2018 (12) TMI 2017 - AT - Income Tax

Estimation of income - bogus purchases - FAA confirming the gross profit rate @ 8% of the bogus purchases as such purchases were totally exported out of India - whether adoption of 8 to 6% is justified/reasonable with respect to the assessee who are indulging in hawala purchase - HELD THAT - So far as the contention of the Ld. DR that the gross profit may be increased to 12.5% is concerned is also not justified since the assessee is trading gems and jewellery and not in general goods. Considering the material available on record find no justification to interfere with the reasoning given in the impugned order as the assessee has already declared G.P. @ 5.4% and since the assessee was involved in hawala/bogus purchases therefore the adoption of gross profit @8% is quite justified because the assessee could not justify the genuineness of bogus purchases consequently the order of the Ld. Commissioner of Income Tax (Appeal) is upheld resultantly the appeal of the assessee is dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in the judgment are:

• Whether the gross profit rate of 8% applied on purchases alleged to be bogus is justified, given that the assessee declared a gross profit of 5.94% on such transactions which were entirely exported out of India.
• Whether the purchases made from parties alleged to be bogus or hawala dealers can be accepted as genuine for the purpose of income computation.
• What is the appropriate rate of gross profit to be adopted in cases involving bogus or hawala purchases, particularly in the gems and jewellery business.
• Whether the Assessing Officer's estimate of gross profit margin and additions on account of bogus purchases is reasonable and sustainable.
• Whether the disallowance of expenses or depreciation relating to capital assets (such as purchase of crane) is justified in the absence of evidence of bogus transactions.
• What evidentiary standards and procedural safeguards apply when relying on statements of third parties (e.g., directors of alleged bogus parties) without cross-examination.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Justification of Gross Profit Rate of 8% on Bogus Purchases

The legal framework involves the principle that where purchases are found to be from bogus parties, the Assessing Officer (AO) may estimate income by applying a suitable gross profit margin. The CBDT Instruction No. 2/08 dated 22/02/2008 prescribes a revised profit margin of 6% for the gems and jewellery business, replacing the earlier 8% margin.

Precedents from various High Courts and the Supreme Court establish that estimation of income in such cases involves an element of guesswork and the AO's estimate must be fair and reasonable. The Gujarat High Court in Sanjay Oilcakes Industries (2009) affirmed the AO's and appellate authorities' concurrent findings that where parties are not traceable and payments are routed through conduit parties, an addition based on inflated purchase prices is justified. The Apex Court in Kachwala Gems (2007) recognized the inevitability of guesswork in best judgment assessments.

In the present case, the assessee declared gross profit at 5.94%, while the AO and appellate authorities applied 8%, citing the involvement of bogus purchases. The Revenue's contention for a 12.5% gross profit rate was rejected as excessive for the nature of the business.

The Court applied the CBDT instruction and relevant case law, holding that the adoption of 8% gross profit margin is justified given the hawala nature of purchases and the inability of the assessee to establish genuineness of the transactions. The fact that the purchases were exported out of India did not absolve the assessee from the burden of proof.

Competing arguments from the assessee that the declared 5.94% gross profit should be accepted were rejected on the basis that the declared profit margin was not supported by credible evidence on the genuineness of purchases.

Conclusion: The Court upheld the application of 8% gross profit margin on bogus purchases as reasonable and justified.

Issue 2: Genuineness of Purchases from Alleged Bogus or Hawala Parties

The legal framework requires that the AO establish the non-genuineness of purchases by adducing evidence such as non-traceability of parties, cash withdrawals soon after cheque deposits, absence of goods movement, and other suspicious features.

Precedents such as CIT vs Bholanath Poly Fab. Pvt. Ltd. (2013) and CIT vs Vijay M. Mistry Construction Ltd. (2013) emphasize that whether purchases are bogus is a question of fact. If the assessee proves that goods were actually received and sold, only the profit margin embedded in the inflated purchase price is taxable.

The Hon'ble jurisdictional High Court in CIT vs Nikunj Exim Enterprises Pvt. Ltd. (2015) held that mere suspicion or absence of suppliers' appearance before the AO is insufficient to disallow purchases if other evidence such as bank payments, confirmations, and stock reconciliation supports genuineness.

In the present case, the AO relied on search and survey findings indicating that dummy parties controlled by the Bhavarlal Jain family were used for hawala purchases. Statements of concerned persons admitted creation of dummy directors and partners. However, the assessee failed to justify the genuineness of these purchases.

The Court noted that the assessee did not provide sufficient evidence to dislodge the finding of bogus purchases, and the gross profit margin was adjusted accordingly.

