Telelinks and Others vs Commissioner of Income Tax and Others

Rajive Bhalla, J.

By way of this order, we shall dispose of I.T.A. No. 269 of 2014 titled as Telelinks v. CIT and I.T.A. No. 225 of 2014 titled as CIT v. Mattewal Co-op. L/C Society. Before delimiting the substantial questions of law that arise for adjudication, it would be appropriate to briefly refer to the facts of each case.

I.T.A. No. 269 of 2014

The assessee is a building contractor. The Assessing Officer refused to accept the profit and loss account, ledger, cash book, etc., and, therefore, applied a net profit rate of 12 per cent, by relying upon a judgment of this court in Commissioner of Income Tax Vs. Parbhat Kumar, and a judgment by the Income-tax Appellate Tribunal in Asst. CIT v. Ess. Buildings (P.) Ltd. (I.T.A. No. 707/Chd./1997). Aggrieved by the assessment order, the assessee filed an appeal. The Commissioner of Income-tax (Appeals) (hereinafter referred to as "the CIT(A)"), Bathinda, reduced the net profit rate to 6 per cent. The Revenue filed an appeal before the Income-tax Appellate Tribunal (hereinafter referred to as the "the ITAT"). The Income-tax Appellate Tribunal accepted the appeal, set aside the order passed by the Commissioner of Income-tax (Appeals) and restored the order passed by the Assessing Officer applying a net profit rate of 12 per cent.

I.T.A. No. 225 of 2014

The assessee in this case is also a building contractor. The Assessing Officer rejected the books of account and applied a net profit rate by 8 per cent. The Commissioner of Income-tax (Appeals), Amritsar, vide order dated November 6, 2012, reduced the net profit rate to 6 per cent. The Revenue filed an appeal whereas the assessee filed cross-objections. The Income-tax Appellate Tribunal dismissed the appeal filed by the Revenue but allowed the cross-objections filed by the assessee and reduced the net profit rate to 5.5 per cent.

Counsel for the assessee and counsel for the Revenue are ad idem that the substantial questions of law that arise for adjudication are:

"(a) the nature of power exercised while determining net profit rate;

(b) the factors required to be taken into consideration while determining net profit rate;

(c) whether the net profit rate determined without assigning any reasons is not perverse; and arbitrary?"

We have heard learned counsel for the parties/considered precedents cited for and against and proceed to answer the questions.

The assessees in both cases are building contractors, whose account books were rejected for one reason or the other. The Assessing Officer, therefore, applied a net profit rate while assessing their income. A perusal of the impugned orders reveals that the Assessing Officer, the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal have applied different percentages of net profit. The Income-tax Appellate Tribunal and the Commissioner of Income-tax (Appeals) have either reduced the rate or restored the rate applied by the Assessing Officer.

The first question relates to the nature of the power exercised while determining a net profit rate. The question must necessarily be answered by holding that where the books of account are rejected or not produced, the Assessing Officer would be well within the limits of his jurisdiction to assess income by applying a fictional net profit rate. The power so conferred is quasi-judicial and, therefore, not unbridled as it must be guided by reason and though it may involve a degree of guesswork, must be based upon a rational analysis of facts. The first question of law is answered accordingly.

The second question of law, namely, factors required to be taken into consideration while applying a net profit rate has come up for consideration, as on the same set of facts the Assessing Officer, the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal have applied different rates of net profit. The discretion to determine an adequate net profit rate undoubtedly vests with the authorities under the Act but the discretion so vested is neither unbridled nor unguided as it must be guided by reason, i.e., should be preceded by reasons which, in turn, should be preceded by a perceptible process of reasoning based upon due consideration of all relevant facts. However, the authorities under the Act appear to construe their jurisdiction as a discretion to apply a thumb rule dependent almost entirely upon the whims of a particular officer.

The discretion to determine a net profit rate must necessarily be exercised on the basis of relevant factors which we shall enumerate but before doing so, would clarify that these factors are neither exhaustive nor a final word on relevant factors that may be considered while determining the net profit rate. A few significant factors are the past tax history of the assessee, if available, assessment orders that may have been passed and accepted by the Department, the nature of the assessees'' business, an appraisal of the value of the contract, prevailing economic conditions vis-a-vis the assessee''s business, the price of raw material, labour, etc., the rise in price index as notified by the Central Government from time to time if applicable and if the Assessing Officer proceeds to rely upon assessments of other asses-sees engaged in similar business to do so only after determining points of similarity, etc. At this stage, it would be appropriate to clarify that the word "similar" is not synonymous with the word "identical". Factors referred to above are merely illustrative and not exhaustive of the circumstances that may or may not be taken into consideration. At this stage, it would be appropriate to reproduce a few words from Dhakeswari Cotton Mills Ltd. Vs. Commissioner of Income Tax, West Bengal, so as to place our conclusions in their correct perspective:

