Disallowance under section 40A(3) remanded for fresh enquiry; failure to verify suppliers and invoke section 250(4)

ITAT Ahmedabad set aside the disallowance made u/s 40A(3) in respect of purchases from three suppliers and remanded the matter to the AO for de novo assessment. The Tribunal held that the AO had not conducted proper enquiry into the identity and existence of suppliers, genuineness of purchases, mode and dates of payment, or the cash trail, nor correlated GST and income-tax records. CIT(A) was found to have mechanically confirmed the disallowance without exercising powers u/s 250(4). Holding that foundational facts for invoking section 40A(3) were not established and natural justice was violated, ITAT restored the issue to the AO with detailed directions and allowed the assessee's appeal for statistical purposes.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether disallowance of purchases under section 40A(3) was sustainable where the Assessing Officer had not identified any specific cash payment in excess of the prescribed limit but presumed cash payments on the basis of suspected genuineness of purchases.

1.2 Whether the enquiry conducted by the Assessing Officer, and the appellate scrutiny by the CIT(A), regarding the genuineness of purchases and the application of section 40A(3), were legally adequate and in conformity with principles of proper investigation.

1.3 Whether, in the circumstances of disputed genuineness of purchases, the addition could be sustained in full or whether the matter required reconsideration including the assessee's alternative plea to restrict addition to the profit element embedded in purchases.

1.4 Whether, in view of factual and investigative deficiencies, the matter warranted restoration to the Assessing Officer for de novo examination with specific directions.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Application of section 40A(3) to disputed purchases without proof of cash payments

Interpretation and reasoning

2.1 The Tribunal noted that the entire disallowance under section 40A(3) was premised on an inference that, since the purchases and suppliers appeared dubious, the banking transactions were merely accommodative and that actual payments were made in cash to unidentified parties.

2.2 It was observed that the Assessing Officer had not identified: (i) any specific party to whom cash was allegedly paid, (ii) any specific date of such payment, or (iii) any specific amount of cash payment exceeding the statutory threshold on any day.

2.3 The Tribunal held that section 40A(3) is triggered by actual cash movement and requires demonstrable evidence of cash payments exceeding the prescribed limit to a person in a day. A presumption of cash payments, without tracing a cash trail or examining bank statements of alleged recipients, is inadequate.

2.4 It was further noted that the Assessing Officer had not brought on record any evidence such as bank statements of the suppliers, cash withdrawal patterns, or fund flow analysis to substantiate the allegation that banking channel payments were not genuine and were substituted by cash payments.

2.5 The Tribunal distinguished the precedents relied upon by the assessee on section 40A(3) by observing that those cases dealt with situations where the genuineness of expenditure was not in doubt and only the mode of payment was at issue, whereas in the present case the core dispute extended to the genuineness of the purchases themselves.

Conclusions

2.6 The Tribunal concluded that the foundational facts required to validly invoke section 40A(3), namely actual cash payments in excess of the prescribed limit, were neither investigated nor established. The disallowance under section 40A(3) could therefore neither be confirmed nor outrightly deleted on the present material and required fresh examination.

Issue 2: Adequacy of enquiry into genuineness of purchases and role of CIT(A)

Legal framework (as discussed)

2.7 The Tribunal referred to the obligation of the Assessing Officer to conduct "proper enquiry" before making additions and to the powers of the CIT(A) under section 250(4) to make or cause further enquiry, including accessing inter-departmental information (such as GST data) available electronically.

Interpretation and reasoning

2.8 The Tribunal recorded that the purchases of about Rs. 147 crores carried a GST component of approximately 3%, and it remained unexamined whether corresponding input tax credit (ITC) had been claimed and whether such ITC was allowed or disallowed by the GST authorities. This was considered a material aspect bearing directly on genuineness of the transactions.

2.9 The Tribunal held that mere issuance of notices under section 133(6), without follow-up verification, correlation with returns or assessments of the suppliers, or examination of GST records, did not amount to proper enquiry. No conclusive findings regarding the existence, identity, or operational status of the supplier entities were placed on record.