Competing arguments that the purchases were genuine and supported by banking transactions were considered but found insufficient in light of the overall evidence.

Conclusion: The Court held that the purchases were from bogus/hawala parties and the AO's additions based on inflated purchase prices were justified.

Issue 3: Disallowance of Expenses and Depreciation on Capital Assets

The AO disallowed expenses and depreciation relating to purchase of a crane and spare parts, suspecting the transactions to be bogus.

The Commissioner of Income Tax (Appeals) and the Tribunal examined documentary evidence including octroi receipts, hypothecation to bank, RTO registration, and physical existence of the crane. They held that the purchase was genuine and the crane was used exclusively for business purposes.

Legal principles dictate that disallowance of capital expenditure or depreciation requires proof of bogus nature of the asset or transaction. Mere suspicion or technical infirmities in documentation are insufficient.

The Court concurred with the concurrent findings of fact by the appellate authorities, holding that the disallowance was not warranted.

Conclusion: The disallowance of expenses and depreciation relating to the crane was rightly deleted.

Issue 4: Reliance on Statements of Third Parties Without Cross-Examination

The jurisdictional High Court in CIT vs Ashish International Ltd. (2011) held that statements of directors of alleged bogus parties, relied upon by the Revenue, cannot be accepted without giving the assessee an opportunity to cross-examine.

In the present case, the assessee disputed the correctness of such statements and was not afforded cross-examination opportunity. The Court held that the Tribunal's decision based on these procedural lapses did not raise any substantial question of law.

Conclusion: Procedural fairness requires cross-examination before adverse reliance on third-party statements; absence thereof weakens the Revenue's case.

Issue 5: Evidentiary Requirements for Establishing Bogus Purchases

The Tribunal in DCIT vs Rajeev G. Kalathil (2015) emphasized that suspicion alone cannot substitute for evidence. The AO must investigate thoroughly, including bank account details, cash withdrawal patterns, and proof of goods movement.

In the instant case, the AO failed to conduct a complete inquiry, such as tracing cash withdrawals or independently verifying goods movement. The Tribunal found that goods were received and part of closing stock, and payments were made by cheque, which supported the assessee's case to some extent.

However, the Court ultimately upheld the addition on the basis of the overall evidence of hawala purchases and inability of the assessee to justify the transactions.

Conclusion: While suspicion is insufficient, failure to provide convincing evidence of genuineness can justify estimation of income by the AO.

3. SIGNIFICANT HOLDINGS

"The action of the Commissioner of Income-tax (Appeals) confirming 25 per cent. of the amounts claimed is fair and reasonable and no interference is called for... It is established that the parties were not traceable; they opened the bank accounts in which the cheques were credited but soon thereafter the amounts were withdrawn by bearer cheques. That fairly leads to the conclusion that these parties were perhaps creation of the assessee itself for the purpose of banking purchases into books of account because the purchases with bills were not feasible."

"Whether the estimate should be at a particular sum or at a different sum can never be an issue of law."

"In a best judgment assessment there is always a certain degree of guess work. No doubt, the authorities should try to make an honest and fair estimate of the income even in a best judgment assessment and should not act totally arbitrarily but there is necessarily some amount of guess work involved."

"Merely because the suppliers have not appeared before the Assessing Officer or the Commissioner of Income-tax (Appeals), one cannot conclude that the purchases were not made by the respondent-assessee."

"Suspicion of highest degree cannot take place of evidence."

"The assessee had conclusively proved the purchase and existence of the crane, and had not debited the expenses to the profit and loss account, no addition could have been made in respect of the purchase price nor could have depreciation been disallowed in respect thereof."

Core principles established include:

• Estimation of income in cases of bogus purchases involves guesswork but must be fair and reasonable.
• Genuineness of purchases is a question of fact, requiring evidence of actual receipt and sale of goods.
• Absence of suppliers or their non-appearance is not conclusive proof of bogus transactions.
• Procedural fairness, including opportunity to cross-examine, is essential when relying on third-party statements.
• Disallowance of capital expenditure or depreciation requires conclusive proof of bogus nature of transactions.
• CBDT instructions on gross profit margins are relevant guides for estimation in specific industries.

Final determinations:

• The gross profit rate of 8% applied on bogus purchases is upheld as reasonable.
• The purchases from alleged bogus parties are held to be non-genuine based on evidence and search findings.
• The disallowances relating to capital asset purchase and depreciation are deleted due to lack of evidence of bogus transactions.
• The appeal of the assessee is dismissed, affirming the additions and adjustments made by the AO and appellate authorities.