ITAT Indore Rules That Low Gross Profit Alone Cannot Justify Rejection of Books or GP Estimation

1. Background and Procedural History

The dispute in Arvind Kumar Singhavi Vs ITO (ITAT Indore) concerns Assessment Year 2017-18 and arises from an assessment framed under Section 144 read with Section 263 of the Income Tax Act 1961. The assessee carries on retail cloth business under the proprietorship concern M/s. Navrang Vastralaya, Jawahar Marg, Nalkheda, Dist. Agar Malwa.

1.1 Original scrutiny assessment under Section 143(3)

  • The assessee filed return of income declaring total income of Rs. 4,38,550/-.
  • The Assessing Officer (AO) completed assessment under Section 143(3) vide order dated 18.12.2019 (Original Impugned Assessment Order).
  • Key features of this first-round assessment:
    • Total income assessed at Rs. 4,75,263/-.
    • Disallowance of Rs. 7,867/- out of telephone expenses of Rs. 31,468/- on the ground that full supporting vouchers were not available; 25% was disallowed.
    • Disallowance of Rs. 28,846/- out of “other expenses” of Rs. 1,15,390/- due to absence of proper supporting evidence, self-made vouchers, and unverifiable thumb-impression vouchers; again, 25% was disallowed.
    • Agricultural income accepted at Rs. 72,000/-.

The assessee’s business profile and profit pattern for three years, as recorded, reflected:

  • Retail cloth trading under M/s. Navrang Vastralaya.

  • Comparison of gross receipts and net profit percentages (as noted in the original order):

    • A.Y. 2017-18: Gross receipts Rs. 2,08,53,053/-, net profit Rs. 5,48,948/-, NP ratio 2.63%.
    • A.Y. 2016-17: Gross receipts Rs. 1,34,00,917/-, net profit Rs. 5,89,389/-, NP ratio 4.39%.

1.2 Revision under Section 263 and second-round best judgment assessment

The Principal Commissioner of Income Tax (PCIT) invoked Section 263 and revised the original order dated 18.12.2019.

  • Revision order under Section 263 was passed on 02.03.2022 (PCIT, Indore-1) revising the Section 143(3) assessment.
  • Pursuant to this revision, the AO framed a fresh assessment under Section 144 read with Section 263 vide order dated 27.03.2023 (second impugned assessment order).

In this second-round assessment:

  • Income as per return remained Rs. 4,38,550/-.
  • Total income was reassessed at Rs. 10,78,950/-.
  • The AO:
    • Rejected books under Section 145(3).
    • Estimated gross profit at 15% of turnover and worked out “estimated profit from business” at Rs. 10,45,394/-.
    • Made aggregate disallowances of Rs. 33,557/- on different heads as detailed in para 6 of the assessment order.

1.3 First appeal before CIT(A)

Aggrieved by the Section 144 r.w.s. Section 263 order dated 27.03.2023, the assessee filed appeal under Section 246A before the CIT(A), NFAC.

  • The CIT(A) passed order No. ITBA/NFAC/S/250/2024-25/1072319660(1) dated 20.01.2025 (Impugned Order).
  • The assessee primarily challenged:
    • Rejection of books under Section 145(3).
    • Estimation of GP at 15% and corresponding addition of Rs. 10,45,394/-.
    • Disallowances totalling Rs. 33,557/-.

The CIT(A):

  • Endorsed the AO’s estimation of GP at 15% (instead of 17.71% of earlier year), holding that the assessee had not given convincing or documentary-backed reasons for the sharp fall in GP ratio from 17.71% to 12.62%.
  • Treated the AO’s approach as “fair and reasonable”, as the AO did not apply the earlier year’s GP but moderated it to 15%.
  • Upheld the remaining disallowances of Rs. 33,557/-, characterising the assessee’s challenge as unsupported by evidence.
  • Ultimately treated the appeal as partly allowed, in substance confirming the additions made in the second-round assessment.

1.4 Second appeal before ITAT Indore

The assessee then approached the Income Tax Appellate Tribunal, Indore Bench, under Section 253, challenging the order of the CIT(A). The key grounds taken included:

  1. Validity of the assessment under Section 144 read with Section 263.
  2. Legality of estimating business profit at Rs. 10,45,394/- on the basis of 15% GP.
  3. Propriety of rejection of books under Section 145(3).
  4. Justification of disallowances aggregating Rs. 33,557/-.

2. Core Controversy: Fall in GP Ratio and Rejection of Books

2.1 Assessee’s explanation for lower GP

For FY 2016-17 (A.Y. 2017-18), the assessee reported:

  • Turnover: Rs. 2,08,53,053/-
  • GP ratio: 12.62%

For the earlier two years:

  • FY 2014-15: Sales Rs. 1,23,94,696/-, GP 17.60%.
  • FY 2015-16: Sales Rs. 1,34,00,917/-, GP 17.71%.

The assessee contended that:

  • There was a marked increase in sales in FY 2016-17 compared to earlier years.
  • A deliberate business strategy was adopted to push higher sales volumes by operating at somewhat lower margins.
  • Sourcing was increasingly shifted from traditional vendors to new suppliers offering wider range and competitive pricing, leading to higher turnover but at a reduced GP percentage.
  • In essence, higher turnover came at the cost of narrower margins, but books were regularly maintained and audited, and no specific defects in purchases, sales or stock were identified.

2.2 AO’s reasoning in second-round assessment

The AO rejected the above explanation on several grounds: