Penalty for Estimated Bogus Purchase Additions Deleted by ITAT Mumbai
Background of the Dispute
The series of appeals decided by the ITAT Mumbai in the case of Ratnaram Kohlaram Chaudhary Vs ITO involved a common issue: whether penalty under Section 271(1)(c) of the Income Tax Act 1961 can be sustained when the underlying additions are based only on an estimated profit element in alleged bogus purchases.
The assessee, an individual resident, was engaged in trading in ferrous and non‑ferrous metals through a proprietary concern named M/s. Nutech Metal. For Assessment Years (A.Ys.) 2009-10, 2010-11 and 2011-12, he filed returns of income under Section 139, which were initially processed under Section 143(1) without scrutiny.
Subsequently, based on investigation inputs from the Investigation Wing, which in turn relied on information from the Sales Tax Department regarding certain "hawala" or accommodation entry providers, the Assessing Officer (AO) reopened assessments under Section 147 for all three years. The allegation was that the assessee had obtained bogus purchase bills from such entry providers.
Reassessment Proceedings and Estimation of Profit
Information from Sales Tax Department
The Sales Tax authorities had identified several suppliers as parties engaged in issuing bogus purchase invoices without actual movement of goods. The Investigation Wing shared this information with the Income Tax Department, and the assessee’s name surfaced as a beneficiary of these alleged accommodation entries.
During reassessment, the AO confronted the assessee with this material and treated purchases from certain parties as suspicious. The assessee consistently maintained that all purchases were genuine, actually made, recorded in the books, and necessary for his trading activity.
AO’s Treatment of Purchases and Ad Hoc Profit Rate
Despite the assessee’s explanations, the AO concluded that the assessee had obtained accommodation bills from listed entities. However, crucially, the AO accepted that:
- The purchases were duly recorded in the books of account.
- The corresponding sales had been accepted and not disturbed.
Proceeding on this premise, the AO reasoned that the assessee might have procured the goods from the grey market while booking bogus bills from accommodation providers to regularise such transactions and suppress the true profit margin.
Instead of disallowing the entire purchase value, the AO chose to tax only the profit element embedded in such purchases. For this purpose, he estimated the profit percentage as follows:
- A.Y. 2009-10: 25% of the value of alleged bogus purchases
- A.Y. 2010-11: 12.5% of the value of alleged bogus purchases
- A.Y. 2011-12: 12.5% of the value of alleged bogus purchases
No specific working or rationale was given in the assessment orders for adopting 25% or 12.5%; it was plainly an ad hoc estimation.
Based on this estimation, additions were made to the assessee’s income in all three years.
First Appeal: Relief by CIT(A)/NFAC
The assessee challenged the additions before the Commissioner of Income Tax (Appeals) functioning through the National Faceless Appeal Centre (NFAC).
The first appellate authority did not accept the high percentages adopted by the AO. Taking a more moderate view, the CIT(A)/NFAC scaled down the profit element as under:
- A.Y. 2009-10: profit rate reduced from 25% to 6.5%
- A.Y. 2010-11: profit rate reduced from 12.5% to 6%
- A.Y. 2011-12: profit rate reduced from 12.5% to 6%
This dramatic reduction in the profit percentage highlighted the purely estimative nature of the additions.