I.T.As. Nos.859/KB of 2000-01, 1592/KB, 1652/KB and 1778/KB of 2002, decided on 2nd November, 2002. VS I.T.As. Nos.859/KB of 2000-01, 1592/KB, 1652/KB and 1778/KB of 2002, decided on 2nd November, 2002.
2005 P T D (Trib.) 1208
[Income-tax Appellate Tribunal Pakistan]
Before Jawaid Masood Tahir Bhatti, Judicial Member and Shaheen Iqbal, Accountant Member
I.T.As. Nos.859/KB of 2000-01, 1592/KB, 1652/KB and 1778/KB of 2002, decided on 02/11/2002.
(a) Income Tax Ordinance (XXXI of 1979)---
----S. 32---Method of accounting---Scope.
Board of Revenue v. Arunachalam Chettiar 1 ITC 75 rel.
(b) Income Tax Ordinance (XXXI of 1979)---
----S. 32---Method of accounting--- Method ---Meaning.ÂÂ
(c) Income Tax Ordinance (XXXI of 1979)---
----S. 32---Method of accounting---Meaning and types of.
CIT v. Singari Bai (1945) 13 ITR 224 (All.) and Dhakeshwar Prased Narain Singh v. CIT (1936) 4 ITR 71 (Pat.) rel.
(d) Income Tax Ordinance (XXXI of 1979)---
----S. 32---Method of accounting---Expression: Computation of Income on such basis and in such manner as thinks fit---Meaning of.
Rajput Metal Works Ltd. v. CIT PLD 1976 Lah. 223 rel.
(e) Income Tax Ordinance (XXXI of 1979)---
----S.32---Methodofaccounting--- Opinion ---Meaningillustrated.
CIT v. Sh. Ehsan Elahi 1980 PTD 261; CIT v. McMillan and Co. (1958) 33 ITR 182 (SC); CIT v. A. Krishnaswami Mudaliar (1964) 53 ITR 122 (SC); CIT v. British Paints India Ltd. (1991) 188 ITR 44 (SC); Dr. Jayanti Dharma Teja v. Secretary Govt. of India, Ministry of Finance, New Delhi, and others (1984) 148 ITR 316(AP); Kashiprasad Carpets (P.) Ltd. v. CIT (1984) 148 ITR 710 (All.) and Star Rolling Mills v. CIT 1974 PTD 200 rel.
(f) Income Tax Ordinance (XXXI of 1979)---
----S. 32---Method of accounting---Expression Choice with the assessee to adopt his own system of accounting ---Connotation.
CIT v. Sarangpur Cotton Mfg Co. Ltd. (1938) 6 ITR 36 rel.
(g) Income Tax Ordinance (XXXI of 1979)---
----S.32---Method of accounting---Rejection of accounts---Factors to be observed by the Assessing Officer before rejecting books of account/ method of accounting stated.
(h) Income Tax Ordinance (XXXI of 1979)---
----S. 62---Assessment on production of accounts, evidence etc.---Sale and production---Consumption of fuel and power---Rejection of sales due to higher consumption of fuel and power than the preceding year---Only inference that could be drawn on account of higher number of unit of electricity consumed was that the assessee had suppressed production and the production records and sales would have been rejected---No objection having been raised to the production records which were duly checked and verified by the Excise and Sales Tax Authorities and the declared sales and production having been accepted, Appellate Tribunal agreed with the line of arguments of assessee and found no substance in the objection of Assessing Officer.
(i) Income Tax Ordinance (XXXI of 1979)---
----Ss. 62 & 32---Assessment on production of accounts, evidence etc.---Method ofaccounting---Low gross profit---Rejection of accounts---Validity---If the method of accounting regularly adopted was the same which had been accepted in the past then the same could not be rejected without very valid reasons---Method of accountancy and the books of accounts regularly maintained and accepted by the department could not be rejected merely for the reason that Gross Profit was low.
Karachi Textile v. CIT 1984 PTD 150; Pimpa (Pvt.) Ltd. v. CIT 1994 PTD 123; CIT v. Krudd Sons Ltd. 1994 PTD 174; Roshan Cloth House v. CIT 1983 PTD 63; 1962 PTD (Trib.) 23; 2001 PTD (Trib.) 2938, M.E.J. Hazari and Sons v. CIT 1985 PTD 516, Printers Combine v. CIT 1984 PTD 276 and S.M. Yousuf and Bros. v. CIT 1974 PTD 45 rel.
(j) Income Tax Ordinance (XXXI of 1979)---
----S.32---Method of accounting---Gross profit---Principles of accounting regarding ascertainment of gross profit---Gross profit---Meaning---Profit and loss account of a trading concern is usually divided into two sections; first being the trading account which is so framed as to show the gross profit, gross profit as shown by the trading account is transferred to second section which is the profit and loss account---Gross profit is defined as the difference between the cost of the goods that have been sold and the proceeds of their sale, without any deduction in respect of the expenses of distribution and general establishment charges---In trading account, it is necessary to include all items of charges directly affecting the cost of the goods sold---When production account and declared sale had been accepted and no direct expenses specially and exclusively disallowed, gross profit is nothing but balancing figure difference between debit and credit side of trading account.
(k) Income Tax Ordinance (XXXI of 1979)---
----S. 62---Assessment on production of accounts, evidence etc.---Better gross profit each year---Assessing Officer s wish that assessee has to declare better gross profits each year has no justification in law---Trading and manufacturing results depend on the conditions of business and operation of manufacturing activity during the year---Nothing existed in the income tax law which binds an assessee to declare better resulteach year---Decrease in declared version has to be seen in broader perspective i.e. the inflationary cost, fixed cost and price fluctuation of different items concerning the transactions engaged by the assessee---Profitability entirely depends on the production.
(l) Income-tax---
----Production and cost---Gross profit margin---Relationship---Whenever production increases, the cost of production decreases and company earns profit---However, wherever the production is lesser, fixed cost remaining the same gross profit margin decreases.
(m) Income-tax---
----Gross profit---Factors on which rate of gross profit depends---Rate of gross profit in a particular year depends on many factors, e.g., the general market condition based on demand and supply positions, the rise or fall in market rates, specially abrupt ones the capital position vis- -vis the turnover achieved---Low G.P. may be due to recession in local and international markets depression in money market, financialstringency,detachment of Pak currency from dollars and open and tacit competition and many others, however, the law does not oblige an assessee to make the maximum profits that he could out of his trading transactions---Application of higher flat rate of G.P. is not proper when a truer state of income could be ascertained without much trouble.
(n) Income-tax---
----Rejection of accounts---Principles---detailed.
Pimpa (Pvt.) Ltd. Karachi v. CIT 1994 PTD 123; CIT v. Krudd Sons Ltd. 1994 PTD 174; M.E.J. Hazri and Sons v. CIT 1985 PTD 516; Karachi Textile v. CIT 1984 PTD 150; CIT v. Fateh Textile Mills Ltd. Hyd. 1984 PTD 218; 1962 PTD (Trib.) 23; Printers Combine v. CIT (1984) 50 Tax 183 (H.C. Kar.); (1961) 4 Tax 230; (1962) 6 Tax 95; International Forest Co. v. CIT (1975) 101 ITR 721 (J & K); M. Durai Raj v. CIT (1972) 83 ITR 484 (Ker.); Pandit Bros. v. CIT (1954) 26 ITR 159 (Bom.); Ratan Caf v. State of Madras (1974) 33 STC 39 (Mad); S. Veeriah Reddiar v. CIT (1960) 38 ITR 152 (Ker.); R.M.P. Perianna Pillai and Co. v. CIT (1961) 42 ITR 370 (Mad); Ravi v. State of Tamil Nadu (1981) 48 STC 274 (Mad.); Vel Metal Industries v. State of Tamil Nadu (1988) 68 STC 55 (Mad.) and Laxmi Stores v. CST (1979) 43 STC, 167, 168 (All.) ref.
(o) Income Tax Ordinance (XXXI of 1979)---
----S.62 (1), proviso---Assessment on production of accounts, evidence etc.---Interpretation of proviso---Proviso should be read as a whole---After detecting defects in books of accounts the Assessing Officer is legally bound to issue mandatory notice under S.62(1) of the Income Tax Ordinance, 1979 to confront the assessee with the defects pointed out by him in his order and provide an opportunity to the assessee to explain his point of view about such defects---Assessing Officer under the said proviso is required to record the explanation of assessee in the assessment order---If Assessing Officer is not satisfied with the explanation he is duty bound to record his reasons indicating the basis on which he is not accepting the assessee s explanation in the assessment order and on what basis he is going to compute assessee s total income---Giving reasons in support of the computation of total income is essential because no unfettered or unexaminable discretionary powers are vested with the Assessing Officer.
(p) Income Tax Ordinance (XXXI of 1979)---
----S. 62(1), proviso---Assessment on production of accounts, evidence etc.---Rejection of accounts---Principles.
1999 PTD (Trib.) 2892 and 2001 PTD (Trib.) 2938 rel.
(q) Income Tax Ordinance (XXXI of 1979)---
----S.62---Assessment on production of accounts, evidence etc.---Department admitted that no noticeunder S.62 of the Income Tax Ordinance, 1979 had been issued after examining books of account, however such defects had duly been incorporated in the assessment order---Validity---Faint argument was advanced before the Appellate Tribunal by the Department which was untenable because the Assessing Officer had to follow the mandatory requirements by issuing notice under S.62 of the Income Tax Ordinance, 1979 confronting defects to the assessee prior to finalization of assessment.
Collector, Sahiwal v. Muhammad Akhtar 1971 SCMR 681; 1993 PTD 392; 1985 PTD (Trib.) 178 and 1993 PTD 1172 rel.
(r) Income Tax Ordinance (XXXI of 1979)---
----Ss.62(1), proviso & 32---Assessment on production of accounts, evidence etc.---Purpose of proviso to S.62(1), Income Tax Ordinance, 1979---Legislature while evolving laws on principles of natural justice devised the practical scheme of proviso (1) of S.62 of the Income Tax Ordinance, 1979---Said proviso was added to income tax law vide Finance Act, 1993 just enabling the tax payers to know the allegation against him and give a proper reply and defence thereof so that the taxpayers be saved from the arbitrary action of the Assessing Officer---In fact this was a rule that an Assessing Officer will be bound to accept a method of accounting which is regular and which is based on some rational and reasonable ground---Section 32 of the Income Tax Ordinance, 1979 was adversely used against the taxpayers and it became a tool for rejection of accounts instead of a measure of protection of the taxpayers.
(s) Income Tax Ordinance (XXXI of 1979)---
----Ss.32 & 62---Method of accounting---Basic idea---Rejection of accounts---Assessee must be given full chance to rebut the material relied upon by the Assessing Officer for rejecting the accounts.
Seth Gurmukh Singh v. CIT (1944) ITR 393 and Mr. Gopi Mohan Sahah Ref. No. 1 of 1955 rel.
(t) Income Tax Ordinance (XXXI of 1979)---
----S.62(1), proviso----Assessment on production of accounts, evidence etc.---Assessing Officer had not issued any notice under S.62 of the Income Tax Ordinance, 1979 after examination of books of accounts and before---Discarding books of accounts of the assessee and rejection of accounts by the Assessing Officer thus could not be sustained---Mandatory provisions of S.62 of the Income Tax Ordinance, 1979 having not been followed the assessment order was found to be capricious and arbitrary by the Appellate Tribunal.
CIT v. Fazal ur Rehman PLD 1964 SC 410; 1984 PTD 255 and 1979 PTD 568 rel.
(u) Income-tax---
----Res judicata, principle of---Applicability---Scope.
CIT v. Pakistan Industrial Engineering Agencies Limited PLD 1992 SC 562 rel.
(v) Income Tax Ordinance (XXXI of 1979)---
----Ss.62 & 32---Assessment on production of accounts, evidence etc.---Method of accounting---Rejection of accounts---Principles of res judicata---Applicability---Past history---Principle of res judicata strictly applies in re-assessment/re-opening proceeding under tax laws to fulfillment of condition of the relevant provisions and if suppression of income is so glaring and floating on the surface of record---Method and system of accounting employed was the same as for the preceding years and assessee had history of acceptance of declared trading results---Previous assessment having been finalized under normal assessment after detailed scrutiny and examination of books of accounts and applying judicial mind to the facts of the case, principle of res judicata would come into play when altogether a new different method of accounting was employed and true profit could not be deduced therefrom---Department had strong evidence of suppressed income/account---Assessing Officer could not take shelter behind the principle of res judicata for rejecting books of accounts of the assessee for determining higher profits and income on the ground that past history could not be accepted being hit by principle of res judicata---Assessing Officer could not depart from the past history and the finding reached by his predecessor just because succeeding officer did not agree with the preceding officer s finding---Taxation authorities should take notice of the conditions under which principle of res judicata did not apply before making such statement and giving such findings.
(w) Income Tax Ordinance (XXXI of 1979)---
----Ss. 62 & 32---Assessment on production of accounts, evidence etc.---Rejection of accounts on the ground of low gross profit---Validity---After considering the explanation of the various objections to the method of accounting and to the books of accounts mentioned in the assessment order, the explanation for the decline in GP, the past and subsequent acceptance of declared results and the relevant case-law on the subject, the case-law that accounts cannot be rejected merely because of low of GP and the legal objection that the mandatory provisions of proviso of S.62 of the Income Tax Ordinance, 1979 had not been fulfilled, the rejection of declared version could not be maintained both on the basis of facts and law---Appellate Tribunal directed that declared version of the assessee be accepted.
(x) Income Tax Ordinance (XXXI of 1979)---
----Ss. 62 & 32---Assessment on production of accounts, evidence etc.---Method of accounting---Scrap sales---Deduction of, from the cost of sales---Assessing Officer rejected books of accounts on the ground that assessee deducted scrap sales from the cost of sales which was a defect in the method of accounting---Validity---Fact that a receipt or an expense is included in the trading account or a direct income or expense in Profit & Loss account would not affect the net income---If the scrap sales were transferred from the cost of sales as direct income the Gross Profit would decline and direct income was increased and the net profit will remain the same---Same is the case, if an expense is transferred from cost of sales to the Profit and Loss account---Such transfer will increase the Gross profit but correspondingly increase the Profit and Loss expenses and the net profit will remain unchanged.
(y) Income Tax Ordinance (XXXI of 1979)---
----Ss. 62 & 32---Assessment on production of accounts, evidence etc.---Transfer of an entry from trading account to profit and loss account---Rejection of accounts---Validity---Rejection of books of accounts is permitted if the books of accounts were found false and manipulated with a view to suppress profits---Mere transfer of an entry from trading account to profit and loss account and vice versa would not justify the rejection of accounts.
CIT v. Krrud Sons Limited 1994 PTD 174 rel.
(z) Income Tax Ordinance (XXXI of 1979)---
----S.32(3)---Method of accounting---Rejection of accounts---Subjective judgment---Section 32(3) of the Income Tax Ordinance, 1979 did not empower an Assessing Officer to reject the books of accounts on the basis of a subjective judgment---Such judgment must be objective and within four walls of subsection (3) of S. 32oftheIncomeTaxOrdinance,1979---Assessing Officer could not reject the books of accounts at his own whim as his action for purpose of rejecting books of accounts was subject to judicial determination---No hard and fast rule existed on such matters---Opinion of the Assessing Officer must not be his subjective, personal or private opinion, same must be based on something which conforms to an objective standard or criteria laid down or recognized by law.
(aa) Income Tax Ordinance (XXXI of 1979)---
----S. 24(1), Explanation---Sindh Employees Special Allowance (Payments) Act (X of 1986)---Deduction not admissible---Salary---Perquisites---Assessing Officer while working out excess perquisites included the payment of dearness allowance and special allowance (cost of living allowance) in perquisites---Validity---Explanation to Cl. (1) to S.24 of the Income Tax Ordinance, 1979 includes dearness or cost of living allowance in salary and not in perquisites---Special allowance was being paid under the Sindh Employees Special Allowance (Payments) Act, 1986 which was part of Employees Cost of Living Relief and Allowances---Appellate Tribunal directed the Assessing Officer that these allowances be treated as salary for calculation of excess perquisites.
(bb) Workers Welfare Fund Ordinance (XXXVI of 1971)---
----S.2---Income Tax Ordinance (XXXI of 1979), preamble---Chargeability---Set off losses---Appellate Tribunal confirmed the direction of first appellate authority that Worker s Welfare Fund may be charged on income after set off of losses .
CIT v. Kamran Model Factory 2002 PTD 14 rel.
(cc) Income Tax Ordinance (XXXI of 1979)---
----S.30---Income from other sources---Scrap sales---Recasting of trading account---Trading account was recast by the Assessing Officer and scrap sales were treated as other income---Appellate Tribunal accepted appeal of the assessee and held that assessee had rightly deducted the scrap sales from the cost of goods.
(dd) Income-tax---
----Rejection of accounts---Principles/propositions emerging in the light of case-law.
S.M. Yousuf and Bros v. CIT 1974 PTD 45; R.B. Jessaram Fateh Chand (Sugar Deptt) v. CIT Bombay (1970) 75 ITR 33 (Bom.); Mr. Durai Raj v. CIT (1972) 83 ITR 484 (Kar.); Muhammad Umer v. CIT (1975) 101 ITR 525 (Pat.) and C.M. Francis and Co. (P.) Ltd. v. CIT (1970) 77 ITR 449 ref.
(ee) Income Tax Ordinance (XXXI of 1979)---
----S. 62---Assessments on production of accounts, evidence etc.---Cash purchases---Addition---First Appellate Authority maintained only 20% of such addition to cover a suspicion of over statement of cash purchases by observing that possibility cannot be ruled out that cash purchases have been recorded at price higher than actually paid ---Validity---Disallowance of total payment of cash purchases was a novel treatment---Raw material purchased in cash was taken into account for calculation of excess consumption---Department had not urged that the raw material purchased from unverifiable parties was not received by the assessee or not utilized for production---Raw material purchased was recorded in the stock register---Add back of total payment from the raw material purchased from unverifiable parties could not be maintained---Suspicion of inflating of purchase price of cash purchases could only arise if the Gross Profit declared had been low or price paid for the cash purchases was more than verifiable purchases---When both these factors were not present the suspicion was totally unfounded and no addition on mere guess and conjecture had been approved by higher judicial authorities---Appellate Tribunal directed that the amount paid for cash purchases by the assessee be allowed in full.
S.M. Yousuf and Bros v. CIT 1974 PTD 45; R.B. Jessaram Fateh Chand (Sugar Deptt) v. CIT Bombay (1970) 75 ITR 33 (Bom.); Mr. Durai Raj v. CIT (1972) 83 ITR 484 (Kr.); Muhammad Umer v. CIT (1975) 101 ITR 525 (Pat) and C.M. Francis & Co. (P.) Ltd. v. CIT (1970) 77 ITR 449 rel.
(ff) Income Tax Ordinance (XXXI of 1979)---
----S. 62---Assessments on production of accounts, evidence etc.---Cash purchases---Rejection of trading result on account of having purchased from unverifiable parties---Validity---Law did not require an assessee to ascertain the whereabouts of seller/purchaser before entering into any deal.
(gg) Income-tax---
----Cash purchases---Mere fact that only 2.9% cash purchases were made from unorganized sector was not a defect either under the law or under the accepted principles of accounting.
(hh) Income-tax---
----Rejection of accounts---Cash purchases---Cash purchases were a fact of life and this fact could not be ignored in the under-developed countries like Pakistan---No principle of accountancy or rule of law was available to the effect that an assessee must purchase the goods either on credit basis or from verifiable parties only---Mere fact that a part of purchases was in cash, would not by itself be a ground for rejecting the book version.
(ii) Income Tax Ordinance (XXXI of 1979)---
----S. 62---Assessments on production of accounts, evidence etc.---Excess consumption/wastage---Addition of---First Appellate Authority deleted such addition on the ground that wastage claimed at 6.52% was less than the minimum of 8.77% allowed by the Department and actually higher wastage of more than 13% had been allowed which action had been confirmed by the Appellate Tribunal in the previous year---Validity---Departmentalappealagainstthereliefallowedinrespectof wastage had no merits, when the wastage allowed at 6.25% wasmuch lessthanthewastageofupto13.61%consideredreasonableby the Appellate Tribunal in assessment year 1996-97---No interference was made with the first appellate authority s order and departmentappealonthisgroundwasdismissedbytheAppellateTribunal.
Messrs Shafiq Textile Mills Ltd. 2001 PTD (Trib.) 2941; Indus Textile Mills Ltd. v. CIT 1989 PTD 56; Tanvir Textile Mills Ltd. v. CIT 1990 PTD 254 and Messrs Shafiq Textile Mills Ltd. 2001 PTD (Trib.) 2941 rel.
(jj) Income-tax---
----Rejection of account---Principles.
Messrs Shafiq Textile Mills Ltd. s case 2001 PTD (Trib.) 2941; Indus Textile Mills Ltd. v. CIT 1989 PTD 507 and Tanvir Textile Mills Ltd. v. CIT 1990 PTD 254 rel.
(kk) Income tax---
----Addition---Excess consumption/wastage---Addition merely on account of excessive consumption/wastage in the absence of defects in accounts coupled with low Gross Profit was not justified.
(ll) Income Tax Ordinance (XXXI of 1979)---
----S. 24---Deductions not admissible---History---Telephone expenses were being consistently disallowed @ 10% of the claim and the same treatment was given last year---Deviation from past history and arbitrary disallowance out of telephone expenses @ 28% without any reason was not maintained---Appellate Tribunal directed that the disallowance be made @ 10% of the claim being inlinewiththehistoryofthecase.
