Ruling on s.145 and s.144: 10% income estimation stands, no further disallowances, CSR issue resolved

ITAT partly upheld the Revenue's appeal. It affirmed rejection of the assessee's books under s.145 due to serious accounting deficiencies (improper SAP entries, non-adherence to standard procedures, lack of GRNs) and sustained estimation of business income at 10% of turnover, following industry comparables and earlier HC precedent. However, ITAT held that once income is estimated under s.144 after rejecting books, all deductions under ss.30-43D are deemed considered and no further disallowances or additions (including unexplained cash credits u/s 68, data centre expenses, or scrap sale additions) are permissible. It further held that disallowance of CSR expenditure was unsustainable as no deduction had been claimed.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether the purchases of old bottles recorded without GRN and other supporting documents could be treated as wholly bogus and the entire value thereof added to income.

1.2 Whether, in the facts, the books of account were liable to be rejected under section 145(3) and business income determined on an estimated profit rate, and if so, what profit rate should be applied.

1.3 Whether additions/disallowances towards data centre expenses and alleged unaccounted sale of scrap could be sustained separately once business income was estimated after rejecting the books.

1.4 Whether disallowance of alleged bogus CSR contribution was sustainable where the impugned amount was neither debited to the profit and loss account nor claimed as deduction in the return of income.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Treatment of purchases of old bottles recorded without GRN as bogus purchases and addition of entire value

Legal framework (as discussed)

2.1 The Court considered the evidentiary value of material found during search, including electronic data and statements recorded under section 132(4), and the principles of natural justice, particularly the right to cross-examination as recognised in binding precedent (Andaman Timber Industries).

Interpretation and reasoning

2.2 The foundational material for the allegation of bogus purchases was an excel workbook ("ENA Schedule") found in a pen drive with three months' data of old bottle purchases from certain vendors. On a standalone reading, the sheets only contained normal purchase details (invoice dates, amounts, GST, cheque dates, etc.) and did not, by themselves, indicate bogus transactions or cash receipts.

2.3 The Assessing Officer construed these entries as representing bogus purchases and cash returns, primarily on the basis of statements of key employees and vendors, and on the distinction in SAP entries between purchases with GRN (treated as genuine) and purchases without GRN (treated as bogus). Hologram utilisation data was also used to allege excess booking of old bottle purchases over actual utilisation.

2.4 The Court held that the excel data was only an anecdotal sample for three months and could not safely be extrapolated across ten years to treat all purchases without GRN as bogus. The action of mechanically extending this limited data to all years and all such purchases was held to be on weak footing and largely based on assumptions.

2.5 It was undisputed that the concerned vendors were genuine old bottle suppliers and that most purchases from them were accepted as genuine. Only a portion of purchases lacking GRN were disputed. The assessee furnished a detailed explanation of its business model: (i) regular, inspected, washed old bottles, for which GRN was generated at receipt, and (ii) emergency/uninspected supplies (chipped, dusty, partially washed bottles), for which GRNs were not generated at receipt and were routed through a separate process, with corresponding accounting complications and higher wastage at various stages of production.

2.6 The Court noted that this explanation regarding emergency purchases and absence of GRN was prima facie plausible and was also supported by statements of factory staff and production/wastage records.

2.7 While employee and vendor statements indicated that certain purchases without GRN were bogus and cash was received back after paying commission, these statements were not subjected to cross-examination at the instance of the assessee. Relying on Andaman Timber Industries, the Court held that failure to afford cross-examination seriously diminished the evidentiary value of such statements and constituted violation of natural justice.

2.8 No unaccounted assets, investments or expenditure commensurate with the alleged bogus purchases of about Rs. 390 crores were unearthed in the multi-day search across group premises, barring seizure of cash of about Rs. 2.5 crores. This was held to be inconsistent with the allegation that enormous unaccounted cash was generated and retained out of bogus purchases.

