The Income Tax Appellate Tribunal, Agra Bench, has clarified that under Section 145(3) of the Income-tax Act, 1961, the Assessing Officer cannot selectively reject only part of an assessee’s books of account. Once the books are found inadequate to reflect true income, the entire business profit must be estimated on total turnover - no piecemeal adjustments are legally permissible. This ruling reinforces doctrinal consistency in income estimation and curbs arbitrary partial rejections.
Background & Facts
The Dispute
The appellant, Jai Dairy, a partnership firm engaged in the purchase, pasteurization, and sale of milk and milk products, along with tanker transportation services, filed its return of income for Assessment Year 2014-15 declaring a net profit of Rs. 3,62,433 on a turnover of Rs. 106,05,76,943. The Assessing Officer (AO) rejected the books of account under Section 145(3), alleging that the transactions with Hardiyal Milk Products Pvt. Ltd. were accommodation entries and that the tanker running expenses were unverified. The AO estimated net profit solely on the basis of receipts from Hardiyal Milk Products, ignoring the rest of the business, and made an addition of Rs. 23,93,967.
Key Facts
- The assessee filed its return on 30.11.2014 declaring net profit of Rs. 3,62,433 (0.034% of turnover)
- Turnover comprised Rs. 106,05,76,643 from milk sales and Rs. 72,06,872 from tanker running income
- The firm purchased raw milk from farmers and small suppliers, and also purchased pasteurized milk from Hardiyal Milk Products Pvt. Ltd.
- The firm pasteurized the milk and sold it back to Hardiyal Milk Products Pvt. Ltd., resulting in reciprocal purchase and sale entries
- Ledger accounts of Hardiyal Milk Products Pvt. Ltd. showed sales of Rs. 55,24,76,727 and purchases of Rs. 50,46,22,247, with bank credits of Rs. 55,12,80,000 to the assessee
- The AO estimated net profit at Rs. 5 per Rs. 1,000 on the Rs. 55,12,80,000 received from Hardiyal, yielding Rs. 27,56,400, and added Rs. 23,93,967 after deducting the declared profit
- The AO disallowed Rs. 82,68,557 as tanker running expenses due to lack of documentation, allowing only depreciation of Rs. 4,80,488
- The assessee had submitted ledgers, audit reports, and copies of bank statements, but not full addresses or confirmations from suppliers
- The AO relied on the previous year’s (2013-14) assessment pattern to justify rejection
- An Inspector’s report dated 2013-14 confirmed the physical existence and operational status of Hardiyal Milk Products’ factory (pages 221 - 223 of paper book)
Procedural History
- 30.11.2014: Assessee filed return for AY 2014-15
- 28.12.2016: AO passed assessment order under Section 143(3), rejecting books under Section 145(3) and making addition of Rs. 23,93,967
- 08.08.2025: National Faceless Appeal Centre (CIT(A)) upheld the AO’s order
- 20.03.2026: Hearing before ITAT Agra Bench
- 20.04.2026: Judgment pronounced
The Parties' Positions
For the Assessee
- Argued that the transactions with Hardiyal Milk Products were genuine and part of a legitimate business model involving purchase, pasteurization, and resale
- Submitted ledger accounts, bank statements, and Inspector’s report confirming Hardiyal’s operational status
- Contended that tanker running expenses were incidental to the core business of milk pasteurization and transportation
- Stated that while some documentation was incomplete, the overall financial pattern was consistent and verifiable
For the Revenue
- Alleged that reciprocal purchase-sale entries with Hardiyal Milk Products indicated circular transactions and accommodation entries
- Claimed that the assessee failed to provide addresses of suppliers or confirmations of their existence
- Asserted that tanker expenses were not substantiated and thus disallowed
- Maintained that the low net profit margin (0.034%) was implausible and justified estimation
Relief Sought
The assessee sought:
- Setting aside of the AO’s order dated 28.12.2016 and CIT(A)’s order dated 08.08.2025
- Acceptance of the declared net profit of Rs. 3,62,433
- Allowance of tanker running expenses or, alternatively, estimation of net profit on total turnover
- Cancellation of the addition of Rs. 23,93,967
The Legal Issue
The central question was whether Section 145(3) of the Income-tax Act, 1961 permits the Assessing Officer to partially reject the books of account and estimate net profit only on a portion of turnover, while accepting other transactions as genuine.
