In the realm of tax assessments, one recurring issue that businesses often encounter is the imposition of ad-hoc disallowances by tax authorities. These disallowances, made without clear reasoning or specific defects, can significantly impact the financial standing of businesses. In recent years, several cases have shed light on the legality and justification of such ad-hoc disallowances, leading to nuanced interpretations and guidance from judicial authorities.
Understanding Ad-hoc Disallowances:
Ad-hoc disallowances refer to the practice of tax authorities arbitrarily disallowing a portion of claimed expenses without providing concrete evidence or reasoning for such action. These disallowances are often based on presumptions, conjectures, or incomplete assessments rather than verifiable discrepancies in financial records. While tax authorities may justify such actions as measures to prevent tax evasion or ensure compliance, the legality and fairness of ad-hoc disallowances have been subject to scrutiny in various legal proceedings.
Key Judicial Precedents:
Several landmark cases have addressed the issue of ad-hoc disallowances, providing valuable insights into the legal principles governing such assessments. Let’s delve into some notable cases and their implications:
1. ACIT V Nirmal Glasstech Industries (2017) 57 ITR (Trib) (S.N) 49 (jaipur)
● The C.O. is against confirming the ad hoc disallowance. The ld counsel for the assessee has submitted that there is no basis for making ad hoc disallowance. He reiterated the submissions as made in the written brief, which is reproduced hereunder:-
● The assessee is maintaining day to day books of accounts. The same are subject to tax audit. The sales and purchases of the assessee are duly supported by the bills and vouchers. No expense in cash has been incurred in violation of the provisions of section 40A(3)of the Act. In running business, there is always a need to incur some expenses in cash and it does not entitle the lower authorities to take an adverse view regarding the declared profits. The lower authorities have not pointed out any expense debited in the trading or profit and loss account which is not for the purposes of the business of assessee. The AO has not rejected the books of the assessee byi nvoking provision of section 145(3). Hence, the lump sum trading addition made by the AO and confirmed by CIT(A) is uncalled for.
●Assessing Officer has not rejected the books of account of the assessee and without making this as a base, it could not be said that the expenditure has been inflated. In the present case, admittedly, the Assessing Officer has not rejected the books of account. He has not given the basis for making ad hoc disallowance, therefore, we direct the Assessing Officer to delete the disallowance. This ground of the assessee’s C.O. is allowed.
2. Babu jewellers vs ITO: [2012] 23 taxmann.com 278 (Chandigarh – Trib.)
● Where expenses in question related to salary, depreciation, interest, etc., and Assessing Officer had failed to point out exact expenses which were not verifiable, adhoc disallowance of such expenses could not be sustained.
● No disallowance is warranted in probability of expenses being unvouched unless it has been established that the expenditure claimed by the assessee are unvouched.
● The Assessing Officer made an adhoc disallowance of 10 per cent of expenses since books of account were rejected in case of assessee.
Held:
● In the first instance, there is no merit in such disallowance of the expenses, in cases where an estimation of income is made by rejecting the books of account. Further, the Assessing Officer had failed to point out the exact expenses which were not verifiable.
● Taking note of the expenses claimed by the assessee during the year under consideration, it was found that major expenses relating to salary, salary of partners, depreciation, interest, rent account and electricity were claimed and no disallowance was warranted out of the said expenses, unless some adversity was pointed out in the said expenditure.
● The Commissioner (Appeals) upheld the disallowance on account of personal use of car and telephone by the partners of the assessee firm.
● Admittedly, the assessee was a partnership concern and personal use by the partners out of various expenses being car expenses, telephone and car depreciation, etc., could not be ruled out.
Accordingly, the Assessing Officer was to be directed to restrict the disallowance to 1/10th out of
car expenses, car depreciation and telephone expenses.
3. ACIT V Arthur Anderson and Co. [2006] 5 SOT 393 (Mumbai)/[2005] 94 TTJ 736 (Mumbai)
Facts:
● The assessee was a chartered accountant firm. It was rendering professional and consultancy services to the foreign clients and earned fees only in foreign currency. In order to generate work from, and execute assignments for, such foreign entities, it had entered into an agreement with AWSC, a co-operative company organized under the laws of Switzerland.
● The said agreement entitled the assessee to use the trade name of AWSC. The assessee claimed education on account of reimbursement of expenses under the said agreement to AWSC.
● The Assessing Officer concluded that the payments to AWSC represented reimbursement of establishment costs, royalty for the use of its trade name and access to knowledge and database and fees for technical services for provision for various other services.