(mm) Income Tax Ordinance (XXXI of 1979)---
----Ss. 32 & 62---Method of accounting---Rejection of accounts---Principles summed up by the Appellate Tribunal after considering the case-law and criterion set out by the superior Courts.
(nn) Income Tax Ordinance (XXXI of 1979)---
----Ss. 32 & 62---Method of accounting---Rejection of accounts---Requirements.
M. Jawed Zakaria and Jan-e-Alam I.T.P., for Appellant/ Assessee.
Shaheen Aziz Niazi, D.R. for Respondent/Department.
Date of hearing: 9th October, 2002.
ORDER
JAWAID MASOOD TAHIR BHATTI (JUDICIAL MEMBER).--These are four appeals against following orders of the learned Commissioner of Income-tax (Appeals):--
| S. No. | CIT (A) s Appellate Order No. and Date | Assessment Year | Under section | Appeal filed by before this Tribunal |
| 1. | CIT (A)/III/2000/14, dated 9-12-2000 | 1998-1999 | 62 | Assessee |
| 2. | CIT (A)/III/2002/49, dated 2-5-2002 | 1998-1999 | 62/132 | Department |
| 3. | CIT (A)/III/2002, dated 2-5-2002 | 1999-2000 | 62 | Both by the assessee and the department (Cross appeal) |
Perusal of the above chart shows that the assessee has filed the appealfor the assessment year 1998-99 against CIT(A) s order passed under section 62 assailing the treatment by the officer below:--
(i)excluding the sale of scrap sales from the cost of goods sold,
(ii)rejection of books of account/method of account,
(iii)applying GP rate of 9.20% and
(iv)calculation of excess perquisites.
While the department for this year is aggrieved against the order of the CIT (A) passed under sections 62/132 attacking and the directions of the learned CIT(A) regarding charge of workers welfare fund ontheincome after setting off brought forward losses.
For the assessment year 1999-2000 the cross-appeals have been filed both by the assessee and the department. For this year also the assessee has challenged the treatment of the officers below:--
(i)excluding the sales from the cost of goods sold,
(ii)rejection of declared version, method of accounting and
(iii)restriction of 20% disallowance of cash purchases being addition in trading/production account and added back to the income of the assessee,
(iv)disallowance of excessive wastage and telephone expenses.
While the department has filed the appeal against the direction of the learned CIT(Appeals) for charging workers welfare fund after setting off brought forwarded losses, relief in cash purchases by restricting the disallowance of cash purchases to 20% and deletion of addition on account of wastage of PVC.
All the Four appeals are decided through this combined order.
2.The assessee has been represented by Mr. M. Jawed Zakaria, Advocate and Mr. Jan-e-Alam, ITP (hereinafter referred to as the learned A.Rs.) while the department has been represented by Mr. Shaheen Aziz Niazi (hereinafter referred to as the learned D.R.). Both the learned representatives have been heard, impugned orders of the learned CIT(A) as well as of the DCIT and the other relevant records, case laws and documents placed before us by both the parties have been perused.
Assessee s appeal for the Assessment year 1998-99.
3.In order to appreciate the arguments of both the sides advanced before us we may, in the first instance, silhouette the brief facts leading to this appeal.
The appellant is a public limited company quoted on the stock exchange engaged in manufacture and sale of Cables, Wires and Conductors. The appellant declared the following results:--
| | Asstt. Year 1998-99 | Asstt. Year 1997-98 |
| Sales | 189,531,567 | 330,166,214 |
| G. P. (before depreciation) | 6,637,952 | 37,280,731 |
| Rate of G.P. (before depreciation) | 3.50% | 11.29% |
| Rate of G.P. (after depreciation) | 0.55% | 9.55% |
It is evident from the record that the declared results were casted and prepared in the same manner as being done from year to year by deducting the sales of scrap from cost of goods sold. This treatment was accepted by the department up to assessment year 1997-98.
During the year under appeal in the opinion of the Assessing Officer the sales of scrap were to be declared as other income and they were not part of the trading account and he therefore recasted the trading account and transferred the scrap sales to profit and loss account and treated them as other income. The recasted trading account is as under:--
1998-991997-98
Sales declaredRs.189,531,567Rs.330,166,214
Cost of salesRs.188,488,575Rs.298,624,700
Add: Cost enhanced by
Scrap salesRs.7,352,287Rs.1,756,010
Recasted cost of salesRs.195,840,862Rs.300,374,710
Gross profit (Recasted)Rs.6,309,295Rs.29,791,504
G.P. Rate9.02%
In view of the defects mentioned in the assessment order to be discussed later the declared version was rejected and the income of the appellant was computed by applying the recasted GP rate of 9.02% on the declared sales. The assessee agitated this treatment of the Assessing Officer in first appeal but the arguments of the appellant/assessee did not find favour with the CIT(A) who maintained the action of the Assessing Officer. Hence this second appeal before us. The following grounds of appeal have been taken by the appellant/assessee:
(1)That the order of the learned CIT(A) is bad in law and on facts.
(2)That the learned CIT Appeals has erred in not accepting the declared version of the appellant.
(3)That without prejudice to above the learned CIT(A) has erred in maintaining the G.P. rate applied on the declared sales which apart from being unjust, without any basis is also very harsh and excessive.
(4)That without prejudice to above the learned CIT(A) has erred in maintaining the action of the learned Assessing Officer in excluding the sale of scrap for computing the declared G.P. and for working out the addition for short G.P. when the treatment given by the appellant was as per regular method of accountancy maintained by the appellant.
(5)That the learned CIT(A) has erred in upholding its observation of the learned Assessing Officer that the details of rate of scrap sales were not furnished when the same were duly furnished by the appellant.
(6)That the learned CIT(A) has erred in taking cognizance of alleged defects mentioned in the assessment order which were not confronted to the appellant.
(7)That the learned CIT(A) has erred in stating that the sales of the appellant were not verifiable.
(8)That the learned CIT(A) has erred in holding that there is no mistake apparent from record in calculating the addition in GP which has been worked out at Rs.23,400,042 instead of Rs.16,052,755.
(9)That the learned CIT(A) has erred in holding that there is no calculation error in the assessment order when the arithmetical mistake is apparent from record.
(10)That the learned CIT(A) has erred in maintaining the addition in respect of excess perquisites of Rs.1,031,419 when the same have not been properly calculated specially by including the Dearness Allowance, Special Allowance, Bus Hiring charges, Washing Allowance, Production Incentive Allowance, Attendance Allowance in perquisites while calculating the excess perquisites of the appellant.
(11)That the learned CIT(A) has erred in maintaining the following disallowances out of the expenses.
1.Travelling expenses.Rs.585,181
That the above disallowance apart from being unjust is also very harsh and excessive.
(12)That the learned CIT(A) has erred in merely setting aside the order on the issue of illegal charge of W.W.F. on income before setting of depreciation loss instead of directing to delete the same.
However, at the time of hearing before us the learned counsel for the assessee has not pressed the grounds enlisted at Sr. Nos. 8, 9, 11 and 12, therefore, we need not to dwell on these issues.
4.From the perusal of the impugned order of the learned CIT(A), assessment order notices and their replies submitted by the assessee and various submissions made by the assessee at the first appellate forum and arguments advanced by the learned A.Rs. and learned DR before us the following main issues arise for our consideration:
(i)Whether receipts from sale of scrap is deductible from the cost of raw material consumed? Or alternatively, it should be shown separately as income from other sources.
(ii)Whether the declared results can be rejected on the ground of deduction of scrap sales from the cost of goods sold when in fact this treatment is being adopted from the very inception of the company.
(iii)Whether the method of accounting/books of account can be rejected when the accounts are being regularly maintained in the same pattern and method of accounting during the year under appeal is as such as employed in the past which were accepted after consciously application of mind and detailed scrutiny and examination of books of accounts under normal law of assessment.
(iv)Whether the rejection of accounts is justified when declared sales and purchases and production account have been accepted by the department and no suppression of income has been proved by the department.
(v)Whether rejection of accounts is justified on the sole ground of lowness of GP rate when GP is a balancing figure.
(vi)Whether rejection of accounts is justified without issuing mandatory notice confronting the defects to appellant after examination of books of account as envisaged under the proviso of section 62.
The above issues will be taken up for discussion in the later part of this judgment.
5.Before we take up the grounds of appeal and further move into the arena of arguments of both the sides it would be advisable to consider the scope of section 32 of the Income Tax Ordinance, 1979.
To understand and to embark upon the discussion on the subject we should have a brief background/history/origin of maintenance of books of account and rejection of accounts/method of accounting for better perception on the issue. Section 32 of Income Tax Ordinance, 1979 corresponds to section 13 of the Income Tax Act, 1922. It would not be out to place to mention that similar provisions exist in the tax laws of most of the countries. In the Indian Income Tax Act, 1961, the provisions of section 145 deal with accounts and method of accounting. Under the British Income tax law, the method of accounting is dealt within assessments made under Schedule D of the Income Tax Act. Under the United States Internal Revenue Code, the corresponding provisions are contained in section 446. The subject-matter of rejection of accounts/ method of accounting is highly sensitive and it always remains a veritable war between the taxpayers and tax collectors. The introduction of section 13 in the defunct Act, 1922 can be traced back in the Income Tax Act, 1918. In the Act, 1918, there were no provisions as are provided in section 13 of the defunct Act, 1922. The necessity to introduce this section in the tax statute arose after decision in (Board of Revenue v. Arunachalam Chettiar (1 ITC 75). The reference and discussion on this judgment will be made in the course of this judgment. Section 13 of Income Tax Act, 1922 (which corresponds to section 32 of Income Tax Ordinance, 1979) is unique in certain respects, and there is a small history behind the section. Even though the origin of book keeping is lost in obscurity, it admits of no doubt that some method of keeping accounts has existed from the remotest times. It is equally manifest that in business it is necessary to record movements of credit, as mere receipts and payments of money would show only a part ofthe total transactions. The only reliable method of preparing the final accounts of a business for a given period is, therefore, by means of the double entry records. The mercantile accountancy system must, therefore, have been adopted in England hundreds of years ago. Thedistinguishingfeatureof mercantile method of accountancy is that it brings into credit what isdue immediately it becomes legally due and before it is actually received;anditbringsintodebitexpendituretheamountforwhichalegalliability has been incurred before it is actually disbursed. The mercantile accountancy system is the opposite of the cash system of book keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed.
In actual business practice, however, the systems of book keeping followed in many cases are such that they can be called neither the full mercantile accountancy system nor the cash basis of book keeping. They are simply mixtures of the two systems and styled as hybrid systems of book keeping . This expression hybrid system of accounting has been borrowed from some of the judicial decisions. The expression hybrid indicates the birth of a system born out of an inter mixture of the two. When the assessee simultaneously in respect of certain transactions following a mercantile system of accounting, in respect of others follows the cash system of accounting, then the proper expression should perhaps be that he maintains a dual or a plural system of accounting in respect of different transactions because the expression hybrid would be the result of inter mixture of two systems and something of a third system emerges. We, however, find that in the English Income Tax Act, 1918 there was no provisions analogous to the provisions of section 13. Even in Indo-Pak sub-continent section 13 was introduced for the first time in the Income Tax Act, 1922 and there was no provision in the Income Tax Acts preceding the Act of 1922 similar to the provisions of section 13. The section does, to my mind, owe its origin to the controversy that culminated in the decision of a Full Bench of the Madras High Court in (Secretary to the Board of Revenue. IT, Madras v. Arunachalam Chettier (1921) 1 ITC 75). The question that arose for determination in that case was whether interest which had accrued due to the year of account to a money lending firm that maintained its account on the mercantile basis, but was not realized in cash or by adjustment in the accounts, was liable to tax under the Income Tax Act, 1918. Four of the five learned Judges constituting the Bench answered the question in the negative. In the course of his judgment Sir John Wallis, C.J. made reference to the language of Rule 1 of Schedule D of the English Income Tax Act, 1918, and observed that in construing the provisions of section 9 of the Act of 1918 which dealt with income derived from business , and the uniforminterpretation which has been put upon the corresponding provisions of English Acts, it must always be borne in mind that in its natural and legal meaning income means periodical receipts; that an income tax is, therefore, presumably a tax on annual receipts. He then went on to observe that while it is open to the legislature for a good and sufficient reason to enact that debts which have not been paid but are still outstanding shall be treated as incomefor the purposes of the Act, the Court could not be justified in attributing such an intention to the legislature, in the absence of the clearest and most express language. The learned Chief Justice referred to a number of English decisions in support of the view held by him that for the purposes of assessment of income-tax only actual and not notional receipts could be taken into account. Towards the close of his judgment he pointed out that if the present Act is found to admit of extensive evasion in India, the remedy, in my opinion, is to be found in an alteration of the law . Sadasiva Ayyar, J., dissented from the view of the majority of Judges and was of the opinion that unrealized interest could be taxed only if it was so completely under the assessee s control that, by an act of his will, he could receive it in cash without greater trouble than was involved in drawing money from his bankers. The judgment of the Full Bench was delivered in October, 1920 and then section 13 was introduced by the legislature in Act of 1922 which received the assent of the Governor General on 5-3-1922. It is fair to assume that in pursuance of the suggestion contained in the judgment of Sir John Wallis, C.J. for an alteration of the law and in order to set at rest the controversy that had arisen in the Madras High Court and had occasioned difference of opinion between the Judges of the Court. Section 13 was enacted by the legislature. In order to appreciate the position and significance of section 32 (old section 13), it would be in the fitness of things, if both the sections are compared. The text of sections in both the statutes would be of great help. For the sake of facility, the sections as appear in both the statutes are reproduced hereunder: Section 13 Act XI of 1922-Text of.
(13) Method of Accounting: Income profit and gains shall be computed for the purposes of sections 10 and 12 in accordance with the method of accounting regularly employed by the assessee:
Provided that if no method of accounting has regularly being employed or if the method employed is such that in the opinion of Income Tax Officer, the income profit and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income Tax Officer may determine.
Proviso was introduced vide Ordinance 15 of 1959 whichreads:--
Provided further that the Central Board of Revenue may, in the case of any person, or a class of persons requires such person or a class of persons to maintain accounts, or prescribe the method of accounting to be employed by such persons or class of persons or the manner in which payments or commercial transactions should be recorded and in such an event, theincome profit and gains of the assessee shall be computed onthe basis of books, accounts, or records maintained accordingly;
Through Ordinance 24 of 1961 w.e.f. 1st July, 1961, an explanation was added;
Explanation. The expression method of accounting as used in this section includes the language or script employed or to be employed by an assessee for the purposes of maintaining his accounts .
In Ordinance of 1979, section 32 read as under:-
(32)Method of accounting.---(1) Income, profits and gains except income from dividends, shall be computed for purposes of sections 17, 19, 22, 27 and 30 in accordance with the method of accounting regularly employed by the assessee.
(2)Notwithstanding anything contained in subsection (1), the Central Board of Revenue may, in the case of any business or profession, or class of business, or profession, or any other source of income or any class of persons,--
(a)require, by a general a special order published in the official Gazette that the accounts shall be maintained in such form and in such manner as may be prescribed; and
(b)prescribe the manner in which payments of commercial nature shall be made or commercial transactions recorded;
and thereupon, the income, profits and gains of the assessee shall be computed on the basis of accounts or records maintained or payments made accordingly.
(3)Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of Deputy Commissioner, the income, profits and gains cannot be properly deducedtherefrom,orwhere,inanycasetowhichsub-section (2) applies, the assessee fails to maintain accounts, make payments or record transactions in the form or manner, as the case may be, prescribed under the said subsection, then, the income, profits and gains of the assessee shall be computed on such basis and in such manner as the Deputy Commissioner thinks fit.
(4)For the purpose of subsection (3), where the Central Board of Revenue deems necessary, it may, by a general or special order in writing, prescribe rates of net profit or gross profit and conditions of their applicability in respect of any trade, business or profession for any assessment year or years:
Provided that such rates shall be applicable in case of an assessee at his option to be exercised in writing before finalizationofassessmentproceedingsforanassessmentyear:
Provided, further that where in any previous year or years, an assessee has declared the net profit or gross profit in respect of his trade, business or profession or has been for more than once assessed in the previous year in excess of rate of profit prescribed by the Central Board of Revenue under this subsection,such option will not be available to him.
In order to analyze the section, the following is the position:--
(i)The department has to compute the income, profits and gains under the heads interest on securities (S.17), income from house property (S. 19), income from business or profession (S.22), capital gains (S.27) and income from other sources (S.30) in accordance with the method of accounting regularly employed by the assessee. Subsection (1) of section 32 provides for the computation of income profits and gains in accordance with the method of accounting regularly employed by the assessee. In this subsection the only condition is that the method employed by the assessee is a regularmethod and the method discloses true profits.
(ii)Subsection (2) as provided in section 32 of Ordinance 1979 takes away the discretion of choice of accounting method to be regularly employed by the assessee. Subsection (2) of the qua section starts with non obstante clause excluding subsection (1) wherein discretion of choice of accounting method vests with the assessee, provides discretion with the Central Board of Revenue to direct any business or profession or person or class of persons to maintain accounts in manner and form as prescribed by the Central Board of Revenue. Not only the maintenance of accounts but also recording of payments and commercial transactions record is to be maintained as directed and prescribed by the Central Board of Revenue.
(iii)The Income Tax Ordinance, 1979 like its predecessor the Income Tax Act, 1922 does not define books of account . This provision of law (quoted supra), inter alia, authorizes the Central Board of Revenue to prescribe maintenance of accounts and recording to payment of commercial transactions. The Central Board of Revenue has consequently framed rules under the Income Tax Ordinance, called the Income Tax Rules, 1982, Rules 27 to 35 of these Rules relate to books of accounts and documents to be maintained by General Medical Practitioners (Rule 28), Medical Specialists etc. (Rule 29), Nursing Homes etc.(Rule30),andLawyers,Accountants,Architectsetc.(Rule 31). The documents prescribed in the Rules 28 to 31 are confined to receipt and expenditure Books, machine numbered slips/cash memos and original Expenditure Vouchers or Counterfoils of Cheques etc. These Rules, however, relate only to specified professions and not to business in general, for whom no method of accounting/books of accounts has so far been prescribed under Income Tax Ordinance, 1979.
(iv)This section outlines the procedure which an DCIT/Assessing Officer/Taxation officer must adopt in computing an assessee s income under specified heads of income or from any source of income, excepting dividend and salary. If the assessee regularly employs a method of accounting, profits are to be computed in accordance with the said method. The method must, however, be such that the income could be properly deduced therefrom.
(v)Where no method of accounting is regularly employed, the Assessing Officer may make a computation under subsection (3) of section 32, on such basis and in such manner as he thinks fit. In certain class of cases this may have to be done by invoking subsection (2) of section 32-A of the Ordinance, 1979.
(vi)We may now focus particular attention on the provisions of subsection (3) of section 32 of the Income Tax Ordinance, 1979, which prescribe:
Where no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the DCIT, the income, profits and gains cannot be properly deduced therefrom then the income, profits and gains of the assessee shall be computed on such basis and in such manner as the DCIT thinks fit.
In the new Income Tax Ordinance, 2001 which is effective from July, 2002 the method of accounting luckily finds the same number i.e. section 32 as it stood in the repealed Income Tax Ordinance, 1979. The section 32 of Income Tax Ordinance, 2001 is reproduced hereunder.
Section 32. Method of accounting: (1) A person s income chargeable to tax under the head Income from business shall be computed in accordance with the method of accounting regularly employed by the persons.
(2)Subject to subsection (3), a company shall account for income chargeable to tax under the head Income from Business on an accrual basis, while other persons may account for such income on a cash or accrual basis.
(3)The Central Board of Revenue may prescribe that any class of persons small account for income chargeable to tax under the head Income from Business on a cash or accrual basis.
(4)A person may apply, in writing, for a change in the person s method of accounting and the Commissioner may, by notice in writing, approve such an application but only if satisfied that the change is necessary to clearly reflect the person s income chargeable to tax under the head Income from Business .
(5)If a person s method of accounting has changed, the person shall make adjustments to items of income, deduction, or credit, or to any other items affected by the change so that no item is omitted and no item is taken into account more than once.
We, at present, do not offer may comments on corresponding provisions of Income Tax Ordinance, 2001. But however, at the same time we would only quote the observation of Lord Summer: The way of taxpayers is hard and the legislature does not go out of its way to make it any easier.
Before we proceed further, it would be fitness of things if the important words used in section 32 of the Income Tax Ordinance, 1979 are clarified, explained and interpreted.
Important words/phrases in section 32 of Income Tax Ordinance, 1979
(i)Method meaning of
(ii)Method of accounting
(iii) Computation of Income on such basis and in such manner as thinks fit .
(iv)In the opinion of DCIT word opinion meaning of.
(I) Method Meaning of.
(i)The method of accounting includes the language or the script for recording transaction.
(ii)Method also includes pattern, system, principles, language and currency on the basis of which the accounts of an assessee are maintained.
(iii)The word method means procedure for attaining an object, system of arrangement, manner, classification or system. Method is the placing several thingsand performing several operations in the most convenient order. Method of accounting will include the basis of calculation of depreciation, valuation of closing stock, adjustment of profit on incomplete contracts, adjustment of liabilities for bonus, gratuity, etc. Method of accounting is not synonymous with single entry or double entry system of accounting or cash basis or mercantile basis of accounting. For example in a double entry system on mercantile basis there may be different methods of accounting adopted by different persons.
(iv)The word method must be given a broad and reasonable interpretation.
