ITAT Mumbai deletes commission income additions in circular trading case, finds no evidence of payments

ITAT Mumbai held that no commission income could be presumed against the assessee in circular trading transactions. The AO estimated 3% commission on total sales/purchases while CIT(A) reduced it to 1%. However, since the assessment order of the primary entity involved in circular trading contained no findings of commission payments to the assessee, no addition was justified. The tribunal also deleted adhoc additions on salary and wages, noting the AO failed to identify specific defects in expense verification despite the assessee maintaining substantial turnover in mobile and electronic goods trading.

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The core legal questions considered in this judgment revolve around the validity of reopening assessments under section 147 of the Income Tax Act, 1961, the correctness of estimating income or expenses arising from alleged circular trading transactions, and the appropriateness of adhoc disallowances of salary, wages, and commission expenses. Specifically, the issues include:

• Whether the reasons recorded by the Assessing Officer (AO) to reopen the assessments under section 147 for the Assessment Years (AY) 2016-17 and 2017-18 were valid and based on tangible material, or merely conjectural and insufficient to justify reopening.
• The legitimacy of imputing commission income at a specified percentage (3%) on the quantum of circular trading transactions, and whether such estimation was supported by evidence or merely guesswork.
• The correctness of the AO's and Commissioner of Income Tax (Appeals) [CIT(A)]'s estimation of unexplained expenses arising from circular trading for AY 2018-19, including the rate adopted for commission and the disallowance of salary and wages.
• The treatment of competing evidence and statements recorded during survey and search proceedings, particularly regarding whether circular trading transactions resulted in any profit or commission income to the assessee.
• The applicability and interpretation of section 69C of the Income Tax Act in estimating unexplained expenditure from circular trading.

Issue-Wise Detailed Analysis

1. Validity of Reopening Assessments under Section 147 for AY 2016-17 and 2017-18

The reopening of assessments was premised on information received from survey and search operations involving related entities engaged in alleged circular trading. The AO recorded reasons stating that the assessee's proprietary concern was involved in circular trading with two other entities, and that the assessee must have earned commission income at least at 3% of the total purchases and sales aggregating approximately Rs. 142.95 crores. The AO relied on statements recorded under section 131 and survey findings to form a "reason to believe" that income had escaped assessment, thus justifying issuance of notice under section 148.

The Court examined the reasons recorded and found them to be primarily based on presumption and conjecture. The AO's conclusion that commission "must have been" charged was not supported by any direct evidence or material indicating the existence of such commission income. The statements recorded during survey explicitly stated that circular trading was undertaken at the same price and that no benefit or profit accrued to the assessee or the related entities. The AO failed to demonstrate how the information or material before him indicated a specific income escaping assessment rather than relying on guesswork.

The Court emphasized the settled legal principle that reopening under section 147 requires a tangible and relevant material forming a prima facie basis to believe that income chargeable to tax has escaped assessment. The AO's reliance on an estimated 3% commission without any corroborative evidence or nexus to the material was held to be insufficient to vest jurisdiction for reopening. The Court noted that the AO did not apply independent mind to ascertain whether the information was sufficient for reopening.

Further, the Court observed that in the assessment order of one of the related entities (KGR Enterprises Pvt. Ltd.), which was part of the circular trading chain, no addition or allegation was made regarding payment of commission to the assessee. This absence of corroboration in the related entity's assessment further weakened the AO's case for presuming commission income in the assessee's hands.

Consequently, the Court concluded that the reasons recorded did not justify reopening assessments under section 147 for AY 2016-17 and 2017-18 and quashed the reassessment proceedings. The merits of additions made in these years were held to be academic due to quashing of reassessment.

2. Estimation of Commission and Unexplained Expenses for AY 2018-19

For AY 2018-19, the AO again relied on information from survey proceedings indicating circular trading among three entities, including the assessee. The AO estimated commission income at 3% of total sales and purchases aggregating over Rs. 505 crore and disallowed salary, wages, and commission expenses on an adhoc basis. The CIT(A) reduced the commission estimate from 3% to 1%, following precedents of the Tribunal from various jurisdictions where rates ranging from 0.05% to 2% had been adopted for estimating unexplained expenses in circular trading cases.

