JAGANMOHAN REDDY, J. - This is a reference consequent upon the directions of this court to the Income-tax Tribunal to refer a case on the following question of law under section 66(2) of the Indian Income-tax Act, 1922 :
'Whether, on the facts and circumstances of the case, there was any basis or material for the department to compute the income at Rs. 60,000 ?'
The assessee is an unregistered firm doing the business of rice milling. The assessment is in respect of the year 1956-57 for which the accounting year is the previous year ending on November 20, 1955. On a return being filed under section 22(2) of the Act declaring a net profit of Rs. 26,034, the Income-tax Officer found the turnover to fall short of the turnover which he expected in the business, because according to the gross profit of Rs. 84,999 returned by the assessee, it would be only 4.5% on the turnover. This was considered to be low compared to other rice millers whose gross profits ranged from 8% to 12%; the outturn of rice from the milling of paddy admitted by the assessee was only 66.7%, while the other millers had accounted for an outturn of about 71%; that the vouchers produced in support of the purchase price paid for paddy were not made out in the regular course of the carrying on of the business but had been fabricated with a view to manipulate the purchase rates; and that although the assessee was dealing in different varieties of rice, no stock accountant were maintained separately for each variety. Apart from these defects, the Income-tax Officer also found that two account books, which the income-tax inspector had earlier, pope his visit to the premises, initialed and which the assessee was directed to produce by a notice under section 22(4) of the Act were not produced, and that those account books being important primary books of account would have disclosed a true state of affairs. According to the statement of the case of the Tribunal, the inspector had found three books, viz., (1) a rough case chitta which, however, had been written up only up to February 28, 1955; (2) a credit purchase and sale books which, however, had been written up at all till date. The assessee, when asked to produce the above books, produced only the credit purchase and sale book, but failed to produce the other two books. The Income-tax Officer, thereupon, concluded that the assessee was deliberately withholding important evidence. From the fact that the entries made in the above books are only up to February 28, 1955, and February 13, 1955, even though the books were seen by the inspector on March 3, 1955, the Income-tax Officer inferred that there were certain other primary books and, since they were not being produced, the assessee must be withholding the same purposefully. In view of the assessees failure to comply with the notice under section 22(4) requiring the production of the books the Income-tax Officer completed the assessment to the set of his judgment under section 23(4) of the Act. As against the disclosed turnover of about 8.61 lakhs of rupees, the Income-tax Officer estimated the assessees turnover at Rs. 10,50,000, and, as against the gross profits admitted at 4.5%, he estimated the gross profit at 9%. The gross profit addition calculated as above came to Rs. 55,249 (gross profit as estimated Rs. 94,500 less gross profit as admitted Rs. 39,251). However, the Income-tax Officer made a round sum addition for the said deficiency in the gross profit of Rs. 55,000 only. The Income-tax Officer supported this addition also by pointing out that of this addition a specific addition for the deficit outturn of rice (difference between 66.7% admitted and 71% held reasonable) could itself be made in the amount of Rs. 27,000 meaning thereby that the balance should be taken as towards other suppressed profits.
The assessee went in appeal against this order and the Appellate Assistant Commissioner gave him relief to the extent of Rs. 22,000. So far as the turnover is concerned, he confirmed the estimate of the Income-tax Officer with the observation that that was quite fair and reasonable. He also confirmed the rate of profit at 9% which, the Appellate Assistant Commissioner thought, was in consonance with the number of cases which the Income-tax Officer had quoted where the rate of profit is at 9%. An appeal to the Appellate Tribunal was dismissed with the following remarks :
'The Appellate Assistant Commissioner has, however, reduced the addition so made by the Income-tax Officer at Rs. 55,000 to Rs. 33,500. We think, in the circumstances of the case, the estimate was justified and is fair.'
Mr. K. Ramachandra Rao for the assessee complains :
(1) that the income-tax authorities were not justified in rejecting the account books,
(2) that even after rejecting the account books, the Income-tax Officer ought to have given the assessee a notice under section 23(2) to support the return by other evidence, the failure of which disentitled the Income-tax Officer to make the best judgment assessment,
(3) that even if the books of accounts were rejected, the assessee should have been given an opportunity to rebut the proposed estimate of 9% based on comparable cases,
(4) that at any rate there is no basis for the estimate of turnover at Rs. 10,50,000, and
(5) that neither the Income-tax Officer nor the Appellate Assistant Commissioner was justified in computing the gross profits by certain items of deduction which are not deductible. For all these reasons, he contends that the assessment of Rs. 60,000 is not based on any material on record.
