Hiral Construction Vs ITO (ITAT Mumbai)
Partner’s Capital Cannot Be Taxed in the Firm Merely Because His Ultimate Source Is Questioned
The Controversy
The Mumbai Tribunal granted substantial relief to a partnership firm against additions relating to partner’s capital contribution, cash deposits, notional interest on tenants’ security deposits and an ad hoc expenditure disallowance.
The principal issue was whether capital introduced by an identified partner could be treated as unexplained income of the firm when the Assessing Officer himself had verified, during remand proceedings, that the contribution originated from the partner’s bank accounts.
The Tribunal held that, on the facts before it, doubts about the partner’s antecedent source required examination in his hands, unless material demonstrated that the money actually belonged to the firm and had merely been routed through him.
Assessment and Additional Evidence
Hiral Construction, a partnership firm engaged in construction and real estate, also derived rental income from portions of its developed property. It filed its return declaring ₹7,29,690.
During scrutiny, the Assessing Officer sought particulars of capital introduced by the partners, cash deposits, tenants’ security deposits and expenditure. He treated ₹2,73,02,823 credited as capital contribution of partner Virendra Manilal Shah as unexplained under section 68.
Further additions included ₹9,18,500 for cash deposits, ₹4,50,600 as notional interest and ₹1,46,239 as an ad hoc expenditure disallowance.
Before the CIT(A), the firm furnished additional evidence under Rule 46A, including the partner’s bank statements. A remand report was obtained, but the additions were nevertheless sustained.
Verified Partner’s Contribution: Firm Need Not Explain Every Preceding Credit
The assessee explained that the partner’s bank statement could not be uploaded during assessment because of an inadvertent omission by its consultant.
Crucially, the Assessing Officer examined the bank accounts during remand proceedings and confirmed that the capital contribution had been transferred from the partner’s accounts to the firm. The partner’s identity was undisputed, and he was a regular assessee.
The CIT(A), however, sustained the addition because the source of credits appearing in the partner’s bank accounts had not been independently established.
The Tribunal found this reasoning unsustainable on the peculiar facts. The immediate source of the credit in the firm’s books stood verified. Any further enquiry into the source available with the partner could be undertaken in his assessment, unless evidence showed that the contribution represented the firm’s own undisclosed money.
Following MKF International v. DCIT, which considered Nova Medicare v. ITO, 459 ITR 477, and Darshan Enterprise v. ACIT, 441 ITR 473, the Tribunal deleted the capital contribution addition.
The original amount had reportedly been rectified under section 154 to ₹2,37,02,823. The Tribunal clarified that relief would relate to the amount subsisting after rectification; the numerical-error ground consequently became academic.
Cash Deposits: Same Amount Cannot Be Added Twice
Of the separate cash deposit addition of ₹9,18,500, the assessee explained that ₹7,58,500 already formed part of the partner’s capital contribution considered by the Assessing Officer.
The Tribunal accepted this correlation. The Revenue had produced no material showing that this amount represented an independent source beyond the capital contribution already examined. A separate addition of the same amount would result in duplication, and ₹7,58,500 was therefore deleted.
The balance ₹1,60,000 was restored for limited verification. The assessee referred to cash-in-hand and its cash book, but the figures required reconciliation. Thus, the entire cash deposit addition was not deleted outright.
Security Deposits Do Not Generate Hypothetical Interest
The firm received interest-free security deposits of ₹37,55,000 from four tenants. The Assessing Officer computed hypothetical interest at 12% and added ₹4,50,600.
The Tribunal observed that this interest was neither received nor shown to have accrued under any contractual arrangement. The actual rental receipts had been offered to tax, and there was no finding that rent had been suppressed, understated or substituted by the deposits.
A commercial advantage from holding an interest-free deposit does not create a right to receive interest. The Tribunal consequently deleted the addition as taxation of hypothetical income.
