Reasonable profit estimation after rejection of books upheld where sub-contract expenditure was not fully substantiated.

Books of account may be rejected where suspicious sub-contract expenditure and surrounding circumstances justify doubt, but any income estimate must still rest on a reasonable factual basis. The assessee produced work orders, ledger extracts, bank statements and TDS-linked payment details, yet did not satisfactorily prove the sub-contractor's execution capacity or conclusively establish actual performance of the work. Third-party material was not independently corroborated to prove fictitious expenditure. On the facts, some profit suppression was inferred; however, the higher ad hoc estimate was arbitrary, while adoption of a 7% net profit rate by the first appellate authority was upheld as reasonable.

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Issues: Whether the rejection of the books of account and estimation of income on account of alleged bogus sub-contract expenditure were justified, and whether the net profit rate adopted by the first appellate authority called for interference.

Analysis: The books were rejected on the basis of suspicion arising from the sub-contractor's low returned income, bank transactions, and a third-party statement, but the assessee had produced work order, ledger extracts, bank statements, and TDS-linked payment details. The third-party material was not independently corroborated to establish that the expenditure was fictitious. At the same time, the assessee did not produce satisfactory evidence to demonstrate the sub-contractor's actual execution capacity or to conclusively prove that the work was performed by that entity. On the facts, some profit suppression was inferred, but the estimation of profit at 40% by the Assessing Officer was found to be arbitrary and unsupported, whereas adoption of 7% by the first appellate authority was held to be a reasonable estimate in the circumstances.

Conclusion: The rejection of books and estimation of profit at 7% were sustained, and the higher estimation made by the Assessing Officer was not accepted.

Ratio Decidendi: Where books are rejected on permissible grounds, income may be estimated on a reasonable basis, but an ad hoc estimate unsupported by material cannot be sustained; estimation must be grounded in the facts and surrounding circumstances.

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