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Income-tax Case No.18 of 1978, decided on 16th July, 1987.

---S. 13 Proviso--Rejection of book results--Income-tax Authorities and Appellate Tribunal have to appreciate assessee's case in the right perspective and not to ignore explanation of assessee, which had a direct bearing upon the reasonableness or otherwise of the grounds for rejecting the assessee's trading results.

The assessee carried on the business of manufacturing and sale of enamelled utensils and extruded aluminium doors and windows.

The assessee's case before the Income-tax Authorities as well as the Appellate Tribunal was that it had maintained its boot, of account exactly in the same manner as they were maintained right from the inception of the assessee's business down to the relevant assessment year. The method of accounting adopted by the assessee in all these years was never found to be deficient so as to make it impossible for the tax authorities to deduce the correct profit therefrom. No defects in the purchases and expenses debited to manufacturing account or sales credited to the said account had been pin-pointed by the assessing authorities, nor had they been held to be not subject to verification. The explanation tendered by the assessee for its inability to maintaining separate trading accounts in respect of enamalled utensils and extruded aluminium products had not been discarded by the Income-tax authorities as being not satisfactory. Similarly the explanation of the assessee, to the effect that the sales were mostly made on the basis of orders which were received by it from private as well as Government organizations and that during the period under consideration the assessee-company did not get sufficient orders and hence the sales could not be pushed higher, had not at all been repelled by the assessing officer. The assessee's explanation was "that expenses like fuel, consumption, labour etc. were common expenses and could not be separated as the same labour generally has to work on both sides of the production". This explanation had neither been held to be unsustainable nor unacceptable by the Income-tax Officer or by the Tribunal. It clearly indicates that the Tribunal did not appreciate the assessee's case in the right perspective. It has thus fallen into an error in completely ignoring the explanation of the assessee, which had a direct bearing upon the reasonableness or otherwise of the ground for rejecting the assessee's trading results. It was also not the case of the department that in any of the earlier assessment years the assessee had maintained separate trading accounts in respect of different kinds of good manufactured by it. The objection of the assessing officer that the decrease in sales was highly disproportionate to the reduction in manufacturing expenses and that it clearly indicated that the sales were not properly recorded in the accounts was ill-contrived rather ill-founded. It is wholly irrelevant if not absurd. The Tribunal appears to have fallen into an error in not appreciating that the absence of correlation of consumption and production 1vas not a new phenomenon. It was always present in the earlier assessment years as well and yet the department felt satisfied to accept the book results of the assessee. It income, profits and gains could properly be deduced in the earlier years there was obviously no good reason to hold otherwise in the relevant years when there had admittedly peen no change whatsoever in the method of its accountancy. The observations of the tribunal to the effect that had the assessee maintained proper manufacturing record it would not have been impossible for it to correlate its production with the raw material consumed, without recording a definite finding that it was feasible to maintain separate manufacturing accounts of the different goods manufactured by tire assessee or that it was so done by other assessees engaged in (his line of manufacturing business, could not justify the rejection of book version by completely ignoring the history of the case. Lastly, the only other factor that prevailed upon the Tribunal for upholding the rejection of book versions was the alleged failure of the assessee, to work out the percentage of wastage. In the assessment orders the I.T.O. had not pointed out as to what was the position of the disclosed wastage and whether it was excessive or unreasonably high as compared to the preceding years. Without so holding or otherwise doing full exercise to make himself intelligible, the mere casual remark 'that the assessee could not work out the percentage' or that 'the percentage of wastage is also not known' cannot be justly made a ground for rejection of books of accounts. Since the history of the assessee was that of acceptance of book results notwithstanding the constant fluctuation in disclosed G.P. rate ranging from 19% to 27% (approximately) and as there had been no change in the method of maintenance of its accounts for the years under reference visa-via the earlier years, when its books of accounts had been accepted, in the facts and circumstances of this case the order of the Appellate Tribunal upholding the rejection of book results could not De sustained.

Star Re-rolling Mills v. Commissioner of Income Tax (1974) 30 Tax. 27; Messrs New Snow-White Dry Cleaners v. The Commissioner of Income-tax East, Karachi 1985 P T D 315; Messrs M.E.J. Hazari and Sons v. The Commissioner of Income-'tax, Karachi, 1985 P T D 516; Commissioner of Income-tax, Bombay v. Sarangpur Cotton Manufacturing Co. A I R 1938 P C 1; Nasir Industries, Karachi v. Commissioner of Income-tax, South Zone, West Pakistan, Karachi P 1 D 1967 Kar. 561 and Commissioner of Income-tax, Central Zone v. Karachi Oil & Seed Industries Limited 1985 P T D 770 ref.

Howrah Trading Company (Private) Limited v. C.I.T. Central, Calcutta, 67 I T R 582 not applicable.

Iqbal Naeem Pasha for Applicant.

M. Shaikh Haider for Respondent.

Date of hearing: 2nd April, 1987.

.--The facts forming the background of these two reference applications under section 66(2) of the repealed Income-Tax Act, 1922 thereinafter called The Act brought at the instance of the assessee are these: -

The applicant company carries on the business of manufacturing and sale of enamelled utensils and extruded aluminium doors and windows. For the assessment years 1971-72 and 1972-73, the respective accounting period ended on 30th June, 1971 and 30th June. 1972. For the charge year 1971-72 the assessee declared total sales of Rs.16,60,766 with gross profits of Rs.4,30,066 conceding a rate of 26%. During this year, not unlike the preceding year, the assessee was found to have not maintained separate manufacturing and trading accounts in respect of enamelled utensils and extruded aluminium products. The assessee's plea before Income-Tax Officer was that the maintenance of separate manufacturing accounts was not feasible for the simple reason that certain expenses, like fuel, consumption, labour, etc. were commonly incurred and so also the same labour generally worked on both sections of production. The I T.O., however, further found teat the above-noted trading results when compared with those of the immediately preceding assessment year 1970-71, indicate that there was a decline in sales about Rs.3,00,000 while the gross profit rate had improved by 1.5%. A comparison of the manufacturing expenses qua the sales of the said two years further revealed that as against the reduction in expenses to the extent of Rs.1,49,075, the sales had dropped down by Rs.3,00,000. The I.T. O., therefore, inferred that the sales had not been properly recorded in the books of accounts. Consequently, he discarded the disclosed returned book version with the following remarks:-

"The assessee, in his letter, dated 28-9-1973 has also admitted that he is not maintaining proper manufacturing account. The consumption of raw materials is in terms of weight while the sales are either by numbers or measurement. Further enamelled utensils are sold by dozens and extruded aluminium products are sold by measurement. In short, consumption and production cannot be co-related. Besides, the assessee could not work out the percentage of wastage."

He then computed the income by estimating the sales at Rs.17,50,000 and applying that the G.P, rate of 26% as disclosed by the assessee. He thus made an addition of Rs.24,000 to the trading results.

4. In the charge year 1972-73, the assessee declared sales at Rs.21,58,624 and gross profit at 25.4%. However, upon recasting of the accounts, the actual G.P, rate, as per I.T 0., worked out to 22.5%. Besides the low G.P rate, the other defects as highlighted in the assessment order for 1971-72 were also found prevalent in this year as well. The I.T.O., therefore, rejected the book version, estimated the sales at Rs.2 ,50,000 and subjected them to G.P. rate of 26% thereby making an addition of Rs.36,891 in the trading accounts.

5. Dissatisfied with the orders of the I.T.O., the assessee preferred appeals to the appellate Assistant Commissioner, who vide his combined order dated 26-1l-1974 allowed the appeals with a direction to the I.T.O. to accept the- book results as disclosed art both the years under consideration. Aggrieved by the order of the A.A.C., the Revenue took the matter in further appeal to the Income-tax Appellate Tribunal The appellate tribunal by its consolidated order dated 30-7-1976 allowed the appeals, upheld the rejection of book versions and maintained the orders of assessment as made by the I.T.O. in respect of both the years under reference.