We will first deal with contentions Nos. 1 and 2 of the learned counsel for the assessee. It is not denied that certain account books were inspected by the income-tax inspector earlier and were initialled. Of these, two books were not produced, one of which was a blank ledger and the other a rough chitta. The excuse given was that they were misplaced, because the firm was dissolved. That excuse has been found to be untenable, and the omission to produce the account books as also the spuriousness of the purchase vouchers were considered to justify the rejection of the books of account. The Income-tax Officer further deducted from the gross profit of Rs. 84,999, four items of expenses towards mill machinery, twine, mill lease amount and establishment charges amounting in all to Rs. 45,748. After this deduction from the gross profit returned viz., Rs 84,999, the gross profits were computed to be Rs. 39,251. It is on the basis of this computation that the Income-tax Officer arrived at his conclusion that the assessee had returned only 4.5% of the profit of the turnover, which was, according to him, considerably low. On the aforesaid basis, the account books were rejected. The Income-tax Officer justified the rejection of the books also on the ground that the assessee had not produced the important primary books of account and that he had produced the vouchers which were not genuine. The Income-tax Officer justified the rejection of the books also on the ground that the assessee had not produced the important primary books of account and that he had produced the vouchers which were not genuine. The withholding of this evidence and the production of spurious documents were the basis for the rejection of the books. The rejection of account books based on certain material is, therefore, a question of fact and this court cannot interfere with it. We will, however, consider the arguments relating to the method of computation of gross profits in another connection, but in so far as the rejection of the account books is concerned, the action of the Income-tax Officer cannot be questioned.
Once the account books are rejected, the Income-tax Officer entitled to make the best judgment assessment under section 23(4). But, Mr. Ramachandra Rao contends that, before the could invoke the provisions of this sub-section, the Income-tax Officer must first give him notice under section 23(2), which sub-section is in the following terms :
'23. (2) If the Income-tax Officer is not satisfied without requiring the presence of the person who made the return or the production of evidence that a return made under section 22 is correct and complete, he shall serve on such person a notice requiring him, on a date to be therein specified, either to attend at the Income-tax Officers Office or to produce, or to cause to be there produced any evidence on which such person may rely in support of the return.'
A notice under this provision, according to the learned advocate, is a condition precedent to the exercise of jurisdiction by the Income-tax Officer to make the best judgment assessment. In support of this, he has cited Rajmani Devi v. Commissioner of Income-tax, wherein it was held that a notice under section 23(2) which merely calls upon the assessee to attend the Income-tax Officers office and does not give him the choice of producing or causing to be produced any evidence on which the assessee may rely in support of the return was, therefore, irregular and invalid. In that case, the notice under section 23(2) only required that assessee in present himself, and scored out the words 'of producing or causing to be produced any evidence on which the assessee may rely in support of the return.' In such circumstances the bench held that whether the issue of a valid notice under section 23(2) was a condition precedent or whether it was only imperative in the circumstances of the case, the assessee was denied a valuable right and he was, therefore, prevented by sufficient cause from complying with the notice issued under section 22(4). In the instant case, we have no sufficient material from which to determine the validity or otherwise of the order of the best judgment assessment relying on the contention of the learned advocate for the assessee that no notice was issued under section 23(2). The statement of the case, while it merely mentions that a notice was given under section 22(4), does not say that any notice was given under section 23(2). Neither before the Income-tax Officer, nor before the Appellate Assistant Commissioner, nor yet again before the tribunal was this question urged or agitated. In these circumstances, we cannot accept the contention of the learned advocate that the Income-tax Officer had not jurisdiction to make the best judgment assessment without giving the assessee an opportunity to support the return by other evidence.
With regard to the third and fourth contentions, viz., that there was no basis upon which the income-tax authorities fixed Rs. 10,50,000 as the turnover and that in any case no opportunity was given to the assessee to adduce any material which may have been taken into account by the income-tax authorities in computing the gross profit at 9% on the estimated turnover, there appears to be justification. The Income-tax Officer, after rejecting the books and after narrating the commissions and omissions of the assessee in not producing certain books and in not adducing sufficient evidence, has merely estimated the turnover in these words :
'I shall, considering the circumstances of the case, estimate the assessees turnover at Rs. 10,50,000 and estimate the gross profit at 9%. Doing so, the gross profit comes to Rs. 94,500.'
