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Income-tax Cases Nos. 176, 177, 178 of 1973 and Income-tax Appeal No. 3134 of 1971-72, heard on 22nd August, 1985.

---S. 13-- Rejection of account books --Assessee showing different figures in wastage of goods for three successive years of assessment--Income-tax Officer not disputing rest of account of assessee but merely challenging wastage figures because of variation of wastage in material during period of tax-holiday and thereafter-- Assessee giving various explanations, most important of which being that variation was not only due to wastage in manufacturing but also including storage and transit losses; that increase in wastage was also due to rejection of more finished goods as assessee had to apply rigid quality control to push sales; that raw material of rejected product was sold out and sale proceeds thereof credited to miscellaneous receipts account Income-tax Officer rejecting explanations of assessee disallowing excessive variation and wastage and making addition on the ground that percentage variation of waste was excessive and it was not possible to pinpoint and complete over all result although day to day stock register had been maintained--Appellate Assistant Commissioner accepting explanations offered by assessee in appeal---Income-tax Appellate Tribunal agreeing with Income-tax Officer that assessee failed to satisfy Income-tax Officer by showing day today and stagewise production record to verify shortage claimed by assessee and that Income-tax Officer rightly rejected book version of assessee--Held: Material explanation was offered by assessee for variations and wastage but same was not taken into consideration- Tribunal, therefore, was not justified in rejecting books of accounts maintained by assessee--Explanations of assessee in respect of storage and transit losses in sale of raw material had been accepted by Assistant Appellate Commissioner; it was, therefore, necessary for Tribunal to deal with these questions and Tribunal erred in failing to apply its mind to questions of transit/storage losses incurred prior to commencement of manufacturing process--Both, Income-tax Officer and Tribunal also failed to pinpoint specific deficiency in accounts and they merely used abstract expressions which was hardly sufficient to reject accounts of shortages of tobacco--Wastage of raw material could be determined satisfactorily only after explanations offered by assessee had been considered and either rejected or accepted--Case was remanded to Tribunal for passing a proper order after considering explanations of assessee, in respect of wastage, and records and after hearing parties.

1986 S C M R 443; 1984 P T D 218 and 1984 P T D 150 ref.

Khalid Anwar for Applicant.

Sheikh Hyder for Respondent.

.--These are three applications made under section 66(1) of the Income-tax Act, 1922 by the assessee. The identical questionnaire involved in all the three cases before us in the three applications referred to the assessment years 1967-68, 1968-69 and 1969-70. The applicant is a cigarette manufacturing company. . They had shown the wastage of the goods in 1967-68 as 3.32% and in the next year as 3.26% and still in the next year as 4.67%. The Income-tax Officer had not disputed the rest of the account, of the Company but had merely challenged the wastage figures for these assessments because he had found a variation of wastage in tobacco whom in the tax-holiday period upto 28-2-1967 and the period thereafter. In the tax-holiday period the Company had shown a variation of 0.93% but thereafter it had changed to 3.32%. The Company gave various explanations. Two important explanations were that the variation was not only due to wastage in manufacturing but also including storage and transit losses. That in the current year of assessment the Company had increased production of prestige brands and, therefore, in order to push the sales of the Company's superior quality brands the company had applied rigid quality control and thereby more cigarettes were rejected. The increase in wastage was due to manufacturing defects. The tobacco of the rejected cigarettes were sold out and the sale proceeds was credited to miscellaneous receipts account.

2. The Income-tax Officer dealt with the above 5 explanations in the following words:--

"The explanation given by the assessee cannot be accepted. The variation from standard works out to 6.25% during the period 1-3-1967 to 30-6-1967. This perc9ntage of variation of waste is excessive although day to day stock register has been maintained it is not possible to pinpoint and complete the overall result from the day to day production records maintained."

3. He, therefore, disallowed the excessive variation and wastage of tobacco above the formula of 2.5% which formula had been adopted by the company itself as a notional target. He, therefore, added the difference in the ratio of wastage between 2.5% and the one shown by the company and increased its price in the income of the company.

