Bogus purchase: Addition should be of income component only

N.K. Industries Ltd. Vs. Dy. CIT (Gujarat High Court)

Gujarat High Court Examines Tax Treatment of Bogus Purchases in N.K. Industries Case

Ahmedabad: The Gujarat High Court has addressed the contentious issue of how additions should be made to the income of an assessee when faced with alleged bogus purchases, particularly within the framework of block assessments initiated following search operations. The court delivered its judgment in the case of N.K. Industries Ltd. against the Deputy Commissioner of Income Tax, considering appeals filed by both the assessee company and the revenue department challenging an order of the Income Tax Appellate Tribunal (ITAT), Ahmedabad.

The dispute originated from search proceedings conducted at the premises of N.K. Industries Ltd., also known as the N.K. Group, which is involved in trading, speculation of castor seed, and the export of castor oil and its derivatives. During the search, tax authorities reportedly discovered materials including blank signed cheque books, vouchers, blank bill books, and letterheads belonging to various other concerns at the company’s office and factory premises. Based on these findings, the Assessing Officer (AO) concluded that purchases recorded by N.K. Industries from these concerns were not genuine.

Citing “elaborate reasons” detailed in the assessment order, the AO treated these purchases as bogus. Consequently, the entire amount of these disputed purchases was added back to the income of N.K. Industries. In some instances, bank deposits in the accounts of these parties were also treated protectively as the assessee’s income.

The matter progressed to the ITAT. The Tribunal, while confirming the findings of the Commissioner (Appeals) on certain aspects, including the deletion of an addition for salt washing loss, took a different stance on the bogus purchases. Referencing its earlier decision in the case of Vijay Proteins Ltd. and the Rajasthan High Court’s decision in Indian Woollen Carpet Factory, the ITAT did not uphold the AO’s action of adding back the entire amount of bogus purchases. Instead, the Tribunal restricted the addition on account of these alleged bogus purchases to 25% of the total disputed purchase value. For example, in one assessment year, against total alleged bogus purchases of ₹2,92,93,288, the Tribunal retained an addition of ₹73,23,322 (25%). Similarly, against alleged bogus purchases of ₹11.99 crores in another period, the ITAT limited the addition to ₹3 crores (approximately 25%).

Both the assessee and the revenue were aggrieved by the Tribunal’s order and filed separate tax appeals before the Gujarat High Court, raising substantial questions of law.

The assessee, represented by advocate Mr. J.P. Shah, argued that the Tribunal erred in retaining any addition for bogus purchases, especially at 25%, without specific evidence found during the search to support such an undisclosed income component. It was contended that if the purchases were accepted as genuine, no addition was warranted, and if not, the addition should be handled differently. Mr. Shah submitted that additions related to falsified entries based on search material, if any, should potentially be the subject of regular assessment, not block assessment under Chapter XIV-B (Section 158BC), particularly when no corresponding undisclosed income was unearthed in the search. He relied on the court’s previous decision in N.R. Paper & Board Ltd.. The assessee also pointed out alleged factual errors in the Tribunal’s reasoning regarding excise/sales tax assumptions that influenced the 25% estimation and argued against additions made based on evidence found in searches on third parties (like M/s. J.D. Shroff) being included in the assessee’s block assessment under Section 158BC instead of following the procedure under Section 158BD. Furthermore, the assessee challenged the addition of gross profit on sales, arguing that the sales were already recorded in the books at market rate and adding a separate gross profit component amounted to double taxation.

The revenue, represented by Senior Counsel Mr. M.R. Bhatt, countered that the Tribunal erred in restricting the addition on account of bogus purchases to merely 25%. Mr. Bhatt argued that once purchases are found to be entirely bogus and based on fictitious invoices, as debited in the trading account, the principles of Section 68 (cash credits) and Section 69C (unexplained expenditure) of the Act would apply, implying that the entire amount of unexplained expenditure should be added back. He contended that the Tribunal, having found the purchases to be bogus, was not justified in restricting the disallowance to only 25%. He defended the Tribunal’s reliance on earlier decisions but sought a modification of the quantum of addition.

