Books rejection, section 10A profit estimation, leave encashment deduction and prospective section 234D interest application clarified.

Material errors in allocating common expenses to the eligible undertaking justified rejection of the books under section 145(3) because the accounts were not sufficiently correct or reliable. After that rejection, the STP unit profit estimate for section 10A required fresh factual examination, as the basis for treating reimbursements and applying the uplift was inadequately explained. An actuarial provision for leave encashment was allowed as an ascertained business liability that had arisen during the year. Interest under section 234D could not be levied for assessment years prior to 2004-05, since the provision applies prospectively only.

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Issues: (i) whether the books of account could be rejected under section 145(3) for inaccuracies in allocation of common expenses in the eligible undertaking; (ii) whether the estimation of profits of the STP unit for exemption under section 10A was sustainable and whether the matter required fresh factual examination; (iii) whether the provision for leave encashment was allowable; and (iv) whether interest under section 234D could be charged for assessment years prior to 2004-05.

Issue (i): whether the books of account could be rejected under section 145(3) for inaccuracies in allocation of common expenses in the eligible undertaking

Analysis: The accounts of the assessee contained multiple admitted errors in allocation of salary, manpower, learning and development and reimbursement-related items, resulting in material inflation of the exempt profits. The expression "correctness" in section 145(3) covers the quality, accuracy and reliability of the accounts, and the statutory power is attracted where the Assessing Officer is not satisfied about such correctness or completeness. In the facts, the mistakes were not treated as trivial, particularly because they affected the computation of exempt profits and were quantified at a substantial amount.

Conclusion: The rejection of books of account under section 145(3) was upheld.

Issue (ii): whether the estimation of profits of the STP unit for exemption under section 10A was sustainable and whether the matter required fresh factual examination

Analysis: After rejecting the books, the profit estimation adopted by the revenue authorities was found to be insufficiently reasoned, especially on the treatment of reimbursement receipts and their impact on the profit rate. The record did not clearly establish the exact nature of those reimbursements, whether they carried a profit element, and whether any such element was derived from the eligible export activity. The manner in which the 10% uplift over the 40% cost margin was fixed was also not adequately explained. The additional evidence on debit notes could be admitted, but the factual foundation for the final estimate remained incomplete.

Conclusion: The estimation of STP profits was set aside for fresh consideration by the Assessing Officer.

Issue (iii): whether the provision for leave encashment was allowable

Analysis: The provision was created on an actuarial basis and represented an ascertained business liability capable of reasonable estimation. Such liability is deductible when it has definitely arisen during the accounting year, even if quantification or discharge occurs later. The revenue authorities did not bring any sufficient ground to deny the claim.

Conclusion: The disallowance of leave encashment was deleted in favour of the assessee.

Issue (iv): whether interest under section 234D could be charged for assessment years prior to 2004-05

Analysis: Section 234D is substantive and applies prospectively from assessment year 2004-05. It cannot be invoked for earlier assessment years merely because the regular assessment or refund order was passed after the insertion date.

Conclusion: Levy of interest under section 234D for the years in question was not permissible.

Final Conclusion: The appeal was partly allowed: the rejection of books was sustained, the profit estimation issue was remanded for fresh adjudication, the leave encashment claim was allowed, and interest under section 234D was held not leviable for the relevant assessment years.

Ratio Decidendi: Under section 145(3), material inaccuracies affecting the correctness of accounts justify rejection of books, but a best judgment estimate must still rest on a clear factual foundation and a reasoned computation; section 234D applies only prospectively, and an ascertained actuarial liability for leave encashment is deductible when it has arisen during the year.

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