Ad Hoc Expenditure Disallowance Rejected
The Assessing Officer disallowed 10% of expenditure aggregating to ₹14,62,396, resulting in an addition of ₹1,46,239, with reference to section 14A.
For the assessment year concerned, the Tribunal held that section 14A could not be invoked when the firm had earned no exempt income. Independently, no specific defect in the bills, vouchers or business purpose of expenditure had been identified. The supporting material had been produced and examined during remand proceedings.
The expenditure ground was allowed. Although paragraph 12.2 mentions ₹14,62,396 as the disallowance deleted, the disputed disallowance identified throughout the order was ₹1,46,239.
Author’s Comments
The decision should not be read as a blanket proposition that naming a partner or showing a bank transfer invariably discharges section 68. The decisive facts were the identified partner, verified ownership and movement of funds, and absence of evidence linking the money to undisclosed income of the firm.
The order also demonstrates why additional evidence and remand findings matter. An appellate conclusion must address the verified facts rather than preserve an addition merely because documents were unavailable during the original assessment.
Interest was directed to be recomputed consequentially, while the challenge to initiation of penalty was treated as premature. The appeal was partly allowed for statistical purposes.
Cases Discussed
- MKF International v. DCIT (ITAT Mumbai), ITA No. 7726/Mum/2025, order dated 12/02/2026 — Followed concerning verified partner contributions and examination of the partner’s source.
- Nova Medicare v. ITO (Telangana High Court), (2023) 459 ITR 477 — Considered through MKF International on Section 68 and the source of partners’ contributions.
- Darshan Enterprise v. ACIT (Gujarat High Court), (2022) 441 ITR 473 — Considered through MKF International concerning capital contribution by an identified partner.
FULL TEXT OF THE ORIGINAL ORDER OF ITAT MUMBAI
Present appeal filed by the assessee arises out of the order passed by the Ld.CIT(A) for A.Y. 2017-18, vide order dated 26/11/2025 on following grounds of appeal:
“1. In the facts and circumstances of the case and in law, the learned Assessing Officer erred in making addition of Rs.4,50,600/- (12% of Rs.37,55,000/-) arbitrary without giving any finding “in the assessee’s business income because assessee has taken this deposit in the course of business which is providing spaces on the rent”.
2. a) In the facts and circumstances of the case and in law, the learned Assessing Officer erred in making addition of Rs.2,73,02,823/- being capital introduction by partner Virendra Manilal Shah which is disallowed as cash credit u/s 68 of the Income Tax Act.
b) Without prejudice the above, in the facts and circumstances of the case and in law, the learned Assessing Officer erred in making addition of Rs.2,73,02,823/- under the caption capital introduction by partner whereas the capital introduced by the partner is Rs.2,37,02,823/-. CIT(A) has mentioned the wrong figure. Correct figure is Rs.2,37,02,823/-.
3. a) In the facts and circumstances of the case and in law, the learned Assessing Officer erred in making addition of Rs.9,18,500/- being cash deposited into bank which is disallowed u/s 68 of the Act, without issuing show cause notice to that effect. The ld. AO failed to appreciate the fact that this deposit is fully explained with documentary evidence in the submission made on 09-12-2019.
b) Without prejudice the above on the facts and circumstances of the case and in law, the learned Assessing Officer erred in making the addition of Rs.9,18,500/- without appreciating the fact that out of this amount of Rs.9,18,500/-, Rs.7,58,500/- is part of capital introduction of Rs.2,37,02,823/- by the partner during the year.
4. In the facts and circumstances of the case and in law, the learned Assessing Officer erred in making adhoc addition of Rs.1,46,239/- (10% of Rs.14,62,396/-) u/s 14A without appreciating the fact that the assessee does not have any exempt income.
5. In the facts and circumstances of the case and in law, the learned Assessing Officer erred in levying interest of Rs.3,85,194/- u/s 234A, Rs.63,55,701/- u/s 234B, and Rs.61/- u/s 234C which is consequential to the various additions made to the total income of the assessee.
