Disallowance of a Recorded Expense Cannot Be Re-characterized as Unexplained Expenditure.

Issue

Can a Principal Commissioner (PCIT), using revisionary powers under Section 263, re-characterize a disallowance of a non-genuine business expenditure (made under Section 37(1)) as an “unexplained expenditure” under Section 69C to invoke the higher tax rate under Section 115BBE, especially when the expenditure was fully recorded in the books of account and paid through banking channels?

Facts

The assessee, engaged in construction, had its assessment completed.
The Assessing Officer (AO) disallowed ₹39.06 crore in purchases and wages, deeming them non-genuine. However, these expenses were duly recorded in the regular books of account, and all payments were made through disclosed banking channels.
The PCIT initiated revision proceedings under Section 263.
The PCIT’s contention was that the AO’s order was “erroneous” because this disallowance should not have been made under Section 37(1). Instead, it should have been treated as “unexplained expenditure” under Section 69C, which would attract the penal tax rate under Section 115BBE.

Decision

The High Court ruled decisively in favour of the assessee and quashed the PCIT’s revisionary order.
It held that Section 69C was not applicable because the “source of such expenditure stood fully explained.” The expenses were properly recorded in the books and paid from disclosed bank accounts.
The court clarified that a disallowance of a non-genuine business expenditure (under Section 37(1)) is legally distinct from an unexplained expenditure (under Section 69C).
The PCIT’s action was merely an attempt to substitute their own opinion and apply a different provision of law, which is not a valid ground for invoking revisionary jurisdiction under Section 263.

Key Takeaways

Section 69C Applies to Source, Not Genuineness: “Unexplained expenditure” under Section 69C applies only when the assessee offers no explanation about the source of the funds for the expenditure. It cannot be applied to an expenditure that is recorded in the books and paid from a disclosed bank account, even if that expenditure is later found to be non-genuine for business purposes.
Recorded Expense is Not “Unexplained”: Once an expense is recorded in the books of account, its source is, by definition, “explained” (i.e., it comes from the business’s disclosed funds). The dispute then shifts to its allowability under Section 37(1), not its source under Section 69C.
Limits of Section 263: A PCIT cannot use revisionary powers under Section 263 simply because they “prefer a different provision of law.” The AO’s original order (disallowing the expense under Section 37(1)) was a legally plausible view and, therefore, not “erroneous.”
No Re-characterization to Invoke 115BBE: This ruling prevents the tax department from re-characterizing a standard (though non-genuine) business disallowance as an unexplained expenditure merely to impose the higher, penal tax rates associated with Section 115BBE.

IN THE ITAT MUMBAI BENCH ‘B’

Nabeel Construction (P.) Ltd.

Principal Commissioner of Income-tax

Amit Shukla, Judicial Member
and Ms. Padmavathy S., Accountant Member

IT Appeal No. 4340 (Mum) OF 2025
[Assessment year 2021-22]

OCTOBER 13, 2025

Pramod Kumar Parida and Ms. Sanjukta Samantara for the Appellant. Dr. Kishor Dhule, CIT DR for the Respondent.

ORDER

Amit Shukla, Judicial Member. – The present appeal has been filed by the assessee against the order dated 27 March 2025 passed by the learned PCIT, Thane-1, in exercise of powers under section 263 of the Incometax Act, 1961, for the assessment year 2021-22.

2. The assessee has challenged the impugned order both on jurisdictional and substantive grounds, contending that the learned PCIT erred in directing the Assessing Officer to recharacterise the disallowance of purchases as unexplained expenditure under section 69C read with section 115BBE and to correspondingly initiate penalty under section 271AAC in respect of the sum of Rs. 39,06,42,323/-.

3. Briefly stated, the assessee is engaged in the business of construction as a sub-contractor, primarily providing labour and allied services to various reputed builders such as Larsen & Toubro Ltd., Avighna Builders and others. It filed its return of income declaring total income of Rs. 1,28,91,690/-. During the scrutiny proceedings, the Assessing Officer noticed that the assessee had shown purchases of Rs. 39,06,42,323/- against contract receipts of Rs. 42,16,53,285/-. He required the assessee to furnish party-wise details of suppliers, their PAN and the statement of wages paid during the year. The assessee produced the details of suppliers with PAN and also wage statements. The Assessing Officer himself reproduced these particulars in the assessment order. However, noting that the time left for completion was only nine days and that verification through notices under section 133(6) could not practically be undertaken, he proceeded to disallow the entire purchases and wages amounting to Rs. 39,06,42,323/- as non-genuine and completed the assessment. The assessee has already filed an appeal before the CIT(A) which is pending disposal.

4. The PCIT, on perusal of the record, issued a show-cause notice under section 263 observing that the Assessing Officer, though disallowed the expenditure, had failed to quote the relevant section and ought to have invoked section 69C read with section 115BBE. In reply, the assessee submitted that the Assessing Officer had treated the expenditure as non-genuine business expenditure within the books, that the payments were duly reflected in the accounts and made through banking channels, and that there was no occasion to invoke the deeming fiction of section 69C which applies only when the expenditure is incurred outside the books and its source remains unexplained. The PCIT, however, rejected these explanations, held that there was failure on the part of the Assessing Officer to apply section 69C, and directed him to reframe the assessment accordingly.

