1. The assessee is a public limited company now under liquidation. It carried on business in the manufacture and sale of cotton yarn mostly 20's and 26's. It had 6,000 spindles. For the assessment years 1957-58, 1958-59 and 1959-60, the assessee submitted returns of its income. The income, the turnover, the gross profit returned, percentage of waste in cotton, the out-turn of yarn for the three years as disclosed in these returns and the assessee's books of account are as follows :
Income or lossRs. 54,691 (loss)Rs. 4,054 (income)Rs. 1.31,673 (loss)TurnoverRs. 14,65,318 Rs. 16,66,038Rs. 3,63,475Gross profit
rate 7.6%9.3% loss.Waste on
cotton 23.8%25.1%28.2%Production of20's 5'7oz.4.72oz.3.57oz.yarn per Ib.26's 3-18,,3.12 '3.17 '
2. In the course of assessment proceedings the Income-tax Officer felt that the waste claimed was excessive and that the standard of production was below normal.
3. As the assessee had not maintained any record to show that the weight of cotton issued, quantity consumed, the processed stock, etc., which would enable proper verification of the waste at every stage of the manufacture, it was called upon to explain the excessive wastage and the extent of wastage at various stages of manufacture and at fornightly intervals. Explanation was also called for as regards the shortage in production. The assessee stated that it had only 6,000 spindles which were very old, that there was no sufficient working capital, that the cotton purchased and used was of inferior qualify, that the labour was very much discontented and efficiency was at a low ebb, and that all these factors contributed to a higher wastage. The Income-tax Officer, however, was not convinced with this explanation. He held that there was no evidence to show that the cotton purchased by the assessee was of an inferior quality and that though the machinery was old, that alone would not account for the higher wastage. He, therefore, declined to accept the wastage disclosed in the books and took the normal wastage at 20%. On that basis he worked out the excess wastage and its value as follows :
Assessment year.Lbs. Rs.
1957-5841,833 35,2971958-5959,119. 56,7541959-6022,707 23,388
4. The Income-tax Officer then compared the production of yarn in these years with the standard of production of yarn fixed by the Appellate Tribunal in the assessee's own case for the assessment year 1949-50, which was 4.5 oz. for 20's and 3.75 oz. for 26's and felt that the production figures disclosed in the books of account cannot be accepted. Taking the out-turn fixed for 1949-50, as the basis, he worked out the overall under-production and their value as under, after allowing a margin of 5% for possible shortage in production on account of inefficiency of machinery, etc.
year.Year endingLbs.Value. Rs.
5. The Income-tax Officer, therefore, added the said sums towards overall under-production of yarn. He, however, felt separate addition on account of excess wastage, was not called for.
6. The assessee went on appeal before the Appellate Assistant Commissioner who reduced the additions to Rs. 17,318, Rs. 1,13,826 and Rs. 35,835 for the assessment years 1957-58, 1958-59 and 1959-60, respectively. The assessee, thereafter, appealed to the Tribunal. Before the Tribunal it was contended for the assessee that the Income-tax Officer has not given any specific finding based on any material that there was inflation of wastage or under-statement of yarn production, that he has not specifically rejected the accounts of the assessee, that there is no warrant for making an estimate in the years in question merely on the ground that estimates were made in the previous years and that, in any event, the estimates made by the Income-tax Officer were quite unreal and excessive. The Tribunal, however, confirmed the Appellate Assistant Commissioner's orders in respect of all the three years. The Tribunal having refused to refer the case, the assessee moved this court for a reference under Section 66(2) of the Indian Income-tax Act, 1922, and this court directed the Tribunal to refer the following questions to this court:
'(1) Whether without rejecting the accounts specifically or without applying the proviso to Section 13 of the Act, it was open to the Income-tax Officer to estimate the income of the assessee while purporting to pass an order under Section 23(3) of the Act ?
(2) Whether there is any material on record for the estimated additions of Rs. 17,318 (for the year 1957-58), Rs. 1,13,826 (for the year 1958-59), Rs. 35,835 (for the year 1959-60), and for not accepting the loss at Rs. 54,691 (for 1957-58), Rs. 4,057 for (1958-59), and Rs. l,31,673,(for 1959-60), or for making any additions whatsoever ?'