6. In the facts and circumstances of the case and in law, the learned Assessing Officer erred in initiating penalty proceedings u/s 270A and 271AAC.
7. In the facts and circumstances of the case and in law, the learned Commissioner of Income Tax (A) erred in confirming the same additions without considering the facts filed by the Appellant and without providing an opportunity of personal hearing and/or through video conferencing and rejecting remand report arbitrarily.”
Brief facts of the case are as under:-
The assessee is a partnership firm engaged in the business of construction and real estate. During the year under consideration, the assessee was deriving rental income from portions of the property developed by it. It filed its return of income for A.Y. 2017 18 on 22/09/2017 declaring total income of Rs.7,29,690/-. The case was selected for scrutiny and notices u/s.143(2) and 142(1) were issued.
2.1. During assessment proceedings, the Ld. AO, called upon the assessee to furnish details regarding the capital introduced by its partners together with the source thereof, details concerning cash deposits, security deposits received from tenants and supporting bills/vouchers in respect of expenditure debited to the Profit and Loss Account.
2.2. The Ld.AO noticed substantial capital credited in the account of partner Shri Virendra Manilal Shah. According to the Ld.AO, held that the assessee did not furnish the partner’s ledger account, bank statement evidencing source of the capital contribution during the assessment proceedings. The Ld.AO therefore treated the capital contribution of Rs.2,73,02,823/- as unexplained cash credit u/s.68.
2.3. The Ld.AO further made additions of Rs.9,18,500/- towards cash deposits, Rs.4,50,600/- being notional interest computed @ 12% on security deposits of Rs.37,55,000/- and Rs.1,46,239/- being 10% of certain expenditure aggregating to Rs.14,62,396/-. The assessment was accordingly completed at total income of Rs.2,95,47,850/-.
Aggrieved by the additions, the assessee preferred appeal before the Ld. CIT(A).
4. During the appellate proceedings, the assessee filed additional evidence under Rule 46A, including bank statements of Shri V.M. Shah and supporting material. The Ld.CIT(A) called for a remand report from the Ld.AO. However, the additions came to be sustained.
Aggrieved by the order of the Ld.CIT(A), the assessee is in appeal before this Tribunal.
5. Ground No.1 is in respect of addition of Rs.4,50,600/- towards notional interest.
The Ld.AR submitted that the assessee received interest-free security deposits aggregating to Rs.37,55,000/- from four tenants to whom portions of the property were let out. The rental income actually received from these parties was duly offered to tax. It was submitted that the security deposits were received from the very same parties in the ordinary course of the letting arrangement and were admittedly interest-free. According to the Ld. AR, neither the Ld.AO nor the Ld.CIT(A) had recorded any finding that the rent charged by the assessee was depressed or understated because of receipt of such security deposits. It was thus contended that computing hypothetical interest @ 12% thereon amounted to bringing purely notional income to tax.
5.1. The Ld.DR on the contrary relied on the findings of the authorities below and submitted that the substantial interest-free security deposits resulted in a commercial benefit to the assessee and that the assessee had not furnished material to establish that such deposits were commercially justified or to rebut the rate adopted by the Ld.AO.
We have perused the submissions advanced by both sides in light of records paced before us.
6. The fact remains that the impugned amount of Rs.4,50,600/- was neither received by the assessee nor shown to have accrued to it under any contractual arrangement. The security deposits were admittedly interest-free and were received from the very tenants from whom rental receipts were earned and offered to tax. There is no finding by the Ld.AO that the rent received from such parties was suppressed, understated or substituted by receipt of the security deposits.
6.1. Merely because an interest-free security deposit may confer a commercial advantage upon the assessee, the same cannot result in accrual of interest income in the absence of any right to receive such interest. Tax can be levied on real income that has accrued or arisen and not upon a hypothetical return which the assessee could notionally have earned on the deposit. We accordingly direct the Ld. AO to delete the addition of Rs.4,50,600/-.
