This appeal has been filed by the revenue against the order of the CIT(A) dated 9-3-2000 for assessment year 1995-96 raising the following grounds of appeal: 1. That the learned CIT(A) has erred in law and facts of the casein deleting an addition of Rs. 1,94,622 on account of trading account under section 145 of the Income Tax Act.
2. That the learned CIT(A) has erred in law and facts of the case in deleting an addition of Rs. 11,05,000 under section 40A(2)(b) of the Income Tax Act, 1961 on account of payment made to sister concerns.
Hence the order of CIT(A) be quashed and that of assessing officer upheld." Before we advert to the aforementioned grounds of appeal, it would be useful to set out a few background facts. The assessee is a firm comprising two partners, namely, Shri Navin Kohli having 90% share and M/s. Navin Projects Pvt. Ltd. (NEPI- for short) having 10% share. The firm is engaged in the business of manufacturing and fabrication of rollers, CI parts, solar equipments, etc.
During the assessment year under reference the assessee has shown sales of Rs. 66,26,000 and gross profit has been shown amounting to Rs. 52,866 yielding the GP rate of 0.79% as against the GP rate of 16.596 shown in the Assessment year 1993-94 and 11.12% for assessment year 1994-95. The turnover of Rs. 66,26,000 shown for the assessment year under reference comprises of the following items :- The design charges of Rs. 8,50,000 credited as above have been received from a sister concern, namely M/s. Telecom Products (P.) Ltd. and if these design charges are excluded from the trading account, the balance gross profit rate would come down to a negative figure. When called upon by the assessing officer to explain the reasons for the steep fall in the gross profit, the assessee submitted vide its letter dated 2-12-1997 as under: "The increase in manufacturing expenses more particularly fabrication expenses of Rs. 1,3 4,665 prior year to Rs. 8,30,865 in relevant previous year are due to change in material of sales/income. The major amount of increase in turnover is due to sales of solar system for Rs. 25.50 lakhs in the relevant previous year. The fabrication of solar system is a much more colour incentive job as compared to other fabrication job undertaken in previous year." The assessee further stated that the orders were received long time back in the year 1994 whereas due to increase in the cost of the input, the profit margin has come down. The assessee further stated that the cost of steel vis-a-vis the cost of fabrication has also increased which has resulted in the decline in the profit margin. The assessing officer took note of the fact that the assessee firm has been engaged in the manufacture of solar water heating system prior to the assessment year 1991-92 and such product manufactured during the year is, therefore, not a new addition. The assessing officer has further reproduced in the assessment order the comparative figures of sales and fabrication expenses for the preceding as well as succeeding assessment year as under:- On the basis of the aforesaid chart, the assessing officer noted the percentage of fabrication expenses to the total sales has shown steep increase to 12.54% as against similar percentage for the preceding assessment car, Le., assessment year 1994-95 being 4.7% and for the immediately succeeding assessment year, i.e., assessment year 1996-97 being only 1.03%. The assessing officer further looked into the details of fabrication expenses and observed that in the last quarter of the accounting year, i.e., January, February and March, 1995, disproportionately high fabrication expenses have been debited in the books as under: In the case of M/s. RK Enterprises, CDPD Fabricators, 92 to 95% payments have been made in cash. In the case of Himco Structural, against the expenses claimed at Rs. 2,37,500, only payment of Rs. 4,750 has been made and the balance amount of Rs. 2,32,750 has been shown as outstanding in the books as on 31-3-1995.
With a view to scrutinizing the genuineness of the fabrication expenses, the assessing officer called upon the assessee to produce evidence regarding the material supplied to the abovementioned fabricators as well as receipt of fabricated goods along with the challans, gate pass, stock register records, manufacturing records, etc. However, the assessee stated that no goods were dispatched to the abovementioned fabricators and the labour of these fabricators came to the business premises of the assessee for doing the fabrication job for the assessee.
The assessing officer issued summons under section 131 to the above three fabricators, but the same could not be served. The Inspector reported that the fabricators M/s. R.K. Enterprises were not available at the address given by the assessee at F-99, Harkesh nagar. The Inspector reported that one Shri Nagpal was residing there and has no connection whatsoever with the fabricator RK Enterprises. At 12-Sham Nagar, one Shri Jagjit Singh was found to be residing by the Inspector and this person was not in any manner connected or concerned with CDPI) Fabricators. The inquiries made by the assessing officer as above were duly confronted to the assessee who was asked to produce the fabricators and also to show cause why cash payments booked in the name of above parties may not be disallowed. The assessee replied vide its letter dated 16-3-1998 as under:- "The assessee firm has paid fabrication charges of Rs. 2,32,250 to Himco Structurals, Rs. 98,601 to M/s. C.D. Prasad Fabricators and Rs. 2,24,228 to M/s. R.K. Enterprises. It is clarified that they are petty fabricators who having gained sufficient experience start independently as free lancers. They have team of workers and move from site to site as per availability of work. They are paid cash every month of which major portion is used by them for distribution of wages to their team.