7. Mr. Vedantam Srinivasan, learned counsel for the assessee, contends that without specifically rejecting the accounts of the assessee or without applying the proviso to Section 13 of the Indian Income-tax Act, 1922, it was not open to the Income-tax Officer to estimate that income of the assessee while purporting to pass an order under Section 23(3) of the Act.
8. It is urged that the Income-tax Officer in this case has not found the assessee's books of accounts to be defective, that he had not invoked specifically the proviso to Section 13, that the defects noticed in the assessee's accounts in the prior years cannot be a reason for holding that the assessee's account books cannot be accepted in the assessment years in question, that there has been a charge of management since then and proper account books have been maintained and scrutinised by the auditors and that, in these circumstances, there was no justification for rejecting the book results. It was also submitted that even if for any reason the proviso to Section 13 could be invoked, there was no justification for ignoring the various adverse factors pointed out by the assessee and that sufficient consideration had not been given to the age of machinery, lack of finance, inefficiency of labour and the inability of the assessee to purchase good quality of cotton, etc.
9. Let us first consider the submission relating to the jurisdiction of the Income-tax Officer to make an assessment under Section 23(3) ignoring the accounts of the assessee. The submission is that the assessee's books of account should normally be accepted except in cases covered by the proviso to Section 13 and that even in proceedings under Section 23(3), the Income-tax Officer cannot make an assessment ignoring the book results, unless he gives a specific finding that the account books are not reliable and invokes the proviso to Section 13. It is, therefore, necessary to consider the relative scope of the proviso to Section 13 and Section 23. Section 13 runs as follows:
'Income, profits and gains shall be computed for, the purpose of Sections 10 and 12, in accordance with the method of accounting regularly employed by the assessee :
Provided that, if no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax Officer may determine.'
10. Section 23(1) states that if the Income-tax Officer is satisfied that the return submitted by the assessee under Section 22 is correct and complete he shall assess his total income and determine the sum payable by him on the basis of that return. Section 23(2) says that if the Income-tax Officer is not. so satisfied, he shall serve a notice requiring the assessee to produce evidence in support of that return. Sub-section (3) which is material for this case is as follows :
'On the day specified in the notice issued under Sub-section (2), or as soon afterwards as may be, the Income-tax Officer, after hearing such evidence as such person may produce and such other evidence as the Income-tax Officer may require, on specified points, shall, by an order in writing, assess the total income of the assessee, and determine the sum payable by him on the basis of such assessment.'
11. This sub-section directs the Income-tax Officer to hear such evidence as may be produced by the assessee and then assess his total income but it does not in terms make the rejection of the accounts a condition precedent before making an assessment not based on the return. It does not also refer to the proviso to Section 13. It is only Section 23(1) that contemplates an assessment being made entirely based on the return which in turn is based on book results. Where the Income-tax Officer is not satisfied that the return made under Section 22 is correct and complete, he is expected to consider under Sub-section (3) the evidence produced by the assessee in support of the return and pass an order of assessment. Subsection (3) contemplates both rejection of the evidence produced in support of the return or acceptance of the same by the Income-tax Officer. If he accepts the evidence he will make the assessment on the basis of the book results. If he does not accept the evidence and proceeds to make an assessment he is deemed to have rejected the accounts and the book results which formed the basis of the return. The rejection of the accounts either in whole or in part can be inferred from the nature of the assessment order passed by the Income-tax Officer. If the books and the book results had been accepted as correct by the Income-tax Officer, he would base his assessment on the book results. We cannot, therefore, accept the contention of the assessee that there should be a specific rejection by the Income-tax Officer of the book results before he proceeds to make additions to the income under Section 23(3), for rejection of the accounts either wholly or partly can be inferred from the fact that the assessment is not based entirely on the return and the book results.
