THE ACIT., PATAN CIRCLE,, PATAN vs. SHIV REFOILS AND CAKES, CHANSAMA, PATAN

The brief facts of the case are that the assessee firm, engaged in the business of manufacturing and trading of agro products, filed its return of income declaring a total income of Rs.36,52,580/- for the AY 2014-15. The case was selected for scrutiny, and due to non-compliance with several notices, the AO completed the assessment under section 144 of the Act. Various additions were made to the total income, including an addition of Rs.6,08,44,207/- under section 68 of the Act for unexplained capital, Rs.18,93,533/- for disallowance of interest on capital, and Rs.43,62,678/- for depreciation claimed on assets. The AO also made an addition of Rs.34,50,000/- on account of unsecured loans u/s 68 of the Act and disallowed Rs.4,14,000/- as interest paid on these loans.

During the course of hearing before us, the Departmental Representative (DR) stated that the order of AO was passed u/s 144 of the Act as the assessee failed to comply with the notices. During the appellate proceedings, the CIT(A) called for a remand report from the AO and decided on the basis of the same.

Under Rule 46A of the Income Tax Rules, 1962, additional evidence can be admitted at the appellate stage if specific conditions are met, such as (a) the AO refusing to admit evidence that ought to have been admitted, (b) the appellant being prevented by sufficient cause from producing evidence during the assessment, or (c) the AO passing an order without providing the The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 appellant sufficient opportunity to produce evidence. The CIT(A) must record reasons in writing for admitting such evidence, ensuring that it aligns with the principles of natural justice. In this case, the CIT(A) observed that the assessee was not able to furnish the documents during the assessment proceedings due to certain mitigating circumstances, as explained by the assessee, including financial difficulties and the failure of internal communication at the assessee's business premises. The CIT(A) admitted the additional evidence under Rule 46A after satisfying himself that these conditions were met. The CIT(A) followed the procedure outlined in Rule 46A by allowing the AO an opportunity to examine the additional evidence and provide a remand report. The AO, in his remand report, did not object to the admission of the additional evidence but commented on its merits. Therefore, the admission of additional evidence by the CIT(A) was in accordance with Rule 46A, and there was no violation of the procedural requirements.

We find no error in the CIT(A)'s decision to admit the additional evidence. The conditions under Rule 46A were satisfied, and the AO was provided with an opportunity to review and comment on the additional evidence. Hence, these grounds of appeal are dismissed.

The AO made an addition of Rs.6,08,44,207/- under section 68 of the Act, which included the disputed capital introduction of Rs.70,47,000/-. The additions included Rs.19,82,000/- introduced by Smt. Sharmilaben I. Patel The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 and Rs.50,65,000/- introduced by Shri Jitendra U. Patel. The AO noted that both partners, Smt. Sharmilaben I. Patel and Shri Jitendra U. Patel, had failed to file their returns of income for the relevant year and, therefore, doubted their creditworthiness and the genuineness of the capital introduced. While the capital was introduced through banking channels, the AO was not satisfied with the evidence provided regarding the sources of the funds.

The DR pointed out that there was a cash deposit of Rs.30,00,000/- in the bank account of Smt. Sharmilaben I. Patel before issuance of cheque of Rs.8,50,000/- which is ignored by the CIT(A). The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15

The Authorised Representative (AR) of the assessee, explained the situation under which the assessee was not able to submit the necessary information to the AO (which the CIT(A) has detailed in his order) and, therefore, the details provided to the CIT(A) as additional evidence were remanded back to AO and upon receiving the remand report, the CIT(A) passed his order. The DR reiterated the judicial precedent relating to Pankaj Dyestuff Industries which was referred by the CIT(A) in his order.

We have considered the contentions of both the parties and note the contents of remand report from the AO. Section 68 of the Act requires the assessee to explain the nature and source of any sum credited in their books. The assessee must prove the identity of the creditor, the genuineness of the transaction, and the creditworthiness of the creditor. In the present case, the AO added the capital introduced by the partners under section 68 of the Act, arguing that their failure to file income tax returns raised doubts about their creditworthiness. We find that the CIT(A) rightly concluded that the identity of the partners and the genuineness of the transactions were established, as the funds were routed through banking channels. The crux of the issue lies in the third test under section 68—whether the partners were creditworthy. Although the partners did not file their income tax returns for the relevant year, the CIT(A) found that they had sufficient balances in their bank accounts before introducing the capital, which demonstrated their ability to introduce the funds. The reliance on the decision in Pankaj Dyestuff Industries is well-founded. The Hon’ble Gujarat High Court held that once the partner’s identity and the fact that the funds were introduced through banking channels are established, the burden of explaining the source shifts to the partner and not the firm. Therefore, the firm cannot be penalized under The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 section 68 for unexplained cash credits when the capital is introduced by partners through legitimate means. The AO’s primary objection was the non- filing of returns by the partners. While non-filing of returns may indicate a lack of compliance, it does not necessarily prove that the funds introduced were unexplained. The partners had provided bank statements showing that they had the requisite funds available, and these transactions were genuine. The AO failed to bring any material on record to suggest that the funds were not available or that the transactions were bogus.

