2026 (1) TMI 978 - AT - Income Tax

Disallowance under section 37(1) for alleged non-genuine purchases overturned after transactions shown to be bona fide business expenditure.

Disallowance under analysis concerned treating purchases from five vendors as non-genuine and denying deduction under the principle that expenditure must ... Disallowance u/s 37(1) - considering certain purchases as non-genuine - CIT(A) erred in partly upholding the disallowance to an extent of 12.5% of the total purchases - HELD THAT:- As no incriminating material was brought on record by the Revenue to prove that the purchase transaction by JMC with the afore-noted five impugned vendors was non-genuine and bogus. Therefore, we are of the considered view that these transactions cannot be called accommodation entry transactions. By considering these purchases as non-genuine, the impugned addition is not made under section 68 or section 69 or section 69C of the Act, and instead the AO disallowed the expenditure u/s 37(1) of the Act, which requires an expenditure to have been incurred wholly and exclusively for the purpose of business for allowability. Expenditure was not disallowed in regular scrutiny assessment, but the same was disallowed pursuant to statements recorded during the search conducted after 10 years from the year under consideration on the resultant entity, i.e. the assessee, which itself had not transacted with these parties, even though it was the parent company of JMC. Still, the purchase and sub-contract agreements were undisputedly entered into by JMC only. Therefore, once, by way of various documents, the assessee has shown that these parties were engaged by JMC for various ongoing projects, we do not see any merit in disallowing the expenditure u/s 37(1) of the Act, more so due to the fact that in the subsequent year transactions with some of these parties were accepted by the AO. CIT(A) merely upheld the disallowance to an extent of 12.5% of the total purchases to plug the leakage of revenue, and there is no other basis for upholding the said disallowance even after recording various factual findings in favour of the assessee in the impugned order. Therefore, such being the facts, we do not find any merit in the part disallowance upheld by the learned CIT(A) in the present case, and the same is directed to be deleted. Accordingly, we do not find any basis in the entire impugned disallowance made under section 37(1) of the Act, when the whole purchase was wholly and exclusively for the purposes of the business of JMC/the assessee. Hence, the entire disallowance made u/s 37(1) of the Act is directed to be deleted. As a result, Ground No.4 raised in assessee’s appeal is allowed. Accordingly, grounds raised by the Revenue for the assessment year 2013-14 challenging the part-deletion of disallowance made by the learned CIT(A) are dismissed. Issues: (i) Whether the disallowance under section 37(1) of the Income-tax Act, 1961 in respect of certain purchase transactions treated as non-genuine is sustainable; (ii) Whether the part-disallowance of 12.5% of the total purchase value to 'plug leakage of revenue' is justified and applicable to subsequent assessment years by way of mutatis mutandis application.Analysis: The reassessment and disallowance were founded on statements and field inspection conducted more than a decade after the year under consideration and on records relating to transactions executed by a merged predecessor entity. Documentary material for the year was partly unavailable due to historical accounting system limitations, while consistent transactional relationships and supporting documentation for subsequent years were produced. Statements of individuals recorded during search showed unfamiliarity with vendors; however, such statements were from persons who joined the relevant units well after the year under consideration or who could not reasonably be expected to know historic procurement across a large multi-site organisation. The field inspection took place many years after the transactions and absence of vendors at inspected addresses can have several legitimate explanations. No incriminating material was produced to establish that the transactions were accommodation entries, and subsequent year records showed acceptance of similar transactions by the revenue. The Tribunal found the decision relied upon by the Revenue factually distinguishable.Conclusion: The disallowance under section 37(1) in respect of the impugned purchase transactions is not sustainable and is deleted. The ad hoc part-disallowance of 12.5% of the total purchases is also not justified and is deleted. The same conclusions apply mutatis mutandis to the connected assessment years.Ratio Decidendi: Where reassessment and disallowance rest on temporally remote search statements and field inspections without incriminating material, and taxpayer furnishes consistent transactional links and subsequent-year corroboration, the revenue has not discharged the burden to treat historical purchase expenditures as non-genuine for disallowance under section 37(1).