The High Court, after considering the submissions and reviewing the Tribunal’s order, examined the issues. Regarding the bogus purchases, the court referenced Sections 68 and 69C, suggesting that taxing only 25% of the bogus claim might go against the principles embedded in these sections when a transaction is found to be fictitious. The court appeared to indicate that if purchases are entirely bogus, the entire amount shown as expenditure without corresponding genuine purchase could be questionable. The court also clarified that its decision in N.R. Paper & Board Ltd., while discussing the scope of regular versus block assessment, should not be read to mean that concealed income arising from the falsity of entries exposed by search material cannot be assessed in the block assessment. Thus, the court upheld the Tribunal’s decision against the assessee on this point in principle, meaning the issue could be assessed in the block assessment.

Concerning additions related to purchases from M/s. Somnath Industries and M/s. Krishna Marketing, which the assessee contended were made without material found related to these parties during the search on N.K. Industries premises, the High Court found the Tribunal was justified in holding against the assessee and in favor of the revenue.

On the question of the addition related to gross profit on sales amounting to ₹3,70,78,125 on sales of ₹37.08 crores, the High Court noted that the sales themselves were accepted as recorded in the regular books. The court agreed that the assessee should not be unduly penalized when the sale price is accepted. While the Tribunal’s basis for a gross profit addition was linked to the bogus purchases (assuming lower purchase cost due to tax avoidance), the High Court recalculated the potential profit component. The court determined that even if a gross profit were to be considered, the corresponding cost price would need to be factored in. The court calculated a profit rate of 5.66% based on the figures. Consequently, the High Court directed the revenue to restrict the addition on this account to ₹20,98,621.88 (5.66% of ₹3,70,78,125), thereby partially favoring the assessee on this specific issue by reducing the quantum of addition.

In conclusion, the Gujarat High Court dismissed the appeals filed by both the assessee and the revenue. However, the impugned judgment and order passed by the ITAT were modified in accordance with the specific findings of the High Court, particularly the revised calculation and reduced quantum of the gross profit addition. While the court upheld the principle of making additions for bogus purchases within the block assessment framework and confirmed additions based on certain third-party-related findings, its modification on the gross profit calculation provided some relief to the assessee on that specific ground.

Read SC Judgment: Supreme Court Upholds Gujarat HC Ruling on Bogus Purchases, Block Assessment

FULL TEXT OF THE GUJARAT HIGH COURT JUDGMENT IS AS FOLLOWS:-

1.1 Similarly, being aggrieved and dissatisfied with the impugned judgment and order passed by the Income Tax Appellate Tribunal, Ahmedabad Bench ‘C’ (hereinafter referred to as ‘the Tribunal’), the revenue has preferred the present Tax Appeals assailing the following orders :–

2. These matters were admitted by this Court for consideration of the following substantial question of law :–

Tax Appeal No. 240 of 2003

Whether on the facts and in the circumstances of the case, Income Tax Appellate Tribunal was justified in retaining the addition on account of alleged bogus purchases at 25% i.e. Rs. 73,23,322 of the total purchases amounting to Rs. 2,92,93,288?

Tax Appeal No. 241 of 2003

(1) Whether on the facts and in the circumstances of the case the Income Tax Appellate Tribunal was justified in confirming the addition of Rs. 3,70,78,125 as gross profit on sales of Rs. 37.08 crores made by the assessing officer despite the fact that the said sales had admittedly been recorded in the regular books during Financial Year 1997-98?

(2) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was justified in holding that the assessing officer had rightly made additions in respect of purchases worth Rs. 1,14,78,000 from M/s. Somnath Industries and Rs. 51,67,228 from M/s. Krishna Marketing in assessment which has been framed under section 158BC of the Act, despite the fact that in proceedings under section 132 of the Act no material was found in relation to said two parties to warrant such additions?

Tax Appeal No. 242 of 2003

Whether on the facts and in the circumstances of the case, Income Tax Appellate Tribunal was justified in retaining the addition on account of alleged bogus purchases at 25% i.e. Rs. 3 crores of the total purchases amounting to Rs. 11.99 crores?

