ORDER
K.R. Dixit, Judicial Member
1. The main ground in the assessee’s appeal raises two questions of some importance viz., whether Section 40A(3) can be applied where an estimate of income has been made and whether the benefit of exceptions to that section in Rule 6DD(j) can be given for payments because they were made in the course of a business outside the books.
2. Briefly, the assessee was carrying on unaccounted business which was detected in the form of certain documents in a raid conducted after the assessee had filed a return. He thereupon revised his earlier return effectively to Rs. 11,28,863. On a perusal of the documents, the Assessing Officer found that the assessee had made the following payments which, according to him, were disallowable under Section 40A(3):
Rs. 43,35,715 … for certain purchases
Rs. 1,60,428 … in respect of expenses which were
also not verifiable and which were
deducted by the assessee in arriving
at his returned income as above.
The Assessing Officer, therefore, disallowed the same along with other amounts which, according to him, were disallowable. Me, accordingly, computed the income from unaccounted business as follows:
Rs. 11,28,863 … Net profit as returned
Rs. 5,696 … Understatement of sales
Rs. 43,35,715 … Purchases for which payments had
been made in cash disallowed
Rs. 1,76,017 … Expenses disallowed for want of
verification including Rs. 1,60,428 as above
Rs. 56,46,291 … TotalIt can thus be seen that the Assessing Officer made the assessment on the basis of both the returned income of the assessee and the above amounts, which, according to him, were disallowable. The assessee had submitted before him that the unaccounted transactions are always in cash and, therefore, the question of applying provisions of Section 40A(3) did not arise and that they were covered by Rule 6DD(j) of the Income-tax Rules and by the Board Circular No. 220, dated 31-5-1977: The Assessing Officer rejected this contention on the ground that Section 40A(3) was mandatory as stated by the Gujarat High Court in the case of Hasanand Pinjomal v. CIT [1978] 112 ITR 134 and that this disallowance was also applicable to illegal business as held by the Andhra Pradesh High Court in the case of S. Venkata Subba Rao v. CIT [1988] 173 ITR 340. Nor was Rule 6DD(j) available to the assessee because in respect of other payments to the same parties, the assessee had made payments by cheques. Regarding the Board Circular, the Assessing Officer stated that it was clarificatory in nature and so it did not help the assessee. Before the Commissioner the same contentions were put forward and it was also urged that since the transactions were unaccounted, the proviso to Section 145(1) had to be invoked which would take the case out of computation of business income so that the question of disallowability under Section 40A(3) would not survive. It was urged that the diary which was found in the raid was not a complete and regular book and so there could only be a best judgment assessment which would take the case out of the purview of Section 40A(3). The Commissioner observed that there was no scope for applying the proviso to Section 145(1) and even if it was applied, separate disallowance could still be made because the officer may be able to pinpoint the specific defects, omissions or non-genuine entries sufficient to make additions in respect of particular items. He repeated the reasoning of the Assessing Officer that Section 40A(3) was mandatory. He also pointed out that according to the facts, submissions of the assessee and the assessment order, the diary found in the search had been fully relied on to ascertain the correct profit in respect of the unrecorded transactions and it was accepted even as per provision under Section 132(4) and no estimate was made out so that there was no scope for any other estimate.
