The Bangalore Bench of the Income Tax Appellate Tribunal (ITAT), in the case of Shri Rajaghatta Papanna Revanna v. ITO, dealt with the issue of estimation of income of a civil contractor where the assessee had not maintained regular books of account and had declared income at 6% of contract receipts.
The assessee was engaged in civil contract work for various Government agencies, and the contract receipts were received through banking channels, with tax deducted at source under Section 194C and reflected in Form 26AS.
For Assessment Year (AY) 2022-23, the contractor filed the return in ITR-2 instead of ITR-4 because the income tax portal did not allow filing ITR-4 without an audit report where gross receipts exceeded Rs 2 crore. While filing the return, the income was mistakenly shown under the head “Income from Other Sources” even though it arose from contract business.
During assessment proceedings, the Assessing Officer issued notices under Sections 143(2) and 142(1) and sought clarifications regarding the TDS, contract receipts and the return form used.
The assessee explained that the receipts represented contract business receipts, that he was not maintaining regular books of account, and that income had been estimated at 6% of receipts based on past accepted profit margins.
The assessee also relied on earlier assessments where net profit of around 6% to 6.40% had been accepted by the Department and submitted sample invoices, RF bills from the government, and GST returns to substantiate the nature of the business. However, the Assessing Officer (AO) rejected the claim based on three main reasons: estimation Section 44AD was not applicable as the income was reported as “Income from Other Sources,” no regular books of account were kept, and the claimed expenses were not substantiated. The AO disallowed the entire claim, including the GST component and assessed the total contract receipts as income from other sources.
On appeal, the CIT(A) accepted that the assessee was carrying on contract business and that the income ought to be assessed under the head “Profits and Gains of Business or Profession”. However, instead of accepting the 6% profit declared by the assessee, the CIT(A) estimated the net profit at 10% of contract receipts.
Aggrieved by this higher estimation, the assessee approached the Tribunal and contended that the 10% rate was excessive, particularly when the Department had accepted profit margins of 6.4% for AY 2020-21 and 6% for AY 2021-22; on similar facts.
The ITAT allowed the assessee’s appeal and held that the profit margin should be accepted at 6% as declared by the assessee. The Tribunal observed that the assessee had consistently declared profit in the range of around 6% in earlier years and such declarations had been accepted by the Department.
The Tribunal also noted that the CIT(A) had not brought any comparable cases, industry data or peculiar facts on record to justify the estimation of profit at 10%. In the absence of any contrary material, and considering the past accepted results, the Tribunal held that the adoption of a 10% profit margin was not justified.
The rationale of the decision is that estimation of income, though permissible where books are not maintained or reliable details are not available, must be based on a reasonable and rational basis.
It cannot be made arbitrarily or merely by adopting a higher percentage without supporting material. The Tribunal relied on judicial principles laid down by the Karnataka High Court and Madras High Court, which emphasise that past accepted profit margins and comparable business circumstances should be considered while estimating income.
Since the assessee’s profit margin of 6% was in line with earlier accepted years and no contrary evidence or comparable data was brought by the Revenue, the Tribunal directed the Assessing Officer to compute income by adopting the profit margin of 6%. Accordingly, the assessee’s appeal was allowed.
“The key legal significance of this ITAT ruling is that, for contractors and small businesses, income estimation must be reasonable, evidence-based and consistent with past accepted results, rather than being made arbitrarily at a higher rate merely because the taxpayer has not maintained regular books or has made a reporting error in the return,” said CA (Dr.) Suresh Surana.
“The ruling clarifies that where contract receipts are supported by banking records, TDS under Section 194C, Form 26AS, Government bills and past accepted profit margins, the Revenue should tax only the reasonable profit element and not treat the entire receipts as taxable income. It also reinforces that past accepted profit rates may be a relevant benchmark unless the Department brings contrary material, comparable cases or specific facts to justify a higher estimate,” Surana further added.
How important are past accepted assessments while estimating income in subsequent years?
Past accepted assessments are relevant and can provide a reasonable basis for estimating income in subsequent years, particularly where the nature of business, method of operations and surrounding facts remain broadly similar.
While the principle of consistency does not prevent the Revenue from adopting a different view where there are material changes in facts or where contrary evidence is brought on record, any deviation from earlier accepted profit margins should ordinarily be supported by cogent reasons, comparable cases or industry data.
“In this ruling, the ITAT noted that the assessee’s profit margins of around 6% to 6.40% had been accepted in earlier years, and in the absence of any specific material justifying a higher estimate, the adoption of 10% profit by the CIT(A) was not considered appropriate. The decision therefore reinforces that past accepted results may serve as an important guiding factor for reasonable estimation, though each year must still be examined on its own facts,” stated Surana.
Does filing the wrong ITR form automatically change the nature of income if the underlying facts clearly establish business income?
Filing the wrong ITR form or reporting income under an incorrect head should not, by itself, automatically alter the real character of the income, where the underlying facts clearly establish that the receipts arise from business activity.
The substance of the transaction and the supporting evidence would be relevant in determining the correct head of income. In the present case, although the assessee had filed ITR-2 and mistakenly disclosed the contract receipts as “Income from Other Sources”, the receipts were from civil contract work executed for Government agencies, payments were received through banking channels, and TDS was deducted under Section 194C.
“The CIT(A), and thereafter the ITAT, recognised the receipts as business income assessable under the head “Profits and Gains of Business or Profession”. However, taxpayers should still exercise care in selecting the correct ITR form and reporting income under the appropriate head, as incorrect filing may invite queries, scrutiny or processing-related issues,” added Surana.
What lessons does this ruling offer to taxpayers who inadvertently report business income under the wrong head?
“This ruling highlights that an inadvertent error in selecting the ITR form or reporting business receipts under an incorrect head may not, by itself, determine the true nature of income, if the underlying facts and supporting documents clearly establish that the receipts arise from business activity,” stated Surana.
However, taxpayers should not treat such errors lightly, as it is their responsibility to furnish an accurate return. Also, they should maintain adequate evidence such as contracts, invoices, work bills, bank statements, GST returns, Form 26AS/TDS details and past return records to substantiate the real character of the income.
Correct return filing and proper classification of income are important to avoid unnecessary scrutiny, disallowance of expenses or litigation.
What do taxpayers do in such cases and what are the mistakes they should avoid?
Taxpayers who mistakenly report business income under the wrong head should promptly correct or explain the error with proper supporting documents such as invoices, contracts, bank statements, GST returns, Form 26AS/TDS details and past assessment records.
If the mistake is noticed in time, they should consider filing a revised return in the correct form and under the correct head.
It is important to note that this is a ruling of the Income Tax Appellate Tribunal (ITAT). ITAT decisions can be challenged before the High Court and, thereafter, the Supreme Court. Therefore, legal positions may evolve depending on further appeals.
Disclaimer: This article is based on an ITAT ruling in the specific facts of the case. Judicial decisions depend on individual facts and circumstances and may be challenged before higher courts. Taxpayers should consult a qualified tax professional before relying on this ruling for their own cases.
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