Revenue's appeals dismissed for unexplained investment additions under Section 69 without proper confrontation or nexus establishment

The ITAT Ahmedabad dismissed the Revenue's appeals regarding additions under Section 69 read with Section 115BBE for unexplained investment in stock based on seized documents. The AO made additions solely relying on a third party's statement without confronting the assessee, despite the assessee producing ledger accounts showing regular recorded transactions. The AO improperly rejected books of account without following Section 145(3) provisions and failed to establish any nexus between alleged cash sales and the assessee. The CIT(A)'s deletion of additions was upheld as no party admitted the seized documents related to unaccounted purchases.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these appeals filed by the Revenue against the CIT(A)'s order under Section 250 of the Income-tax Act, 1961, for AYs 2020-21 and 2021-22 are:

• Whether the addition of unexplained investment in stock under Section 69 read with Section 115BBE of the Act, made by the Assessing Officer (AO) based on seized documents and statements recorded during search and post-search proceedings, was justified or rightly deleted by the CIT(A).
• Whether the addition made by the AO on account of estimation of gross profit on unaccounted purchases, relying on seized documents and statements recorded during search/post-search proceedings, was sustainable or rightly deleted by the CIT(A).
• Whether the AO was justified in rejecting the books of accounts under Section 145(3) of the Act on the ground that the trading results did not depict completeness and correctness, particularly when the assessee maintained audited books and had filed returns.
• Whether the AO properly applied the evidentiary value of statements recorded under Section 132(4) and Section 131(1) of the Act, including the statements of third parties, without allowing cross-examination or confronting the assessee with seized documents.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Legitimacy of Addition of Unexplained Investment in Stock under Section 69 r.w.s. 115BBE

Relevant Legal Framework and Precedents: Section 69 of the Income-tax Act pertains to unexplained investments and allows the AO to treat such investments as income if the assessee fails to satisfactorily explain the source. Section 115BBE imposes a special rate of tax on such unexplained income. The provisions require that the AO establish a nexus between the unexplained investment and the assessee's income, supported by credible evidence.

Court's Interpretation and Reasoning: The AO relied on seized documents and statements recorded during search under Section 132 and post-search proceedings to conclude that the assessee made unaccounted purchases of tobacco and other products from M/s Zen Industries Pvt. Ltd. and related entities. The AO treated the investment in stock as unexplained and added Rs. 59,08,859/- for AY 2020-21 and Rs. 1,47,07,050/- for AY 2021-22 accordingly.

The CIT(A) deleted these additions after observing that the seized documents did not contain vital details such as the name of the assessee, quantity, description, rate of items, delivery details, payment mode, or any cash trail linking the transactions to the assessee. The CIT(A) also noted that neither the assessee nor the sellers admitted the transactions during the search or post-search statements. The CIT(A) further observed that the AO failed to confront the assessee with the seized documents or allow cross-examination of the third-party witness whose statements were relied upon.

Key Evidence and Findings: The AO's main evidence was the statement of Shri Mayank Ashokbhai Khatri, an employee of a third party, and loose papers seized from his vehicle. However, the assessee produced ledger accounts showing regular recorded transactions with Zen Group, and the statements of Shri Rashmin Majithia, director of the seller companies, denied any connection with the alleged transactions. The AO did not confront the assessee with the seized documents or allow cross-examination of the third-party witness, which was highlighted by the CIT(A) and the Tribunal.

Application of Law to Facts: The Tribunal emphasized that the AO's rejection of books and addition under Section 69 must be based on cogent evidence linking the unexplained investment to the assessee. The absence of direct evidence, failure to confront the assessee with seized documents, and ignoring exculpatory statements of the seller's director undermined the AO's case. The Tribunal held that the CIT(A) rightly deleted the addition as the AO failed to establish the nexus required under Section 69.

Treatment of Competing Arguments: The Revenue argued that the seized documents and statements clearly showed unaccounted purchases and that the AO rightly rejected the books under Section 145(3). The assessee contended that the AO's reliance on third-party statements without cross-examination violated principles of natural justice and that the books were regularly maintained and audited. The Tribunal accepted the assessee's arguments, noting the procedural lapses and lack of substantive evidence by the AO.

Conclusion: The addition of unexplained investment in stock under Section 69 r.w.s. 115BBE was not sustainable and rightly deleted by the CIT(A). The Tribunal dismissed the Revenue's appeal on this issue.

Issue 2: Addition on Account of Estimation of Gross Profit on Unaccounted Purchase

Relevant Legal Framework and Precedents: Section 145(3) empowers the AO to reject the books of account if they do not depict the true income. In such cases, the AO may estimate income on a reasonable basis, including estimation of gross profit on unaccounted purchases. However, such estimation must be based on reliable evidence and proper application of mind.

Court's Interpretation and Reasoning: The AO estimated gross profit on alleged unaccounted purchases amounting to Rs. 11,16,31,500/- for AY 2020-21 and Rs. 5,92,40,000/- for AY 2021-22. The AO's basis was the seized documents and statements indicating unrecorded purchases. The AO rejected the books of account under Section 145(3) for lack of completeness.

The CIT(A) and the Tribunal found that the AO did not provide any cogent reasons or basis for rejection of books other than the absence of cash sales records, which were destroyed daily as per the assessee's explanation. The AO failed to establish that the books were incomplete or incorrect. The Tribunal noted that the assessee maintained audited books and filed returns accordingly.

Key Evidence and Findings: The Tribunal highlighted that the AO's estimation was based solely on unverified third-party statements and seized documents lacking essential details. The assessee's ledger accounts and explanations were not adequately considered. The CIT(A) found no evidence of unrecorded cash payments or excess stock during the search. The AO's estimation was thus arbitrary and not supported by sufficient material.

