AO cannot make adhoc disallowance without rejecting audited books under Section 44AB, says ITAT ruling

The ITAT Bangalore held that the AO could not make an adhoc disallowance of expenditure without rejecting the assessee's books of accounts, which were duly audited under section 44AB and accepted in prior and subsequent years. The AO's disallowance based on self-made vouchers and suspicion of inflated expenditure was not justified. The net profit rate had increased in the relevant year, further undermining the AO's basis for disallowance. The tribunal allowed the assessee's grounds, ruling that adhoc disallowance without rejecting the books is impermissible.

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ISSUES:

Whether the Assessing Officer (AO) can make disallowance of expenditure on an estimated or adhoc basis without rejecting the books of account under section 145 of the Income Tax Act.Whether disallowance of labour payment and hire and water charges supported only by self-made vouchers without recipient confirmations is justified.Whether the appellant's books of account, audited under section 44AB of the Act, can be disregarded solely on the basis of self-made vouchers.Whether the Commissioner of Income Tax (Appeals) erred in confirming additions made by AO without affording proper opportunity to the appellant.Whether interest levied by AO on the disallowed amount is justified.Whether adhoc disallowance without specific infirmities or rejection of books is sustainable in law.

RULINGS / HOLDINGS:

The AO cannot make any adhoc disallowance of expenditure without first rejecting the books of account under section 145 of the Act; "without rejecting the books of accounts, the ld. AO cannot make any adhoc disallowance."Disallowance of labour charges and related expenses supported by self-made vouchers is not justified merely because the vouchers lack signatures of recipients, especially when the nature of business and volume of transactions are considered; such expenditure is "wholly and exclusively for the purpose of its business."Audited books of account maintained under the mercantile system and audited under section 44AB cannot be disregarded solely on the basis of self-made vouchers; the AO must specify entries considered bogus or unverifiable after rejecting books.The CIT (A) erred in confirming the addition without giving proper opportunity and without conducting any enquiry; the adhoc disallowance "is not legally sustainable."The interest levied by AO on the disallowed amount is not specifically upheld or discussed, but the disallowance itself being deleted implies that interest thereon is also not justified.Adhoc disallowance without rejection of books and without specific infirmities is arbitrary and excessive; "to estimate any disallowance the first and foremost thing is that the A.O. has to reject the books of accounts."

RATIONALE:

The Tribunal applied the legal framework under the Income Tax Act, particularly sections 143(3), 145, and 44AB, emphasizing that estimation of income or disallowance of expenses is permissible only after rejection of books of account.Reliance was placed on precedents including the jurisdictional High Court's decision in CIT Vs. Anil Kumar & Co., which held that "jurisdiction to estimate assessee's income is not available when books of account have not been rejected."The Tribunal also relied on its own earlier decisions and the Karnataka High Court's ruling in Shri Ganesh Shipping Agency, which recognized the legitimacy of business expenditures supported by self-made vouchers in certain trades and rejected adhoc disallowance without proper basis.The Tribunal noted that the AO's disallowance was based on conjectures and surmises without any specific infirmity in the books or vouchers and without conducting sample verification or enquiry.The Tribunal underscored the principle that the AO must reject the books of account after finding them unreliable before making any disallowance, and must specify entries considered bogus or unverifiable.The Tribunal highlighted the commercial realities of the appellant's business, acknowledging that obtaining signatures from casual or illiterate labourers is impractical and that such payments are a normal business practice.The Tribunal noted that the CIT (A)'s confirmation of adhoc disallowance at reduced percentages also lacked legal sanction and was not justified.No dissenting or concurring opinions were noted in the judgment.

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