Two primary legal issues were considered by the Court in these Tax Appeals arising from assessment years 2010-11 concerning transactions recorded by the assessees:
(a) Whether the Income Tax Appellate Tribunal (ITAT) erred in deleting additions made under Section 68 of the Income Tax Act, 1961, on account of alleged bogus purchases recorded by the assessees;
(b) Whether the ITAT erred in disregarding the precedent set by this Court in the case of N.K. Industries Ltd. vs. DCIT, as confirmed by the Supreme Court, which upheld additions based on bogus purchases.
These issues revolve around the tax treatment of transactions involving circular sales and purchases among entities, and the applicability of Section 68 additions when the assessee claims to have earned only commission income from accommodation entries rather than being the beneficiary of the entire transaction amounts.
Issue 1: Applicability of Section 68 Additions on Bogus Purchases in the Context of Circular Transactions
The relevant legal provision is Section 68 of the Income Tax Act, which permits the Assessing Officer (AO) to treat any sum credited in the books of an assessee as income if the assessee fails to satisfactorily explain the nature and source of such sum. The Revenue sought to add the entire amount of purchases shown by the assessees as unexplained cash credits under this section, contending these purchases were bogus and unsupported by genuine business activity.
However, the assessees contended that they were engaged in circular transactions, acting as conduits facilitating accommodation entries between related parties, and that they earned only a small commission (0.02%) on the sales amount. The assessees submitted ledger accounts and sales and purchase registers to substantiate their claim that the amounts received on sales were immediately utilized to fund purchases from other entities, indicating no real income or benefit beyond the commission.
The CIT (Appeals) accepted the assessee's contention of circular transactions without real movement of goods and restricted the addition to the difference between sales and purchases, disallowing expenses claimed by the assessee. The AO's addition of the entire purchases as unexplained cash credits was thus curtailed.
The ITAT upheld the CIT (Appeals) order, reasoning that Section 68 applies only when the assessee fails to provide a satisfactory explanation for sums credited. Here, the assessee's explanation-that the amounts were part of circular transactions and only commission income was genuine-was accepted. The Tribunal relied on the Bombay High Court decision in PCIT vs. Alag Securities (P.) Ltd., which held that Section 68 is inapplicable where the assessee satisfactorily explains the source and nature of the credited sums, even if the transactions are accommodation entries.
The Tribunal further observed that the assessee was not the beneficiary of the entire amounts credited but only the commission earned on facilitating the circular transactions. Bank statements showed immediate utilization of sales proceeds against purchases, supporting the claim that the amounts were not unexplained cash credits. The Tribunal concluded that the real income was the commission, and no addition under Section 68 was warranted for the bogus purchases.
The Revenue's argument that the entire bogus purchases should be added under Section 68 was rejected as contrary to the statutory provision, which requires unsatisfactory explanation for addition. The Court agreed with the Tribunal and CIT (Appeals) that the addition under Section 68 was not justified in these facts.
Issue 2: Applicability of Precedent from N.K. Industries Ltd. Case
The Revenue relied heavily on the precedent set by this Court in N.K. Industries Ltd. vs. DCIT, where additions were upheld on the basis of bogus purchases amounting to 25% of total purchases. The Revenue contended that this principle should apply to the present cases to justify additions under Section 68.
The Court distinguished the present facts from those in N.K. Industries Ltd. In that case, the assessee was a beneficiary of bogus purchases supported by fictitious invoices, and there was manufacturing activity outside the books of accounts. The Court had upheld additions based on the undisclosed income estimated as a percentage of bogus purchases, relying also on the Supreme Court's confirmation of that decision.
In contrast, the present assessees were middlemen engaged in circular transactions without real business activity or benefit beyond commission. The Court emphasized that the principles applied in N.K. Industries Ltd. were not applicable where the assessee was only facilitating accommodation entries and not deriving full benefit of the amounts credited.
Thus, the Court held that the precedent relied upon by the Revenue did not support additions in the present facts and circumstances.
Additional Considerations and Application of Law to Facts
The Court noted the factual findings that the assessees admitted before the VAT authorities and during survey proceedings that the transactions were circular in nature. The assessees did not produce complete books of accounts, but the ledger accounts and bank statements indicated immediate utilization of sales proceeds against purchases, supporting the claim of circular transactions.
The Revenue did not controvert the CIT (Appeals) and Tribunal's findings on the utilization of funds or the nature of transactions during the hearing. The Court found no reason to interfere with the concurrent findings of fact and law by the lower authorities.
The Court also considered the Revenue's alternative submission that additions could be made at 0.02% commission on total sales and purchases. The CIT (Appeals) and Tribunal had already accepted commission income as the real income and disallowed expenses accordingly, which the Court found appropriate.
Conclusions
The Court answered both substantial questions of law in the negative, i.e., against the Revenue and in favour of the assessees, holding that:
- The additions under Section 68 of the Income Tax Act on account of bogus purchases were rightly deleted by the ITAT and CIT (Appeals) since the assessee satisfactorily explained the nature and source of the sums credited as commission income from circular transactions.
- The precedent in N.K. Industries Ltd. was not applicable to the facts of these cases as the assessees were middlemen engaged in circular transactions and not beneficiaries of bogus purchases.
- The real income assessable was the commission earned by the assessees, and the addition of the difference between sales and purchases along with disallowance of expenses was appropriate.
Significant Holdings
The Court preserved the following crucial legal reasoning verbatim from the Tribunal's order:
"Section 68 would come into play when any sum is found credited in the books of the assessee and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not in the opinion of the Assessing Officer satisfactory. In such a situation the sum so credited may be charged to income tax as the income of the assessee of the relevant previous year. But that is not the position here. It has been the consistent stand of the assessee which has been accepted by the First Appellate Authority and affirmed by the Tribunal that the business of the assessee centered around customers/beneficiaries making deposits in cash amounts and in lieu thereof taking cheques from the assessee for amounts slightly lesser than the quantum of deposits, the difference representing the commission realized by the assessee."
Further, the Court emphasized:
"In the given facts and circumstances, the principles laid down in the above case directly applies to the case on hand. The assessee is just acting as a middleman and carrying out the circular transactions. Thus, at the most commission income can be brought to tax."
And regarding the distinction from N.K. Industries Ltd.:
"The assessee being NK Industries Ltd was not engaged in circular transaction by way of providing accommodation entries for commission. In that case, the assessee was one of the beneficiary of the accommodations entries which were provided by the other parties whereas in the case on hand the assessee is middleman and engaged in the circular transaction. Thus, in our humble understanding we are of the view that the principles laid down by the Hon'ble Gujarat High Court in the case of NK Industries (supra) cannot be applied in the given facts and circumstances."
These holdings establish the core principle that Section 68 additions require unsatisfactory explanation of sums credited, and where an assessee acts as a conduit in circular transactions earning only commission, the entire amounts involved cannot be treated as unexplained cash credits. The real income is limited to the commission earned, and precedent involving beneficiaries of bogus purchases does not apply to such middleman entities.
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