2025 (4) TMI 1566 - AT - Income Tax

ITAT deletes 25% ad-hoc disallowance of expenses without rejecting books or proving specific defects

ITAT Delhi allowed the assessee's appeal against AO's 25% disallowance of various expenditures. The Tribunal found that AO failed to provide rational ... Disallowance @ 25% of various expenditure - non rejection of books of accounts - whether AO has not followed the direction of the DRP? - HELD THAT:- The voluminous evidence regarding the expenses were submitted before the AO. The copies of those documents, addition evidence, submission, etc. were also furnished before us in the paper book with the certification that these were dully submitted before the lower authorities. AO had not consider the additional evidence submitted before the DRP and that is why he has not made any comment thereon. AO is duty bound to incorporate the specific directions issued by the DRP in the relevant para of the assessment order and do needful accordingly. DRP directed the AO to reconsider and verify the submissions (including additional evidence) before completing the assessment. DRP direction did not mandate the AO to provide opportunity of being heard to the assessee on this score. From the perusal of the final assessment order, it is not evident that whether the AO followed the direction of the DRP in this regard as there is no such mention in the final assessment order. Thus, it cannot be held that the AO has not followed the direction of the DRP in this regard as it cannot be ruled out that the verifications of submission might have not resulted new facts other than those mentioned the draft assessment order. Hence, the argument AO had failed to carry out the statutory duty to abide by the direction of the DRP as the AO had not issued any notice to the assessee, nor did he independently examine the additional evidence filed by the assessee before the DRP is held to have no merit. AO has adopted an ad-hoc percentage of 25% to make a disallowance out of certain expenses. AO has not given any rational basis for the same except holding that the assessee has not filed details of employee cost of Rs. 16.40 Crores and Marketing expenses of Rs. 148.00 Crores. however, the facts are contrary as evident from the Paper book and statement at Bar by the Ld. Counsel that the assessee has submitted these details much time ahead of the draft assessment order. As per various benches of the Tribunal on the issue of the disallowability of expenses on ad-hoc basis without rejecting the books of accounts. In the present case the AO has not specify any shortcoming/discrepancy in the bills, vouchers, etc. in the expenses. The books of accounts have not been rejected by the AO. AO has not pointed out that any part of the expenditure in question is either found to be bogus or fictitious nor is found to have not been incurred by the assessee wholly and exclusively for business. There is no mention of rationale in arriving at the percentile of disallowance in the instant case. Further, there is no clear findings as to the number of bills and vouchers requiring denial of allowances with the amount of expenditure and nature of defects therein or therewith. AO’s action (25% disallowance out of certain expenses) is hereby deleted. Appeal of the assessee is allowed. Issues Presented and ConsideredThe primary legal issue considered by the Tribunal in this appeal pertains to the validity and justification of the disallowance of expenses amounting to Rs. 44,25,00,000/- made by the Assessing Officer (AO) under section 143(3) read with section 144C(13) of the Income Tax Act, 1961 (the Act) for the Assessment Year 2018-19. Specifically, the Tribunal examined whether the AO was justified in disallowing 25% of various expenses aggregating to Rs. 177 crores on an ad-hoc basis without rejecting the assessee's books of accounts or pointing out specific discrepancies in the submitted evidence.Other grounds raised by the assessee, including those relating to Transfer Pricing Adjustments amounting to Rs. 69,24,50,000/-, were not pressed during the hearing and were therefore dismissed. The appeal thus focused solely on the disallowance of expenses.Issue-wise Detailed Analysis1. Validity of Disallowance of 25% of Certain ExpensesRelevant Legal Framework and Precedents: Under the Income Tax Act, expenses claimed by an assessee are deductible if they are incurred wholly and exclusively for the purpose of business or profession. The burden lies on the assessee to prove the genuineness of such expenses. However, disallowance on an ad-hoc basis without specific reasons or rejection of books of accounts is generally not sustainable. Precedents emphasize that the AO must point out specific defects in the evidence or books to justify any disallowance.Court's Interpretation and Reasoning: The Tribunal observed that the AO initially proposed a disallowance of Rs. 3 crores in the draft assessment order but enhanced it to Rs. 44.25 crores in the final assessment order without providing any new material or specific rationale. The AO's finding in the draft order acknowledged that the assessee had provided details