2026 (2) TMI 871

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....tion 44AB. The part addition made by AO and confirmed by Ld. CIT(A) is arbitrary, illegal and not justified. 4. Ld. CIT(A) erred in estimating income on adhoc basis despite disagreeing to AO's rejection of books of account. 5. The appellant reserve the right to amend, modify or add any of the ground/s of appeal." 3. The relevant facts giving rise to this appeal are that the assessee, a civil contractor, filed its Income Tax Return ('ITR') of the relevant year on 28.09.2014 declaring income of Rs. 11,89,140/-. The case was picked up for scrutiny. The assessee does contract works of mainly PWD Korba, PWD Champa, Chhattisgarh Rural Development Agency Bilaspur & Raipur, etc. The Ld. Assessing Officer ('AO'), observing that the assessee had not produced all bills & vouchers of certain expenditures; therefore, such expenses were unverifiable. Further, the Ld. AO had also opined that owning of the Plant & Machinery worth of Rs. 2.69 crores by the assessee would lower its expenditure with consequential enhancement in the profit. The relevant finding of the Ld. AO reads as under: "The assessee has paid cash labour payments in a gap of every sweets in lakhs of r....

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....n of the cash book of the whole of the FY, it is found that the assessee has huge payments to labourers and transporters, motor parts suppliers, repairing expenditure, cement, Wages, truck freight and various other types of work payments. The assessee has prepared mostly self prepared vouchers which are nothing but a self serving piece of evidence and far away from the truth and reality and not amenable to verification along with preparation of consolidated books prepared for whole of the contract which are not at all open to verification at all." 3.1 Based on the above observation and some more similar observations as mentioned in the assessment order, the Ld. AO rejected the books of accounts of the assessee under section 145(3) of the Act and applied Net Profit ('NP') rate of 12.50% before the claim of deduction of interest, depreciation and remuneration to partners. Accordingly, the Ld. AO worked out the income at Rs. 2,02,93,357/- against returned income of Rs. 11,89,140/-. Aggrieved, the assessee filed appeal before the Ld. CIT(A), who reduced the Net Profit rate from 12.5% to 0.70/- after the claim of deduction of interest, depreciation and remuneration to partne....

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.... AO's estimation should be based on reasonable and credible evidence. I held that the Id. AO's estimation of net profit rate should be based on a thorough analysis of the assessee's financials and industry norms and not on assumptions only. The assessee's cash expenditure is minimal, amounting to only 40.44 lakhs out of a total expenditure of 2186.56 lakhs, which is just 1.89%. Given this low level of cash expenditure, it is implausible that the assessee could significantly impact its profitability by splitting transactions to avoid Section 40A(3). The Id. AO's suggestion that the assessee's profitability was affected by such splitting is not supported by the facts, and it is unreasonable to assume that the assessee's profit would be substantially impacted by such a small proportion of cash expenditure. The assessee had produced copies of bills raised by subcontractors and made payments via banking channels with due tax deduction demonstrating compliance with relevant laws The absence of a written agreement with subcontractors is a common trade practice, especially with petty contractors and does not necessarily imply any discrepancy or....

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....r consideration and subsequent years is a crucial factor in determining the reasonable net profit rate. Specifically, the firm's net profit rate after interest, depreciation and remuneration has been 0.61% in FY 2011-12, 0 70% in FY 2012- 13, and 0.54% in F.Y. 2013-14. The highest net profit rate among the aforementioned three years is 0.70%, which can be considered a reasonable benchmark for estimating the firm's net profit rate after interest depreciation and taking into industry's performance and the firm's own historical data. Thus, the highest of net profit after interest depreciation and remuneration of above three years is 0.70%. In the absence of any evidence to the contrary, I deem it fit to estimate the net profit rate after interest, depreciation and remuneration at 0.70%, which is the higher net profit rate of the past three years. I have considered the submissions made by the assessee and the Id AO's order, and I am of the view that the estimated net profit rate after interest. depreciation and remuneration of 0.70% is reasonable and justified in the facts and circumstances of the case" [Emphasis supplied.] 4. Before us, the assessee was not r....

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....d and the defects pointed out by the Id. AO are not significant enough to warrant rejection. I agree with the assessee's submission that the Id AO's rejection of books is not justified." 7. In section 145(1) of the Act, while making it mandatory to compute the income under head 'business & profession' or 'Income from other sources' based on cash or mercantile system of accounting being regularly followed by the assessee, the word 'shall' have been specifically used to make it mandatory leaving no discretion to use any another method of accounting which is not being regularly followed. Whereas in section 145(3) of the Act, the word 'may' have been deliberately used in a discretionary/directory context because the word 'may' as used in 145(3) of the Act is intricately linked to the AOs satisfaction also about the correctness of accounts in the very same section. A critical examination of language of this section along with principles of harmonious construction would make it clear that powers of the AO to invoke 145(3) of the Act is merely declaratory/discretionary and not mandatory, where the legislature had no intention to prescribe....