Rejection of books for non maintenance of stock register / incorrect valuation method

Rejection of books of accounts for non maintenance of stock register or incorrect valuation method or non compliance with accounting standard not sufficient.

ABCAUS Case Law Citation:
ABCAUS 3328 (2020) (07) ITAT

Important case law relied upon by the parties:
ACIT vs. Yerra Nagabhushanam (1997) 226 ITR 843, 849 (AP)
Kunhambu & Sons vs. CIT (1996) 219 ITR 235, 241-42 (Ker)
Hira Singh & Co. vs. CIT (HP) 230 ITR 791
S.N Namasivayam Chattiar vs. CIT (1960) 38 ITR 579,588 (SC)
Ajay Oil Mills vs. CST (1995) 98 STC 380, 381 (All)
Bharat Milk Products vs. CIT (1981) 128 ITR 682 (All)
CIT vs. British Paints India Ltd. (SC) 88 ITR 44
Alfa Radiological Centre P. Ltd. 44 ITR (Trib) 284 Chd

The issue involved in the present case was related to the rejection of books of account of the assessee u/s 145(3) of the Income Tax Act, 1961 (the Act) and estimation of gross profit earned.

During the scrutiny proceedings, the Assessing Officer (AO) noted that the assessee did not maintain any stock register and there was a defect in the method of valuation of stock adopted by the assessee.

The AO resorted to rejection of books of accounts maintained by the assessee under section 145(3) of the Act and proceeded to apply the Gross Profit Rate (GPR) of 18% to the turnover of the  assessee for estimating the profit earned during the year.

That the matter was carried in the appeal before the CIT(A) who upheld the rejection of books of account but reduced the percentage of estimation of GPR.

Before the Tribunal, the assessee contended that merely because stock registers were not maintained by the assessee it could not be the reason for  rejecting  the  books  of  accounts  more  particularly  when no other defects were found in the books.

It was submitted that the assessee was manufacturing large number of small items and it was not feasible and was not in the practice of maintaining stock register for each items.  

It was contended that it had been explained to the authorities below that the assessee was consistently following the method of physical verification of stock done at the year end for the purpose of determining the value of closing stock at the end of the year.

On the contrary, the Revenue supported the order of the authorities below and contended that not maintaining of stock register and  application of GPR for the year to determine the value of stock at  the year end was incorrect.

It was contended that it did not matter that assessee had been consistently following this method from year to year since consistency could not be a reason for upholding the incorrect method adopted by the assessee for determining the profit.

The Tribunal noted that undeniably the power to reject books of accounts u/s 145(3) of the Act is to be exercised only when the books are found incorrect or incomplete for determining the true and correct profits earned by the assessee. This power is implied in the Income Tax Officers power to inquire into the total income of the assessee.  

The Tribunal further observed that in the instant case, undisputedly the only basis for rejecting the books of accounts was non maintenance of stock register and the incorrect method of valuation of stock adopted by the assessee. No other defect had been pointed out for rejecting the books of accounts.

As for the non maintenance of stock register, the Tribunal noted that the assessee had explained the non feasibility of maintaining it considering the fact that it was dealing in a large number of small items. It was also explained that the assessee was consistently following the method of physically verifying its stock at the end of the year.

Rejection of books for non maintenance of stock register or incorrect valuation method insufficient

In view of the above facts, the Tribunal dissented with the Revenue that the non maintenance of stock register was sufficient for exercising  the power  of  rejecting  the  books  of  the  assessee. 

The Tribunal stated that it is not unusual for businesses dealing in large number of small items and operating at a small or medium scale to do away with the maintenance of any stock register since it is not feasible maintaining movement of stock of every such item.  Such businesses usually verify physically their stock at the end of the year and all wastages, pilferages and other losses therefore get automatically accounted for in the process, reflecting the true profits  earned by the assesses. The assessee had been doing the same consistently.

The Tribunal stated that the Revenue had found no other defect in the books. All purchase and sale vouchers and other records had been found to be in order. The Revenue had not demonstrated as to how the non maintenance of stock register had been a  hindrance in determining  the  true and correct profits earned by the assessee and also what was the infirmity in the method adopted by the assessee of physically verifying its stock at the end of the year.

Accordingly, the Tribunal opined that the mere fact of non maintenance of stock register could not be the basis for rejection of books of accounts.

The other defect pointed out by the Revenue was the method of valuation adopted by the assessee for determining the value of the stock. The assessee had been applying the Gross Profit Rate of the year to the stock for determining the value.

The Tribunal though agreed with the Revenue on that the valuation method followed by the assessee was incorrect which ideally should be at cost of market price whichever is less, but opined that merely because of adoption of an incorrect method of valuation or  merely on account of non compliance with the prescribed Accounting Standard, the books of accounts cannot be rejected.  

The Tribunal opined that such defects, relating to method of valuation of stock, do not render the books of accounts unreliable, incorrect or incomplete, in which circumstances alone the Books of accounts can be rejected. On the contrary such defects can be cured and the taxable profits determined by applying the correct method of accounting/valuation.

The Tribunal added that the entire exercise of assessment is aimed towards determining the correct taxable income of assesses  and  the power of rejecting books of accounts therefore must be exercised only towards that end and not arbitrarily.

Accordingly, the Tribunal set aside the order of the CIT(A) upholding the rejection of books of accounts of the assessee under section 145(3) of the Act. The AO was directed to determine the value of stock  after applying the  correct  method of  valuation  and  thereafter  determine  the  taxable  profits earned by the assessee.

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