Taxes on sales comprising in turnover to be excluded for estimating net profit

Amount of taxes on sales comprising in turnover to be excluded while computing gross receipts for estimating net profit – ITAT

In a recent judgment, ITAT Hyderabad directed AO to exclude the amount of taxes collected on sales comprised in turnover, while computing gross receipts for the purpose of estimating net profit.

ABCAUS Case Law Citation:
4933 (2025) (12) abcaus.in ITAT

In the instant case, the assessee had challenged the order passed by the CIT(A) of National Faceless Appeal Centre (NFAC) in inter alia confirming estimating the income from business at 3% of gross receipts after rejection of books of account u/s 145(3) of the Income Tax Act, 1961 (the Act).

The appellant assessee was an individual engaged in the business of processing raw cotton into lint and cotton seed and trading in these products under proprietorship name. The case of the assessee was selected for Limited Scrutiny under CASS. Accordingly, notices under section 143(2) and section 142(1) of the Act were issued.

The case of the assessee was selected for Limited Scrutiny for examining (i) sales turnover mismatch, (ii) squared-up loans, (iii) unsecured loans, (iv) tax credit mismatch and (v) interest income mismatch.

The assessment was completed by the Assessing Officer (AO) after making certain other additions and completed the assessment under section 143(3) of the Act.

Before the Tribunal the assessee raised a legal issue regarding conversion of Limited Scrutiny into Complete Scrutiny without obtaining approval from the competent authority.

The second issue was with respect to estimation of net profit at 3% on the gross receipts which also included taxes collected on sales which should be excluded for the purpose of profit estimation. 

The assessee submitted that as far as sales turnover mismatch was concerned, the AO was required to restrict his verification only to sales. However, the AO went beyond the scope of Limited Scrutiny and verified the purchases of the assessee, which was not a parameter prescribed for expansion of Limited Scrutiny.

With regard to the legal ground, the Tribunal observed that one of the parameters for Limited Scrutiny selection was sales turnover mismatch. In our considered opinion, verification of sales turnover mismatch cannot be effectively carried out without examining the corresponding purchases. Therefore, the assessee’s contention that verification of purchases falls outside the scope of Limited Scrutiny on the issue of sales turnover mismatch was not acceptable.

However, on the issue of estimation of net profit at 3%, the Tribunal noted that the AO had not recorded any factual basis, comparative analysis, industry data, or past profit history to justify adoption of 3% as the net profit rate.

The Tribunal opined that an estimation cannot be made on an ad hoc or arbitrary basis. Either the AO should adopt the industry average or the average net profit rate of the assessee for the past three years as the basis for estimation.

Therefore, the issue of profit estimation was remanded to the file of the AO with a direction to recompute the net profit by adopting either (i) the industry average profit rate, or (ii) the average of the assessee’s net profit rates for the immediately preceding three years. It was clarified that if there is any completed assessment for earlier years, the assessed net profit rate should be adopted.

As regards the quantum of gross receipts, the AO was directed to exclude the amount of taxes collected on sales while computing gross receipts for the purpose of estimating net profit.

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