Estimated Income at Average Rate of Last three FY Upheld Following Rejection of Books of Account.

Estimated Income at Average Rate of Last three FY Upheld Following Rejection of Books of Account.

Issue:

Whether the Appellate Authority was justified in accepting the assessee’s alternative offer of computing net profit at 0.77 percent of total turnover, based on the average net profit of the preceding three financial years, after the Assessing Officer (AO) rejected the books of account and initially estimated income at 2 percent of contracted work.

Facts:

For Assessment Year 2013-14, the Assessing Officer (AO) rejected the assessee’s books of account. The stated reason for rejection was non-compliance with notices issued to some sundry creditors. The AO then computed the assessee’s income using an estimation method, fixing it at 2 percent of the contracted work. The assessee, however, had computed the average net profit for the three preceding financial years at 0.77 percent of the total turnover and offered this percentage to the AO, albeit “under protest,” as an alternative.

The Appellate Authority found that the AO’s rejection of books solely due to non-compliance for some sundry creditors and the subsequent determination of income at 2 percent of contracted work was not tenable. Accordingly, the Appellate Authority deleted the AO’s 2 percent addition. The Appellate Authority then noted that the assessee had, in the alternative, admitted during the assessment proceedings to the determination of net profit for the current year based on the average of the earlier three years, which was computed at 0.77 percent of the total turnover. This percentage was accepted by the Appellate Authority, and consequently, the net profit for the assessment year in question was fixed at 0.77 percent of the total turnover.

Decision:

In favor of the revenue: The Appellate Authority was held to be right in accepting the said percentage (0.77 percent) as the net profit for the assessment year in question, given that this offer was made by the assessee to the Assessing Officer during the assessment proceedings by computing the average of the net profit for the three financial years.

Key Takeaways:

• Rejection of Books of Account (Section 145(3)): An AO can reject books of account if they are not correctly maintained or do not reflect the true income. However, the ground for rejection (e.g., non-compliance for some creditors) must be reasonable and substantial enough to invalidate the entire accounting system. The Appellate Authority’s deletion of the 2% addition suggests the initial rejection might have been flawed or the estimation excessive.
• Estimation of Income after Rejection: Once books are rejected, the AO is empowered to estimate the income to the best of their judgment. However, this estimation must be reasonable and based on relevant material.
• Assessee’s Alternative Offer: If an assessee, even “under protest,” provides an alternative method or percentage for income estimation, especially one based on their own past performance (like average net profit from previous years), and this offer is deemed reasonable, tax authorities and appellate bodies can adopt it. This is a common practice to resolve disputes in estimation cases.
• Consistency and Reasonableness: The Appellate Authority’s decision to accept 0.77% was likely seen as reasonable because it was based on the assessee’s own past performance, providing a more consistent and potentially less arbitrary basis for estimation than a flat 2% of contracted work, especially when the initial basis for rejection was debatable.
• “In Favour of Revenue” despite Assessee’s Claim Accepted: The decision is “in favour of the revenue” because, while the AO’s higher estimated rate was rejected, the assessee’s alternative, lower estimated rate was adopted, which still results in income being assessed and tax being collected, thus ensuring revenue collection, albeit at a rate lower than the AO’s initial demand. It represents a practical resolution of the dispute.