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P.M. Abdul Razak v. Income-tax Officer
Concise Analytical Summary of the Opinion
Factual and Procedural Background
This is an appellant’s appeal against the order of the Deputy Commissioner of Income-tax (Appeals), Trivandrum, dated 26-10-1993. The appeal arises from two core sets of issues:
- Grounds 1–4: challenge to the Assessing Officer's estimation of gross profit and an addition of Rs. 50,000 to gross profit.
- Grounds 5–6: challenge to the disallowance of Rs. 15,600 under section 40A(3) of the Income-tax Act, 1961, for cash payments allegedly exceeding Rs. 2,500 at a time.
The appellant is a dealer trading in black pepper, ginger, tea dust and similar hill products and sells to exporters. He declared gross profit at 0.58% on a total turnover of Rs. 1,72,00,000 (gross profit declared at Rs. 1,01,766). The Assessing Officer considered this gross profit unusually low compared with similar dealers (1%–1.5%) and estimated gross profit at 1% (resulting in an addition of Rs. 50,000). The Assessing Officer also made a disallowance under section 40A(3) of Rs. 15,600 for a particular cash purchase.
The Deputy Commissioner (Appeals) confirmed the Assessing Officer’s action, and the appellant appealed further to the Tribunal. The hearing involved the appellant’s representative, Sri V. Narayanan Nampiathiri, and the departmental representative, Sri K. Harilal Naick.
Legal Issues Presented
- Whether the Assessing Officer was justified in estimating the appellant's gross profit at 1% (and adding Rs. 50,000) instead of accepting the gross profit declared by the assessee (0.58%), particularly where the books of account were maintained and the turnover for the commodity (black pepper) was accepted.
- Whether the disallowance of Rs. 15,600 under section 40A(3) of the Income-tax Act, 1961, for cash payments (exceeding the prescribed limit) was justified where the genuineness of the cash transactions was not doubted and the appellant asserted that small cultivators insisted on cash payments.
Arguments of the Parties
Appellant's Arguments
- The appellant maintained books of account and declared a gross profit of 0.58% on turnover; similar dealers declare 1%–1.5%, but that alone does not justify rejecting the book results or estimating gross profit at a higher rate.
- The Assessing Officer purportedly "rejected" the books only on the ground that bought-out notes' genuineness could not be verified, but he did not identify defects or discrepancies or follow the procedural requirements of section 145(2) before applying estimation.
- Evidence is required before concluding that bought-out notes are not verifiable; absent such evidence the Assessing Officer's observations are insufficient.
- With respect to section 40A(3), the appellant contended that cash payments were genuine: small cultivators insisted on cash and would not accept cheques; refusal to pay cash would cause loss of business. The appellant relied on case law holding that section 40A(3) does not operate absolutely and genuine transactions can be accepted when business exigencies or seller insistence are shown.
Departmental Representative's Arguments
- The Assessing Officer considered the declared gross profit (0.58%) to be too low compared with the normal rate in that trade and therefore applied a 1% gross profit estimate—an approach the Department sought to justify as reasonable.