3. Before us, the assessee’s Advocate reiterated the same arguments. He also submitted that in the present circumstances, the Assessing Officer was bound to invoke the proviso to Section 145(1) relying on the decision of the Supreme Court in the case of CIT v. British Paints India Ltd. [1991] 188 ITR 44. In this connection, he pointed out that the observation of the Assessing Officer in para 4 of his order where it has been stated that the assessee used to mix up recorded and unrecorded raw-materials in the process of manufacture and so it was not possible to clarify the stock position discrepancy. In fact, no day-to-day manufacturing and stock position details are maintained. He relied upon the Tribunal’s decision in the case of M. Sreedhara Panicker v. ITO [1979] 7 TTJ (Cochin) 573 in support of the proposition that when an estimate is made, there was no scope for application of Section 40A(3). On the other hand, the learned D.R. submitted that the application of Section 40A(3) was mandatory and that this section was to be applied even if the proviso to Section 145(1) was applied. He also submitted that the alternative claim based on application of Rule 6DD(j) on specific payments made before the Tribunal should not be entertained at this stage because such a claim was not made before the Assessing Officer or the CIT (Appeals). In this connection, he pointed out from para 6 of the Assessing Officer’s order the following:
However, certain exceptions have been enumerated in Rule 6DD of the IT Rules. But the assessee has not made any attempt to establish that its case is covered by the aforesaid Rule. Therefore, in order to ascertain whether mitigating circumstances referred to in the second proviso to Section 40A(3) are applicable to the assessee’s case, Shri Ashwin C. Shah, the learned Counsel of the assessee, was again requested to submit further explanation, if any. In response thereof, a written submission has been made on 29-3-1989.
At the time of hearing, the assessee’s counsel supplied a copy of this written submission and we do not find therein any details attempting to prove the genuineness of the transaction. The learned D.R. also relied upon the decision of the Andhra Pradesh High Court in the case of S. Venkata Subba Rao (supra) relied upon by the Assessing Officer. In rejoinder the assessee’s counsel again relied upon his earlier arguments that there was no scope for applying Section 40A(3) where an estimate of income had been made and also submitted that since the cash transactions were with the very parties with whom transactions by cheque were made, the genuineness of those cash transactions was proved.
4. We will now consider the above contentions. Broadly speaking, there are two submissions, the first is that the Assessing Officer is bound to apply Section 145(1) as laid down by the Supreme Court in the case of British Paints India Ltd. (supra) and that when that section is applied, Section 40A(3) would be inapplicable. The second is that if Section 40A(3) is applied, the assessee’s case would fall under the exceptions as provided therein and Rule 6DD(j) made thereunder.
5. Regarding the first point, it is true that in the case of British Paints India Ltd. (supra), the Supreme Court did say that “it is, therefore, not only the right but the duty of the Assessing Officer to act in exercise of his statutory power, as he has done in the instant case, for determining what, in his opinion, is the correct taxable income” (at page 56). However, that was a case where the assessee’s method of accounting was not such as to enable the Assessing Officer to determine the correct taxable income. Section 145 deals with two situations — (a) where the method of accounting is faulty, and (h) where the accounts are not correct or complete. In the case of the former, the Assessing Officer is empowered to compute the income upon such basis and in such manner as he may determine. So far as the latter is concerned, the Assessing Officer is empowered to make a best judgment assessment as provided in Section 144, that is, after taking into account all relevant materials which he has gathered. Therefore, when the accounts are not correct or complete, it is not as if the Assessing Officer is compelled to ignore internal material which he has gathered and merely depend upon some external material to make an estimate. Further, Section 145(1) is an enabling provision. It is intended to enable the Assessing Officer to make the correct assessment which is the paramount object. This has been clearly stated in the above quotation from the Supreme Court judgment in the case of British Paints India Ltd. (supra), relied upon by the assessee. It is not intended to confer any right or benefit upon an erring assessee. The burden of the Supreme Court judgment is that Section 145 is intended to make the correct assessment in compliance with the law and not to by-pass the statutory provisions. Now regarding the second part of the submission, it is a fair proposition that if an overall estimate of income has been made, there would not be any scope for making any disallowances and applying Section 40A(3). This is not because the statutory provisions can be ignored or excluded but because they must be deemed to have been applied in making the estimate so that there is no scope for any further deductions. Thus, if an estimate is made on the basis of G.P. by using comparative instances, there would be no scope for further deductions applying Section 40A(3). In this connection, the Tribunal’s decision in the case of M. Sreedhara Panicker (supra) relied upon by the assessee may be mentioned. That was a case where best judgment assessment was made and the AAC made further disallowance under Section 40A(3). The Tribunal held that that was not permissible because the income had been computed not on the basis of specific items of expenditure allowed as deduction. The Tribunal observed, “how the assessee made these purchases, whether it was on one day or on various dates and what quantity and for what price, whether by cheque or cash and whether payments exceeded were not at all matters for our consideration. Those are alien to an estimate of reasonable profit. When estimates are made, it is not possible to say that specific items of expenditure exceeding Rs. 2,500 in cash have gone into the computation of those estimates. So that such items can be disallowed under Section 40A(3)”. (at page 578)
