* THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003; INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005 % 21.6.2011 # The Commissioner of Income Tax, Rajahmundry ... Appellant VERSUS $ M/s.R.Narayanarao & others, Mg. Pr. Sri R.Dasaradha Ramaiah Goud, Kakinada And others ... Respondents < GIST: > HEAD NOTE: ! Counsel for Appellants: M/s.S.R.Ashok and V.R. Badri ^Counsel for Respondents: M/s.Y.Ratnakar, A.V.Krishna Koundinya ? Cases referred THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003; INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005 June 21, 2011 Between: The Commissioner of Income Tax, Rajahmundry … Appellant AND M/s.R.Narayanarao & others, Mg. Pr. Sri R.Dasaradha Ramaiah Goud, Kakinada And others … Respondents THE HON’BLE SRI JUSTICE V.V.S.RAO AND THE HON’BLE SRI JUSTICE RAMESH RANGANATHAN INCOME TAX TRIBUNAL APPEAL Nos.3, 6, 7, 10, 12, 13, 14, 15, 22, 36, 57, 58, 61, 64, 76, 77, 81, 82, 83, 87, 88, 106, 108, 118, 119, 126, 128, 129, 131, 137, 141, 143, 147, 151, 167, 169, 170, 171, 172, 176, 179, 183, 185, 187, 188, 193, 194, 197, 206, 208, 210, 227, 240, 253, 259, 272, 278, 294, 302, 304, 305, 309, 314, 333 of 2003; INCOME TAX TRIBUNAL APPEAL Nos.74, 126 of 2004; and INCOME TAX TRIBUNAL APPEAL No.393 of 2005 COMMON JUDGMENT: (Per Hon’ble Sri Justice V.V.S.Rao) This group of Income Tax Tribunal Appeals is filed under Section 260A of the Income-tax Act, 1961 (the Act) by the Commissioner of Income Tax (CIT), Rajahmundry against different common orders passed by the Income Tax Appellate Tribunal, Visakhapatnam Bench. The learned Tribunal passed various common orders in all the appeals filed by the assessees as well as the Revenue. The appeals by the assessees were partly allowed and those of Revenue were dismissed. The issue, in these appeals, is whether the best judgment assessment made by the Income Tax Officer, Kakinada estimating the gross profit from the assessees’ arrack business at 40% of the purchase value is sustainable in law and if not what would be the estimate of gross profit as per the principles of best judgment assessment? The fact of the matter is not in serious dispute. The respondent asseessees (the arrack contractors), at the relevant point of time, were engaged in the business of selling arrack. For the assessment years 1993-94 and 1995-96 these assessees, assessed either as individuals, partnership firms or Association of Persons (AoPs), filed their returns of income admitting a net loss. The assessing officer did not accept the returns. He took up assessment under Section 143(3) of the Act. Objections were invited with regard to the nature of the concern – whether it is a firm or AoP; justification for the expenditure claimed; and profit/loss shown in the return. The assessees filed their explanation. They contended that, due to prohibition on the sale of arrack introduced from 30th September, 1993 by the Government, the whereabouts of the partners were not known; it was not possible to maintain or issue sale bills; there was no practice at any time to maintain the books of complete accounts; and the expenses claimed were nominal. The assessing officer rejected the books of accounts wherever they were produced and estimated the gross profit at 40% of the purchases. In the appeals, before the CIT (Appeals), it was inter alia contended that the additions/disallowance of expenditure made by the assessing officer, after computing gross profit at 40% of the purchase price of arrack, were arbitrary and excessive. It was urged that arrack business suffered unforeseen set back due to State wide agitation which preceded imposition of prohibition of sale of arrack in the State. In addition it was also contended that arrack business in agency areas and other places, where extremist activities were at the peak, the arrack contractors suffered loss. The CIT (Appeals) upheld adoption of gross profit at 40% of the purchase price taking into consideration the agitation which preceded introduction of prohibition in the State as well as disturbance in certain areas due to extremist activities. He also took into consideration the question of loss due to agitation. The Commissioner agreed with the assessing officer in restricting the expenditure claimed at 50% on the ground that the assessee did not place any evidence on both the aspects. The purchase value, rental payments, licence fee and bank commission were accepted and allowed as deduction. Addition made to bank interest was also deleted. Thus the assesses got some relief before the CIT (Appeals). As already noticed supra, there were a number of assessments of arrack contractors in East Godavari District by the same assessing officers and orders by the same CIT (Appeals). Various groups of appeals were filed before the Tribunal. In all these matters the assesses contended that taking 40% of the purchase price as the gross profit is without any basis. Reliance was placed on a consolidation order dated 30.5.2001 of the learned Tribunal in the case of Anakapalle Municipal Units Arrack Shop and others (ITA Nos.1418 to 1424/Hyd/1996 and batch), wherein the Tribunal held that estimation of turnover at eight (8) times of the purchase price and 1% thereon as profit would be reasonable. Indeed there is no dispute that this order was followed in all the other common orders by which the appeals of the assesses were allowed and those of the Revenue were dismissed. The Senior Standing Counsel, Sri S.R.Ashok, submits that, when estimation of income under Section 145 of the Act was held to be justified by the Tribunal, interference with the estimation of gross profit by the assessing officer as confirmed by the CIT (Appeals) is uncalled for. The Senior Counsel would further submit as follows. The best judgment assessment involves an element of guess work. When the assessee has not proved the correctness of the books of accounts, or has not produced any record to support his claim as to the taxable income, it is always open to the assessing officer to estimate the income and profit therein as per similar business data. In arrack business the profit margin is very high and the expenditure and facilities are minimal. The assessing officer is justified in disallowing the expenditure claimed to the extent of 50%. S ri Y.Ratnakar and Sri A.V.Krishna Koundinya made submissions for the assesses. They would contend that estimation of 40% of the purchase price as gross profit is unreasonable, arbitrary and without any basis. The Tribunal was, therefore, correct in estimating the sales turnover at eight (8) times of the purchase price and then estimating the net profit at 1% of such estimated sales. They would point out that in all the cases the assesses had filed returns showing the price for the purchase of arrack which were verifiable and non-variable, and the assessees had also admitted certain amount as total sales. The total sales were found to be approximately eight (8) times the purchase price. In the background facts and, in view of the rival submissions, the only question that would arise for consideration is whether the learned Income-tax Appellate Tribunal is justified in holding that profit shall be adopted at 1% of the total sale value? There is no dispute that in all the cases the assessees had shown the turnover sales without producing books of accounts. Even when the books of accounts were produced they were not verifiable. The maximum retail price of arrack was not fixed by the government and it was for the arrack contractor to sell the liquor at whatever price the contractor would get. After receiving assessments in all the cases the assessing officer issued show cause notice; the assessees filed their objections and produced books of accounts. When they were not produced the assessing officer disbelieved the turnover of sales as they were not supported by vouchers or books of accounts and, wherever the books of accounts were produced, they were rejected. The assessing officer then, indisputably, took up best judgment assessment under Section 145(3) read with 144(1) of the Act. The best judgment assessment resorted to by the assessing officer is not challenged either before the learned Tribunal or before us. Therefore, what is required to be examined are the principles of best judgment assessment. Provisions and Precedents As per the charging Section of the Act, income shall be charged at any rate or rates as per the Central Act for that year. Section 2(24) defines ‘income’ inclusively and elaborately. As per Section 2(43) tax means the income tax chargeable under the provisions of the Act for the relevant assessment year in determining the income tax liability of an assessee who is liable to pay tax under the Act. In computing the income, Sections 5 and 7 and the provisions in Chapter IV of the Act provide the modalities. While doing so, deductions to be made in computing the total income are enumerated in Chapter VIA. Chapter VIII deals with rebates and reliefs to be allowed in computing income tax. The law mandates that every person shall furnish a return of the total income if it exceeds the maximum amount which is not chargeable to income tax. Chapter XIV contains the procedure for assessment, and Chapter XIVB contains the procedure for block assessment pursuant to search and seizure taken in cases of tax evasion. Besides these provisions, the Income Tax Act contains the machinery provisions for Collection and Recovery of Tax (Chapter XVII), Refunds (Chapter XIX), Settlement of Cases (XIXA), Appeal/Revision System (Chapter XX) and Penalties imposable under the Act (Chapter XXI). In determining the income tax liability of a person, computation of the total income of the assessee is the first stage which is sometimes complex. The next stage is determination or computation of the sum payable by the assessee on the basis of such assessment towards income tax. While determining the sum payable, it might become necessary for the assessee, or the competent assessment officer, to take into consideration the income received or is deemed to be received keeping in view the definition of income. While doing so, the deductions to be made and rebates and reliefs to be allowed cannot be ignored. The last and ultimate exercise is only the determination of the tax on the total income as per the Central Act for the relevant assessment year read with Section 4 of the Act. In CIT v Suresh N.Gupta[1], the Supreme Court considered the charging Section and made observations which are apt to quote below. The rate at which a charge on the total income of the previous year is imposed under Section 4(1) of the 1961 Act is not laid down in the Income Tax Act and, therefore, the said section provides that the charge has to be fixed by the Central Act. It is because of this, that income tax is levied at different rates under the Finance Act. ... ... It must be borne in mind that the Income Tax Act deals with tax on income and