The Appellate Assistant Commissioner, dealing with the contention of the assessee that the estimate of the turnover was not proper or correct, said :
'...... I find that the appellant had with held the very relevant account book, viz., the rough cash book, which forms the basic record for writing up the other records. The appellants have not produced all the relevant material to check up the correctness of their business transactions. Further, there is unaccounted for yield which forms part of the turnover of the appellant. Keeping in view all the circumstances of the case, I consider that the Income-tax Officer was right in estimating the turnover at Rs. 10,50,000 which is quite fair and reasonable. Coming to the rate of profit adopted by the Income-tax Officer, he has quoted a number of cases where the rate of profit is 9%. Therefore, in the peculiar circumstances of this case, there the full facts were not made known to the Income-tax Officer, he was right in estimating the rate of profit at 9%. Coming the computation of comparable rate of profit, I find that the appellants contention is right. In similar cases in the recomputation, the lease amount paid and the management salaries were debited to the profit and loss account instead of to the trading account. Therefore, adjustment do this extent is necessary in the recomputation of the comparable profit. That means the comparable rate of profit computed by the Income-tax Officer will be increased by Rs. 22,000 in round figures. This will reduce the difference on account of gross profit made by the Income-tax Officer. Thus in effect the reduction in this case works out to Rs. 22,000 in round figure which I allow.'
The Appellate Tribunal, as we have already observed, merely stated thus :
'The assessee, however, withheld important original books and in view of this and both the low yield and the low gross profit, the Income-tax Officer estimated the sales at Rs. 10.50 lakhs and the gross profits thereon at 9%. The Appellate Assistant Commissioner has, however, reduced the addition so made by the Income-tax Officer at Rs. 55,500 to Rs. 33,500. We think, in the circumstances of the case, the estimate was justified and is fair.'
We find that none of these orders really furnish a basis for arriving at Rs. 10,50,000 as the turnover, nor do these orders, which purported to show that the number of cases upon which the Income-tax Officer is supposed to have relied in coming to the conclusion that 9% was a reasonable rate of profit, were ever disclosed to the assessee, nor was the assessee given an opportunity to rebut that the conclusion based on that material is not warranted. Not only this court, but their Lordships of the Supreme Court, have in several cases insisted that the income-tax authorities before making an estimate must state the basis, which basis must be disclosed to the assessee and he be given an opportunity to rebut it. We may cite only a few cases on this point. In Jonnalagadda Yedukondala Rao v. Commissioner of Income-tax, a Bench of this court, to which one of us was a party, held that the rate fixed by the Tribunal as capricious and without any basis and as such its order was not sustainable in law. The facts upon which this expression of opinion was based are that : the assessee, a bus owner, furnished accounts which were rejected and the gross profits were determined by the Income-tax Officer. The Appellate Assistant Commissioner on appeal determined the gross income at a lump sum amount. On further appeal, the Tribunal arrived at the figure of Rs. 1,20,000 computed on the basis of Rs. 5,000 per bus for 24 busses, but did not give the basis on which it fixed the amount. On these facts, it was held that the rate adopted by the tribunal was capricious and its order was not sustainable in law. In Dhakeshwari Cotton Mills Ltd. v. Commissioner of Income-tax their Lordships of the Supreme Court held that, in making an assessment under section 23(3) of the Income-tax Act, the Income-tax Officer is not fettered by technical rules of evidence and pleadings and he is entitled to act on material which may not be accepted as evidence in a court of law, but the Income-tax Officer is not entitled to make a pure guess and make an assessment without reference to any evidence or any material at all. There must be something more than bare suspicion to support the assessment under section 23(3). In coming to this conclusion, their Lordships relied on the rule of law stated by the Lahore High Court in the case of Seth Gurmukh Singh v. Commissioner of Income-tax as having been fairly and rightly stated. In the Supreme Court case, Mahajan C.J., at page 782, observed thus :
'In this case we are of the opinion that the Tribunal violated certain fundamental rules of justice in reaching its conclusions. Firstly, it did not disclose to the assessee what information had been supplied to it by the departmental representative. Next, it did not give any opportunity to the company to rebut the material furnished to it by him, and lastly, it declined to take all the material that the assessee wanted to produce in support of its case. The result is that the assessee had had a fair hearing. The estimate of the gross rate of profit on sales, both by the Income-tax Officer and the Tribunal, seems to be based on surmises, suspicions and conjectures. It is somewhat surprising that the Tribunal took from the representative of the department a statement of gross profit rates of other cotton mills without showing that statement to the assessee and without giving him an opportunity to show that that statement had no relevance whatsoever to the case of the mill in question.'
In the circumstances, their Lordships observed :
'We think that the both the Income-tax Officer and the Tribunal in estimating the gross profit rate on sales did not act on any material but acted on pure guess and suspicion.'
