ITAT Deletes Section 271AAA Penalty on Diamond Stock Discrepancy for Failure to Establish Undisclosed Income:

The assessee is Rosy Blue (India) Private Limited who was engaged in the business of manufacturing and exporting rough and polished diamonds and trading in commodity derivatives. A search and seizure operation under Section 132 of the Income Tax Act, 1961 was conducted on 25 August 2011 at its business premises and the residences of its directors.

During the search, the Department found a difference between the physical stock of diamonds and the stock recorded in the assessee’s books. After considering the assessee’s stock reconciliation, the difference ultimately stood at 60.11 carats. The AO, however, worked out a stock discrepancy of 539.05 carats, resulting in an addition of Rs. 1,24,78,900.

Following the quantum proceedings, the AO imposed a penalty of Rs. 1,39,153 under Section 271AAA, treating the sustained stock discrepancy as undisclosed income arising from the search. The CIT(A) upheld the penalty.

Before the Tribunal, the assessee argued that the physical stock was actually less than the stock recorded in the books, and therefore the case could not be treated as one involving unrecorded stock. It further submitted that the 60.11-carat difference represented only 0.005% of the total caratage handled and could arise from ordinary weighing and calibration errors in the diamond trade. According to the assessee, the addition had been made merely on an estimated basis and there was no evidence demonstrating that the missing diamonds had actually been sold and that the sale proceeds had remained unrecorded.

The Tribunal examined the statutory requirement of “undisclosed income” under Section 271AAA and observed that where stock is recorded in the books but corresponding physical stock is not found, it cannot automatically be presumed that the assessee sold the stock and failed to record the sale consideration. The Tribunal emphasised that mere confirmation of an addition in quantum proceedings, by itself, does not automatically justify levy of penalty under Section 271AAA and the statutory conditions for determining undisclosed income must be satisfied.

Consequently, the penalty of Rs. 1,39,153 imposed on the assessee was unsustainable and the Tribunal set aside the penalty and allowed the assessee’s appeal.