Late A.Y. Arulanandaswami Nadar v. Commissioner Of Income-Tax

The Judgment of the Court was delivered by

Srinivasan, J.:— The assessee, late Arulanandaswami Nadar, who was carrying on abkari business at Thanjavur, took up certain military contracts at Renigunta in the year 1943. Work of the value of nearly Rs. ten lakhs was to be completed within three months from 28-3-1948. It could not be so completed and it dragged on for eleven months till 25-3-1944. There appear to have been certain alterations in the works to be carried out. There was also a dispute between the assessee and the Military Department with regard to the rates, particularly with reference to those works which were not covered by the contract. These deviations from the original contract were the subject-matter of a reference to an arbitrator, who held that the assessee was entitled to certain compensation. Payments were made from the date of the contract or shortly thereafter up to the year ending 31st March, 1948. The total of such receipts by the assessee came to Rs. 7,65,658. In addition thereto, the Military Department had supplied materials to the value of Rs. 5,96,725. On closing his books as on 5-2-1946, the assessee claimed a net loss of over Rs. 51 lakhs, but after adjusting subsequent receipts, a net loss of Rs. 3,27,744 was indicated in the return submitted by him.

2. The assessee gave several reasons for his loss, particularly instancing excessive deviations from the original contract, which drove the assessee to obtain labour and materials at a much higher cost than originally envisaged, that he was not paid at market rates in respect of the new works, that the assessee had to import coolies from Thanjavur District and other places and had to pay higher wages and incur expenditure for transport and feeding charges, that there was damage caused by adverse weather conditions and that constructions which had been completed but which had suffered damage had to be rebuilt at his own cost. However valid these contentions might be, the Departmental Authorities rejected these claims. During the course of the assessment proceeding, the Income-tax Officer was not satisfied with the accounts produced by the assessee. He found that no separate accounts were maintained in respect of the contract works and that the accounts maintained by the ??? business were also utilised for the purpose of the contract works, though these contracts were at different places. Remittances of moneys from Thanjavur, which were claimed to have been made for the purpose of carrying on the contract work, were not evidenced by Bank drafts of the like, the assessee claiming that large amounts of as much as Rs. two lakhs were being sent by personal messenger, an employee of his, but whose travelling expenses did not find place in the accounts. There was no proper muster roll. The Income-tax Officer was also of the view that the two fair ledgers and fair-day-books, which alone appear to have been maintained could not represent a contemporaneous account of the transactions. These books were accordingly rejected, the more so as no books of original entries were produced.

3. The income-tax Officer also reached the conclusion that in respect of various items of expenditure, figures had been unduly inflated. He instanced the case of the assessee manufacturing bricks on his own at a higher cost than what was paid for their purchase in the open market. In the case of messing expenses and transport charges and also in the daily wages paid to the large number of coolies, he reached the conclusion that the figures shown in the accounts were recorded at much higher rates than the expenses that should have been actually incurred.

4. The further proceeding of the Income-tax Officer resulting in his determination of a profit of Rs. 3,54,401 against the loss of an almost similar amount claimed by the assessee, took a somewhat curious turn. The Income-tax Officer purported to examine the wealth position of the assessee and proceeded to investigate how the assessee could have met this huge loss. The assessee's claim was that his father Yagappa, who died in 1938, had left a large amount of cash to the assessee's mother Gnanambal, a sum as much as Rs. seven Lakhs. The assessee claimed that he drew upon this amount which was lying idle with his mother and also from other relations and that was how he was able to carry on the work despite the loss that was incurred. The Income-tax Officer purported to examine the provisions of the will left by Yagappa and other material in connection with the properties devised thereunder and declined to believe that there could have been any amount at all in the hands of Gnanambal which could have been utilised for the purpose of the business. Proceeding on this reasoning, he thought that there could have been no loss as claimed by the assessee. Certain credits which appeared in the accounts of the assessee in the names of family relations of the assessee were also disbelieved by the Income-tax Officer.

5. In reaching the conclusion that the assessee should have made a profit and in ascertaining that quantum of profit, what the Income-tax Officer did was to estimate the in flation in expenses as equivalent to what he railed the fictitious credit in the accounts of the assessee. He took that sum to be Rs. 6,92,272. The total receipts came to Rs. 7,69,966 and the total expense Rs. 10,97,710 Obviously, the income-tax officer took the book figures in this regard this showed a net loss of Rs. 3,24,000 and odd and setting off the estimated inflation of Rs. 6,79,000 and odd, be reached the net profit of Rs. 3,54.401 This profit was computed in respect of the period covered by the duration of the work from 28-8-1943 to 25-3-1944 and it was divided on I he time basis between the two assessment years 1944-1945 and 1945-1946.

