Only the profit element embedded in purchases would be subjected to tax and not the entire amount 

IN THE HIGH COURT OF JUDICATURE AT BOMBAY
ORDINARY ORIGINAL CIVIL JURISDICTION
INCOME TAX APPEAL (IT) NO.1330 OF 2017
Pr.Commissioner of Income Tax-13, Mumbai.… Appellant
V/s.
Rishabhdev Tachnocable Ltd. … Respondent
—
Mr.Akhileshwar Sharma, Advocate for the Appellant.
—
CORAM : UJJAL BHUYAN &
MILIND N. JADHAV, JJ.
DATE : FEBRUARY 10, 2020
P.C.:-
1. Heard Mr.Akhileshwar Sharma, learned standing counsel,
Revenue for the appellant.
2. This appeal has been preferred by the Revenue under
Section 260A of the Income Tax Act, 1961 (briefly “the Act”
hereinafter) against the order dated 3rd November, 2016
passed by the Income Tax Appellate Tribunal, “D” Bench,
Mumbai (briefly “the Tribunal” hereinafter) in Income Tax
Appeal No.7773/Mum/2014 for the assessment year 2010-
11.
3. Revenue has preferred this appeal projecting the
following question as substantial question of law:-
“Whether on the facts and in the circumstances
of the case and in law, Tribunal is justified in
restricting the disallowance to 5% of the gross
purchases when it is established that none of the
Priya Soparkar 2 8 itxa 1330-17-o
supplier parties are in existence and the assessee
has just taken accommodation entries without
getting actual supplies from the said parties?”
4. To appreciate the question proposed, it may be apposite
to advert to the orders passed by the authorities below.
5. Respondent is an assessee under the Act. It is a
company which is engaged in the business of manufacturing
and dealership of all kinds of industrial power controlling
instrument cables and related items. For the assessment year
2010-11 assessee filed e-return of income declaring income
of Rs.1,35,31,757.00. In addition, assessee also declared
income of Rs.3,64,15,007.00 under Section 115JB of the Act.
The case was selected for scrutiny and in scrutiny
proceedings Assessing Officer noticed that Sales Tax
Department, Government of Maharashtra had provided a list
of persons who had indulged in the unscrupulous act of
providing bogus hawala entries and purchase bills. Names of
beneficiaries were also provided. Assessing Officer noticed
that assessee was one of the beneficiaries of such bogus
hawala bills. Assessing Officer referred to purchases allegedly
made by the assessee through four hawala entries for the
assessment year under consideration, the details of which are
as under :-
Name of the Party
providing Bogus Bills/
Hawala Entries
A.Y. of the
transaction
Amount (Rs.)
SHREE GANESH
TRADING COMPANY
2010-11 54670729
AKSHAT ENTERPRISES 2010-11 76998384
Priya Soparkar 3 8 itxa 1330-17-o
SHREYAS MARKETING
AGENCY
2010-11 55018874
ASIT TRADERS 2010-11 55118398
241806385
6. In this backdrop, Assessing Officer issued notice to the
assessee under Section 142(1) of the Act to explain as to
why suitable action should not be initiated for such
undesirable act. It was mentioned in the said notice that
the Assessing Officer was vested with the authority of passing
an order of best judgment assessment under Section 144 of
the Act. Assessee did not respond to the notice issued under
Section 142(1) of the Act. Therefore, Assessing Officer drew
the inference that assessee had no plausible explanation
and had admitted the fact of bogus purchases mentioned in
the notice under section 142(1) of the Act. Accordingly,
Assessing Officer proceeded to finalize the assessment under
Section 144 of the Act. For the grounds and reasons given in
the assessment order dated 6th March, 2013 passed under
Section 144 of the Act, Assessing Officer disallowed the entire
expenditure shown as incurred by the assessee amounting to
Rs.24,18,06,385.00.
7. Respondent/assessee assailed the aforesaid order of the
Assessing Officer in appeal before the Commissioner of
Income Tax (Appeals)-18, Mumbai, (shortly referred to as
“CIT(A)” hereinafter).