Arguments Presented
For the Appellant
The assessee relied on the principle that Section 145(3) is a provision for complete rejection of books when they are unreliable. It argued that once the AO accepts the genuineness of certain transactions (e.g., sales to other customers), those must be included in the computation. The transactions with Hardiyal Milk Products were not circular but reflected a legitimate supply chain: purchase of pasteurized milk, processing, and resale. The Inspector’s report corroborated the existence of the entity. The low net profit margin was consistent with prior years and industry norms. The disallowance of tanker expenses was unjustified as they were integral to the business.
For the Respondent
The Revenue contended that the reciprocal entries between the assessee and Hardiyal Milk Products indicated a sham transaction designed to inflate turnover. The absence of supplier confirmations and addresses rendered the books unreliable. The low net profit margin (0.034%) was unsustainable for a business with such high turnover. The disallowance of tanker expenses was justified due to lack of supporting documents. The estimation under Section 145(3) was therefore valid and limited to the suspicious portion of transactions.
The Court's Analysis
The Tribunal observed that Section 145(3) does not contemplate partial rejection of books. The provision empowers the Assessing Officer to estimate the total income only when the books of account are found to be inadequate to reflect the true income. Once the books are rejected, the entire business must be assessed on an estimated basis. The AO cannot selectively accept some transactions and reject others under the same provision.
"The provisions of Section 145(3) of the Act nowhere mandates the application of partial rejection of book results of the assessee. Once the book results are rejected, the only recourse available to the revenue is to estimate the net profit."
The Tribunal noted that the AO had accepted the genuineness of transactions with other customers and suppliers, thereby implicitly acknowledging the overall reliability of the business model. The transactions with Hardiyal Milk Products were not inherently suspicious; the reciprocal entries were explained as part of a legitimate pasteurization and resale cycle. The Inspector’s report from 2013-14, which confirmed the physical existence and operations of Hardiyal Milk Products, was ignored by the lower authorities.
Regarding tanker expenses, the Tribunal held that while documentation was incomplete, the expenses were directly linked to the core business of transporting pasteurized milk. The AO’s complete disallowance was disproportionate. However, since the assessee had not fully complied with notices under Section 142(1), a reasonable estimation was warranted.
The Tribunal then analyzed the net profit trend over the last four years:
- AY 2011-12: 0.027%
- AY 2012-13: 0.032%
- AY 2013-14: 0.033%
- AY 2014-15: 0.034%
The average of the last three years was 0.031%. The Tribunal held that applying this rate to the total turnover of Rs. 106,77,83,815 yielded a net profit of Rs. 3,31,012. Since the assessee had declared Rs. 3,62,433 - higher than the estimated amount - the declared income was accepted.
"We make it very clear that the said estimation shall not act as a precedent for other assessment years for the assessee itself and the same is made in the peculiar facts and circumstances of the instant case for the year under consideration."
The Verdict
The appeal was allowed. The Tribunal set aside the orders of the AO and CIT(A), directed the Assessing Officer to accept the declared net profit of Rs. 3,62,433, and cancelled the addition of Rs. 23,93,967. The Tribunal estimated net profit at 0.031% of total turnover (Rs. 3,31,012), which was lower than the declared income, thereby rendering no addition necessary. The disallowance of tanker expenses was effectively overturned by the acceptance of the declared income.
What This Means For Similar Cases
Partial Rejection of Books Is Legally Invalid
- Practitioners must challenge any AO order that accepts some transactions and rejects others under Section 145(3)
- If the books are rejected, the entire business income must be estimated - not just the "suspicious" portion
- The burden shifts to the Revenue to prove total unreliability, not selective unreliability
Estimation Must Be Based on Total Turnover
- When estimating income under Section 145(3), the base must be total turnover, not partial receipts
- Comparative profitability analysis over multiple years is a valid and preferred method
- Declared income higher than the estimated amount must be accepted unless proven fraudulent
Documentation Gaps Do Not Automatically Justify Rejection
- Minor lapses in documentation (e.g., missing addresses) do not warrant full book rejection if the overall pattern is consistent
- Inspector’s reports, bank statements, and ledger entries with corroborative evidence must be given due weight
- The Tribunal’s reliance on historical profitability trends sets a precedent for reasonable estimation over arbitrary rates
