Section 37 IT Act | Ad Hoc Expense Disallowance Invalid Without Prior Rejection of Books: ITAT Agra

The Income Tax Appellate Tribunal, Agra Bench, has delivered a significant ruling clarifying the limits of revenue authorities in making ad hoc disallowances and estimating profits in cases involving unorganized sector purchases. The judgment reinforces that without rejecting the assessee’s books of accounts under Section 145(3), no arbitrary deduction or profit estimation can be sustained.

Background & Facts

The Dispute

The appellant, Al Hamd Agro Food Products Pvt. Ltd, is engaged in the manufacture and trading of frozen buffalo meat products. The assessment for the financial year 2018-19 was conducted under Section 143(3) read with Section 144B of the Income-tax Act, 1961. The Assessing Officer (AO) made two major additions: (1) an ad hoc disallowance of Rs 97,99,086 towards business expenses, and (2) additions of Rs 5,39,90,360 and Rs 9,89,91,987 on account of alleged bogus purchases from two suppliers.

Key Facts

• The assessee filed its return on 14.11.2018 declaring total income of Rs 51,54,85,440.
• Total expenses debited under 'other expenses' amounted to Rs 19,59,81,720, comprising:
  • Buffalo slaughtering expenses: Rs 16,57,54,017
  • Business promotion: Rs 1,69,13,878
  • Travelling: Rs 61,26,651
  • Other minor heads including housekeeping, mobile, printing, etc.
• The AO issued a notice under Section 142(1) on 14.12.2020 seeking bills, vouchers, and ledger copies for verification.
• The assessee submitted complete books of accounts, bank statements, stock registers, purchase invoices, and ledger accounts for all expense heads.
• Payments for all expenses were made through account payee cheques via banking channels.
• The AO did not invoke Section 145(3) to reject the books of accounts.
• Two major purchase transactions were scrutinized:
  • From Baloch Jamal Khan Bhuran Khan: Rs 9,89,91,987
  • From Nasruddin Qureshi: Rs 69,93,57,000
• The assessee provided:
  • Ledger accounts of both suppliers
  • Confirmation letters from both suppliers
  • Assessment orders of Nasruddin Qureshi for AYs 2016-17 and 2017-18 (Nil addition)
  • Audited financial statements of Nasruddin Qureshi showing gross profit of Rs 47,93,381
  • Purchase invoices and stock register linking purchases to sales
  • Comparative purchase data across AYs 2016-17 to 2018-19
• The revenue did not dispute the corresponding sales made from these purchases.
• The trade in live animals is unorganized; no e-way bills or GST apply; no formal agreements exist; payments are made post-slaughtering based on weight.

Procedural History

• 14.11.2018: Return filed for AY 2018-19
• 16.09.2021: AO passed assessment order under Section 143(3) r.w.s. 144B, making disallowance of Rs 97,99,086 and additions of Rs 5,39,90,360 and Rs 9,89,91,987
• 07.02.2025: Commissioner of Income Tax (Appeals)-3, Gurugram upheld the AO’s order
• 17.03.2026: Hearing before ITAT Agra Bench
• 13.05.2026: Judgment pronounced

Relief Sought

The assessee sought:

• Deletion of the ad hoc disallowance of Rs 97,99,086
• Deletion of the addition of Rs 5,39,90,360 on estimated profit from Nasruddin Qureshi
• Reduction or deletion of the addition of Rs 9,89,91,987 on purchases from Baloch Jamal Khan Bhuran Khan

The Legal Issue

The central questions were: (1) Whether an ad hoc disallowance of 5% of expenses is permissible without rejection of books of accounts under Section 145(3)? (2) Whether profit estimation at 6.72% on purchases from a supplier whose assessment order shows no adverse findings can be sustained? (3) Whether a lesser profit estimation of 2% is justified for first-time purchases from a supplier lacking audited financials?

