ITAT Rajkot holds demonetization cash deposits can’t be taxed under Section 69A when fully recorded in books

Background and appeal context

The dispute before the Income Tax Appellate Tribunal, Rajkot Bench, in DCIT Vs Vaibhav Ginning & Spinning Mill Private Limited arose from an addition of Rs.9.75 crore made under Section 69A read with Section 115BBE of the Income Tax Act 1961. The controversy pertained to substantial cash deposits made during the demonetization window in Assessment Year 2017-18.

The assessee, a closely-held company, is engaged in:

  • Manufacturing cotton bales from raw cotton through ginning; and
  • Manufacturing cotton yarn from cotton bales through spinning.

For the relevant year, the assessee e-filed its return of income on 30.10.2017 declaring Rs.3,44,49,019, supported by an audit report. A revised return was filed on 11.01.2019 without any change in the returned income.

The case was selected for complete scrutiny through the Computer Aided Scrutiny Selection (CASS) system on multiple occasions, including for the following flagged reasons:

  • Large cash deposits during the demonetization period; and
  • Undisclosed income reflected on the ITBA AIMS portal after online verification of demonetization deposits.

Following scrutiny, the Assessing Officer (AO) framed an assessment under Section 143(3) and made a substantive addition under Section 69A, treating a major portion of demonetization cash deposits as “unexplained money”. The Commissioner of Income Tax (Appeals)-11, Ahmedabad [CIT(A)] deleted this addition. The Revenue then carried the matter in appeal before the ITAT Rajkot.

Assessment proceedings and addition under Section 69A

Notices and partial compliance

The AO issued notices under Section 143(2) and Section 142(1) at various points in time, calling for detailed information. According to the assessment order, there was limited and delayed compliance by the assessee. Ultimately, the assessee filed submissions through the e-filing portal on multiple dates in November and December 2019.

One of the core issues flagged was cash deposits of Rs.12,29,50,000 in the assessee’s State Bank of India account (A/c No. 31559184504) during the demonetization period. The AO sought a clear explanation of the source of this cash.

Despite multiple opportunities, the AO recorded that the assessee did not provide a narrative explanation for each entry, and only furnished a cash book on 26.12.2019. A show cause notice dated 20.12.2019 proposed to treat the entire demonetization cash deposits as unexplained under Section 69A.

AO’s analysis of the cash book

On examining the cash book, the AO noticed:

  • The assessee was reflecting very high cash-in-hand while still making frequent cash withdrawals from bank accounts in small tranches.
  • Substantial outstanding creditors were shown in the books; however, detailed confirmations or break-up for all creditors were not produced to AO’s satisfaction.
  • In spite of purportedly large cash-in-hand and bank balances, the assessee continued to utilize cash credit facilities and pay interest, instead of reducing borrowings.

From this pattern, the AO inferred:

  1. The cash shown in the books was not actually available in physical form;
  2. Cash withdrawals recorded in the books were allegedly applied for some other undisclosed purpose; and
  3. Cash deposited during demonetization represented unaccounted funds being routed through the books by taking advantage of a high book cash balance.

The AO further observed that:

  • In the cotton ginning trade, purchases are predominantly from unregistered dealers (URD), usually agriculturists, and typically involve cash transactions.
  • As per the AO, the assessee’s cash book did not show cash payments towards URD purchases in the “expected” manner.
  • The assessee had not, according to the AO, furnished full quantitative details of purchases, sales and stock as called for.

Computation of addition

The AO considered that cash withdrawals in October 2016 amounting to Rs.2,54,00,000 could explain part of the demonetization deposits. Accordingly:

  • Total cash deposited during demonetization: Rs.12,29,50,000
  • Less: cash withdrawals (October 2016) treated as explained: Rs.2,54,00,000
  • Balance treated as unexplained money under Section 69A: Rs.9,75,50,000

This amount was brought to tax under Section 69A read with Section 115BBE.

Appellate findings by CIT(A)

The assessee challenged the addition before the CIT(A).