Looking at the nature of services rendered by them, the typical system of their operation with petty wage earners and their frequent migration from site to site, it is imperative to make them payment in cash only.
They are mostly poor illiterate labour from eastern Uttar Pradesh, Bihar and Orissa who migrate to the Urban areas for work and move back for harvesting. Disallowance of expenses paid in cash to such parties is uncalled for and would be against the natural justice and normal business practice." The assessing officer observed that the contention of the assessee that fabricators have been paid cash every month is refuted by the own books of the assessee indicating payment of Rs. 4,750 only to M/s. Himco Structural as against the amount of Rs. 2,37,500 debited to the fabrication account and credited to this party. On the basis of the aforesaid facts, the assessing officer held that the assessee has failed to establish :- (iii) Failed to produce any evidence of the quantum of work done by these fabricators.
(iv) Failed to provide the terms and conditions on which these alleged fabricators have worked.
The assessing officer, therefore, concluded that the expenses of Rs. 5,51,027 booked under the head 'fabrication expenses' were noll genuine and fictitious and are liable to be disallowed.
The assessing officer has further scrutinized the sales turnover of the assessee and noted vide para 5 of the assessment order that the entire sales have been made to M/s. Navin Projects Pvt. Ltd., 235, Okhla Industrial Estate, New Delhi, the company being a partner in the firm with 10% share. As we have already mentioned above the firm comprises two partners M/s. NEPL having 10% share, other partner Shri Navin Kohli having 90% share. Shri Navin Kohli, Partner is also the Director of the above said company. The constitution of the firm, thus, clearly indicates that Shri Navin Kohli is the key person controlling and running the firm. The assessing officer noted that goods allegedly sold by the assessee to NEPL are directly supplied to Century Pulp & Papers under the same GR number of the transporter whereas corresponding sale bill raised by NEPL is for a much higher figure. The comparative figures along with other particulars like bill No. as well as GR No.have been given by the assessing officer at page 5 of the assessment order as under: From the above figures it is evidently clear that the assessee firm has made out aggregate sale bill of Rs. 11,22,445 for sale of goods to the partner who has further shown the goods as sold to Century Pulp and Papers for an amount of Rs. 28,18,544. When called upon to explain the aforesaid suppression of sales the assessee stated vide its letter dated 5-3-1998 as under:- "During the year under assessment an order was placed on the assessee firm for the supply of fabricated steel items. The rates were fixed as per the prevailing market price. Accordingly the assessee firm raised bills as per the order placed on them. Since the firm supplied material for Century Pulp Pipes, the material were dispatched directly to them and documents were exchanged according to sec. 6(2) of the Central Sales Tax Act." The assessing officer, however, rejected the explanation of the assessee as factually incorrect with the following observations: "The billing of the sales were being raised as per Schedule is not correct. As on perusal of the bills raised by, NIPPL clearly show that rates have been applied as per per pcs. e.g. in Bill No. 28,178 pcs. of brockets has been sold for Rs. 86,226 excluding sales tax of Rs. 3,449 by the assessee firm but M/ section NIPPL has raised bill for 178 brockets at 1,30,000 before charging Sales tax of Rs. 3,449. Bill No.38 is in respect of 450 Associates rollers has been billed for Rs. 86,246 by the assessee and Ws. NIPPL has billed the same 450 pcs. for Rs. 2,94,013 as per the bill No. PRO 212, 455 Associated Roller has been billed for Rs. 80,220 vide bill No. 31 of the assessee and Ws.
NIPPI- has booked the sales of same 455 rollers at Rs. 2,51,700." From the aforesaid facts, the assessing officer concluded that the assessee is selling the products to its sister concern M/s. NEPL at an understated price even less than the cost price so as to reduce its tax liability. Placing reliance on the decision of Supreme Court in the case of McDowell & Co. Ltd. v. CTO (1985) 154 ITR 148 the assessing officer concluded that colourable device has been adopted by the assessee to avoid tax liability by understating the sale made to the sister concern.
