Ad hoc disallowance of labour charges was arbitrary where documentary evidence and contractor confirmations supported genuine business .

Ad hoc disallowance of labour charges was found unsustainable where the assessee produced labour bills, confirmations, vouchers, bank records and contractor responses to notices under Section 133(6). The books were not rejected under Section 145(3), stock records showed no discrepancy, and labour charges were an integral business expense in jewellery manufacturing. As there was no evidence that cash withdrawals by contractors were returned to the assessee, and flawed field-verification reports could not alone prove bogus expenditure, a percentage-based disallowance without a specific finding of inflation or non-business use was held arbitrary. The disallowance was deleted.

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Issues: Disallowance of labour charges paid to five parties was justified on an ad hoc basis.

Analysis: The assessee produced labour bills, confirmations, issue and receipt vouchers, bank records, and replies from the labour contractors to notices issued under Section 133(6) of the Income-tax Act, 1961. The books were not rejected under Section 145(3) of the Income-tax Act, 1961, and no discrepancy was found in the stock records. Labour charges were found to be an integral part of the jewellery manufacturing business, and there was no evidence that the cash withdrawals by the contractors were returned to the assessee. The field verification reports were found to be flawed and could not, by themselves, sustain a conclusion of bogus expenditure. An ad hoc percentage disallowance, unsupported by a specific finding of inflated or non-business expenditure, was held to be arbitrary.

Conclusion: The disallowance of Rs. 16,71,940 was deleted and the assessee succeeded on the merits of the labour-charge issue.

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