Profit ratio of 8% as per Section 44AD is not sacrosanct when higher Profit ratio is estimated by AO on basis of Books [ITAT]

The Income Tax Appellate Tribunal(ITAT Delhi) in the matter of Shiv Shakti Construction vs. ACIT has retreated that the Profit ratio of 8% as per Section 44AD is not sacrosanct when higher Profit ratio is estimated by AO on the basis of Books.

The Relevant Text of the Judgment:

Briefly stated, the assessee a partnership firm is stated to be engaged in 100% Government contracts only and is a government approved civil contractor. The assessee is engaged in the execution of irrigation development activities including earth work, canal lining works, river and canal protection works and other work of similar nature. The assessee firm is stated to be also involved in various construction activities of diverse nature. The contracts are executed by the assessee on the basis of contracts awarded based on legal bidding / tendering process of the Government Department. All the receipts of the assessee are from Govt. contracts. These projects are stated to be carried out in remote areas which are not easily accessible. The revenue generated is thus 100% on the basis of approved tenders/invoices generated on the basis of work certified and approved by the government engineers and architects for the work awarded.

We however do not see merit in the plea of the assessee for such indulgence. The issue is highly factual and varies from case to case. The income estimated at 8% in the case of Subodh Gupta (supra) is based on its own set of facts. The judgment in Subodh Gupta cannot be read to mean that net profit ratio of 8% is sacrosanct percentage in all circumstances. The CIT(A), in his wisdom, has estimated profit at 10% after considering host of circumstances such a quality of evidence made available to support ‘other sundry creditors’, large cash expenses incurred, the net profit ratio declared and net profit ratio determined by the Assessing Officer etc. The law has not invented any straight jacket formula to judge such estimations precisely. Such estimations are in the realm of probabilities. There is nothing conclusive about it. The estimations carried out by the CIT(A) cannot be said to be marred by any kind of perversity. The estimates of profits by the CIT(A) are not fanciful or whimsical but appears to be guided by the principles of objectivity, fairness and considerations of justice and maintains some sort of equilibrium. We thus are not inclined to interfere and reestimate the estimations made by the CIT(A) in the absence of any palpable overreach on this score.

We however find merit in the plea of the assessee towards treatment of interest on fixed deposits as integral part of business activity. It is common knowledge that the large scale guarantees and securities are required in contract businesses. The factual matrix also underscores the proposition that the fixed deposits have not been placed to enjoy interest income simplicitor out of any surplus money. Circumstantially, large scale outstanding liabilities suggests otherwise. Coupled with this, the assessee has also incurred interest and finance costs. Having regard to the peculiarity of contract business, the claim of the assessee that the interest on FDRs cannot be seen differently from receipt derived directly from contract work carries weight. Having regard to the nature of business, we thus find force in the plea of the assessee that such FDRs are nothing but integral part of working capital of the assessee kept and expanded for commercial reasons. Hence, the interest income deserves to be treated alike with business contract receipts for the purposes of estimations.

The interest income cannot be treated differently from contract receipts merely because such income flows from a different source. As already noted, the fixed deposits are a necessity to provide security and meet the contingency of such peculiar business. The accounts and other attendant circumstances vindicate the position. We thus have no hesitation to modify the order of the CIT(A) to this extent. The interest income and similarly discount credits shall thus form integral part of the business receipts and shall be subjected to estimation at same rate of 10% as made applicable to contract receipts. However, the interest income on IT refunds and NSC deposits will not get the benefit of estimations but will be chargeable as other income in accordance with law.

At this juncture, the assessee has claimed that share of profit arising from joint venture in some assessment years are fully exempted from taxation under Section 10(2A) of the Act. Needless to say, where the income is exempt from the ambit of taxation under the provisions of the Income Tax Act, same has to be excluded from the taxability at the threshold. Thus, the AO is directed to do so by determining the taxable income.

In the light of the delineation made in the preceding paragraphs, the appeal of the assessee is partly allowed while the appeal of the Revenue is dismissed on all counts.

In the result, the appeal of the assessee in ITA No.2554/Del/2022 is partly allowed whereas the appeal of the Revenue in ITA No.2836/Del/2022 is dismissed.

Identical grievances have been raised by the assessee as well as by the Revenue in their respective captioned appeals relating to different assessment years.

For the reasons mentioned in Assessment Year 2015-16, we affirm the action of the CIT(A) in estimating the net profits at 10% of the receipts from contract business estimated by the CIT(A) after rejection of books of accounts of the assessee. We thus decline to interfere with the action of the CIT(A) on first principles. However, we find merit in the plea of the assessee for applying the principles of estimations on interest income from fixed deposits as well and income received by way of discount arising in the course of business. Therefore, the estimations at 10% on such business receipts by way of interest income from fixed deposits and discount income shall apply mutatis mutandis. The action of the CIT(A) is modified to this extent. The Assessing Officer is directed to combine and include the interest income from fixed deposits as well as discount and other business receipts of similar nature for the purposes of estimations of taxable income. The assessee thus gets relief to this extent in tune with the observations made in relation to the Assessment Year 2015-16 (supra). All these respective appeals of the assessee are thus partly allowed.

In short, the facts and the issue being identical, our observations in Assessment Year 2015-16 shall apply to all other assessment years.

For the identical reasons assigned for AY 2015-16, we do not see merit in the grievance raised in the respective Revenue’s Appeals. The income assessed by the Assessing Officer has been rightly modified by the CIT(A) subject to the observations made in respect of interest income from fixed deposits and discount income.

In the result, all the Revenue’s Appeals are dismissed.

In the combined result, all the captioned appeals of the assesse are partly allowed whereas all the captioned appeals of the Revenue are dismissed.

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