2025 (12) TMI 975 - AT - Income Tax

Addition u/s 28 deleted as average GP rate cannot be applied item-wise to Cascade tag prices

ITAT Mumbai allowed the assessee's appeal, deleting the addition made u/s 28 based on the AO's and CIT(A)'s application of an average GP rate on item-wise ... Addition u/s 28 - applying average GP percentage on the cost of comparable companies for certain specified items identified by the AO - commercial prerogative for the determination of final sale price - Diamond jewellery industry Assessment - certain sales related data was pulled out by the search party from the software known as Cascade - applying 'average GP percentage on the cost of comparable companies' - AO applying a 50% adjustment to Cascade tag prices HELD THAT:- GP rate of 15.65% on cost as per the comparable is reasonable and is based on data to arrive at correct income in the hands of the assessee. Since the accuracy of sales figures itself is in dispute, it is more appropriate to apply the GP percentage on cost rather than on sales. Thus, while applying so, the GP percentage of comparable fairly matches with the results of the assessee. It is worth noting here that the GP rate of 15.65% on cost basis once accepted by the authorities below on an aggregation, then the item wise GP percentage ascertainment is not tenable. There are many items on which profit earned by the assessee is less than the said GP rate of 15.65%. There are items which the assessee has sold at loss also. All these details are already tabulated, when assessee gave its analysis to demonstrate its GP percentage on cost of 16.86%. Also, there is no incriminating material found during the course of such for each of such identified items whereby the itemized GP percentage is to be arrived at for the purpose of making addition in the hands of the assessee. GP percentage of 15.65% on cost arrived at by way of aggregation has been directed to be applied for itemized GP percentage computation to make addition towards suppressed sales. By adopting such a methodology, CIT(A) has concluded to sustain the addition partly. We do not find any rationality for sustaining such an addition, based on itemized GP percentage determination by applying the percentage of GP arrived at in aggregation. It is unrealistic and impractical that assessee earns identical GP percentage on each of the item of sale. Assessee has already demonstrated that it has earned GP percentage at cost which is in line with the industry margin as well as has submitted data for items on which there was no profit or loss as well as items on which it incurred loss. Thus, the addition sustained by CIT(A) is not tenable. The basis which forms for arriving at our conclusion are Tag prices in Cascade are reference prices, which are considerably higher than the final sale prices. Assessee claimed that this pricing method is common in the high-end jewellery industry, where the initial price is set higher for marketing purpose to create an impression of greater value and exclusivity in the minds of the customer and also for negotiation purpose. The final sale price is typically much lower, and various factors such as quality. design, market demand, and customer perception play a role in determining the final price and the final sale price is accurately reflected in the assessee's Tally accounting software. Assessee has submitted that the discrepancy is attributed to such high difference between the display price and the real sale price. Assessee also emphasized that 'Discount' word was used in post search and assessment proceedings for nomenclature purpose to explain the reconciliation and the difference amount between the Cascade tag price and the actual sale price cannot be said to be real discount usually given in other industries. Assessee also relied on the valuation report prepared by the Department's appointed registered valuer at the time of search action to show that the tag prices entered into Cascade are substantially higher than the realisable value of the items. Assessee has disputed the difference figure stated in the show cause notice and has provided a revised difference with detailed reconciliation, considering updated tag prices, returns, remade items, etc. Assessee contends that if the Cascade tag price were to be considered as the sale price, it would lead to unrealistic results, with the sale price being more than three times the cost, which is not feasible in its business. Assessee also highlighted that no substantial undisclosed assets or incriminating material were found during the search or assessment proceedings and that there is no evidence to support the claim that sales were made at the inflated Cascade tag prices, and if that was the case, search party would have discovered much larger undisclosed assets, which was not the case. Assessee appeal allowed. 1. ISSUES PRESENTED AND CONSIDERED 1.1 Whether, on the basis of data retrieved from the Cascade inventory software and its comparison with sales recorded in Tally, the difference between Cascade 'tag prices' and Tally invoice values could be treated as suppressed sales and added as business income under section 28. 