8 Method of accounting – Section 145(3) – AO cannot reject the accounts on the basis that the goods are sold at the prices lower than the market price or purchase price – the law does not oblige/compel a trader to make or maximise its profits

The Pr. CIT vs. Yes Power and Infrastructure. Pvt. Ltd. [AY 2005-06] [Income tax Appeal no. 813 of 2015 dated:20/02/2018 (Bombay High Court)].  [ACIT vs. Yes Power and Infrastructure. Pvt. Ltd.[ITA No.7026/Mum/2012; dated 17/12/2014 ; Mum.  ITAT ]

The assessee is engaged in trading of steel and other engineering items. The A.O during year found that the assessee had sales of Rs. 52.17 crore while gross profit was only Rs. 26.08 lakh. This led the A.O. to call for an explanation for such low profits from the Assessee.

In response, the Assessee pointed out that the company, is a concern mainly engaged in trading of steel & engineering products. The company  purchase and sale these goods on very competitive low margin but our volume are very high. Normally, company purchases the goods and resale them at the minimum time gap. It is a known fact that rates of steel keep fluctuating and it is a very volatile item. To avoid any risk due to market price fluctuation, company  has to take the fast decision to sell at the available rate received from the market, some time it may be sold on a low price or some times at a higher price. During the year, some of the transactions are sold at lower price because of the expectation of the rate of steel going lower and lower. Moreover, due to fact that assessee works with a very small capital and no borrowing from banks, assessee does not have capacity to hold stock for longer periods. Hence, company has to take decision to sell and purchase, keeping the time gap at the minimum.

However, the A.O. did not accept the explanation for low profits and rejected the books of accounts. This on the ground that the purchase price of goods was much higher than the selling price of those very items. On rejection of the books of accounts, the A.O. estimated the gross profit on the basis of 2 percent of the sales. This resulted in enhancement of gross profits from Rs. 26.08 lakh to Rs. 1.18 crore.

Being aggrieved with the order, the assessee filed an Appeal to the CIT(A). The CIT(A) dismissed the assessee’s appeal.

On further Appeal, the Tribunal allowed the assessee’s Appeal. This inter alia on the ground that it found that the assessee had along with return of income filed audited accounts along with audit report for the subject assessment year. Moreover, during the course of scrutiny, complete books of accounts with item-wise and month-wise purchase and sales in quantitative details were also furnished. It found that the A.O. did not find any defect in the books of accounts nor with regard to quantity details furnished by the assessee. In the above circumstances, it held that merely because the assessee being a trader has sold goods at prices lower than the purchase price and/or the prevailing market price would not warrant rejection of the books of accounts.

Being aggrieved with the order, the revenue filed an Appeal to the High Court. The grievance of the Revenue with the impugned order is that the assessee has sold goods at price lower than its purchase price. Therefore, the books of accounts cannot be relied upon. Thus, the rejection of the books of accounts and estimation of profits in these facts should not have been interfered with.

The High Court held  that it is not the case of the Revenue that the amounts reflected as sale price and/or purchase price in the books do not correctly reflect the sale and/or purchase prices. In terms of section 145(3) of the Act, the A.O. is entitled to reject the books of accounts only on any of the following condition being satisfied.

(i) Whether he is not satisfied about the correctness or completeness of accounts; or

(ii) Whether the method of accounting has not been regularly followed by the Assessee; or

(iii) The income has been determined not in accordance with notified income and disclosure standard.

 It is not the case of the Revenue that any of the above circumstances specified in section 145(3) of the Act are satisfied. The rejection of accounts is justified on the basis that it is not possible for the assessee who is a trader to sell goods at the prices lower than the market price or purchase price. In fact, as observed by the Apex Court, Commissioner of Income Tax, Gujarat vs. A. Raman & Co. and in S.A. Builders vs. Commissioner of Income Tax – 2, the law does not oblige/compel a trader to make or maximise its profits. Accordingly, the revenue Appeal was dismissed.