● On that basis, the Assessing Officer held that the expenditure was incurred wholly and exclusively for the purpose of business. However, he disallowed 20 per cent of the said expenditure on the ground that ‘considering the magnitude and complexity of expenditure, it could not be ruled out that there might be an element of excess expenditure embedded in the reimbursement to cost of AWSC’.
Held:
●A plain reading of the assessment order indicates that while the Assessing Officer had in effect held the deduction in respect of the reimbursement of expenses is admissible because he had given categorical findings in support of the expenditure being for the purposes of business and commercially expedient, he had also made a ‘token disallowance’ of 20% of the expenses to cover the possible loss of revenue. 20% of the said expenditure on the ground that “considering the magnitude and complexity of expenditure, it cannot be ruled out that there may be an element of excess expenditure embedded in the reimbursement of cost to AWSC”.
●The Assessing Officer accepts that the accounts were duly audited, that expenses are justified on the grounds of business expediency and in the light of the substantial benefit received from AWSC and yet he makes an adhoc disallowance of 20% of expenses
● In our considered view, however, such an approach is entirely unsustainable in law. The very concept of token disallowance is bad in law, because such a disallowance is inherently based on ‘surmises and conjectures’ and devoid of a legally sustainable foundation. It is a case where one accepts all the contentions but not the consequences flowing from accepting the same. That cannot meet our approval. The CIT(A) was quite justified in deleting the disallowance.
● We approve and confirm the stand of the CIT(A). His action of deleting the disallowance does not call for any interference by us. Accordingly, we approve the conclusions arrived at by the CIT(A) and decline to interfere in the matter.
4. Mahendra Oil Cake Industries (P.) Ltd. v. Asstt. Commissioner [1996] 55 TTJ (Ahd.) 711
● The assessee-company claimed travelling expenses of Rs. 64,216 in connection with foreign tour of BN, a director of the assessee. The Assessing Officer disallowed one-fourth out of foreign travelling expenses holding that the assessee-company had nowhere mentioned that BN had devoted his time fully and exclusively for company’s work while on tour.
● The assessee contended that the main purpose of the visit was to study the future trend in extraction market and the expected price variation in the available stocks in the West European markets. It further submitted that this would enable the company to plan its export targets especially in relation to the type of extractions. The said director had visited foreign countries with due permission from the RBI.
● The assessee further contended that the tour undertaken by the director of the assessee-company was entirely for the business purpose and the authorities below had wrongly disallowed the expenses incurred by the director of the assessee-company.
Held:
● Assessing Officer while disallowing 1/4th foreign travelling expenses had held that during the stay of BN in foreign countries, he must have devoted certain time in sight-seeing, recreation or other personal work other than company’s work. Similarly, the Commissioner (Appeals) while confirming the order of the Assessing Officer had observed that entire expenses incurred by the director while on foreign tour could not be held to be business expenditure.
● The aforesaid reasoning and conclusions of the authorities below were not tenable in the eyes of law, as no specific item or instance of personal expenditure had been noted. Both the authorities below had gone on conjectures and surmises and the disallowance was made on probabilities. Moreover, the authorities below had also not pointed out any violation of rule 6D.
In this view of the matter the disallowance made by the Assessing Officer was not justified.
5. Continental Device India Ltd. vs. ACIT, [2015] 63 taxmann.com 364 (Delhi – Trib.)
● The assessee claimed deduction in respect of expenditure incurred on foreign travelling of directors.
● The Assessing Officer noticed that although the details were filed but no bills and voucher with respect to the boarding and lodging were filed. Accordingly, the Assessing Officer disallowed 50 per cent of said expenditure.
● The Commissioner (Appeals) held that the Assessing Officer was justified and reasonable in disallowing 50 per cent of the claim for which evidence was not produced.
On second appeal
Held:
● In the instant case, the assessee claimed foreign and travelling expenses of Rs. 20,33,758/-. The Assessing Officer has noted that during the assessment proceedings, the assessee could not furnish bills and vouchers in respect of boarding and lodging expenses aggregating to Rs. 6,32,295/- and as such, disallowed 50% of the expenditure and computed the disallowance at Rs. 3,66,148/-. It is thus apparent that the Assessing Officer has not disputed the genuineness of the expenditure on an individual specific level.
● The travelling expenses have also been allowed in entirety other than above disallowance of boarding and lodging disallowance in an ad hoc manner on the ground that supporting explanations were not furnished. We do not find merit in such a manner and the method of the disallowance.