It is not necessary to cite any further cases as the position admits of no doubt. In this case, while both the Appellate Assistant Commissioner as well as the Tribunal stated that, in arriving at the percentage of gross profits, the Income-tax Officer took into consideration similar cases, there is nothing to show that the assessee was given an opportunity to rebut that evidence. What these similar cases are whose percentage of gross profits, viz., of the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal, is that the turnover of Rs. 10,50,000 is fair and reasonable and that the Income-tax Officer was right in estimating the rate of profits at 9% based on similar cases. It is not shown why the turnover was fixed at Rs. 10,50,000 and not anything less or more. In every case the rate of 9% would certainly depend upon the computation of the turnover. If the turnover is Rs. 10,00,000, the gross profits would be Rs. 90,000 and if the turnover is Rs. 9,50,000, accordingly, the gross profits would be reduced. If it is more than Rs. 10,00,000, naturally the gross profits would equally swell. It would, therefore, appear that the estimate of the gross profits and the fixations of the percentage of profits in this business are two important elements which effect the assessment and, if these are fixed to the detriment of the assessee, he is entitled to know the basis and to be given an opportunity to rebut the same, both of which have not been done in this case. Consequently, the orders of the income-tax authorities can be said to be capricious and without any validity.
We will now deal with the fifth contention, viz., that the method of computation of the gross profits by the Income-tax Officer as well as by the Appellate Assistant Commissioner was not in accordance with the accepted methods of accounting. It may be noticed that a sum of Rs. 45,748 was deducted on account of four items. Of these, one of the items, viz., Rs. 19,463, was on account of the lease of the mill. The other figures have not been given. But, we must assume that the aggregate sum of Rs. 45,748 consists of four items, viz., mill samans, twine, mill contract and the factory salaries. The question raised before us is whether the Income-tax Officer as well as the Appellate Assistant Commissioner were justified in deducting this amount from the gross profits returned by the assessee and thereby holding that the profits as returned by the assessee on the turnover were 45%, which, compared with other mills, was very low. The assessees contention is that the profits returned by him without this deduction comes to 9%, which is what the Income-tax Officer has accepted as reasonable on the gross turnover.
The profit and loss account of a trading concern is usually divided into two sections. The first section is termed the trading account which is so framed as to show the gross profit. The gross profit as shown by the trading account is transferred to the second section which is the profit and loss account proper. Batliboi in his Advanced Accounting (20th edition), at page 50, defines gross profit as the difference between the cost of the goods that have been sold and the proceeds of their sale, without any deduction in respect of the expenses of distribution and general establishment charges. In the trading account, therefore, it is necessary to include all items of charges directly affecting the cost of the goods sold. By the ascertainment of gross profit, the proprietor is enabled to see what percentage of profit he has earned on the buying and selling of goods. A careful comparison of such percentage and also of the different items of the trading accounts, with those of previous periods, will disclose the weak and strong points of his business, and, at the same time, give him a fund of valuable information that will really guide him as to the facing of his future selling rices and also afford him a cheek to a certain extent upon the cost of materials and labour. Batliboi further sets out the following items which usually appear on the debit and credit ides of the trading account :
'On the debit side :
1. Stock on hand at the commencement of the period.
2. Total purchases made during the period, less returns outwards.
3. Direct charges, i.e., such expenses as add directly to the cost of the goods purchased, such as freight, duty, clearing charges, dock does, carriage inwards and cartage.
On the credit side :
1. Total sales made during the period, less the value of returns inwards.
2. Stock on hand at the end of period.'
The excess of the credit total over the debit is called the gross profit, i.e., the excess realised on the sales over the purchase price of the goods sold, and is transferred to the profit and loss account. These principles appear to exclude from the computation of gross profit any items which do not affect the cost of the goods sold. It is, perhaps, for this reason that the Appellate Assistant Commissioner deleted certain items from the items which the Income-tax Officer computed for deduction from the gross profit, such as the lease amount and certain establishment charges as claimed by the assessee. Mr. Ramachandra Rao states that the other items also should have been excluded. But it appears from the order of the Appellate Assistant Commissioner that the items which the assessee claimed have been allowed. The learned advocate for the department contends that the assessee did not take any objection before the Appellate Tribunal that the other items ought to have also been deleted from the gross profit. But Mr. Ramachandra Rao contends that his grounds of appeal covered this aspect of the matter also, and that the amounts in respect of the items which have been deleted from the gross profit returned by him are also shown in the profit and loss account, from which they have been computed. It is also contended that the computation of the gross profit must be in accordance with law and on the material on record. It is not permissible for the income-tax authorities to allow a part and disallow the rest, if, in law, he is entitled not to take any of these items into consideration in arriving at the gross profits. We think that, on the principles of accountancy as stated by Batliboi, and it has not been shown to us why the above principle is not correct, we must accept the contention of the learned counsel for the assessee. But, since we are holding that no basis is given for the fixation of the turnover and no material upon which the rate of 9% was arrived at, is furnished to the assessee, this point does not assume importance.
For the aforesaid reasons answer to the reference must be in the negative. This, however, does not preclude the authorities from making fresh assessment. Let the reference be answered with costs of the assessee. Advocates fee, Rs. 250.
Reference answered in the negative.