Accordingly, Ground No.1 raised by the assesse stands allowed.
7. Ground Nos. 2(a) & 2(b) raised by the assesse is in respect of the addition made on account of the capital introduced by partner Shri V.M. Shah
The Ld. AR submitted that the addition arose only because the bank statement of Shri V.M. Shah could not be furnished during the assessment proceedings. It was submitted that the assessee furnished the capital account, however, due to inadvertence on the part of the consultant, the bank statement could not be uploaded within the time available. Before the Ld.CIT(A), the assessee therefore filed an application under Rule 46A along with additional evidence. Our attention was invited to the submissions reproduced at page 11 of the appellate order and to the remand proceedings subsequently conducted by the Ld.AO.
7.1 The Ld.AR particularly drew our attention to the remand report reproduced by the Ld.CIT(A), wherein, after examining the bank accounts of Shri V.M. Shah and the summary of transactions, the Ld.AO recorded that the amounts claimed as capital contribution had in fact been transferred from the bank account of Shri V.M. Shah to the assessee-firm. Attention was also drawn to the bank statement placed at page 174 of the paper book evidencing the banking transactions. It was submitted that despite the aforesaid factual verification, the Ld.CIT(A) sustained the addition on the premise that the assessee failed to establish the source of the credits appearing in the bank account of the partner and thus effectively required the assessee-firm to establish the “source of source”.
7.2 The Ld.AR further submitted that Shri V.M. Shah is an identified partner and a regular assessee. His identity is undisputed and the remand report itself establishes that the funds were introduced by him into the assessee-firm. It was contended that any further enquiry regarding the ultimate source of funds in the hands of the partner could, if considered necessary, be undertaken in his individual case and could not constitute a basis for treating the capital contribution as unexplained income of the assessee-firm. Reliance was placed by him on the decision of the Co-ordinate Bench of this Tribunal in MKF International v. DCIT, ITA No.7726/Mum/2025, order dated 12/02/2026, which in turn considered the decisions of Hon’ble Telangana High Court in case of Nova Medicare v. ITO reported in(2023) 459 ITR 477 and decision of Hon’ble Gujarat High Court in Darshan Enterprise v. ACIT reported in (2022) 441 ITR 473.
7.3 The Ld.DR on the contrary relied upon the orders passed by the authorities below. It was submitted that mere transfer through banking channels establishes only movement of funds and does not by itself prove the creditworthiness of the partner or genuineness of the underlying source. According to the Ld. DR, substantial credits in the bank accounts of the partner remained unexplained and, therefore, the requirements of section 68 were not satisfactorily discharged.
We have perused the submissions advanced by both sides in light of records paced before u/s.
8. It is an admitted position that Shri Virendra Manilal Shah is a partner of the assessee-firm and his identity is not in dispute.
Further, during the remand proceedings, the Ld.AO examined the bank accounts furnished by the assessee and specifically recorded that the amounts towards capital contribution was transferred from the bank accounts of Shri V.M. Shah to the assessee. Thus, the immediate source of the credit appearing in the books of the assessee stood factually verified in remand proceedings.
8.1. The Ld.CIT(A), has also not dispute the aforesaid movement of funds but sustained the addition only on the ground that the source of the credits appearing in the partner’s bank accounts was not independently established. In our view, on the peculiar facts before us, such reasoning travels beyond the enquiry required to determine whether the impugned amount constituted unexplained income of the assessee. Once the identity of the partner is established and the fact that the capital contribution emanated from the partner stands verified, any further doubt regarding the antecedent source available with such partner would require examination in the hands of the partner in accordance with law, unless there is material to demonstrate that the money in fact belonged to the assesse and was routed through the partner.