nothing else. Therefore, in order that the charge should be a legal charge under Section 4, it must be a tax on the income of the assessee. If the charge is the tax on anything else, then it would not be a valid charge. This is the only limitation upon the power or authority of Parliament to fix any rate it pleases. So long as the charge is on “total income” of the previous year, there is no limitation upon the power or authority of Parliament to fix any rate it pleases. However, if “rate” is understood to mean the fixing of the tax irrespective of “total income” and unconnected with “total income”, then, in our view, Parliament would be travelling outside the ambit of Section 4(1). The Income Tax Act, therefore, contains an elaborate machinery for ascertaining “total income” of an assessee. If Parliament has power to fix tax at a rate which has no connection with the “total income”, then the machinery set up under the 1961 Act becomes infructuous. In our view, Section 4(1) prescribes the subject-matter of the tax and the rate of that tax is prescribed by the legislature, either under the Act as in the case of Section 113 or vide the Finance Act. As long as the charge is on “total income” of the previous year and so long as the rate relates to the subject-matter of the tax, there is nothing to prevent Parliament from fixing the rate. But the rate must be applied to the “total income” and the tax that an assessee has to pay must be at the rate in respect of total income of the previous year. The term ‘assessment’ is an inclusive definition. ‘Assessment’ includes re-assessment (Section 2(8) of the Act). The understanding of the scope of ‘assessment’ is necessary as, in these cases, we are concerned with the computation of income for the purpose of determining or assessing income tax payable by the respondent – assessees. In C.A.Abraham v I.T.Officer[2], the Supreme Court quoted with approval the observations of the Privy Council in Commissioner of Income Tax v Khemchand Ramdas,[3] to the effect that “the word ‘assessment’ is used as meaning sometimes the computation of income, sometimes the determination of the amount of tax payable and sometimes the whole procedure laid down in the Act for imposing liability upon the tax payer”. The word “assessment”, as used in the Income Tax Act, 1922 (the 1922 Act), includes a proceeding for imposition of penalty (CIT v Kirkend Coal Company[4]). Asst. Collector of Central Excise v National Tobacco Co. Ltd[5] is a case which arose under the Central Excise Rules, 1944. It was argued that there would be no ‘levy’ in the eye of law unless there is ‘assessment’ for the purpose of determining the value of excisable goods. While observing that Article 265 of the Constitution makes a distinction between ‘levy’ and ‘collection’, it was held that the term ‘levy’ does not extend to ‘collection’ although ‘levy’ is wider than ‘assessment’. The Supreme Court also held that, “the term ‘assessment’ is generally used for the actual procedure adopted in fixing the liability to pay a tax on account of particular goods or property or whatever may be the object of the tax in a particular case and determining its amount”. Section 35 of the 1922 Act conferred power on the Commissioner or the Appellate Commissioner to suo motu rectify any mistake apparent on the record, appeal, revision, assessment or refund within four years from the date of such order. I n I.T. Commissioner v J.K. Commercial Corporation[6], the Supreme Court was required to consider whether the expression ‘assessment order’ in Section 35 of the 1922 Act includes an order made under Section 23A which authorized the Income Tax officer to levy super tax at specified rates. Referring to Khemchand Ramdas as approved in C.A.Abraham, the Supreme Court held that, “the word ‘assessment’ is capable of bearing a very comprehensive meaning; it can comprehend the whole procedure for ascertaining and imposing liability on the tax payer and literally speaking … … the assessment is of the total income of the assessee and then in the same order sum payable by the assessee is determined which would include income tax, surcharge, super tax etc”. On this reasoning, the Apex Court ruled that the expression ‘assessment order’ occurring in Section 35(1) of the 1922 Act would include an order made under Section 23A of the said Act. It may, therefore, be taken as well settled that the word ‘assessment’ used in various provisions of the Act connotes different meanings, namely, the computation of income, the determination of the amount of the tax payable and some times the whole procedure laid down in the Act for imposing liability upon the tax payer. The word ‘assessment’ would certainly take within its fold, “computation of income as well as determination of tax payable thereon”. The immediate question, therefore, would be on what basis income is computed although the determination of the tax liability would depend on the Finance Act passed by the Parliament to be applicable for each assessment year. The computation of income, unless specifically provided for by the Act, is ordinarily left to the choice and option of the person liable to pay the income tax. Every tax payer is expected to disclose all types of income contemplated under the Act, namely, income from salary, income from other sources etc. If any assessee fails to disclose various types of income truthfully or the assessing officer comes to a conclusion that the income is either not fully disclosed or improperly computed, he can then himself compute the income of a person liable to pay the tax. Sections 144 and 145 of the Act are relevant and are quoted hereunder. 