ITAT Mumbai Explains Demonetisation Cash Deposits, Section 40A(3) & Section 68 in Fashion Designer Firm’s Case

Background and Procedural History

The Mumbai Bench “A” of the Income Tax Appellate Tribunal dealt with cross-appeals in the matter of Abu Jani Sandeep Khosla vs DCIT (ITA Nos. 2504 & 2530/Mum/2025, AY 2017-18). The appeals arose from an order of the CIT(A)-51, Mumbai dated 12.02.2025 for Assessment Year 2017-18.

Both the assessee and the Revenue were aggrieved on different issues emerging from the same assessment order. Since the underlying facts were common, the Tribunal decided both appeals together through a consolidated order.

The assessee is a partnership firm engaged in the business of high-end fashion designing and readymade garments. For AY 2017-18, it filed its return of income declaring approximately ₹1.53 crore as taxable income. The case was selected for scrutiny, primarily to examine large cash deposits made during the demonetisation window.

Grounds Raised by the Assessee

The assessee challenged the order of the CIT(A) on two main counts:

1. Addition of unsecured loan u/s 68

   • The assessee objected to confirmation of an addition of ₹18,00,000 made under Section 68 treating an unsecured loan as unexplained cash credit, despite the assessee having disclosed it fully as a bona fide loan.

2. Disallowance of interest on such loan

   • Consequential disallowance of ₹2,34,000 as interest on the above loan was also assailed, on the ground that the interest payment was fully supported by records and documents.

Grounds Raised by the Revenue

The Revenue, in its cross-appeal, contested the relief granted by the CIT(A) on two major issues:

1. Demonetisation-period cash deposits

   • Deletion of an addition of ₹3,01,29,433 under Section 68 towards alleged unexplained cash credits arising from cash deposited during the demonetisation period was challenged on the ground that the assessee failed to substantiate the genuineness of such large cash deposits.

2. Disallowance u/s 40A(3)

   • Deletion of disallowance of ₹37,70,347 under Section 40A(3) in respect of cash payments alleged to be in excess of ₹20,000 per person per day was opposed, claiming the assessee did not furnish work orders, contracts, or TDS proof.

Assessment Proceedings: Key Additions by the AO

During scrutiny, the Assessing Officer (AO) focused on three primary aspects:

1. Cash deposits during demonetisation
2. Cash payments allegedly hit by Section 40A(3)
3. Unsecured loan of ₹18 lakh under Section 68

1. Demonetisation-Period Cash Deposits and Section 68

During the demonetisation window, the assessee deposited ₹5.50 crore in cash across ten different bank accounts. The AO also examined the assessee’s turnover, ranging between ₹33.57 crore and ₹84.08 crore for AYs 2014-15 to 2018-19, along with cash-in-hand figures as per balance sheets.

The assessee explained that:

• The cash deposits were sourced from cash in hand generated from regular business operations.
• A month-wise cash on hand statement was produced.
• A chart of cash deposits for earlier years was furnished to show a consistent pattern.
• Cash sales had surged due to festive and wedding seasons (including Navratri and Diwali).
• There were cash sales of gift vouchers of around ₹1.00 crore (147 vouchers) from 22.08.2016 to 28.10.2016.
• All cash sales were duly reflected in VAT returns and in audited books; no rejection of books was proposed by the AO.

Despite this, the AO did not accept these explanations. Instead, he:

• Computed an “average cash availability” for October and November based only on two earlier years (AYs 2015-16 and 2016-17).
• Concluded that the average cash available for deposit in October–November was about ₹3.35 crore.
• Observed that actual cash deposits in October–November 2016 were about ₹6.36 crore.
• Treated the difference of approximately ₹3.01 crore (₹6.36 crore – ₹3.35 crore) as unexplained cash credit under Section 68, and taxed it at the higher rate under Section 115BBE.
• Justified the addition primarily on the doctrine of “preponderance of probabilities”, arguing that the level of cash deposit was not in line with past patterns.

2. Cash Payments and Disallowance Under Section 40A(3)

The AO noticed multiple cash payments recorded in the assessee’s books which, on the face of the ledger, appeared to exceed ₹20,000 to a single party, thereby attracting Section 40A(3).

The assessee explained that:

• It operates in a labour-intensive sector (fashion and garment manufacturing), which requires skilled and semi-skilled workers.
• Workers often insist on receiving remuneration in cash for daily subsistence needs.
• Actual payments were made in small denominations – each individual worker was paid less than ₹20,000 per day.
• Consolidated entries exceeding ₹20,000 appearing in the books represented aggregation of multiple small payments, passed for ease of accounting.
• Many payments related to work executed through group entities, including Abu Jani Sandeep Khosla Designers Private Limited and another group company, both regularly assessed to tax.
• Details such as PAN of payees and vouchers evidencing cash payments below the statutory threshold were made available.

The AO rejected this explanation and disallowed ₹37,70,347 under Section 40A(3) on the premise that the assessee had made cash payments exceeding the prescribed limit and failed to prove the nature of work or TDS compliance with formal contracts or work orders.

3. Unsecured Loan of ₹18 Lakh Under Section 68

The AO further observed that the assessee had recorded an unsecured loan of ₹18 lakh from Blue Star Investment.