The assessing officer further noted that apart from the aforesaid sales made to the sister concern, NEPL assessee has sold the solar system to the said sister concern in the month of February, 1995 vide bill No.101/94-95 dated 22-2-1995 for a consideration of Rs. 20.50 lakhs. Cost of production of such a solar system has been furnished by the assessee as Rs. 30.55 lakhs. The assessing officer, therefore, concluded that solar system has been sold at a loss of Rs. 11,05,000 and applying the provisions of section 40A(2) the assessing officer made an addition of Rs. 11,05,000 on this score. The assessing officer rejected the books of account by invoking the provisions of section 145(2) for the various discrepancies enumerated at page 9 of the assessment order as under: "(i) Bogus expenses booked in the trading account under the head fabrication expenses.
(ii) Suppression of sales, no stock register, no manufacturing a/c. day to day production register and incomplete audit report.
Applying GP rate of 13.6% on the sales made to the sister concern excluding the sales of solar system, the assessing officer estimated the income of the assessee at Rs. 9,67,466 and made the following two additions - Both these additions separately made by the assessing officer were assailed by the assessee before the CIT(A). In so far as the first addition of Rs. 9,67,466 is concerned, the CIT(A) held that the expenses claimed in the Profit and Loss account amounting to Rs. 2,06,147 have not been allowed by the assessing officer and further other income which has been separately credited amounting to Rs. 11,525 has not been considered. The CIT(A) accordingly allowed a relief of Rs. 1,94,622 and sustained the balance addition of Rs. 7,72,844. With regard to the addition of Rs. 11,05,000 on account of sale of solar system, the CIT(A), however, deleted the same on the ground that since addition has already been made on the basis of estimation of GP, no separate addition on account of understatement of solar system sales deserves to be made. The CIT(A) further held that provisions of section 40A(2) cannot be applied in the matter considering the reasonableness of the sale consideration received by the assessee from the sister concern. The revenue is aggrieved against the reliefs on both the grounds as above and has come up in appeal before us.
We have heard the learned representatives on both the sides and also gone through the orders of the tax authorities below. In so far as rejection of books of account of the assessee under the provisions of section 145 is concerned, the CIT(A) has clearly upheld the finding of the assessing officer. The defects in the books of account have been elaborately indicated by the assessing officer in the assessment order and the same have been duly noted by the CIT(A) in the appellate order while upholding the addition of Rs. 7,72,844 in the trading account. It appears that no appeal has been filed by the assessee against the impugned order of the CIT(A). Therefore, there is no dispute before us regarding the rejection of accounts of the assessee. The revenue has assailed the order of the CIT(A) firstly on the relief allowed to the extent of Rs. 1,94,622 out of the addition of Rs. 9,67,466. From the facts as discussed herein before, it is clear that the assessing officer has analyzed the total turnover of the assessee amounting to Rs. 66,26,000 which comprise the following 4 items as indicated vide para 2.3 of the appellate order: The assessing officer has stated that the entire sales of Rs. 28.33 lakhs (being S. No. (iii) as above) comprising various items of structural fabrication have been sold to NEPI, at grossly understated price. NEPL which is a partner in the assessee firm has sold the same goods vide the same consignments at a much higher price to M/s. Century Pulps and Papers and in para 5 of the assessment order bill-wise comparative details have been given in the assessment order, extracted hereinbefore which indicate that assessee has made sales of Rs. 11,22,445 to the partner i.e., M/s. NEPI, and the said partner has sold the same goods loaded in the same truck with the same GR Nos. of the transporter for aggregate amount of Rs. 28,18,544. This is a clear case where the assessee by understating the sale price has diverted the profits through its partner M/s. NEPL. The surrounding circumstances of the case, particularly, the fact that sales have been made by the assessee firm at grossly understated price to a partner which is a company and the other partner of the assessee firm is a Director of the said company and that the goods have been directly supplied and dispatched to the ultimate buyer namely M/s. Century Pulps and Papers eloquently bring out the factum of suppression of sale price.
Obviously, a colourable device has been adopted whereby assessee firm sells the goods to (lie partner to NEPL at much lower price and the NEPL in turn supplies the goods to Century Pulp and Papers at much higher price, thus, diverting a major chunk of profits belonging to the assessee firm. The landmark judgment of McDowell & Co. Ltd. v. CTO (1985) 154 ITR 148 (SC) relied upon by the assessing officer clearly applies wherein adoption of colourable devices for diversion of profit has been strongly disapproved by a Full Bench decision of the Hon'ble Supreme Court constituted by 5 judges. In this decision, the Hon'ble Supreme Court has specifically and unequivocally buried deep the Westminster, principles as had been enunciated by the British Courts.