The Court noted that the existence of circular trading was not disputed. However, the question was whether commission income or unexplained expenses could be imputed to the assessee without specific evidence. The Court reiterated that estimation of commission or expenses must be supported by some finding or material indicating such payment or benefit. The statements from the related entity (KGR Enterprises Pvt. Ltd.) and the assessee's own statements recorded under section 131 negated any profit or benefit from circular trading, and there was no evidence of commission payment.

The Court further held that the AO's estimation of commission at 3% was arbitrary and not supported by evidence. The CIT(A)'s reduction to 1% was in line with judicial precedents and was a reasonable approach to estimating unexplained expenses under section 69C. However, since there was no evidence of commission income or payment, the Court deleted the addition of commission income and adhoc disallowances of salary and wages, noting that no specific defect or unverifiability of these expenses was pointed out by the AO.

The Court emphasized that mere circular trading does not automatically imply benefit or commission income to all parties involved, especially when the statements on oath negate such benefit. The purpose of circular trading in this case was found to be for saving bank guarantee commission rather than generating profit or commission income.

3. Treatment of Evidence and Competing Arguments

The Court carefully analyzed the statements recorded under section 131 and survey findings, which consistently indicated that circular trading was conducted at the same price and that no profit or commission was earned by the assessee or related entities. The AO's reliance on these statements to infer commission income was rejected as speculative.

The Revenue's argument that circular trading by its nature implies commission or profit was countered by the Court's observation that such inference cannot replace concrete evidence. The Court held that the AO's duty is to apply independent mind and base reopening on tangible material, not on surmise or conjecture.

The Court also noted the inconsistency in the AO's approach, where in the related entity's assessment no commission payment was found, yet in the assessee's case commission income was presumed. This inconsistency undermined the AO's case.

4. Application of Section 69C and Legal Precedents

The CIT(A) applied section 69C for estimating unexplained expenditure arising from circular trading and adopted a 1% rate for commission expenses, following precedents from Mumbai and Ahmedabad Tribunals. The Court found this approach reasonable and consistent with judicial practice.

However, the Court held that in the absence of any evidence of commission income or payment, such estimation cannot be made against the assessee. The Court's decision aligns with the principle that estimation under section 69C must be based on credible material and not mere assumptions.

Significant Holdings

"The reasons recorded are purely based on guess work and conjecture that circular trading might have resulted in some kind of commission income."

"The element of income escaping assessment should have live link nexus with the material / information coming on record. In other words, the material itself should indicate specific nature of income and not that income has to be inferred by some guess work based on some estimate."

"Circular trading per se may create a doubt but that does not lead to concrete inference that assessee is benefitted by such circular trading."

"The reasons recorded by the ld.AO do not clothe the ld. AO the jurisdiction to reopen the assessment u/s. 147 merely based on some guess work or estimate."

"No addition can be made in the hands of the assessee in absence of any finding or material or evidence found in the course of search / survey in the case of related entity that some unaccounted commission has been paid."

"Mere circular trading does not automatically imply benefit or commission income to all parties involved, especially when the statements on oath negate such benefit."

"Estimation of unexplained expenditure under section 69C must be based on credible material and not mere assumptions."

In conclusion, the Court quashed the reopening and reassessment orders for AY 2016-17 and 2017-18 due to lack of valid reasons recorded and evidence. For AY 2018-19, the Court deleted additions relating to commission income and adhoc disallowances of salary and wages, holding that the AO failed to establish any nexus between circular trading and commission income or unexplained expenses beyond reasonable doubt. The Court upheld the principle that reopening of assessment requires tangible material indicating escaped income and that estimation of income or expenses must be grounded in evidence rather than conjecture.

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