6. On appeals, the Appellate Assistant Commissioner substantially agreed with the conclusions reached by the Income-tax Officer. He thought that the unexplained credits in the accounts should be regarded as income from undisclosed sources, and after issuing notice to the assessee, held that a sum of Rs. 3,23,350 should be regarded as income from undisclosed sources, and directed the assessment to be made on that basis. On a further appeal to the Tribunal, the Tribunal restored the finding of the Income-tax Officer, holding that it was not open to the Appellate Assistant Commissioner to vary the scope of the Assessment in dealing with and in introducing a new source of income which was not in dispute in the appeals before the Appellate Assistant Commissioner the result was that the Appellate Tribunal accepted the finding of the Income-tax Officer that the contracts in question yielded a profit of Rs. 3,54,401 The assessee's application for a reference under Section 66(1) of the Act failing, this Court directed the appellate Tribunal to refer a case on the following two questions.

“(1) Whether on the facts and in the circumstances of the case, there was material for the Tribunal to determine the income from the Renigunta contracts at Rs. 3,54.4019?

(2) Whether the Tribunal was right in holding that the Appellate Assistant Commissioner had no jurisdiction to assess the assessee to an income of Rs. 3,23.350 for the assessment year 1944-1945 under the head ‘other sources’?’.

7. It may be mentioned that the second question was referred at the instance of the Department, which challenged the correctness of the decision of the Tribunal that the Appellate Assistant Commissioner in the quantum appeals before him was not competent to direct the estimation in respect of other sources of income which were not the subject-matter of the appeals before him.

8. The question at issue is a simple one and it is whether in arriving at the estimate of profit in the contract business, the Income-tax Officer had material on which he could reach particular figure as the probable income from the contract business Mr. T.V Viswanatha Iyer, learned counsel for the assessee, urges that while the Income-tax Officer had jurisdiction to reject the accounts on proper grounds, the method of arriving at an estimate of the income is wholly arbitrary and entirely unrelated to the real state of affairs disclosed by the material before him. We shall proceed on the basis that the rejection of the accounts was correct. We have already set out the various defects noticed in the accounts. It is not in dispute before us that the primary accounts were not forthcoming and that many of the indispensable accounts, such as muster rolls vouchers for the purchase of material, attendance register of coolies payment of wages and the like were not available Though the proceedings dragged on till 1948 with the Military Department, the works themselves had been completed by 1944.

9. The Income-tax Officer pointed out that even the profit and loss statement was not prepared till 1946 and that, further, when the assessee made representations for increased payment in respect of additional works, no claim had been made by him that any loss had been incurred Whatever that may be there is no doubt that in the absence of proper accounts, the Income-tax Officer could not accept the accounts produced as capable of displaying the true income of the contract. He was accordingly justified in rejecting he accounts but the question still remains whether the method followed by the Income-tax Officer, and which has received the approval of the Income-Tax Appellate Tribunal in making an estimate of the probable income from the business is a correct one. To all intents and purposes, what the income-tax officer has stated is:

“I reject the various entries in your accounts. I find that there has been an inflation in the prices and in the recorded expenditure. What you claim to be a loss I hold to be the profit.”

10. That in effect is the approach of the Income-tax Officer, though it has been sought to be supported by what we really believe to be irrelevant material, such as the wealth position of the assessee or the property he and the members of his family inherited from the assessee's father Yagappa in 1938.

11. At least, in one of the aspects, the Income-tax Officer appears to have been in error in holding that there was inflation. The assessee claimed that in view of the very short period within which this huge contract had to be fulfilled and for lack of adequate supplies in the open market, he had to manufacture bricks on his own, in addition to purchasing bricks such purchases were made at the rate of Rs. 11/- per 1000. His cost of manufacture however worked out to Rs. 18-12-0 per 1000. We are hard put to it to agree with the Income-tax Officer that this alone indicates a deliberate inflation in the accounts of the assessee. Where a person, in order to fulfil a contract of this description is compelled to embark upon an allied activity such as the manufacture of the materials themselves, it is not unlikely that his expenditure on that head would be greater than that of a regular manufacturer already in the field. The fact that the assessee's cost of manufacture of bricks came to Rs. 13-12-0 per 1000 as against Rs. 11/- per 1000, for which bricks were available in the market, does not immediately prove that inflated figures were recorded in the accounts.

12. In a similar manner, the assessee claimed that for want of adequate local labour, he had to import coolies from other places. While in the beginning stages of the contract coolies were available at daily wages of 9 annas per man and 6 annas per woman, in the later stages, he had to pay as much as 12 annas or Rs. 1/- per cooly. It is common knowledge that during the years in question, prices were rapidly rising. It does not also appear to be disputed that the assessee did have to import coolies from other places, a feature that must necessarily have increased the wage rate. Beyond refusing to believe the statement of the assessee in this regard, the Income-tax Officer has furnished no materials which would show that his claim is untrue. In contrast, the Appellate Assistant Commissioner pointed out that another contractor, who did similar work in the neighbourhood, actually suffered loss, presumably for reasons like those stated above, and the claim to loss had been accepted in that case by the Department. It is no doubt true that is not conclusive in so far is the assessee's claim is concerned. But, there was at least a comparable case which the Income-tax Officer could have taken note of. If the Income-tax Officer thought that the wages claimed to have been paid by the assessee to the coolies were deliberately inflated, he could have shown by the reference to similar contract works in that area that the wage structure as adopted by the assessee was abnormal. There is no material of that kind.

