GHAZI TANNERIES LTD., KARACHI VS COMMISSIONER OF INCOME TAX, CENTRAL ZONE `B', KARACHI, 2011 PTD-KARACHI-HIGH-COURT-SINDH 2161 (2006)

(a) Income Tax Ordinance (XXXI of 1979)---

----S.32---Books of accounts produced in support of explanation of assessee-Burden of proof---Once such books were produced, onus would lie on Assessing Officer to examine and controvert such explanation with specified instances of its fallacy from such books.

Commissioner of Income Tax, Companies-III, Karachi v. Krudd Sons Ltd. 1994 SCMR 229 = 1994 PTD 174; Pima (Pvt.) Ltd., Karachi v. Commissioner of Income Tax, Companies-I, Karachi 1994 PTD 123; New Snow White Dry Cleaners, Karachi v. Commissioner of Income Tax (Eaast) Karachi 1985 PTD 315; Messrs Zafar Saleem Bros. Ltd., Karachi v. The Commissioner of Income Tax, Karachi 1984 PTD 225; Star Rolling Mills v. Commissioner of Income Tax PLD 1974 Note 129 at Page 189; Messrs Pakistan Oil Mills Ltd. Hyderabad v. The Commissioner of Income Tax (West), Karachi 1985 PTD 320; Muhammadi Textile Mills Ltd. v. Commissioner of Income Tax (East), Karachi 1984 PTD 239 and Unreported judgment dated 12-8-2005 passed in I.T.A. No.493 of 1999 ref.

(b) Income Tax Ordinance (XXXXI of 1979)---

----Ss.32(3) & 136---Trading accounts of assessee, rejection of---Reference to High Court---Maintainability---Question of rejection of such accounts being mixed question of law and facts could be adjudicated upon by High Court.

Commissioner of Income Tax, Companies-III, Karachi v. Krudd Sons Ltd. 1994 SCMR 229 1994 PTD 174 rel.

Iqbal Salman Pasha for Petitioner.

Jawaid Farooqui for Respondent.

Nasrullah Awan, Advocate.

Dates of hearing: 13th April, and 11th May, 2006.

ORDER

MUHAMMAD ATHAR SAEED, J.---These income tax references have been filed under section 136(2) of the Income Tax Ordinance through which the opinion of this Court has been sought on the following questions:-

(1)Whether on the facts and in the circumstances of the case the learned Appellate Tribunal was correct in holding that subsection (3) of section 32 of the Income Tax Ordinance, 1979 was applicable to the case of the applicant.

(2)Whether on the facts and in the circumstances of the case the learned Appellate Tribunal misdirected itself in law by rejecting the declared trading results.

2. Brief facts of the case are that the applicant is a private limited company engaged in the manufacture and export of leather from the raw skins and hides. The assessment years involved are 1987-88 1988-89 and 1989-90. For these assessment years, the Income Tax Officer had rejected the trading account of the applicant and estimated sales and gross profits as per the chart detailed below:-

3. The comparative position of the declared trading accounts for these three years along with assessment year 1986-87 are as follows:--

4. The reasons highlighted for the rejection of books of accounts by the Income Tax Officer are reproduced for every year as under:--

1987-88

The above comparison reflects Improvement in Turn over and Gross profit whereas there is decline in G.P., rate. The A.R. of assessee was required to explain the reasons for decline in G.P. rate. The assessee has filed a letter of explanation along with details/documents wherein it has been stated that purchase price, conversion cost and chemical cost almost doubled but the Sales price increased by only 50% which resulted in decrease of G.P. rate. The explanation filed by the A.R. of assessee is of general nature and is not supported by any documentary evidence. Purchase are mostly unverifiable. Expenses claimed on conversion cost are supported by self made debt vouchers. Neither Manufacturing register has been maintained nor there is any co-relation between the input of raw material and out put of finished goods/products.

1988-89

The comparison above goes to Prove that turn over has improved, however rate of G.P. has been declining continuously. The explanation for fall in G.P. in case. which was advanced in earlier years and rejected being general in nature.