8. CIT(A) in the appellate proceedings admitted additional
evidence furnished by the assessee under Section 46A of
the Income Tax Rules, 1962 (briefly “the Rules” hereinafter)
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and allowed opportunity to the Assessing Officer to
examine the documents and thereafter, to submit remand
reports. Following the same, Assessing Officer submitted two
remand reports dated 10th December, 2013 and 25th July,
2014. Both the remand reports were extensively considered
by the CIT(A). Copies of the reports were also furnished to the
assessee and based on the reports an opportunity was
granted to the assessee to show cause as to why the quantum
of purchases should not be enhanced from
Rs.24,18,06,385.00 to Rs.65,65,30,470.00 in terms of Section
251(2) of the Act.
9. CIT(A) considered the rival submissions and noticed that
assessee did not raise any objection to the higher figure of
purchase because the said amount was also declared in the
revised sales tax return filed by the assessee with the Sales
Tax Department. Thereafter, CIT(A) enhanced the quantum
of purchases from Rs.24,18,06,385.00 to Rs.65,65,30,470.00.
Having enhanced the quantum of purchases as above, CIT(A)
posed a question as to whether the entire purchases being
bogus purchases were to be added back to the taxable
income of the assessee or only the profit margin or the
difference in gross profit/net profit should be added.
10. For the grounds and reasons given in the appellate order
dated 14th October, 2014, CIT(A) found as a matter of fact
that assessee had made circular purchases and sales from
12 parties as declared in the sales tax return. Though the
genuineness of purchases and sales were not proved before
Priya Soparkar 5 8 itxa 1330-17-o
the Assessing Officer and also during the appellate
proceedings, CIT (A) noted that while Assessing Officer had
treated the purchases as bogus but had accepted the sales
and gross profit declared in the return of income. CIT(A) held
that there can be no sales without purchases. When the sales
were accepted, then the corresponding purchases could not
be disallowed. Therefore, CIT(A) held that only the profit
element embedded in the purchases would be subject to tax
and not the entire purchase amount. On due consideration
CIT(A) added 2% of the purchase amount of
Rs.65,65,30,470.00 as profit which worked out to
Rs.1,31,30,609.00 to the income of the assessee and the
balance addition was deleted.
11. Aggrieved by the said order of the CIT(A), Revenue
preferred appeal before the Tribunal. Tribunal vide the order
dated 3rd November, 2016 took the view that 2% of the profit
which was directed to be added by the CIT (A) was on the
lower side and therefore, the Assessing Officer was directed
to make further addition of 3%.
12. It is against this order of the Tribunal that Revenue is
before us in appeal under Section 260-A of the Act.
13. Mr.Sharma learned standing counsel, Revenue submits
that when the purchases were bogus, the entire amount
covered by such purchases should have been added to the
total income of the assessee. There is no question of only
adding the profit margin to the income of the assessee. In this

Priya Soparkar 6 8 itxa 1330-17-o
connection learned standing counsel has referred to a
decision of the High Court of Allahabad in Kaveri Rice Mills
Vs. Commissioner of Income-Tax, (2006)157 Taxman
376. He has also placed reliance on a decision of the Delhi
High Court in Commissioner of Income-Tax Vs. La Medica,
250 ITR 575, wherein it was held that once it was
accepted that the supplies made were fictitious, question of
the assessee making purchases from other sources ought not
to have been considered by the Tribunal. It was not open to
the Tribunal to make out a third case which was not even the
case of the assessee. He therefore submits that atleast an
arguable case is made out by the department and therefore,
the appeal should be admitted on the question of law
proposed.
14. We have carefully considered the submissions made by
learned standing counsel and have also perused the
materials on record.
15. We have already discussed the context in which the Assessing
Officer had made the additions. We have also noted that in the
appellate proceedings before the first appellate authority i.e.CIT(A)
the quantum of purchases was enhanced from Rs.24,18,06,385.00
to Rs.65,65,30,470.00. Having raised the quantum of purchases
as above, CIT(A) posed a question to itself as to what
should be the treatment of purchases; whether the same
should be added back to the taxable income of the assessee
as a whole or only profit margin should be added back.
After referring to various case laws on the subject, CIT(A)
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returned a finding of fact that assessee had made circular
purchases and sales with 12 parties as disclosed in the sales
tax return. Though genuineness of the purchases and sales
were not proved, yet it was noted that the Assessing Officer
had accepted the sales and gross profit declared in the
return of income. CIT(A) held that there can be no sales
without purchases. When the sales were accepted, then the
entire purchases could not be disallowed. Referring to a
decision of the Gujarat High Court in the case of CIT Vs.
