ITAT Mumbai Restricts Bogus Purchase Disallowance to 5%

ITO Vs Khimchand Okchand Bhansali (ITAT Mumbai)

Summary: The Income Tax Appellate Tribunal (ITAT), Mumbai Bench, has recently adjudicated on the extent of disallowance permissible in cases involving alleged bogus purchases, modifying an earlier order by the Commissioner of Income Tax (Appeals) [CIT(A)]. The case, involving the Income Tax Officer (ITO) and Khimchand Okchand Bhansali, centered on the disallowance of purchases deemed non-genuine by the Assessing Officer (AO) for the assessment years 2009-10, 2010-11, and 2011-12. Initially, the AO had disallowed 12.5% of the total purchases, citing information from the Sales Tax Department regarding accommodation entries and the assessee’s failure to produce certain documents like delivery challans. The AO’s stance was that merely proving payment through banking channels and submitting invoices was not conclusive evidence of genuineness. The CIT(A), however, partially accepted the assessee’s documentation and reduced the disallowance to 4%. Dissatisfied with this reduction, the Revenue Department appealed to the ITAT, strongly relying on a Bombay High Court judgment in the case of PCIT v. Kanak Impex, where a 100% disallowance of alleged bogus purchases was upheld. The department contended that the principle established in Kanak Impex should apply, leading to a higher disallowance, potentially restoring the AO’s 12.5% addition or even allowing 100%.

Before the Tribunal, the assessee countered the department’s arguments by asserting that the purchases in question were fully supported by comprehensive documentation, including invoices, bank statements reflecting payments, and quantitative records demonstrating the flow of goods leading to corresponding sales. The core of the assessee’s argument was that while the genuineness of the parties might have been questioned, the purchase transactions themselves were factual and verifiable through financial and stock records. The assessee’s counsel specifically argued that the Kanak Impex judgment was factually distinguishable. The ITAT concurred with the assessee’s distinction of the Kanak Impex case, noting that in Kanak Impex, the taxpayer had failed entirely to prove that the purchases were made or to explain the source of expenditure. In contrast, in the present case, the AO’s action of disallowing a percentage (12.5%) rather than the full 100% of purchases indicated that the AO had implicitly accepted the existence of the transactions, merely doubting the parties involved. The Tribunal referenced other coordinate bench decisions, including Mr. Manish P. Lathia, HUF and Mr. Vinesh Arvindkumar Shah, involving similar facts and the same line of business, where the addition was restricted to 5%. Applying the principle that when purchases and subsequent sales are established, only a component representing potential inflated pricing or profit suppression can be added back to income, the ITAT deemed it appropriate to restrict the disallowance. Consequently, the ITAT directed the Assessing Officer to compute the profit element at 5% of the purchases, modifying the CIT(A)’s order from 4% to 5%, and thereby partly allowing the Revenue’s appeal. The ruling underscores the critical importance of taxpayers maintaining and presenting robust documentation to substantiate the reality of their business transactions during assessment proceedings to mitigate potential adverse actions by the tax authorities.