144. Best judgment assessment. (1) If any person— (a) fails to make the return required under sub-section (1) of Section 139 and has not made a return or a revised return under sub-section (4) or sub-section (5) of that section, or (b) fails to comply with all the terms of a notice issued under sub- section (1) of Section 142 or fails to comply with a direction issued under sub-section (2A) of that section, or (c) having made a return, fails to comply with all the terms of a notice issued under sub-section (2) of Section 143, the Assessing Officer, after taking into account all relevant material which the Assessing Officer has gathered, shall, after giving the assessee an opportunity of being heard, make the assessment of the total income or loss to the best of his judgment and determine the sum payable by the assessee on the basis of such assessment: Provided that such opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the assessment should not be completed to the best of his judgment : Provided further that it shall not be necessary to give such opportunity in a case where a notice under sub-section (1) of section 142 has been issued prior to the making of an assessment under this section. (2) The provisions of this section as they stood immediately before their amendment by the Direct Tax Laws (Amendment) Act, 1987 (4 of 1988), shall apply to and in relation to any assessment for the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year and references in this section to the other provisions of this Act shall be construed as references to those provisions as for the time being in force and applicable to the relevant assessment year. 145. Method of accounting. (1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. (2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. (3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in Section 144. The above two provisions empower the assessing officer to make assessment of the total income to the best of his judgment and determine the tax payable by the assessee. If a case falls under any of the three categories under Section 144(1) of the Act, it is mandatory for the assessing officer to make a best judgment assessment. In a case falling under Section 145(3) of the Act, discretion is given to the assessing officer to make a best judgment assessment in the manner provided under Section 144 of the Act. For more clarity, we shall indicate different situations herein below. The mandatory best judgment assessment is to be made in any of the four cases. (a) If any person fails to make the return under Section 139(1) of the Act and has not made a return or a revised return under Section 139(4) or (5) of the Act; (b) if any person fails to comply with all the terms of a notice issued under Section 142(1) of the Act; (b) if any person fails to comply with a direction issued under Section 142(2A) of the Act; or (d) if a person having made a return fails to comply with all the terms of a notice issued under Section 143(2) of the Act. Section 145(2) of the Act confers discretionary power on the assessing officer to make a best judgment assessment in two situations, namely, where the assessing officer is not satisfied about the correctness or completeness of the accounts of the assessee; and where the assessee has not followed regularly any method of accounting provided in subsection (1) of Section 145 of the Act (cash system or mercantile system of accounting). “What is the scope of best judgment assessment”? The mandatory and discretionary best judgment assessment under Sections 144(1) and 145(3) of the Act provide some guidelines. As per Section 144(1) of the Act, the assessing officer has to take into account all relevant material which he has gathered and should make assessment after giving the assessee an opportunity of being heard. Therefore the best judgment assessment is not to be an arbitrary assessment. Whatever the computation of income and tax thereon, it shall have some bearing with reference to the material gathered by the assessing officer and, if there is no material, the question of best judgment assessment would not arise. The availability of material or availability of material gathered by the assessing officer is crucial for making a best judgment assessment. It is not the ipse dixit of the assessing officer to compute the income of an assessee either under Section 144(1) or 145(3) of the Act. Nor the computation and determination can be as per the whims and fancies of an assessing officer. The language of Section 144(1) and 145(3) of the Act indicate that the computation of total income should be by adopting an objective method, and subjectivity in arriving at the taxable income is not contemplated under law. The word ‘assessment’ is, therefore, to be understood in each Section with reference to the context in which it has been used. In some Sections it has a comprehensive meaning and in some Sections it has a restrictive meaning (A.N. Lakshman Shenoy v I.T.Officer[7]). The power to make best judgment assessment is not an arbitrary power. These principles of law are well settled. As observed by the Supreme Court in State of Orissa v Maharaja Shri B.P.Sing Deo[8], the scope of the best judgment assessment power has been explained by the Supreme Court in number of