● The Assessing Officer neither having identified, highlighted the specific items in respect of which, disallowance has been made by him, the adhoc disallowance so made is deleted. The ground raised is thus allowed.
6. M/S. Mokshstar International,, … vs The Additional Cit, ITA No. 397/Rjt/2017
Facts:-
● The assessee is a firm engaged in the business of importing plastic scrap from European countries, USA and countries situated in UAE. The AO noticed that the assessee has not maintained a log-book or any other document to separate business and non-business expenses. Therefore, it is not established that expenses were wholly and exclusively incurred for the business purposes. Further, the AO noted that many expenses were accounted for on the basis of self-made vouchers. In some of the supporting evidence, addresses of the recipient were missing and vouchers were lacking proper details about the expenditure made. Therefore, the AO disallowed a lump sum amount of 2 lakhs out of the above expenditure by treating it to be incurred for non-business use and added the same back to the total income of the assessee.
● The assessee is in appeal against the addition of 2 lakh made during the assessment proceedings. The counsel for the assessee submitted that the disallowance has been made on a purely ad-hoc basis, without finding any fault in the audited books submitted before the AO during the course of assessment proceedings. Accordingly, the AO has erred in law and on facts in making disallowance of 2 lakhs on a purely ad-hoc basis, which is impermissible law.
Held:
● In view of the consistent position taken by various Tribunals on the issue of disallowability of expenses on a purely ad- hoc basis, without the AO having rejected books of accounts, present Tribunal is allowing the assessee’s appeal in respect of the ad-hoc disallowance. Appeal of the assessee is allowed.
● The AO has not disputed that the accounts and records the assessee are audited under the provisions of Section 44AB of the Act. The AO has not rejected the books of the assessee.
7. Commissioner of Income tax, meerut vs Modi Xerox [2014] 50 taxmann.com 201 (Allahabad) (Allahabad High court)
Facts:
The Assessing Officer had made an addition of Rs. 15,00,000 as estimated expenses for the guest house. The appellant claimed that the guest house was being run as a training center and justified the estimated expenses.
Held:
● The Commissioner of Income-tax (Appeals) sided with the appellant, stating that the Assessing Officer made an ad hoc disallowance on conjectures and surmises, which is entirely unsustainable in law and on facts.
● The Commissioner also noted that the Assessing Officer did not refer to any expenditure or material for estimating the expenditure of Rs. 15,00,000. The Commissioner found that the addition was made on presumption, and there was nothing to indicate that the appellant incurred such an expenditure.
● The Tribunal affirmed the findings of the Commissioner of Income-tax (Appeals), stating that there was no material to indicate any other expenses incurred by the assessee apart from paying rent.
8. Commissioner of Income tax vs Kohinoor foods ltd. [2015] 61 taxmann.com 84 (Delhi) (High court of Delhi)
Facts:
● The case involves appeals arising from the common orders of the Income-tax Appellate Tribunal (ITAT) dated July 21, 2014.
● The primary issue revolves around the acceptance of the assessee’s appeals concerning the rejection of books of account and an addition of 1 per cent gross profit on a uniform basis for the assessment years 2002-03 to 2007-08.
● The assessee, engaged in processing and trading of rice, pulses, and food products, underwent a search on December 5, 2007. Subsequently, a notice was issued under section 153A of the Income-tax Act, 1961.
Held:
● The ITAT considered that the assessee’s books of account were regularly maintained and audited without discrepancies indicated by the AO.
● The Tribunal criticized the AO’s rejection of books and the ad hoc addition of 1 per cent of sales, terming it an interplay of surmises and conjectures without material basis.
● The ITAT found no justification for the rejection of books and supported the assessee’s claim that the yield of rice, bran, and faak was in line with industry norms. It emphasized that a search alone does not establish nefarious activities.
● The ITAT referred to a circular by the Punjab Mandi Board, which notified the milling yield rate as 61 per cent, and noted that the assessee’s books had been accepted in previous scrutiny assessments.
● The High Court affirmed the ITAT’s decision, concluding that the AO’s narrow basis for rejecting books and adding 1 percent of sales was legally untenable.
Conclusion: In conclusion, the issue of ad-hoc disallowances in tax assessments remains a contentious one, with judicial authorities consistently emphasizing the need for concrete evidence and specific defects to justify such actions. While tax authorities have the responsibility to ensure compliance and prevent evasion, arbitrary disallowances without factual basis can undermine the fairness and legality of assessments. Businesses should remain vigilant and seek appropriate legal recourse when faced with unjustified ad-hoc disallowances, thereby upholding the principles of transparency and accountability in tax administration.
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