Labour expense disallowance needs evidence of sham payments, while rough diamond polishing is not manufacture for section 80-IA.

Estimated disallowance of labour charges could not be sustained where the assessee produced contractor agreements, payment details and vouchers, and there was no material showing the payments were sham, inflated or unsupported by the books; the disallowance was therefore deleted. Cutting and polishing rough diamonds did not amount to manufacture or production for section 80-IA, because the section requires an industrial undertaking engaged in manufacturing or production and the broader definition in another provision could not be imported into it; the deduction claim was rejected.

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Issues: (i) Whether the disallowance out of labour charges paid to job contractors was sustainable under section 37 of the Income-tax Act, 1961; (ii) Whether cutting and polishing of rough diamonds qualified the assessee for deduction under section 80-IA of the Income-tax Act, 1961.

Issue (i): Whether the disallowance out of labour charges paid to job contractors was sustainable under section 37 of the Income-tax Act, 1961.

Analysis: The assessee had produced agreements with contractors, payment details and supporting vouchers. The work was entrusted to job contractors, who engaged the labourers, and there was no material to show that the assessee had made excessive payment merely to suppress gross profit. In the absence of evidence that the payments were sham, inflated, or unsupported by the books, an -based disallowance could not stand.

Conclusion: The disallowance out of labour charges was not sustainable and was deleted, in favour of the assessee.

Issue (ii): Whether cutting and polishing of rough diamonds qualified the assessee for deduction under section 80-IA of the Income-tax Act, 1961.

Analysis: Deduction under section 80-IA required an industrial undertaking to be engaged in manufacture or production of an article or thing. The wider definition of industrial undertaking in section 33B did not by itself satisfy that condition. The Explanation to section 10A, which treated cutting and polishing of precious and semi-precious stones as manufacture or production, was confined to that section and could not be imported into section 80-IA. The governing principle remained that conversion of rough diamonds into polished diamonds was not manufacture or production for section 80-IA purposes.

Conclusion: The claim for deduction under section 80-IA was rightly rejected and the assessee was not entitled to the deduction.

Final Conclusion: Relief was granted on the labour-expense disallowance, but the denial of deduction under section 80-IA was upheld.

Ratio Decidendi: An estimated disallowance of business expenditure cannot be sustained without material showing that the payments were excessive, sham, or not genuine, and cutting and polishing of rough diamonds does not amount to manufacture or production for the purposes of section 80-IA.

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