during the 2018 floods.
AO Verification: The Assessing Officer (AO) noted that expenses claimed were grossly disproportionate to the modest year-on-year increase in turnover, rendering the Profit and Loss figures unreliable.
Estimation of Profit: In the absence of books of account, the AO adopted industry-standard parameters for LPG distribution businesses and estimated the net profit at approximately 2.4% of turnover under combined orders under Sections 143 and 147.
Assessee’s Challenge: The assessee contended that the assessments were best judgment assessments under Section 144 and were legally unsustainable due to the lack of a prior formal rejection of returns under Section 143.

Decision

Validity of Assessment Orders: The assessment orders were explicitly issued under the joint scope of Sections 143 and 147 rather than Section 144. Therefore, they were not invalid for lack of a prior formal rejection of returns under Section 143.
Justification of Industry Standard Estimation: Where books of account are admittedly unavailable and P&L entries reflect unexplained variations, the Assessing Officer has no alternative but to adopt cogent parameters, such as industry profit standards, to estimate income.
Ruling: Decided in favor of the Revenue.

Key Takeaways

Adoption of Industry Benchmarks: When books of account are lost, destroyed, or not produced, tax authorities are fully empowered to estimate net profits based on established industry standards and comparable business benchmarks.
Distinction Between Section 143/147 and Section 144: An assessment order issued under Section 143 read with Section 147 based on estimated profit parameters does not automatically constitute a Section 144 best judgment assessment requiring prior procedural rejection of returns.
Burden of Substantiating Expenses: Financial statements reflecting disproportionate expenses relative to turnover growth are vulnerable to rejection or profit estimation if underlying primary books of account cannot be produced for verification.

HIGH COURT OF KERALA

Kadungaparanbil Manuel George Joseph

Income-tax Officer

Devan Ramachandran and Basant Balaji, JJ.

IT Appeal Nos. 39, 42, 51, 52 and 53 OF 2025^†

OCTOBER 1, 2026

A. Krishnan, Adv. for the Appellant. Jose Joseph, SC and Cyriac Tom for the Respondent.

JUDGMENT

Devan Ramachandran, J. – These appeals relate to assessment years 2011-12, 2012-13, 2013-14, 2014-15, 2015-16 and 2017-18.

2. According to the appellant, his books of accounts for the aforesaid assessment years were lost in the floods of the year 2018; but that he filed his returns, under the Value Added Tax Act (the “Act”, for short), after having conducted an audit of his accounts. He says that, however, without “rejecting” the returns, the authorities have made a best judgment assessment under Section 144 of the Income Tax Act, 1961, assessing his profits to be 2.4% of his turnover; while his Profit and Loss accounts and the returns conceded only a profit margin of 0.7%. He says that he, therefore, filed an appeal before the 1^st Appellate Authority; and on the same being rejected, he approached the learned Income Tax Appellate Tribunal (ITAT), Cochin Bench, with a further appeal, but which has also been dismissed. He says that he is thus constrained to approach this Court through these appeals.

3. Sri. A. Krishnan – learned counsel for the appellant in these cases, reiterated that, without the returns filed by his clients being rejected under Section 143(3) of the “Act”, a best judgment assessment under Section 144 of the “Act”, could not have been done. He asserted that, therefore, the impugned orders are in error.

4. We notice that the questions of law framed for consideration in these appeals are as under:

(a)

Whether Annexures A, B and C orders are bad under Section 143(3) of the “Act”?

(b)

Whether Annexures A, B and C orders are bad under Section 144 of the “Act”?

5. Interestingly, the response of Sri. Jose Joseph -learned Senior Standing Counsel for the respondents, was that the appellant had not filed his returns in time, but only consequent to a statutory notice issued to him by the Assessing Officer. He insisted that the assessments were not done under best judgment, but as per the provisions of Section 147 of the “Act”; and hence, that the questions of law framed would not require to be answered on its merits. He prayed that these appeals be, therefore, dismissed.

