Ad hoc disallowances invalid without formal books rejection under Section 145(3); profit estimation must be justified

The ITAT Visakhapatnam held that neither the AO nor the CIT(A) formally rejected the assessee's books of accounts before making ad hoc disallowances or estimating profit at 2%. The tribunal found no basis for the CIT(A)'s profit estimation, as it lacked support from comparable cases or the assessee's past records. Citing the Madras HC, the tribunal emphasized that formal rejection of books under Section 145(3) is mandatory before making such assessments. Arbitrary partial rejection of entries without justification is impermissible. Consequently, the matter was remanded to the CIT(A) for fresh consideration, allowing the assessee another opportunity to substantiate purchase claims. The grounds raised by the assessee were allowed for statistical purposes.

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ISSUES:

Whether an addition can be made by disallowing a percentage of purchases as bogus without formally rejecting the books of accounts under the Income Tax Act, 1961.Whether estimation of net profit at a fixed percentage on turnover is justified without invoking Section 145(3) or recording formal rejection of books of accounts.The extent of the assessee's burden to prove the genuineness of purchases claimed, including production of invoices and details of parties.The correctness of the assessing officer's and Commissioner of Income Tax (Appeals)'s approach in disallowing purchases and estimating profits respectively.The applicability and interpretation of precedent regarding rejection of books of accounts as a prerequisite for best judgment assessments and profit estimation.

RULINGS / HOLDINGS:

The disallowance of 25% of purchases as bogus by the Assessing Officer without formally rejecting the books of accounts is not sustainable.The estimation of net profit @ 2% on turnover by the Commissioner of Income Tax (Appeals) is without any basis, "not supported either by the comparable cases or past records of the assessee," and hence cannot be upheld.The "rejection of books of accounts is sine qua non before the Assessing Officer to make his own assessment" and such rejection must be recorded before making any ad hoc additions or estimations.The assessee bears the onus to prove the genuineness of purchases with "substantive documentary evidences" such as invoices, PAN details, GST numbers, or confirmations from parties, and failure to do so justifies inquiry but not arbitrary disallowance without proper procedure.Both the disallowance by the Assessing Officer and the profit estimation by the Commissioner of Income Tax (Appeals) were made without valid reasons and without rejecting the books of accounts, rendering such actions arbitrary and erroneous.The matter is remitted back to the Commissioner of Income Tax (Appeals) for fresh adjudication after giving the assessee an opportunity to substantiate the purchases, with a caution that non-cooperation may result in adverse conclusions.

RATIONALE:

The Court applied the statutory framework of the Income Tax Act, 1961, particularly sections 143(1)(a), 143(2), 142(1), 144, and the principles under Section 145(3) relating to rejection of books of accounts and best judgment assessments.The Court relied on binding precedents, including the decision that "rejection of books of accounts is sine qua non before the Assessing Officer to make his own assessment," as held by the High Court of Madras, and the Gujarat High Court's ruling that disallowance without rejecting books cannot be sustained.The Court emphasized the principle that partial rejection of entries in books of accounts without proper justification is arbitrary and leads to incomplete and erroneous income computation.The Court distinguished the case law relied upon by the Department, finding it factually inapplicable to the instant case.The decision reflects a doctrinal adherence to procedural fairness and evidentiary standards before making ad hoc additions or profit estimations in income tax assessments.

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