Surinder Jit Singh
Chief Commissioner of Income Tax-3,
New Delhi
sjsingh59@gmail.com

Surinder Jit Singh is graduate in Mechanical Engineering from Punjab Engineering College in 1981 and joined Income Tax Department in 1984 as an IRS officer and has worked at Chandigarh, Ludhiana, Pune, Bombay, Amritsar and at Delhi in various capacities including on the post of Principal DG(L&R) and has acquired rich experience in dealing with issues that arises in assessment proceedings. Article on “Bogus Purchases” is intended to provide guidance to AO as this issue is frequently encountered in assessment proceedings and there is pressing need that AO should adopt uniform approach in dealing this is issue.

Executive Summary

There is tendency on the part of tax payers to reduce their taxable income for which they are resorting to various innovative methods. To reduce taxable income, tax payers inflate expenses on the debit side of manufacturing as well as profit & loss account. To inflate expense, tax-payers often shows expenses on account of purchase of goods which have actually not been purchased. Such purchases are generally referred as “Bogus Purchases”. This article is intended to guide assessing officers how to deal with the issue of ‘Bogus Purchases’ encountered during assessment proceedings.

There is tendency on the part of taxpayers to reduce their taxable income for which they are resorting to various innovative methods. To reduce taxable income, taxpayers inflate expenses on the debit side of manufacturing as well as profit & loss account. To inflate expense, tax-payers often shows expenses on account of purchase of goods which have actually not been purchased. Such purchases are generally referred as “Bogus Purchases”. This article is intended to guide assessing officers how to deal with the issue of ‘Bogus Purchases’ encountered during assessment proceedings.

(A) What are Bogus Purchases?

In layman’s language, Bogus Purchase are entries made in books of accounts for purchases made, when infact, no purchases have been made. As stated above, aim of the tax payer is to reduce taxable income by inflating expenses on account of purchases. Though it is generally easy to identify such purchases, process to establish that purchases are bogus is very difficult. This is due to the facts that it is extremely difficult to bring on record admissible evidences which may stand the test of judicial scrutiny. There is no hard and fast rule with regard to the kind of evidences that will be required to prove that purchases made are bogus in a particular case. However, an effort must be made to bring following types of evidences on record.

1. Whether seller of goods is an existing party and is traceable? If party is not existing at the given address, report of inspector must be obtained and placed on record.

2. If the seller of goods is available at the given address, his statement must be recorded. If he accepts the fact that he is only providing accommodation entries, statement should be made part of the record.

3. What are the modes of payments? If payments are made by banking channels, how the recipients of payments dealt with the amounts received must be brought on record. In cases where accommodation entries are provided, generally the amount received is immediately withdrawn in cash.

4. Mode of transportation of goods.

5. Existence of Transporter and his reliability.

If these facts are properly investigated by Assessing Officer and evidences collected, it will be possible to establish that purchase are made are Bogus Purchases. Assessing Officer should take care that all evidences collected, including statements relied upon, are duly confronted to the taxpayers before same are utilized in the assessment order.

(B) Additions to be made on issue of Bogus Purchases Case I: Entire amount of bogus purchases to be disallowed.

After it is established that certain purchases are bogus, generally taxpayers take the stand that since corresponding sales are shown, no addition can be made as sales cannot be made without there being purchases. This stand of the tax payers needs to be rejected. The taxpayer cannot take advantage of its failures as held by Bombay High Court in the case of Shri. Arun kumar J. Muchhala in ITA 363 of 2015. An addition should be made equal to the amount of bogus purchases even if there are corresponding sales. Delhi High Court in the case of CIT Vs La Medical(250 ITR 575) held that once it is held that purchases are not made from the party shown in the books of accounts, the fact that purchases are made from some other sources is not relevant and entire amount is required to be disallowed. Further, Allahabad High Court in the case of Kaveri Rice Mills, (157 Taxman 376) held that once purchases were bogus addition has to be made to the extent of purchases found to be fictitious. In this case Hon’ble High Court further held that “To neutralize the effect of inflation in purchases, the only course open to the AO is to add back the amount of purchases to the income irrespective of the fact whether the rate of GP goes up and whether the resultant GP is higher than the GP normally shown in yester years.”

There is another important decision of ITAT Bombay Bench in the case of M/s. Lifeline Drugs and Intermediates Pvt. Ltd. (5535/Mumbai/2007). In this case ITAT held that when the assessee has no explanation to offer for the bogus purchases, the same has to be added to the total income. It cannot be said that no addition can be made since the assessee might have made purchases from Grey Market. An assessee can’t be given an opportunity to legalize its illegal transaction through accommodation entries.

