2025 (9) TMI 904 - AT - Income Tax

INR 2.08 crore purchase credits allowed; remaining purchases hit with 25% disallowance (INR 45.32 lakh)

ITAT DELHI - AT held that credits totaling INR 2,08,52,538 representing purchases during the year are to be allowed, but the assessee failed to prove ... Additions of the closing balance of 27 creditors - Unexplained expenditure - Onus to Prove the Genuineness of Creditors - Non-Compliance Despite Sufficient Opportunity - Admission by the Assessee During Appellate Proceedings - HELD THAT:-Considering the facts that entire outstanding balances were squared off by making payment in subsequent years in cash to these parties, we are not unable to accept the contentions of the assessee intoto and therefore, as against total addition we direct the AO to consider the credits to the extent of INR 2,08,52,538/- being the amount of purchase made during the year and claimed the expenditure. It is further directed that out of the purchase made from alleged 27 parties made from M/s. Erica Enterprises Pvt. Ltd. could not be doubted therefore, the remaining purchase could be considered as purchase which was claimed as expenses and for which assessee has not able to discharge the burden of proving the genuineness of the parties. To sum up the issue and in the larger interest of justice, we hold that disallowance @ 25% of the remaining purchase of INR 1,81,29,900/- would be reasonable to meet the end of justice for any possible leakage of revenue. Accordingly, we direct the AO to disallow a sum of INR 45,32,475/- (25% of INR 1,81,29,900/-) on account of purchase made from the alleged 27 parties as unexplained expenditure. Therefore, grounds raised by the assessee are partly allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer's addition of closing sundry creditors as bogus (aggregate amount) is sustainable where the assessee has recorded purchases from those creditors and sales (realisation) of the purchased goods have been accepted. 2. What is the legal burden and evidentiary standard on an assessee to prove identity, existence and genuineness of sundry creditors when challenged by the Revenue (including the relevance of notices issued under section 133(6) and enquiries by departmental inspectors)? 3. Whether, and to what extent, expenditure claimed as purchases can be allowed under section 37(1) of the Income-tax Act when the creditor is alleged to be non-existent or unverifiable - i.e., whether disallowance must be confined to purchases shown in the profit & loss account for the year rather than to entire closing balances. 4. Whether secondary indicia (audit under section 44AB, VAT returns/input tax credits, pattern of gross profit, mode of subsequent payments in cash) can negate or support the genuineness of creditors and related purchases. 5. What remedial or proportionate adjustment (if any) is appropriate where some purchases are accepted/established but the assessee fails to satisfactorily prove genuineness for the remainder of the claimed creditors (including the quantum of a reasonable disallowance to meet possible leakage of revenue)? ISSUE-WISE DETAILED ANALYSIS Issue 1 - Sustainment of AO's aggregate addition of closing sundry creditors where sales are accepted Legal framework: The statutory scheme places onus on the assessee to substantiate liabilities recorded in books; where expenditure is claimed for business purposes, allowability is governed by section 37(1). AO may treat undocumented/ unproved liabilities as unexplained income or disallow expenditure when genuineness/subsistence is not proved. Precedent treatment: The Tribunal was remitted by the High Court to examine the matter specifically in the light of section 37(1); the High Court did not disturb other factual findings on genuineness but required express consideration whether expenditure should be allowed as wholly and exclusively for business. Interpretation and reasoning: The Tribunal examined ledger copies, VAT returns, inspector reports and postal remarks. It found (a) acceptance of sales indicates goods were accounted for and turned into sales, (b) AO had added entire closing balances rather than matching disallowance to purchases claimed in the year, and (c) one creditor's purchases (Erica Enterprises) were accepted on evidentiary material and corresponding addition deleted. The Tribunal reasoned that if purchases were recorded and sold, the input cannot be doubted in toto; the real issue is whether bills/credits correspond to the recorded creditor names or are merely vouchers obtained from third parties. Ratio vs. Obiter: Ratio - an addition of entire closing balances is unsustainable where purchases forming part of those balances have been claimed and goods sold; the correct inquiry is into allowability of expenditure under section 37(1) rather than mechanically adding back closing creditor balances. Obiter - general observations on VAT acceptance not being conclusive probative value. Conclusion: AO's aggregate addition of closing balances cannot stand without consideration of purchases claimed and allowability under section 37(1); the Tribunal deleted the amount attributable to a specifically verified creditor and remitted the remainder for proportionate treatment (see Issue 5 below). Issue 2 - Burden and evidentiary standard to prove identity, existence and genuineness of sundry creditors Legal framework: Where liabilities are disputed, the assessee bears the primary burden of proof to show identity, existence and genuineness. Notices under section 133(6) and enquiries under section 142(1) are legitimate fact-finding tools for the AO; adverse postal remarks and inspector reports are relevant secondary evidence. Precedent treatment: Authorities recognise that non-service/ adverse postal remarks coupled with failure to produce confirmations or third-party evidence permit the AO to draw adverse inference; however, such inference must be balanced against available documentary evidence proving economic reality (e.g., purchase ledgers, VAT inputs, bank payments). Interpretation and reasoning: The Tribunal accepted that notices under section 133(6) to 27 creditors produced numerous returns marked 'no such firm/ wrong address/ incomplete address', and that departmental field enquiry supported non-traceability. The