8.2. In MKF International v. DCIT (supra), the Co-ordinate Bench, after considering the decisions by Hon’ble High Court referred to herein above held that, once the identity of the partner and ownership of the capital contribution stand established, the firm cannot be saddled with an addition merely because the Revenue entertains doubt regarding the ultimate source in the hands of the partner. The Bench further observed that an enquiry into the source in the hands of the partner may appropriately be undertaken in the assessment of such partner. The principle assumes greater significance in the present case since the Ld.AO himself has verified in the remand proceedings that the impugned capital contribution had flowed from the bank accounts of Shri V.M. Shah.
8.3. Nothing has been brought on record by the Revenue to demonstrate that Shri V.M. Shah was a fictitious person or that the capital ostensibly introduced by him actually represented undisclosed income belonging to the assessee-firm. In the absence of any such material, suspicion regarding the sources available in the hands of the partner cannot justify taxing the contribution once again in the hands of the firm. We therefore hold that the addition u/s.68 cannot be sustained. We accordingly direct the Ld. AO to delete the addition in respect of capital introduced by Shri V.M. Shah.
It is submitted by the Ld.AR that the Ld.AO subsequently rectified the quantum u/s.154 from Rs.2,73,02,823/- to Rs.2,37,02,823/-, the relief shall be with reference to the amount subsisting pursuant to such rectification.
Accordingly, Ground No.2(a) is allowed and Ground No.2(b), relating to the numerical error already rectified u/s.154, becomes academic.
9. Ground Nos.3(a)&3(b) is in respect of the addition of Rs.9,18,500/- towards cash deposit
The Ld.AR submitted that the cash deposit of Rs.9,18,500/- was duly explained during the course of proceedings. It was submitted that a substantial portion thereof represented cash capital introduced by Shri V.M. Shah and that the very same amount already formed part of the capital contribution considered by the Ld.AO while making the addition on the issue considered herein above.
9.1. The Ld.AR submitted that Rs.7,58,500/- out of the cash deposit was part of the capital introduced by Shri V.M. Shah and, therefore, sustaining a separate addition to that extent would amount to taxing the same amount twice. With regard to the source in the hands of the partner, reference was made to the loan obtained from Shivkrupa Path Peti and the supporting documents furnished during appellate/remand proceedings.
9.2. The Ld.DR on the contrary relied on the orders passed by the authorities below and submitted that the source of the cash deposit had not been satisfactorily established during assessment proceedings and that the evidence relied upon subsequently did not conclusively establish the nexus sought to be made by the assessee.
We have perused the submissions advanced by both sides in light of records paced before us.
10. We have perused the submissions advanced by both sides and examined the material placed on record. It is noted that the assessee had explained the cash deposit of Rs.9,18,500/- as being substantially attributable to the capital introduced by Shri V.M. Shah. Out of the said amount, Rs.7,58,500/- is stated to form part of the capital contribution of the partner which has already been considered by the Ld.AO while making the addition on the issue adjudicated hereinabove. The Revenue has not brought any material on record to establish that the said amount represents a source independent of, or in addition to, the capital contribution already considered.
10.1. We also note that, in support of the source of funds in the hands of Shri V.M. Shah, the assessee placed reliance on the loan obtained from Shivkrupa Path Peti and furnished the relevant supporting documents during the appellate/remand proceedings. The fact that such evidence was produced at a later stage cannot, by itself, be a ground for sustaining the addition when the evidence has been placed on record and no specific infirmity therein has been brought out by the Revenue. At the same time, the question is not merely whether the partner had a source of funds, but whether the particular cash deposit in the assessee’s bank account stood satisfactorily explained and whether the same amount had already been considered as capital introduced by the partner.
10.2. On examination of the material on record, we find merit in the contention of the Ld.AR to the extent of Rs.7,58,500/-. Once the said amount has already been considered as part of the capital introduced by Shri V.M. Shah and the same has been taken into account while making the addition on the issue dealt with hereinabove, sustaining a further addition of the very same amount on account of cash deposit would result in double addition of the same amount. Such duplication cannot be sustained.
Accordingly, the addition of Rs.7,58,500/- is directed to be deleted.
