ITAT Chandigarh on Adhoc Expense Disallowance: Relief to Assessee Where AO Finds No Concrete Defects

Background and Context

The Chandigarh Bench of the Income Tax Appellate Tribunal (ITAT) in the case of DCIT Vs Theon Pharmaceuticals Limited dealt with a crucial issue relating to adhoc disallowance of business expenditure. The Assessing Officer (AO) had made a flat 30% disallowance of certain expenses aggregating to ₹11.52 crore, resulting in an addition of ₹3.45 crore (₹345.66 lakh), alleging non-verifiability and lack of supporting details.

The assessee, a large pharmaceutical manufacturer and exporter with turnover exceeding ₹457 crore, had placed on record audited financial statements, detailed ledgers, party-wise break-ups, and sample invoices. Despite this, the AO proceeded with a broad-brush disallowance without clearly pinpointing specific defects or undertaking third-party verification.

The Commissioner of Income Tax (Appeals), NFAC [CIT(A)] deleted the disallowance, and the Revenue carried the matter in appeal before the ITAT Chandigarh. The Tribunal upheld the CIT(A)’s order and dismissed the Revenue’s appeal, reiterating that adhoc disallowances cannot be sustained in the absence of specific findings or proper enquiry.

Assessment Stage: Nature of Expenditure and AO’s Approach

Income Declared and Scrutiny Assessment

  1. For Assessment Year 2023-24, the assessee filed its return declaring income of ₹14.60 crore.
  2. The case was selected for scrutiny, and assessment was completed under Section 143(3) of the Income Tax Act 1961 on 21-03-2025.

Heads of Expenses Under Dispute

The AO primarily questioned several major expenditure heads, including:

  • Sales Commission
  • Marketing & Distribution Expenses
  • Clearing & Forwarding Expenses
  • Carriage & Freight Inward
  • Sales Discount

The total of these expenses was recorded at about ₹11.52 crore.

The assessee submitted:

  • Audited financial statements
  • Party-wise details including names, addresses and amounts
  • PAN details wherever available
  • Ledgers of the relevant expense heads

However, the AO alleged that the assessee did not furnish all individual invoices, bills, complete ledgers with narration of purpose, bank statements marking the specific payments, or copies of underlying agreements/arrangements for every party.

The AO further observed that there was alleged non-compliance with Tax Deduction at Source (TDS) provisions, but did not link this allegation to any concrete instance of default as per the tax audit report.

Assessee’s Explanation During Assessment

In reply dated 10-03-2025, the assessee clarified:

  • The volume of documentation was extremely large considering the scale of operations and turnover exceeding ₹457 crore.
  • Due to practical constraints and limited assessment time, it was not feasible to electronically submit scanned copies of each and every supporting document for every party.
  • Sample invoices and supporting documents were, however, produced to demonstrate the nature and genuineness of expenditure.
  • All expenses were duly recorded in the regular books, which were audited.

Despite this, the AO identified what he termed “minor discrepancies” such as:

  • Non-mention of vehicle numbers on certain invoices
  • Absence of e-way bill details in many cases
  • No clear indication of mode of payment on some vouchers

Relying on these generic observations, the AO concluded that both the genuineness and reasonableness of the expenses could not be conclusively verified. Without identifying any specific bogus or inflated claim, the AO disallowed 30% of the total relevant expenses, treating ₹3.45 crore as unexplained expenditure.

Travelling & Conveyance Expenses

Another addition related to Travelling & Conveyance expenses of ₹40.02 lakh.

The assessee explained that:

  • These expenses were incurred primarily in relation to export operations.
  • They included travel for sales activities in foreign markets and expenses of foreign auditors who carried out quality and compliance audits of manufacturing facilities.
  • Such audits were a pre-condition for export of pharmaceutical products to certain jurisdictions.
  • Ledger accounts of the travelling and conveyance expenses were produced.