The Income Tax Appellate Tribunal, Mumbai, has reaffirmed that tax authorities cannot resort to arbitrary or mechanical additions under Section 68 of the Income Tax Act merely due to perceived financial weakness of lenders. The judgment underscores the necessity of structured, evidence-based verification before any disallowance is made.
Background & Facts
The Dispute
The dispute arose from the assessment of Bluepearl Trading Company Private Limited for the assessment year 2022-23. The assessee filed its return on 03.11.2022 declaring a business loss of Rs. 1,98,134. The Assessing Officer, despite receiving detailed submissions and documentary evidence from the assessee, proceeded to make substantial additions under Sections 69 and 68 of the Income Tax Act, 1961.
Key Facts
- The assessee had invested Rs. 2,13,30,000 in unlisted equity shares, which were duly recorded in its books of account and financial statements.
- The Assessing Officer treated this as "unexplained investment" under Section 69 and made an addition of Rs. 2,13,30,000.
- The assessee had also shown short-term borrowings and advances aggregating to Rs. 263,43,09,943 under the head "Short Term Borrowings".
- The Assessing Officer made an adhoc disallowance of 10% of this amount, i.e., Rs. 26,34,30,994, under Section 68, without verifying the identity, genuineness, or creditworthiness of the lenders.
- The total income was thus assessed at Rs. 28,45,62,860, despite the return showing a loss.
- The assessee had furnished bank statements, ledger accounts, and explanations regarding the nature of these liabilities, which were acknowledged in the assessment order.
Procedural History
- 03.11.2022: Assessee filed return of income declaring loss of Rs. 1,98,134.
- Before 19.11.2025: Assessment proceedings conducted under Section 144; assessment order passed on unspecified date.
- 19.11.2025: Commissioner of Income Tax (Appeals), NFAC, Delhi, set aside the assessment order, holding that the additions under Sections 69 and 68 were unsustainable.
- The CIT(A) directed the Assessing Officer to re-examine the source of funds, fund flow, and creditworthiness of lenders, and pass a fresh order in accordance with law.
- 21.05.2026: Hearing before ITAT Mumbai.
- 27.05.2026: ITAT Mumbai pronounced order.
Relief Sought
The Revenue sought to set aside the CIT(A)'s order and restore the original assessment order with the additions of Rs. 2,13,30,000 under Section 69 and Rs. 26,34,30,994 under Section 68.
The Legal Issue
The central question was whether an adhoc disallowance of 10% of short-term borrowings under Section 68 of the Income Tax Act is legally permissible in the absence of any specific finding regarding the identity, genuineness, or creditworthiness of the lenders.
Arguments Presented
For the Appellant (Revenue)
The Revenue contended that since the assessee had submitted documents during assessment proceedings, the order could not be treated as ex-parte. It argued that the CIT(A) should have adjudicated the issues on merits using the material already on record, rather than remanding the matter. The Revenue relied on the fact that the lenders had declared business losses, suggesting their creditworthiness was questionable, and therefore the 10% disallowance was a reasonable estimate.
For the Respondent (Assessee)
The assessee argued that the investments in unlisted shares were duly recorded in the books and financial statements, making the invocation of Section 69 prima facie untenable. Regarding the borrowings, it submitted that the amounts were continuing balances from earlier years, properly reflected in ledger accounts. It emphasized that Section 68 requires a specific inquiry into the identity, genuineness, and creditworthiness of lenders, and that an arbitrary 10% disallowance has no statutory basis. The assessee accepted the remand direction as lawful and fair.
The Court's Analysis
The Tribunal examined the nature of the additions made by the Assessing Officer and found them to be mechanical and legally unsustainable. It noted that the assessment order itself recorded that the assessee had furnished submissions and documents throughout the proceedings. Despite this, no meaningful verification was undertaken.
"The addition under section 69 has been made despite the admitted factual position that the investments were reflected in the books of account and financial statements."
The Tribunal held that Section 69 applies only to investments not recorded in the books. Since the investments were duly recorded, the addition under this provision was legally invalid.
Regarding Section 68, the Tribunal emphasized that the provision does not permit estimation or adhoc disallowances. The law requires a three-pronged verification: identity of the lender, genuineness of the transaction, and creditworthiness of the lender. The Assessing Officer’s reliance on the lenders’ declared business losses was insufficient without actual verification of bank statements, loan agreements, or fund flow.
"Either the ingredients of section 68 are satisfied or they are not satisfied, but an arbitrary disallowance at the rate of 10% without any cogent basis cannot be sustained in law."
The Tribunal found that the CIT(A) had acted correctly by directing a remand for proper verification. The direction was not a failure to decide on merits but a lawful exercise of appellate authority to ensure compliance with statutory procedure. The assessee had not challenged the remand, and the Revenue had no legitimate grievance since the matter was not finally decided against it but merely sent back for lawful adjudication.
The Verdict
The Revenue’s appeal was dismissed. The ITAT upheld the order of the CIT(A) dated 19.11.2025. The Assessing Officer was directed to re-examine the source of funds, fund flow, bank statements, and creditworthiness of lenders in accordance with Section 68. No addition under Section 69 or adhoc disallowance under Section 68 shall be made without such verification. The matter stands remanded for fresh adjudication within a reasonable time.
What This Means For Similar Cases
Adhoc Disallowances Under Section 68 Are Illegal
- Practitioners must challenge any flat-rate disallowance (e.g., 5%, 10%, 20%) on loans or cash credits as legally invalid.
- The burden is on the department to prove non-compliance with the three conditions under Section 68 - identity, genuineness, creditworthiness - not on the assessee to disprove suspicion.
- Merely showing that lenders have losses or are non-residents does not satisfy the legal test.
Documentation Is Key - But Verification Must Be Meaningful
- Assessee must maintain complete records: loan agreements, bank statements, ledger folios, and lender KYC.
- If the department ignores submitted documents and makes mechanical additions, the appellate forum will remand the case - not uphold the addition.
- A remand order is not a win for the department; it is a procedural reset requiring lawful compliance.
Section 69 Cannot Be Invoked If Investments Are Booked
- Any investment recorded in the books of account and financial statements cannot be treated as "unexplained" under Section 69.
- The department must prove the investment was not recorded - not that it was unexplained.
- This principle applies equally to shares, property, or other assets.