6. The assessee then filed applications under section 66(1) of the Act to the Appellate Tribunal (Karachi Bench), requesting it to draw up a statement of the case and refer to this Court the following common question, which is claimed to be a question of law.

"Whether on the facts and in the circumstances of the case: the learned Appellate Tribunal was correct in holding that proviso to section 13 of the Income-tax Act was applicable' "

7 The Appellate Tribunal dismissed the reference applications filed by the assessee and while doing so, recorded a finding that it (Tribunal) had come to the conclusion that the book results shown in these two years were rightly rejected after detailed scrutiny and examination of facts and evidence obtaining on record and the Tribunal's order does not give rise to any question of law. It is to impugn the said refusal of the Tribunal to refer the above-mentioned question to this Court for opinion that the present applications have been filed with a prayer that the said common question is a question of law arising out of the order of the Tribunal under section 33 of the Act and it may be decided according to law.

8. Mr. Iqbal Naim Pasha, the learned counsel for the applicant submitted that the Appellate Tribunal had misdirected itself in law in not stating the above-noted question arising out of the judgment of the Appellate Tribunal to the High Court for its opinion. The learned counsel contended that the Officers of the Income-tax Department and so also the Appellate Tribunal failed to appreciate that it was not feasible or possible to co-relate the consumption with the production and working of percentage of wastage in the line of business being carried ors by the Company. No other assessee carrying on the, types of business had beer maintaining such records. There is rip such finding recorded by the Income-Tax Officer that this plea of the appellant was factually incorrect. Similar was the position of accounts in the earlier years as well when the assessee's account had been accepted. The purchases and expenses debited to manufacturing account are all verifiable and so also the sales credited to the said accounts are open to verification and hence there was no justification for the Income-fax Officer to have invoked the proviso to section 1a of the act. The Income-Tax Officer, the learned counsel pointed out, has not found any defects either in the manufacturing account or in sales. The trading results were also not, in the context of the history of the appellant low, nor when compared with other parallel cases. In the absence of a positive finding by the Income-Tax Officer to the effect that the maintenance of production records was unreliable, there was no course open to him but to accept the assessee's book results for both the years is it was done in the preceding assessment years.

In support of his contention the learned counsel for the appellant sought to place reliance on the following reported decisions: -

(i) Star Re-rolling Mills v. Commissioner of Income-Tax (1974) 30 Tax. 27)). It was a case of the assessee, which was engaged in the business of manufacturing bars etc. from scrap and iron billets and had not maintained the stuck register and manufacturing account.

The book version was accepted in the past several years but for the year 1953-54 the Income-Tax Officer rejected the book results, estimated the sales and applied thereto gross profit rate. The assessee's appeal to the Appellate Assistant Commissioner succeeded but on an appeal from the Revenue the Appellate Tribunal reversed the order of the first appellate authority and restored that of the Income-Tax Officer. At the instance of the assessee a question was referred to the High Court seeking its opinion as to whether on the facts and circumstances of the case the Income-tax Authorities were justified in applying the proviso to section 13 of the Income-tax Act The High Court answered the question in the negative. The relevant extract from the decision of the High Court is reproduced below:-

"In the instant case, the stand of the assessee is that in the tine of business, which it was carrying on it was not practicable to maintain a regular stock register or a manufacturing account. There is no material to controvert this averment made by the assessee. In fact, as would appear from the order of the Appellate Assistant Commissioner, in the past years, the assessee's method of accounting was relied upon and the rate of profit given by it was accepted, despite the fact it had not been maintaining a regular stock register or a manufacturing account. There is nothing to indicate either in the order of the Assessing Office or the Tribunal that it is feasible and practicable in the lire of business in which the assessee was engaged, to maintain a regular stock register or a manufacturing account, or that other persons engaged in such business were maintaining such accounts and registers. If in the previous years the assessing authorities had accepted the method of accounting adopted by the assessee and had found that it was possible to deduce sand determine the rite of profit of the assessee therefrom, there was is no valid reason for them in respect of the charge year in question to reject the assessee s method of accounting or to hold that it was not possible to deduce therefrom the assessee's rate of profit."