Tax Appeal No. 260 of 2003

Whether on the facts and in the circumstances of the case, Income Tax Appellate Tribunal was justified in retaining the addition on account of alleged bogus purchases at 25% i.e. Rs. 3 crores of the total purchases amounting to Rs. 11.99 crores?

Tax Appeal No. 261 of 2003

Whether on the facts and in the circumstances of the case, Income Tax Appellate Tribunal was justified in retaining the addition on account of alleged bogus purchases at 25% i.e. Rs. 73,23,322 of the total purchases amounting to Rs. 2,92,93,288?

3. The assessee company also popularly known as N.K. Group of companies is involved in trading and speculation of castor seed and also engaged in export of castor oil and castor oil derivatives. During the course of search proceedings at the office premises of NKPL, blank signed cheque books and vouchers of number of concerns were found. Endorsed blank cheques of NKPL by these concerns were also found from the office premises of NKPL wherein the endorsement was on the back of the cheques. Blank bill books, letter heads and vouchers of these concerns were found and seized from the factory premises of NKPL. Purchases made from these concerns have been treated by the assessing officer as bogus purchases in view of elaborate reasons recorded in the assessment order. The entire deposits in the bank accounts of these parties were treated as assessee’s income on protective basis.

3.1 On appeal before the Tribunal by the revenue, by impugned judgment and orders, Tribunal confirmed the findings of the Commissioner (Appeals). The Tribunal also deleted the addition shown for salt washing loss. Being aggrieved and dissatisfied with the impugned orders passed by the Tribunal, the revenue has preferred the present Tax Appeals for consideration of the aforesaid substantial question of law.

4. Mr. J.P. Shah, learned advocate appearing for the assessee submitted that the Tribunal erred in holding that 25% of Rs. 2.92 crores is undisclosed income as defined under section 158B(b) of the Income Tax Act, 1961. He submitted that the Tribunal erred when on one hand it accepted the purchases to be genuine and then went ahead to estimate 25% thereof as the undisclosed income without a shred of evidence to that effect found in search.

4.1 Mr. Shah further submitted that the Tribunal failed to appreciate that in accordance with the decision of this Court in the case of N.R. Paper & Board Ltd. v. Dy. CIT (1998) 234 ITR 733 (Guj.), the addition which the Tribunal foisted on the assessee could be if at all the subject matter of the regular assessment and not the block assessment more particularly when no evidence was found during the course of search supporting such undisclosed income.

4.2 Mr. Shah further submitted that the Tribunal committed a grievous mistake in presuming that there was excise duty and sales tax and other taxes on oil purchased by the assessee and on the basis of such grievous error coming to the conclusion that the purchase price of the appellant would be 25% less than the market price. He submitted that the fact of the matter is there are no such taxes on oil.

4.3 Mr. Shah further submitted that the Tribunal failed to appreciate that the addition in respect of the evidence from M/s. J.D. Shroff can be made in the hands of the appellant only under section 158BD after going through the process and procedure laid down therein and not under section 158BC where under the addition can be made only on the basis of the evidence seized from the appellant and therefore the addition of Rs. 3,66,78,297 and interest of Rs. 1,78,20,544 under section 158BC were bad in law as it was not made on the basis of the evidence found in search on the assessee but was made on the basis of the evidence found in search of M/s. J.D. Shroff and the restoration of the point to the assessing officer was also bad.

4.4 Mr. Shah submitted that the Tribunal failed to appreciate that the assessee had already credited the amount of Rs. 37,07,81,250 at market rate to sales account in its books of account and therefore there was no justification on the part of the Tribunal to again add gross profit of Rs. 3,70,78,125 or any portion thereof to the (undisclosed) income of the assessee. He submitted that the Tribunal failed to appreciate that the assessing officer had solely without application of mind relied on appraisal report of ADIT, the copy of which was never supplied to the assessee.

