2025 (7) TMI 1480 - AT - Income Tax

Disallowance of 50% of total expenses - addition made as no business activity was carried out by the Proprietorship as there were no purchases and sales during the relevant previous year - HELD THAT - AO had not disallowed the expenses in entirety but had only made disallowance of a percentage of expenditure. In our view disallowance made by the AO was merely an ad-hoc disallowance without any basis. On the other hand the Assessee had explained that the Assessee was carrying out business during the relevant previous year and the expenditure related to the same were booked/bifurcated for the each Proprietorship separately. Assessee has filed audited financials (consolidated for all businesses) break up of expenses business-wise and head-wise)and ledger accounts. The details/documents furnished support the contention of the Assessee that the expenses have been incurred for the purpose of the business of the Assessee carried out under the Proprietorship. We note that Expenses under consideration include (a) depreciation, (b) Legal Professional expenses (incurred on legal disputes related to properties held) (c) payment to bank towards interest and bank charges (d) Salary (in addition to salarympaid to staff employed for the proprietorship M/s JK Shah ) and (e) Printing Stationery Expenses. A perusal of ledger accounts shows that the Travelling Expenses and Advertisement Expenses are also related to legal disputes. Based upon the material on record related to the aforesaid expenses we accept the contention of the Assessee that the same were incurred wholly and exclusively for the purpose of business. Therefore we hold that the Assessee is entitled to claim deduction for the same in full under Section 32/37(1). As regards the balance expenditure while the Assessee has filed ledger accounts the expenditure details cannot be verified. Therefore we accept the alternative contention of the Assessee and restrict the disallowance to 10% of the said expenditure. As a result the disallowance made is restricted to INR. 9, 494/- and balance disallowance of INR. 10, 00, 456/- is deleted. Thus Ground No. 1 and 2 raised by the Assessee are partly allowed.

Summary

ISSUES:

Whether the disallowance of 50% of total business expenses claimed by the assessee under a proprietorship concern is justified where no sales or purchases were recorded during the relevant previous year.Whether the Assessing Officer was correct in making an ad-hoc disallowance of business expenses without proper inquiry or verification of the detailed breakup and supporting documents furnished by the assessee.Whether expenses incurred on legal disputes related to properties and interest on loans taken for business purposes qualify as wholly and exclusively incurred for the purpose of business under the Income Tax Act, 1961.Whether the quantum of disallowance can be reasonably reduced from 50% to a lower percentage based on the evidence and verification of expenses.

RULINGS / HOLDINGS:

The disallowance of 50% of total expenses was held to be an "ad-hoc disallowance without any basis" as the Assessing Officer failed to conduct inquiry or verification despite the assessee furnishing detailed breakup, ledger accounts, vouchers, and bills.The mere absence of sales during the relevant previous year cannot be the sole basis to conclude that no business activity was carried out, especially when opening and closing stock were essentially the same properties, indicating ongoing business operations.Expenses including depreciation, legal and professional fees related to legal disputes on properties, bank interest and charges, salaries, and certain other expenses were accepted as "wholly and exclusively for the purpose of business" and allowed as deductions under Sections 32 and 37(1) of the Income Tax Act.The disallowance was restricted to 10% of the unverifiable portion of expenses, reducing the disallowance from INR 5,04,975 to INR 9,494, thereby partly allowing the appeal.

RATIONALE:

The Court applied the provisions of Section 32 (relating to depreciation) and Section 37(1) (relating to expenses wholly and exclusively incurred for business) of the Income Tax Act, 1961.The Court emphasized the requirement of proper inquiry and verification before making any disallowance of business expenses and rejected the Assessing Officer's reliance on ad-hoc percentage disallowance without basis.The Court recognized that business activity cannot be negated solely on the absence of sales if other indicators such as holding of stock and incurring of business-related expenses exist.The decision reflects a doctrinal insistence on evidentiary support and reasonableness in disallowance of expenses, limiting the scope of arbitrary or mechanical disallowances by tax authorities.