Application of Law to Facts: The Tribunal held that estimation under Section 145(3) requires a valid reason to reject books and a reasonable basis for estimation. The AO failed to demonstrate either. The absence of confrontation with the assessee and ignoring contradictory statements further vitiated the AO's findings.

Treatment of Competing Arguments: The Revenue maintained that the AO's estimation was justified based on search results and third-party statements. The assessee argued that the AO's rejection of books was unjustified, and the estimation was arbitrary and not based on any cogent material. The Tribunal sided with the assessee, emphasizing procedural fairness and evidentiary requirements.

Conclusion: The addition on account of estimation of gross profit on unaccounted purchases was not sustainable. The CIT(A)'s deletion of this addition was upheld by the Tribunal.

Issue 3: Validity of Rejection of Books of Account under Section 145(3)

Relevant Legal Framework and Precedents: Section 145(3) allows the AO to reject books if they do not depict the true income. The AO must record reasons for rejection and base the rejection on material evidence. The assessee's right to maintain books and have them accepted unless disproved is a recognized principle.

Court's Interpretation and Reasoning: The AO rejected the books solely on the ground that the assessee did not maintain records of cash sales (DSR) beyond daily entries which were destroyed. No other deficiencies were pointed out. The Tribunal found this insufficient to reject books, especially when the assessee maintained audited books and filed returns.

Key Evidence and Findings: The Tribunal noted that the AO did not specify any material irregularity or discrepancy in the books. The assessee produced ledger accounts and explanations for the destroyed DSR. The AO's rejection appeared to be a pretext to make additions based on unverified third-party statements.

Application of Law to Facts: The Tribunal held that rejection of books requires cogent reasons and cannot be based on mere absence of auxiliary records if the main books are regular and audited. The AO's failure to follow the procedure and record reasons vitiated the rejection.

Treatment of Competing Arguments: The Revenue contended that the absence of DSR and unrecorded cash sales justified rejection. The assessee argued that the main books were complete and regularly audited and the AO did not establish any material discrepancy. The Tribunal accepted the assessee's contentions.

Conclusion: The rejection of books under Section 145(3) was not justified. The CIT(A)'s acceptance of books was upheld.

Issue 4: Reliance on Third-Party Statements and Procedural Fairness

Relevant Legal Framework and Precedents: Statements recorded under Sections 132(4) and 131(1) of the Act are admissible but the assessee must be afforded an opportunity to cross-examine or confront adverse statements to comply with principles of natural justice.

Court's Interpretation and Reasoning: The AO relied heavily on the statement of Shri Mayank Ashokbhai Khatri, an employee of a third party, and seized loose papers to make additions. However, the AO did not allow cross-examination of this witness nor confronted the assessee with the seized documents. The statement of Shri Rashmin Majithia, director of the seller companies, denying any connection with the alleged transactions, was ignored.

Key Evidence and Findings: The Tribunal observed that the AO's selective reliance on statements without affording the assessee a chance to test their veracity amounted to non-application of mind and violation of natural justice. The assessee's statements denying the transactions and the absence of any corroborative evidence were significant.

Application of Law to Facts: The Tribunal held that the AO cannot base additions solely on third-party statements without confronting the assessee or allowing cross-examination. The failure to do so rendered the AO's findings unsustainable.

Treatment of Competing Arguments: The Revenue asserted the statements were recorded under statutory provisions and hence admissible. The assessee emphasized the procedural lapses and lack of opportunity to rebut. The Tribunal agreed with the assessee.

Conclusion: The AO's reliance on third-party statements without procedural fairness was improper. The CIT(A)'s deletion of additions based on such statements was affirmed.

3. SIGNIFICANT HOLDINGS

"The statement of Shri Mayank Ashokbhai Khatri was not confronted to the assessee while recording the assessee's statement by the Assessing Officer. Further, the Assessing Officer has not followed the basis given under provisions of Section 145(3) of the Income Tax Act, 1961, but only rejected the said books on the ground that no record of cash sales viz. name of the party, contract no., exact amounts were maintained by the assessee as DSR after making entries in tally software and the same was destroyed on daily basis. The Assessing Officer has not given any finding as to on what basis he has arrived on the said conclusion."

"Neither the purchase party i.e. the assessee or his family members nor the seller party i.e. Shri Rashminbhai M. Majithia, Director of M/s Zen Tobacco Pvt. Ltd. & M/s Zen Industries Pvt. Ltd. had admitted in the statement recorded during the course of search action or post search action that the said seized page no. 156 to 159 was related to the assessee or his group concern regarding unaccounted purchase of tobacco or other products."

"The entire Assessment Order is based only on the statement of Shri Mayank Khatri which was not even verifiable from the evidences produced by the Assessee. The Assessing Officer has not established the nexus of cash sale to the Zen Group to the assessee concern."

"There is no need to interfere with the findings of the CIT(A). Thus, ITA No. 1888/Ahd/2024 for A.Y. 2020-21 filed by the Revenue is dismissed."

Core principles established include the necessity for the AO to:

• Establish a clear nexus between unexplained investment and the assessee with credible evidence before making additions under Section 69.
• Provide cogent reasons and material basis before rejecting books of account under Section 145(3).
• Afford the assessee an opportunity to confront adverse evidence and cross-examine witnesses whose statements are relied upon.
• Not rely solely on third-party statements or unverified seized documents without corroboration and procedural fairness.

The final determinations on each issue were that the additions made by the AO on account of unexplained investment and estimation of gross profit were rightly deleted by the CIT(A), and the rejection of books under Section 145(3) was not justified. The Tribunal dismissed the Revenue's appeals for both AYs 2020-21 and 2021-22 accordingly.

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