2016 (9) TMI 958 - AT - Income Tax

Tribunal allows appeal, directs cash as business loss, deletes excess stock & profit rate additions.

The Tribunal allowed the assessee's appeal and dismissed the Revenue's appeal. The Tribunal directed the Assessing Officer to treat the embezzled cash as ... Treatment of embezzled cash as business loss - claim for bad debt under section 36(2) of the Income-tax Act - valuation of closing stock by reducing gross profit margin - adjustment for excess stock found on search - computation of gross profit rate including offered excess stockTreatment of embezzled cash as business loss - claim for bad debt under section 36(2) of the Income-tax Act - Embezzled cash written off in books could not be allowed as a bad debt but is allowable as a business loss. - HELD THAT: - The Tribunal found that the conditions for treating the sum as a bad debt under section 36(2) were not satisfied, and therefore the claim could not be allowed under that head. However, the embezzlement occurred in the course of the assessee's business while the employee-director was entrusted with managing day-to-day affairs, civil and criminal proceedings were instituted and recovery attempts were made, and the net shortfall was reflected in the books. On these facts the loss is inevitable and arose in the course of business; consequently the embezzled amount written off in the year under consideration is properly regarded as a business loss and must be allowed as such. [Paras 5]Orders of the lower authorities disallowing the claim are set aside and the Assessing Officer is directed to allow the embezzled amount of Rs. 1,86,24,839/- as a business loss.Adjustment for excess stock found on search - valuation of closing stock by reducing gross profit margin - Addition towards excess stock quantified by the Assessing Officer was deleted and the deletion is confirmed. - HELD THAT: - Both parties and the Assessing Officer valued physical stock by reducing gross profit margin from tag/MRP. The Assessing Officer, however, used a 20% gross profit ratio instead of the 14% actually applied to compute cost, which inflated the excess stock figure. Because the Assessing Officer's adoption of a higher gross profit ratio was incorrect, the Tribunal held that the addition of Rs. 88,76,731/- was unwarranted and the CIT(A)'s deletion of that addition was correct. [Paras 9]Deletion of the addition of Rs. 88,76,731/- is upheld and the Revenue's appeal on this ground is dismissed.Computation of gross profit rate including offered excess stock - valuation of closing stock by reducing gross profit margin - Addition on account of fall in gross profit rate was deleted and the deletion is confirmed. - HELD THAT: - The assessee had offered excess stock for taxation which represents profit and therefore must be taken into account when estimating gross profit. When the offered excess stock of Rs. 2,36,39,742/- is included, the gross profit margin works out to 21%, exceeding the assessee's earlier average of 18%. Since the Assessing Officer's adjustment did not properly account for the excess stock offered by the assessee, the Tribunal agreed with the CIT(A) that the addition on account of alleged fall in gross profit rate was not justified. [Paras 14]Deletion of the addition of Rs. 1,48,54,638/- is upheld and the CIT(A)'s order is confirmed.Final Conclusion: The assessee's appeal is allowed insofar as the embezzled amount is to be allowed as a business loss; the Revenue's appeals in respect of excess stock and alleged fall in gross profit rate are dismissed and the CIT(A)'s deletions are confirmed. Issues:1. Disallowance of loss claimed due to embezzlement by an employee.2. Addition of excess stock.3. Addition on account of fall in gross profit rate.Issue 1: Disallowance of Loss Due to Embezzlement:The assessee claimed a loss of Rs. 1,86,24,839 due to embezzlement by an employee, which was written off as bad debt. The employee embezzled cash during business activities, leading to the loss. The Tribunal noted that while the conditions for claiming bad debt under section 36(2) were not met, the embezzled amount should be allowed as a business loss. The Tribunal directed the Assessing Officer to treat the embezzled cash as a business loss, overturning the lower authorities' disallowance.Issue 2: Addition of Excess Stock:The Revenue found excess stock during a search operation, leading to an addition of Rs. 88,76,731. The dispute arose from the valuation of closing stock based on gross profit margin. The Assessing Officer used a 20% profit ratio instead of the correct 14%, resulting in an inflated excess stock figure. The Tribunal agreed with the assessee's valuation method and upheld the CIT(A)'s decision to delete the addition, as the correct profit ratio showed no excess stock warranting the addition.Issue 3: Addition on Account of Fall in Gross Profit Rate:The Assessing Officer added Rs. 1,48,54,638 due to a decrease in the gross profit rate compared to previous years. The discrepancy arose from the assessee declaring a lower profit margin of 12.92% without considering excess stock offered for taxation. The CIT(A) deleted the addition, noting that considering the excess stock would result in a 21% profit margin, higher than the average of 18% in previous years. The Tribunal upheld the CIT(A)'s decision, emphasizing that the excess stock should be factored into the profit margin calculation.In conclusion, the Tribunal allowed the assessee's appeal and dismissed the Revenue's appeal, confirming the decisions made regarding the issues of loss due to embezzlement, addition of excess stock, and fall in gross profit rate.