Income Tax Appellate Tribunal - Ahmedabad
P.T. Synthetics, Surat vs Department Of Income Tax on 1 October, 2007
IN THE INCOME TAX APPELLATE TRIBUNAL
'D' BENCH - AHMEDABAD
(BEFORE S/SHRI BHAVNESH SAINI, JM AND D. C. AGRAWAL, AM)
ITA No.4520/Ahd/2007
A. Y: 2004-05
The Income Tax Officer, Vs M/s P. T. Syntheics,
Ward-5 (3), 4- Super Yarn Market,
Room NO.315, Zampa Bazar, Surat
Aayakar Bhhavan,
Majura Gate, Surat
PA No. AAEFP 7522 Q
(Appellant) (Respondent)
ITA No.4543/Ahd/2007
A. Y: 2004-05
M/s P. T. Syntheics, Vs The Income Tax Officer,
4- Super Yarn Market, Ward-5 (3),
Zampa Bazar, Surat Room NO.315,
Aayakar Bhhavan,
Majura Gate, Surat
PA No. AAEFP 7522 Q
(Appellant) (Respondent)
Department by Shri S K. Meena, DR
Respondent by Shri Mehul K. Patel, AR
ORDER
PER BHAVNESH SAINI: Both the cross appeals are directed against order of the learned CIT(A)-III, Surat dated 01-10-2007 for assessment year 2004-05.
2. We have heard the learned representatives of both the parties, perused the findings of the authorities below and the materials available on record.
3. Ground No.1 of the appeal of the revenue reads as under:
"1. On the facts and in the circumstances of the case and in law, the learned CIT (A) has erred in restricting the ITA No.4520 and 4543/Ahd/2007 2 M/s. P. T. Synthetics addition made by the A. O. on account of low gross profit o Rs.5 lacs as against disallowed by the A. O. amounting to Rs.15,30,398/-. Thus, the learned CIT(A) has given the relief of Rs.10,30,398/-"
4. Grounds No. 1 and 2 of the appeal of the assessee read as under:
"1. That on the facts and in the circumstances of the case, the learned CIT (A) has grossly erred in sustaining lump sum addition of Rs.5,00,000/- on ADHOC BASIS on account of alleged fall in gross profit margin in the activity of manufacturing of grey cloth".
2. That on the facts and in the circumstances of the case, the learned CIT (A) has erred in sustaining the impugned addition even after discarding the stand of he learned AO of rejecting the regularly maintained books of accounts and quantity records of the appellant".
5. Briefly, the facts of the case are that the AO made addition of Rs.15,30,398/- on account of low gross profit by rejecting the books of account. The AO observed that the assessee was engaged in the business of sale of grey cloths manufactured on its own machine and getting it manufactured on job work basis from other parties whereas in earlier years the assessee carried out activity on its own machine only. The gross profit rate in the year under consideration was 4.31% compared to 19.96% last year. When required to explain the same, the assessee gave detailed working of two financial years in respect of production and sale on its own machine and job work from outside parties and stated that the gross profit in respect of own production was 14.52% and was 0.26% in respect of job work production in the preceding financial year 2003-04. The chart was reproduced by the AO on page 3 and 4 of the assessment order. The assessee stated that the gross profit of the two years cannot be compared, since there was no production through job work in earlier year. The AO did not accept the contention of the assessee and held that there is no justification in the explanation of the assessee that cost of purchase of raw material increased and finished goods were ITA No.4520 and 4543/Ahd/2007 3 M/s. P. T. Synthetics sold at lower price. Further, no quality wise stock register and production register was produced by the assessee nor any day to day consumption register was maintained. Further, opening and closing stock in terms of quality, rate of value is not verifiable. The AO, therefore, rejected the book results u/s 145(3) of the IT Act and he worked out the production for the year under consideration by estimating gross profit rate at 20.24% as in the last year and made the addition. The addition was challenged before the learned CIT(A) and it was submitted that that the assessee achieved turnover of Rs.736 lacs as against 200 lacs in the earlier year. Therefore, there was increase of almost 268% in the turnover. No specific defect in maintenance of books of account has been pointed out and valuation of the closing stock was accepted. It was explained that all expenses were paid through account payee cheques and complete details were maintained. Sale and purchase details were maintained. The submission of he assessee in detail are noted by the learned CIT(A) in the impugned order in which it was also explained that there was a strike in textile industries on account of levy of excise duty. Therefore, there was a recession in the market in the first quarter. The assessee relied upon the decision of the Tribunal in support of the contention that on such facts no addition can be made. The learned CIT(A) considering the submission of the assessee and material on record noted that the book results have been rejected on the ground of decrease in the gross profit disbelieving the explanation of the assessee that purchase cost increased during the year under consideration and the finished goods were sold at lesser price in order to achieve turnover and that the assessee has not maintained day to day record of consumption of raw material and opening and closing stock were not verifiable. However, it was found that the observations of the AO are not correct. The learned CIT(A) noted that complete details were produced at the assessment stage along with evidences which support the submission of the assessee. Complete quantitative details of finished goods and details ITA No.4520 and 4543/Ahd/2007 4 M/s. P. T. Synthetics of day to day stock register have been filed. Therefore, rejection of the book results has been done arbitrarily. The learned CIT(A) noted that in the instant case the assessee has maintained detail stock register on day to day basis comprising of details of purchase, production and sales. The AO has not found any instances of unaccounted purchase or sales. All purchases and sales were confirmed by the parties. No specific defect has been pointed out in maintenance of the account. Therefore, rejection of book results is not in order. The learned CIT(A) thereafter noted that the turnover of the assessee has increased by more than 3.5 times and increased turnover would normally result in increase in over all profit. Hence, gross profit has decreased. The learned CIT(A) accepted the contention of he assessee regarding destruction of file and documents through photographs. However, he has confirmed the addition of Rs.5,00,000/- because some disallowance out of the purchases shall have to be made and it was directed that the AO shall restrict the addition made on account of gross profit to this amount only.