The details filed by the assessee have been examined. It is noted that sales are exports as well as local. The local sales are partly verifiable on account of cash transactions and incomplete particulars of parties. The purchases are mostly cash made from numerous verifiable parties. The expenditure claimed on conversion are also supported by self made internal vouchers. Neither manufacturing register has been maintained nor there is any co-relation between the import of raw material and output of finished goods/products. It may be noted that similar, defects were found in immediate proceedings year, where after rejecting the accounts G.P. rate was applied 22.9%.

1989-90

The above data reveals that both sales and G.P. Irate have considerably reduced compared to the last two years. In support of the above the following explanation has been provided.

There is no substantial decrease in sales figures and G.P. rate of assessment year 1989-1990 in comparison to previous year. However sales have been deceased due to prevailing situation in the country during the year 1988. Such camp tragedy dismissal of Junejo Government, I resident Zia's air crash tragedy and October, 1988 general elections and therefore export businesses was effected and the G.P. rate was deceased by only 0.86%.

The explanation of the assessee has been considered and is found to be of general nature and more or less the same as in earlier years which were rejected by the department.

Details filed by the assesses have been examined in detail and it has been found out that during the year local sales have almost doubled that of export sales whereas- in the previous year they were more or less the same. However as details of local sales were without complete addresses and as complete details of job receipts were not filed. The assessee was confronted on this issue vide letter dated 23-12-1991. In compliance, vide letter dated 15-3-1992 the assessee offered the following explanation.

"As regards addresses of the parties mentioned in para.6 of your letter we have to state that our clients have sold goods of these parties on cash, as such no full addresses are available. However the rates charged on such sales as charged on credit sales."

Our clients submitted the details of job receipts over Rs.1,000. This statement shows job receipts at Rs.1651423 the balance job receipts represent, the accounts received below Rs.1000.

The above explanation reveals that sales are not Completely verifiable being on cash basis and similarly about 40% of job receipts are not verifiable. Regarding production, the assessee has only provided figures of opening stock and purchases of raw skin and their corresponding sale. The day-to-day production figure showing daily input and output and wastage have not been provided thereby making it impossible to verify the pro results.

Keeping the above facts in mind, the assessee's deal, Varian does not merit acceptance. However, the rejection of book version for 1987-88 has also been upheld at the first appeal stage. Therefore sales are estimated at Rs.450,00,000 and G.P rate as per history is applied at 22 .9%, This will give an addition of Rs.53,,82,223 to the trading account.

5. The applicants' appeals for all the three years were dismissed by the CIT Appeals. Being aggrieved by the order of the CIT the applicant filed appeals before the Tribunal, but vide their combined order dated 16-1-1994 they upheld the rejection of accounts, but reduced the gross profit to 17.76 percent. The books of accounts were also produced before the Income Tax Appellate Tribunal, but after examination the same were rejected on the basis of the defects highlighted in their order.

It will be pertinent to reproduce the reasons on the basis of which the Tribunal rejected the books of 'accounts:--

Books of accounts were produced before us to establish the contention of the assessee. The examination of books of accounts revealed that the assessee maintains books of accounts in a manner that wastage in the manufacturing process and qualitative reconciliation of the items processed cannot be determined. Purchase of rain skins has been recorded batch-wise making the entry as consisting of a batch of raw skins while sellers are not identified by name. On receipt of skins these are subjected to processing; and when these are processed certain percentage of the skins disintegrate into pieces. No separate account has been maintained for such skins Mr. Muhammad Hussain, manager of the company attended along with the learned A.R. and gave replies to various questions. From his replies it was found that around. l0'% skins disintegrate in the process. Method of sale of such percentage was that the skins was treated as one piece and sold at a lower, value as compared to the ordinary skins.

6. The Reference application filed under section 136(1) before the Tribunal for referring the question reproduced in the earlier order of this Judgment was dismissed by the Tribunal for the reason that it was purely a -question of fact as they had arrived at that conclusion on the basis of the of examination books of accounts and therefore, no question of law was involved hence this reference application under section 36(2).

7. We have heard Mr. Iqbal Salman Pasha, learned counsel for the applicant, Mr. Jawaid Farooqui and Mr.Nasrullah Awan, learned counsel for the respondent.