(v)The expression method of accounting obviously includes the manner in which the assessee displays the activities of his business by entries in such books of account he maintains.
(II)Method of Accounting.
Mainly there are three types of accounting methods:
(i)Mercantile/accrual system
(ii)Cash system/Receipt system
(iii)Hybrid/heterogeneous, dual or plural/mixed systems of accounting or other basis
It is not necessary that only one of the two aforesaid methods of accounting should be employed by an assessee. He can choose different methods for different parts of his business or under special circumstances two different methods for one part of business may be employed e.g., mercantile system for dealing with Govt. department and cash system for local parties. He may also employ any other method but it is necessary that such method should be regularly employed from which the income can be deduced properly. Some firms employ the hybrid system which is mixture of cash and mercantile systems but there may be other methods also.
Mercantile system of accounting.
Sir Iqbal Ahmed in the case of [CIT v. Singari Bai (1945) 13 ITR 224 (All)]. Commented upon the mercantile system of accounting asfollows:--
Under this system, the net profit or loss is calculated after taking into account all the income and all the expenditure relating to that period, whether such income has been actually received or not whether such expenditure has been actually paid or not. That is to say, the profit computed under this system is the profit actually earned, though not realised in cash, or the loss computed under this system is the loss actually sustained though not necessarily paid incash.
The distinguishing feature of this method of accountancy is that it brings into credit what is due, immediately after it becomes legally due and before it is actually received; and it brings into debit expenditure the amount for which is legal liability has been incurred before it is actually disbursed.
Cash system of accounting.
Sir Courtney Terrell in the case of [Dhakshwar Prased Narain Singh v. CIT (1936) 4 ITR 71 (Pat.)] observed that accounting to cash system of accountancy a record is kept of actual receipts and actual payments, entries being made only when money is actually collected or disbursedand if the profits of the business are accounted for in this way, the tax is payable on the difference between the receipts and the disbursements for the period in question.
To conclude, it can be said that under mercantile system of accounting, income is realized when fixed and unconditional rights to receive it accrues to the taxpayer, under cash system realization of income is usually deemed to occur when payment is actually received by taxpayer.
Hybrid heterogeneous, mixed or dual or plural systems of accounting.
Besides the cash system and the mercantile system, there are innumerable other systems of accounting which may be called hybrid or heterogeneous or mixed system of accounting in which certain elements and incidents of cash and mercantile systems are combined. It is not incumbent upon an assessee to follow a purely cash method of accounting or a purely mercantile method of accounting, it can be a mixture of both. An assessee may choose the mercantile system for certain transactions and the cash basis for other transactions.
Dual or plural system of accounting.
When the assessee simultaneously in respect of certain transactions following a mercantile system of accounting, in respect of other followsthe cash system of accounting, then the proper expression should perhaps be that he maintains a dual or a plural system of accounting in respect of different transactions because the expression hybrid would be the result of inter mixture of two systems and something of a third system emerges. In fact, the name by which a method of accounting is called, is not so important nor is it important whether the system of accounting adopted by the assessee conforms to the requirements of a known method of accounting so long as the profits of the business could fairly and properly be determined from the accounts. A method of accounting may not be scientific and yet if the assessee regularly follows it, the authorities cannot discard it unless the method fails to reflect the true profits.
Different accounting method.
The Income Tax Law permits an assessee may employ one method of accounting for one part of business or oneclass of customers, and a different method for another part of his business or another class of customers. He may also keep accounts in respect of different parts of the same business on different basis. If such different methods are employed regularly and consistently the profits have to be computed in accordance with the respective methods provided it results in a proper determination of true profits.
III. Computation of Income on such basis and in such manner as thinks fit
(a)
--Where the assessee fails to maintain accounts, or does not record payment of commercial or general transactions in the form or the manner prescribed by the C.B.R.;
--Where the assessee chooses not to keep any accounts;
--Where accounts are kept but the method of accounting is not regularly employed;
--Where method of accounting is regularly employed but income, profits and gains cannot be properly deduced thereform.
(b)It would be beneficial to cite the classical observation of his lordship Mr. Justice Muhammad Akram for ascertaining the definition of aforesaid words/phrases, while delivering the judgment at Lahore High Court as [Rajput Metal Works Ltd. v. CIT reported as (PLD 1976 Lahore 223):
The first proviso to section 13 of the Act expressly lays down that if no method of accounting has been regularly employed or if the method employed is such that in the opinion of the Income Tax Officer the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income Tax Officer may determine. It is, therefore, clear from the proviso that after the Income Tax Officer, had rejected the account version for the reasons assigned by him, a further and much onerous duty was cast upon him to make his computation of the income upon such basis and in such manner as he may determine . The determination and the computation of the Income must be made on a basis evolved by the Income Tax Officer. His judgment must be based on reason. He cannot just take a leap in dark and indulge in a pure guess by making arbitrary, capricious and an ad hoc addition without laying down the basis for it. He should endeavour to the best of his ability to ascertain the income, profits and gains of the assessee nearest to his true income, profits and gains as far as possible under the circumstances of the case.
(c)The legal position appears to be well-settled that if DCIT (Assessing Officer) proposes to make an estimate in disregard of the evidence (oral or written) furnished by the assessee, he should in all fairness disclose to the assessee the material basis on which he intends to frame the assessment, the same to be disclosed to assessee so as to apprise him of the basis for the proposed assessment. The assessee may also be provided fair and full opportunity for rebuttal. This proposition, based on the principles of natural justice and audi alteram partem, is so axiomatic that it does not require support of any case-law more so when these principles are to be read as part of every enactment.
(IV)In the opinion of DCIT/Assessing Officer/Taxation Officer, Word opinion---meaning of.
Before forming an opinion there must exist reasonable grounds known to the (DCIT/Assessing Officer/Taxation Officer) and made clear to the assessee before the power in this behalf is validly exercised under section 32. The opinion must be that of a prudent person, based on reasonable grounds emerging from direct or circumstantial evidence but not on mere suspicion or rumour. Similarly, conclusion about the satisfactory nature of the explanation must emanate from a state of mind which has been induced by the existence of reasonable ground for satisfaction or dissatisfaction. Moreover, such opinion or satisfaction should not only be clearly mentioned in the order itself but before doing so as per principle of natural justice, equity and fairplay basisof opinion or satisfaction or dissatisfaction must disclose to the assessee concerned and these shouldbe clearly mentioned in the assessment order itself as this is a direct way to give out the mind of the Authority who passed the order. It is all the more essential in an appealable order so as to enable the higher forum whether mind was consciously applied to the material brought on record. The opinion or satisfaction unless demonstrated in absolute terms cannot be presumed, hence it should be mentioned in un-ambiguous language. In the absence of reasons recorded to justify such opinion or satisfaction, the whole exercise would become tainted with illegality and amount to non-application of mind which would render it devoid of lawful Authority, as it is held in [CIT v. Sh. Ehsan Elahi 1980 PTD 261 (PEH HC)] that Exercise of discretion should be neither capricious, nor arbitrary nor perverse and should be able to meet test of reasonableness and justification . The words in the opinion of the Taxation Officer/Assessing Officer which are particularly provided in section 32 of the Income Ordinance, 1979. It needs no elaborate arguments to canvass that the opinion mustbe honest conviction based on tangible materialcapable sustaining such an opinion and not a mala fide opinion or colourable exercise of statutory authority. What is required is that there must exist reasonable ground known to the officer and made clear to the assessee before the power conferred in this behalf could be validly exercised. The opinion must be such as an honest person would form on reasonable grounds emerging from direct evidence and not from mere suspicion or a rumour. Moreover, the opinion should be significantly expressed in the mandatory notice under section 62 and also in the body of the order itself, because only such a course can disclose the mind of the authority who should frame the order and spell out the reasons for framing it. This is all the more essential in an appealable order so as to enable the higher appellate forum to judge whether mind was consciously applied to the material brought on record. The opinion should be expressed in unambiguous terms because omission to record reason for forming an opinion, is bound to taint the whole exercise with illegality thus making it devoid of lawful authority.
It may now be taken as well-settled by a catena of decisions of the Supreme Court of India in the following reported decisions: (CIT v. McMillan and Co. (1958) 33 ITR 182 (SC), CIT v. A. Krishnaswami Mudaliar (1964) 53 ITR 122 (SC) and CIT v. British Paints India Ltd. (1991) 188 ITR 44 (SC) wherein it has been held that the expression in the opinion of the Assessing Officer does not confer a mere discretionary power, but in the context of the words used in the provision of the Income Tax Law as in India or Pakistan they impose a statutory duty on the officer to examine in every case the method of accounting to see:
(i)Whether or not it is regularly employed; and
(ii)to determine whether the income, profits and gains can properly be deduced therefrom.
The decision as to method, is to be arrived at first by the officer after a careful scrutiny of the accounts, whether they are simple or complicated, and the power is to be reasonably and judicially exercised, which excludes any subjective or arbitrary decision by the officer. A non-exercise of the power so conferred is also a decision inasmuch as it amounts to an acceptance of the method of accounting on the ground that the income, profits and gains can properly be deduced therefrom.
It must however be kept in mind that while section 32 of Income Tax Ordinance, 1979 enables the officer not to accept the method of accounting of the assessee if he is of the opinion that the method employed is such that the income cannot properly be deduced therefrom, thus, apart from section 32 there is no power in the officer to impose his own method of accounting on the assessee. In this case the method of accounting accepted by the income tax authorities for a large number of years was sought to be altered for no reason causing great hardship to the assessee.
The expression in the opinion of the DCIT in the provision of section 32 of Income Tax Ordinance does not confer a mere discretionary power, in the Tax context it imposes a statutory duty on the DCIT (Assessing Officer) to examine in very case the method of accounting employed by the assessee and to see whether or not it has been regularly employed and to determine whether the income, profits and gains of the assessee could properly be deduced therefrom. Such statutory obligation cannot be exercised arbitrarily or capriciously or dishonestly. The DCIT (Assessing Officer) must exercise his judgment in such a manner as would make it possible for him to ascertain the profits and gains of the assessee most approximating to truth and must exercise his discretion and judgment judicially and reasonably, merely surmises and conjectures cannot be the basis to reject account version.
From the above discussion it is very much clear that the material basis for the formation of opinion has been circumscribed in this section. The mere ipsi dixit of the Income Tax Authorities unrelated to the criteria laid down in the statute would not be considered opinion but a dogmatic assertion, which is impermissible under the statute.
The Andhra Pradesh High Court in a case titled as (Dr. Jayanti Dharma Teja v. Secretary Govt. of India, Ministry of Finance. New Delhi, and others reported as (1984) 148 ITR 316(AP) has held that in the opinion of the Income Tax Authority means subjective satisfaction of the Authority. But that subjective satisfaction must be arrived at in an objective way, that is to say, there must be some material on the basis of which such opinion could be reasonably formed. For the formation of the opinion to disallow an expenditure being excessive or unreasonable, the circumstances to be taken into account are the legitimate business needs of the company and the benefit derived by or accruing to it. In another case titled (Kashiprasad Carpets (P.) Ltd. v. CIT reported as (1984) 148 ITR 710 (All.), it has been held that excessiveness or unreasonableness of the commission paid to directors has to be judged from the standpoint of a prudent businessman having regard to the legitimate business needs of the company and could not be left to the subjective opinion of the Income Tax Authorities. As for section 32 the opinion of the DCIT must be without prejudice or bias.
Any opinion which is prima facie arbitrary, capricious or perverse, or is based on subjective consideration or irrelevant fact is no opinion in the eye of law and could be so held by the Appellate Authorities and Courts. Whether or not the DCIT has exercised his opinion honestly, fairly, reasonably and judicially, is a question of law. It is further observed by us that the opinion of the learned DCIT has to be based on justice, equity and on tangible material. The word opinion has been judicially analysed by the Hon ble (Karachi) High Court in a case titled (Star Rolling Mills v. CIT reported as 1974 PTD 200 in the following manner:--
The proviso does not give any arbitrary, unguided, uncontrolled ornaked power to the Assessing Officer. In Webster s New International Dictionary, Second Edition, the word opinion has been defined as notion or conviction founded on probable evidence; belief stronger than impression, less strong than positive knowledge . According to Corpus Juris Secundum the word opinion contemplates, conclusion or judgment held with confidence, but falling short of positive knowledge . An opinion on the basis whereof a statutory authority is entitled or empowered to take any action or initiate any legal proceeding, may be accurate or erroneous, but it must be an honest opinion or conviction, based on tangible material capable of sustaining such opinion and not mala fide opinion or colourable exercise of statutory power .
The power of Assessing Officer/DCIT/Taxation Officer under section 32 is not power to destroy, the power, as envisaged under section 32 read with proviso to subsection (1) of section 62, does not mean that while forming an opinion he has to act arbitrarily, capriciously and without any regard to the rules of justice. The statutory duty cast by the aforesaid sections is to be exercised in accordance with the recognized and well-settled principles. Even in cases where the actions are taken by administrative authorities under the garb of discretionary power they do not have an unfettered discretion to act arbitrarily.
Starting with the concept of method of accounting it is desirable to consider how books of accounts are rejected under section 32(2), (3) and (4). This question requires a brief but significant elaboration. Section 32 is mandatory according to subsection (1) of section 32 incomes, profits, and gains under section 17, 19, 22, 27 and 30, except income from salary and dividends are computed in accordance with the method of accounting regularly employed and method of accounting can be rejected only the DCIT opines that it is not possible to deduce income, profits and gains therefrom, therefore, and if the Assessing Officer has some concrete/tangible evidence that the assessee has suppressed his income the Assessing Officer under the law is duty bound to record the reasons based on evidence in respect thereof. The books of accounts without recording such finding cannot be rejected under subsection (1) of section32oftheIncomeTax Ordinance, 1979. Subsection (2)ofsection 32 of the Income Tax Ordinance, 1979 is a non-obstante provision, it also supersedes subsection (1), thereof, in respect of these assessees who are required to maintain books of account in such form and manner what the C.B.R. may prescribe by a general or special order in writing.
From perusal of above said section as a whole it is vivid that the Assessing Officer is bound to accept the book version and choice of method of accounting regularly employed by the assessee unless by that method the true income profits and gains cannot be deduced therefrom and if the Assessing Officer has some concrete/tangible evidence that the assessee has suppressed his income and shall record the reasons in respect thereof. Therefore, if theassessee regularly employs a particular method of accounting and if no defects are found in the method of maintenance of accounting, the Assessing Officer is bound to accept the same.
Choice with the assessee to adopt his own system of accounting.
The assessee may keep his accounts in any language he chooses. Accounts in Pakistan are normally maintained in English or Urdu languages certain scripts employed by certain persons of the communities such as Gujrati in Guajrati language. All these are traditionally permissible scripts in practice of Income tax law in Pakistan.
The Income Tax Ordinance, 1979 permits an assessee to adopt his own system of accounting. However the assessee must show that he has followed the method regularly. In this connection we may cite the relevant observation from a reported case titled (CIT v. Sarangpur Cotton Mfg Co. Ltd. reported as (1938) 6 ITR 36), wherein it has been held that:--
..the section relates to a method of accounting regularly employed by the assessee for his own purposes in this case for the purposes of the company s business and does not relate to a method of making up the statutory return for assessment to income tax. Secondly, the section clearly makes such a method of accounting a compulsory basis of computation unless in the opinion of the income tax officer the income, profits and gains cannot properly be deduced therefrom. It may well be that, though the profit brought out in the accounts is not the true figure for income tax purposes the true figure can be accurately deduced therefrom. The simplest case would be where it appears on the face of the accounts that a stated deduction has been made for the purpose of reserve. But there may well be more complicated cases in which, nevertheless, it is possible to deduce the true profit from the accounts, and the judgment of the income tax officer under the proviso must be properly exercised. It is misleading to describe the duty of the Income Tax Officer as a discretionary power.
Analyzing this peace of legislation, it would appear that it postulates the following conditions:
If the assessee has been regularly employing a method of accounting and his income profits and gains can properly be deduced therefrom, the assessment has to be made in accordance with the regularly employed method, the DCIT is bound to accept the same as envisaged under proviso to section 32(1) of the Income Tax Ordinance, 1979. However, if method of accounting is not such and there is concrete and tangible evidence with the DCIT that the assessee has deliberately omitted/suppressed the income then by recourse to subsection (3) of section 32 the DCIT shall compute the gains and profits of the assessee on that basisashethinksfit.Howeverthereisnomentionofthewordsbooksofaccountsinsection32theprovisiontosection32iscomputationsection. Thewords booksofaccount appearinsection 62(1)ofIncomeTaxOrdinance, 1979.Theprovisionofsection 62 is assessment section. If books of account were unreliable, false, incorrect the DCIT has power to reject such books of account under the proviso of subsection (1) of section 62 to make this position clear, the legislature has specifically provided such power in section 62. There may be cases where the method ofaccounting regularly employed wasacceptabletotheAssessingOfficerasthepropermethod,butthe entries in the books of accounts may be found to be false or fabricatedin such a case the DCIT has to reject the books of account under section 62. The section 32 is invoked when methods of accounting are as such that true profits cannot be deduced therefrom. The expression method of accounting as used in section 32 obviously includes the manner in which the assessee displays the activities of his business by entries in such books of account he maintains. Before discarding method of accounting and after having found serious defects in the method of accounting the legislature has cast a heavy duty on the Assessing Officer to confront the defects in the method of accounting and his computation of income by issuing notice under section 62. Likewise if the accounts maintained by the assessee are defective, in the sense that they do not lead to a correct assessment of income, profits and gains of the business, in this situation the law required to the Assessing Officer to issue notice under section 62 incorporating defects therein and confronting the same to the assessee. In other words sections 32 and 62 are invoked simultaneouslyandthatifthemethodofaccountingisincorrect(section 32) obviously it would lead to defective books of accounts. Therefore, both these sections co-exist simultaneously and for both these situations viz. defects in method of accounting/computation of income under section 32 and defects in maintenance of books of accounts, mandatory notice under section 62(1) is pre-requisite condition for confronting the defects in the method of accounting or defects in the books of accounts jointly and singly as the case may be as after the insertion of said proviso to subsection (1) of section 62 through Finance Act, 1993 the cumulative reading of these provisions shows that the position in this regard is now however different inasmuch as legislature has provided mandatory notice under the said proviso to subsection (1) of section 62. Where the books of accounts are produced, section 32cannot be invoked without recourse to the proviso to subsection (1) of section 62. The provisions of these two sections cannot be entirely divorced from each other. It is on the basis of inquiry under proviso to section 62(1) of the Income Tax Ordinance, 1979 that the provisions of section 32 can be invoked. There is no conflict between the provisions of the two sections and they operate together in appropriate cases. No rejection of method of accounting and books of account under section 32 can be sustained if the Assessing Officer has not considered and recorded afinding against the assessee as to whether he has been regularly employing a method of accounting or whether his income, profits and gain can properly be deduced from his method of the accounting if he has been regularly employing a method of accounting and that the Assessing Officer s decision on the matters not to be a subjective or arbitrary decision but a judicial decision and cannot be accepted if there is no material to support his finding. Further after having been called the books of accounts the Assessing Officer must examine the same and if he detects some major defects, discrepancies/suppression of income in the accounts books from which true income cannot be deduced therefrom, the law has casted an obligation on the Assessing Officer to issue mandatory notice under section 62(1) of Income Tax Ordinance, 1979 if these precedent conditions having not been followed before rejection of accounts the rejection of accounts cannot be sustained.
From the above discourse it is evident that the Assessing Officer must observe the following factors before rejecting books of account/method of accounting: (i)If on examination of books of accounts and details, the Assessing Officer (DCIT) is of the opinion that the method of accounting employed by the assessee is such that true profit and income cannot be deduced therefrom, the DCIT shall give mandatory notice to the assessee as provided in the proviso to subsection (1) of section 62.
(ii)If the method of accounting/books of account maintained by an assessee has been accepted for several years and it has been held that it is possible to deduce profit or loss from the employed methodthenthesamecannotberejectedanditcannotbesaid that it is not possible to deduce true profit from the methodof accounting regularly employed without some concrete evidence and defects detected from the examination of books of accounts.
(iii)After detailed scrutiny of the books of account, if DCIT reaches a conclusion that books of account/method of account suffered such major discrepancies and suppression, then the law has cast a mandatory obligation on the DCIT to issue mandatory notice under section 62(1) of the Income Tax Ordinance, 1979 to the assessee and confront the defects detected by him in the books of account.
(iii-a)When an assessee produces books of accounts as evidence in support of the return, the DCIT disagreeing with such accounts, shall issue a mandatory notice under section 62(1) confronting the defects in the books of accounts to the assessee.
(iii-b)After confronting the defects the Assessing Officer is required to give an opportunity to assessee to rebut the defects, obtain explanation and assessee s view points/explanation about such defects.
(iii-c)The Assessing Officer is bound to record the defects detected in the accounts, explanation of the assessee and also reasons for not accepting the viewpoint/explanation of the assessee and the basis of computation of income in the assessment order.
(iv)The DCIT is required to give a clear-cut finding based on material evidence as to whether the assessee has been regularly employing a method of accounting or whether his income, profits or gains can properly be deduced from method of accounting if he has been regularly employing a method of accounting and the Assessing Officer decision on these matters is not to be a subjective or arbitrary decision but a judicial decision and cannot be accepted if there is no material to support his finding.
6.Mr. M. Javed Zakaria, Advocate alongwith Mr. Jan-e-Alam, ITP, the learned counsel for the assessee have argued the matter in detail and have addressed elaborately, both on factual/the merit of the case as well as on legal plane and have drawn our attention to the relevant sequence of the facts and day to day proceedings of the case. Copies of the notices received and their replies with certified copies of the order sheet were also placed before us in support from which following picture emerges:
The Assessing Officer after having received the return vide notice under section 61, dated 23-8-1999 asked for various details includingreasonforlownessofGP.Therequisitedetailswerefiledby the assessee through letter, dated 13-9-1999 with following details:--
(1)Statement of raw material consumed along with wastage and statementshowingproductionforthreeyearsincomparisontotheconsumptionofelectricity-- (S. No. 11ofthesaidletter)
(2)Qualitative and quantitative details of opening and closing stock (S. No. 12 of the said letter).
(3)Details of sales and purchases above Rs.10,000 with names and addresses of parties (S. No. 15 of the said letter).
Through another letter, dated 20-9-1999 the explanation for decline in sales and GP was filed, which has been reproduced on page 3, 4 and 5 of the assessment order. ThereasonsattributedfordeclineinsalesandGP was elaborately discussed in the above referred letter. It would be moreadvantageous to reproduce the relevant extract from the said letter:--
It is evident that the sales have declined by Rs.140 million which is 43% lower as against last year, the rate of G.P. before depreciation declined by 7.79% and the rate of G.P. after depreciation declined by 9.00%.
Decline in sales by43%
Decline in G.P. before depreciation by7.79%
Decline in G.P. after depreciation by9.00%
Increase in net loss before tax by9.53%
Decline in Turnover
The decline in sales is mainly on account of lack of orders from KESC and WAPDA. The KESC and WAPDA are two major buyers of our products and during the year under review, they did not place significant orders due to their own financial constraints.
The reason for decline in sales would become evident if your goodself will examine the following comparative figures of sales to some major clients.
Rs. in 000
| | 1997-98 Asstt. Year 1998-99 | 1996-97 Asstt. Year 1997-98 | Increase/(Decrease) Amount | Increase/ (Decrease)% |
| KESC | 4,138 | 24,322 | (20,184) | (83%) |
| WAPDA | 60,635 | 116,602 | (55,967) | (48%) |
| Uni Commerce (Pvt.) Ltd. | 32,251 | 93,477 | (61,226) | (65%) |
| Total | 97,024 | 234,401 | (137,377) | (59%) |
It is evident from the above figures that sales to our three major clients as above has dropped by Rs.137 million, out of total decline of Rs.140 million.
REASONS FOR FALL IN G.P:
This year the Company has suffered a net loss of Rs.24.211 million as against loss of Rs.10.681 million of last year. Thus the total difference in the loss is Rs.13.530 million which is due to low G.P. earned during the year. Reasons for fall in G.P. are narrated below:--
(1)Increase in cost of raw material
The fall in G.P. is mainly on account of increase in raw material cost which has increased from 81.42% to 86.18% in comparison with last year. The raw material cost increased due to 13% devaluation of Pak. Rupee during the year.
Pak. Rupee to a US$ on 1-7-199740.7028
Pak. Rupee to a US$ on 30-6-199846.0000
5.2972
Pak Rupees devalued during the year by13%
The massive devaluation of Pak. Rupees resulted in increase in the raw material prices, which could not be compensated because of industrial recession.
(2)Decrease in selling prices
Due to recession and fierce competition we would not fetch better prices of our products. Comparative figures for few sizes are given below:
| | 30-6-1998 | 30-6-1997 | Increase/ (Decrease)% |
| 7.029,S/C, Cu. PVC | 5.63 | 5.93 | (5.06) |
| 1.5. S/C, Cu. PVC | 2.84 | 2.98 | (4.70) |
| 2.5, S/C, Cu. PVC | 4.47 | 4.80 | (6.87) |
| 4, S/C, Cu. PVC | 7.32 | 7.94 | (7.81) |
| 6, S/C, Cu. PVC | 10.42 | 11.05 | (5.70) |
| 10, S/C, Cu. PVC | 16.01 | 16.71 | (4.19) |
| 6, 4/C, Cu. U/A | 59.81 | 62.66 | (4.55) |
| 10,4/C, Cu. U/A | 86.68 | 91.07 | (4.82) |
| 150,3-1/2C, Cu. U/A | 726.46 | 904.34 | (19.66) |
| 240, 3-1/2C,Cu. SWA | 1854.14 | 1891.19 | (1.96) |
| 300, 3-1/2C, Cu. SWA | 1547.51 | 1718.92 | (9.97) |
From the above schedule, it is evident that in spite of the massive devaluation of Pak. Rupee and due to the stiff competition, we had to reduce the prices of our products to get orders so as to keep the industry in operation. This badly affected the raw material cost, as on one hand the cost of our raw material increased and on the other hand the prices of finished products reduced as compared to the preceding year.
(3)Comparative statement of cost of sales
The other reason for decline in the G.P. is manufacturing overheads which in fact has reduced by Rs. 4.532 million but has increased as percentage to sales from 7.29% to 10.32% due to heavy decline in sales. We produce hereunder the comparative statement of our manufacturing expenses.
Asstt. YearAsst. Year
1998-991997-98
year endingyear ending
30-6-199830-6-1997
| | Rs. in 000 | % | Rs. in 000 | % | (Inc)/Dec % |
| Net Sales | 189,532 | -- | 330,166 | - | - |
| Packing Material | 163,345 | 86.18 | 268,805 | 81.42 | (4.76) |
| Stores & Spares | 1,280 | 0.68 | 2,508 | 0.75 | (0.07) |
| Salaries & Wages | 11,934 | 6.30 | 13,899 | 4.21 | (2.09) |
| Fuel, Power and Light | 4,159 | 2.19 | 4,443 | 1.35 | (0.84) |
| Rent, rates & taxes | 149 | 0.08 | 172 | 0.05 | (0.03) |
| Insurance | 89 | 0.05 | 102 | 0.03 | (0.02) |
| Repairs & maintenance | 517 | 0.27 | 928 | 0.28 | (0.01) |
| Vehicles expenses | 550 | 0.29 | 647 | 0.20 | (0.09) |
| Others | 871 | 0.46 | 1,382 | 0.42 | (0.04) |
| | 182,894 | 96.50 | 292,886 | 88.71 | (7.79) |
| G.P. before dep. | 6,638 | 3.50 | 37,28 | 11.29 | (7.79) |
| Depreciation | 5,595 | 2.95 | 5,739 | 1.74 | (1.22) |
| G.P. after dep. | 1,043 | 0.55 | 31,541 | 9.55 | (9.00) |
Stores and spares
Stores and spares expenses have reduced by R.1.228 million and has reduced by 0.07% to the sales.
Salaries and wages
In spite of the fact that the total claim of salaries and wages in terms of rupees shows a decline of Rs.1.965 million as compared to last year,there is an increase of 2.09% in the percentage of salaries and wages to the sales. This increase is mainly on account of the fact that sales have gone down therefore the percentage has gone up.
Fuel, power and light
Although the expense under this head has declined by Rs.0.284 million but it shows an increase of 0.84% compared to decreased sales, though units of electricity consumed are also lesser than last year. This increase in financial terms is on account of increase in the rates made by the Govt. from year to year. The effect of the increase could not be absorbeddue to drastic fall in sales.
In the same letter, dated 20-9-1999 the appellant, also gave a comparative chart of production, wastage of three years including the year under appeal. This has not been reproduced in the assessment order. However, it would be helpful in deciding the issue hence it is also re-produced:
Excess consumption/wastage:
The comparative chart of consumption/wastage is as under:
| | 30-6-1998 | 30-6-1997 | 30-6-1996 |
| Copper Rod | 2.92% | 2.99% | 3.01% |
| Aluminum Rod | 2.96% | 2.87% | 3.10% |
| PVC Compound | 4.61% | 4.48% | 13.61% |
| G.I. Wire (Kgs. consumed against Sales) | 0.08% | 0.10% | 0.12% |
From the above comparative statement, it may be noted that the wastage/consumption in respect of Copper, Aluminum and G.I. Wire is within the allowable limits. The wastage in PVC at 4.61% is lower than the wastage allowed in assessment year 1996-97 at 13.55%.
The appellant in this letter also gave description of the method of accountancy and books of accounts maintained which is also reproduced below for the facility of decision:
The explanation regarding G.P. was given to satisfy your query. We would like to clarify that the accounting methods and policies are consistently followed by us and the transactions are open for verification. Our declared results have a history of acceptance irrespective of the rate of G.P. The broad points are as under:--
(1)Sales are fully verifiable and are mostly to Government, semi-Government organizations and to well-known groups and organizations.Approx.99%ofthepaymentswereceivefrom our valued clients are through crossed cheques andbanking instrument such as L/C, Pay orders and Demanddrafts.
(2)Most of our raw materials are purchased from recognized manufacturers or imported and subjected to customs duty partly in cash and party against indemnity bond which are retrievableon proving consumption based on strict input and output ratios prescribed by Government of Pakistan, Central Board of Revenue. The Collector of Central Excise and the Collector of Customs (Appraisement) both these authorities ensure that the raw materials imported are consumed for the production of wire and cables and issue consumption certificate after verificationof production records. The local purchases are also subjected to deduction of tax at source according to section 50(4) from the parties supplying the goods.
(3)Goods produced by us are subjected to excise and sales tax and the full production records are maintained as prescribed by the Excise and Sales Tax Department. The production is co-related with consumption and is subjected to frequent checks and verification during the year by various audit teams from Excise and Sales Tax Authorities.
After receipt of explanation the Assessing Officer vide notice under section 62, dated 29-10-1999 asked for certain details and explanation. The issues relating to the rejection/acceptance of declared version are mentioned at para. 5, 8 and 13 of the said notice which are reproduced below:
Para. 5 of DCIT s letter. Under the head cost of sales , an amount of Rs.4,159,359 has been claimed on account of fuel, power and light as against last year s claim of Rs.4,443,125. This shows decline of 6.82% as compared to that of last year s expenses. Whereas, sales for the year have decreased by 43%. Please explain such decline and file month-wise consumption of electricity and production account and details under each head along with supporting bills/vouchers, failing which adverse inference would be drawn.
Para. 8 of DCIT s letter. At Note No.17.1, an amount of Rs.7,352,287 on account of scrap sales has been reduced directly from material consumed which is against the accounting principles. In this way, you have enhanced your G.P. rate. Please file complete details of scrap with supporting vouchers and explain as to why the trading account may not be recasted and recasted G.P. rate of 1997-98 @ 9.02% may not be applied on your declared sales.
Para. 13 of DCITs letter. At Note No.17 to the audited accounts, Salaries, wages and other benefits have been claimed Rs.11,934,193. Please file complete details of above expenses, wages register, register of shift work, evidence of tax deduction under section 50(1) of the Income Tax Ordinance, 1979 and production register, failing which adverse inference would be drawn.
The explanation/details asked through notice under section 62 was responded by the assessee vide his letter, dated 4-11-1999. The relevant paras 5,8and13oftheexplanationofassessee,arereproducedbelow:--
Para. 5 of assessee s reply. As regard to the claim of fuel, power and light, we wish to state that rather comparing the electricity expense against the sales volume it is more appropriate to examine the units consumed during the year against the actual production, as the electricity expense may increase due to upward revision in the electricity tariff by the Government and the sales figures may vary due to increase/ decrease in the sales prices of the products. We have already filed a statement showing production and the consumption of units during last three years in compliance to your notice under section 61. From the said statement, it is evident that the production in terms of Meters has declined by 34% and the units consumed during the year have declined by 26%. However, we enclose herewith month-wise consumption of electricity and production alongwith copies of monthly bills.
| | 30-6-1998 | 30-6-1997 |
| Production in Kgs | | 36,076 |
| Production in Meters | 6,452,694 | 9,738,131 |
| Electricity units consumed | 843,700 | 1,145,400 |
| Amount of Electrical Bill (Rs.) | 4,159,359 | 4,443,125 |
Para. 8 of assessee s reply. The acceptance of the books and the declared version and their reliability as per various judicial pronouncements is to be considered in the light of method of accountancy regularly employed by an assessee.
In this case the treatment to the sale of scrap of raw material that it is deducted from the cost of sales is being given regularly by the company and this treatment has been accepted by the department and the auditors of the company.
We may add here that the assessee is listed public company and the accounts are also submitted to Security and Exchange Commission of Pakistan and they have also never objected to the accounting treatment given to the sale of the scrap by the company.
The treatment given is also according to the method approved in various books and authorities on accounting. The extract of some of the books are enclosed.
Even without the help of any accounting book, the logical basis to arrive at the cost of sale can only be worked out by taking the actual cost of raw material consumed in the production. If part of the raw material is sold in its pure form or in the form of industrial waste the sale proceeds of the such sales have to be deducted from the cost of raw material for arriving at the correct and actual cost of raw material in total cost of production.
The way you have recasted the trading account is against the history, accounting principle and also logic.
Without prejudice, we would like to bring to your kind notice that the accounts of the Company are fully verifiable and open to verification and the declared version of the Company has always been accepted right from its inception. The department has always found that it is possible to work out the profit of the Company from the method of accountancy consistently followed by the Company. As the declared results of the Company are accepted, any recasting in the trading account would not affect the income assessed because in any case whether there is higher G.P., lower G.P., or gross loss, the declared results of the Company are to be accepted due to the fact that the results are fully verifiable. Your recasting of the trading account would not affect the income assessed because the declared results merit acceptance in view of the reasons discussed earlier.
Para. 13 of assessee s reply. The required information regarding salaries and wages in respect of taxable employees is already available from copy of statement under section 139 filed before you. This covers expense of Rs.9,222,033.
As regard payments of non-taxable salary and wages in view of large number of persons involved, it is requested that the same may be verified from salary and wages register which will be produced before you at the time of hearing. As regard your requirement of register of shift work, this query is not clear. It may please be explained. We may add here that the Company does not maintain shift-wise wages register and non-maintaining of said register is requirement of law and accounting.
8.The learned counsel for the assessee have drawn our attention to the order sheet entries. It would be in the interest of justice if the relevant extract of order sheet entries relating to the assessment are also reproduced. The relevant order sheet entries are as under:--
| S. No. of Order and Date | Brief order, mentioning reference, if necessary |
| 17-11-1999 | Mr. Iqbal Qasim, AR of assessee Co. attended filed explanation letter along with Annexures. POF. Case adjourned to 19-11-1999 for production of books of A/Cs including wages register and consumption account register. |
| 19-11-1999 | Mr. Iqbal Qasim AR of assessee Co. filed details of raw material, salary, wages and some copies of NICs. POF. Case adjourned to 25-11-1999 for filing of evidence of use of building during the year, details of P&L account expenses, etc. |
| 25-11-1999 | Mr. Iqbal Qasim, AR of assessee Co. attended filed details and produced books of accounts comprising of cash book and ledger and some of vouchers examined. The AR was asked to explain the treatment of scrap with evidence but he failed to explain satisfactorily the same. Hence trading account is rejected. |
The learned ARs of the assessee have argued that the notices issued in this case, the replies filed by the assessee and the order sheet entries clearly show that the Assessing Officer was satisfied on all issues raised by him in his letter/notice under section 62, dated 29-10-1999 except the treatment given by the assessee to the sales of scrap. He pointed out that on 17-11-1999 when reply to notice under section 62 was filed no dissatisfaction about the explanation was recorded. Case was adjourned for production of books of accounts, wages register and consumption register.
According to learned counsel when details of raw material, salaries, wastage and copies of NIC were filed on 19-11-1999 the Assessing Officer did not record his dissatisfaction nor required any further details and documents in respect of wages and the case was adjourned for filing of evidence in respect of building and profit and loss expenses.
Referring to the last entry of order sheet, dated 25-11-1999 when the book of accounts were produced, learned ARs submitted that the dissatisfaction was expressed regarding the explanation in respect of treatment to scrap and the trading account was rejected on this solitary ground as per entry of the order sheet, (the relevant portion of the order sheet entry, dated 25-11-1999 quoted supra and underlined by us for emphasis).
The explanation of the order sheets entries, notices and their replies to which the ARs of the assessee have drawn attention support the reasoning advanced by the learned ARs and the learned D.R. did not dispute the facts narrated. However the learned D.R. has invited our attention towards the defects pointed out by the Assessing Officer and learned CIT(Appeals). According to learned D.R. while going through the orders of two officers below, a number of reasons for rejection of accounts have been given which are:--
(I)The method regularly employed by the appellant by deducting the sale value of scrap material from the cost of goods sold is not according to the accounting principles.
(II)The percentage of receipts from sale of scrap during this year is higher as compared to last year i.e. 3.49% as against 0.6% of last year.
(III)The percentage of scrap of raw material consumed is higher as compared to last year i.e. 3.58% as compared to 0.78% of last year.
(IV)The consumption of fuel and power per unit of production is higher as compared to last year.
(V)The percentage of expenses of salaries and wages charged to the cost of goods is higher as compared to last year.
(VI)The explanation for fall in G.P. quoting the increase in cost of raw material due to devaluation of Pak Rupee is not acceptable.
(VII) Sales are not fully open to verification. In support he has cited the example of sales of approximately Rs.3 lacs all being under Rs.30,000 except for one of Rs.60,000.
(VIII)In a parallel case the G.P. declared is 12.12%.
(IX)That the appellant has enhanced G.P. by deducting the scrap sales.
According to learned D.R. the learned CIT Appeals has also agreed with the Assessing Officer and has confirmed the rejection of account. Relevant paras. 3, 4, 5 and 6 of the impugned order of the learned CIT(A) are reproduced hereunder:--
(3)The debatable point which prominently thus emerges apart from others, from the narrative above is whether receipts from sale of scrap is deductible from the cost of raw material consumed? Or, alternatively it should be declared separately on income from other sources. The appellant shielded himself by citing the history of the case. This was however refuted that the doctrine of res judicata does not hold good in tax matters. Every year has to be viewed independently and conclusion has to be drawn exclusively on the state of affairs prevailing in that individual and particular year. I therefore, concur with the viewpoint of the learned DCIT. The plea, on this count, is hence rejected.
(4)It is also my considered opinion that, in the past, for obvious reasons, this practice was perpetuated against the established principles of book keeping. The sale proceeds of scrap , as it is understood in commercial parlance or even in its ordinary meanings, is purely and surely a direct receipt and ought to be declared as such under the regular head of other income. The treatment is thus confirmed. If, otherwise, allowed it tantamounts to double deduction. I agree with this line of thinking as discussed at length in the impugned order. The contention of the appellant is assuredly misplaced.
(5)It has also been alleged that solitary ground for discarding the book version is owing to the treatment of the sale of scrap. The matter has been looked into from this angle too but found wanting. The reasons assigned for rejection of the book version have beendiscussed threadbare in the body of the order, to wit, the quantity of electric higher units consumed, increase in cost of sales, low G.P., unverifiability of sales and the like. It was also recorded that the appellant failed to file quantity-wise consumption of raw material and wastage including rate of sale scrap. The application of G.P. rate at 9.02% is also in line with rate declared by the appellant in the immediately preceding year. Hence bringing in the status of Pakistan Cables by the appellant, being on a different higher technical plane and hence its margin of profit cannot be compared with the present case. The worthy DCIT has stated that it was simply to draw a general comparison. The history of the appellant is invariably the best guide. The G.P. rate applied is thus confirmed. For the foregoing reasons and facts of the case, I am of the firm opinion that the declared book version has been appropriately discarded. The method of accounts employed by the appellant has also been rightly rejected since it is such a state of unreliability to arrive at the true income, profit and gains. At this juncture mention of section 32(3) of the Ordinance (Method of Accountancy) is considered essential. The phrases in the opinion and things fit gives a long handle to the Assessing Officer in situation like the one the appellant is in.
(6)That the appellant was not confronted with regard to the issues of salaries and wages, in contrary to facts available on record. Details of the employees and copies of NIC were asked but incomplete submission was made (apropos page 9 of the order). Likewise, it has been agitated that verification of the 11 parties on the issue of sales ought to have been referred to the appellant as well and so on and so forth. Suffice it to say, such suggestions are not mandatory and cannot thus be claimed as a matter of legal right. In such matters the discretion of the officer prevails. The objection is thus misplaced.
9.Objecting to the above findings of the officers below and replying the first objection of the Assessing Officer regarding deducting of scrap sales from the cost of goods sold the learned ARs of the assessee submitted that the issue regarding the treatment of the scrap sales has already been decided by the Division Bench of this Tribunal in I.T.A. No.894/KB/2000-2001 decided on 4-6-2002 in the case of Pakistan Cables Ltd. for the assessment year 1998-99. According to learned counsel in that case also, the same treatment was given to the scrap sales and on the basis of same objection theaccount was recasted. The learned Division Bench did not approve this treatment and held as under:--
As regards addition of Rs.7,494,000 under the head other income since admittedly the amount represents sale of scrap which has a direct nexus to the manufacture of cables and wires, the same could not be considered as other income . Ratio of the order of the Income Tax Appellate Tribunal in R.A. Nos.157 to 162 of 1996-97, dated 19-9-2001 referred to supra covers the instant case.
Additional of Rs. 7,494,000 under the head other income is therefore deleted.
We are in respectful agreement with finding given by the Division Bench of this Tribunal and following the same we hold that the original trading account as per accounts should be considered for assessment and the scrap sales taxed as other income be transferred to trading account.
Explaining the objection that percentage of scrap is higher this year the learned A.R.sexplained that the Assessing Officer and the learned CIT Appeals fell in error by comparing the percentage of sales of scrap instead of comparing the percentage of waste suffered in the process of manufacture during the year. They have explained that the scrap sold includes accumulated scrap of earlier years. The learned counsel has also produced some samples for examination before this Bench. He has explained that the percentage of production waste was given by the assessee in his letter, dated 20-9-2002 which is within the limit of wastage allowed to the assessee in the earlier years.
