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Introduction
Power to carry out search under
section 132 and survey under section 133A are important tools in the
armoury of the Income–tax department for detecting and preventing
tax evasion. Though the need to have such tools cannot be grudged,
the department has to use them sparingly and in deserving cases and
after complying with necessary guidelines and safeguards. A search
is violation of personal privacy and rights of a citizen and its use
should only be in rarest of rare cases.
The subject of assessment in pursuance
of survey and search is very vast.
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Provisions of section 132, 132A
and 133A relating to powers of search and survey,
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Provisions of Chapter XIV B relating
to procedure of block assessment in pursuance of search, which
have been replaced by sections 153A to section 153C by Finance
Act., 2003 and the same have been discussed in a special story
of the review in July 2003.
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Provisions of law relating to
computation of income and rules of evidence laid down by sections
68 to 69C of the Act.
The present
article deals with only the third aspect referred to above.
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Determination of income in pursuance
of survey and search
Survey and search result in gathering of evidence from the assessee.
There is an element of surprise, atleast for the assessee. As such,
in most cases, department is able to collect evidence which otherwise
would not have been available to it. However, such evidences may not
necessarily be complete in all respects and does not contain full
details of transactions. Therefore, determination of income on the
basis of such evidences always presents various possibilities.
Evidence found during survey
and search can be broadly classified into following category of transactions:
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Undisclosed sales/turnover.
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Undisclosed investments
in assets, cash, stock, valuables, etc.
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Shortage of cash and /
or stock,
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Undisclosed expenditure
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Admission/declaration of
income in statement recorded.
The
above is not an exhaustive list but the above are most common areas
of findings in a survey and search proceedings. These have been discussed
considering the relevance to assessees engaged in the construction
business.
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Determination
of income on the basis of evidence found
Rebuttal of the conclusions drawn on the basis of documents /
evidence found during the course of survey / search is a major task,
which has to be accomplished by the assessee with the aid of his advisors.
This is not to suggest to the reader that a bland denial of the evidence
found is possible. In fact if the evidence/ documents directly lead
to an inference of undisclosed of income, there can hardly be a defence.
However, as discussed in the following paragraphs, over zealousness
on the part of the revenue, results in the evidence, being extrapolated
beyond limits and applied to areas to which it does not relate. It
is this action that can be prevented.
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Undisclosed Sales Turnover
In the case of builders and developers, undisclosed turnover would
be by virtue of treatment in the books of actual sales as either advances
or liabilities, or the receipt of what is popularly known as "on money"
not disclosed in the books.
The first step towards quantification
of income in such cases would be to determine the undisclosed turnover.
Depending upon the nature of evidence and facts of the case, following
are some of the issues that arise:
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Whether evidence found
relates to a solitary transaction of the said type or it represents
a modus operandi and therefore the finding can be applied to other
similar transactions of the year as well as of earlier years though
no evidence is found for all such transactions.
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Even if the transaction
represents a modus operandi in as much as finding has to be applied
to other similar transactions, whether concealment in other similar
transaction is to the same extent as in the transaction detected.
Here the year to which the
income relates would become very important in view of the amended
provisions relating to Post search assessments in respect of searches
after 1st June 2003. This is because the block period concept has
now given way to reassessment of six years prior to the search.
The second step would be to
determine undisclosed income earned in such undisclosed turnover.
Issue will arise as to whether whole of such turnover is income or
only net profit from such turnover after deducting probable expenditure
can be treated as income.
In the case of developers and
builders the establishment of expenditure poses a major problem. This
is for the reason that the quantum of expenditure does not conform
to any particular benchmark/standard given the nature of the business
and even otherwise a part of the expenditure may be of a character
that would attract disallowance under the explanation to section 37.
However, reasonable allowance
for unassailable expenditure must be given. If undisclosed receipt
of money from flat owners is found during the course of survey or
search and this is combined with the absence of or gross inadequacy
of expenditure on construction of the flats in the regular books of
accounts, an allowance will have to be made for such expenditure unless
the revenue is able to establish that this expenditure has been incurred
from other sources.
