2026 (3) TMI 126 - AT - Income Tax

Income estimation by percentage found unsustainable; audited books and bank trail uphold expenses and defeat unexplained cash credits.

Estimation of undisclosed income by applying arbitrary percentage rates to turnover was held unsustainable where no tangible cash-receipt evidence or ... Estimation of income by applying percentage on sales turnover - allowability of expenses where income from circular trading/transactions - treatment of intra corporate loans under section 68 as unexplained cash credit Estimation of income by applying percentage on sales turnover - Whether additional income could be estimated on sales turnover (AO at 7%; CIT(A) at 0.5%) and whether any addition was sustainable? - HELD THAT: - The Tribunal analysed the nature of the transactions (consignor consignee and heavy bulky steel trading), the material seized, bank/payment records and appellate findings. It recorded that purchases and sales were reflected in the books and payments flowed through banking channels via LC and bill discounting; no evidence of introduction of cash to generate accommodation entries was found and the AO did not explain basis for selecting the 7% rate. While the CIT(A) accepted some circularity and sought to quantify 'additional income' at 0.5% relying on orders in related matters, the coordinate bench precedents (including Subhkaran & Sons [2026 (1) TMI 607 - ITAT MUMBAI] and Duli Trade & Commodities [2025 (8) TMI 1508 - ITAT MUMBAI]) dislodged the factual and evidentiary basis for any estimation: absence of seized documents, absence of statements indicating cash receipts, failure to identify payer of alleged unaccounted amounts, and industry profit margins showing thin accepted net margins. Applying those findings to the facts of the present case, the Tribunal held that estimation even at 0.5% was unsustainable and deleted the addition. [Paras 15, 16, 17, 18, 19] Deletion of addition computed by applying a percentage on sales turnover; estimation at 0.5% or 7% is unsustainable and addition is deleted. Disallowance of indirect expenses and depreciation - depreciation and indirect/financial expenses incurred in relation to the recorded circular trading disallowed as transactions were alleged to be bogus - HELD THAT: - There is no reason to suspect the genuineness of the purchase and sales transactions of the assessee and deleted the addition made by the AO by treating the transactions as bogus. Moreover, AO has not raised any doubt regarding the actual incurring of the expenses. Tribunal agreed that once regular income is disclosed in books and expenditures are genuinely incurred (not shown to be penal or unlawful), the related expenses, including finance costs, and depreciation are allowable. There was no material to show that payments were not made or that expenses were fictitious. [Paras 20, 21] Disallowance of depreciation and indirect/financial expenses is not justified; the CIT(A)'s deletion of these disallowances is upheld. Treatment of intra corporate loans under section 68 as unexplained cash credit - FAA deleted addition - HELD THAT: - The AO treated certain unsecured loans as unexplained cash credits relying on third party statements. The CIT(A) examined ledger entries, repayments, bank evidence and found the identity and creditworthiness of creditors established, major part of loans repaid during the year or subsequently, repayment included recovery of earlier advances made by the assessee to those parties, and transactions routed through banking channels with no finding of cash being introduced. The Tribunal found the AO failed to consider advances given by the assessee to the lenders and the bank records showing sufficiency of funds before loans were advanced. In view of these facts and the coordinate bench precedents on identical group transactions, the CIT(A)'s deletion of the section 68 additions was held to be correct. [Paras 23, 24, 25, 26] Addition under section 68 is not sustainable; deletion of the unexplained cash credit is upheld. Final Conclusion: Tribunal held that the AO's estimation of undisclosed income on turnover (whether at 7% or 0.5%) could not be sustained, accepted the allowability of depreciation and indirect/financial expenses where income was disclosed in audited books and payments made through banking channels, and upheld the deletion of additions under section 68; accordingly the revenue appeals were dismissed and the assessee's appeals were partly allowed. Issues: (i) Whether the Assessing Officer's estimation of additional income at 7% (and the First Appellate Authority's reduction to 0.5%) of sales turnover is sustainable; (ii) Whether disallowance of indirect expenses and depreciation is sustainable where transactions are alleged to be bogus; (iii) Whether unsecured loans treated as unexplained cash credit under section 68 of the Income-tax Act, 1961 are liable to be added.Issue (i): Whether estimation of additional income at specified percentages of sales turnover is sustainable.Analysis: The assessment followed search and seizure material alleging back-to-back transactions using letter of credit facilities. The Assessing Officer rejected books u/s 145(3) and estimated income at 7% of turnover; the First Appellate Authority accepted books and estimated additional income at 0.5% relying on earlier coordinate-bench orders. The Tribunal examined (a) presence of documentary evidence of transactions and bank payments, (b) absence of any cash trail or specific evidence of introduction of cash in search records, (c) precedents of coordinate Benches addressing identical factual matrix, and (d) absence of rationale or industry basis for AO's 7% rate.Conclusion: Estimation of additional income at 7% and at 0.5% of sales turnover is unsustainable; the additions based on such estimation are deleted in favour of the assessee.Issue (ii): Whether disallowance of indirect expenses and depreciation is justified where the AO alleged transactions to be bogus.Analysis: The AO disallowed indirect expenses and depreciation because he considered trading bogus. The appellate authority and the Tribunal found that transactions were recorded in audited books, payments were made through banking channels (LC and bill discounting), no specific defect in books was pointed out by AO, and AO did not dispute actual incurrence of expenses. Section 37 principles regarding illegality were considered in context of LC charges paid to banks and the absence of any finding that payments were penal or prohibited by law.Conclusion: Disallowance of indirect expenses and depreciation is not justified; the deletion of such disallowances is upheld in favour of the assessee.Issue (iii): Whether unsecured loans treated as unexplained cash credit under section 68 can be added to the income.Analysis: The appellate authority examined identity and creditworthiness of lenders, bank routing of transactions, existence of advances by the assessee to lender parties, repayment pattern, and absence of any finding of cash introduction prior to loans. The Tribunal found AO did not adequately consider ledger evidence, repayments, and bank balances indicating genuineness.Conclusion: Addition as unexplained cash credit under section 68 is not sustainable; deletion of the addition is upheld in favour of the assessee.Final Conclusion: On the merits, additions based on percentage estimation of turnover, disallowance of indirect expenses and depreciation, and section 68 additions are deleted; Revenue's appeals are dismissed and the assessee's appeals are partly allowed.Ratio Decidendi: In absence of tangible evidence of cash receipts or demonstrable defect in books of account, estimation of income by applying arbitrary percentage rates and additions under section 68 cannot be sustained; where transactions are recorded in audited books and payments flow through banking channels, related business expenses and depreciation are allowable.