12. The next contention of the assessee is that the power of the Income-tax Officer to assess under Section 23(3) should be delimited with reference to Section 13, that the Income-tax Officer should normally make an assessment in accordance with the books of accounts of the assessee except in cases governed by the proviso to that section, and that he cannot reject the return and the book results and estimate the income without invoking the proviso to Section 13, while making an assessment under Section 23(3). Reliance is placed on the following cases :
13. In R.B. Bansilal Abirchand Spinning and Weaving Mills v. Commissioner of Income-tax, : 75ITR260(Bom) an addition of Rs. 1,00,000 had been made to the income returned by the assessee, a textile mill, by the Income-tax Officer on the ground that the excessive dead loss of cotton indicated suppression of production figures. That addition was restricted to Rs. 50,000 by the Tribunal. Even this addition was challenged by the assessee before the High Court on the ground that the proviso to Section 13 cannot be invoked as there was no specific finding by the Income-tax Officer that the account books are not acceptable. The revenue contended that the estimated addition has not been made under the proviso to Section 13, that in fact the proviso has not been called in aid and the addition was made only under Section 23(3). The court, however, held that the revenue has invoked only the proviso to Section 13 of the Act for making the estimate and the condition precedent for invoking the proviso, i.e., a finding recorded by the Income-tax Officer as to the unacceptability of the method and irregularity of the accounts kept not having been satisfied, the estimated addition could not be sustained. Admittedly, in that case there was no such finding recorded by the authorities. They had proceeded on the basis that the matter will not fall under the proviso to Section 15. It cannot be disputed that the proviso to Section 13 can be invoked only if a finding is recorded as to the unacceptability of the method and irregularity of the accounts kept. In our view this case can be considered to be an authority only for the proposition that before invoking, the proviso to Section 13, the Income-tax Officer must give a specific finding that the method of accounting adopted by the assessee is not acceptable and the account books are not reliable and that in the absence of such a finding the proviso cannot be invoked. But it is not an authority for the proposition that the Income-tax Office cannot make assessment on an estimated basis without invoking the proviso to Section 13. As a matter of fact, in that case the revenue contended that it has not invoked the proviso to Section 13 but the court rejected the contention and proceeded to hold that the assessment in that case should have been made under the proviso to Section 13 and that there was no justification for invoking the proviso without giving a finding as to the unacceptability of the method of accounting and the irregularity of the accounts kept. But, the question in this case is whether the revenue can make assessment on an estimated basis under Section 23(3) without reference to the proviso to Section 13 as alleged by the revenue. In S. N. Namasivayam Chettiar v. Commissioner of Income-tax, : 38ITR579(SC) . 1-96-53, the assessee, a dealer in grain, fodder, gram and other foodstuffs, did not maintain a stock register. Therefore, the Income-tax Officer proceeded to make an addition to the book turnover, applying the proviso to Section 13. It was contended that the non-production o the stock account was not such a defect as to entitle the income-tax authorities to reject the assessee's books and to apply the proviso to Section 13. The Supreme Court expressed the view that the keeping of a stock register was of great importance because that was the means of verifying the assessee's accounts by having a 'quantita- tive tally', that if after taking into account all the materials including. the want of a stock register, it was found that from the method of accounting the correct profits of the business were not deducible, the operation of the proviso to Section 13 would be attracted, that the Income-tax Officer, even if he accepted the assessee's method of accounting, was not bound by the figure of profits shown in the accounts and that if he was of the opinion that the correct profits cannot be deduced in the absence of a stock register coupled with other books of account he would be justified in applying the proviso to Section 13.