- On the cash payments point, the departmental representative relied on precedent (Gauhati High Court decision) to support the proposition that cash payments may be disallowed where there is no credible explanation for why payments could not be made by cheque and the payee's certificate does not indicate genuine difficulty necessitating cash payments.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CM. Francis & Co. (P.) Ltd v. CIT [1979] 77 ITR 449 (Ker.) | Held that bought-out notes being common in a particular trade (e.g., purchases from agriculturists) is not by itself a defect justifying application of the proviso to section 145; acceptance of accounts for other commodities indicated regular maintenance. | The court relied on this authority to show that the presence of bought-out notes, when common to the trade and absent any material showing inflated or bogus purchases, is not sufficient ground for rejecting books or invoking section 145(2). |
| M. Durai Raj v. Commissioner of Income-Tax, Ernakulam [1972] 83 ITR 484 (Ker.) | It is improper to reject trading results without establishing suppressed turnover; relevant considerations include whether accounts are maintained according to the method regularly employed, and whether income can be computed from the accounts. | The court used this authority to reinforce that routine differences in practices (e.g., stock registers in different units of measure) or absence of particular details do not justify rejecting accounts when the method is regularly followed and income is computable. |
| CIT v. Chaudhary & Co. [1996] 217 ITR 431 (Allahabad) | Section 40A(3) aims to prevent fictitious revenue expenditure but is not absolute; bona fide cash transactions may be allowable where business expediency or seller insistence makes non-cash payment impracticable; assessee may satisfy the AO by evidence (e.g., certificates). | The court relied on this decision to support the proposition that if a seller insists on cash and evidence (certificates) is produced, payments may not be hit by section 40A(3); applied to find the appellant's cash payments could be genuine and allowable. |
| Girdharilal Goenka v. CIT [1989] 179 ITR 122 (Cal.) | If genuineness of cash transactions is not doubted, claims should not be rejected under section 40A(3). | The court cited this as supporting authority for not disallowing cash payments where their genuineness is not in dispute. |
| Attar Singh Gurmukh Singh v. ITO [1991] 191 ITR 667 (SC) | Taxing statutes should be interpreted in the context of preventing the proliferation of black money; provisions like section 40A(3) and rule 6DD are intended to regulate transactions and reduce opportunities for unaccounted money. | The court referenced this Supreme Court pronouncement to acknowledge the object of section 40A(3) and rule 6DD, while noting that in the present appeal there was no dispute about use of black money. |
| Associated Engg. Enterprise v. CIT [1995] 216 ITR 366 (Gauhati) | Cash payments may be disallowed where both parties have bank accounts in the same city and no genuine difficulty is shown to justify cash payments; mere mention of amounts received by cash without indicating difficulty is inadequate. | The departmental representative relied on this case; the court distinguished it on facts because, in the present case, small cultivators allegedly refused cheques and insisted on cash, unlike the Gauhati facts where no difficulty was shown. |
Court's Reasoning and Analysis
The court proceeded in two analytical strands corresponding to the two sets of grounds.
1) Gross-profit estimation (Grounds 1–4):
- The tribunal noted that the appellant maintained books of account and declared gross profit at 0.58% on turnover. Although the Assessing Officer treated this as low compared to similar dealers (1%–1.5%), the Assessing Officer both (a) did not record specific defects or discrepancies in the books and (b) did not follow the procedural requirements of section 145(2) before estimating profit.
- Section 145(2) allows the AO to determine income under section 144 only where the AO is not satisfied about correctness/completeness of accounts or where no regular method of accounting is employed. The court found that the AO had not complied with these provisions because the AO accepted the turnover for black pepper and did not cite defects sufficient to justify rejecting the books or applying the estimation power.
- The court emphasized that mere assertion that bought-out notes' genuineness "cannot be verified" is insufficient without supporting evidence. Citing jurisdictional authorities (CM. Francis and M. Durai Raj), the court observed that bought-out notes may be a regular feature of certain trades and do not automatically justify rejecting accounts.
- On this analysis the court concluded that the AO's estimation of gross profit at a higher rate was unjustified and could not be sustained.
2) Disallowance under section 40A(3) (Grounds 5–6):
- The Assessing Officer noted cash purchases (including one of Rs. 15,600) and found the assessee had not satisfactorily explained certain particulars under rule 6DD. However, the AO did not doubt the genuineness of the cash payments nor alleged any falsity in the claim.
- The court considered authoritative decisions (Allahabad High Court, Calcutta High Court, and the Supreme Court) which establish that section 40A(3) is aimed at preventing fictitious claims and the use of unaccounted money but is not absolute; genuine transactions justified by business exigency or seller insistence may be allowed if satisfactorily explained.
- The Gauhati decision relied on by the Department was held distinguishable on facts because there both parties had bank accounts in the same city and no difficulty was shown; however, in the present case the appellant produced evidence and argued that small cultivators insisted on cash and would not take cheques, making cash payment commercially necessary to avoid loss of business.
- On the basis of the record and the cited authorities, and noting that the AO did not impugn genuineness, the court found no reason to sustain the disallowance under section 40A(3).
Holding and Implications
APPEAL ALLOWED.