10.3. As regards the balance cash deposit of Rs.1,60,000/- (Rs.9,18,500 – Rs.7,58,500), the assessee has not demonstrated, with the same degree of correlation, that the said amount forms part of the capital contribution already considered by the Ld.AO. However, the written submissions refer to cash-in-hand and supporting cash book, however, the figures appearing in the record require reconciliation. We therefore restore the limited issue pertaining to the balance amount to the file of the Ld. AO for verification from the cash book and material already furnished by the assessee. Needless to say, reasonable opportunity of being heard shall be granted.
Accordingly, Ground Nos.3(a) and 3(b) are partly allowed for statistical purposes.
11. Ground No.4 relates to an ad hoc disallowance of Rs.1,46,239/-
The Ld.AR submitted that the Ld.AO made an ad hoc disallowance of 10% of expenditure aggregating to Rs.14,62,396/- on the ground that supporting bills and vouchers were furnished during assessment proceedings. It was submitted that the Ld.AO erroneously invoked section 14A although the assessee had not earned any exempt income during the relevant year. It was further submitted that all supporting bills and vouchers were subsequently produced before the Ld.CIT(A) and were examined in remand proceedings. According to the Ld.AR, the Ld.AO did not identify any specific defect in such evidence. It was also pointed out that, out of the aggregate expenditure of Rs.14,62,396/-, only Rs.800/- was stated to have been incurred in cash and the balance Rs.14,61,596/- was through banking channels.
11.1. The Ld.DR on the contrary, supported the orders of the authorities below and submitted that the disallowance was justified in view of the failure of the assessee to produce complete supporting evidence during the original assessment proceedings.
We have perused the submissions advanced by both sides in light of records paced before us.
12. We have considered the rival submissions and perused the material available on record. The disallowance made by the Ld.AO is not sustainable in law. Section 14A of the Act can be invoked only in respect of expenditure incurred in relation to income which does not form part of the total income under the Act. Therefore, the existence of exempt income during the relevant previous year is a necessary precondition for invoking section 14A. In the present case, it is an undisputed position that the assessee did not earn any exempt income during the year under consideration. Consequently, no disallowance under section 14A of the Act could have been made.
12.1. Further, the Ld.AO has made an ad hoc disallowance of 10% of the expenditure aggregating to Rs.14,62,396/- without identifying any particular expenditure which was not incurred for the purposes of the assessee’s business or without pointing out any specific defect in the supporting bills and vouchers. The fact that the supporting documents were furnished during the assessment proceedings, by itself, cannot justify an ad hoc disallowance, particularly when the same were subsequently produced before the Ld.CIT(A) and examined in the remand proceedings. It is also relevant that, out of the total expenditure of Rs.14,62,396/-, expenditure of only Rs.800/- was incurred in cash, while the remaining amount of Rs.14,61,596/- was incurred through banking channels.
12.2. In view of the above, the very invocation of section 14A is without statutory foundation, there being no exempt income earned by the assessee during the year. Further, even otherwise, no specific defect or infirmity in the expenditure has been brought on record by the Revenue. Accordingly, the ad hoc disallowance of Rs.14,62,396/- is deleted.
Accordingly, Ground No.4 raised by the assessee stands allowed.
13. Ground Nos.5 to 7
Ground No.5 relating to levy of interest u/s.234A, 234B and 234C is consequential. The Ld. AO is directed to recompute the interest, if any, while giving effect to this order.
13.1. Ground No.6 challenges initiation of penalty proceedings u/s.270A and 271AAC. The challenge at the stage of initiation is premature and therefore does not call for adjudication in the present proceedings.
13.2. Ground No.7 raises a general grievance regarding consideration of evidence and the remand report by the Ld. CIT(A). As the substantive additions have been adjudicated by us hereinabove on merits, no separate adjudication is called for.
In the result, the appeal filed by the assessee is partly allowed for statistical purposes.
Order pronounced in the open court on 08/10/2026.