1.2 Whether, in the absence of direct evidence of sales at Cascade tag prices or other incriminating material, an addition for suppressed sales could validly be made merely on an estimated or extrapolated basis. 1.3 Whether the valuation report of the Departmental Registered Valuer and the gross profit margins of comparable jewellery businesses supported or contradicted the Assessing Officer's methodology and conclusions regarding alleged suppressed income. 1.4 Whether the method adopted by the first appellate authority in partly sustaining the additions by applying an average gross profit percentage on cost (derived from comparable companies) on an item-wise basis was legally sustainable. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Use of Cascade 'tag prices' versus Tally sales for additions under section 28 Interpretation and reasoning 2.1 The Court recorded that the assessee used two software systems: Cascade for inventory management and Tally for recording final, actual sales and maintaining financial accounts. Cascade recorded 'tag' or reference prices and tracked movement of inventory; Tally contained the final written, signed invoices and was the basis for return filing. 2.2 The assessee explained, and the Court accepted, that tag prices in Cascade were intentionally set much higher than realizable prices as a marketing and negotiation strategy common in high-end diamond jewellery, and were not actual transaction prices. The difference between tag price in Cascade and invoice value in Tally was therefore not per se unaccounted sale. 2.3 The Assessing Officer treated the difference between the recorded sale price and 50% of the Cascade tag price as suppressed sales and added it as business income under section 28. This led, on the figures examined, to a resultant gross profit of 40.66% on sales and 68.52% on cost for the impugned items, which the Court held to be 'highly unrealistic and absurd' for this line of business. 2.4 The Court noted that the Assessing Officer himself acknowledged that taking updated Cascade tag prices as actual sale prices would lead to sale price multiples of cost of more than three times, which he accepted as 'impossible to realize' in the jewellery business. The Assessing Officer also accepted that tag prices were inflated reference prices used for negotiation and marketing, and that normal discounts could not be ruled out. 2.5 The Court further observed that no evidence was brought on record by the Assessing Officer to show that any customer actually paid the tag prices reflected in Cascade or that any portion of sale consideration received from customers remained unrecorded in Tally. No direct enquiry was made with the assessee's limited clientele to verify actual sale prices. Conclusions 2.6 The Court held that Cascade tag prices are only reference prices and cannot, without corroborative evidence, be treated as actual sale prices for the purpose of computing suppressed sales. 2.7 The additions based on treating the difference between Cascade tag prices (even after an arbitrary 50% discount) and Tally sales as suppressed sales under section 28 were found to be estimative, unsupported by corroborative data, and leading to patently unrealistic profit margins, and hence unsustainable. Issue 2: Necessity of corroborative evidence and incriminating material for estimated additions of suppressed sales Legal framework (as discussed) 2.8 The additions were made under section 28 on the basis of alleged suppression of business income. The Court proceeded on the principle that estimation of income must rest on reasonable basis and be supported by evidence or corroborative material, particularly in search-related contexts. Interpretation and reasoning 2.9 The Court emphasized that apart from the internal data of Cascade and Tally, no significant undisclosed asset, in original or converted form, or other incriminating material was found in the search to evidence large-scale suppression of sales or accumulation of unaccounted income corresponding to the alleged differences. 2.10 Only cash of approximately Rs. 2 crore was found and seized, while the assessee had already offered additional income of around Rs. 2.30 crore across multiple assessment years in respect of unreconciled Cascade items. This additional income exceeded the cash found, weakening the inference of further large, unrecorded sales. 2.11 The assessee furnished documentary evidence-copies of invoices, customer ledger accounts, and sales vouchers from Tally-which, according to the Court, stood as testimony to actual realized prices. These were not rebutted or disproved by the Assessing Officer. 2.12 The Assessing Officer extrapolated from unreconciled items (for which the assessee itself had offered GP-based income) to all items by applying Cascade tag price-based adjustments. The Court held such generalization to be unwarranted, particularly in the face of specific explanations and reconciliations given by the assessee (updated tag prices, return sales, customer-owned remaking items where only labour was charged, etc.). Conclusions 2.13 In the absence of any material showing that sales were actually effected at Cascade tag prices or that consideration was received but not recorded, and with no substantial incriminating assets found, the Court held that mere internal software discrepancies could not justify large estimated additions for suppressed sales under section 28. 