Whether or not evidence as
to undisclosed purchase cost & other expenditure is available,
if the assessee can prove that such expenditure has not been recorded
in regular books of accounts, the same will have to be considered
in computing income earned by making undisclosed sales. The whole
of the sale proceeds cannot be treated as income but only income component
thereof can be subjected to tax. In the case of CIT vs. S. M. Omer
(1992) 201 ITR 608 (Cal), the Assessing Officer treated whole
of the unaccounted sales receipt as income. The Hon’ble Calcutta High
Court held that whole of the unaccounted sales cannot be treated as
income and only net profit can be added to total income. Similar proposition
has been laid down in the case of Ashok Kumar Rastogi vs. CIT (1991)
100 CTR (All) 204.
In case where transaction of
sale is already recorded in books and the case is of suppression of
sales price, it may be possible to contend that though cash premium
has been charged on sale, similar premium was paid on purchase of
material used in construction, which has not been recorded in books
of accounts. Deduction of such premium paid can be made from premium
charged and balance only can be treated as income. The probability
of incuring such expenditure has to be established either by documentary
evidence or if that is not possible by way of circumstantial evidence.
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Effect of Amendment to Section
37 and 69C by Finance (No. 2) Act, 1998.
The amendments to section 37 and 69C by Finance (No. 2) Act,
1998 may substantially affect computation of income in pursuance
of survey and search.
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An explanation has been
inserted in section 37 with retrospective effect from 1-4-1962
to provide that any expenditure incurred by an assessee which
is an offence or which is prohibited by law shall not be allowed
as deduction. The objective of the amendment is stated to be to
overcome the decision of the hon’ble Tribunal which held that
payment of protection money is allowable as deduction.
A proviso is inserted in
section 69C with effect from 1-4-1999 to provide that unexplained
expenditure deemed to be income u/s. 69C shall not be allowable
as deduction under any head of income.
The amendments shall affect
allowability of expense in following circumstances:-
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Payments of bribes,
etc. would not be allowable as expenditure even if incurred
to earn the income, which is detected to have been earned.
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If income is assessed
on the ground that the source of expenditure incurred is not
explained then such expense shall not be allowed as deduction.
Proviso to section 69C may
not apply if unexplained expenditure detected has been incurred out
of undisclosed income detected and only income so detected may be
treated as income.
Builders Cases
In the foregoing paragraphs, I have made an attempt to explain
various provisions which would be relevant to searches, surveys on
builders developers and contractors. Readers may find the article
rather cryptic but the intention has been to avoid the general aspects
of survey and search, about which lot has been written earlier in
various journals including the Income Tax Review. The facts of each
search and survey case are unique and do not normally lend themselves
to generalisation. I must point out as I have done earlier that if
evidence clearly points to undisclosed income it cannot be wished
away. However experience shows that assessee’s do not put on record
all the defences legitimately available to them resulting in difficulties
at the appellate stage
In two recent cases, Hon’ble
Income Tax Appellate Tribunal has dealt with cases of search or survey
in case of builders and the same are summarized hereinafter, to the
extent the same are relevant to the subject under discussion. I trust
readers will find the analysis useful.
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Sharma Associates vs. Asst. Commissioner
of Income Tax [1995] 55 ITD 171 (Pune) (TM)
Background
In this case, the assessee-firm was carrying on business of
promoters and builders since 1984. It followed financial year
as the previous year and the method of accounting followed by
the assessee had not been stated in the assessment orders. For
the assessment year 1989-90 it filed return of income on 23-3-1990
declaring a total income of Rs.13,00,783/- but the Assessing Officer
computed the total income at Rs.16,42,140/- after making certain
additions. For the assessment year 1990-91, the assessee filed
return of income on 31-12-1990 declaring income of Rs.3,69,880,
but the Assessing Officer determined the total income at Rs.25,74,110/-
after making certain additions. These additions were sustained
by the CIT (A).