The assessee claimed interest of Rs.18,93,533/- paid to the partners on the capital introduced during the assessment year 2014-15. The AO The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 disallowed the interest, reasoning that the capital introduced by the partners was treated as unexplained under section 68 of the Act. Since the capital itself was deemed unexplained, the interest paid on such capital was also treated as non-genuine and disallowed. The CIT(A) deleted the addition of Rs.70,47,000/- under section 68, holding that the capital introduced by the partners was adequately explained. The CIT(A) also deleted the disallowance of interest on capital as a direct consequence of the deletion of unexplained capital. The CIT(A) observed that the interest paid to the partners was as per the terms of the partnership deed and within the limits prescribed under section 40(b) of the Act and, therefore, there was no basis to disallow the interest when the capital was already treated as explained.

The DR relied on the order of AO and, on the other hand, the AR relied on the order of CIT(A).

Section 40(b) of the Act allows a deduction for interest paid to partners provided it is within the prescribed limits (12% per annum) and is as per the terms of the partnership deed. In this case, the CIT(A) verified that the interest paid was in accordance with the terms of the partnership deed and within the allowable limits. The AO did not dispute this fact. Therefore, there was no violation of section 40(b), and the interest payment was eligible for deduction. The Revenue’s primary contention was that since the capital was treated as unexplained, the interest paid on it should not be allowed. However, the CIT(A) rightly pointed out that once the capital was held to be genuine and the addition under section 68 was deleted, the interest paid on such capital automatically became allowable. The Revenue’s argument does The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 not hold since the foundation of the disallowance, i.e., the unexplained nature of the capital, was disproved.

We agree with the CIT(A)'s conclusion that the disallowance of Rs.18,93,533/- on account of interest paid on capital cannot be sustained. Since the capital introduced by the partners has been found to be genuine, the corresponding interest paid is allowable as a deduction. The conditions under section 40(b) of the Act have been met, and the interest payments were made in accordance with the terms of the partnership deed. The disallowance of Rs.18,93,533/- is deleted. This ground of appeal by the Revenue is dismissed.

During the assessment proceedings, the AO scrutinized payments made by the assessee firm to related parties. The payments included salary of Rs.3,00,000/- paid to Shri Prakash U. Patel, the brother of one of the partners, and purchases of Rs.14,12,08,014/- made from M/s. Bhavya Enterprises, a proprietary concern of another partner, Shri Jitendra U. Patel. The AO disallowed these payments stating that the assessee failed to produce adequate supporting documents, such as salary registers, proof of work done by Shri Prakash U. Patel, and bills or invoices for purchases from M/s. Bhavya Enterprises. The AO questioned the reasonableness of the payments, particularly the salary paid to Shri Prakash U. Patel, as no evidence of his qualifications or services rendered was provided. Additionally, the AO noted The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 that M/s. Bhavya Enterprises had not filed its return of income for the relevant year, raising doubts about the genuineness of the transactions.

The CIT(A) deleted the disallowances noting that the assessee had submitted additional evidence during the appellate proceedings, including proof of salary payments, work done by Shri Prakash U. Patel, and invoices for purchases from M/s. Bhavya Enterprises. These documents were verified during the remand proceedings, and the AO did not dispute their authenticity in the remand report. The CIT(A) held that the payments made to related parties were not excessive or unreasonable under section 40A(2)(b) of the Act. The payments for salary and purchases were in line with the business requirements of the assessee, and there was no evidence to suggest that the amounts paid were inflated. The CIT(A) emphasized that the assessee firm and its related parties are separate legal entities. Merely because payments were made to related parties does not justify disallowance unless it is proven that the payments were unreasonable or excessive. In this case, the CIT(A) concluded that the payments were genuine and made in the normal course of business.

The DR relied on the order of AO and stated that the turnover of the related party Bhavya Enterprises was more than Rs.100 Cr and the return of income is not filed, and the CIT(A) has directed to re-open the case considering the facts.

The AR pointed out that the AO has not questioned the genuineness but has questioned the reasonableness of the amounts. The further pointed out that the CIT(A) in his order has noted that the AO has neither made any The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 comparison of similar goods purchased from sister concern and outside parties nor given his findings on excessive or unreasonable fair market value of the goods or services (so far as disallowance of salary of Rs.300,000/- is concerned). The AR with the help of various bills of related parties and outside parties demonstrated the reasonableness of the prices of goods purchased from related parties.

We have considered the facts and circumstances relating to the transactions with related parties. Section 40A(2)(b) of the Act empowers the AO to disallow any expenditure incurred by the assessee in respect of payments made to related parties if such payments are found to be excessive or unreasonable compared to the fair market value of the services rendered or goods purchased. The onus is on the AO to establish that the payments are excessive or unreasonable. In the present case, the AO disallowed the payments solely on the basis of suspicion, without providing concrete evidence to show that the payments were excessive. The CIT(A) found that the payments were justified based on the evidence provided by the assessee, including salary registers, invoices, and details of the work performed by Shri Prakash U. Patel. The AO failed to provide any comparable data or market rates to demonstrate that the payments were excessive. The AO’s primary objection was the lack of sufficient documentary evidence to substantiate the payments. However, during the appellate proceedings, the assessee produced additional evidence, including proof of salary payments and purchase invoices. The CIT(A) admitted this additional evidence under Rule 46A and forwarded it to the AO for comments. The AO, in the remand report, did not raise any objections to the authenticity of these documents but maintained that the payments were excessive. he CIT(A) rightly concluded The ACIT vs. Shiv Refoils and Cakes Asst. Year : 2014-15 that once the additional evidence was verified and found to be authentic, there was no basis for disallowing the payments.