14. In our view it is not possible to accept the contention of the learned counsel for the assessee that unless the Income-tax Officer invokes the power under the proviso to Section 13 and rejects the assessee's books of account, it is not open to him to ignore the book results while passing an order under Section 23(3) and that an estimate of the income could be made only under the proviso to Section 13 and not under Section 23(3). Section 13 deals with the method of accounting and states that normally the income, profits and gains shall be computed in -accordance with the method of accounting regularly employed by the assessee and the proviso says that if no method of accounting has been regularly employed or if the method employed is such that, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced therefrom, he may compute the income upon such basis and in such manner as he thinks fit. Section 13 does not deal with the books of account of the assessee. It may be that even in cases where the assessee employs a regular method of accounting from which the income could properly be deduced, the Income-tax Officer may not accept the books of accounts as truly representing the assessee's affairs and in such cases he has to make an estimate after rejecting the accounts of the assessee. Similarly, there may be cases in which the assessee had not regularly employed a method of accounting, or the method of accounting adopted by him did not enable the Income-tax Officer to compute the income, but the Income-tax Officer accepts the book results and makes an assessment on that basis without making an estimate. The method of accounting, therefore, does not seem to be relevant on the question as to whether the book results are to be accepted or whether they are to be ignored and an estimate is to be made in a particular case. Whatever be the method of accounting employed by an assessee, if the Income-tax Officer finds that his accounts are incorrect and incomplete, he may reject such accounts and make an assessment under Section 23(3) or make a best judgment assessment under Section 23(4). The impropriety of the method of accounting should, therefore, be distinguished from the falsity and unreliability of the books of account. While a method of accounting may be rejected under the provisoto Section 13, the account books can be rejected in exercise of the power under Section 23(3), for the power to reject the accounts is inherent in the power to call for evidence in support of the return and investigate the same. As pointed out in Seth Gurmukh Singh v. Commissioner of Income-tax, :
'The power to reject the books produced by the assessee in support of his return is implied in the Income-tax Officer's power to enquire into the total income of the assessee and does not need to be specifically conferred......When an assessee produces his books of account in supportof his return, he produces them in an investigation under Sub-section (3) of Section 23, just as he may produce any other kind of evidence that he wishes, and the sub-section does not say how the Income-tax Officer should deal with the evidence. Now, entries in books of accounts may be quite true as to the transactions purporting to be recorded therein or they may be wholly false, fictitious and 'cooked up' for the purpose of assessment to income-tax. If the books are false, the Income-tax Officer may reject them as he may reject any other false evidence, oral or documentary, produced by the assessee. What consequences follow from the rejection of such books is not stated in the section just as it is not stated what result may follow from the rejection of other oral or documentary evidence produced by the assessee. Section 16 is not relevant to a case where evidence, be it books of account or other evidence, documentary or oral, is rejected by the Income-tax Officer on the ground that it is false.
15. It is only in cases where the books of account are true but that they have been kept in such a manner that it is not possible to deduce therefrom the true income, profits and gains of the assessee, Section 13 comes into play. It is quite clear, therefore, that the section can operate only in cases where the books of account are accepted as correct in regard to the transactions recorded therein and that when the books of account are held to be false and incorrect they cannot at all form the basis for computing the true income under Section 13. This is the opinion expressed by Sir Lionel Leach C.J., speking for the Full Bench, in Gunda Subbayya v. Commissioner of Income-tax, : 7ITR21(Mad) ,. The relevant observations are these :
'It seems to me that all the section really says is that, if the method of accounting employed by the assessee is a method which does not properly disclose the income, profits and gains of the assessee, the Income-tax Officer can adopt his own method. But in doing so he must have reference to the accounts before him as Section 13 does not contemplate the rejection of the accounts. Section 13 adds nothing to and takes nothing away from Section 23(3).'
16. This view was again reaffirmed in PR. AL. M. Muthukaruppan Chettiar v. Commissioner of Income-tax, : 7ITR76(Mad) wherein it was held that Section 13 relates merely to the method of accounting and that under that section though the Income-tax Officer may adopt any method for arriving at the true income where the assessee has no regular or proper method of accounting, he cannot reject the assessee's books merely on the ground that the method of accounting does not appeal to the Income-tax Officer. In Seth Gurmukh Singh v. Commissioner of Income-tax, a Full Bench of five judges considered this question but the majority view was against the opinion expressed by the Full Bench of this court in Gunda Subbayya v. Commissioner of Income-tax, : 7ITR21(Mad) ., while the minority agreed with the same. According to the majority the Income-tax Officer can have recourse to the proviso to Section 13 even in those cases where he rejects the accounts on the ground that they are not genuine and they fail to represent truly his income, profits and gains. The majority, however, did not say that the Income-tax Officer while acting under Section 23(3) cannot reject the books of account and make an assessment without invoking the proviso to Section 13.