4. The company appealed to the Appellate Assistant Commissioner and the Appellate Assistant Commissioner accepted the explanations, which have been offered by the company in respect of the variation in the wastage of tobacco and has made the following comments:

"In this respect the appellant-Company has maintained elaborate records prescribed under Central Excise Rules and Excise Duty is paid on the tobacco before it is issued from bonded warehouse for manufacturing and then it is again paid when the finished products namely cigarettes are received. It has thus been urged that there is absolutely no question of either the suppression in purchase and sales of tobacco or during the process of manufacturing or otherwise. The loss occurs as has been explained by the appellant Company not only in the process of manufacturing but also during the course of storage and transit. In summer season due to heat the tobacco loses weight. It, however, gains in weight in winter. There is thus loss or gain in weight due to atmospheric conditions."

"The transit and storage losses are fully substantiated by monthly stock statements received from the factories and Leaf Buying Centres, where proper day to day stock records are maintained."

The A.A.C. has also made the following observations in respect of sale of tobacco of rejected cigarettes:

"The tobacco of rejected cigarettes is sold out and not refused for manufacturing cigarettes and sale proceeds credited to miscellaneous receipts account."

The A.A.C. has further observed that there was no justification for the Income-tax Officer to have made additions in all the years under appeal, which were thereby deleted.

5. The department went in appeal in the Appellate Tribunal and the Appellate Tribunal after hearing elaborate arguments from both sides observed as under:

"It is absolutely correct that more low yield or abnormal shortage alone does not entitle the Income-tax Officer to proceed with the rejection of accounts."

6. However, the Tribunal agreed with the Income-tax Officer and Departmental Representative that it was not possible to pinpoint and correlate the overall record from day to day record maintained by the assessee. He, therefore, held that book version of the assessee was not reliable and did not repudiate the true state of affairs. The Tribunal asked for stagewise day to day production register from the assessee. But they could not show the stagewise production register, however, they had produced the production register but the Tribunal did not fully feel satisfied with the same. The Tribunal came to the conclusion that the assessee had failed to satisfy the I.T.O. about the particulars and stages where the wastage had occurred. They took the view that the I.T.O. had not accepted the books of accounts to be correct and, therefore, he had good reasons to invoke the proviso of section 13. They however, hold that the Appellate Assistant Commissioner had misread the order of the I.T.O. by holding that the I.T.O. had not challenged the correctness or authenticity of the accounts. They observed that the notional standards are the outcome of expert's practical experience in a particular field. Finally they came to the conclusion that the shortage claimed by the assessee could not be verified as day to day production record was not kept and therefore, real profits could not really be deduced and fence the I.T.O. had rightly rejected the book version of the assessee in respect of wastage and additions were absolutely reasonable. The applicants have raised the following questions of law:

"(1) Whether the Tribunal was legally justified in rejecting the books of accounts maintained by the applicant

(2) Whether the Tribunal has not erred by failing to apply its mind to the questions of the transit the storage losses incurred prior to the commencement of the manufacturing process

(3) Whether the Tribunal has not radically misconstrued the order of the Appellate Commissioner by holding that he had not accepted the book version of the assessee

(4) Whether the Tribunal did not misread the order of the Income-tax officer in holding that he had invoked the proviso to section 13

(5) Whether in law it was open to the Tribunal to reject the book version of the applicant without pointing out any specific defects or discrepancies therein "

