2025 (7) TMI 880 - AT - Income Tax

Disallowances of 50% of subs-contract work expenses - disallowance of excavation and compaction expenses claimed as labour expenses - HELD THAT - AO has made both the disallowance on adhoc basis at the rate of 50% without specifying the basis for the same in any manner. AO though in the order of assessment has disputed the expenses; however once he himself accepted the expenses to the tune of 50% then we do not find any reason to interfere the decision of the CIT(A) deleting the other part of expenses which was disallowed by the Ld. AO without specifying any basis to do so. It is well settled proposition of law that disallowance of expenses on ad-hoc basis that too without rejecting the books of accounts is untenable. CIT(A) found substance in the case made out by the assessee and allowed the disallowance made by the AO which in our considered view is just and proper so as not to warrant interference. Decided against revenue.

Summary

The core legal questions considered in this appeal pertain to the validity and correctness of the Assessing Officer's (AO) disallowance of expenses claimed by the assessee under the Income Tax Act, 1961 for the Assessment Year 2016-17. Specifically, the issues are:

1. Whether the AO was justified in disallowing 50% of the subcontract work expenses claimed by the assessee on an ad-hoc basis, given the nature and documentation of the subcontract agreements and genuineness of the expenses.

2. Whether the AO was justified in disallowing 50% of the excavation and compaction expenses claimed as labour expenses on an ad-hoc basis, considering the explanations and comparative data furnished by the assessee.

Issue 1: Disallowance of 50% of Subcontract Work Expenses

Relevant Legal Framework and Precedents: The expenses claimed under subcontract work are allowable under sections 36 and 37 of the Income Tax Act, provided they are incurred wholly and exclusively for business purposes and are genuine. The AO's power to disallow expenses must be based on tangible evidence or specific defects in the accounts, not on arbitrary or ad-hoc bases. The Tribunal referenced a precedent where ad-hoc disallowances without pointing out specific defects were held untenable.

Court's Interpretation and Reasoning: The AO disallowed 50% of subcontract expenses amounting to Rs. 7,69,18,350/- on the following grounds: the subcontract agreement with Saran Construction Co. was dated prior to the assessee's receipt of the main subcontract; the assessee failed to submit documents proving actual work done by subcontractors; contracts were on letterheads rather than stamped papers; and mere payments through banking channels and TDS deduction were insufficient to establish genuineness.

The assessee countered these objections by explaining that large contracts are often negotiated and documented at different times for commercial prudence; the subcontractors were genuine and had been accepted in previous assessments; payments were made through banking channels with TDS deduction, creating a clear audit trail; and contracts on letterheads are valid and corroborated by other evidence. Importantly, the assessee argued that the AO failed to conduct any on-site verification or seek confirmations from the main contractee to disprove genuineness.

The CIT(A) accepted the assessee's explanations, noting that the AO's disallowance was based on mere suspicion and ad-hoc estimation of profit margins rather than concrete evidence. The AO's assumption that 50% of expenses were inflated was deemed illogical and arbitrary. The Tribunal concurred, emphasizing that the AO did not point out any specific disallowable expenses or defects in the accounts, nor did he reject the books of account. The AO's action was thus contrary to settled principles that disallowances must be founded on evidence and proper inquiry.

Key Evidence and Findings: The assessee provided detailed payment records to subcontractors, copies of agreements, TDS certificates, and comparative data from the previous year where similar expenses were accepted. The Tribunal noted the absence of any inquiry or contrary evidence from the AO. The AO's own acceptance of 50% of the expenses implied recognition of their genuineness.

Application of Law to Facts: The Tribunal applied the principle that expenses cannot be disallowed on vague or speculative grounds. The AO's disallowance without identifying specific discrepancies or conducting investigations was held to be unjustified. The burden of proof to show non-genuineness or non-business purpose lies on the revenue, which was not discharged.

Treatment of Competing Arguments: The revenue's reliance on timing of agreements and lack of stamped contracts was rejected as insufficient to disallow expenses. The assessee's arguments regarding business practices, evidence of payments, and prior acceptance were accepted as reasonable and credible.

Conclusion: The Tribunal upheld the deletion of the 50% disallowance on subcontract expenses, ruling that the AO's ad-hoc disallowance lacked basis and was contrary to law.

Issue 2: Disallowance of 50% of Excavation and Compaction Expenses

Relevant Legal Framework and Precedents: Labour expenses incurred for business purposes are allowable deductions under the Income Tax Act. The genuineness and business nexus of such expenses must be established. Ad-hoc disallowances without evidence or specific defects are impermissible. The Tribunal relied on precedent holding that AO must specify defects or unverifiable vouchers to justify disallowance.

Court's Interpretation and Reasoning: The AO disallowed 50% of excavation and compaction expenses amounting to Rs. 42,57,000/- on the ground that the assessee failed to establish genuineness and business purpose of labour expenses. The AO did not delve into labour law compliance but questioned the authenticity of claimed expenses.

The assessee responded by furnishing detailed comparative data showing that labour expenses as a percentage of turnover had actually decreased from the previous year (where expenses were accepted), thus negating any presumption of inflated or bogus expenses. The assessee argued that the nature of the work is labour intensive and the reduction in expenses demonstrated prudent cost management rather than any irregularity.

The CIT(A) accepted the assessee's submissions, noting that the AO's disallowance was based on a wrong premise and was not supported by any specific evidence or enquiry. The AO had not identified any particular vouchers or payments as unverifiable. The Tribunal agreed, reiterating that ad-hoc disallowances without pointing out defects are not sustainable.

Key Evidence and Findings: The assessee provided detailed financial data comparing labour expenses over two years, showing consistency and reduction in labour costs. No contradictory evidence was produced by the AO.

Application of Law to Facts: The Tribunal applied the principle that expenses should be viewed in context and relative terms, and that the AO must provide a reasoned basis for disallowance. The AO's failure to do so rendered the disallowance arbitrary.

Treatment of Competing Arguments: The revenue's contention rested on suspicion without supporting evidence, which was rejected in light of the assessee's detailed explanations and prior acceptance of similar expenses.

Conclusion: The Tribunal upheld the deletion of the 50% disallowance on excavation and compaction expenses.

Significant Holdings:

"In our opinion the scheme of the Act does not authorize the Assessing Officer to make a disallowance according to his wishes, rather it provides that he should first point out the defects in the accounts of the assessee... no interference is called for in the order of Id. CIT(A) on this issue."

The Tribunal established the core principle that ad-hoc disallowances of expenses without specific, evidence-based findings or rejection of books of account are untenable under the Income Tax Act. The AO must identify particular defects or unverifiable expenses to justify disallowance.

On the issue of subcontract expenses, the Tribunal emphasized that mere timing discrepancies in agreements or absence of notarized contracts do not justify disallowance if the assessee can demonstrate business purpose, genuineness, and payment trail. The burden lies on the AO to disprove genuineness, which was not discharged.

Regarding labour expenses, the Tribunal held that expenses must be considered in context and compared with prior years, and unexplained ad-hoc disallowance without evidence is impermissible.

Final determinations were that the AO's disallowances of Rs. 7,69,18,350/- on subcontract expenses and Rs. 42,57,000/- on excavation and compaction expenses were deleted, and the revenue's appeal was dismissed as devoid of merit.