Arguments Presented

For the Appellant

The appellant contended that:

• Complete books of accounts, vouchers, bank statements, and supplier confirmations were furnished to the AO and CIT(A).
• No provision under the Act permits ad hoc disallowance when books are not rejected under Section 145(3).
• The supplier Nasruddin Qureshi had been assessed with Nil addition and submitted audited financials, confirming the genuineness of transactions.
• The trade in live animals is informal; no e-way bills or GST apply; invoices are prepared post-slaughter.
• The revenue did not challenge the sales made from these purchases, undermining the claim of bogus transactions.
• Reliance was placed on CIT v. M/s. S. S. Agro Industries and CIT v. M/s. R. S. Agro Products to argue that estimation without book rejection is illegal.

For the Respondent

The revenue argued that:

• The assessee failed to provide sufficient documentary evidence for expenses and purchases.
• The high value of purchases from Nasruddin Qureshi, coupled with the absence of formal agreements, raised suspicion.
• The gross profit margin of 6.72% was used as a benchmark to estimate hidden profits.
• The purchase from Baloch Jamal Khan Bhuran Khan was a one-time transaction without audited financials or assessment orders, warranting a profit addition.

The Court's Analysis

The Tribunal conducted a meticulous review of the evidence and procedural compliance. It emphasized that the burden of proof lies with the revenue to establish the non-genuineness of transactions, not with the assessee to prove innocence beyond all doubt.

"There cannot be any ad-hoc disallowance of expenses that could be made. Further we find that the books of accounts of the assessee had not been rejected by the Learned AO by invoking the provisions of section 145(3) of the Act. There is absolutely no case for the lower authorities to make an ad-hoc disallowance at the rate of 5% of the aforesaid expenditure."

The Tribunal held that the AO’s disallowance of Rs 97,99,086 was legally unsustainable. The assessee had submitted all required documents, and the absence of a formal rejection of books under Section 145(3) rendered the 5% disallowance arbitrary and without statutory basis.

Regarding Nasruddin Qureshi, the Tribunal noted that:

• His assessment order for AY 2018-19 showed no adverse findings.
• His audited financials disclosed substantial turnover and modest profit, indicating legitimate business.
• The notice under Section 133(6) was responded to with full cooperation.
• The revenue did not challenge the sales made from these purchases.

"When the scrutiny assessment order has been framed in the hands of Nasruddin Qureshi by the revenue, the said party could not be categorized as ingenuine."

Thus, the addition of Rs 5,39,90,360 based on estimated profit was deleted.

For Baloch Jamal Khan Bhuran Khan, the Tribunal acknowledged the lack of audited financials and assessment order. However, since the corresponding sales were not disputed, it concluded that the transaction was genuine but poorly documented. In such cases, the Tribunal held that a minimal profit estimation of 2% was reasonable to account for documentation deficiencies without penalizing the assessee for the nature of the unorganized trade.

The Verdict

The appeal was partly allowed. The ad hoc disallowance of Rs 97,99,086 was deleted. The addition of Rs 5,39,90,360 on purchases from Nasruddin Qureshi was deleted. The addition of Rs 9,89,91,987 on purchases from Baloch Jamal Khan Bhuran Khan was reduced to Rs 19,79,960, representing 2% of the purchase value. The AO was directed to give effect to these modifications in the assessment order.

What This Means For Similar Cases

Ad Hoc Disallowances Require Book Rejection

• Practitioners must challenge any disallowance based on estimation if the AO has not invoked Section 145(3).
• Revenue cannot substitute documentary verification with arbitrary percentages.
• Maintain complete records of all expenses, even in informal sectors, to preempt disallowance.

Genuineness of Suppliers Must Be Assessed Holistically

• A supplier’s own assessment order with Nil addition is strong evidence of transaction genuineness.
• Audited financials of suppliers, even if not audited by a CA, carry weight if consistent with declared income.
• Absence of e-way bills or GST does not imply illegality in unorganized sectors like livestock trade.

Reasonable Estimation Permissible Only for Documentation Gaps

• Where sales are verified and supplier is assessed, no profit estimation is justified.
• For first-time or poorly documented suppliers, a minimal profit addition (e.g., 1-3%) may be upheld if it reflects actual industry norms.
• Estimation must be proportionate and not punitive.