4.5 Mr. Shah has relied upon the decisions of this Court in the case of CIT v. Nangalia Fabrics (P.) Ltd. [Tax Appeal No. 689 of 2010, date 22-4-2013], Dy. CIT v. Radhe Developers India Ltd. (2010) 329 ITR 1 (Guj.) and N.R. Paper & Board Ltd. (supra) in support of his submissions.

4.6 Mr. Shah submitted that the case of Vijay Proteins Ltd. v. CIT [IT Reference No. 139 of 1996, Tax Appeal No. 243 of 2002, date 9-12-2014] is not applicable on the facts of the present case. Drawing attention to para no. 16 of the order in the case of Vijay Proteins, he submitted that this Court decided the said case by placing reliance on Sanjay Oilcake Industries v. CIT (2009) 316 ITR 274 in which it is held that there is no substantial question of law since there is inflation in purchase price. He submitted that there is distinction in facts of the present case and Vijay Proteins Ltd. (supra) inasmuch as in the case of Vijay Proteins Ltd. (supra) there is inflation in purchase price whereas in the present case the remand report clearly states that the purchases were at prevailing market rate. He submitted that even the GP and the yield is better.

5. Mr. M.R. Bhatt, learned Senior Counsel appearing with Mrs. Mauna Bhatt, learned advocate for the revenue submitted that the Tribunal has erred in law and on facts in restricting the addition on account of bogus purchases to 25% i.e. Rs. 3 crores out of the addition of Rs. 11.99 crores made by the assessing officer. The Tribunal has decided the issue regarding bogus purchases relying on the decision of the Rajasthan High court in the case of Indian Woollen Carpet Factory v. ITAT (2003) 260 ITR 658 (Raj) wherein it has been held that addition under section 68 or 69 of the Act is tenable in the case of peak credit in the accounts of bogus suppliers. He submitted that the quantum of such peak credit and retention of the addition has been decided by the Tribunal at 25% of the total bogus purchases on the basis of its earlier decision in the case of Vijay Proteins Ltd. (supra)

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 dis allowance to only Rs. 73,23,322.

6.1 In the case of NR Paper & Boards Ltd. (supra), this Court has discussed the issue as to whether after making of block assessment, regular assessment is barred or prohibited by law. This court has held that there would be no overlapping in the nature of assessment made under this Chapter of undisclosed income and the regular assessment made under section 143(3). However, if the said decision is read in context of questions raised in the present appeal, it cannot be read as having held that even if the material found during the course of search expose the falsity of the entries made in the regular books of accounts, the consequent concealed income cannot be assessed as undisclosed income in the block assessment under Chapter XIV-B. The said decision shall therefore not be applicable on the facts and circumstances of the present case. The Tribunal is justified in holding the same against the assessee and in favor of revenue.

7. So far as question regarding additions in respect of purchases worth Rs. 1,14,78,000 from M/s. Somnath Industries and Rs. 51,67,228 from M/s. Krishna Marketing in assessment which has been framed under section 158BC of the Act, despite the fact that in proceedings under section 132 of the Act no material was found in relation to said two parties to warrant such additions is concerned, we are of the view that the Tribunal is justified in holding the same against the assessee and in favor of the revenue.

8. So far as the question regarding addition of Rs. 3,70,78,125 as gross profit on sales of Rs. 37.08 crores made by the assessing officer despite the fact that the said sales had admittedly been recorded in the regular books during Financial Year 1997-98 is concerned, we are of the view that the assessee cannot be punished since sale price is accepted by the revenue. Therefore, even if 6% gross profit is taken into account, the corresponding cost price is required to be deducted and tax cannot be levied on the same price. We have to reduce the selling price accordingly as a result of which profit comes to 5.66%. Therefore, considering 5.66% of Rs. 3,70,78,125 which comes to Rs. 20,98,621.88 we think it fit to direct the revenue to add Rs. 20,98,621.88 as gross profit and make necessary deductions accordingly. Accordingly, the said question is answered partially in favor of the assessee and partially in favor of the revenue.

9. In view of the above, the impugned judgment and order passed by the Tribunal is modified accordingly. Hence, the present Tax Appeals are dismissed.