2011 (7) TMI 1274 - HC - Income Tax

Court sets aside arbitrary 40% gross profit estimation, directs 2% net profit for assessees' arrack business

Commissioner of Income-tax Versus R. Narayana Rao

The court found the 40% gross profit estimation by the Assessing Officer and the Commissioner of Income-tax (Appeals) to be arbitrary and irrational, ... Scope of Best Judgement Assesment - Power of AO u/s 144(1) and 145(3) - Assessee, arrack contractor were engaged in selling arrack - AO while not accepting the returns, rejected the book results and by adopting best judgement method estimate of gross profit at 40 per cent - HELD THAT:- We sum up the principles to be followed when best judgment assessment is undertaken by a taxing officer as follows: (1) The power to levy assessment on the basis of best judgment is not an arbitrary power. It is an assessment on the basis of best judgment of the officer ; (2) when best judgment assessment is undertaken it cannot be as per the whims and fancies of the Assessing Officer and it should base on some material either produced by the assessee or gathered by the taxing officer. If for any reason the material like books of account produced by the assessee is rejected as unreliable or unsatisfactory, there should be some valid reasons for doing so; and (3) whenever best judgment assessment is made, the court would not call for proof from the officer if there is some nexus between the amount arrived at after some guess work and the facts of the case. Estimation of Income u/s 145 - CIT(A) held that, though the AO was justified to reject the book results, estimate of gross profit at 40 per cent. of purchase price and disallowances of expenditure is arbitrary and excessive, thereby estimated the gross profit at 1 percent of estimated sales or declared sales, whichever is more, clear of all deductions and allowances, and if the profit so estimated is less than the profit declared should be accepted. HELD THAT:- We are convinced that the Tribunal estimated the net profit at 1 per cent. Though, we are of the considered opinion that estimation of net profit at 1 per cent. in arrack business is certainly on the lower side and, therefore, it needs to be re-estimated. Given the fact that there is no price fixed by the Government for sale of arrack and it is generally a seller's market, to assume that the gross profit would be at 1 per cent. of the estimated sales, in our considered view, is low. Indeed, in the case of A SANYASI RAO AND ANOTHER VERSUS GOVERNMENT OF ANDHRA PRADESH AND OTHERS [1989 (3) TMI 116 - ANDHRA PRADESH HIGH COURT] which was affirmed by Supreme Court in the case of UNION OF INDIA AND OTHERS VERSUS A. SANYASI RAO AND OTHERS [1996 (2) TMI 4 - SUPREME COURT], it was found that in some cases the profit margin was higher in arrack business. Therefore, estimating the net profit at 2 per cent. of the estimated sales or 16 per cent. of the purchase price (the Tribunal estimated at 8 percent. of the purchase price) would not be unreasonable. Therefore, we set aside the orders of the Tribunal directing that the net profit be estimated at 2 per cent. of the estimated sales or 16 percent. of the purchase value, whichever is higher. Issues Involved:1. Whether the best judgment assessment made by the Income-tax Officer estimating the gross profit from the assessees' arrack business at 40% of the purchase value is sustainable in law.2. What would be the estimate of gross profit as per the principles of best judgment assessmentRs.Issue-wise Detailed Analysis:1. Sustainability of the Best Judgment Assessment at 40% Gross Profit:The case revolves around the best judgment assessment made by the Income-tax Officer, Kakinada, who estimated the gross profit from the assessees' arrack business at 40% of the purchase value. The assessees, engaged in the arrack business, filed returns admitting a net loss, which the Assessing Officer did not accept. The Officer rejected the books of account and estimated the gross profit at 40% of the purchases, leading to objections from the assessees who cited the prohibition on arrack sales and disturbances due to extremist activities as reasons for their losses.The Commissioner of Income-tax (Appeals) upheld this estimation despite the assessees' contentions. However, the Tribunal found the 40% estimation arbitrary and without basis, instead relying on a previous consolidation order where a more reasonable estimation method was applied.The court found the 40% estimation by the Assessing Officer and the Commissioner of Income-tax (Appeals) arbitrary and irrational. It was noted that the estimation did not fit into any known principles of best judgment assessment, and no valid reasons were provided for such a high gross profit percentage. The court referenced the decision in A. Sanyasi Rao v. Government of Andhra Pradesh, where a similar provision was deemed irrational and arbitrary.2. Estimate of Gross Profit as per Best Judgment Assessment Principles:The Tribunal, in its previous decision in the case of Anakapalle Municipal Units Arrack Shops, had considered various factors and concluded that estimating sales at eight times the purchase price and then estimating the net profit at 1% of such estimated sales was reasonable. This method was followed in the impugned orders, but the court found the 1% estimation too low.The court reviewed the principles of best judgment assessment, emphasizing that it should be based on some material and not be arbitrary. It cited precedents where the Supreme Court had held that best judgment assessments should be based on rational and bona fide estimates, not speculative or fanciful grounds.Given the nature of the arrack business and the expenses involved, the court concluded that estimating the net profit at 2% of the estimated sales or 16% of the purchase price would be more reasonable. This estimation considered the wide variation in purchase price and sales recoveries and the fact that the arrack business had no fixed price, making it a seller's market.Conclusion:The court set aside the orders of the Income-tax Appellate Tribunal and directed that the net profit be estimated at 2% of the estimated sales or 16% of the purchase value, whichever is higher. This decision aimed to provide a more reasonable and just estimation of the gross profit in the assessees' arrack business, considering all relevant factors and adhering to the principles of best judgment assessment.