Bholanath Polyfab Limited, 355 ITR 290 (Guj) CIT(A)
held that only the profit element embedded in purchases
would be subjected to tax and not the entire amount. Having
said so, CIT(A) noted that the gross profit rate of the
assessee showed a decreasing trend over the years. In such
circumstances, CIT(A) took the view that 2% of the purchases
of Rs.65,65,30,470.00 would be a fair and reasonable profit
percentage which should be added to the income of the
assessee, deleting the balance amount.
16. While doing so, CIT (A) observed that only reasonable
profit on the purchases made from the hawala party should
be added back to the income of the assessee. Relevant
portion of the order of the CIT (A) is extracted hereunder:-
“2.7 From the perusal of the decisions of the
Hon’ble courts on this issue, specially the decision
of the Hon’ble Bombay High Court in the case of
CIT Vs. Nikunj Eximp Enterprises Pvt. Ltd. (supra),
it was clearly held that the A.O. and the CIT (A)
had disallowed the amount of Rs.1.33 crores on
account of purchases merely on the basis of
suspicion because the sellers and the canvassing
agents have not been produced before them. The

Priya Soparkar 8 8 itxa 1330-17-o
Hon’ble Mumbai Tribunal in the case of Saroj Anil
Steel Pvt. Ltd. Vs. ITO vide order dated 30-10-
2012 has also decided this issue that only profit
margin @ 1 % is to be added back. Similar view
has been taken by the Hon’ble Tribunal Mumbai in
the case of Anil Goyal Exim (P) Ltd. Vs. ITO vide
order dated 25-04-2005. The Hon’ble Gujarat High
Court in the case of CIT Vs. Bholanath Polyfab Pvt.
Ltd., 40 Taxman.com 494 has held that whether
the assessee did purchase cloth and sell finished
goods and purchasers were not traceable, profit
element embedded in purchases would be subject
to tax and not entire amount. From the facts of
the present case, it is noticed that the assessee
has made circular purchases and sales with 12
parties as declared in sales tax return. The
genuineness of purchases and sales were not
proved before the A.O. and even during the
appellate proceedings. The A.O. has treated the
purchases as bogus but accepted the sales and
gross profit declared in the return of income. Now
question arise whether there can be any sales
without purchases. The answer is always in the
negative that no sales can be made without
purchases. The situation can be that purchases
may not be made from the parties from whom
invoices have been obtained as mentioned by the
A.O. in the assessment order. But when the sales
are accepted then the whole purchases cannot be
disallowed as held by various courts stated above.
As per the decision of the Hon’ble Gujarat High
Court in the case of CIT Vs. Bholanath Polyfab Pvt.
Ltd., it is clearly held that only the profit element
embedded in purchases would be subject to tax
and not the entire amount. Now the question
arises how to determine the profit element. For
this purpose, the total turnover and percentage
of gross profit for the earlier three years was
obtained from the AR of the appellant. It is
noticed that in earlier years, the main business of
the assessee was manufacturing and dealership
of all kinds of industrial power control instruments
and related items but in the year under
consideration it has shown trading of

Priya Soparkar 9 8 itxa 1330-17-o
Rs.65,65,30,470/- out of the total purchases at
Rs.67,34,02,306/-. The gross profit shown in the
year under consideration was at 5.71 % as
against 8.77% in the preceding year. From the
perusal of the submissions made by the AR of the
appellant, it is noticed that the contention of the
appellant was correct that in the earlier years the
main business of the assessee was
manufacturing and in the year under
consideration the major activity is of trading. The
gross profit rate was also decreasing every year
and in the year under consideration it has
decreased to 3%. It is also an established fact
that the gross profit of trading activity is lower
than the manufacturing activity. The AR of the
appellant has also offered that additional gross
profit @ ½% of the turnover can be added
back. But there is no reasonableness in adopting
this ½% G.P. Keeping in view the principles of
natural justice and the decision of the Hon’ble
Courts on this issue, only the reasonable profit
has to be added back on the purchases made
from the hawala parties. The gross profit has
been reduced from 8.77 % to 5.71% during the
year under consideration which is explained as
major manufacturing activity in the last year and
major part of the trading activity in the year
under consideration. Keeping in view of these
facts and circumstances, I am of the view that
2% of the purchases made from the hawala
parties amounting to Rs.65,65,30,470/- which
works out at Rs.1,31,30,609/- is fair and
reasonable, hence, upheld and the balance
addition made is deleted. Ground of appeal is
partly allowed.”