7. In our view questions Nos. 1 and 2 are alone sufficient to dispose of these applications. In our view, the question of wastage of the tobacco was the only question involved between the department and the assessee. The department had never challenged the account books maintained by the assessee except the question of wastage of tobacco. I.T.O. was otherwise justified in relying upon the notional standard of 2.5 wastage which had been devised by the company itself and the same must have been based on their experience and result obtained by them. But the notional standard is a matter of average and the average standard presupposes that there could be slight deviation one way or the other in the different period. It is, therefore, obvious that if there is a variation detected by the I.T.O. and the assessee is quite prepared to explain the cause of variation then it is necessary that the I.T.O. should take into consideration the explanation offered by the assessee. We however, find that both the Income-tax Officer as well as the Tribunal have rejected the books of the assessee in respect of the wastage of tobacco without taking into consideration the explanations offered by the assessee and particularly two explanations that the variations were due to losses of tobacco in storage and transit and the other explanation that the rejected tobacco had been sold in the market and the receipts of the same are shown in the account. It is pertinent to note here that both the I.T.O. and the Tribunal have noted the explanations offered by the applicant/assessee but have failed to take the same into consideration. It is, therefore, obvious to us that the Appellate Tribunal has failed to take into consideration the two material explanations offered by the applicant in respect of the shortage and wastage in tobacco and, therefore, the findings of the Tribunal in rejecting the accounts are not justified and answer to the first question has to be in the negative, while the second question is answered that the Tribunal has erred. It is needless to point out that the explanations of the assessee in respect of the storage and transit losses in the sale of tobacco had been accepted by the Assistant Appellate Commissioner and, therefore, it was all the more necessary for the Tribunal to deal with these questions. In respect of the questions Nos. 3 and 4 we are of the view that they are really not material to the whole case but still we do answer question No.3 in the affirmative and hold that the Tribunal did misconstrue the order of the A.A.C. because the A.A.C. had accepted the books version of the assessee. In respect of the question No.4 we do not find any misreading of the I.-T.0's: order by the Tribunal because while dealing with the wastage of tobacco the I.T.O. has in fact held that it was not possible for him to correctly deduce the profits or gains in view of the uncertainty in wastage of tobacco. In our view answer to question No.5 is not really required in this case because of the fact that we are of the view that there has been material omission on the part of the Tribunal as well as the I.T.O. in considering the two important explanations tendered by the assesssee in respect of the shortage of tobacco and, therefore, the proper basis for this question can only be reached after the material pointed out in respect of question No.2 has been considered. We would however, observe that the specific deficiencies in accounts have to be pointed out and mere use of the following abstract expression used by the Tribunal as well as the I.T.O. is not sufficient to reject the accounts:-

"It is not possible to pinpoint and co-relate the overall result from the day to day production record maintained."

The above question is singularly vague and ambiguous in nature and lacks by particulars of deficiencies in accounts and this could be hardly sufficient to reject the accounts in respect of the shortage of tobacco. But we would observe that the attitudes of the I.T.O. and the Tribunal, who while seeking explanations in respect of the shortage of tobacco had compared the same with the notional figure of 2.3% wastage was initially justified as it was a standard set by the assessee itself. Therefore, we have refrained from answering the question No. 5. We are of the view that the wastage of tobacco 'can be determined satisfactorily only after the explanations offered by the assessee have been considered by the Tribunal and they are either rejected or accepted.

8. We may note that Mr. Khalid Anwar had relied upon a number of rulings to show that under section 13 of the Income-tax Act accounts regularly employed by the assesses could not be rejected by the I.T.O. or the Tribunal merely because of shortfall in production and without pointing specific defects. Reference was made to 1988 S C M R 443, 1984 P T D 218 and 1984 PTD 150 etc. He had also urged that the Tribunal was not justified in asking for stagewise production records as cigarettes are made by the applicants on automatic machines.

9. On the other hand Mr. Shaikh Hyder had drawn our attention to A I R 1938 PC 1, in which it has been held that in a case where regular method of accounting had been employed by the assessee it is the duty of tie I.T.O. to consider wither the income, profits and gains can properly be deduced. If not they are bound to proceed according to their judgment of this question.

10. In this respect we may state that such matters pertain to question No. 5 which was not ripe in the case. We are however, sanguine that the Tribunal would be conscious of the law in this subject and will act in accordance with law. The Tribunal would of course take into consideration the explanation of not producing the stagewise production record.

11. It will now be for the Tribunal to pass a proper order after considering the explanations of the assessee in respect of the wastage and records and after hearing the parties. These three applications are, therefore, allowed. The first four questions are thus answered while the fifth question is left unanswered as stage is not ripe for it. The three connected cases are disposed of.

M. Y. H. Case remanded.

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