"The Income-tax Officer is not barred by technical rules of evidence and pleadings, and he is entitled to act on material which may not be accepted as evidence in a court of law, but in making the assessment under sub-section (3) of section 23 the Income-tax Officer is not entitled to make a pure guess and make an assessment without reference to any evidence or any material at all. There must be something more than bare suspicion to support the assessment under section 23(3). In this case the Tribunal violated certain fundamental rules of justice in reaching its conclusions. Firstly, it did not disclose to the assessee what information had been supplied to it by the Departmental Representative. Next, it did not give any opportunity to the company to rebut the material furnished to it by him, and lastly, it declined to take all the material that the assessee wanted to produce in support of its case. The result is that the assessee had not had a fair hearing. The estimate of the gross rate of profit on sales, both by the Income-tax Officer and the Tribunal, seems to be based on surmises, suspicions and conjectures. It is somewhat surprising that the Tribunal took from the representative of the Department a statement of gross profit rates of other cotton mills without showing that statement to the assessee and without giving him an opportunity to show that statement had no relevancy whatsoever to the case of the mill in question. It is not known whether the mills which had disclosed these rates were situate in Bengal or elsewhere, and whether these mills were similarly situated and circumstanced. Not only did the Tribunal not show the information given by the representative of the Department to the appellant, but it refused even to look at the trunk load of books and papers produced before it by the assessee. The Income-tax Officer and the Tribunal in estimating the gross profit rate on sales did not act on any material but acted on pure guess and suspicion. The order of the Tribunal was set aside and the matter was remanded to it with directions that in arriving at its estimate of gross profits and sales it should give full opportunity to the assessee to place any relevant material on the point that it has before the Tribunal, whether it is found in the books of account or elsewhere and it should also disclose to the assessee the material on which the Tribunal is going to found its estimate and then afford him full opportunity to meet the substance of any private inquiries made by the Income-tax Officer if it is intended to make the estimate on the foot of those enquiries."

A relevant extract from CIT v. Laxmi Narain Badridas [1937] 5 ITR 170 (PC) the Privy Council (page 180) reads as follows:

"The officer is to make an assessment to the best of his judgment against a person who is in default as regards supplying information. He must not act dishonestly, or vindictively or capriciously because he must exercise judgment in the matter. He must make what he honestly believes to be a fair estimate of the proper figure of assessment, and for this purpose he must, their Lordship thinks, be able to take into consideration local knowledge and repute in regard to the assessee''s circumstances, and his own knowledge of previous returns by and assessments of the assessee, and all other matters which he thinks will assist him in arriving at a fair and proper estimate; and though there must necessarily be guess work in the matter, it must be honest guess work. In that sense, too, the assessment must be to some extent arbitrary. Their Lordships think that the section places the officer in the position of a person whose decision as to amount is final and subject to no appeal, bust whose decision if it can be shown to have been arrived at without an honest exercise of judgment, may be revised or reviewed by the Commissioner under the powers conferred upon that official by section 33."

It would also be necessary to refer to another judgment in State of Kerala Vs. C. Velukutty, wherein while dealing with the expression "best of his judgment", it has been held that the discretion to determine net profit rate vests in the authorities but discretion shall not be arbitrary and should have a reasonable nexus to the available material and the circumstances of the case, followed by reasons that appear to be legal and valid. A reference may also be made to judgment of this court in Aggarwal Engineering Co. v. Asst. CIT I.T.A. No. 478 of 2006 decided on December 6, 2010 Aggarwal Engineering Company Vs. Asstt. CIT, . The second question of law is answered accordingly.

The third question of law reads as follows:

"Whether a net profit rate determined without assigning any reasons is not perverse and arbitrary?"

The question need not detain us for long. The question arises as the Assessing Officer and the Tribunal have relied upon Parbhat Kumar''s case (supra) to hold that the net profit rate once determined is a question of fact and, therefore, does not call for interference. A judgment is a binding precedent where an opinion is recorded on a question of law. The authorities under the Act apparently misread the above judgment and ignored that while dismissing the appeal filed by the Revenue, it was held that applying the net profit rate on the basis of the best judgment assessment "in a given situation" will be a question of fact unless such assessment is shown to be arbitrary or perverse, thereby clearly setting out that if the net profit rate is not perverse and arbitrarily, it shall only be a question of fact. The judgment, in our considered opinion, therefore, cannot be read as a precedent for a conclusion that in each and every case of a contractor, the Assessing Officer would be legally obliged to apply a net profit rate of 12 per cent, de hors, the facts of the case and even where the net profit rate discloses an arbitrary and perverse consideration, it would be a question of fact. A perusal of the judgment reveals that the net profit rate of 12 per cent was affirmed as counsel for the Revenue was unable to point out any perversity or arbitrary consideration in the exercise of discretion. The third question of law is, therefore, answered by holding that if consideration leading to a net profit rate is perverse and or arbitrary, the finding so rendered shall be illegal and shall not be a question of fact.

The questions of law having been answered, we have no hesitation in allowing the appeal as the impugned orders setting out different rates of net profit are devoid of any rational reasons much less a perceptible process of reasoning by referring to the relevant facts.

Consequently, the orders passed by the Assessing Officer, the Commissioner of Income-tax (Appeals) and the Income-tax Appellate Tribunal are set aside and the matters are restored to the Assessing Officer concerned to re-determine the net profit rate by reference to and after due consideration of relevant factors narrated hereinbefore and such other factors as may be deemed relevant. Any objection as to limitation in finalizing the assessment shall not prohibit the Assessing Officer from proceeding to finalize assessment proceedings. Parties are directed to appear before the Assessing Officer on January 12, 2015.