13. It is true that the Income-tax Officer has been at considerable pains to examine the matter. But, almost the whole of his order is concerned with the deficiencies and discrepancies in the accounts which led to their rejection rather than an attempt to determine the reasonable cost of such of the items in respect of which the Income-tax Officer thought that there was an inflation.

14. The principal basis upon which the quantum of this suspected inflation was fixed was, what in our opinion is a wholly unrelated fact. In his accounts, the assessee had brought in as credits certain amounts from his relations. The value of these credits in the name of the assesse's mother, sister and wife came to Rs. 7,39,850/-. The Income-tax Officer thought that these credits were all fictitious and they had been put in to show a huge loss in the Renigunata works and to reduce the profits in the other business at Tiruchirapalli, Tiruvarambur, etc. He also relied upon the fact that in dealing with the businesses other than the abkari contracts and Renigunta contracts, he had held the accounts in respect of those other businesses to be squally unreliable, and had estimated the income on the net percentage basis. How this can have any relevance to the determination of the profits from the Renigunta contract we are really unable to see. These facts can only show that the accounts are unreliable, but the Income-tax Officer proceeded further and stated that this amount of Rs. 7,39,850/- which represented the fictitious credits, reduced by it sum of Rs. 60,000/- and odd for some unexplained reason, yielding Rs. 6,79,272/-, represented, in the opinion of the Income-tax Officer, the inflation in expenses in Renigunta works. It is exceedingly difficult for us to see how the existence of unexplained credits in the accounts can lead to the conclusion that amount represents the inflation in expenses in Renigunta works. There seems to be no logic in forging a connection between the two, and it is this figure, which, set off against the loss claimed, resulted in the estimated profit, which is the subject-matter of question No. 1.

15. We are of the view that this method of estimating the income is wholly irrational. It is impossible for us to lay down any inflexible procedure as the one to be followed in cases where an estimate of the income is to be made. The method to be followed will depend upon the nature of the business in most cases. During the years in question, hundreds of military contracts of this description were being executed and a comparison of other like cases would have yielded a measure of adequate data on feet of which an estimate of income could have been made. That is one of the methods that is generally followed Another method would he to classify the various heads of expenditure and estimate in respect of each such head the probable inflation by that means one could reach an approximately correct figure of the expenditure on that head of account. On the basis of such recomputation of the expenses, the net income could be assessed. None of such methods as are generally adopted in making an estimate has been followed by the Income-tax Officer in this regard.

16. The Income-tax Officer in his order has no doubt dealt with some of the items and concluded that in respect of those items there had been some inflation in the record of expenditure. There could have been no difficultly in assessing such inflation in respect of each head of expenditure. It is true that the work involved would be considerable, but that does not justify an estimate of inflation being made on the basis of wholly unrelated circumstances, viz., the credit entries in the accounts which the Income-tax Officer did not choose to accept it accordingly seems to us that the Tribunal was in error in accepting this method of estimating the income. We have no alternative but to answer this question in favour of the assessee. The result would be that the Income-tax Officer will have to re-compute the income afresh on a rational basis.

17. The second question invites an examination into the jurisdiction of the Appellate Assistant Commissioner to assess the assessee under the head of ‘Income from other sources’, when the appeals before the Appellate Assistant Commissioner did not raise any point referable to other sources at all. We may also paint out in this connection that the Appellate Assistant Commissioner himself found that there was no evidence to show that the assessee's father Yagappa had left a sum of Rs. Seven lakhs in cash with the assessee's mother Gnanambal, and with that finding that this amount did not exist, and with the further finding that the various credits were all fictitious and represented non-existent amounts, there could hardly be any justification for the conclusion that the total of these credits should represent the income from undisclosed sources. If the amounts did not exist, as is the clearly expressed finding of the Appellate Assistant Commissioner, the finding that there was any income from undisclosed sources cannot possibly follow. On that ground alone, the Income-tax Appellate Tribunal was justified in setting aside the order of the Appellate Assistant Commissioner that there was any income to be assessed under the head ‘other sources’. Apart from that, the jurisdiction of the Appellate Assistant Commissioner in this regard has been clearly negatived by a decision of the Supreme Court in Commissioner of Income-tax, Bombay v. Shapoorji Pallanji Mistry, 1962-44 I.T.R 891 : (AIR 1962 SC 1086). The headnote is sufficient. It reads:

“In an appeal filed by the assessee, the Appellate Assistant Commissioner has no power to enhance the assessment by discovering new sources of income not mentioned in the return of the assessee or considered by the Income-tax Officer in the order appealed against.”

18. Both on fact and on law, the second question has to be answered in the affirmative. In the circumstances of the case, we make no order as to costs.

BJ/RSK/D.V.C

19. Reference answered.