6. All depends upon the manner of making the estimate. If it has been made in a way which covers the entire position regarding income and expenditure, naturally there would not be any scope for further deductions. In the present case, however, the assessee revised its return after detection of certain incriminating material. When that data is available, it is as if that is part of the assessee’s regular books before the assessinent. The assessee has taken all that data into account and filed the return as shown from the following passage of the Assessing Officer’s order:
The total sales in the above documents have been worked out at Rs. 53,95,189 inclusive of sale of oil empty tins, Acid oil and Bardana, etc. The assessee has effected purchases also from these documents which are as under:
Cotton seed oil .. Rs. 2,34,380
Cotton seed oil .. Rs. 30,74,405
Rapeseed oil .. Rs. 2,37,906
Cotton seed oil .. Rs. 80,000
Empty tins .. Rs. 4,44,624
Coal purchases .. Rs. 92,335
Empty tins .. Rs. 1,72,065
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Rs. 43,35,715
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The assessee has disclosed profit from its unaccounted business in the return of income. In reply to question No. 1 in the statement of Shri B.A. Patel, Chairman of the Company, recorded under Section 131 on 21-3-1989, he has clearly stated that ‘there were certain transactions of sale and purchase of oil which were recorded in the diary Annex. D-66/ A-36/M.B. Patel and Annex. A-28/K.V. Patel. The profit derived from such unaccounted business has been disclosed in the disclosure petition and, accordingly, the Income-tax returns for assessment years 1986-87 and 1987-88 have been revised’.
From the above version of the Chairman of the Company, it is clear that the income disclosed in the revised return is represented by the transactions written in the two seized diaries mentioned above. Further in reply to question No. 2, Shri B.A. Patel has stated that —
entries in the diary were summarised. The purchases and the expenses as recorded in the diary were deducted from the sale proceeds and the profit was thus derived.
In reply to question No. 3, the Chairman specifically stated that —
the sale price was received in cash and the purchase price and expenses were paid in cash since the transactions were of unaccounted business.
7. From the reply to question Nos. 2 and 3 reproduced above, it can be seen that the assessee has deducted all the expenses including those which are not allowable under Section 40A(3). The assessee’s own computation resulting in the revised return also shows that the items disallowable under Section 40A(3) have been taken into account and allowed.
8. This leads to the second question whether the assessee’s case falls under the exceptions under Section 40A(3) as provided in the Rule made therein. First of all it was the assessee’s contention that since cash payments were made to those parties to whom cheque payments had also been made, there is no reason to doubt the genuineness of those cash payments and so they should be allowed. To this, the Commissioner has given a reply that if cheque payments could be made in some cases to the same party, there was no reason why cash payments should be made to the same party and, hence, the cash payments would be disallowable. In our view, the Commissioner is right because the assessee has to make out a case that cash payment was necessary, independently of the fact that the payee was the same. We therefore, come to the second important submission of the assessee that the circumstances in this case were such that cheque payments could not be expected and was, therefore, not made. To put it plainly, the contention was that since these payments were made in a business outside the books, the payments had to be made in cash and they could not be expected to be made by cheques. Now here is a situation where a person carries on activity which is outside his regular books and derives income from it and this very fact enables him to claim the exemption under Section 40A(3). In other words, he derives an advantage from his own wrong. Are we to hold that such a result would be permissible under the law or would be within the policy of law? Secondly, if the deduction is permitted in such cases, it would put a person doing irregular business in a better or more advantageous position than a person who does business within the legal requirements. On this question, the revenue has relied upon the decision of the Gujarat High Court in the case of Hasanand Pinjomal (supra) in support of the contention that application of Section 40A(3) is mandatory and more particularly on the decision of the Andhra Pradesh High Court in the case of S. Venkata Subba Rao (supra).
