Facts of the Case

The assessee, Aadarsh Laddha, legal heir of late Kailash Chand Laddha, filed the return of income for Assessment Year 2016-17 on 21.09.2016 declaring total income of ₹10,55,930. The case was selected for limited scrutiny under CASS on issues relating to low income compared to commission receipts and mismatch in turnover reported in Form 3CD and ITR.

The assessee was engaged as a general commission agent, earning commission income, interest income and income from share trading. During assessment proceedings, the Assessing Officer observed that several business expenses such as staff payments, incentives, conveyance, advertisement, travelling, telephone, books, data processing, car maintenance, postage and salary expenses were supported largely by self-made vouchers. On this basis, the Assessing Officer made multiple ad-hoc disallowances ranging from 20% to 50% under various heads, aggregating to substantial additions, and assessed total income at ₹28,48,869. The Addl./JCIT(A) confirmed the disallowances. Aggrieved, the assessee preferred an appeal before the Tribunal.

Issues Involved

Whether ad-hoc disallowance of business expenditure is justified merely because expenses are supported by self-made vouchers, whether such expenses can be disallowed under Explanation 1 to Section 37 in absence of any finding that the expenditure is prohibited by law or constitutes an offence, and whether the lower authorities were justified in confirming disallowances without any material evidence of inflation or illegality.

Petitioner’s Arguments

The assessee contended that all expenses were incurred wholly and exclusively for business purposes and were duly recorded in the books of account. It was argued that mere absence of third-party vouchers or maintenance of salary registers cannot lead to ad-hoc disallowance without any evidence of bogus or illegal expenditure. Reliance was placed on the decision of the ITAT Mumbai in HDFC Ergo General Insurance Company Limited, wherein it was held that unless an expenditure is shown to be prohibited by law or penal action is taken by a competent authority, Explanation 1 to Section 37 cannot be invoked. It was submitted that no authority had taken any penal or punitive action against the assessee for violation of any law.

Respondent’s Arguments

The Revenue supported the orders of the lower authorities and contended that the expenses were excessive, unverifiable and supported only by self-made vouchers, which justified ad-hoc disallowance. It was argued that the Assessing Officer had acted reasonably in disallowing a portion of the expenses to safeguard revenue.

Court Order / Findings

The ITAT Kolkata observed that the sole basis for disallowance was that the assessee had produced self-made vouchers and not third-party documentary evidence. The Tribunal noted that there was no material on record to establish that the expenses were bogus, inflated or incurred for any purpose prohibited by law. Relying on the decision of the ITAT Mumbai in HDFC Ergo General Insurance Company Limited, the Tribunal held that unless the assessee is shown to have committed an offence or violated a statutory prohibition resulting in penal action, Explanation 1 to Section 37 cannot be applied. The Tribunal further observed that no penal proceedings or adverse action by any competent authority had been brought on record. Accordingly, the ad-hoc disallowances made by the Assessing Officer and sustained by the appellate authority were held to be unsustainable.

Important Clarification

The Tribunal clarified that business expenditure cannot be disallowed on an ad-hoc basis merely because supporting vouchers are self-made, unless the Revenue brings material evidence to prove that the expenditure is non-genuine, excessive or prohibited by law. Explanation 1 to Section 37 applies only where the expenditure constitutes an offence or is expressly prohibited by law.

Final Outcome

The appeal filed by the assessee was allowed. All ad-hoc disallowances made by the Assessing Officer and confirmed by the appellate authority for Assessment Year 2016-17 were deleted in full.

Source Link- https://itat.gov.in/public/files/upload/1767263361-pBUjJ7-1-TO.pdf

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