Best judgement evaluation – Arbitrary percentage adoption is not permitted

Facts and issues of the case

The brief facts of the case are that the assessee is engaged in the business of civil contracts, filed his return of income for the assessment year 2012-13 declaring total income of Rs.3,74,216/- and the said return was processed u/s.143(1) of the Income Tax Act, 1961 (hereinafter the ‘Act’). The case has been subsequently reopened u/s.147 of the Act, for the reasons recorded as per which income chargeable to tax had escaped assessment, on account of lower profit from business. Therefore, notice u/s.148 of the Act was issued and served on the assessee.

In response to notice, the assessee has filed return on 08.11.2017, declaring total income as admitted in the original return of income filed u/2.139(1) of the Act. The case was taken up for scrutiny and during the course of assessment proceedings, the AO called upon the assessee to furnish books of accounts and other evidences to justify various expenditures debited into the profit & loss account. Since, the assessee failed to produce relevant documents and has also filed a letter stating that in absence of bills and vouchers in support of expenditures, net profit of 3% may be estimated on total receipts from contracts, the AO has rejected books of accounts u/s.145(3)of the Act and completed best judgement assessment as per provisions of section 144 r.w.s. 143(3) of the Act and estimated 5% profit on gross receipts.

Observation by the court

The assessee carried the matter in appeal before the first appellate authority but could not succeed. The ld.CIT(A) dismissed the appeal filed by the assessee and confirmed estimation of profit at the rate of 5% on gross receipts by holding that if the AO is not satisfied about correctness or completeness of the account, he may make assessment in the manner provided u/s.144 of the Act. Therefore, there is no error in the findings recorded by the AO to reject books of accounts u/s.145(3) of the Act and estimation of profit at his best judgement assessment as per the provisions of section 144 of the Act. Aggrieved by the CIT(A) order, the assessee is in appeal before us.

The ld.AR for the assessee submitted that the ld.CIT(A) has erred in rejection of books of books and estimation of profit at the rate of 5% without appreciating the fact that the books of accounts of the assessee were audited under the provisions of section 44AB of the Act and no adverse comments from the auditor on books of accounts maintained by the assessee. In absence of any adverse comments from the auditor, books of accounts cannot be rejected merely for the reason that no supporting bills and vouchers are produced for expenses. The AR further submitted that even the books of accounts are rejected u/s.145(3) of the Act, but estimation of profit should be reasonable having regard to the nature of business of the assessee. In this case, the assessee is into civil contracts, where net profit varies from 2 to 3% depending upon the nature of contracts and place of contracts, where the assessee has undertaken works. Therefore, without any basis, no adhoc estimation can be made towards profit from business.

The ld.DR on the other hand strongly supporting order of the CIT(A) submitted that once books of accounts are rejected u/s.145(3) of the Act, then the AO is empowered to pass best judgement assessment as per the provisions of section 144 of the Act, having regard to nature of the business of the assessee. Therefore, there is no merit in the arguments of the assessee that there is no basis for adopting 5% profit on gross receipts. The CIT(A) after considering relevant facts has rightly upheld the order of the AO and his order should be upheld.

Court had heard both the parties, perused the materials available on record and gone through the orders of the authorities below. It is an admitted fact that the ld.AR for the assessee has filed a letter dated 14.11.2017 and expressed his inability to produce supporting bills and vouchers for various expenditures debited into the profit & loss account. It is also an admitted fact that the ld.AR for the assessee agreed for estimation of profit on gross receipts. Therefore, based on the inability of the ld.AR for the assessee to produce necessary bills and vouchers, the AO has rejected books of accounts u/s.145(3) of the Act and resorted to best judgement assessment as per provisions of section 144 of the Act.

It is an admitted fact that if books of accounts maintained by the assessee are incomplete or not supported by necessary evidences then the AO is empowered to complete assessment in the manner provided in section 144 of the Act. But fact remains that still in the best judgement assessment, the AO has to bring on record material on the basis of which he has arrived at the conclusion with regard to rate of profit for estimation of income from the business. No doubt, under the best judgement assessment there is an element of guesswork but it should not be arbitrary. Therefore, while completing the assessment under best judgement assessment, the AO has to bring on record certain material to support his finding with regard to rate of profit admitted for estimation of profit with some comparable cases of similar nature or the profit declared in the similar industry.

In this case, although the AO has adopted 5% net profit on gross receipts, but failed to bring on record any comparable case of similar nature nor give reasons for adopting such rate of net profit. On the other hand, the assessee has agreed for estimation of 3% profit on gross receipts considering the nature of business and place of work. Further in the civil construction work, the rate of profit varies from nature of contract executed by the assessee and place of such contracts.

Therefore, no uniform yardsticks can be applied for estimating net profit. Therefore, considering the fact that the assessee is into civil construction business and also the AO has not given any reasons for adopting 5% net profit rate, Court considered view that a reasonable profit of 3% on total receipts would meet the ends of justice. Therefore, Court direct the AO to estimate 3% profit on total gross receipts received by the assessee for the year.