Holding (core ruling): The Tribunal allowed the appeal in full — (a) the estimation of gross profit by the Assessing Officer at 1% and the resulting addition of Rs. 50,000 was not justified where the turnover was accepted and the Assessing Officer had not followed the provisions of section 145(2) or produced adequate evidence to reject the books; and (b) the disallowance of Rs. 15,600 under section 40A(3) was not sustainible on the record because the genuineness of the cash payments was not impugned and the facts supported a business necessity explanation.
Implications:
- Direct effect on the parties: the impugned addition of Rs. 50,000 to gross profit and the disallowance of Rs. 15,600 under section 40A(3) are set aside and the appellant succeeds on all grounds raised in the appeal.
- The opinion applies established principles from the cited authorities (as summarized above) and does not purport to lay down a new legal principle; the decision follows existing case law and fact-specific distinctions (for example, distinguishing the Gauhati decision on its facts).
This summary is confined strictly to the content of the provided opinion and does not add or infer facts beyond that text.
1. This is an appellant’s appeal against the order of the Dy. CIT (Appeals), Trivandrum, dated 26-10-1993 on two issues. Ground Nos. 1 to 4 relate to the estimation of gross profit and making an addition of Rs. 50,000 to the gross profit. Ground Nos. 5 and 6 relate to the disallowance of Rs. 15,600 under section 40A (3) of the Income-tax Act, 1961, in respect of cash payments exceeding Rs. 2,500 at a time.
2. I have heard the learned representative for the appellant, Sri V. Narayanan Nampiathiri and the learned departmental representative, Sri K. Harilal Naick. Their arguments are taken into consideration.
3. The appellant is carrying on the business as a dealer in purchasing black pepper, ginger, tea dust, etc., and selling them to the exporters. He has declared the gross profit at 0.58 per cent of the total turnover of the business done by him. The total turnover is of Rs. 1,72,00,000 and the gross profit declared by the assessee is Rs. 1,01,766. The Income-tax Officer considered that the-gross profit declared by the appellant is of a low rate. According to him in the identical business, the gross profit is being declared at one per cent to 1.5 per cent. Therefore, the Assessing Officer estimated the gross profit on the turnover of the business done by the appellant at one per cent and, thus, he has made an addition of Rs. 50,000 to the gross profit declared by the appellant.
4. The assessee being aggrieved by this assessment, that is estimation of gross profit by the Assessing Officer, agitated the dispute before the Dy. CIT (Appeals), who considered it proper and confirmed the Assessing Officer’s action. The appellant being further aggrieved preferred this second appeal before the Tribunal.
5. The appellant declared an income of Rs. 29,580. The gross profit declared was Rs. 1,01,766, i.e., @ 0.58 per cent. Similar dealers have declared the gross profit from 1 per cent to 1.5 per cent. Most of the purchases are on the basis of assessee's own bought notes and according to the Assessing Officer, the genuineness of the same cannot be verified. Hence, he estimated the gross profit at 1 per cent on the total turnover of Rs. 1,51,53,360 in respect of black pepper only. On this count, he made an addition of Rs. 50,000 to the net profit.
6. The appellant has maintained the books of account. There is no doubt that the assessee estimated the gross profit on his own bought out notes. From the assessment order, it can be made out that the Assessing Officer rejected the books of account but he did not give any reasons as to why he rejected the books of account. The only reason given by him is that own bought out notes and the genuineness of the same cannot be verified. That does not mean that the Assessing Officer did not want to accept the book results because of having found certain defects or discrepancies and, therefore, he wanted to apply the provisions of section 145(2) of the Income-tax Act, 1961, to estimate the gross profit. He did not doubt the turnover of the dealings of black pepper. When he has accepted the turnover of black pepper and did not find out any defects or discrepancies in the account books, in that event, in the ordinary course, it was not just and proper to estimate the gross profit at a higher rate. In accordance with section 145(2) of the Act, where the Income-tax Officer is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting has been regularly employed by the assessee, the Income-tax Officer may make an assessment in the manner provided in section 144. The Assessing Officer did not comply with the provisions of section 145(2) of the Income-tax Act.