6. The learned DR relied upon the order of the AO and submitted that specific point has been raised by the AO in the assessment order which justify rejection of the book results. However, the learned DR admitted that no specific ground is taken challenging the findings of the learned CIT(A) with regard to acceptance of the book results. On the other hand, the learned Counsel for the assessee reiterated the submissions made before the authorities below.
7. On consideration of the rival submissions, we do not find it to be a fit case for sustaining even part addition on this issue. The learned CIT(A) gave a specific finding that rejection of the book results is not in order in this case. The learned CIT(A) verified all the details and material filed on record and came to the finding that the assessee maintained detailed stock register on day to day basis comprising of details of sales ITA No.4520 and 4543/Ahd/2007 5 M/s. P. T. Synthetics and purchases which are verified. No specific defect has been pointed out in the maintenance of the book results. The learned CIT(A), therefore, held that book results cannot be rejected u/s 145(3) of the IT Act. The above finding of facts recorded by the learned CIT(A) have not been challenged by the revenue in the ground of appeal. In the absence of any challenge to the finding of facts recorded by the learned CIT(A), it is clear that the book results declared by the assessee shall have to be accepted. Therefore, there is no reason for the learned CIT(A) to maintain even part addition on this issue. The finding of facts recorded by the learned CIT(A) have not been rebutted through any material on record. We, therefore, confirm the findings of the learned CIT(A) with regard to the acceptance of the book results. However, the part addition sustained by the learned CIT(A) in a sum of Rs.5,00,000/- is set aside and the part addition maintained by him is also deleted by setting aside the order of the learned CIT(A) to that extent. In the result, the departmental appeal on ground No.1 is dismissed and the appeal of the assessee on ground No.1 and 2 is allowed.
8. Ground No.2 of the appeal of the revenue reads as under:
"2. On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in deleing the addition made by the A. O. regarding addition u/s 40A(2)(b) on account of excess job charges paid to its associate sister concerns of Rs.95,39,796/-."
9. The AO made the addition of Rs.95,39,796/- out of job charges paid to sister concern by invoking the provisions of section 40A(2)(b) of the IT Act. The AO observed that the assessee was paying higher cost for job work done by its sister concerns. The assessee stated that the payment to all these concerns was for two activities, which is twisting, warping and winding of yearn as preparatory for weaving and thereafter weaving of grey cloths and mending the same. Compared to the assessee firm did not own any twisting, warping or winding set up and therefore ITA No.4520 and 4543/Ahd/2007 6 M/s. P. T. Synthetics the cost of production arrived at by own firm was not comparable with the cost of job work production and the job charges paid were the same as charged by other parties in similar circumstances. The AO however, held hat the assessee did not furnish quality wise details of grey cloths manufactured and since the same quality of grey cloths was produced on own machines and on job work basis, there should not be any difference in cost per meter. He therefore, worked out the cost per meter of the assessee from own production at Rs.14.88 per meter compared to Rs.18.17 per meter produced by job worker and worked out the excess payment for production of 28,99,634 meters at the excess rate of Rs3.29 per meter thereby making a disallowance of Rs.95,39,796/-.