2.14 The Court concluded that the additions were based on conjectures and extrapolation, without adequate evidentiary foundation, and therefore liable to be deleted. Issue 3: Effect of Departmental Valuer's report and comparable gross profit margins Legal framework (as discussed) 2.15 The jewellery stock was valued by a Department-appointed Registered Valuer under rule 11UA of the Income-tax Rules, 1962, which mandates valuation at the price the jewellery would fetch if sold in the open market on the date of valuation. Interpretation and reasoning 2.16 The valuation report yielded a market value of about Rs. 141 crore for jewellery items in stock, while the tag prices in Cascade for the same items aggregated to about Rs. 400 crore. The Court considered this 2.80 times difference as strong corroboration that Cascade tag prices were significantly higher than realizable market values. 2.17 The Assessing Officer argued that the valuer's figures represented cost and excluded profit. The Court rejected this reading, observing that valuation under rule 11UA is based on current market value and not historical cost, and that it is practically impossible for the valuer, in a search situation with voluminous items, to reconstruct historical cost and production data as suggested by the Assessing Officer. 2.18 The assessee also produced data of comparable jewellery businesses, showing average gross profit margins of 13.47% on sales and 15.65% on cost. When the Assessing Officer's method was applied, the resultant GP on cost (68.52%) and on sales (40.66%) far exceeded these industry benchmarks, indicating inherent absurdity in the additions. 2.19 The assessee's own item-wise data for the disputed items showed an overall GP of 13.85% on cost and 16.86% GP on cost for profit-making items, broadly aligning with the comparable averages. There were items sold at no profit or even at a loss, consistent with normal commercial realities. Conclusions 2.20 The Court held that both the Departmental Valuer's report and the comparable GP margins strongly supported the assessee's explanation that Cascade tag prices were inflated reference figures and undermined the Assessing Officer's approach of treating them (even at an arbitrary 50% discount) as actual realizable sale prices. 2.21 The unreasonably high gross profit percentages resulting from the Assessing Officer's method were held to be incompatible with market and industry realities, rendering the additions untenable. Issue 4: Sustainability of the first appellate authority's method of partial sustenance of additions by applying average GP on cost on an item-wise basis Interpretation and reasoning 2.22 The first appellate authority rejected the Assessing Officer's methodology as arbitrary and instead adopted the comparable companies' average GP rate on cost (15.65%) and applied this rate on an item-wise basis to compute and partially sustain additions towards 'suppressed sales,' deleting the balance. 2.23 The Court noted that the 15.65% GP on cost was an aggregate industry average. Once such aggregate margin was accepted as reasonable for the assessee's overall business, it was unrealistic to insist that each item must yield the same profit percentage. 2.24 The Court emphasized that in the jewellery business, it is commercially normal for some items to have higher margins, some to break even, and some to be sold at a loss. The assessee had already demonstrated, with detailed item-wise data, instances of zero or negative profits in line with this business reality. 2.25 No incriminating material was found in respect of any specific item justifying computation of 'itemized' GP for the purpose of making separate additions. The Court found no rational basis for translating an aggregate, industry-based GP percentage into a rigid item-wise benchmark. 2.26 In view of its earlier findings-that the basic premise of suppression based on Cascade tag prices was flawed, and that the assessee's overall margins were in line with industry norms-the Court held that there was no justification even for the reduced, partially sustained additions. Conclusions 2.27 The Court held that the method of applying an aggregate industry-average GP percentage on cost, on an item-wise basis to compute suppressed sales, was irrational and impractical, and not supported by any incriminating evidence for specific items. 2.28 The partial addition sustained by the first appellate authority (e.g., Rs. 63,41,679/- for the lead year) was therefore held to be not legally tenable and was deleted in toto. Overall disposition on issues 2.29 On the merits of additions under section 28 for alleged suppressed sales based on Cascade-Tally differences, the Court deleted the entire additions made by the Assessing Officer and fully reversed the partial sustenance by the first appellate authority. 2.30 Consequently, all grounds of the assessee on this issue were allowed, and all corresponding grounds of the Revenue challenging the relief granted by the first appellate authority were dismissed, with the findings applied mutatis mutandis to all assessment years in the consolidated appeals.