ITAT Mumbai Clarifies Tax Treatment of Bogus Purchases in Diamond Trading

Background of the Dispute

The case ITO Vs Sahen Enterprises came before the ITAT Mumbai involving additions made on account of alleged bogus purchases in the diamond trading/export business. The core controversy was whether:

the entire amount of alleged bogus purchases of ₹84,48,501 should be added as income,
or
only the profit component embedded in such purchases is liable to tax, particularly where sales corresponding to such purchases are accepted as genuine.

The Assessing Officer (AO) had treated 100% of the purchases as non-genuine and added the full ₹84,48,501 to income. The CIT(A) accepted that the purchases were bogus but restricted the addition to 6% of such purchases, i.e., ₹5,06,901.

The Revenue filed an appeal against this relief, while the assessee filed a cross-objection challenging both the reopening under Section 147 and the residual addition sustained by the CIT(A).

Facts of the Case

Assessee’s Business and Return Filing

The assessee is a partnership firm engaged in trading and exporting polished diamonds.
Return of income for Assessment Year 2012-2013 was filed on 01/11/2012 and processed under Section 143(1) of the Income Tax Act 1961.

Basis of Reassessment

Reassessment proceedings under Section 147 were started on the basis of information received from the Director General of Income Tax (Investigation), Mumbai. As per this information:

The assessee had allegedly obtained accommodation entries of bogus purchases from concerns linked with the Bhanwarlal Jain Group, a group found to be engaged in providing bogus purchase bills in the diamond trade.

The AO noted that the assessee recorded purchases aggregating to ₹84,48,501 from the following concerns:

Surya Diam – ₹10,71,329
Daksh Diamond – ₹73,77,172
Total – ₹84,48,501

These entities were stated to be managed and controlled by the Bhanwarlal Jain Group and were treated as entry providers of bogus diamond bills.

Assessment Order

In the reassessment order dated 19/12/2019 passed under Section 143(3) read with Section 147, the AO:

Held the entire purchases from Surya Diam and Daksh Diamond as bogus,
Added 100% of the purchase value, i.e., ₹84,48,501, to the income of the assessee.

Proceedings before CIT(A)

Documentation Produced by the Assessee

Before the CIT(A), the assessee produced extensive documentation, including:

Purchase invoices from Daksh Diamond and Surya Diam
Corresponding export invoices showing that the diamonds purchased were exported
Bank statements evidencing payments through banking channels
Copies of income tax return, computation of income and financial statements
Stock register for cut and polished diamonds for FY 2011-2012
Purchase register and details of purchases for the year

The assessee argued:

Every purchase from the alleged bogus entities had a matching export transaction, and the quantity of diamonds purchased was fully reconciled with the quantity exported.
The sales were never doubted by the AO; hence, questioning the corresponding purchases alone was contrary to logic and commercial reality.
When purchases and exports were fully documented, disallowance of 100% of the purchases was unjustified.

CIT(A)’s Findings on Bogus Purchases

The CIT(A) accepted the department’s investigation findings that:

Surya Diam and Daksh Diamond formed part of a wider accommodation entry racket in the diamond industry operated by the Bhanwarlal Jain Group.
The arrangement involved issuance of bogus/ inflated purchase bills without actual supply of diamonds, amounting to a clandestine practice.

Accordingly, the CIT(A) agreed that:

Purchases booked from these two parties were bogus in form, and
The assessee had obtained purchase bills from these concerns to inflate purchase figures and reduce tax liability.

However, the CIT(A) also examined the commercial reality:

ITAT Mumbai on Bogus Purchases in Diamond Trade: Only Embedded Profit Taxable, Not Entire Purchase Value