Books of Account Cannot Be Rejected Merely for Non-Audit: ITAT Mumbai

Deepika A. Mehta v. DCIT (ITAT Mumbai), ITA Nos. 379/Mum/2023 & 1178/Mum/2023, AY 1992-93, order dated 5 April 2024

When an Assessing Officer (AO) is unhappy with a taxpayer’s records, one of the most powerful steps available is rejecting the books of account and making a best-judgment assessment. A recent ITAT Mumbai ruling is a useful reminder that this power has limits. The Tribunal held that failure to get accounts audited under Section 44AB is not, by itself, a reason to reject books under Section 145(3). It also set aside several additions that rested on weak or unsupplied material.

Key takeaways

• Non-audit under Section 44AB attracts its own penalty, but it does not automatically justify rejecting the books.
• To reject books, the AO must show that the accounts are incorrect or incomplete, not simply record general doubts.
• If the Department wants to make an addition on the basis of third-party material, it must give that material to the taxpayer.
• Once books are accepted, an estimated “composite disclosure” cannot be added on top of income worked out from those books.
• Section 234D interest cannot be charged where the original assessment was completed before 1 June 2003.

Background of the case

The matter concerned Assessment Year 1992-93 and had already gone through two earlier rounds of litigation. The assessment under appeal was framed under Section 144 read with Section 254, following the Tribunal’s earlier directions. The AO had rejected the taxpayer’s books under Section 145(3) and made several additions and disallowances. Both the taxpayer and the Revenue appealed. The Tribunal partly allowed the taxpayer’s appeal and dismissed the Revenue’s.

1. Rejection of books under Section 145(3)

The AO’s reasons included non-audit under Section 44AB, non-availability of certified bank statements, books written long after the year-end, dealings with closely related persons, and difficulty in cross-verifying entries.

The Tribunal did not accept these grounds:

• Non-audit: The law provides a separate penalty for failing to get accounts audited (Section 271B). That consequence does not turn into a power to reject the books.
• Bank statements: The Department already held the taxpayer’s bank account details and receipts and payments for the relevant period, collected during the original assessment. The objection was contrary to the record.
• Other reasons: Uniform monthly drawings, related-party dealings and the passage of time did not show that the accounts were incorrect or incomplete. If drawings looked too low, the AO could have made an addition for that, but could not reject the entire books on that basis. Related-party transactions are not a ground for rejection unless something deceitful is shown.

2. Unexplained investments under Section 69

The Tribunal had earlier directed the AO to give the taxpayer all material on which additions were proposed, and to examine its correctness if disputed. Instead, the AO largely repeated the earlier addition, with reasons that were substantially the same, and did not supply the underlying documents despite repeated requests.

Understanding the Rejection of Books of Account

The addition of ₹14,90,103 was deleted. Since the issue had already been sent back twice, the Tribunal refused to send it back a third time. It also noted that findings favouring the taxpayer, which the Department had not appealed, had become final.

3. Addition based on a group disclosure

An addition of ₹2,01,61,000 was based on a ₹100 crore composite disclosure made on behalf of the whole group. Following an earlier coordinate Bench ruling in Cascade Holdings Pvt. Ltd., the Tribunal held that such a disclosure is only an estimate made when complete books were unavailable. Once books exist and income can be determined from them, the estimate cannot support a separate addition. It was deleted.

4. Interest expenditure

The taxpayer had claimed interest of ₹2.05 crore on money borrowed to invest in shares, but the AO allowed only ₹9,08,273. The main reason for the disallowance was that the books were unreliable, and that reason fell away once the rejection of books was reversed. The remaining reasons had no material behind them. Relying on coordinate Bench rulings and the Supreme Court’s decision in Seth R. Dalmia v. CIT, the Tribunal allowed the balance interest. It held that the link between the expenditure and the income earned need not be direct, and that an indirect nexus is enough for deduction against income from other sources.

5. Other issues

• Section 234D interest: Following CIT v. Reliance Energy Ltd. (Supreme Court), the AO was directed not to levy it, since the original assessment was completed before the section came into force on 1 June 2003.
• Mismatch of balances between two sets of books: Sent back to the AO for fresh decision, in line with directions given in a related case.
• Interest under Sections 234A and 234B: Sent back to the AO to be levied as per law.
• Unexplained receipts of ₹29,343: Dismissed, as the taxpayer did not press the ground.
• Profit from a partnership firm: The additional ground was dismissed, as the AO had agreed to the addition before the first appellate authority.
• Revenue’s appeal: Dismissed, since its grounds covered issues already decided in the taxpayer’s favour.

What this means for taxpayers

1. Keep books complete and reconcilable. The taxpayer’s position was strengthened because bank records and accounts were available to the Department.
2. Do not ignore the tax audit requirement. Rejection of books may not follow, but penalty exposure remains.
3. Ask for the material in writing. The taxpayer made repeated written requests for the documents used against it, and that record helped.
4. Challenge generic reasons. A rejection of books must rest on specific defects, not suspicion or the age of the records.
5. Document borrowing and investment trails. Clear records of how borrowed funds were used support the interest deduction.

Frequently asked questions

Can the Assessing Officer reject my books if my accounts were not audited under Section 44AB?
According to this ruling, not on that ground alone. Non-audit can lead to a penalty, but books can be rejected only if the AO is dissatisfied with their correctness or completeness for specific reasons.

Can the Department make an addition without giving me the documents it relies on?
In this case, the Tribunal deleted an addition where the AO did not supply the material despite repeated requests and a direction to do so.

Is a disclosure made during a search enough to tax additional income if my books are accepted?
Per this decision, an estimated composite disclosure cannot be added separately once income can be computed from accepted books.

JUDGEMENT

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Disclaimer: This article is for general information only, is based on the facts of a specific ITAT order and does not constitute professional advice. Outcomes depend on the facts of each case, so please consult a qualified professional before acting.