8. Learned counsel for the petitioner vehemently argued that the Tribunal had committed error by rejecting the trading account of the applicant under, subsection (3) of section 32 the Income Tax Ordinance, 1979 as according to him the applicant was following' the same method of accounting from the very inception of its business and his accounts were always accepted. He said that the Tribunal had also committed -error while considering the past history of the case by observing that the accounts were rejected for the years 1983-84 and 1984-85 and ad-hoc additions were made. He drew our attention to the orders of the CIT Appeals dated 21-2-1989 and 8th April, 1987 by which- these ad-hoc additions were deleted. He pointed out that the learned counsel for the respondent had sought time on the last date of hearing 'to find out whether the department had filed any appeals against the order of the CIT appeals, but has not been able to clarify the situation.

9. Mr. Salman Pasha further pointed out that the books of accounts were rejected by ITO for different reasons and the Tribunal had rejected the same for completely different reasons. He said, therefore, it was obvious that the reasons advanced by the Income Tax Officer for rejecting the trading accounts were not accepted by the Tribunal and they had given their own reasons for rejection of trading account. He was therefore, of the view that if he could convince this court that the reasons given by the tribunal for rejection of the account cannot be sustained he would have proved his case. However, without prejudice to his above arguments he pointed out that the Income Tax Officer had given only general reasons for the rejection of the books, of accounts and had not provided any single instance of specific unverifiability to substantiate the rejection of the books of accounts. When it was pointed out to him that the Income Tax Officer in his first order for the assessment year 1987-88 had observed that only some vouchers were produced and had also observed that the explanation filed by the applicant was of general nature and not supported ' by any documentary evidence . He argued that the ITO had examined the books of accounts and he should have pointed out from the books of account as to which vouchers were not produced, which purchases were unverifiable and on what basis the explanation of the assessee applicant was not substantiated by the books of accounts. Without discharging this onus according to the learned counsel the Income Tax Officer could not have rejected the books of accounts and estimated the sales and gross profit.

10. Referring to the reasons advanced by the Tribunal for rejecting, the books of accounts he stated that in his line of business it was impossible for applicant to maintain, the books accounts in the manner which the Tribunal wanted. He further pointed out that from the very Initiation of business the process followed by him has resulted around ten percent of the skins disintegrating and sold at a lower value. He said that this method of accounting has been accepter' by the department for a number of years and there is no finding on:-record that the disintegration wastage this year is more than in the previous years. He pointed out that the sales were completely verifiable and no instance of unverifability has been pointed out either by the ITO or by the Tribunal. He also pointed out that final project register was available in which the finished products have been treated and this register was acknowledged by the Tribunal. He also argued that the order of the Tribunal was also against the principle of natural justice for the reason that Tribunal had examined the books on the same day without confronting him with the proposed defect finalized the appellate order. He said that once the Tribunal had accepted that the arguments of A.R. were reasonable then they should have accepted the accounts and not provided relief just by reducing the gross profit. In support of his contentions he relied on the following case-laws:

(1)Commissioner of Income Tax, Companies-III, Karachi v. Krudd Sons Ltd. 1994 SCMR 229 = 1994 PTD 174.

(2)Pima (Pvt.) Ltd., Karachi v. Commissioner of Income Tax, Companies-I, Karachi 1994 PTD 123.

(3)New Snow White Dry Cleaners, Karachi v. Commissioner of Income Tax (Eaast) Karachi 1985 PTD 315.

(4)Messrs Zafar Saleem Bros. Ltd., Karachi v. The Commissioner of Income Tax, Karachi (1984 PTD 225).

(5)Star Rolling Mills v. Commissioner of Income Tax PLD 1974 Note 129 at Page 189.

(6)Messrs Pakistan Oil Mills Ltd. Hyderabad v. The Commissioner of Income Tax (West), Karachi (1985 PTD 320).

(7)Muhammadi Textile Mills Ltd. v. Commissioner of Income Tax (East), Karachi 1984 PTD 239,

(8)Unreported judgment dated 12-8-2005 passed in I.T.A. No.493 of 1999.

11. On the basis of the above arguments, he prayed that the proposed questions were questions of law which should be answered in his favour.