6. Sri. Jose Joseph, thereafter, submitted that, the Authorities under the “Act” have acted without error because, neither were the books of accounts produced before them by the appellant, in spite of having been given several opportunities; nor was there a plausible explanation on how the expenses for the relevant years was inflated to over 285% to 377%, when the turnover had an increase of less than 10% per year. He asserted that, therefore, the finding of the Assessing Officer, that the figures in the Profit and Loss account of the appellant, are incorrect, is fully justified.

7. We must say that we find force in the aforesaid submissions of Sri. Jose Joseph, as also in the findings contained in the assessment orders and the impugned orders.

8. The order of assessment itself records as under:

“4. In response to the summons, assessee appeared in person on 26.12.2018 but did not produce the Books of accounts, documents/details etc. but it was stated that all his books were damaged in flood which were kept at his house at Chellanam. There were no books of account available at the time of survey except VAT return. However assessee produced stock register for the relevant period on 28.12.2018. It is seen that assessee’s accounts were audited on 27.11.2018 i.e. after the flood affected Kerala. During the course of assessment proceedings, assessee was given several opportunities to furnish, the Books of account, purchase & sales bills and vouchers, the ledger copy & bills and vouchers of expenses etc, claimed in the P&L account but the same have not been furnished till date. From all these it is inferred that audit was conducted without books and therefore the net profit shown in the P&L A/c is not acceptable.

5. A comparison of figures as per Returns filed in response to Notice u/s. 148 it is seen that the Gross profit of the assessee varies from 1.45% to 11.87% and net profit from 0.76% to 1.31%. For same type of business, there is no possibility of gross turnover varying from 1.45% to 11.87%. A comparison of expenses claimed for A.Y. 2015-16 and A.Y. 2016-17, it is found that increase in turnover in A.Y. 2016-17 is only Rs. 42,75,657/- (8.55%) whereas increase in expenses is Rs. 42,46,976/- (285%) and on comparison expenses claimed for A.Y. 2012-13 and 2013-14, it is found assessee that increase in expenses of Rs. 27,90,061/- (377%) whereas increase in turnover is Rs. 36,54,819/- (8.38%) in A.Y. 2013-14 only. Further, it can be seen from table below that expenses claimed in P&L account is varied from Rs. 6,79,860/- (1.40% of turnover) to Rs. 57,35,403/-(10.56% of turnover) which shows that the expenses claimed in P&L account is not genuine.”

9. The afore facts are conceded; and Sri.A.Krishnan, in fact, admits that his clients could not produce the books of accounts on account of it having been allegedly lost in the floods. However, as already recorded, the specific submission of the appellant is that, when the returns have been filed accompanied by the Profit and Loss accounts, an assessment under Section 144, or even under Section 147 of the “Act”, could not have been done, without they being “rejected”.

10. It is not possible for us to accept the afore contention because, the assessment orders do not reveal itself to be ones settled by the Assessing Officer under best judgment method. As noticed above, the said orders have been issued under the combined ambit of Sections 143 and 147 of the “Act”.

11. That apart, when the books of accounts were admittedly not available, and when the Profit and Loss accounts showed the aforementioned variation, the Assessing Officer could have done nothing more, but to have adopted other cogent yardsticks, to arrive at the figures. This, we notice, the officer did, by adopting the industry standard of income and profits. This is wholly justified because, the appellant is a distributor of LPG cylinders, which business depends upon the commission he obtains from the oil companies. The only manner in which the profits can vary from business to business, in normal circumstances, is where the expenditure is vastly different. However, as mentioned above, the books of accounts are not available; and all with the Assessing Officer could rely upon was the Profit and Loss accounts, which showed the enhancement of the expenditure to be grossly in disproportionate to the increase in the turnover for the relevant years.

12. We notice that both the statutory Appellate Authorities have concluded as above; and hence, find no reason to interfere.

In the above circumstances, these appeals are dismissed; with both the questions of law answered against the appellant -though, as regards the second among them, it may not be relevant at all, for the reason that the assessment has been made under Section 147 of the Income Tax Act.