Will Entire amount of bogus purchases be disallowed under Income Tax Act
What do you mean by Bogus Purchases?
In simple terms, bogus purchases are entries made in books of accounts for purchases made, when in fact, no purchases have been made. The aim of the tax payer is to reduce taxable income by inflating expenses on account of purchases. Whenever bogus purchases are found during scrutiny the same will be disallowed i.e. will be added to the income of the assessee.
Is the entire quantum of purchases to be added back or just the amount of profits (when sales are considered as a part of the income)?
A similar situation arose in a High Court Appeal in the case of Principal Commissioner of Income Tax v/s Rishabhdev Technocable Ltd.
Appeal was raised on the following question:-
Whether Tribunal is justified in restricting the disallowance to 5% of the gross purchases when it is established that none of the supplier parties are in existence and the assessee has just taken accommodation entries without getting actual supplies from the said parties?
Facts of the Case
- Assessee is a company which is engaged in the business of manufacturing and dealership of all kinds of industrial power controlling instrument cables and related items. The case was selected for scrutiny.
- The Sales Tax Department had provided a list of persons who had indulged in the unscrupulous act of providing bogus hawala entries and purchase bills.
- AO noticed that assessee was one of the beneficiaries of such bogus hawala bills. AO referred to purchases allegedly made by the assessee through four hawala entries for the assessment year under consideration.
Action by the AO
- In this backdrop, AO issued notice to the assessee under Section 142(1) to explain as to why suitable action should not be initiated for such undesirable act.
- Assessee did not respond to the notice issued under Section 142(1) of the Act.
- Therefore, AO drew the inference that assessee had no plausible explanation and had admitted the fact of bogus purchases mentioned in the notice under section 142(1) of the Act.
- Accordingly, AO proceeded to finalize the assessment under Section 144 (best judgment assessment) and disallowed the entire expenditure shown as incurred by the assessee.
- Assessee criticized the aforesaid order of the AO in an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)).
Proceedings of CIT(A)
1.CIT(A) considered the rival submissions and noticed that assessee did not raise any objection to the higher figure of purchase because the said amount was also declared in the revised sales tax return filed by the assessee with the Sales Tax Department.
2. Therefore, CIT(A) enhanced the quantum of purchases.
3. Having enhanced the quantum of purchases as above, issue with the CIT(A) was:-
i. Whether the entire purchases being bogus purchases were to be added back to the taxable income?
ii. Or only the profit margin or the difference in gross profit/net profit should be added to the taxable income?
4. CIT(A) found that the assessee had made circular purchases and sales from 12 parties as declared in the sales tax return.
5. CIT (A) noted that while AO had treated the purchases as bogus but had accepted the sales and gross profit declared in the return of income. CIT(A) held that there can be no sales without purchases. When the sales were accepted, then the corresponding purchases could not be disallowed. Therefore, CIT(A) held that only the profit element embedded in the purchases would be subject to tax and not the entire purchase amount.
6. On due consideration CIT(A) added 2% of the purchase amount as profit to the income of the assessee and the balance addition was deleted.
7. Aggrieved by the said order of the CIT(A), Revenue preferred appeal before the Tribunal. Revenue was of the view that 2% of the profit which was directed to be added by the CIT (A) was on the lower side and therefore, the Assessing Officer was directed to make further addition of 3%.
Proceedings of ITAT
- Tribunal noted that it was an admitted fact that the AO did not object to the sales made by the assessee. Therefore, it was evident that they were corresponding purchases.
- Having noted the above, Tribunal examined the books of accounts of the assessee wherefrom it was found that the assessee had made payments on account of the purchases through account payee cheques and the purchases were entered in its books of account.
- Thus, assessee was able to prove that the purchases were made only in the alternative way. If that be so, then Revenue was only required to estimate the profit at a particular rate.
- Referring to the figure of 2% arrived by the CIT(A), Tribunal observed that assessee’s gross profit varied from 5% to 8.77%. The gross profit has been reduced from 8.77 % to 5.71% during the year under consideration which is explained as major manufacturing activity in the last year and major part of the trading activity in the year under consideration.
- Since the purchases were made from the grey market, the corresponding profit element would be little higher. Therefore, Tribunal directed the AO to make further addition of 3% on the bogus purchases and to estimate the income on such basis.
Proceedings of the High Court
- On thorough consideration of the matter, we do not find any error or infirmity in the view taken by the Tribunal.
- The lower appellate authorities had enhanced the quantum of purchases much beyond that of the AO but having found that the purchases corresponded to sales which were reflected in the returns of the assessee in sales tax proceedings and in addition, were also recorded in the books of accounts with payments made through account payee cheques, the purchases were accepted by the two appellate authorities and following judicial direction decided to add the profit percentage on such purchases to the income of the assessee.
- While the CIT (A) had assessed profit at 2% which was added to the income of the assessee, Tribunal made further addition of 3% profit, thereby protecting the interest of the Revenue.
- The High Court did not find any merit in this appeal. Also no substantial question of law arises from the order passed by the Tribunal. Consequently, the appeal was dismissed.
- Therefore, 5% of the gross purchases will be disallowed.
Bholanath Polyfab Limited (Gujarat HC) – Gujarat High Court was also confronted with a similar issue. In that case Tribunal was of the opinion that the purchases might have been made from bogus parties but the purchases themselves were not bogus. Considering the fact situation, Tribunal was of the opinion that not the entire amount of purchases but the profit margin embedded in such amount would be subjected to tax. Gujarat High Court upheld the finding of the Tribunal. It was held that whether the purchases were bogus or whether the parties from whom such purchases were allegedly made were bogus was essentially a question of fact. When the Tribunal had concluded that the assessee did make the purchase, then not the entire amount covered by such purchase but the profit element embedded therein would be subject to tax.