The Supreme Court disapproved its earlier decision in the case of CIT v. A. Raman & Co. (1968) 67 ITR 11 (SC) wherein it was observed that avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. The said dictum, which pertains to alluring logic of tax avoidance is no longer valid after the Mcdowell decision. We feel that the Mcdowell decision clearly applies in the facts of the instant case in as much as there are tell tale features in the entire evidence brought on record indicating a deliberate and conscious effort on the part of the assessee to divert its profits to a partner by understating the sale consideration. In so far as sale of structural fabrication to the sister concern aggregating to Rs. 28.33 lakhs is concerned the assessing officer has estimated the turnover at Rs. 71,13,725 and applied GP rate of 13.696 and worked out the gross profit at Rs. 9,67,466. Obviously the sale of solar system shown by the assessee at Rs. 20.50 have been excluded by the assessing officer while working out the gross profit on sale of structural fabrication. The CIT(A) has upheld the working of the GP. He has, however, held that expenses claimed in the P&L. Account amounting to Rs. 2,06,147 have got to be deducted to arrive at the net profit and further an amount of Rs. 11,05,025 shown as other income which has not been considered by the assessing officer would have to be added for adopting the figure of net income. On this basis the CIT(A) reduced the addition from Rs. 9,67,466 to Rs. 7,72,844 allowing a relief of Rs. 1,94,622. We feel that the finding of the CIT(A) is correct inasmuch as once gross profit on the sale of structural fabrication has been worked out by the Assessing officer, naturally, the expenses relatable to P&L.
Account are liable to be deducted while computing the net income of the assessee. Therefore, relief of Rs. 1,94,622 allowed by the CIT(A) is justified. Ground No. 1 is, therefore, dismissed.
Now, we take up Ground No. 2 against the deletion of the addition of Rs. 11,05,000 relating to sale of solar system. As we have already mentioned, the assessee has sold solar equipment to the sister concern NEPL incurring a loss of Rs. 11,05,000. As we have seen in the case of sale of structural fabrication, even in respect of sale of solar equipment the assessee has adopted the same colourable device of understating the sale consideration with a view to reduce its own profit. The assessing officer has, therefore, disallowed the claim of loss and made the addition of Rs. 11,05,000 on the sale of solar equipment. From the facts as discussed above, it is amply clear that the assessing officer has separately dealt with the sale of structural fabrication as well as solar equipment while analyzing the trading account. In so far as structural fabrication is concerned, the assessing officer has made the addition of Rs. 9,67,466 and the CIT(A) has sustained the addition to the extent of Rs. 7,72,844 which we have upheld. So far as sale of solar equipment is concerned the assessing officer has separately disallowed the loss of Rs. 11,05,000 which is reflected in the trading results as shown by the Assessee. The CIT(A) has, in our opinion, erroneously deleted this addition on the ground that he has already sustained the addition of Rs. 7,72,844 and no further addition of sale of solar equipment is called for. We are unable to endorse the reasoning and finding of the CIT(A) on the issue.
The first addition of Rs. 9,67,466 made by the assessing officer and reduced to Rs. 7,72,844 by the CIT(A) does not take into account sale of solar equipment. In fact, the sale of solar equipment has been separately dealt with by the assessing officer and, therefore, since the facts and circumstances with regard to these sales are also identical with that of sale of steel fabrication discussed above, we feel that the addition of Rs. 11,05,000 made by the assessing officer deserves to be upheld. The admitted facts are that the assessee has shown sale of solar equipment to its sister concern for a consideration which is much less than the cost of production claimed by the assessee itself. Thus, colourable device has been adopted by the assessee by understating the sale consideration in respect of solar equipment also so as to reduce its profits. The addition of Rs. 11,05,000, therefore, is liable to be upheld. Regarding the observations of the CIT(A) that section 40A(2) applies only in respect of incurring of expenditure, we fell that the basic issue to be considered while adjudicating the sustainability of impugned addition of Rs. 11,05,000 is not whether section 40A(2) is applicable or not. The relevant issue to be considered is whether sale of solar system by the assessee to its sister concern, in the facts of the instant case is a part of a colourable device whereby profits have been diverted to the sister concern. Since we have held that the assessee has made a conscious and deliberate attempt to divert its profits by understating the sale consideration in respect of solar equipment, we feel that the impugned addition of Rs. 11,05,000 deleted by the CIT(A) deserves to be sustained. We would accordingly reverse the finding of the CIT(A) on the issue and sustain the addition of Rs. 11,05,000. Ground No. 2 of the revenue is, therefore, allowed.