Issue
The issue was in respect of disallowance in respect of cash
payments in excess of Rs.10,000/- u/s 40A(3) read with rule 6DD(j)
by the assessing officer. The facts relating to the said issue
were that during search proceedings u/s 132, it was seen that
according to the bills for work done by one, M/s. Mehta Constructions
Co., the total amount worked out to Rs.40,51,418/- whereas verification
of the ledgers of the assessee revealed total payment shown at
Rs.26,39,200/-. The assessee admitted to have paid Rs.13.42 lakhs
to M/s. Mehta Construction who also admitted to have received
such payment in course of mutual business transaction. The said
transactions were admitted to be outside books of accounts, which
related to one full accounting year. Assessee declared said sum
as income in its return and simultaneously claimed deduction as
expenditure. The Assessing Officer though not doubted genuineness
of payment disallowed claim u/s 40A(3) because the exceptional
circumstances contained in rule 6DD(j) were not proved by the
assessee. Even the claim of deduction as expenditure was not accepted
by the CIT (A) because at the time of disclosure it was not the
case of the assessee that the amount has been actually expended.
The amount was declared by the assessee only because the assessee
had incurred expenditure outside books without explaining the
source thereof. Accordingly, he confirmed the addition made by
the Assessing Officer.
Before the Hon’ble Tribunal the
assessee contended the following:
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That the payee demanded payment
in cash for making payment to the labour force and but for
the payment in cash it would have caused genuine difficulty
to the payee and hence the assessee paid the amount in cash.
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That the very basis of treating
the amount of Rs.13,42,000/- as income was that it represented
the expenditure actually incurred by the assessee which the
recipient had admitted and also offered it for taxation.
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If the payment was genuine,
there was no reason to invoke section 40A(3).
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The burden was on the department
to show that each payment exceeded Rs.10,000/- and that therefore,
the provisions of section 40A(3) were applicable. In this
case, the department has merely assumed that the individual
payments must have been more than Rs.10,000/- because the
total payments were amounting to Rs.13,42,000/-.
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That the payment was covered
by Explanation provided in Rule 6DD(j) viz. the payment by
cheque or draft was not practicable or it would have been
caused genuine difficulty to the payees.
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If the payment in cash was
made as a commercial requirement rule 6DD(j) was satisfied
and disallowance would not be made.
The learned departmental representative,
on the other hand, pointed out that such cash payment came to
light only during the survey operations conducted under section
133 of the Income-tax Act simultaneously in the business premises
of M/s. Mehta Construction Co. When the Assessing Officer asked
for details of payments of Rs.13,42,000/- the assessee was unable
to furnish such details. He submitted that the burden to show
that individual payment was less than Rs.10,000/- was on the assessee
and since the assessee failed to show these facts the department
should presume that the entire amount was a one-time payment and
thus clearly hit by section 40A(3). He further pointed out that
as the assessee did not show the payments from the books there
was obviously an admission of suppression and the department is
fair in disallowing of Rs.13,42,000/- under section 40A(3). The
learned departmental representative further contended that the
concept of business expediency should not be stretched too far
to defeat the provisions of section 40A(3).
Decision
There was a difference of opinion between the Hon’ble Members
of the Tribunal. The Hon’ble Accountant Member upheld the disallowance
on the ground that the assessee had failed to discharge the burden
with evidence and establish satisfactorily the exceptional or
unavoidable circumstances or genuine difficulty so as to lift
the bar of disallowance contemplated by section 40A(3) of the
Act.
The Hon’ble Judicial Member,
on the other hand, allowed the assessee’s claim on the ground
that genuineness of expenditure and identity was clearly established
and that there was no case for disallowance u/s 40A(3). Further
the initial burden was on the department to show that there was
individual payment of more than Rs.10,000/- because the recipient
itself claimed that the amount was paid from time to time. He
further opined that the assessee’s arguments that rule 6DD(j)
was satisfied carried force as there could have been urgency in
payment to labourers on various occasions and M/s. Mehta Constructions
Co. would have asked the assessee to pay the amount in cash to
avoid delay in banking procedure.
As there was difference of opinion
reference under section 255(4) of the Income-tax Act, 1961, was
made to the Third Member.