10. The addition was challenged before the learned CIT(A) and it was submitted that during the year the assessee firm obtained production of grey cloth by manufacturing on is own set up as well as by getting it manufactured through several job workers. The job workers were the sister concerns of the assessee firm. The assessee paid average job charges of around Rs.6.32 per meter to them for manufacturing of grey cloths. The said activity in the job work includes twisting, warping and winding of yarn and thereafter weaving of grey cloths and mending thereof. In order to substantiate the rate of job work charges for similar activity, the assessee firm had also submitted copy of bills of certain independent job workers, who has charged at the rate equivalent to or even higher than the rate paid by the assessee firm to its associate concerns for similar services in the same year from some other parties. The AO however, ignoring this fact went on to compare the cost of production as incurred by the assessee firm in its own stream of production with that of the cost of production in respect of grey cloths manufactured on job work basis. The AO failed in appreciating the provisions of section 40A (2) (b) of the IT Act which provide for disallowance of expenditure incurred by an assessee in the course of its ITA No.4520 and 4543/Ahd/2007 7 M/s. P. T. Synthetics business or profession only if the AO was of the opinion that such expenditure was excessive or unreasonable having regard to fair market value of the goods, services or facilities for which the payment was made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him there from. However, the AO resorted to compare the cost of production as incurred by the assessee firm on its own manufacturing set up with that of the cost of production incurred on job work basis for making the impugned disallowance, which was improper, unjustified and even illogical. The learned Counsel for the assessee further submitted that the assessee firm owned only power looms utilized for weaving of grey cloths and not other machines for twisting, warping and winding of yarn, while the job charges paid by the assessee firm to the job workers were for two activities i.e. primarily twisting, warping and winding of yarn as preparatory for weaving and thereafter weaving of grey cloths and mending thereof. Thus, the cost of production in own unit could not be compared with that of the cost of production on job work basis. The assessee also submitted copy of bills of independent job workers who charged job charges at equivalent rates for similar services to prove reasonability of job charges incurred by the assessee firm as per the prevailing market rate for similar services Even other wise if the production achieved through job workers was carried in the own manufacturing set up of the assessee, it would require incurrence of additional expenses on plant, machinery, factory building, additional technical staff, upgraded power connections, etc. which would be over and above the basic expenses of yarn and labour charges. Thus, the comparison of cost of production on job work basis with cost of production on own set up was totally unjustified. All the concerns of the job workers were regularly assessed to tax on profit and they were not incurring losses, hence, the payment of job charges to those concerns was not with the intent to avoid tax through getting profit of the assessee firm absorbed in loses of those associate. Thus, the basis adopted by the ITA No.4520 and 4543/Ahd/2007 8 M/s. P. T. Synthetics AO for evaluating the reasonability of job charges incurred by the assessee firm was erroneous and accordingly the disallowance made there from was also unjustified and improper. In this regard, the learned Counsel for the assessee relied on the following decisions:
(i) ITAT Mumbai Bench in the case of Balivala & Karani Vs ACIT 2 SOT 379
(ii) The Hon'ble Gujarat High Court in the case of Sirhind Steel (P) Ltd.
(iii) CIT Vs Print Systems & Products (2006) 285 ITR 337 (Mad)
(iv) DCIT s Joshi Formulabs (P) Ltd. (2000) 67 TTJ (Rajkot) 396 The learned Counsel for the assessee further submitted that the AO failed in duly adhering to the requirement of section 40A(2)(b) of the IT Act prior to its application and he failed to consider the prevailing market rate of similar services and ignored the evidences pertaining to market rates as provided by the assessee during the course of assessment proceedings, and on the contrary compared the cost of production of the assessee itself with the cost of production of job work, which could never be made a base as per the explicit provisions of law.
11. The learned CIT(A) considering the submissions of he assessee deleted the entire addition. His findings are reproduced as under:
"I have considered the submissions and have gone through the details. It is seen that during the year under consideration the appellant has produced grey cloth by own manufacture and by getting it manufactured through the job workers, who are the sister concerns of the appellant. A perusal of details also shows that the appellant firm owns only power looms utilized for weaving of grey cloth and no other machines for various other processes, like twisting, warping or winding of the yearn. However, the job charges have been paid o the sister concerns for two activities, that is twisting, warping and winding of the yarn and thereafter weaving the yarn into grey cloth. I failed o understand as to how the AO has arrived at the conclusion that the job charges paid to the sister concerns were excessive when the activities of the job workers and the appellant were totally different. It ITA No.4520 and 4543/Ahd/2007 9 M/s. P. T. Synthetics is also seen that the appellant has filed copies of bills independent job workers, who charged at almost the same rat4e for similar services. This evidence has not been taken into account by the AO Further, section 40A(2) of the IT Act can be invoked only if the conditions precedent for invoking the provisions are satisfied. The AO in the instant case has not taken into account whether the fair market value of services rendered by the job workers was less than that charged by the job workers, who were sister concerns of the appellant. In fact, the AO is apparently influenced by the fact that the payments for the job charges have been made to the sister concern. He would have probably accepted the payments had the same been made to the outside parties. I find that the AO has compared the cost of production of the appellant itself with the cost of production in the course of job workers which cannot be a base since the activities of the two parties are different. The important point to note in case a disallowance u/s. 40A(2) of the IT Act is to be made is whether the payments made to persons specified in that section are excessive compared to the fair market value of services rendered by such persons In the instant case the AO has erred in comparing the cost component of the appellant itself in production of such grey cloth with that of the payments made to the sister concerns because the activities performed by the two entities are totally different and there can never be a comparison between to different activities. The AO has nowhere brought out any fact that the payments made by the appellant to its sister concerns were excessive as compared to amounts charged by outsider job workers for similar activity and therefore the disallowance is not sustainable. It is also important to note that an assessee generally resorts to making excessive payments to their sister concerns to reduce its taxable profits and to lessen the total tax burden. However, in the case of the appellant the payments have been made to the sister concerns, which are regularly assessed to tax and are not incurring losses and therefore since the very basis adopted by the AO for evaluating the reasonability of job charges paid to the sister concern is erroneous, disallowance made under section 40A(2) of the IT Act is not sustainable and is directed to be deleted."