The percentage of production wastage has been reproduced earlier in this order. This wastage was not found excessive by the Assessing Officer and was within the limits of wastage allowed to the assessee in earlier years. The learned D.R. could not say anything to rebut these arguments thus these objections of Assessing Officer and CIT Appeal also do not carry any weight. As regards objection of the Assessing Officer relating to the higher consumption of fuel and power the ARs explained that the objection regarding increase in consumption of electricity is also of no consequence. The only inference that could have been drawn on account of higher number of unit of electricity consumed was that the assessee has suppressed production and the production records and the sales would have been rejected. However, no objection has been raised to the production records maintained by the assessee which are duly checked and verified by the Excise and Sales Tax authorities and the declared sales and production have been accepted. We are inclined to agree with the line of arguments of learned ARs and find no substance in this objection.
Similarly the objection regarding sales is also not comprehensive. First of all the total sales which have been doubted constitute less than 0.16% of the total sales meaning thereby that more than 99% sales are verifiable and acceptance of declared sale by the Assessing Officer and the declared sales have been accepted. The same objection has also been taken regarding scrap sales but the same has also been accepted and no weight can be given to this observation. The Assessing Officer on the subject of scrap sales has admitted in the order that 90% of the scrap sales are to limited companies as mentioned at page 8 and para. 2 of the assessment order. The assessee has filed copies of bills which show that 98% of sales of scrap are to verifiable parties. Explaining the increase in the wages as a percentage of sales the ARs submitted that the assessee was never confronted with the fact that the Assessing Officer was considering the wages as unverifiable or excessive. The percentage of wages has gone up by only 2% which is not excessive when the sales have gone down by 43%. According to learned ARs the workers cannot be reduced in the same ratio as declined in sales. There is over all decrease in the claim of wages which has gone down to Rs.11.9 (M) as against Rs.13.9 M of last year but due to decline of 43% in the receipt the percentage has gone up by 2%. Further when the assessee had produced details of salaries and wages and copy of NICs on 19-11-1999 the Assessing Officer did not express any doubt and dissatisfaction regarding the claim of wages which is evident from the order sheet entry, dated 19-11-1999. The AR has furnished before us the copies of paid challans of EOBI showing the number of employees varies from 122 to 132. The employees have C.B.A. (Collective Bargaining Agent) registered with the Directorate of Labour Welfare Baluchistan.
10.The learned DR could not controvert the factual position in respect of the genuineness of the claim of wages and the valid reason for increase as a percentage of sales. Thus in our opinion there is no merit and force in this objection of the two officers below.
11.As regards the reference to the G.P. declared in parallel case the AR submitted that the same has no relevance in view of the history of the assessee. Further the case referred as parallel case revolves around its own facts, its range of product includes number of items not manufactured by the assessee like Aluminum profiles, fabrications etc. Even otherwise according to learned ARs the referred assessee alleged to be parallel is an old company operating since, 1953 whereas the assessee is operating since 1979. However we need not dwell long on this objection because the Assessing Officer in his comments to the CIT(A) recorded in the impugned order has stated that the parallel case has been quoted for purposes of comparison only but the assessee s history has been adopted for application of GP rate etc.
Explaining the reason for fall in G.P. the learned ARs have contended that the officers below rejected the detailed explanation for fall in GP submitted by the assessee summarily by only discussing the increase in the cost of raw material explained by the assessee to be on account of increase in dollar rupee parity. This explanation of the assessee was rejected by statingthattheincreaseindollarratetookplaceon28-5-1998 one month before the close of the financial year thus having no effect on the cost of raw material.
According to learned A.R. apart from giving detailed reasons for increase in the production expenses as percentage of sales under all the heads the assessee gave a comparative statement showing increase under each head and that statement has been reproduced on page 4 of the assessment order by the Assessing Officer himself.
That comparative statement shows that the percentage of cost of raw material as cost of sales this year was 86.18% as against 81.42% of last year showing an increase of 4.76%. This increase took place due to the depreciation of rupee against the Dollar. At start of the year the Dollar rupee rate was Rs.40.7 equal to one Dollar. On 15-10-1997 the rupee was devalued and the rate became Rs.44.3 equal to one Dollar. On 31-3-1998, it was increased to Rs.44.49 per Dollar. At the end of the year the rate was Rs.46 per Dollar. Thus the rupee depreciated by 9.3% between 1-7-1997 to 31-3-1998. The average effect of the increase in the cost of raw material was 4.76% given in the chart.
The second major factor for decline in GP to which the assessee had referred was increase of 2.09% as percentage of sales in respect of wages. The claim of wages has been held as genuine earlier in this order therefore we need not dwell further on this issue.
The other major factor for decline in GP is claim of depreciation. The component of depreciation as cost of sales this year was 2.95% as against 1.74% of last year showing an increase of 1.22% and pulling down the GP by same percentage. The depreciation is a statutory deduction and actually claim during the year is less than last year but on account of decline in receipt its percentage as cost of sales went up.
The other major item which pulled down the GP is power and fuel whose percentage as a cost of sales went up by 0.84% pulling down the GP by same percentage. The increase in the percentage of fuel and power as the cost of sales was on account of two factors:
(i)Increase in the rate of electricity.
(ii)Higher per meter consumption by 10%
According to learned counsel the negative effect on the rate of GP on account of these four items alone comes to 8.9% as against the total decline in GP of 9%.
He has therefore, contended that decline in GP was also attributed to decline in selling rates due to competition and lower demand. Statement of declining in prices is reproduced on page 4 of the assessment order showing decline between 1.96% to 19%. The Assessing Officer has not considered this reason, obviously if the increase in cost of production is coupled with decline inselling price the GP is bound to fall.
After considering all these facts we find force in the arguments of the learned counsel of the assessee that the fall in GP was properly explained and the authorities below arbitrarily rejected the explanation for fall in GP.
It has further been contested by the learned counsel for the assessee that the assessee has history of acceptance of accounts right from its inception. The sales and the declared GP have always been accepted in past, some addition was made on account of production wastage which was not approved by the appellate authorities and was deleted by the CIT(A) as well as by this Tribunal. Learned counsel have also referred to the subsequent assessments where the declared version has been accepted in assessment years 2000-2001 and 2001-2002.
In support of their contentions learned counsel for the assessee have referred following cases of the Honourable High Court and Supreme Court.
Karachi Textile v. CIT 1984 PTD 150, Pimpa (Pvt.) Ltd. v. CIT 1994 PTD 123, CIT v. Krudd Sons Ltd. 1994 PTD 174 and Roshan Cloth House v. CIT 1983 PTD 63.
In all these cases, it has been consistently held that if the method of accounting regularly adopted is the same which has been accepted in past then the same cannot be rejected without some very valid reasons and that the method of accountancy and the books of account regularly maintained and accepted by the department cannot be rejected merely on the lowness of GP. On this issue following cases have also been referred:--
1962 PTD (Trib.) 23, 2001 PTD (Trib.) 2938, M.E.J. Hazari and Sons v. CIT 1985 PTD 516, Printers Combine v. CIT 1984 PTD 276 and S.M. Yousuf and Bros. V. CIT 1974 PTD 45.
12.During the course of arguments learned counsel have also referred relevant principle of accounting regarding ascertainment of gross profits and what gross profit really means. The profit and loss account of trading concern is usually divided into two sections. The first section is termed the trading account which is so framed as to show the gross profit. The gross profit as shown by the trading account is transferred to the second section which is the profit and loss account. Gross profit is defined as the difference between the cost of the goods that have been sold and the proceeds of their sale, without any deduction in respect of the expenses of distribution and general establishment charges. In the trading account, therefore, it is necessary to include all items of charges directly affecting the cost of the goods sold, hence, it appears that when production account and declared sale having been accepted and no direct expenses specially and exclusively disallowed gross profit is nothing but balancing figure difference between Debit and Credit side of trading account.
From the perusal of the assessment order it appears that the Assessing Officer wishes that assessee has to declare better gross profits each year. Such an inference has no justification in law. The trading and manufacturing results depend on the conditions of the business and operation of manufacturing activity during the year. There is nothing in income-tax law which binds, an assessee to declare better results each year. The decrease in the declared version has to be seen in broader prospective i.e. the inflationary cost, fixed cost and price fluctuation of different items concerning the transactions engaged by the assessee. The profitability entirely depends on the production. Whenever production increases the cost of production decreases simultaneously and company earns profit, however, wherever the production is lesser, fixed cost remained the same as such the gross profit margin decreases. Furthermore, the rate of gross profit in a particular year depends on many other factors, e.g., the general market condition based on demand and supply positions, the rise or fall in market rates, specially abrupt ones, the capital position vis- -vis the turnover achieved low G.P. may be due to recession in local and international market depression in money market, financial stringency, detachment of Pak currency from Dollars and open and tacit competition and many others, however, the law does not oblige an assessee to make the maximum profits that he can out of his trading transactions. The application of higher flat rate of G.P. is not proper when a truer state of income can be ascertained without much trouble.
13.On behalf of the assessee following cases have also been referred which we have perused. In a case titled Pimpa (Pvt.) Ltd. Karachi v. CIT reported as 1994 PTD 123 Hon ble High Court in this case has held that:--
(i)Rejection of trading result is not justified merely for non-maintenance of consumption and production account or non supply of full addresses of the persons from whom purchase had been made could not be taken as indicative of suppression of the production and sales. It is further held that in the absence of any omission, irregularity or other defect in the method of maintaining the accounts or positive evidence to show that the accounts did not disclose the whole income of the assessee, his books of accounts could not be rejected.
In another case titled CIT v. Krudd Sons Ltd. reported as 1994 PTD 174 (S.C. Pak).
the main reason for rejecting the method of accounting by the Assessing Officer and maintained by the Tribunal was that the assessees were showing stocks by weight and production by measurement. Further, consideration which compelled them to reject was that separate manufacturing and trading accounts of enameled utensils and extruded aluminum products were not maintained. For these reasons it was concluded that the income, gains and profits could not be deduced from the accounts books. The past history of the assessee established that it had been maintaining its accounts in similar manner. The assessing authorities had been deducing income, gains and profits without any difficulty and had been assessing for many years. Nothing had been brought on record to controvert these facts to show that defects had been detected in the method of accounting which made it impossible to deduce income, profits and gains. Mere expression of opinion that such deduction could not be made was not sufficient unless cogent reasons to support such conclusion were also stated. It had been pointed out that separate manufacturing and trading accounts in respect of enameled utensils and extruded aluminum products had not been maintained. The assessee had explained that maintenance of such accounts was not possible as common labour and energy were employed for their production. They had also stated that such practice was in vogue from the very beginning and accounts had been prepared in the same mannerwhich were accepted. It was further stated that in the line of trade no one maintained accounts in the manner required by the department. In these circumstances the question was whether the Assessing Officer could form an opinion that income, profits and gains could not be deduced from the method of accounting adopted by the assessee. The history of the assessee s case supported its contention. If the assessing authority had not felt any difficulty in determining income, profits and gains on the basis of the accounting method maintained by the assessee in the past how was it that in these two years they had been facing difficulty and invoking proviso to section 13. Furthermore, if in line of trade certain method of accounting had been adopted and accepted by the Assessing Officer without pointing out any difficulty in determining the income, profits and gains then if they want to resort to proviso to section 13, they must give cogent reasons and convincing grounds to justify their action. In such circumstances if on the basis of such accounts the Assessing Officer could deduce income, profits and gains in the past merely by change of opinion without any substantial material or cogent reasons the method of accounting could not be rejected.
The Hon ble Supreme Court of Pakistan in this case has laid down following proposition/principles:--
(i)The language of section 13 of the Income Tax Act, 1922 is simple and unambiguous. It applies to income, profits and gains accruing from business profession or income from any other source. It gives a choice to the assessee to maintain his accounts in any manner orby adopting any method with the limitation that such method should be so that income, profits and gains can be deduced from it. If an assessee adopts a method of accounting from which income, profits and gains can be deduced, the Assessing Officer has no option but to accept it. The proviso to section 13 empowers the Assessing Officer to compute income, profits and gains where either no method of accounting has regularly been employed or the method employed is such that in the opinion of the Assessing Officer the income, gains and profits cannot be properly deduced. The opinion is to be formed by the Income Tax Officer on the basis of the material available in the account books and on such facts which may justify such a conclusion and also establish that it is not possible to deduce correctly the income, profits and gains from the accounts books maintained according to the method employed by the assessee. However, such an opinion should not be whimsical or based on erroneous or mala fide grounds.
(ii)If from the properly kept accounts it is not possible to deduce the profits and income of the assessee from it, the Assessing Officer can reject the same. However, the Assessing Officer should not insist nor base his finding on the non-maintenance of record of such particulars and data which possibly cannot be maintained in a particular trade or business.
(iii)While interpreting section 13 accounts must be distinguished from method of accounting. There may be a regular method of accounting and yet for defects the accounts may be rejected but it does not lead to automatic rejection of the system and method of accounting employed by an assessee. Occasion may also arise where although the profits shown in the accounts are not true or correct the Assessing Officer can deduce correct figures from the accounts. If the accounts books are found to be false and manipulated with a view to suppress the income and profits and the same cannot be deduced correctly the Assessing Officer can reject the accounts.
(vi)Assessing Officer has to determine whether the assessee had adopted method of accounting from which income, profits and gains could properly be adduced.
(v)Rejection of accounts/method of accounting Regular method of accounting in the past cannot be accepted as a matter of routine without examining same and if the Assessing Officer comes to the conclusion that it is defective and true income, profits and gains cannot be deduced from it then same can be rejected while giving proper, sufficient and valid reasons and reasons must be based that accounts are false and manipulated with a view to suppress income and correct income cannot be deduced on the basis of such recorded evidence.
In another case titled M.E.J. Hazari and Sons v. CIT reported as 1985 PTD 516, the Honourable High Court laid down following proposition/principles:
(i)Rejection of accounts on the basis of non-maintenance of stock register was not justified.
(ii)Mere low GP rate as compared to last year is not a ground for rejection of accounts.
(iii)In the above cited case the department has alleged that 13% sales were unverifiable being cash sales. However, the Hon ble High Court observed that it is not a ground for rejection of accounts because substantial sales i.e. 87% were verifiable.
Likewise in a case titled as Karachi Textile v. CIT reported as 1984 PTD 150 it has been held that:--
(i)The method of accounting adopted was in the form prescribedby the Excise Rules which was accepted in the past, hence accounts are acceptable because there is no form or method had been provided in Income Tax Law for maintaining books of accounts.
(ii)Before rejecting the accounts the DCIT should have pinpointed the defects.
In a case titled CIT v. Fateh Textile Mills Ltd. Hyd. reported as 1984 PTD 218, it has been laid down that:--
(i)The accounts for the previous year had been accepted and for the year the assessee had maintained the same type of accounts as mentioned by the assessee for earlier year the same is liable to be accepted.
(ii)The Assessing Officer was not justified in rejecting the results of those accounts merely because rate of gross profit had gone down and in spite of the fact that a reasonable explanation for the same had been offered by the assessee.
In a case reported as 1962 PTD (Trib.) 23 it has been said that:--
(i)Mere lowness of GP rate is not a sufficient ground for rejection of accounts.
(ii)Rejection of accounts on the basis that the declared GP rate is higher in the parallel cases was unjustified.
(iii)The Assessing Officer was not competent to apply gross profit supply because the gross profit was low.
(iv)The law does not require an assessee to sell the commodities at profit. An assessee is at liberty to sell their commodities at concessional rates or rates much below the prevailing market rates what is material is that the assessee has recorded the sale price.
In a case of Printers Combine v. CIT reported as (1984) 50 Tax 183 (H.C. Kar.) it has been laid down that the:
(i)Assessing Officer has discretion to reject accounts books if the assessee has not adhered to method of accounting regularly employed.
(ii)The books of accounts cannot be rejected until and unless it is proved by the Assessing Officerthat accounts are manipulated.
(iii)if method of accounting employed by the assessee is duly vouched and verifiable the book version cannot be rejected.
(iv)Low GP rate is not a ground for rejecting the assessee s account version.
The above judgments referred by the learned counsel are very much relevant to the facts of the case alongwith the following further case-laws and various judgments from the Indian jurisdiction which are very advantageous on the subject.
(1961) 4 Tax 230
(1962) 6 Tax 95
International Forest Co. v. CIT (1975) 101 ITR 721 (J & K)
M. Durai Raj v. CIT (1972) 83 ITR 484 (Ker.)
Pandit Bros v. CIT (1954) 26 ITR 159 (Bom.)
Ratan Cafe v. State of Madras (1974) 33 STC 39 (Mad.)
S. Veeriah Reddiar v. CIT (1960) 38 ITR 152 (Ker.)
R.M.P. Perianna Pillai and Co. v. CIT (1961) 42 ITR 370 (Mad.)
Ravi v. State of Tamil Nadu (1981) 48 STC 274 (Mad.)
Vel Metal Industries v. State of Tamil Nadu (1988) 68 STC 55 (Mad.)
Laxmi Stores v. CST (1979) 43 STC, 167, 168 (All.)
Indeed we are well cognizant that apart from the above cited precedents there are several other pronouncements on the subject of rejection of books of accounts/method of accounting but for the sake of brevity the same are not reproduced here, however the principles laid down in these judgments will be incorporated in the summarized conclusion in the penultimate paragraph ofthis Judgment-4. Mr. M. Jawed Zakaria, the learned counsel for the appellant/assessee while contesting the ground relating to non-confrontation of various defects in the books of accounts before rejection of books of accounts has vociferously contended thatthe Assessing Officer has not followed the mandatory provision of section 62. The learned counsel has in this regard referred to the notice under section 62 , dated 29-10-1999 wherein the DCIT vide para. 14(f) has asked for production of books of accounts.
According to learned counsel the requirement of the law is that the notice under section 62 will be issued after the examination of books of accounts pointing out the defects in the accounts. He stated that in this case the alleged notice, dated 29-10-1999 captioned as notice under section 62 was issued prior to the production of books of accounts. He drew our attention to the order sheet entries according to which the books of accounts were produced for the first time on 25-11-1999 the day when the assessment proceedings were finalized. No notice was issued after this date. The learned AR has contended that the notice, dated 25-11-1999 is not a notice under section 62 as provided under the law but is in fact a notice requiring furnishing of details and production of books of account. Aftercalling the certain details and books of accounts no mandatory notice under section 62 as envisaged in the provision of section 62(1) of Income Tax Ordinance, 1979 has been given to the assessee.
He has in this respect read out the relevant extract of proviso to subsection (1) of section 62 of Income Tax Ordinance, 1979 which is reproduced as under:--
Provided that where the assessee produces books of account as evidence in support of the return, the Deputy Commissioner shall, before disagreeing with such accounts, give a notice to the assessee of the defects in the accounts and provide an opportunity to the assessee to explain his point of view about such defects and record such explanation and the basis of computation of total income of the assessee in the assessment order.
While explaining the words the basis for computation the learned counsel has submitted that the proviso should be read as a whole. After detecting defects in books of accounts the Assessing Officer is legally bound to issue mandatory notice under section 62(1) to confront with the assessee the defects pointed out by him in his order and provide an opportunity to the assessee to explain his point of view about such defects. The Assessing Officer under the said proviso required to record the explanation in the assessment order. If Assessing Officer still is not satisfied with the explanation he is duty bound to record his reasons on what basis he is not accepting the assessee s explanation in the assessment order and on what basis he is going to compute assessee s total income. Giving reasons in support of the computation of total income is essential because no unfettered or unexaminable discretionary power vestedwiththeDCIT.Theinterpretationofprovisotosub-section (1) of section 62 by the learned counsel appears to be proper and correct.
While giving the brief history of enactment of this proviso the learned counsel for the appellant has submitted that this proviso was enacted through Finance Act, 1993. In the context of provision ofsection 13 of the repealed Income Tax Act, 1922 which is analogous to provision of section 145 of Indian Income Tax Act, and section 32 of the Income Tax Ordinance, 1979. The higher appellate forum including apex Court has laid down the principle that books of accounts cannot be rejected without confronting the defects in the books of accounts and without issuing mandatory notice under section 62 of the Income Tax Ordinance, 1979. Where this pre-requisite notice under section 62(1) has not been issued the assessment so made cannot be sustained. The learned counsel Mr. M. Javed Zakaria has submitted that there is no dearth of case-laws on the subject. The learned counsel has in this regard mainly relied upon the case law reported as (1999) 79 Tax 263 (Trib.) and recent judgment of the Tribunal reported as (2001) 83 Tax 275 (Trib.) wherein it has been held that notice under section 62 to confront the assessee with the defects in the accounts is a statutory/ mandatory requirement which the Assessing Officer is required to follow. This having not been done, the assessment is void and illegal.
Relying very strongly on the above cited judgments learned counsel has submitted that failure to follow the mandatory provisions in this assessment year the accounts/declared trading result is liable to be accepted as declared and assessment framed is ab initio, void being illegal. Let us, therefore, examine as to what principle of law these cases have enunciated.
We have found that in a case reported as 1999 PTD (Trib.) 3892 it has beenheld that:--
(i)Proviso (1) to subsection (1) of section 62 brought on the statute book by Finance Act, 1993 is a mandatory provision.