The Hon’ble Third Member agreed
with the view expressed by the Hon’ble Judicial Member and held
as follows:-
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Since the genuineness of
the payment has been established by the assessee, which is
also not doubted by the revenue, the appellant is entitled
to the deduction of Rs.13,42,000/- as the genuine expenditure
incurred by the assessee for the purpose of his business.
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The word ‘sum’ used in Section
40A(3) denotes the payment at any one time and not the sum
total of payments made to a particular person during the course
of any one-day. For the purpose of applying section 40A(3),
it is therefore, mandatory that one single payment must exceed
a sum of Rs.10,000/-.
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There is no material on record
to suggest that the entire sum was paid as one transaction
or the various payments on various dates or months exceeded
statutory limit laid down by section 40A(3).
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To invoke section 40A(3),
a clear finding with evidence is necessary that the single
payment by an assessee exceeded the statutory limit. If the
disallowance is based on mere guesswork, untold harm is likely
to visit an honest taxpayer.
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Since the transaction was
outside the books, it was not practicable or advisable to
make the payment by account-payee cheque or crossed demand
draft. Therefore, the case of the assessee is covered by rule
6DD(j) of the Rules.
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Since the assessee declared
a sum of Rs.13,42,000/- it had to be included as the income
of the assessee and simultaneously deduction had to be allowed.
If the assessee had incurred the expenditure in excess of
amounts recorded in books, then the unexplained expenditure
would be assessable as income under section 69C of the Act.
However, on the same analogy the expenditure had to be allowed
as deduction while computing the income of the assessee and
net results would therefore, be NIL addition.
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Further, section 40A(3) places
no restrictions on the assessee in his trading activities.
It only empowers the Assessing Officer to disallow the deduction
claimed as an expenditure, in respect of which, the payment
is made by cash and there are no exceptional and unavoidable
circumstances. The consideration of business expediency and
other relevant factors are not excluded. The genuine transactions
wherein rule 6DD(j) also applies, are therefore, outside the
sweep of section 40A(3) of the Act.
- Param Anand Builders (P.) Ltd. vs. ITO
(Mumbai), 59 ITD 29 (Mum)
Facts
The assessee was engaged in construction work. It had started
a project for construction of 30 buildings in 1980, which was
to take several years for completion. Hence, it adopted Project
Completion Method as its method of accounting and contended that
it should be treated to have earned no profits till assessment
year 1985-86.
There was a search in the premises
of the assessee on 11-5-1987 where some incriminating materials
were found. The assessee declared unaccounted profit of Rs.66
lakhs as ‘on money’ and wanted that Rs.26 lakhs should be assessed
in A.Y. 1987-88 and Rs.40 lakhs in A.Y. 1988-89.
One of the directors of the assessee-company
stated that the assessee had been charging 15 percent to 20 per
cent ‘on money’ and no ‘on money’ was charged from institutions
like BML, Dena Bank and some educational trusts. Further, employees
of the assessee company deposed that it was charging 30 to 40
percent ‘on money’.
The Assessing Officer held that
‘on money’ was unaccounted receipt, that there were no provisions
in law to assess unaccounted money arbitrarily in two years only
and that the contention of the assessee that it had been following
project completion method of accounting was not correct. The Assessing
Officer concluded that accounts were not kept properly so that
income could be properly deduced therefrom and therefore, rejected
method of account followed by assessee.
He worked out ‘on money’ receipts
on basis of statements of employees and that of the director.
He also applied rate of profit at 25 percent on total receipts
and allocated profits in different years.
Issues Involved
Rejection of method of accounting
One of the main issues before the Hon’ble Tribunal was whether
Assessing Officer had rightly rejected method followed by assessee
and assessed income in each assessment year by application of provisions
of section 145(2). After appreciating the facts of the case the Tribunal
upheld the action of the Assessing Officer. The Tribunal while arriving
at the said decision made the following observations and held as under:-
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Whatsoever method an assessee
might be following, even the most recognised method of mercantile
system or the cash system, once it is found that either the method
of accounting is such from which correct profits cannot be deduced
[proviso to section 145(1)] or the books of account maintained
by the assessee are not correct and complete [section 145(2)],
the method of accounting followed by the assessee looses its significance.