12 The learned DR relied upon the order of the AO and submitted that excessive charges were paid to the sister concerns. The closing stock valuation, if compared with the payment to the sister concerns, it would ITA No.4520 and 4543/Ahd/2007 10 M/s. P. T. Synthetics have effect on the profit of the assessee. The assessee made excessive and unreasonable payment to the sister concerns. Therefore, the AO was justified in disallowing part of he amount.
13. On the other hand, the learned Counsel for the assessee reiterated the submissions made before the authorities below and submitted that exclusive work is done by sister concerns. But the AO went on to compare the cost of production as incurred by the assessee in its own production with that of the cost of production in respect of grey cloths manufactured on job work basis. He has submitted that cost of production of the assessee is compared with the job charges from the assessee which is impermissible u/s 40A (2) of the IT Act. No work is assigned to other parties. The AO has not brought anything on record to explain fair market value. Independent bills were produced to show that the assessee paid reasonable amount to the sister concerns. Since the AO compared cost of production incurred by the assessee, therefore, addition has been rightly deleted by the learned CIT(A).
14. We have considered the rival submissions and the material available on record. Section 40A(2) of the IT Act provides that when the AO is of the opinion that expenditure is excessive or unreasonable having regard to fair market value of the goods, services or facilities in which payment is made for the legitimate needs of the business or profession of the assessee or benefit derived by or accruing to him, therefore, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as deduction. Hon'ble Supreme Court in the case of Upper India Publishing House Pvt. Ltd. Vs CIT 117 ITR 569 held that "before section 40A (2) is applied, AO should have prove expenditure as excessive or unreasonable". The assessee specifically pleaded before the authorities below that the AO compared the cost of production incurred by the assessee on its own manufacturing set up ITA No.4520 and 4543/Ahd/2007 11 M/s. P. T. Synthetics with that of the cost of production on job work basis for making the above disallowance which was improper. Thus, the comparison of cost of production on job work basis with the cost of production on own set up was totally unjustified. The learned CIT(A), therefore, rightly noted that he failed to understand as to how the AO has arrived at the conclusion that the job charged paid to the sister concern were excessive when the activities of the job workers and the assessee were totally different. Further evidence in the form of bills of independent job workers were filed to prove that same amounts were charged at almost same rate for similar services. Therefore, the whole basis of making the addition was unjustified and the learned CIT(A) on proper appreciation of the facts and material on record rightly came to the conclusion that the addition is unjustified. The assessee has explained before the authorities below the circumstances in which payments have been made. There is nothing unreasonable in the regard. In any case, even for applying the provisions of section 40A(2) (b) of the IT Act, it is for the AO to make out a case that the expenditure incurred is excessive or unreasonable having regard to fair market value of such services. No effort in this regard has been made by the AO. The AO has not brought out any fact that the payment made by the assessee to its sister concern was excessive as compared to the amount paid to outsider for the similar activities. The learned CIT(A), therefore, has rightly deleted the addition in the matter in issue. We, therefore, do not find any infirmity in the order of the learned CIT(A) in deleting the addition. In the result, ground No.2 of the appeal of the revenue is dismissed.
15. No other point is argued or pressed.
ITA No.4520 and 4543/Ahd/2007 12M/s. P. T. Synthetics
16. In the result, the departmental appeal is dismissed and the appeal of the assessee is allowed.
Order pronounced on 22-10-2010.
Sd/- Sd/-
(D. C. AGRAWAL) (BHAVNESH SAINI)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Date : 22-10-2010
Lakshmikant/-
Copy of the order forwarded to:
1. The Appellant
2. The Respondent
3. The CIT concerned
4. The CIT(A) concerned
5. The DR, ITAT, Ahmedabad
6. Guard File
BY ORDER
Dy. Registrar, ITAT, Ahmedabad