(ii) Messrs New Snow-White Dry Cleaners v. The Commissioner of Income-tax East, Karachi 1985 P T D 315. It was a case of an assessee who was carrying on business of dry-cleaning. Its accounts were rejected on the grounds that (i) a new dry-cleaning plant has installed in 1971-72, (ii) the applicant did not furnish the details of the plant utilisation based on meter reading of gas and electricity consumption converted into hours of running times etc., (iii) the details of day-to-day chemicals was not available, (iv) the record of daily inward and outward movement of clothes was also not available and (v) sales were in cash and could not be verified. On appeal, the learned Income-tax Appellate Tribunal upheld the rejection of accounts but reduced the estimated receipts. The matter came up before this Court in direct reference at the insistence of assessee made under section 66(1) of the Income-tax Act, 1922. A Division Bench of this Court of which one of us (Mr. Ajmal Mian, J.) was a member, held: -

6- - - - - We are inclined to hold that book results cannot be rejected merely on the basis of suspicion unless a finding of fact is recorded that on verification the account books disclose some defect or discrepancy, which cannot reasonably be explained. We are also inclined to hold that the Income-tax Authorities once accept a particular method of accounting system adopting by an assessee and find it possible to determine profits on the basis of such accounting system, cannot reject the book results on the ground that the accounting system is defective in the absence of any glaring discrepancy. We are also of the view that the proviso to section 13 cannot be pressed into service without recording a finding that the accounts are defective and the determination of profits on their basis is not possible.

7. The rejection of the account books for the assessment years in question on the grounds referred to hereinabove by the Income-Tax Officer and by the learned Income-Tax Tribunal was not warranted by law and the rejection is based on surmis and conjectures. We therefore, answer the above questions in the negative."

(iii) Messrs M.E.J. Hazari and Sons v. The Commissioner of Income-Tax Karachi (1985 P T D 516). The assessee in that case was engaged in the business of dealings in paints, varnishes and other goods and its accounts version was discarded by the Revenue for want of maintenance of daily stock register for dealings in the goods and the lowness of disclosed gross profit rate for which no plausible explanation was tendered. A Division Bench of this Court in appreciation of the fact that no objection was taken that the books of accounts were not properly maintained by the assessee and that it was admitted by the counsel for the department that there was no legal requirement for maintenance of daily stock register by an assessee carrying on business of the nature that was being carried on by the applicant in that case, held:

"- - - - -In these circumstances we are of the view that there was no material before the Income-tax Officer on the basis of which he could reject the accounts of the applicants and compute the income under the first proviso to section 13. If on the basis of the aforesaid two circumstances, decrease in the rate of profit and non-maintenance of a daily stock register, a doubt had been raised about correctness of the accounts, the Income-tax Officer should have made a further enquiry to discover material on the basis of which he could have given a finding that the accounts did not disclose the true income, profits arid gains of the assessee for the years in question. In the facts and circumstances of this case on merely recording that the profit had decreased and the daily stock register was not mentioned the accounts submitted by the assessee could not be rejected and the income computed under the first proviso to section 13 of the Income-tax Act."

8-A. Mr. Shaikh Hyder, the learned counsel for the respondent on the other hand, supported the rejection of accounts. He emphasised that in the absence of co-relation of consumption and production, it was not possible to work out the true profit of the assessee and hence the I.T.O. was justified in rejecting the results. He sought to support his contention by referring to the following cases: -

(i) Commissioner of Income-tax Bombay v. Sarangpur Cotton Manufacturing Co. A I R 1938 P C 1, in which it was held, "that the view of the Assistant Commissioner that the Income-tax officer is prima facie entitled to accept the profits shown by the accounts, where there is a method of accounting regularly employed' by the assessee, is not a correct view. It is the duty of the Income-tax Officer, where there is such a method of accounting, to consider whether the income, profits and gains can properly be deduced therefrom, and to proceed according to his judgment on this question