12. Learned counsel for the respondent submitted that due to the defects pointed out by the I'TO and the Tribunal it .was not possible to deduce the correct profits from the books of accounts maintained by the applicant and their method of accounting could not be relied upon. They argued that on the basis of defects the Income Tax Officer and the Tribunal had rightly refused to accept the declared trading results and estimated the sale and gross profit. They submitted that the applicant had already received considerable relief from the Tribunal as the Tribunal had reduced the G.D. by more than five percent. They also stated that no question of law arises out of the order of the Tribunal as he conclusion reached by the Tribunal has been reached on the basis of the examination the facts and, therefore, no question arises which can be adjudicated by this Court in exercise of 'its power under section 136(2) of the Income Tax Ordinance, 1979. They, therefore, prayed that they order of the Tribunal may be upheld and the reference application be dismissed.

13. We have examined the case in the light of the arguments of the learned counsel and the records of the case. The contention of the learned counsel f 4r the applicant is prima facie correct that both the Income Tax Officer and the Tribunal have rejected the accounts for different reasons. It is apparent that the Tribunal was not impressed by the reasons on the basis of which the ITO had rejected the trading account and after examination of books of accounts had rejected the trading account on completely different reasons. We have initially examined the reasons on the basis of which the Income Tax Officer had rejected the accounts. We find that although the Income Tax Officer has contended that the explanations offered by the applicant for decline in gross profit rates is of general nature and not substantiated by documentary evidence, but his decision to reject the accounts is also based on general assertions and no instance unverifiable purchases or shortfall of vouchers or non-substantiation of the applicants' contention have been pointed out from the books accounts. It is a settled law that once books of accounts are produced the onus is on the Income Tax Officer to examine it and controvert the explanation of the applicant, with specified instances of the fallacy of assessee's explanation from the books of accounts. This exercise has apparently not been done by the ITO and, therefore, his decision of rejecting the trading accounts cannot be sustained. We will now examine the reasons advanced by the Income Tax Appellate Tribunal in the light of the judgments relied on by the learned counsel.

14. A careful examination of these judgments lead to the conclusion that there should be some tangible material before the tax authorities to reject the trading account and the same cannot be rejected merely on suspicion and surmises. It has also been specifically held that for non-maintenance of details or stock register or other manufacturing accounts especially where this method of accounting has been accepted by the department from year to year, the accounts cannot be rejected without detection of a serious defect in the books of accounts from which the honest belief can be reached that correct profits cannot be deduced. In these judgments the following principles have also been enunciated:--

(a)That if the same method of accounting has been accepted in prior years then the Income Tax, Officer if he wants to resort to provisions of section 32(3) of the Income Taxi Ordinance must give cogent reasons to justify his action.

(b)where the books of accounts have been produced by the assesses, the Income Tax Officer cannot reject the accounts without pointing out specific instances of unverifiability and the reasons on the basis of which he is of the opinion that correct profit cannot be deduced from the books of accounts.

(c)That the books of accounts cannot be rejected without recording finding that the method of accounting adopted by the assessee is irregular and unacceptable for the reasons given.

(d)The accounts cannot be rejected merely for the lownest of gross profit.

(e)Section 32(3) does not give arbitrarily, unguided, uncontrolled or naked power to the Assessing Officer to form an opinion regarding the unverifiability of the books of accounts.

(f)That where the Income Tax Officer rejects the accounts for the reason that true income could not be deduced from it, he should not merely adopt a flat rates or make additions in income arbitrarily but has to base such additions on material or evidence of which notice must be given to the assessee.

15. We have examined the facts of the case the anvil of the above principles. It appears that these principles have not been adhered to by the Income Tax Officer and the Tribunal. We are also of the opinion that the reasons enumerated by the ITO and the Tribunal for rejecting the, accounts are not proper; sufficient and valid and therefore the rejection of accounts cannot be sustained.

16. It is a settled-law that the question pertaining to the rejection of account is a mixed question of law and fact and has to be adjudicated by this Court. Reliance on this can be placed on the judgment of this Court in the case of Pimpa (Pvt.) Ltd. Karachi v. Commissioner of Income Tax, Companies-I, Karachi (1993) 68 Tax 193 (H.C. Kar.).

17. As a consequence thereof we allow this reference application and answer the first question referred to us in negative in favour of the applicant and the second question in affirmative in favour of the applicant and against the department.

18. A copy of this order under the seal of this court and signature of the Registrar be sent to the Appellate Tribunal for passing of order in conformity to this order.

S.A.K./G-25/KAnswer accordingly.