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:-