7. The learned representative of the assessee argued that without rejecting the book results and without finding any defects or disclepancies in the account books, the Assessing Officer was not right in invoking the provisions of section 145(2) of the Income-tax Act, 1961. In support of this contention, he relied on the judgment of the Kerala High Court in the case of CM. Francis & Co. (P.) Ltd v. CIT [1979] 77 ITR 449 . The Kerala High Court has held in that case "that the fact that the assessee did not obtain bought notes from the sellers in respect of its trade in arecanuts was not a defect by itself or something which the assessee could have helped, since the sellers were agriculturists from whom it was not possible in the ordinary course of business to obtain vouchers and also the fact that the maintenance of bought out notes by the purchasers was the common feature in the assessee's line of business. Further no case had been made out that the purchases were inflated or bogus purchases and gone into the assessee's accounts. Since the accounts were properly and regularly maintained and they had been accepted in respect of three out of four' commodities in which the assessee dealt, the fact that the purchases of arecanuts were supported only the assessee’s bought notes was no ground for the application of either the proviso to section 13 of the 1922 Act or the proviso to section 145 of the 1961 Act". Their Lordships further held that "if the finding of the Appellate Tribunal cannot be sustained on any material, or if the facts stated in support of its finding have no relevancy to the conclusion of the Tribunal, it raises a question of law and the High Court is entitled to examine whether the said finding can be sustained". In the instant case, also there is a regular feature in this line of business to take bought out notes.
8. The learned representative has also relied on another judgment of the jurisdictional High Court in the case of M. Durai Raj v. Commissioner Of Income-Tax, Ernakulam* [1972] 83 ITR 484 (Ker .), wherein it had been held that "that the Tribunal was not right in rejecting the trading results of the assessee without it being established that there was any suppressed turnover. What is relevant to consider in such cases is whether the assessee's accounts are maintained according to the method regularly employed by him, whether they are correct and complete, and whether the income can be properly computed from the accounts, The assessee gave an explanation for the low profits when compared with others. The Tribunal did not find that the explanation was not true. Regarding the stock register, the assessee's case was that he bought rice in terms of the number of bags and also sold it in the same manner and that the stock register was, therefore, maintained in terms of bags. This case was apparently accepted by the Tribunal and the subordinate authorities. In a wholesale business like that of the assessee, who bought and sold in terms of the number of bags, maintenance of a stock register in terms of weight would be a very laborious process. There was no need to have complete particulars of the names and addresses of customers in the case of cash transactions, and the absence of such particulars in the sale bills would not be a ground for not accepting the books of account of the assessee. The assessee had admittedly maintained his accounts according to the method regularly employed by him, and the profits and gains of the business could be properly computed from his accounts. The grounds stated by the Tribunal were neither valid nor relevant in rejecting the accounts of the assessee.
9. Some evidence is required to be adduced to say that bought out notes of the assessee are genuine and cannot be verified. Without such supporting evidence, the Assessing Officer's observations cannot be considered as sufficient.
10. After considering the facts, arguments and the case laws in this respect, without rejecting the books of account for any good reasons, the estimation of the gross profit cannot be considered as correct. The learned departmental representative tried to justify the estimation on the ground that the estimation of gross profit at a rate of 0.58 per cent is very low and, therefore, the Assessing Officer's estimation at one per cent is quite reasonable, in this type of business and the same should be accepted. There is no doubt that the Assessing Officer has considered the declared gross profit at 0.58 per cent as low, but that itself is not sufficient in the absence of rejecting the book results without any reasons. Hence, the contention of the learned departmental representative is not acceptable. In this view of the matter, the appellant succeeds on ground Nos. 1 to 4 of the appeal.