17. On a proper interpretation of Section 13 and Section 23 the correctlegal position appears to be this. If the account books are unreliable, false,incorrect or incomplete, the Income-tax Officer has the power to reject suchaccount books, but that power is traceable to Section 23(3) and not to theproviso to Section 13. To make this position clear the legislature has nowspecifically provided such power in Section 145(2) apart from the provisoto Section 145(1) which corresponds to the proviso to Section 13, After theenactment of Section 145 of the new Act if the accounts are found to be incorrect and incomplete the case would fall under Sub-section (2) of Section 145 and not under the proviso to Sub-section (1) of that section. Theremay be cases where the method of accounting regularly employed wasacceptable to the Income-tax Officer as the proper method, but the entries inthe books of account may be found to be false or fabricated. In such a casethe Income-tax Officer has to reject the books of account under Sub-section (2) and to estimate the income under Section 143(3) or Section 144 without calling in aid the proviso to Section 145(1). Conversely the account booksmay be accepted as true but the method of accounting may be rejected bythe Income-tax Officer as improper. In such a case the proviso to Section 145(1) will have to operate. This shows that the legislature has keptin mind the distinction between impropriety of the method of accountingand the falsity of the account books, and that proviso to Section 13 dealswith only impropriety of the method of accounting leaving the falsity ofaccount books to be dealt with under Section 23(3). The view taken insome of the decisions that the Income-tax Officer has to act only under theproviso to Section 13 to reject the account books as being false or incomplete, in our view, ignores the above distinction. As already stated, Section 23(3) gives the power to the Income-tax Officer to collect and act on such evidence as considered necessary, and this power naturally implies the power to reject the evidence including the books of account and, therefore, it is not necessary for the Income-tax Officer to invoke the proviso to Section 13 for that purpose. The proviso to Section 13 relates to the method of accounting alone and not to the acceptance or rejection of the books of account. It is true that Section 13 cannot altogther be divorced from Section 23(3) for it is only in an enquiry under Section 23(3), Section 13 can operate. The proviso to Section 13 has to be resorted to by the Income-tax Officer when the account books are rejected as to their method of accounting but accepted as to their facts. Thus there is no conflict between Section 23(3) and Section 13, and in proper cases they operate together.
18. According to the learned counsel for the assessee there is no specific finding given by the Income-tax Officer rejecting the accounts and that, therefore, it was not open to the Income-tax Officer to estimate the income even in exercise of the power under Section 23(3). From a perusal of the order of the Income-tax Officer it can easily be inferred that he actually rejected the entries in the assessee's books of account as not representing the correct state of affairs and proceeded to estimate the income on the basis of its past performance. Though there is no express finding that the books of account are not reliable, such a finding can be inferred from the assessment order itself. It is true, if the proviso to Section 13 is invoked, a specific finding about the impropriety of the method of accounting or the unreliability of the books of account is necessary, But, according to the revenue the proviso to Section 13 has not been invoked and only the power under Section 23(3) has been exercised in this case. As we have already held that the Income-tax Officer need not resort to the proviso to Section 13 for rejecting the books of account as unreliable, it does not appear to be necessary that the Income-tax Officer should specifically give a finding that the account books are not reliable. If such a finding could be inferred from the facts set out in the assessment order, the estimate made in this case under Section 23(3) could be sustained. We have to, therefore, answer the first question in the affirmative and against the assessee.