9. Now although the application of this section is mandatory, it is not without exceptions that are found in the rule made under this section. The Andhra Pradesh High Court has dealt with this application in the above case. That was a case of a person dealing in smuggled goods and claimed immunity from application of this section on the ground that since the business was illegal, it was not possible to comply with that section. The High Court rejected the assessee’s contention stating, “may be that in an illegal business, like smuggling, it may not be practicable to comply with the requirements,of Sub-section (3) of Section 40A, but that only means that such illegal business ought not to be carried on. It is a business prohibited by law. By taxing its income, it is not legalised or validated” (at page 344). The High Court held that the assessee must establish the genuineness of the payment and the identity of the payee and unless he does that, he cannot take advantage of Clause (j) of Rule 6DD. For ready reference, the relevant part of the rule is reproduced below:
No disallowance under Sub-section (3) of Section 40A shall be made where any payment in a sum exceeding two thousand five hundred rupees is made otherwise than by a crossed cheque drawn on a bank or by a crossed bank draft in the cases and circumstances specified hereunder, namely: —
(i) in any other case, where the assessee satisfies the ITO that the payment could not be made by a crossed cheque drawn on a bank or by a crossed bank draft —
(1) due to exceptional or unavoidable circumstances, or
(2) because payment, in the manner aforesaid was not. practicable, or would have caused genuine difficulty to the payee, having regard to the nature of the transaction and the necessity for expeditious settlement thereof,
and also furnishes evidence to the satisfaction of the ITO as t o the genuineness of the payment and the identity of the payee.
The above quotation of the High Court judgment refers to the practicable difficulty in complying with Section 40A(3) and the judgment also speaks of the requirements of proving the genuineness of the payment and idenity of the payee. The word “and” in the sentence after Clause (2) connects this requirement with Clause (2). It can, therefore, be seen that the High Court was dealing with the application of Clause (2) only. Clause (1), however, is separate because the word “or” is at its end and the High Court has not applied it. If that clause is applicable, it would not be necessary for the assessee to prove the genuineness of the payment and the identity of the payee because that requirement is not connected with Clause (1). Moreover the Andhra Pradesh High Court was dealing with the case of illegal business, while the present case is of business outside the books, which may or may not be illegal. That would be covered by the expression ‘exceptional circumstances’ in Clause (1) because generally speaking business recorded in the books is within the rule and business outside the books is an exception. While, therefore, it could be the intention of the law makers that illegal business should not be done, if the assessee finds it difficult to supply the proof of payment, it would not have been intended that business outside the books should not be done but that it should be recorded in the books. On the above reasoning, the decision of the Andhra Pradesh High Court is distinguishable. However, even if it is applicable, in the alternative if it is the intention of the law makers the income from that kind of business is to be taxed, then logically speaking, the law makers must be deemed to have taken into account the difficulty in obtaining proof regarding the expenditure. Therefore, while complying with the statutory requirements, we must so interpret the clause that reality of the situation is duly taken into account. Finally, if the State claims a share in any income, it cannot deny to the citizen the expenditure whereby the income is earned – CIT v. S.C. Kothari [1971] 82 ITR 794 (SC). Therefore, we are of the view that, the assessee’s case would be covered by the exceptions provided in Rule 6DD(j).
10 to 18. [These paras are not reproduced here, as they involve minor issues].