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When the provisions of
section 145(2) become applicable, even the entire books of account
go in the background because if the books of account have not
been maintained or are found to be not correct and complete, the
Assessing Officer is authorised to assess the income in accordance
with the provisions of section 144 of the Income-tax Act which
in turn would mean that he is authorised to assess the income
according to best of his judgment.
Applying the above tests to
the facts of the case the Hon’ble Tribunal found that the assessee
had itself made an admission that its books of account were not correct
and complete because as per its own admission the amount of Rs.66
lacs had been received by it outside the books of account.
Spreading of ‘on money’
in all assessment years
Another issue before the Hon’ble Tribunal was whether the Assessing
Officer was justified in rejecting assessee’s version that ‘on money’
was received only in last two assessment years and therefore was justified
in spreading it in all assessment years under consideration and preceding
years.
The Hon’ble Tribunal observed
that the director had admitted in his statement that normally the
‘on money’ was being charged at the time of booking itself and only
in exceptional circumstances, the payment of ‘on money’ was postponed.
It was further observed that in the returns filed for A.Y. 1986-87
to 1988-89, the incomes had been returned not on the basis of book
results but on estimate basis.
As a result of the above observations,
the Tribunal was of the view that it could not be said that the returned
income of the assessee had to be accepted. It held that the theory
of the assessee that the ‘on money’ should be assessed as assessee’s
income only in the last two years could not be accepted as there was
no basis or justification even with the assessee. It further held
that the assessee had been earning ‘on money’ from the beginning of
the project although the percentage might have been increased in the
later years.
Allowance of possible expenditure
incurred against ‘on money’
The assessee made a contention to the effect that if the assessee
was charging some on money, which was not accounted for in the books
of account, it must also have been incurring some expenditure that
was not accounted for in the books of account.
The Hon’ble Tribunal observed
that it is an established principle that if an assessee makes some
claims for deductions, it is the assessee who has to establish it.
Though the Tribunal accepted the assessee’s argument that it did not
charge any on money from some banks, institutions or BMC, it observed
that no one can believe that while selling the shops or flats to these
institutions, the assessee should not have even charged its normal
rate of profit. The Tribunal further stated that this in turn would
mean that so far as the normal profit element was concerned, it was
included in the recorded sale price because no builder would be selling
the shops or flats at par or at a loss on the ground that the profits
would be earned only in terms of on money.
The Hon’ble Tribunal therefore
concluded that the assessee should have earned normal profits in the
sale prices recorded by it in its books of account and the on money
earned by it was meant to represent its unrecorded income which could
be spent in any manner the assessee liked. The Tribunal held that
in order to claim that any expenditure out of those receipts was made
for the purpose of assessee’s business, the burden of proof was on
the assessee and since it has not brought anything on record to show
as to what amount, if any and for what purposes was spent by the assessee
for meeting the purposes of business, no deduction as such can be
allowed.
Whether rate of profit
to be applied on total receipts?
The last issue before the Hon’ble Tribunal was whether rate of
profit at 25 percent was correctly applied on total receipts and not
on receipts after deducting profits.
The Hon’ble Tribunal held that,
the Assessing Officer’s view that the assessee should have earned
profits at the rate of 25 percent of gross receipts, was reasonable.
The Tribunal while arriving at the said conclusion observed as follows:-
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As per assessee’s own submissions
and disclosure, it had earned ‘on money’ at the rate of 17.5 per
cent. As no builder could be expected to be selling the shops
and flats without charging some profits, a rate of 7.5 per cent
was considered to be reasonable rate of net profit.
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This net profit is in addition
to the ‘on money’ and must have been earned even from those parties
from whom no ‘on money’ is stated to have been charged such as
Banks, BMC and other institutions. This would mean that the total
profit rate would be 17.5 per cent + 7.5 per cent = 25 per cent.
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When a net profit or gross
profit rate is applied for estimating the profits, it is applied
on the total receipts and not on the receipts after deducting
the profits.
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