In the case of N.K. Industries Ltd. Vs DCIT [2016] 72 taxmann.com 289 (Gujarat)

entire purchases shown on basis of fictitious invoices was debited in trading account. Assessing Officer made addition of 25 per cent of total purchase. Tribunal came to a categorical finding that there were purchases from bogus suppliers and, thus, Tribunal made addition of total purchases. Hon’ble Gujarat High Court upheld Tribunal’s finding as follows:

6. The Tribunal in the case of Vijay Proteins Ltd. (supra) has observed that it would be just and proper to direct the Assessing Officer to restrict the addition in respect of the undisclosed income relating to the purchases to 25% of the total purchases. The said decision was confirmed by this Court as well. On consideration of the matter, we find that the facts of the present case are identical to those of M/s. Indian Woollen Carpet Factory (supra) or Vijay Proteins Ltd. (supra) In the present case the Tribunal has categorically observed that the assessee had shown bogus purchases amounting to Rs. 2,92,93,288/- and taxing only 25% of these bogus claim goes against the principles of Sections 68 and 69C of the Income Tax Act. The entire purchases shown on the basis of fictitious invoices have been debited in the trading account since the transaction has been found to be bogus. The Tribunal having once come to a categorical finding that the amount of Rs. 2,92,93,288/- represented alleged purchases from bogus suppliers it was not incumbent on it to restrict the disallowance to only Rs. 73,23,322/-.”

Above case of N K Proteins Ltd (earlier N.K. Industries Ltd.) Vs CIT has been confirmed by Hon’ble Supreme Court vide SLP(C) No. 769 of 2017

Case II: Alternative additions

Some courts have taken a different view that sales shown by taxpayers are not possible without there being purchases which are being held as bogus and hence,no addition can be made except addition on account of inflation in the price of goods if any. Therefore, the Assessing Officer must incorporate in the body assessment order alternate additions without prejudice. Amount of addition to be made on alternative basis will depend upon the nature of business under taken by the Tax Payer.

Following approach is suggested:-

(1) The case before Assessing Officer can be purely the case of taxpayer doing trading of operation only or cases of manufacturing where it is possible to quantify inputs required for goods traded or produced. Such cases can be cases of car dealers, cases of trading in high value electronic goods etc. In such cases Tax-Payers may be having difficulty in obtaining bills for the goods purchased. These will be cases where goods are purchased by the tax-payers in the grey market and bills are obtained from parties engaged in providing accommodation entries. In such cases it will be difficult for the Assessing Officer to modify trading results. However, Assessing Officer can enquire as to whether tax payer has resorted to inflation of value of goods purchased. He can make addition by adjusting the inflation of value of goods resorted to by the tax payers.

(2) There can be cases before Assessing Officer where there is no relation between goods produced and quantity of inputs and, therefore, it is not possible to estimate the exact quantity of inputs required for goods traded or production of goods. In such cases, the Assessing Officer should resort to addition by estimating GP Rate of the business undertaken by of the taxpayer. For estimating the GP rate,the Assessing Officer should take into account GP rate of the assessee in earlier years and GP Rate of persons doing similar business.

Case III: Applicability of section 40A(3)

v There is a dispute about whether any addition, with or without prejudice, can be made on account of bogus purchases? If evidences are collected that payment for bogus purchases are made in cash then there is no doubt that provisions of section 40A(3) are applicable. However, difficulty arises where Assessing Officer assumes that payments are made in cash. In the case of M/s Vijay Proteins 58 ITD 428 it was heldthat the provision of s.40A(3) would not be applicable and even if they are held to be applicable, the expenditure would be covered by the exceptions provided in r.6DD(j) of the Rules.” However it may be mentioned that this decisions was overruled by Gujarat High Court in the case of Hynoup Food & Oil India (P) Ltd (290 ITR 702). Hon’ble High Court held as follows:

“In the light of what is stated hereinbefore, it is not possible to accept the findings of the Tribunal. The Tribunal has committed an error in law in holding that the case of the assessee would be covered by the exceptions provided in r. 6DD(j) of the Rules. The Tribunal has apparently lost sight of the distinction between an entire business which is illegal and a business which is otherwise lawful wherein the assessee resorts to unlawful means to augment his profits. In this connection the following observations made by the Apex Court may be fruitfully reproduced from the case of MaddiVenkataraman& Co. (P) Ltd. Vs. CIT (1998) 144 CTR (SC) 214: (1998) 229 ITR 534 (SC):”

However if there are evidences that purchases are made in cash and are taken into account while computing business profits, then provisions of section 40A(3) can be invoked to disallow purchases as held by Punjab and Haryana High Court in the case of M/s Sai Metal Works ( 241 CTR 377).

In this case it was held as follows:

“If the estimated income impliedly takes into consideration the expenditure incurred, the said principle may apply. If the expenditures which are legally not permissible have been taken into account, the same can certainly be disallowed,”

Source- CBDT Taxalogue Magazine Jul – Oct 19 | Volume 1 | Issue 1

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