2.10 It was observed that, despite the availability of electronic interfaces with the GST system, neither the Assessing Officer nor the CIT(A) requisitioned verification reports or vendor status from GST authorities. The Tribunal regarded this omission as indicative of mechanical confirmation by the CIT(A) rather than independent judicial scrutiny.

2.11 The Tribunal noted that there was material on record suggesting that the assessee had also effected sales to one of the disputed suppliers (Dhanadeepa Gold), while the corresponding purchases from the same party were treated as fictitious. This asymmetric treatment, and the possibility of circularity or commercial settlement, had not been reconciled or investigated.

2.12 The Tribunal emphasised that the genuineness of purchases depends on multiple evidentiary facets such as delivery, stock, banking trail, and GST treatment, none of which had been comprehensively verified by the Assessing Officer, nor had the assessee fully discharged its onus to substantiate the claimed suppliers and transactions.

Conclusions

2.13 The Tribunal held that the assessment and the appellate order suffered from material infirmities due to incomplete and inadequate enquiry into the genuineness of purchases, the GST position, and the banking trail. In the absence of such foundational verification, the disallowance could not be sustained purely on suspicion, but equally could not be deleted without proper investigation. The matter therefore required restoration for de novo enquiry.

Issue 3: Treatment of purchases found non-genuine and alternative plea to tax only profit element

Interpretation and reasoning

2.14 The assessee had raised an alternative ground that, if the purchases were ultimately held to be non-genuine, the addition should be restricted to the profit element embedded in such purchases, in line with judicial practice where alleged bogus purchases are estimated.

2.15 The Tribunal recognised this alternative plea as legally permissible and consistent with prevailing judicial approach in similar fact situations where purchases are held unverifiable or from non-existent parties.

2.16 At the same time, the Tribunal observed that assertion of such a fallback position, coupled with inadequate documentation and lack of transportation and movement records, could be read as supporting the Assessing Officer's suspicion regarding full genuineness of purchases, and therefore reinforced the need for fresh estimation and verification rather than straight deletion of the disallowance.

Conclusions

2.17 The Tribunal did not itself estimate profit or restrict the addition. Instead, it directed that, upon fresh enquiry, the Assessing Officer must also consider the assessee's alternative plea to confine any addition to the profit element, if the purchases are found to be not fully genuine.

Issue 4: Necessity of remand and scope of de novo adjudication

Interpretation and reasoning

2.18 Having found that (i) the statutory prerequisites for invoking section 40A(3) were not established, (ii) genuineness of purchases remained inadequately enquired into, and (iii) inter-departmental (GST) verification and banking trail analysis were missing, the Tribunal held that the case could not be disposed of on the existing record.

2.19 The Tribunal also noted that issues such as reconciliation of ITC, examination of vendor status under GST, correlation of purchase and sale transactions with the same parties, and tracing of cash/bank fund flows are factual matters requiring primary investigation by the Assessing Officer, not fact-finding at the appellate stage.

Conclusions

2.20 The Tribunal set aside the disallowance under section 40A(3) and restored the matter to the file of the Assessing Officer for de novo assessment on the disputed purchases with the following specific directions:

(a) To conduct proper verification of the identity and existence of the supplier parties.

(b) To reconcile input tax credit claimed under GST law and ascertain the status of such credit with the GST authorities.

(c) To enquire into sale and purchase transactions with the same parties and reconcile any circularity or cross-entries.

(d) To independently examine the actual mode, dates and manner of payments vis-à-vis section 40A(3), including tracing any cash trail or banking trail as necessary.

(e) To consider the assessee's alternative plea for restricting disallowance to the profit element, if purchases are held non-genuine or unverifiable.

(f) To correlate findings with any assessments or proceedings in the case of the supplier parties.

2.21 The Tribunal directed that the assessee be afforded reasonable opportunity to furnish evidence and explanations, and that the Assessing Officer pass a speaking, reasoned order in accordance with law. The appeal was allowed for statistical purposes pursuant to this remand.

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