2.9 The Court also observed that if the entire value of alleged bogus purchases were disallowed, the resulting gross profit would shoot to abnormally high levels (35-42%), far beyond what is commercially realistic for this line of business and inconsistent even with industry comparables furnished and examined.

2.10 On these cumulative facts, the Court held that though there were serious accounting deficiencies and suspicious features regarding purchases without GRN, there was no conclusive basis to treat the totality of such purchases as wholly bogus and to add the entire corresponding amount to income.

2.11 The Court also clarified that the observed accounting deficiencies (misclassification of offset accounts, manual SAP entries without full documentation, and procedural lapses) could not, on the seized material and statements alone, be elevated to a proved case of "falsification of entries" in books so as to sustain a finding of false entries; the strict evidentiary threshold for such a finding was not met.

Conclusions

2.12 The entire value of purchases without GRN from genuine suppliers could not be treated as bogus and added in full. The additions made by the Assessing Officer on that footing were unsustainable. The case warranted rejection of books and estimation of profits, not wholesale disallowance of purchase value.

Issue 2 - Rejection of books under section 145(3) and estimation of business income at 10% of turnover

Legal framework (as discussed)

2.13 The Court examined section 145(3), which permits rejection of books where they are not correct or complete, or where the method of accounting is not regularly employed, and the consequent best judgment assessment under section 144. It referred to decisions upholding rejection of books and estimation of profit where stock details, vouchers, or proper accounts were not maintained or were unreliable, including decisions of jurisdictional and other High Courts.

2.14 The Court also relied on the jurisdictional High Court decision in Empee Distilleries Ltd, which dealt with similar allegations of inflated old bottle purchases in the same industry, where disallowance at 10% of purchases/profit element was upheld rather than disallowance of the entire purchase value.

Interpretation and reasoning

2.15 The Commissioner (Appeals), after detailed examination of the bottle procurement and reconditioning process, accepted that both regular purchases with GRN and emergency purchases without GRN were routed through stock accounts in SAP and used in production, but found multiple accounting anomalies: incorrect offset accounts, processing of invoices without GRN, non-adherence to standard procedures, and unreliable documentation, all of which rendered the books unfit to determine true income.

2.16 The Court agreed that these deficiencies justified rejection of the books under section 145(3). It approved the Commissioner (Appeals)' view that, given the complexity of the liquor business, the absence of clear, consistent and verifiable records of old bottle purchases and utilisation, true profits could not be reliably deduced from the existing accounts.

2.17 The Commissioner (Appeals) noted that despite the department's working of very large bogus purchases over multiple years, no corresponding unaccounted application of such alleged income (assets, investments or expenditure) was demonstrated. At the same time, the evidence and statements showed that some purchases were either not properly supported or not fully used for business purposes, justifying some disallowance through profit estimation.

2.18 Having rejected the books, the Commissioner (Appeals) turned to estimation of income. He relied heavily on the Empee Distilleries line of decisions, wherein in a similar liquor industry context and similar allegations about old bottle purchases, the disallowance at 10% of purchases/profit element embedded therein was upheld as meeting the ends of justice.

2.19 The Commissioner (Appeals) compared the assessee's net profit-to-turnover ratio across AYs 2019-20 to 2022-23 (ranging from 4.63% to 7.69% with an average of 6.31%) and noted that even without any further disallowance, the assessee's reported profitability was already higher than some industry comparables. He nevertheless, following judicial discipline and the Empee Distilleries precedent, considered 10% of turnover as a fair net profit rate post rejection of books.

2.20 For the impugned AYs 2020-21 to 2022-23, he computed the incremental income by taking the difference between 10% of turnover and the net profit already reported by the assessee, and treated only that differential as representing the profit embedded in non-verifiable/bogus elements of purchases of old bottles. He then correspondingly reduced the Assessing Officer's much higher additions to these smaller figures.

2.21 The Court endorsed this approach. It held that, in the facts, rejection of books was justified; that estimation based on turnover and a reasonable profit rate was the correct course; and that the 10% net profit rate adopted by the Commissioner (Appeals) was supported by the binding jurisdictional precedent in Empee Distilleries and by the comparative data on the assessee's and industry profit margins.