Tribunal nevertheless emphasized that where purchases recorded in the year are supported by contemporaneous entries and sales, the focus is whether the expenditure was incurred for business purposes (section 37(1)), and not solely the formal existence of creditor entities. Ratio vs. Obiter: Ratio - absence of confirmations and adverse postal/inspection reports supply cogent evidence to challenge liabilities; but such evidence does not automatically extinguish allowance of purchase expenditure if independent proof of purchase/consumption exists. Obiter - criticisms of reliance on VAT/audit as conclusive proof. Conclusion: The assessee failed to discharge the onus in respect of a substantial portion of creditors (absence of confirmations, adverse postal remarks, and cash mode of later payments); that permits the AO to treat the unproved portion as suspect, but does not ipso facto negate purchases proven by contemporaneous records and subsequent acceptance. Issue 3 - Applicability and scope of section 37(1) where creditors are alleged non-existent; distinction between purchases in P&L and closing balances Legal framework: Section 37(1) allows deduction for expenditure wholly and exclusively laid out for business. Additions under other provisions (e.g., as unexplained liabilities) must be reconciled with the allowance under section 37(1) if the expense was actually incurred and recorded in the profit & loss account. Precedent treatment: The High Court directed re-examination under section 37(1), indicating that Tribunal's earlier order lacked specific findings on allowability as business expenditure. The principle adopted is that disallowance should not exceed the amount of expenditure claimed in the relevant year. Interpretation and reasoning: The Tribunal held that the AO had added closing balances rather than limiting disallowance to purchases claimed during the year. It accepted evidence that purchases aggregating INR 2,08,52,538 were made during the year; one creditor's purchases were specifically verified and allowed. Consequently, addition confined to entire closing balances is inappropriate; the correct approach is to test allowability of purchases under section 37(1), with due regard to supporting evidence. Ratio vs. Obiter: Ratio - disallowance should be confined to the quantum of purchases claimed in the year that cannot be substantiated under section 37(1); whole-balance additions are impermissible where part of the purchases are otherwise established. Obiter - remarks on mechanics of matching opening balances and prior years. Conclusion: Section 37(1) entitles allowance of expenditure that is proved to be wholly and exclusively for business even if creditor identity is questioned; therefore the Tribunal directed AO to consider purchases of INR 2,08,52,538 and not make a blanket addition of closing balances. Issue 4 - Relevance of secondary indicia: VAT returns, audited books, gross profit pattern, and subsequent cash payments Legal framework: Secondary indicia can corroborate or detract from the genuineness of recorded transactions; audited books or VAT filings are relevant but not conclusive - Income-tax authorities may require corroborative third-party evidence where genuineness is contested. Precedent treatment: Acceptance by other authorities (VAT) or audit does not automatically preclude Income-tax additions when primary verification (confirmations, verifiable addresses) is absent. Interpretation and reasoning: The Tribunal noted that while VAT returns reflected input tax claims, the particulars of supplier parties in VAT returns were not verifiable from the returns. The regular pattern of gross profit was relied upon by the assessee to argue commercial impossibility of disallowance, but the Tribunal found that the mode of subsequent payments - cash, often below INR 20,000 on frequent occasions - raised serious suspicion and undermined the probative value of book entries. Hence such secondary indicia were not determinative in favour of the assessee. Ratio vs. Obiter: Ratio - VAT returns and audit reports do not substitute for primary evidence of creditor existence; suspicious patterns of payment (small cash payments) can be a factor justifying disallowance. Obiter - commentary on commercial practicability of daily sub-20,000 cash settlements. Conclusion: Secondary indicia were insufficient to discharge the burden for a large portion of creditors; however, where specific contemporaneous and subsequent documentary proof existed (as with one creditor), that portion was allowed. Issue 5 - Appropriate remedial/proportionate adjustment where part of purchases are established and remainder unproved (quantum of disallowance) Legal framework: Tribunal has discretion to make proportionate adjustments where part of claim is substantiated and part is not; such adjustments aim to balance revenue protection with fairness to assessee and must be supported by reasoning and quantification. Precedent treatment: In cases of mixed evidence, tribunals have applied proportionate disallowances rather than blanket additions, applying a reasonable estimate to meet revenue concerns. Interpretation and reasoning: The Tribunal accepted purchases of INR 2,08,52,538 (including fully accepted purchases from one creditor). For the remaining unproved portion (INR 1,81,29,900), the Tribunal, applying a pragmatic standard to prevent undue hardship and to meet possible revenue leakage, disallowed 25% (INR 45,32,475) as unexplained expenditure. The Tribunal deleted the AO's addition in part (allowed specific verified amounts) and upheld a proportionate disallowance for the unverified remainder. Ratio vs. Obiter: Ratio - where a portion of claimed purchases is unproved and evidence is mixed, a quantified, reasonable percentage disallowance is an appropriate remedy to reconcile competing interests. Obiter - the specific choice of 25% was treated as reasonable on the facts; other facts may justify different percentages. Conclusion: The Tribunal partly allowed the appeal: deletion of the addition to the extent of purchases proved (including full allowance for the specifically verified creditor) and directed disallowance of 25% of the remaining unproven purchases, thereby quantifying the revenue adjustment as a balanced remedy.