Mumbai ITAT Strikes Down Section 145(3) Rejection: Absence of Qualitative Diamond Stock Records Not Sufficient Ground When Books Are Otherwise Complete
Background and Context
The Income Tax Appellate Tribunal, Mumbai Bench, recently delivered a significant ruling in Sparkle Diam Pvt. Ltd. Vs DCIT (ITAT Mumbai) concerning Assessment Year 2022-23. The central question before the Tribunal was whether an Assessing Officer is legally empowered to reject an assessee's books of account under Section 145(3) of the Income Tax Act, 1961 solely on the basis that qualitative attributes of diamond stock — such as size, clarity, colour, and shape — were not separately recorded and maintained, even when all other books, registers, and statutory documents were found to be complete and in order.
The Tribunal's answer was an unambiguous no. The addition of Rs. 3,16,71,331/- made by the Assessing Officer was directed to be deleted in its entirety.
Facts of the Case
About the Assessee
Sparkle Diam Pvt. Ltd. is a company with nearly three decades of standing in the gem and jewellery sector. Its business operations span the manufacture and export of studded gold jewellery as well as the trading of polished diamonds — an industry where product valuation is inherently linked to qualitative characteristics of individual stones and components.
For AY 2022-23, the assessee:
- Declared a turnover of Rs. 1,79,37,37,589/-
- Reported a net profit of Rs. 2,21,40,797/-
- Disclosed a net profit ratio of 1.23%
The books of account were duly audited under Section 44AB of the Income Tax Act, 1961, and the Tax Audit Report was filed in Form No. 3CA.
Books and Records Maintained
The Chartered Accountant's Tax Audit Report (TAR) confirmed that the following books and records were duly examined and maintained:
| Sl. No. | Books Examined |
|---|---|
| 1 | Cash Book — Cash receipts and payment vouchers |
| 2 | Bank Book — Bank receipts and payment vouchers, Bank reconciliation statements |
| 3 | Journal Books — Journal vouchers |
| 4 | Sales Register — Sales Invoices |
| 5 | Purchase Register — Purchase Invoices |
| 6 | General Ledger — Expense Invoices |
| 7 | Salary Register — Monthly pay sheets and bank statements |
| 8 | Fixed Asset Register — Invoices for purchase of fixed assets |
| 9 | Inventory Register — Packing List |
In addition to the above, the assessee furnished before the revenue authorities:
- Statement of trade payables as on 31.03.2022
- Closing stock details from the Tax Audit Report
- Party-wise sales and purchase statements
- Statement of trade receivables as on 31.03.2022
- Profit & Loss matrix in percentage terms for the years ended 31.03.2022, 31.03.2021, and 31.03.2020
- Party-wise details of sales to new customers
- Stock valuation reports for closing stock as on 31.03.2021 and 31.03.2022, certified by a registered valuer
- Quantitative stock details and daily stock register for the relevant financial year
Why the Case Was Selected for Scrutiny
The case was picked up for scrutiny for several stated reasons, including:
- Discrepancies between opening and closing stock figures
- High turnover accompanied by a low net profit margin
- Alleged non-compliance with Ind-AS standards
- Large loans squared up during the year
- High liability figures relative to declared income
The Assessing Officer's Action
Rejection of Books Under Section 145(3)
The Assessing Officer rejected the assessee's books of account under Section 145(3) of the Income Tax Act, 1961. The sole stated ground for rejection was that the assessee had failed to maintain quality-wise particulars of its diamond stock — specifically, attributes such as size, clarity, colour, and shape — which the AO considered essential for determining the correct valuation of opening and closing stock.
The AO's reasoning, as reproduced in paragraph 4.5 of the assessment order, was as follows:
"It is noticed that purchase register is maintained by the assessee according to quantity of the particular item but quality, shape, clarity, size is not taken into account whereas in such type of business, quality, shape, clarity and size of the items is very important for determination of price... it is clear that the purchase records are not maintained totally and the value of closing stock declared is not verifiable."
Profit Estimation and Addition
Having rejected the books, the AO proceeded to estimate the net profit at 3% of turnover, which translated to:
- Estimated profit: Rs. 5,38,12,128/-
- Declared profit: Rs. 2,21,40,797/-
- Addition made: Rs. 3,16,71,331/-
This addition was incorporated into the total income of the assessee.
Appeal Before CIT(A) / NFAC
The assessee challenged the assessment order before the National Faceless Appeal Centre (NFAC), Delhi, functioning as the CIT(A). However, the CIT(A) upheld the Assessing Officer's action in its entirety through an order dated 24.11.2025.