(ii)When books of accounts were produced as evidence in support of declared version, the Assessing Officer while disagreeing with such accounts shall issue the notice to the assessee mentioning therein the defects noted by him and provide an opportunity to the assessee to explain his view point and record his explanation in the assessment order.
(iii)Failure of the Assessing Officer to issue such mandatory notice and any addition made to the declared income is, therefore, ab initio illegal and void and rejection of trading results by the Assessing Officer is unjustified.
(iv)Failure to follow the mandatory provisions, accounts cannot be rejected, assessment framed ab initio void being illegal.
Likewise in the case reported as 2001 PTD (Trib.) 2938 it has been held that:--
(i)Notice under section 62 is mandatory notice to confront the assessee with the defects in the books of accounts.
(ii)Entries in the order sheet even disclosing the defects are not substitute/equivalent to the mandatory notice under section 62 this mandatory notice ought to be issued in writing.
(iii)Order sheet entries are meant only for day to day record of proceedings.
(iv)The unverifiability of sales and purchases is immaterial in the context of this case because the accounting version was accepted by the Assessing Officer for the proceeding year on the same basis.
The learned counsel Mr. Jawed Zakaria has vehemently argued that this mandatory provision has not been followed and therefore the addition is liable to be deleted. In this connection he has referred the following case laws also:
The case titled as Collector, Sahiwal v. Muhammad Akhtar reported as 1971 SCMR 681 wherein it has been held that:--
The principle so far as this country is concerned, is accordingly, well-settled that where the requirement to be fulfilled to be given by the statute is a mandatory, then the failure to comply with such a mandatory requirement of the statute would render the act void ab initio as being an act performed in disregard of the provisions of the statute. It was further observed by their lordship that any further action taken on the basis of such a void order would also be vitiated and the defect at the initial stage would be incurable by a hearing at a subsequent stage.
He has also placed reliance on following decisions of this Tribunal wherein it has been held that No addition is legally sustainable if mandatory requirement had not been complied with.
1993 PTD 392, 1985 PTD (Trib.) 178 and 1993 PTD 1172.
15.We have heard the learned representatives Mr. M. Jawed Zakaria, Advocate and Mr. Jan-e-Alam ITP of assessee and Mr. Shaheen Aziz Niazi the learned DR on this point.
The learned DR has admitted that no notice under section 62 has been issued after examining books of accounts. However, the learned DR has submitted that the alleged defects have duly been incorporated in the assessment order. A faint argument was advanced before us by the learned DR which is untenable because the Assessing Officer has to follow the mandatory requirements by issuing notice under section 62 confronting the defects to the assessee prior to finalization of assessment.
The arguments of the learned counsel have substantial substance. The concept of issuance of notice before rejecting books of account is not a new phenomena. It is as much as old as the history of taxation itself and this concept was recognized through catena of rulings by the superior Courts of the sub-continent. Initially, as far as our study is concerned, proviso (1) of section 62 was a sophisticated and fine improvement after the high handedtax system presented by Jonathan Swift in his famous classic Gulliver s Travels. There in his third voyage he referred to an imaginary Island. Laputa which in fact according to him was Ireland in which the system was very harsh and very high handed. In that island the king had no consideration for the paying capacity of the subjects and he managed a bureaucracy which had a hovering island which was used to extract taxes from subjects. The veryconcept of a flying island indicates that there was not sense of natural justice and there was no consideration for the paying capacity of the subjects and there was no concern for justice. If the people of some area did not pay thetaxes the flying island was kept hanging over their heads to cause dearth and disease and if finally they did not pay the taxes they were not given any further opportunity. The hovering island was stamped on them and they were destroyed.
So our legislature while evolving case-laws on principles of natural justice devised the practical scheme of proviso (1) of section 62. This proviso was added to income tax law vide Finance Act, 1993 just enabling tax payers to know the allegation against them and give a proper reply and defence thereof so that the taxpayers be saved from the arbitrary action of the DCIT. In fact this was a rule that an Assessing Officer will be bound to accept a method of accounting which is regular and which is based on some rational and reasonable ground. Section 32 was adversely used against the taxpayers and it became a tool for rejection of accounts instead of measure of protection of the taxpayers. What is the basic idea of section 32 is highlighted by a few of the decisions of Privy Council as well as other Courts.
In this regard we would like to cite a landmark judgment of (Seth Gurmukh Singh v. CIT (1944) ITR 393) wherein their lordship observed as under:--
but all the same as remarked by me in Ganga Ram Balmakund v. CIT he (I.T.O.) is required to proceed without bias and give sufficient opportunity to the assessee to place his case before him as well as to meet the case made out against him. More emphatic is the language used by Kania (C.J.) in the well-known Bombay High Court s decision in Sarupchand Hukamchand s case (1945 PTD 249). The learned Chief Justice observed in fairness and in law it is a duty of the authority entrusted with the task of recording its finding to give every opportunity to the other side to meet the case which the authority thought was in existence (page 256).
A further case-law of Mr. Gopi Mohan Saha Ref. Case No.1 of 1955 may be cited wherein Mr. Amin Ahmed (C.J.) of Dacca High Court made the following observations:
We fail to understand why the assessee should be made to pay much higher than what was warranted by the accounts produced by him on the basis of confidential enquiry by the Income tax authority without giving him an opportunity to place his case or explanation. It is of course open to the authorities to assess on the basis of the records and other information and enquiry but in doing so the authorities cannot rely on material which are not disclosed or kept unknown to assessee without giving him hearing in respect of the same.
From perusal of the above judgments it is seen that assessee must be given full chance to the rebuttal of material relied by the Assessing Officer for rejecting the accounts. However the compliance was not made. Therefore the C.B.R. has also by taking cognizance of the fact issued various circulars time and again for compliance of this rule. In this connection one may easily cite a C.B.R. Circular No.19 of 1957 (C. No.15(9)-ITP/5, dated 17-8-1957) if needed.
The principle of natural justice in connection with income tax matter to the best of our knowledge first come for consideration before our own Supreme Court in the case of CIT v. Fazal-ur-Rehman reported as PLD 1964 SC 410 wherein their lordships observed as under:--
We do not think the mere absence of a provision as to notice can override the principle of natural justice that an order affecting the rights of party cannot be passed without an opportunity of hearing to that party. Yet it cannot be said that it is not necessary to hear the parties affected in a proceeding under section 115, C.P.C. The fact that the proceedings are judicial or quasi-judicial in nature is sufficient to entitle a party to a hearing in the absence of specific provision to the contrary.
We are fortified further in our view with the case reported as (1984 PTD 255) wherein the Hon ble High Court of Sindh relying upon earlier order of the Hon ble High Court in the case of (Muhammad Textile Mills Ltd. reported as (1979 PTD 568 (H.C. Kar.) has laid down the law in the following words:
It was held in this case if the assessee had employed a regular method of accounting and accounts were maintained regularly, the I.T.O. was not entitled to reject the books results without finding any flaw, defect or discrepancy in the accounts. It was further held that even in cases where the accounts or the method employed were rejected as being such that true income could not be deduced from it, the income tax officer could not merely adopt a flat rate or make addition in the income arbitrarily and that he is required base such additions on material or evidence of which due notice must be given to the assessee.
This principle was however given legal recognition in Pakistan with the insertion of provision (1) of section 62 and as rightly contended by the learned counsel that this is a mandatory proviso. In the instant case the Assessing Officer has not issued any notice under section 62 after examination of books of accounts and before discarding books of accounts of the assessee hence, rejection of accounts by the Assessing Officer cannot be sustained on this score also by now following this mandatory provision of section 62 the assessment order is held to be capricious and arbitrary.
16.The other aspect which we feel needs to be explained is the principle of application of doctrine of res judicata in income tax proceedings. The reference to past history of acceptance of accounts of the assessee was rejected by the Assessing Officer by stating that the principle of res judicata isnot applicable to income tax proceedings. The Assessing Officer on page 6of the assessment order has referred to certain Indian cases and case of our Honourable Supreme Court. We will confine ourselves to the principle spelled out by our Honourable Supreme Court in the case titled (CIT v. Pakistan Industrial Engineering Agencies Limited reported as PLD (1992) SC 562) relied by the Assessing Officer.
In this very judgment on page 566, the conditions under which the principle of res judicata will not apply to the income tax proceedings have been explained which are as under:--
Principles of res judicata do not apply to the cases on assessments under the income tax law in the same manner as they are applied in civil proceedings Restrictions on applicability on principles of res judicata enumerated.
Principles of res judicata cannot be applied to the cases on assessments under the Income Tax Act in the same manner as they are applied in civil proceedings.
Applicability of principles of res judicata has been restricted asfollows:--
A previous decision of an Income Tax Authority will not be a bar in the following cases:--
(i)where the earlier decision is clearly open to some objection;
(ii)if it is a decision which is not reached after proper enquiry;
(iii)if it is a decision as could not reasonably have been reached on the material before the authority;
(iv)it is a decision which suffers from such a defect which falls within the purview of the grounds mentioned in section 100, C.P.C. and liable to correction thereunder in second anneal, if it were a decision of civil Court; and
(v)if fresh evidence having a material bearing on the point decided in the previous decision is available.
In our humble opinion the doctrine of res judicata strictly applies in re-assessment/re-opening proceeding under tax laws subject to the fulfilment of condition of the relevant provisions and if suppression of income is so glaring and floating on the surface of record. In the instant case the method and system of accounting employed is the same as for the preceding years and assessee has history of acceptance of declared trading results. The previous assessment having been finalized under normal assessment after detailed scrutiny and examination of books of accounts and applying judicial mind to the facts of the case. The doctrine of res judicata would come into play when altogether a new different method of accounting employed is as such that true profit could not be deduced therefrom and departmenthas strong evidence of suppressed income/account. The Assessing Officer cannot take shelter of the doctrine of res judicata for rejecting books of account of the assessee for determining higher profits and income on the ground that past history cannot be accepted being hit by principle of res judicata. The Assessing Officer cannot depart from the past history and the finding reached by his predecessor because succeeding officer does not agree with the preceding officer s finding. Officers/Taxing authorities should take note of the conditions under which this principle does not apply before making such statement and giving such findings.
17.After considering the explanation of the various objections to the method of accountancy and to the books of accounts mentioned in assessment order, the explanation for the decline in GP, the past and subsequent acceptance of declared results and the relevant case-laws on this subject, the case-law that accounts cannot be rejected merely lowness of GP and the legal objection that the mandatory provision of proviso of section 62 have not been fulfilled, we are of the opinion that the rejection of the declared version cannot be maintained both on the basis of facts and law. It is therefore directed that the declared version of the assessee be accepted. The directions regarding the treatment to be given the scrap sales given earlier in this order should also be followed.
18.Before parting with the issue of rejection of accounts/method of accounts we consider it necessary that two misunderstandings about principle of accountancy and law should be cleared.
From the perusal of the assessment order and the order of the learned CIT (Appeals), it was noticed that both the officers were highly influenced by the treatment given to the scrap sales by the assessee. In their opinion the fact that the assessee deducted the scrap sales from cost of sales was a defect in the method of accountancy, justifying rejection of the book version.
This impression is totally incorrect. The fact that a receipt or an expense is included in the trading account or as direct income or expense in P&L account does not affect the net income. In this case if the scrap sales are transferred from the cost of sales as direct income the GP will decline and direct income is increased and the net profit will remain the same. Same is to, if an expense is transferred from cost of sales to the P&L account. This transfer will increase the GP but correspondingly increase the P&L expenses and the net profit will remain unchanged. For this we don t have to look beyond the principle laid down by our Honourable Supreme Court in the case (CIT v. Krrud Sons Limited reported as1994 PTD Page 174. While explaining this principle under a worst scenario, their lordships observed as under:--
Another aspect of the case is that while interpreting section 13 accounts must be distinguished from method of accounting. There may be regular method of accounting and yet for defects the accounts may be rejected but it does not lead to automatic rejection of the system and method of accounting employed by an assessee. Occasion may also arise where although the profit shown in the accounts is not true or correct the Assessing Officer can deduce correct figures from the accounts. If the accounts books are found to be false and manipulated with a view to suppress the income and profit and the same cannot be deduced correctly the Assessing Officer can reject the accounts .
The rejection of the books of accounts is permitted if the books of accounts are found false and manipulated with a view to suppress profits. This aspect of the case has been enlightened exhaustively in the preceding paras of this order while giving the history and background of rejection of accounts. Mere transfer of an entry from trading account to profit and loss account and vice versa does not justify the rejection of accounts. Further subsection (3) of section 32 of Income Tax Ordinance, 1979 does not empower an Assessing Officer to reject the books of account on the basis of a subjective judgment. On the other hand, such judgment must be objective and within four walls of subsection (3) of section 32 of Income Tax Ordinance, 1979. The Assessing Officer cannot reject the books of accounts at his own whims as his action for the purpose of rejecting books of account subject to judicial determination. There need not be any hard and fast rule on such matters with the authority arrives at must not be his subjective, personal or private opinion it must be something which conforms to an objective standard or criteria laid down or recognized by law.
19.The only other ground taken by the representatives of the assessee is against the matter of computation of excess perquisites. The learned ARs pointed out that the Assessing Officer while working out excess perquisites included the payment of dearness allowance and special allowance (cost of living allowance) in perquisites. He has filed evidence that in the earlier orders and subsequent orders this was not treated as perquisites.
We don t have to go to the past history because explanation to clause (1) to section 24 includes dearness or cost of living allowance in salary and not perquisite. The special allowance is being paid under the Sind Employees Special Allowance (Payments) Act, 1986 which is part of the Employees Cost of Living Relief and Allowances, copy of the relevant gazette has also been placed before us.
It is therefore directed that these two allowances may be treated as salary for calculation of excess perquisites.
Departmental Appeal for the Assessment year 1998-99.
20.This appeal is directed against the order of the learned CIT Appeals, dated 2-5-2002, against the order of the DCIT passed under sections 62/132. The only ground of appeal is against the direction of the learned CIT Appeals that WWF may be charged on income after set off of losses as directed by Honourable High Court of Sindh in a case reported as CIT v. Kamran Model Factory 2002 PTD Page 14. The direction of the learned CIT(A) being in conformity with the order passed by the Hon ble High Court does not warrant any interference and we thereforeuphold the same. In consequence the departmental appeal being devoid of any merit stands dismissed.
Assessee sandDepartmentalAppealsfortheassessmentyear1999-2000:
21.For this year both the assessee and the department are in cross-appeal against the order of the CIT Appeals passed against the order under section 62 of DCIT. The following grounds of appeal have been filed by the assessee and the grounds Nos. 2, 3, 4 and 5 were taken by the department which are discussed as under:--
Assessee s grounds of appeal:
(1)That the order of the learned CIT(A) is bad in law and on facts.
(2)That the learned CIT(A) has erred in holding that the ground against appointment of special auditor was beyond the jurisdiction of the office of the CIT(A).
(3)That learned CIT(A) has erred in not holding that the appointment of the special auditor was illegal.
(4)That the learned CIT Appeals has erred in holding that the Assessing Officer was justified in recasting the trading account by excluding the scrap sales when the Special Auditors appointed by the department has accepted, the treatment adopted by the appellant.
(5)That the learned CIT Appeals has erred in not accepting declared version of the appellant.
(6)That the learned CIT Appeals has erred in holding that 20% of cash purchases may be disallowed and added back to the income of the appellant.
(7)That the learned CIT Appeals has erred in upholding the said disallowance merely on the ground that there is possibility of recording cash purchase price higher than actual. There is no evidence, recording the cash purchase at higher price.
(8)That the learned CIT Appeals has erred in maintaining the disallowance/addition of alleged excessive wastage of Rs.662,427 in respect of following items:
XLPE sloplasRs.283,018
P.P. FilmRs.94,413
CabelecRs.223,150
Copper tapeRs.176
Genkline/TrinkloneRs.61,670
(9)That the learned CIT Appeals has erred in maintaining the following disallowances out of expenses claimed:
Out of travelling expensesRs.343,263
Out of missing vouchersRs.30,885
Out of for expenses allegedly not supportedRs.41,555
Security chargesRs.146,600
Out of telephone expensesRs.272,402
(10)That the learned CIT(A) has erred in maintaining the addition of Rs.170,000 under the provision of section 24(c) when the payment was not hit by the provision of section (c).
(11)That the learned CIT(A) has erred in maintaining the disallowance of the following expenses on the ground that these are previous year s expenses when the same were determined and quantified in the year under appeal.
Arrears of staff/Worker s salariesRs.254,013
BonusRs.72,943
(12)That the CIT(A) has erred in maintaining the addition of alleged excess perquisites of Rs.552,382.
(13)That the computation of alleged excess perquisite apart from being inaccurate is also unjust and very harsh and excessive.
However, at the time of hearing before us the learned A.Rs have not pressed the grounds mentioned at S. Nos.1 to 3 and grounds Nos. 10 to 13 and hence these grounds not require any adjudication and the appeal filed by the assessee on these grounds is dismissed.
The Department in its appeal has taken the following grounds:--
(2)That the learned CIT Appeals-III, Karachi was not justified in relying on the judgment of Hon ble High Court reported as CIT v. Kamran Model Factory 2002 PTD Page 14.
(3)That the learned CIT Appeals-III, Karachi was not justified in considering that WWF is to be charged on income assessed after set off of losses.
(4)That the learned CIT Appeals was not justified in restricting the disallowances under the head cash purchase, improvement in gross profits results cannot be an excuse for the reduction in disallowances.
(5)That the learned CIT Appeals has wrongly deleted the addition on account of excessive wastage because the assessee himself accepted the excessive wastage in PVC.
23.From perusal of impugned order of the learned CIT(A); assessment order, correspondence exchanged between the appellant assessee and the department and arguments before the CIT(A) as well as before this Bench, the following issues stand thrashed out for our discourse:
(i)Rejection of declared trading version (Assessee s Ground No.5)
(ii)Whether the learned CIT(A) was justified in confirming the recasting the declared GP by excluding scrap sales and treating them as other income (Assessee s Ground No.4)
(iii)Whether the treatment given to the scrap sales by the appellant amounted to defect in the method of accounts (Assessee s Grounds Nos. 4 & 5).
(iv)Whether the learned CIT(A) was justified in confirming/ restricting 20% cash purchases out of total cash purchases of Rs.63,14,287 (Assessee s Grounds Nos. 6 and 7 Department s Ground No.4).
(v)Whether the learned CIT(A) was justified in confirming the alleged excessive waste when the wastage declared was within the limited allowed and accepted by the department in earlier years (Assessee sGroundNo. 8)andtheadditionunderthehead PVC rightly deleted by the CIT(A) (Department s Ground No.5)
(vi)Disallowance of telephone expenses @ 28% when history of disallowanceis10%underthehead.(Assessee sGroundNo.9)
(vii)Whether WWF could be charged on income before set off of assessed losses (Department s Grounds Nos.2 and 3).
24.Thebrieffactsforthisyeararethattheassesseehaddeclaredthefollowingtradingresultsascomparedtoearlieryears:--
| | 1997-98 | 1998-99 | 1999-2000 |
| Sales. | 330,166,214 | 189,531,567 | 238,952,429 |
| G.P. | 31,541,514 | 1,042,992 | 26,518,741 |
| Rate of G.P. | 9.55% | 0.55% | 11.1% |
As per past practice trading account was casted by deducting scrap sales from the cost of sales. This treatment was not approved by the Assessing Officer and thetradingaccountwasrecastedandthesalesofscrapwere transferred to direct income. The recasted trading account is as under:
| | 1997-98 | 1998-99 | 1999-2000 |
| Sales. | 330,166,214 | 189,531,567 | 238,952,429 |
| G.P. | 29,791,504 | (6,309,295) | 22,646,741 |
| Rate of G.P. | 9.02% | | 9.48% |
The case was assigned to Special Audit under section 4(A) of the Income Tax Ordinance, 1979 and assessment has been mainly completed in the light of the recommendations of the Special Auditor (M. Nasim and Co., Chartered Accountants).
This year the declared trading results were rejected to the extent of making the following adjustments/additions:
(i)The claim of deduction from receipts on account of payment made/to be made to WAPDA and KESC was disallowed.
(ii)Treatment by the officers below in transferring of scrap sales from cost of sales to direct income.
(iii)The payment on account of cash purchases amounting to Rs.6,314,287 claimed in the cost of raw material consumed/purchased was disallowed and added-back.
(iv)Addition of Rs.1,123,109 was made on account of excess production wastage claimed by the appellant.
The deductions claimed by the assessee from the receipts and the treatment given to them by the two learned officers below is not subject matter of this appeal. Both the assessee and the department are in appeal against the treatment given by the CIT Appeals to the addition on account of cash purchases and production wastage. The assessee has assailed the order of the CIT(A) whereby he has confirmed the treatment of the DCIT in transferring scrap sales from cost of sales to direct income and insufficiency of relief in respect of cash purchases and confirmation of excessive wastage. In short the learned CIT(A) gave the following decision on the issues relating to trading account, which are being contested in these appeals:
(a)The treatment given to the scrap by the Assessing Officer was confirmed.
(b)80% of the addition made on account of cash purchases was deleted and balance 20% was maintained.
(c)Out of addition on account of wastage the learned CIT Appeals deleted addition of Rs.460,682, in respect of claim of wastage of PVC and balance addition of Rs.662,427 in respect of wastage of other items was maintained.
25.First we take up ground No.4 of the assessee against recasting of trading account by transferring scrap sales and treating scrap sales as other income. This issue has already been decided in the preceding paras. of this order in respect of assessee s appeal for the assessment year 1998-99 whereby we have on the basis of earlier order of this Tribunal held that the assessee has rightly deducted the scrap sales from the cost of goods. Accordingly the appeal of the assessee for this year on this ground succeeds.
26.Next we take up the grounds Nos.5 to 7 of assessee and ground No.4 of department which relates to issue of cash purchases. The Special Auditors noted that the assessee has made purchases of Rs.6,314,287 in cash. The letters sent to these parties for verification were returned un-served. In view of this the learned Assessing Officer made following observations on page 6 of the assessment order:--
The assessee has shown total purchases at Rs.215,835,673. As pointed out by the auditor, certain payments have been shown on account of purchases amounting to Rs.6,314,287 in total. However, these payments are not verifiable as the parties to whom such payments were made are not traceable. This therefore calls for rejection of declared accounts of the assessee company as the true gross profit could not be ascertained. Hence the accounts are to be recasted to work out true GP of the assessee company.
The assessee was confronted on this issue vide notice under section 62 dated 31-3-2001 it would be useful to reproduce the contents of the notice and the reply of the assessee:--
The auditor has pointed out that the certain materials have not been received in the store. Similarly certain payments have been made in cash as cheques were encashed by the cashier of the company. Besides, letters to such parties were issued which returned undelivered. Hence an addition to the income at Rs.6,314,287 is proposed . Please explain your position as to the same, failing which the addition may be made as proposed.
(List of parties giving date, amount, name and raw material reproduced in assessment order which is not being reproduced for the sake of brevity).
The reply of the assesee has been partly recorded in the assessment order, therefore, it would be proper if relevant paras of reply of the assessee, dated 30-4-2001 is reproduced in full for resolving the issue under dispute.
First of all we would like to clarify that the comments of the auditors that the raw materials have not been received in store is wrong. The stock register is lying in your custody and if we are allowed to refer to the stock register in your presence entry of all the raw materials referred in the report of the auditors will be shown. The summary of the total quantity of the raw materials purchases mentioned in the note 10 of the auditors report is as under:--
Copper rod.47000Kgs.
Aluminium rod.6000Kgs.
PVC.203000Kgs
Copper tape.2000Kgs.
The fact that the letters sent to sellers were received undelivered or payments were made through bearer cheques can lead to one conclusion only that the purchases to this extent are unverifiable and it does not authorize the assumption that these purchases were not at all made and they are to be disallowed in full.
This is specially so when all the raw materials purchased have been entered in the stock register and it has appeared in the reconciliation of raw material consumed and the finished goods produced. At para. 11 of the report auditors only found the following amount of excess wastage/consumption in respect of the alleged unverifiable purchases of these raw material.
(a)PVC 30712 Kgs excess consumption/wastage as against purchases doubted of 203000 Kgs.
(b)Aluminum rods nil excess consumption/wastage as against purchases doubted of 6000 Kgs.
(c)Copper rods nil excess consumption/wastage as against purchases doubted 47000 Kgs.
(d)Copper tape excess consumption/wastage 2.20 Kgs as against purchases doubted of 2000 Kgs.
When the production has been carried on from these raw materials and the consumption of these raw materials has been found reasonable and within limit and the only alleged excess consumption/wastage in respect of raw material has been noted by the auditors to the extent of 30712 Kgs of PVC and 2.20 Kgs of copper tape then if you disallow the total purchases of Rs.6.314 M made by our client from unrecognized sector then it will lead to mathematical fallacy resulting in production and sale without their being adequate raw material to manufacture them.
Such objection can be made by the auditor who is biased and does not know tax law but you must be coming across cases of cash/alleged unverifiable purchases every day and such purchases are not added only an adverse inference is drawn that these may be inflated if their price does not compare favourably with verifiable purchases. This is not applicable in the case of our client because rate of GP declared is more than fair and reasonable and the rate of these purchases compares favourably with purchases from organized sector and imported raw material.
For your satisfaction the explanation given to the auditors is also reproduced below:
We wish to clarify that there are two stores one raw materials store and other one is general store. All the items received in the factory are recorded in respective stores and there is no item un-entered/unrecorded.
The matter was also clarified to the auditors as under:--
The raw material store keeper receives the materials and enters in the Raw materials Receiving Report as against the other Store Keeper receives the goods and stamp the bills. Both these procedures are effectively working and payments are made only after confirmation of receipts of the raw material. Theraw materials are further recorded in the stock register which is already provided to you. The raw materials referred by you are duly recorded accordingly, this may be checked with the records available with you.
As to the list of cash cheques faxed to us on 22-1-2001, we may state that these supplies are from the unrecognized sector. We insist and they deliver the material at our factory site as it is not possible for us to take delivery from various locations. Despite their insistence for the cash payments, it should be appreciated that we invariably prepare cheques in favour of these parties rather than handing over cash in order to keep our records straight and to adhere to the company policy to make payments through cheques only. Our staffs are at times requested to accompany them to the bank for safe withdrawal of cash.
We also wish to state that withholding tax has been deducted on these payments and deposited in the treasury. The photocopies of paid challans have already been provided to you.
As regards the matter of confirmation letter received undelivered, the matter was clarified as under:--
Unfortunately, we do not have control on this aspect. It is matter which is regularly faced by every company in even during the statutory audit. The company has taken every precaution for making payment through cheques and deducting tax wherever withholding provision are applicable. If a person due to his own reasons does not receive a letter no adverse inference can be drawn against the company.
Keeping in view of the explanation/clarification as above as well as our comments per point 4(1) about the Raw Material Register, we may state that the amount of Rs.6.3 M should not be treated as unverifiable purchases in the best interest of dispensation of justice. We may also add that such purchases are approximate 2-3% of our total purchases so to say that the rest 98% of our purchases are verifiable and unassailable:
Most importantly we may add that these materials were purchased at comparatively lower price from unrecognized sector to curtail the cost, consumed in production, and have resulted in higher GP. We have also paid withholding tax on these goods produced/sold. The production records and sales records have been verified by the auditor, therefore, no adverse inference can be drawn.
However, the learned DCIT was not satisfied with the above reply and explanation submitted by the assessee and has proceeded to make the infra trading additions in respect of (i) scrap sales by treating them as other income, (ii) cash purchases (iii) Excessive and wastage to the income of appellant.
27.Being aggrieved and dissatisfied with the above treatment the appellant has filed an appeal before the CIT(A). In appeal the learned CIT Appeals reduced addition on account of cash purchases by 80% and maintained balance addition of 20%. The learned CIT Appeals decided issue with the following remarks:
I am inclined to agree with the contentions of the learned AR of the appellant that there is no justification for adding the cash purchases of Rs.6,314,287. The argument of the learned AR that the declared version cannot be rejected merely on the ground that nominal purchases of 2.92% are cash. The declared GP has not been held low by the Assessing Officer and even after recasting it is higher than the rate of GP of 9.02% accepted in 1997-98 and applied in 1998-99. The Assessing Officer has not settled that the cash purchases are at rate higher than verifiable purchases. The fact that tax has been deducted at source from these purchases under section 50(4) and the purchases of these raw material have been taken into consideration for working out the alleged excess consumption/wastage also goes against the treatment given by the department.
However, after giving due weight to the arguments of the AR of the appellant, the fact that the purchases of 6.3M are in cash the possibility cannot be ruled out that cash purchases have been recorded at price higher than actually paid. Giving due consideration to the improved GP and other argumentsof the learned AR it would be fair to direct that 20% of the amount on cash purchases may be added-back instead of disallowing and adding the total cash purchases.
Before us the learned ARs of the assessee are contesting the addition out of cash purchases maintained by the CIT(A). Apart from drawing our attention to the notice of the DCIT, reply of the assessee and the decision of the learned CIT Appeals reproduced supra they have also filed copies of following statements referred in the reply:--
(i)Statement of consumption of PVC from which it is noted that against raw material issued for production 10,40,225 Kgs, the imported raw material was 900,000 Kgs, and 203,000 Kgs, were from cash purchases. The balance difference is on account of opening and closing stock adjustment. Similar statement was also filed in respect of copper rod, which shows that production could not have been affected without the raw material purchased in cash.
(ii)Statement giving comparative rate of verifiable purchases and cash purchases from which it is noted that the rate of cash purchases is much lower than the verifiable purchases. The statement is reproduced below:--
| | Verifiable purchases Per Kg. | Cash purchases Per Kg. |
| Copper rod. | Rs.107.50 | Rs.65.00 |
| Aluminum rod. | Rs.91.00 | Rs.45.00 |
| PVC. | Rs.38.35 | Rs.15.00 |
| Copper tape. | Rs.163.25 | Rs.80.50 |
The learned counsel has explained that no defect has been found in the books of accounts apart from these nominal cash purchases.
They have submitted that the rate of GP declared this year is better than the rate of GP applied by the Department in assessment year 1998-99 and accepted in assessment year 1997-98. In this regard and in support of these contentions they have also referred to and also drawn our attention to a number of Pakistani and foreign judgments to which reference will be made in the course of this judgment, however, in nutshell; in these case-laws it has been held that no adverse inference can be drawn on account of cash purchases/sales unless the rate of cash purchases/sales does not compare favourably with verifiable sales and purchases. The learned A.Rs. for the appellant have vehemently argued that cash purchases or sales are not a defect either under the law or under the accountancy principles unless evidence of inflation in purchaserates or suppression in sale rates vis- -vis rates relating to verifiable purchases and sales is brought on record and therefore, the mere fact of purchases on cash basis does not provide sufficient justification to the DCIT for rejection of accounts. The learned A.Rs. have also relied on case-laws where it has been held that where the proportion of cash purchase is not substantial the declared version cannot be rejected. The following case-laws cited by the learned A.Rs. alongwith relevant extract of the judgments are reproduced as under:--
S.M. Yousuf & Bros. v. CIT 1974 PTD 45:--
In the above case, Hon ble Karachi High Court held that books results cannot be rejected on the ground that Cash sales and expenses not verifiable , the Hon ble High Court observed nowhere either in the order of the Assessing Officer or in the order of the Appellate Tribunal, it has been found as to what is the proportion of the unvouched or unverified cash sales to the total cash sales or the proportion of unvouched or unverified expenses to the total expenses incurred by the assessee. Unless such proportion is substantial, that is, such proportion creates doubts with regard to the genuineness of the assessee s accounts, it may not ordinarily be proper to reject outright the results of the books of account with regard to unverified cash sales or unverified cash expenses. The Tribunal was, therefore, not entitled to confirm the rejections of the book result of the assessee s business .
R.B. Jessaram Fateh Chand (Sugar Deptt.) v. CIT Bombay (1970) 75 ITR 33 (Bom.):--
In the case of a cash transaction where delivery of goods is taken against cash payment it is hardly necessary for the seller to bother about the name and address of the purchaser. Therefore, the accounts books cannot be rejected in such case merely on the ground that the addresses of the purchasers are not mentioned in such cases transactions.
Mr. Durai Raj v. CIT (1972) 83 ITR 484 (Ker).
In this cited case, the assessee was a dealer in rice. In the previous year ending on August 16, 1962, relating to the assessment year 1963-64, his books of account showed a turnover of Rs.11,56,138. The grossprofit was Rs.4,365 which worked out a rate of 0.4%. The Income Tax Officer stated three reasons for rejecting the assessee s accounts; (1) a low rate of profit when compared to other similar dealers; (2) non-maintenance of a stock book on the basis of weight, without which the stock could not be verified in terms of weight, though the assessee had maintained a stock book on the basis of the number of bags; and (3) absence of particulars of the addresses of the customers, without which verification of the sales was not possible. He estimated the turnover as Rs.11,70,000 and the gross profit at 2%. This resulted in addition of Rs.10,035 to the income returned by the assessee. This order was confirmed on appeals by the Appellate Assistant Commissioner and the Appellate Tribunal. On a reference to High Court:
The Hon ble High Court held, that the Tribunal was not right in rejectingthe trading results of the assessee without it being established that there was any suppressed turnover. What is relevant to consider in such cases is whether the assessee s account are maintained according to the method regularly employed by him, whether they are correct and complete and whether the income can be properly computed from the accounts. The assessee gave an explanation for the low profits when compared with others. The Tribunal did not find that the explanation was not true. Regarding the stock register, the assessee s case was that he bought rice in terms of the number of bags and also sold it in the same manner and that the stock register was, therefore, maintained in terms of bags. This case was apparently accepted by the Tribunal and the subordinate authorities. In a wholesale business like that of the assessee, who bought and sold in terms of the number of bags, maintenance of a stock register in terms of weight would be a very laborious process. There was no need to have complete particulars of the names and addresses of customers in the case of cash transactions and the absence of such particulars in the sale bills would not be a ground for not accepting the books of account of the assessee. The assessee had admittedly maintained his accounts according to the method regularly employed by him, and the profits and gains of the business could be properly computed from his accounts. The grounds stated by the Tribunal were neither valid nor relevant in rejecting the accounts of assessee.
Muhammad Umer v. CIT (1975) 101 ITR 525 (Pat).
If no defects are found in the accounts, they cannot be rejected merely on the ground that in absence of cash memos. the sales were not verifiable and that certain transactions were noted in the books in lump sum.
In this case the assessee, an individual, derived income from the sale of country liquor. For the assessment year 1966-67, the assessee filed a return showing a total turnover of Rs.12,90,678 and a net profit of Rs.22,218, which came to about 1.75 per cent. The Income Tax Officer found certain defects in the accounts of the assessee and did not accept the figures shown by the assessee and estimated the assessee s sales at Rs.12,95,000 and a net profit of Rs.29,875 at the rate of 2.5 per cent. His order was affirmed on appeals. On a reference:--
Held, that the only two defects found by the Income Tax Officer for rejecting the book profits were that, in the absence of cash memos., the sales were not verifiable and that certain transactions were noted in lump sum. No finding was recorded by the departmental authorities as to the unacceptability of the method and irregularity of the account kept by the assessee. It is well-settled that in the absence of such a finding recorded by the authorities, the book results cannot be ignored or brushed aside. It was not a case of rejection of the assessee s accounts under section 145(2) of the Income Tax Act, 1967; it was a case under the provisions of the proviso to subsection (5) of section 145. Once, therefore, the method of accounting employed by the assessee has beenregularly employed and income, profits and gains could properly be deduced from such regularly employed method of accounting that is the end of the matter for the purpose of the proviso to subsection (1) of section 145. There was no finding in the present case that any of the entries in the books of account was not correct, there was no finding that the assessee was not employing a method of accounting and there was no finding that such a method of accounting had been irregularly employed by the assessee. In the absence of any such finding, there being no reason germane to the unacceptability of the book results, it had to be held that the Tribunal and the authorities below had no materials before them on the basis of which it could be said that the trading results were not verifiable and that, therefore, they should not be accepted nor was it their case that the trading results could not be deduced from the entries of the books of account regularly employed. Consequently, the assessment made in the pursuance of the proviso to section 145(1) would be vitiated.
C.M. Francis and Co. (P.) Ltd. v. CIT (1970) 77 ITR 449
If sellers/purchaser are illiterate/unorganized absence of purchase voucher-Accounts cannot be rejected.
In this cited case the assessee did not obtain/bought notes from the sellers in respect of its trade in Erica nuts was not a defect by itself or something which the assessee could have helped, since the sellers were agriculturists from whom it was not possible in the ordinary course of business to obtain vouchers and also the fact that the maintenance of bought notes by the purchasers was the common feature in the assessee s line of business. Further, no case had been made out that the purchases were inflated or bogus purchases had gone into the assessee s accounts
.the facts the purchases of Erica nuts were supported only by the assessee s bought notes was no ground for rejection of accounts.
From the perusal of the above judgments the following principles/propositions emerged from the above cited case:
In the 1st case-law cited by the learned counsel which is reported as S.M. Yousuf and Bros. v. CIT 1974 PTD 45 the following principles have been laid down in that case:
(i)Unless unverifiability of purchases/sales is substantial, i.e., such proportion as to create doubts with regard to the genuineness of the assessee s accounts, it may not ordinarily be proper to reject outright the results of the books of account with regard to unverified cash sales or unverified cash purchases or cash expenses or few unverifiable expenses.
(ii)It is improper for the DCIT to base his order only on mereguess and that there should be something more than suspicion to justify the rejection of book versions of the assessee s business; low profit is not sufficient ground for rejection of booksversion.
(iii)Non-maintenance of stock register is not a sufficient ground for rejection of trading account.
(iv)The petition was allowed by the Hon ble High Court of Karachi by holding that the Tribunal was not entitled to confirm the rejection of the books results of the assessee s business.
In the 2nd case-law cited by the learned A.Rs. which is reported as (R.B. Jessaram Fateh Chand (Sugar Deptt.) v. CIT Bombay (1970) 75 ITR 33 (Bom.) the following principles have been laid down in thatcase:
(i)There is no necessity whatsoever for the assessee to have maintained the addresses of cash sellers/purchasers.
(ii)Non-supply of addresses of cash purchases/sales cannot giverise to a suspicion with regard to the genuineness of the transactions.
(iii)It is, therefore, followed that assessee s account books are to be accepted unless, on verification, they disclosed any faults or defects, which cannot be reasonably and satisfactorily explained by the assessee.
In the 3rd case-law cited by the learned A.Rs. which is reported as (Mr. Durai Raj v. CIT (1972) 83 ITR 484 (Ker.) the following principles have been laid down in that case:--
(i)There was no need tohavecompleteparticularsofthenameand addresses of the customers in the case of cash transactions, andtheabsenceofsuchparticularsinthesale billwouldnotbe a ground for not accepting the books of accounts of the assessee.
(ii)The assessee had admittedly maintained his accounts according to the method regularly employed by him, and the profit and gains of business could be computed from his accounts therefore, there is not valid reason in rejecting the accounts of the assessee.
(iii)Non-maintenance of stock register is not a valid ground for rejecting the assessee s accounts.
In the 4th case-law cited by the learned counsel which is reported as Muhammad Umer v. CIT (1975) 101 ITR 525) (Pat) the following principles had been laid down in that case:--
(i)The account books of the assessee cannot be rejected merely on the ground that addresses of the purchasers are not mentioned in the cash memo. copies.
(ii)If no defects are found in the accounts they cannot be rejected merely on the ground that in the absence of cash memos. the sales were not verifiable and that certain transactions were noted in the books in lump sum.
(iii)Recording of clear finding by the Assessing Officer is necessary. It may be observed that the proviso to section 145 (equivalent to section 32 of Income Tax Ordinance, 1979) cannot be invoked by the Assessing Officer unless he has considered and recorded a finding against the assessee as to whether he has been regularly employing a method of accounting or whether his income, profits and gains can properly be deduced from his method of accounting if he has been regularly employing a method of accounting. The Assessing Officer s decision on these matters is not to be a subjective or arbitrary decision but a judicial decision and cannot be accepted if there is no material to support his finding.
In the last case-law cited by the learned A.Rs which is reported as (C.M. Francis and Co. (P.) Ltd. v. CIT (1970) 77 ITR 449) the following principles had been laid down in that case:---
(i)If the sellers/purchasers were agriculturist/unorganized/illiterate from whom it was not possible in the ordinary courseof business to obtain vouchers the rejection of accounts on this ground is unjustified.
(ii)If the accounts were properly maintained and they have been accepted in the past there was no ground for the application of either the proviso of section 13 of the Income Tax Act, 1922 or the proviso of section 145 of Income Tax Act, 1961 (equivalent to section 32 of the Income Tax Ordinance, 1979).
The learned A.Rs also drew our attention to the decision of the learned CIT Appeals where addition of 20% has been maintained only to cover a suspicion of over statement of cash purchases the exact words used are possibility cannot be ruled out of cash purchases have been recorded at price higher than actually paid.
28.The DR has supported order of the learned DCIT and has stated that the cash purchases were rightly disallowed and the learned CIT(A) was not justified in giving relief by way of accepting 80% cash purchases and restricting only 20% cash sales.
29.We have given very thoughtful consideration to the arguments advanced by both the parties and have also perused the record of the case.
The disallowance of the total payment of cash purchases is a novel treatment. When the raw material purchased in cash was taken into account forcalculation of excess consumption, it is not the case of the department that the raw material purchased from unverifiable parties was not received by the appellant or not utilized for production. In the explanation filed appellant/assessee stated that the raw material purchased is recorded in the stock register and asked the department a number of times to give appellants access to the stock register so that the receipt of raw material may be shown in the stock register. Copy of the letter of auditors retaining the stock register and letter sent to the DCIT asking return of stock register have been filed before us. In view of these circumstances action of the Assessing Officer in adding back total payment for the raw material purchased from unverifiable parties cannot be maintained.