for certain expenses and no adverse inference was drawn in respect of those. Contrarily, in the final order, the AO disallowed 25% of total expenses aggregating to Rs. 177 crores, citing failure to submit details, which the Tribunal found factually incorrect given the voluminous evidence submitted by the assessee before both the AO and the Dispute Resolution Panel (DRP).Key Evidence and Findings: The assessee had submitted extensive documentation, including details of salaries, marketing expenses, warehousing charges, service expenses, legal and professional fees, traveling expenses, and miscellaneous expenses. These submissions were made prior to the draft order and again pursuant to DRP directions. The Tribunal noted that the AO did not specifically address or discredit this evidence in the final order.Application of Law to Facts: The Tribunal held that since the assessee had fulfilled its onus by submitting detailed evidence and the books of accounts were duly audited under section 44AB of the Act without any adverse remarks, the AO was not justified in making an ad-hoc disallowance of 25% of the expenses. The AO failed to identify any expense as bogus, fictitious, or not incurred wholly and exclusively for business purposes.Treatment of Competing Arguments: The AO argued that the assessee failed to provide complete details, particularly regarding TDS deduction certificates and genuineness of marketing and other expenses, justifying the disallowance. The assessee contended that such details were furnished, and the AO's enhancement of disallowance lacked any basis or reasoning. The Tribunal sided with the assessee, emphasizing the absence of any specific shortcoming pointed out by the AO and the lack of any rejection of books of accounts.Conclusions: The Tribunal concluded that the AO's action of disallowing Rs. 44.25 crores on an ad-hoc basis without proper justification or rejection of books was unjustified and unsustainable.2. Compliance with DRP DirectionsRelevant Legal Framework: Under the Act, the DRP issues directions to the AO to reconsider objections raised by the assessee. The AO is duty bound to follow these directions and incorporate them in the final assessment order.Court's Interpretation and Reasoning: The DRP had directed the AO to reconsider the assessee's submissions and additional evidence regarding the disallowance of expenses. The Tribunal observed that the final assessment order did not explicitly mention the AO's consideration of the additional evidence submitted before the DRP. However, it could not be conclusively held that the AO did not follow the DRP's directions, as the AO might have verified the submissions without recording specific comments.Key Findings: The Tribunal rejected the assessee's contention that the AO failed to carry out statutory duties by not providing a further opportunity of hearing or independently examining the additional evidence before the DRP. The DRP directions did not mandate such opportunity, and absence of explicit mention in the final order did not imply non-compliance.Application of Law to Facts: The Tribunal held that since the AO's final order did not contradict the DRP's directions and there was no evidence of non-compliance, the AO's procedural conduct was not faulted.Conclusions: The AO was deemed to have complied with DRP directions, and the argument of procedural lapse was dismissed.Significant Holdings'It is hereby held that the AO has not pointed out that any part of the expenditure in question is either found to be bogus or fictitious nor is found to have not been incurred by the assessee wholly and exclusively for business.''There is no mention of rationale in arriving at the percentile of disallowance in the instant case. Further, there is no clear findings as to the number of bills and vouchers requiring denial of allowances with the amount of expenditure and nature of defects therein or therewith.''The AO has not given any reasoning for enhancing the disallowance to Rs. 44,25,00,000/- in the final assessment order than the proposed disallowance of Rs. 3,00,00,000/- in the draft assessment order.''The Revenue has not brought out any deprecative material on the record to substantiate its conclusion as logical particularly when the AO has not rejected the books of the assessee.''Hence, the AO's action ((25% disallowance out of certain expenses aggregating to Rs. 177.00 Crores), in view of the details mentioned above and in para 5.2 of this order is held unjustified. Consequentially, the disallowance of Rs. 44,25,00,000/- made in the impugned order is hereby deleted.'Core principles established include the requirement that the AO must provide specific reasons and evidence to justify disallowance of expenses, especially when books of accounts are not rejected, and that ad-hoc disallowances without rational basis are impermissible. The AO must consider and incorporate DRP directions and examine additional evidence submitted by the assessee.Final determination on the sole issue was that the disallowance of Rs. 44,25,00,000/- was unjustified and was consequently deleted, allowing the appeal of the assessee.