19. Then we come to the second question. It is to be seen whether the material on record is sufficient to sustain the rejection of the book results as also the estimated additions. It should be noted that the assessee's books of account have been rejected right from the year 1949-50 up to the years in question and assessments have been made only on the basis of estimate. As already stated, during the years in question there was excessive wastage in cotton and shortfall in the production of certain counts of yarn when compared to the earlier years. The assessee's explanation for such excessive wastage has not been accepted. The correctness of the quantity of waste recorded in the books could not be verified in the absence of certain particulars which the assessee failed to furnish. Further, it was found that the waste sold by the assessee was of better quality which could have been reused. The assessee's explanation as regards the under-production of yarn was that the production in the earlier years could not be taken as the basis, that sufficient weightage has to be given to the age of the machinery, inferior quality of cotton, paucity of working capital, inefficient labour and financial pressures from various sources, etc. But each one of the grounds pleaded by the assessee was considered by the Income-tax Officer and he held that the books of account did not disclose that the cotton purchased was of inferior quality and that the low out-turn was due to inefficiency of labour, etc. He also felt that the financial difficulties of the assessee during the year, even if true, will not lead to the low outturn of yarn. The above factors have been taken into consideration also by the Appellate Assistant Commissioner who actually reduced the estimated production to a considerable extent based on the age of machinery. The Tribunal found that the assessee has not proved the excessive wastage claim and that there is no reasonable explanation for such an overall fall in the production of yarn. The assessee's learned counsel contends that all the above circumstances will not constitute a sufficient reason for rejecting the assessee's books of account and for making an estimate. He refers to the following decisions in support of his contentions. In Arumugaswami Nadar v. Commissioner of Income-tax, : 42ITR237(Mad) , certain additions came to be made to the income returned by the assessee, a match manufacturing concern, based on the consumption of chlorate for the manufacture of matches. That was challenged before the Tribunal. The Tribunal sustained the addition on the ground that the assessee has to failed maintain a daily mixture account in the absence of which correlation of the issues of chemicals for the production could not be established. On a reference to this court, it was held that the maintenance of a daily mixture account could not possibly help in the correlation of the issues of chlorate with the manufacture of matches, that the absence of daily mixture account, the maintenance of which was not at any earlier time insisted upon by the revenue, did not lead to the conclusion that the book results of the assessee were not reliable, that the accounts maintained by the assessee cannot be said to be incapable of reflecting the assessee's true income and that there was no scope for invoking the proviso to Section 13. This decision is also relied on in support of the assessee's proposition that any addition to the book turnover can be made only by invoking the proviso to Section 13 and not otherwise.
However, we do not understand that decision as laying down such a proposition. As a matter of fact we find that the assessing authority in that case proceeded to make the addition by invoking the proviso to Section 13 and this court held that there is no jurisdiction for invoking the said proviso. The learned judges in that case have not gone into the question as to whether the addition to the book turnover can be made under Section 23(3). Harakchand Radhakisan v. Commissioner of Income-tax, [1962| 46 I.T.R. 196 was a case where the assessee, a manufacturer of oil, submitted a return showing the quantity of seeds crushed and the quantity of oil and cakes obtained. The Income-tax Officer did not reject the accounts of the assessee, but on the basis of the previous year's assessment presumed that the rate of yield must be much higher, and estimated the yield of oil and oil cake. That estimate was challenged. The court held that, in the absence of any material to show that the book results are not acceptable, the estimate based purely on the basis of the yield in the previous year cannot be sustained. In S. Veeriah Reddiar v. Commissioner of Income-tax, : 38ITR152(Ker) (Ker.) the revenue invoked the proviso to Section 13 and made an addition to the income of the assessee on the ground that the assessee had showed low profits and had no maintained a variety-wise stock register. The court held that it is not a sufficient reason for rejecting the assessee's accounts under the proviso to Section 13. The above decisions have laid down the principle that the revenue authorities cannot reject the book results on bare suspicion and there should be concrete material to show that the book results are unreliable. Further, the said decisions dealt with the scope of the proviso to Section 13 and not of Section 23(3).
20. In the decision of the Supreme Court in Dhakeswari Cotton Mills Ltd. v. Commissioner of Income-tax,  26 I.T.R. 775 the scope of Section 23(3) has been dealt with. According to their Lordships in making an assessment under Section 23(3) 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 he is not entitled to make an assessment without reference to any evidence or material at all and there must be something more than bare suspicion to support the assessment under Section 23(3). We are not inclined to say that the authorities have proceeded in this case by mere suspicion. When considerable disparity is found in the wastage claimed and in the standard of production of yarn, the assessee has to explain the same. If he fails to explain, the authorities are justified in rejecting the book results and in estimating the yarn produced on the basis of prior years' performance. We, therefore, in the circumstances, feel that there is material on record to sustain the estimated additions. The second question is also answered in the affirmative and against the assessee. The revenue will have its costs from the assessee. Counsel's fee Rs. 250.