Now we have to see if the CIT Appeals had any justification in maintaining addition of 20% out of cash purchases. It is observed here that purchases on cash basis is normal phenomena and it is also normal business practice to which no exception can be taken. Further as far as the false verifiable addresses of parties mentioned by the DCIT are concerned we do not think that they are unverifiable and in any case justified the rejection of trading results the law doesnot require an assessee to ascertain the whereabout of seller/purchaser before entering into any deal. The alleged unverifiable cash purchases constitute only 2.9% of the total purchases. The learned counsel has rightly pointed out that these unverifiable cash purchases were from unorganized sector just to save the cost. This fact was also brought to the knowledge of the DCIT/Assessing Officer by the assessee through its reply. The mere fact that only 2.9% cash purchases were made from unorganized sector is not a defect either under the law or under the accepted principle of accounting. We are afraid we cannot agree with the reason given by the learned CIT Appeals for maintaining addition of 20%. She accepts the fact that the GP declared is better than last year. Further in the cash memo. the rates of items and quantity purchased were mentioned and these particulars were incorporated in the stock register which were in the custody of the department and the appellant has requested time and again to verify these from the stock register in the presence of department officers. The learned CIT(A) has not disputed the fact that the rates of purchases of these raw materials are much less than the average rate of verifiable purchases. It is observed by us that tax in respect of these purchases under section 50(4) has been deducted out of the payments made and was duly deposited in the Government exchequer. This fact was admitted by both the officers below. At this juncture we would like to further observe that cash purchases are a fact of life and this fact cannot be ignored in the under-developing countries like ours. There is no principle of accountancy or rule of law that an assessee must purchase the goods either on credit basis or from verifiable parties only. The mere fact that a part of purchases was in cash would not be itself aground for rejecting the book version. In the instant appeal the appellant has provided the rates of credit purchases and cash purchases which has been reproduced in the earlier part of this order which clearly depicts that the rates of cash purchases/unverifiable purchases are much less than the verifiable parties/credit purchases. The suspicion of inflating of purchase price of cash purchases could only arise if the GP declared had been low or price paid for the cash purchases was more than verifiable purchases. When both these factors are not present the suspicion is totally unfounded and no addition on mere guess and conjecture has been approved by higher judicious authorities. The ratio of few judgments has already been reproduced supra in this order. It is, therefore, directed that the amount paid for cash purchases by the appellant may be allowed in full.
30.The next ground we take up is in respect of addition on account of excessive production wastage on which both the assessee and the department are in appeal.
The factual matrix:
An addition of Rs.11,23,109 was made on account of excessive wastage. The break up of the wastage is gathered from the grounds of appeal of the assessee before us and the relief allowed by the learned CIT(A) under this head which is as under:--
PVCRs.4,60,682
XLPE sioplasRs.283,018
P.P. FilmRs.94,413
CabelecRs.223,150
Copper tapeRs.176
Genkline/TrinkloneRs.61,670
Rs.1,123,109
This addition was made with the following observations recorded on serial 9 of page 10 of the assessment order, the same is reproduced below:--
The assessee had shown excess wastage which is not allowable. The same was confronted to the assessee vide notice under section 62 supra. The reply of the assessee is not satisfactory in so much as it is non-specific hence amount is added back.
The content of the notice and the reply of the assessee has not been reproduced in the order. In the notice under section 62, dated 31-3-2001 the assessee has been confronted on this issue at para. 4(iv) which is reproduced below:
(iv)You are requested to please file explanation to the proposed addition under the head wastage
This does not reveal any thing however the reply filed by the assessee vide his letter, dated 30-4-2001 sheds more light on the proposed addition under this head made on the recommendations of the auditor. It would be useful to reproduce the reply:
The company has it own history of allowable wastage and it cannot be ignored against specific judgment of higher Courts that history of case is to be considered and respected.
At this juncture, we wish to point out that the wastage suffered this year in PVC is just 6.25%. Our client has history of accepted wastage of PVC to the extent of 13.25% (8.77% allowed by DCIT and the balance 4.48% allowed by CIT (Appeal). The decision of CIT(A) was upheld by the learned Tribunal relating to the Assessment year 1991-92). The wastage, percentages relating to other items could be valid and unassailable on the same grounds as upheld by CIT(A) and Tribunal in the case of PVC as the wastage suffered are actual. (Copy of the Tribunal s order also cited).
The auditors have worked out alleged consumption/wastage on the basis of the allowable consumption allowed by the Government for the facility of lower rate of duty in respect of raw material consumed in production. This percentage has been fixed by them but the percentage varies sometimes less and sometimes more than the allowable limits fixed by the Government for purposes of concessional duty. Consumption over the limit fixed for the purposes of duty cannot be treated excessive and added back when a proper production results and the G.P. declared is more than fair and reasonable. We may add here that as you will see from the proposed amounts of the addition an amount of Rs.176 is also proposed in respect of consumption exceeding crores of rupees. This alone shows the unreasonable action of the auditors and your notice undersection 62. Case-law also enclosed as Annexure B; where addition merely on account of alleged excess consumption/ wastage was not approved.
The learned CIT(A) deleted the addition made in respect of PVC and maintained the addition in respect of the balance items. The decision of the learned CIT(A) is reproduced below:--
The contention of the AR that the wastage claimed in PVC at 6.52% is less than the minimum of 8.77% wastage allowed by the department. Actually higher wastage of more than 13% has been allowed in respect of PVC, whichaction has been confirmed by the learned ITAT.
The addition of Rs.460,682 on account of excessive wastage in respect of PVC, is, therefore, deleted.
As regards the other items the percentage of wastage in these items is excessive and no previous history has been given by the appellant to support the allowance of the wastage. The disallowance of wastage in respect of other items is, therefore, maintained.
Contesting the action of the learned CIT(A) in maintaining the addition on account of excess production wastage the learned A.Rs mainly referred to the explanation submitted before the learned DCIT reproduced supra. He further elaborated that in past the consumption of only four items mainly PVC, Copper, Aluminum and G.I. Wire was considered/examined by the department. He further elaborated that any addition made on account of excess consumption over the prescribed limit of 3% fixed for calculation of concessional duty was deleted in appeal. He has filed copy of the order of this Tribunal in respect of assessment year 1996-97 in this very case where 13.61% wastage in respect of PVC was allowed by the CIT(A) and this treatment was upheld by the Tribunal in ITA No.1460/KB of 1997-98 vide order, dated 16-4-1998. It has been contended by the A.Rs. that the Assessing Officer has been allowing wastage of 8.77% in respect of PVC right from its inception.
As regards the other items the AR argued that the wastage in respect of these items has never been added in the past. He drew our attention to the various case-laws where addition on account of excessive wastage has not been approved without any defects in the accounts coupled with lowness of the GP. Some of the case-laws alongwith relevant extract are reproduced below:
Case laws regarding excess consumption/wastage
(a)A reported judgment in the case of Messrs Shafiq Textile Mills Ltd. reported as 2001 PTD (Trib.) 2941 wherein the Hon ble Income Tax Appellate Tribunal has accepted the wastage claim as high as between 16.97% to 22.18% and also accepted the declared wastage alongwith declared trading version.
(b)(Indus Textile Mills Ltd. v. CIT (1989) 60 Tax 1 (H.C. Kar.) = 1989 PTD 567 (H.C. Kar). Accounts of the assessee cannot be rejected merely on the ground that the assessee had not maintained record of stage-wise production and wastage.
(c)Tanveer Textile Mills Ltd. v. CIT 1990 PTD 254. Wastage claimed by assessee-Rejection Genuineness of account books maintained by the assessee was not doubted -- Nothing wrong was pointed out in the manner of accounting maintained by assessee Where it was not possible to maintain record of wastage and no such record was maintained in the past as well, department could not reject the accounts of assessee for that reason.
In the first case-law cited by the learned ARs which is reported as (Messrs Shafiq Textile Mills Ltd. 2001 PTD (Trib.) 2941 the following principles have been laid down:--
(i)Rejection of accounts on account of non-maintenance of wastage account is unjustified.
(ii)Rejection of accounts by using stock phrases like sales were not verifiable, production record not produced and wastage excessive was not held proper.
(iii)Higher claim of wastage is not a valid ground for rejection of account if accounts were accepted in the past.
(iv)Non-maintenance of stage-wise production and stage-wise wastage could not be made a basis for deviation from the past if account were maintained properly and in similar manner.
In the second case-law cited by the learned A.Rs and reported as (Indus Textile Mills Ltd. v. CIT 1989 PTD 567 the following principles have been laid down:--
(i)Accounts of the assessee cannot be rejected on the ground that stage-wise wastage was not maintained.
(ii)Rejection of accounts is unjustified if the assessee maintained accounts properly and in the similar manner as in the past which were accepted.
(iii)Assessing Officer cannot insist nor base his findings on the non-maintenance of record of stage-wise wastage.
(iv)Accounts cannot be rejected if the sales are subjected to excise duty and records are kept in accordance with the excise duty laws.
In the last case-law cited by the learned A.Rs. and reported as (Tanveer Textile Mills Ltd. v. CIT 1990 PTD 254 the following principles have been laid down:
(i)Rejection of declared result was not justified on the ground of short production.
(ii)Non-maintenance of wastage record is not a valid reason for rejection of books of account.
The learned DR has supported the order of the Assessing Officer and has stated that addition has been made on the basis of valid objection and recommendations of the special auditors. He has contended that CIT(A) was not justified in deleting the additions in respect of wastage of PVC.
31.After considering the arguments of the learned A.Rs. of the assessee and the learned DR, we find that there is no merit in the departmental appeal against the relief allowed in respect of wastage of PVC when the wastage allowed this year at 6.25% is much less than the wastage of up to 13.61% considered reasonable by this Tribunal in assessment year 1996-97. Following this decided position in respect of excessive wastage of PVC has been accepted by the department itself up to 8.7% in the previous years and 13% by the Income Tax Appellate Tribunal for the assessment year 1996-97, hence, no interference is required to be made with the CIT(A) s order and the department appeal on this ground stands dismissed accordingly.
32.As regards the assessee s appeal on the issue of excessive wastage in respect of remaining items other than PVC we find that neither the Assessing Officer has given the past history in respect of wastage in these items nor the assessee has given the figures of wastage allowed in these items in earlier years. Agreeing with the judicial pronouncement that addition merely on account of excessive consumption/wastage in the absence of defects in account coupled with low GP is not justified. We still feel that as comparative data is not available it would meet the needs of justice if theaddition in respect of the items maintained by the CIT(A) is set aside with the direction that the percentage of consumption/wastage may be examined in the light of the past history keeping in view the ratio of the judgment cited supra.
33.Out of various add-backs learned counsel has only pressed the disallowance of telephone expenses.
This year out of telephone expenses claimed at Rs.969,829 an amount of Rs.272,402 has been disallowed. The Assessing Officer in support of the treatment given this year has also referred to the decision given last year, which was confirmed in appeal.
The learned ARs of the assessee has given a comparative chart from which it is noted that telephone expenses are being consistently disallowed @ 10% of the claim. The same treatment was also given last year. No proper reason has been given for deviation from past history therefore the arbitrary disallowance out of telephone expenses @ 28% cannot be maintained. It is, therefore, directed that the disallowance may be made @ 10% of the claim which is being in line with the history of the case.
34.This brings us to the remaining other ground of the department which is against the direction of CIT(A) to charge WWF after setting off of assessed losses. This issue has already been decided against the department while deciding the appeal for the assessment year 1998-99. This being the decided position no interference is required to be made with the order of the CIT(A) and the appeal of the department accordingly stands dismissed.
35.The intrinsic complexity of laws and the innumerable variety of circumstances, as also the intricacies emerging from combination of facts of varying shades, have given rise to controversies necessitating resolution by the superior Courts with reference to the use of discretion by the Assessing Officer. The learned Judges have, with dexterity and wisdom, elucidated the legal aspects and offered solutions, a discerning study of which brings out that the Assessing Officer has been restrained from overstepping the limits of legal discretion.
After careful consideration of the arguments of the learned counsel, case-laws cited at bar and from the criterion set out by the superior Courts and survey of these precedents and above discussions clearly reveal the following propositions/principles which may be summed up as follows:--
The superior Courts have emphasized that the power under section 32 of Income Tax Ordinance, 1979 are to be exercised with circumspection in a manner to avoid arbitrariness, smacking of abuse of authority.
If the assessee has employed a regular method of accounting and the accounts are maintained regularly, the Assessing Officer is not entitled to reject the book result without pointing out specific defects based on evidence.
If the method of accounts has been accepted in the preceding year after detailed scrutiny and examination of accounts and a conscious order stand passed after application of mind and on that basis the assessee has a history of acceptance of method of accounts, and for the year under dispute the method is the same as for the preceding year and no suppression of income was detected, the rejection of accounts by the Assessing Officer is unjustified.
If method of accounting regularly employed by the assessee stands accepted by the department in the past, then in the absence of anyconcrete and tangible evidence of suppression of income, the Assessing Officer is not entitled to reject books of accounts.
It is a settled law that the assessee is entitled to adopt a method of accounting and even change it, if prima facie the change is bona fide and the change adopted for long time and correct income also represented by account. The Assessing Officer cannot reject the change and make certain addition on the basis of such change in method, which was necessitated by practical and technical considerations and to remove difficulties of business.
It has also been held that where the assessee followed the same method of accounting, from year to year and if the profit of the business from year to year correctly computed by the department on the same method, the Assessing Officer cannot reject the book version or discard the regularly employed method.
Accounts cannot be rejected only because the method does not appeal to the Assessing Officer:
In the absence of any omission, irregularity or other defect in the method of accounting or positive evidence to show that the accounts did not disclose, the whole income of the assessee, books of accounts could not be rejected.
Method of accounting adopted by assessee was not objected to by Department in previous years on any ground. Samemethod was employed in assessment year under dispute. Rejection of accounts and addition made to the declared gross profit, held unjustified.
In account case or even in no account case material used against assessee must be placed before assessee for rebuttal. This principle of natural justice was always deemed to be treated as an in-built provision in law even prior to enactment of proviso to subsection (1) of section 62.
In the absence of any omission, irregularity or other major defect in the method of accounting or presence of positive evidence to show that the accounts did not disclose the real income of the assessee, the books of account cannot be rejected. Therefore, the income tax authorities have to reach positively to a finding that there were defects in the method of accounting as maintained by the assessee. Accordingly, the following would not constitute a ground for rejecting the method of accounting/ books of accounts:--
-Minor mistakes or insignificant defects;
-certain transactions were noted in the books in lump sum;
-difficulty in apportionment of profits;
-suspicion without any positive evidence;
-mere different tabulation treatment between trading and profit and loss accounts items;
-profits low and comparatively unfavourable with those of others in the same line of business;
-low profits without any other defects in the books of suppressed income merely on the basis of presumption; and
-mere use of abstract expression was not sufficient.
We may further elaborate the requirements for rejecting the method of accounts/book of account as follows:--
--Where purchases/sales are found (with evidence) to be omitted/suppressed the books can be rejected but mere absence of full addresses on cash memos. is not necessarily a ground for rejection of books.
--That after rejection of books of accounts/method of accounting on valid grounds a much more onerous duty is cast upon Assessing Officer to determine his computation of the income/ profit or gain. The determination and the computation of income must be made on a valid basis evolved by DCIT/ Assessing Officer. His judgment must be based on material evidence. The Assessing Officer cannot just take a leap in dark and indulge in a pure guess by making arbitrary, capricious and ad hoc/bald/ lump sum or round figure additions without laying down the proper mode, manner and basis for additions. He should endeavour to the best of his ability to ascertain the income/profit and gain of the assessee nearest to the truth.
--That the assessment based on mere conjectures, surmises, suspicions or irrelevant and inadmissible evidence and material is invalid and unsustainable in law.
--Result of the accounts maintained cannot be rejected merely because rate of gross profit had gone down whereas a reasonable explanation for the same had been offered by assessee.
--Accounts of assessee regularly kept, vouched and variable. Accounts were rejected on the ground that rate of gross profit shown in the books is very low without bringing any other evidence or material on record in support of the rejection of account. Rejection of book version cannot be justified.
--Rejection of accounts in the instant case on the ground that the scrap sales have been deducted from cost of goods sold is not sustainable in view of the earlier judgment of this Hon ble Tribunal.
--Rejection of accounts on the ground of excessive cost of fuel, electricity without proving any omission or suppression is unjustified.
--If some cash purchases are unverifiable as alleged by the DCIT in present case, the same cannot be made a ground for rejection of books of accounts. Absence of full addresses on purchase vouchers of cash memos. is not necessarily a ground for rejecting books of account.
--If a negligible portion of the transactions is unverifiable or doubtful in the opinion of the Assessing Officer, he does not have any authority to conclude that all the transactions are false. Say in a case 97% transactions are verifiable and other transactions are not verifiable but comparable with the verifiable transactions the Assessing Officer has no authority to reject the accounts and make his own arbitrary estimate.
--That it is the duty of the Assessing Authority to examine each register and books of account furnished by the assessee before him. He cannot give vague findings and clich s that sales and purchases are unverifiable. Unverifiability itself is not criterion for rejection. Unverifiable transactions may be true or false and it depends on the facts and circumstances of each case.
--Non-maintenance of stock register is not a valid ground for rejection.
--If production results and declared sales have been accepted by the department, then the gross profit is nothing but a balancing figure which ought not to be discarded for lowness unless suppression of income is proved by the Assessing Officer.
--Where the assessee s accounts in the past have been accepted for a number of years after scrutiny of books of account and assessment framed undernormal law after due inquiry, the DCIT will not be justified if he for any subsequent year refuse to accept such method of accounting in that valid reason.
--The power of Assessing Officer to reject accounts is not a mere discretionary power but amounts to a statutory duty. Such power is not purely a subjective or arbitrary exercise of discretion, and it is required to be exercised judicially. Adverse inference cannot be drawn unless the Assessing Officer is satisfied that the income has been suppressed by the assessee.
--Income Tax Officer cannot reject the accounts merely because either he had no time to go into details or he got influenced by the idea that others have shown better results.
--Income Tax Authorities cannot estimate sales and gross profit after rejecting books results without bringing any material evidence on record and without giving due notice to the assessee.
--That whenever the Assessing Officer rejects books of account on the basis of suppression, this ought to be on some definite material and not based on mere imagination, speculation or suspicion.
--Doctrine of res judicata is not applicable in income tax proceedings but it does not, however, mean that findings arrived at after due enquiry during the assessment proceedings for the preceding years can be totally ignored by the Assessing Officer under the garb of res judicata and in these cases the Assessing Officer cannot depart arbitrarily from the past history when assessment was finalized after detailed examination and scrutiny of the facts and where earlier assessments are neither arbitrary nor perverse. Thus, it appears that the very rule of res judicata is more particularly applicable to re-assessment/reopening proceedings where fresh facts come to light which on investigation would entitle the Assessing Officer to come to a differentconclusion from the one reached earlier and earlier assessments are either arbitrary or perverse. If this rule is made strictly applicable to the whole Income Tax Ordinance, the re-assessment proceeding would be hit by this rule and would render the re-assessment proceedings as infractuous.
However, a finding reached in the assessment proceedings for an earlier year cannot be reopened in a subsequent year if such finding is not arbitrary or perverse and has been arrived at after due enquiry and no fresh facts are placed on recordin the subsequent assessment year.
The DCIT/Assessing Officer cannot arbitrarily depart from the finding reached in an earlier year, after due enquiry, by his predecessor-in-office, merely on the ground that he is the succeeding officer, does not agree with the preceding officer s findings.
Where, even in re-assessment/re-opening proceedings, the question relating to assessment does not vary with the income but depends on the nature of the property or on any other question on which the rights of the parties are based, such questions if decided by a Court on a reference made to it would be res judicata and cannot be subsequently agitated.
Where the facts are purely variable from year to year the principle of res judicata cannot have application.
That the principle of res judicata can be applied to income tax proceedings where a finding reached in the assessment proceedings for an earlier year would not be re-opened in a subsequent year if it is not arbitrary or perverse, and had been arrived at after due enquiry and if no fresh facts are placed in the subsequent assessment year. This is on the principle that there should be finality and certainty in all litigations including litigations arising out of the Income Tax law.
36.From the above discussion, the proposition that emerges is that when accounts are regularly maintained in the course of business these have to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. The Department has to prove satisfactorily that the account books are unreliable, incorrect or incomplete before it can reject the accounts. The rejection of accounts is not a matter to be done light-heartedly, though it may not be possible to lay down in general terms the exact circumstances in which the accounts should be considered as unreliable or incorrect. The accounts could be rejected as unreliable if important transactions are deliberately omitted and suppressed.
37.We will conclude this order by quoting Lord Maugham: There is always a possibility of finding in the twists and turns of the income tax maze some relief or refuge for the harassed taxpayer, and this possibility we must now examine . Our own observation is that the power to tax is not the power to destroy. The power to discard the declared version does not seem to us to be a test of the right to tax and collect more and more revenue from the taxpayers.
38.Resultantly the appeal of the assessee for the assessment year 1998-99 on the following grounds agitated before us succeeds:--
(i)Treatment by the officers below of the scrap sale to be item of income from other source is not sustainable, hence, deleted in view of the decision of the Tribunal in respect of other parallel case discussed supra.
(ii)Rejection of books of account and application of higher GP rate by the officers below was unjustified. Hence, declared version is ordered to be accepted for the reasons mentioned supra.
(iii)Dearness allowance and special allowance being part of salary cannot be included in the definition of excess perquisites.
While the appeal for the assessment year 1999-2000 for the reasons as discussed in this judgment is disposed as follows:--
(i)Treatment of scrap sales by the officers below is not sustainable for the reasons as discussed for the assessment year 1998-99.
(ii)Disallowance of 20% cash purchases to income of assessee is deleted, and declared trading version is ordered to be accepted.
(iii)Disallowance of excessive wastage other than PVC is set aside for fresh consideration in the light of directions mentioned supra.
(iv)Telephone expenses is restricted to 10% of the amount claimed, being in accordance with the history of the case.
The appeals of the department for both the years stand dismissed on all the grounds for the reasons recorded.
In consequence all the four appeals stand disposed of as above.
39.Before parting with these appeals we would like to record our appreciation for the valuable assistance rendered by Mr. M. Jawed Zakaria, Advocate and Mr. Jan-e-Alam, ITP for taking pains while placing reliance before us on the case-laws of Pakistan and India as well as other foreign jurisdiction and explaining the principles of accountancy very artistically and further deserve to be mentioned for providing requisite details, informations and other relevant case-laws.
C.M.A./355/Tax(Trib.)Appeals dismissed.