2.22 The Court rejected the assessee's plea for a lower rate than 10% on the ground of alleged COVID-related profit depression and TASMAC price effects, as the turnover figures did not substantiate a materially adverse impact warranting deviation from 10%.

Conclusions

2.23 The books of account were rightly rejected under section 145(3) due to serious accounting anomalies and unreliable documentation relating to bottle purchases.

2.24 Post rejection of books, business income was correctly estimated by applying a 10% net profit rate on gross turnover, in line with jurisdictional precedent. The incremental income over and above the reported net profit, so computed, alone was to be brought to tax for each year in substitution of the specific disallowances made by the Assessing Officer.

2.25 The enhanced additions made by the Assessing Officer on account of bogus old bottle purchases were accordingly restricted to the lower figures computed by the Commissioner (Appeals), and the Court found no reason to interfere with this estimation.

Issue 3 - Sustainability of separate additions for data centre expenses and alleged unaccounted sale of scrap after estimation of business income

Legal framework (as discussed)

2.26 The Court considered the settled principle that once books are rejected and business income is determined on estimated basis by applying a profit rate, such estimate is in substitution of the income computed under sections 30 to 43D, and no further separate additions under those provisions or based on the rejected books are generally warranted. It relied on decisions of various High Courts (including Indwell Constructions and Banwari Lal Banshidhar) and of the Tribunal.

Interpretation and reasoning

2.27 The Revenue argued that even after rejection of books and estimation of profit, specific disallowances (e.g., data centre expenses) and income elements (e.g., alleged unaccounted scrap sale) should be independently adjudicated and possibly added over and above the estimated business income.

2.28 The Court rejected this contention. Once the books are rejected and income from business is estimated by applying a profit rate to turnover, the estimation subsumes all allowable and disallowable expenses and receipts pertaining to that business covered by sections 30 to 43D. Consequently, separate additions relying on the same rejected books or on individual items of business expenditure or business receipts are impermissible.

2.29 The Court referred to decisions which held that after estimation of income following rejection of books, no separate addition can be made for cash credits, unexplained purchases, unexplained expenditure or disallowances like section 40A(3), as all such items stand absorbed in the estimated profit.

Conclusions

2.30 Since the books of account were rejected and income from business was estimated at 10% of turnover, no separate additions or disallowances towards data centre expenses and alleged unaccounted sale of scrap could be sustained. The deletion of these additions by the Commissioner (Appeals) was upheld.

Issue 4 - Disallowance of CSR contribution not debited to profit and loss account or claimed in the return

Interpretation and reasoning

2.31 In one of the years, the Assessing Officer treated CSR donations of Rs. 4,00,00,000 as bogus and added the amount to income. The Commissioner (Appeals), after examining seized material and the assessee's accounts, found: (i) that the question whether the recipient entities were genuine or the donations were bogus had not been properly examined by the Assessing Officer; and (ii) more critically, that the said amount had not been debited to the profit and loss account and was not claimed as a deduction in the computation of income.

2.32 The Court agreed that, as a matter of tax computation, only amounts actually debited to the profit and loss account or otherwise claimed as deduction can be disallowed or added back. Since the impugned CSR amount was not claimed as an expenditure at all, there was nothing in the returned income to "disallow" or to add back on that account.

2.33 It emphasised the basic principle of fairness in taxation: a sum not claimed as deduction cannot be brought to tax by labelling it a disallowance of expenditure. The factual finding that the assessee had never claimed deduction for the said CSR amount in the return of income remained uncontroverted by the Revenue.

Conclusions

2.34 The disallowance of Rs. 4,00,00,000 on account of alleged bogus CSR contribution was factually and legally untenable, as the amount was neither debited to the profit and loss account nor claimed as deduction. The deletion of this addition by the Commissioner (Appeals) was upheld.

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