Section 145(1) deals with method of accounting.  Section 145(3) provides for best judgment assessment (as prescribed in section 144) in the following circumstances:

  • where the AO is not satisfied about the correctness or completeness of the accounts of the assessee; or
  • where the method of accounting provided in section 145(1) have not been regularly followed by the assessee; or
  • where the accounting standards as notified under section 145(2) have not been regularly followed by the assessee.

Therefore, the AO can make best judgement assessment only in the above prescribed circumstances. The issue has arisen before the Courts as to whether the AO can reject the books of accounts on the ground of lower GP and estimate the total income. This aspect is discussed in the following decisions:

Malani Ramjivan Jagannath vs. ACIT 316 ITR 120 (Raj HC) – It was held that mere deviation of GP rate cannot be a ground for rejecting books of accounts and income cannot be determined on the basis of estimate and guesswork.

CIT v Jas Jack Elegance Exports (Delhi HC) (2010) 324 ITR 95 – There was fall in gross profit.  The Assessee was not maintaining stock register. The AO rejects books and adopts GP of earlier year. 

The HC observed that it was not the case of the revenue that the assessee had not followed either cash or mercantile system of accounting stipulated in sub-section (1) of section 145. It was also not the case of the revenue that the Central Government had notified any particular accounting standards to be followed by manufacturers and exporters of readymade garments. Hence, the second part of sub-section (3) of section 145 did not apply to the instant case. The ITAT held that the AO has not pointed out any defect in the account books maintained by the assessee, which, admittedly, were produced before the AO for his consideration.  It was also not the finding of the Assessing Officer that the accounts of the assessee were not complete. There is no provision either in the Act or in the Rules requiring an assessee carrying on business of this nature to maintain a stock register as a part of its accounts. As regards non-production of stock register, the assessee had given an explanation which had been accepted not only by the CIT(Appeals) but also by the Tribunal and both of them had given a concurrent finding of fact that maintaining stock register was not feasible considering the nature of the business being run by the assessee, engaged in the business of manufacturing readymade garments by purchasing fabric which was then subjected to embroidery, dyeing and finishing and then converted into readymade garments by stitching.  The HC held that section 145(3), therefore, could not have been applied by the AO to the instant case.

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