(ii) Nasir Industries, Karachi v. Commissioner of Income-tax South Zone, West Pakistan, Karachi P L D 1967 Kar. 561. It was a case of a manufacturer of plastic goods. In that case the books of account were rejected for several defects by the Income-tax Officer. However when the case reached the Tribunal it found that no stock registers were maintained by the assessee showing manufacturing account. The Tribunal then observed that in a business of that kind no manufacturing account could be maintained giving, quantitative reconciliation and hence the profit rate of the business was to be determined on the basis of estimates. The matter came up in reference before the erstwhile West Pakistan High Court, Karachi Bench. It was contended on behalf of the assessee before the High Court that on the basis of the finding of the Tribunal regarding the impossibility of maintaining manufacturing account the Tribunal was not justified either in estimating the sales or in applying a flat rate of gross profit. It was further pleaded that since the Tribunal had not doubted she genuineness of the account books of the appellant, the proviso to section 13 of the Income-tax Act would not be applied to the facts of that case. The High Court after referring to the remarks of the Tribunal 'with regard to the absence of manufacturing accounts held that "it was open to the Income-tax Appellate Tribunal to have resort to the provision to section 13 of the Income-tax .Act".

(iii) Commissioner of Income-tax Central Zone v. Karachi Oil & Seed Industries Limited 1985 P T D 770. By its judgment the High Court disposed of four reference applications filed by different assessees under section 66(2) of the Income-tax Act. This case, our opinion, is not relevant to the facts of the instant case.

(iv) Howrah Trading Company (Private) Limited v. C.I.T. Central Calcutta, 67 I.T.R. 582. The assessee in this case carried on the business of manufacturing iron pipes drain pipes, from raw materials. The Income-tax Officer noticed that the profits of the assessee from the method of accounting kept by it in relation to quantity of raw materials received for manufacture and the volume of finished product, because while the finished goods were accounted for not to weight, but in terms of running feet of pieces of different sizes, so that any reconciliation between the production and the sales and closing stocks was not possible. The Income-tax Officer rejected the book version and applied the proviso to section 13. His action was upheld by the appellate Assistant Commissioner as well as by the Tribunal. On a reference the High Court has held:-

"What remains is in regard to the hypothesis upon which the Income-Tax Officer proceeded, namely, that the method of accounting employed was such that, by its very nature, nobody could properly deduce the profits therefrom. If the stocks received be shown in the account by one standard and the goods produced from those raw materials be shown by another standard, as has been done in the instant case, it is quite clear that there cannot be any deduction of profits therefrom and this proposition could not be controverted on behalf of the assessee. In the circumstances, the question referred, to must be answered in the affirmative. The Commissioner shall be entitled to his costs."

9. It is evident from the facts recorded above that in the preceding years the results of the assessee were always accepted save in the assessment year 1965-66 when an ad-hoc addition of Rs.30,000 was made for raising the declared gross profit rate of 14.3% to 21%. It is further evident from the chart given by the learned A.C.C. in his order that the G.P. rate of the assessee has been ranging from 19.9% in 1962-63 to 27.7 in 1968-69. It was in 1967-68 that declared G.P. rate was 36%. It is also mentioned in the order of the learned A.C.C. that the I.T.O. has discarded the book results in the charge years 1968-69 and 1969-70 when the matter had gone in appeal upto the stage of Appellate Tribunal. In the charge year 1968-69, it may be noted that the sales were shown at Rs.6,57 ,223 with 27.7% G.P. rate, while in 1969-70 the G.P. rate of 23.2% was disclosed on a turnover of Rs.14,01,565. Notwithstanding the variation of declared gross profit rate, as stated above, the Tribunal vide its order in I.T.A. No. 1038(KB) of 1972-73 for 1968-69 and I.T.A. No. 2024(KB) of 1972 73 for 1969-70 accepted the book results of the assessee-applicant. The assessee's case before the Income-tax Authorities as well as the Appellate Tribunal was that it had maintained its books of account exactly in the same manner as they were maintained right from tire inception of the assessee's business down to the assessment year 1970-71. The method of accounting adopted by the assessee-applicant in all these years, as already stated, was never found to be deficient so as to make it impossible for the tax authorities to deduce the' correct profit therefrom. No defects in the purchases and expense debited to manufacturing account or sales credited to the said account have been pinpointed by the assessing authorities, nor have the been held to be not subject to verification. The explanation tendered by the assessee for its inability to maintaining separate trading accounts in respect of enamelled utensils and extruded aluminium products has been discarded by the Income-tax authorities as being not satisfactory. Similarly the explanation of the assessee vide its letter dated 22-9-1973 referred to in the assessment year for the charge year 1971-72 to the effect that the sales are mostly made on the basis of orders which were received by it from private as well as Government organisations and that during the period under consideration the assessee company did not get sufficient orders and hence the sales could not be pushed higher, has not at all been repelled by the assessing officer. The learned Tribunal, however seems to have been mislead when it observed that "the assessee had said nothing as regards the circumstances, which rendered it difficult for them to keep separate trading accounts". The assessee's explanation, it may be observed even at the cost of repetition, was "that expenses like fuel, consumption, labour, etc. are common expenses and cannot be separated as the same labour generally has to work on both sides of the production". This explanation has neither' been held to be unsustainable nor unacceptable by the Income-Tax Officer nor by the Tribunal. It clearly indicates that the tribunal did not appreciate the assessee's case in the right perspective. It has thus fallen into an error in completely ignoring the explanation of the assessee, which had a direct bearing upon the reasonableness or otherwise of the ground for rejecting the assessee's trading results. It was also not the case of the department that in any of the earlier assessment years the assessee had maintained separate trading accounts in respect of different kinds of goods manufactured by it.

10. The objection of the assessing officer, in the charge year 1971-72, that the decrease in sales was highly disproportionate toy the reduction in manufacturing expenses and that it clearly indicated that the sales were not properly recorded in the accounts, is ill Contrived rather ill-found. Truly speaking, it is wholly irrelevant it not absurd. The learned Tribunal appears to have fallen into an error to not appreciating that the absence of correlation of consumption and production was not a new phenomenon. It was always present in the earlier assessment years as well anal yet the department felt satisfied to accept the book results of the assessee. If income, profits gains could properly be deduced in the earlier years there was obviously no good reason to hold otherwise in these two years when there had admittedly been no change whatsoever in the method of it accountancy. The observations of the learned tribunal to the effects that had the assessee maintained proper manufacturing record it would not have been impossible for it to correlate its production with the raw material consumed, without recording a definite finding that it was feasible to maintain separate manufacturing accounts of the different goods manufactured by the assessee or that it was so done by other assessees engaged in this line of manufacturing business could not justify the rejection of book 'version by completely ignoring the history of the case as enunciated above. Lastly, the only other factor that prevailed upon the learned Tribunal for upholding the rejection of book versions was the alleged failure of the assessee, to work out the percentage of wastage. Here we find that in the assessment orders the I.T.O. has not pointed out as to what was the position of the disclosed wastage and whether it was excessive or unreasonably high as compared to the preceding years. Without so holding or otherwise doing full exercise to make himself intelligible, the mere casual remark "that the assessee could not work out the percentage' or that 'the percentage of wastage is also not known' cannot, in our view, be justly made a ground for rejection of books of accounts.

11. Since the history of the applicant-assessee is that of acceptance of book results notwithstanding the constant fluctuation in disclosed G.P. rate ranging from 19% to 27% (approximately) and as there had been no change in the method of maintenance of its accounts for the years under reference vas-a-vas the earlier years, when its books of accounts had been accepted, we are of the opinion that the decision of the Calcutta High Court in the case of Howrah Trading Company (Private) Limited (Supra) cannot be held to be squarely applicable to the facts of the instant case.

12. For the foregoing reasons we are of the opinion that in the facts and circumstances of this case the order of the learned Appellate Tribunal upholding the rejection of book results cannot be sustained. The above question is, therefore, answered in the negative.

13. The aforesaid reference applications are, therefore, decided and the question is answered a mentioned above. However, in the facts and circumstances of the case, the parties are left to bear their own costs.

M.B.A./K-38/K Reference answered.

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