11. The ground Nos. 5 and 6 relate to the disallowance of Rs. 15,600 under section 40A (3) of the Income-tax Act, 1961, in respect of cash payments exceeding Rs. 2,500 at a time. In this respect, the Assessing Officer noted that the appellant made several cash purchases exceeding Rs. 10,000. He has made- cash purchases from dealers in the same locality. He has effected a cash purchase for Rs. 15,600 on 1-3-1989. According to the Assessing Officer, the assessee did not satisfactorily explain the circumstances specified in clauses (a) to (i) of Rule 6DD. But he has not doubted the genuineness of the cash payment nor he has alleged anything of making false claim of cash payment. The learned representative for the appellant argued that the genuineness of the cash transactions are not doubted and the assessee is purchasing the hill products from small cultivators. The cultivators themselves demand the cash payments and if the assessee refuses to make the cash payment, in that event, the assessee will be losing the business. In support of this conte,ntion, he has relied on the judgment of the Allahabad High Court in the case of CITv. Chaudhary & Co. [1996] 217 ITR 431 wherein their Lordships held that the "object of section 40A (3) of the Income-tax Act, 1961, is that a fictitious amount should not be claimed as revenue expenditure. The intention of section 40A (3) was not that cash payment can never be allowed as a deduction. The terms of section 40A (3) are not absolute. Considerations of business expediency and other relevant factors are not excluded. Genuine and bona fide transactions are not taken out of the sweep of the section. It is open to the assessee to furnish to the satisfaction of the Assessing Officer the circumstances under which the payment in the manner prescribed in section 40A (3) was not practicable or would have caused genuine difficulty to the payee". The Allahabad High Court held that "the Tribunal had found that the seller had been insisting on cash payment. The identity of the seller had been disclosed by the assessee. The assessee had furnished the certificates from the sellers stating that, they had insisted on cash payment and as to. the genuineness of the payments. Hence, the Tribunal wasjustifjed in holding that the payments in question were not hit by section 40A (3) and in deleting the addition".
12. The Calcutta High Court in the case of Girdharilal Goenka v. CIT [1989] 179 ITR 122 has held that if the genuineness of the cash transactions are not doubted, such claims should not be rejected. The Supreme Court in the case of AttarSingh Gurmukh Singh v. ITO [1991] 191 ITR 667 has held that "in interpreting a taxing statute, the Court cannot be oblivious of the proliferation of black money which is under circulation in our country. Any restraint intended to curb the chances and opportunities to use or create black money should not be regarded as curtailing the freedom of trade or business". The Supreme Court further held that "it will be clear from the provisions of section 40A (3) and rule 6DD that they are intended to regulate business transactions and to prevent the use of unaccounted money or reduce the chances to use black money for business transactions". There is no such dispute in the instant appeal.
13. The Allahabad High Court in the case of Chaudhary & Co. (supra) held that "the Tribunal had found that the seller had been insisting on cash payment. The identity of the seller had been disclosed by the assessee. The assessee had furnished the certificates from the sellers stating that they had insisted on cash payment and as to the genuineness of the payments. Hence, the Tribunal was justified in holding that the payments in question were not hit by section 40A (3) and in deletmg the addition".
14. The learned departmental representative has relied on the decision of Gauhati High Court in the case of Associated Engg. Enterprise v. CIT [1995] 216 ITR 366 in support of his contention that because the assessee made a cash payment and, therefore, they are not allowable. In fact the Gauhati High Court has held that "both the assessee as well as the payee had their offices at Gauhati admittedly with their bank accounts. It was not anybody’s case that cash payments had to be made on account of a bank holiday. It was significant to note ethe certificate issued by the payee merely mentioned the amounts received by cash. It did not even remotely indicate any genuine difficulty posed or presented to the parties necessitating cash payments by the assessee on that dates they were made. Hence, the Tribunal was justified in law in holding that the disallowance by the Income-tax Officer in respect of the cash payments of Rs. 31,809 made on various dates to the payee was proper". The facts of that case are distinguishable from the facts of the instant case because in that case, the bank accounts of both the parties are at Gauhati and no difficulties were pointed out necessitating the cash payment. In the instant appeal, the small cultivators were not ready to accept the cheques and for that purpose not to loose the business, the cash payment had been made.
15. I have examined the facts on this point and considered the case laws. I do not find any reason to confirm the disallowance of cash payment as just and proper and the e,-vidence as brought on record does not allow to do so. AccordiIlgly, the appellant succeeds on ground Nos. 5 and 6.
16. In the result, the appellant succeeds and the appeal is allowed.
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