17. Before the Tribunal, Revenue expressed the grievance
that CIT (A) had erred in disallowing bogus purchases at 2%
being profit on purchases made by the assessee from the

Priya Soparkar 10 8 itxa 1330-17-o
grey market. Tribunal vide its order dated 3rd November, 2016
held as under :-
“4. We have heard rival contentions and gone
through the facts and circumstances of the case.
Admitted facts are that the AO neither in the
original proceedings nor during remand
proceedings objected to sales made by assessee.
In that eventuality it is imperative on our part to
hold that there must be purchases. Whether the
purchases are from Grey Market or whatever the
assessee has made purchases although
payments are made to hawala dealers. In that
eventuality it is to be seen whether the payments
are recorded in the books of account or not. This
fatum is not denied by Revenue, rather the
assessee has proved that the payments are made
through accounts payee cheques and purchases
are entered in its books of account. Once the
assessee is able to prove that the purchases were
made only in alternative way, the revenue is to
estimate the excess profit at a rate. Here, our
difference is that 2% is reasonable or some
higher profit is to be estimated. We are of the
view that the assessee’s gross profit varies from
5% to 8.77%, but these purchases are from
Grey Market and its profit element is little higher
and accordingly, we direct the Assessing Officer
to make further addition of 3% of the bogus
purchases and accordingly estimate the income.
We direct the Assessing Officer accordingly. This
issue of Revenue’s appeal is partly allowed.”
18. Tribunal noted that it was an admitted fact that the
Assessing Officer did not object to the sales made by the
assessee. Therefore, it was evident that they were
corresponding purchases. Having noted the above, Tribunal
examined the books of accounts of the assessee wherefrom
it was found that the assessee had made payments on
account of the purchases through account payee cheques
Priya Soparkar 11 8 itxa 1330-17-o
and the purchases were entered in its books of account. Thus,
assessee was able to prove that the purchases were made
only in the alternative way. If that be so, then Revenue was
only required to estimate the profit at a particular rate.
Referring to the figure of 2% arrived by the CIT(A), Tribunal
observed that assessee’s gross profit varied from 5% to
8.77%. Since the purchases were made from the grey market,
the corresponding profit element would be little higher.
Therefore, Tribunal directed the Assessing Officer to make
further addition of 3% on the bogus purchases and to
estimate the income on such basis.
19. On thorough consideration of the matter, we do not find
any error or infirmity in the view taken by the Tribunal. The
lower appellate authorities had enhanced the quantum of
purchases much beyond that of the Assessing Officer i.e.,
from Rs.24,18,06,385.00 to Rs.65,65,30,470.00 but having
found that the purchases corresponded to sales which were
reflected in the returns of the assessee in sales tax
proceedings and in addition, were also recorded in the
books of accounts with payments made through account
payee cheques, the purchases were accepted by the two
appellate authorities and following judicial dictum decided to
add the profit percentage on such purchases to the income
of the assessee. While the CIT (A) had assessed profit at 2%
which was added to the income of the assessee, Tribunal
made further addition of 3% profit, thereby protecting the
interest of the Revenue. We have also considered the two
decisions relied upon by learned standing counsel and we

Priya Soparkar 12 8 itxa 1330-17-o
find that facts of the present case are clearly distinguishable
from the facts of those two cases to warrant application of the
legal principles enunciated in the two cited decisions.
20. In Bholanath Polyfab Limited (supra), Gujarat High
Court was also confronted with a similar issue. In that case
Tribunal was of the opinion that the purchases might have
been made from bogus parties but the purchases themselves
were not bogus. Considering the fact situation, Tribunal was
of the opinion that not the entire amount of purchases but
the profit margin embedded in such amount would be
subjected to tax. Gujarat High Court upheld the finding of the
Tribunal. It was held that whether the purchases were bogus
or whether the parties from whom such purchases were
allegedly made were bogus was essentially a question of
fact. When the Tribunal had concluded that the assessee did
make the purchase, as a natural corollary not the entire
amount covered by such purchase but the profit element
embedded therein would be subject to tax.
21. We are in respectful agreement with the view expressed
by the Gujarat High Court.
22. Thus, we do not find any merit in this appeal. No
substantial question of law arises from the order passed by
the Tribunal. Consequently, the appeal is dismissed. However,
there shall be no order as to cost.
(MILIND N. JADHAV, J.) (UJJAL BHUYAN, J.)