5. The appeal was filed with a delay of 37 days accompanied by an affidavit explaining that the authorised representative handling the matter was suffering from serious liver and gallbladder ailments and therefore could not file the appeal within time. On being advised, the assessee engaged new counsel who filed the appeal on 02 July 2025. Finding the reasons bona fide and supported by medical cause, the delay is condoned and the appeal is admitted.

6. Before us, the learned counsel for the assessee submitted that the assessee is engaged in labour-intensive construction work employing more than 1,500 workers across several sites and that all receipts from clients were through cheques and all payments for materials and wages were made through banking channels and duly recorded in the books. It was argued that even if some purchases were held to be non-genuine, the disallowance represented a business disallowance under section 37(1) and not an unexplained expenditure under section 69C because the source of such expenditure was already on record being the very trading account forming part of the books. It was further contended that the PCIT cannot revise an order merely because he prefers a different provision of law; the Assessing Officer’s view, if plausible, cannot be substituted under section 263.

7. The learned CIT-DR, on the other hand, supported the revisionary order and submitted that once the purchases were found to be bogus, they represented unexplained expenditure and therefore section 69C was rightly invoked by the PCIT.

8. We have carefully considered the rival submissions and perused the material placed on record. It is an admitted fact that the assessee’s receipts of Rs. 42.16 crore have been received through account-payee cheques from reputed builders and that the purchases and wages aggregating Rs. 39.06 crore are debited in the regular books forming part of the trading and profit-and-loss accounts. There is no dispute that these transactions flow through the books and their funding source is entirely explained. The Assessing Officer, while doubting genuineness, treated them as non-genuine business expenses, a treatment clearly referable to section 37(1) and not to section 69C.

9. The deeming provision of section 69C is a narrow and exceptional one. It postulates that where an assessee has incurred any expenditure and offers no explanation about the source thereof, or the explanation offered is not satisfactory in the opinion of the Assessing Officer, the amount may be deemed to be the income of the assessee. The provision therefore presupposes that the expenditure is incurred outside the regular books or from unexplained sources; its object is to bring to tax undisclosed outgoings whose source of funding is unknown. The essential pre-condition is that the Assessing Officer must find that the expenditure was actually incurred and that the assessee failed to explain the source of such expenditure.

10. When the expenditure is already recorded in the books of account and its source flows from the same books as in the present case where payments are made from disclosed bank accounts and the trading account reflects both income and expenditure, the statutory fiction of section 69C is not attracted. The reason is self-evident: one cannot describe as “unexplained” what is already explained by the books themselves. A business disallowance, howsoever wide, does not metamorphose into a case of “unexplained expenditure”. To invoke section 69C in such circumstances would amount to taxing the same disclosed outlay once again under a deeming fiction, a result that Parliament never intended.

11. It is well-settled that deeming provisions, being legal fictions, must be construed strictly and applied only to situations expressly contemplated by the statute. Section 69C cannot be invoked merely because an expenditure is found non-genuine or excessive; it applies only when the source of such expenditure is itself unexplained or outside the books. Where the Assessing Officer has accepted the existence of books, examined the entries, and merely disallowed the claim as non-genuine, he has taken one plausible view permissible under law. Such a view cannot be characterised as “erroneous” merely because the PCIT prefers to tax the same sum under a different provision.

12. The jurisdiction under section 263 is supervisory and not appellate. For valid exercise of that power, two conditions must co-exist: the order must be both erroneous and prejudicial to the interests of the Revenue. An order cannot be termed erroneous if the Assessing Officer has taken one of the possible views after due inquiry. Here the Assessing Officer, having examined the trading results and the purchases, made a conscious disallowance of the entire expenditure treating it as non-genuine. That view, though perhaps harsh, is within the bounds of law and does not render the order erroneous. The PCIT, by merely substituting his own interpretation that section 69C should have been applied, travelled beyond the permissible confines of section 263.

13. Once it is found that all payments are routed through banking channels, recorded in the accounts, and form part of the trading results out of which the net income has been computed and offered to tax, the source of expenditure stands fully explained. The legislature never intended that every business disallowance should ipso facto be taxed as unexplained expenditure under section 69C and further subjected to the penal rate under section 115BBE. Such an approach would obliterate the distinction between a disallowance of business expenditure and a deemed income, leading to double jeopardy.

14. In view of the foregoing discussion, we hold that the impugned order of the PCIT proceeds on an erroneous assumption of law and fact. The Assessing Officer’s view was legally tenable; the twin conditions of section 263 are not satisfied. Accordingly, the revisionary order dated 27 March 2025 is quashed.

15. In the result, the appeal filed by the assessee is allowed.