When the source of payment for purchases is known but the supplier isn’t genuine

By | September 24, 2025
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When the source of payment for purchases is known but the supplier isn’t genuine, the disallowance should be made under Section 37(1) of the Income-tax Act, 1961, not the harsher Section 69C.

Issue

If an assessee’s purchases are found to be non-genuine, but the payments for them are properly documented through bank accounts, should the disallowance be made under Section 37(1) for a non-genuine business expense, or under Section 69C for unexplained expenditure?

Facts

  • The assessee’s case was reopened because it had claimed purchases from an entity believed to be non-genuine.
  • The assessee submitted audited accounts, bills, and bank statements proving the payments were made from its declared bank account.
  • The Assessing Officer (AO) conducted a detailed inquiry, which included a physical verification of the supplier and taking a statement from its controller.
  • After the inquiry, the AO concluded the purchases were not genuine and disallowed the expense under Section 37(1).
  • However, the Principal Commissioner of Income Tax (PCIT) initiated revision proceedings under Section 263. The PCIT argued that the AO’s order was erroneous because the disallowance should have been made under Section 69C. This change would have subjected the amount to a much higher tax rate under Section 115BBE. The PCIT also claimed the AO had failed to conduct a proper inquiry.

Decision

The Tribunal ruled in favour of the assessee and cancelled the revision proceedings.

  • It held that since the nature and source of the expense were not in doubt (i.e., they were claimed as purchases and paid through the bank), the correct provision for disallowance was Section 37(1). Section 69C applies only when the source of funds for an expenditure is unexplained, which was not the case here.
  • The Tribunal also found that the AO had, in fact, conducted a thorough inquiry. Therefore, the PCIT’s assertion of a “lack of enquiry” was factually incorrect and not a valid basis for revision.

Key Takeways

  • Section 37(1) for Disputed Genuineness: When the source of funds is clear, but the legitimacy of the transaction or the vendor is in question, the disallowance falls under Section 37(1) as an expense not wholly and exclusively for business.
  • Section 69C for Unexplained Source: Section 69C is a deeming provision used when the taxpayer cannot explain the source of the money used for an expenditure. It cannot be applied when payments are made through regular books of account.
  • Revision Requires a Clear Error: A PCIT cannot invoke revision under Section 263 simply because they prefer a different section of the Act. The AO’s order must be demonstrably erroneous. In this case, the AO had taken a legally correct and plausible view.
  • Inquiry is a Question of Fact: A claim of “lack of inquiry” can be rebutted by showing that the AO took concrete steps to investigate the matter. If the assessment order reflects an application of mind, a revision on this ground is not justified.
IN THE ITAT DELHI BENCH ‘A’
Arvind Kumar
v.
Principal Commissioner of Income-tax
SATBEER SINGH GODARA, Judicial Member
and Naveen Chandra, Accountant Member
IT Appeal No. 2178 (DELHI) of 2025
[Assessment year 2018-19]
AUGUST  26, 2025
Dhruv Goel, CA for the Appellant. Jitender Singh, CIT-DR for the Respondent.
ORDER
Naveen Chandra, Accountant Member.- This appeal by the assessee is preferred against the order of the Pr. CIT, Rohtak dated 21.03.2025 framed u/s 263 of the Income-tax Act, 1961 [the Act, for short] pertaining to Assessment Year 2018-19.
2. The sum and substance of the grievance of the assessee is that the assessment order dated 27.03.2023 framed u/s 147 r.w.s. 144B of the Act is neither erroneous nor prejudicial to the interest of the Revenue.
3. Representatives of both the sides were heard at length. Case records carefully perused. Relevant documentary evidence brought on record duly considered in light of Rule 18(6) of the ITAT Rules.
4. Briefly stated, the facts of the case are that the case of the assessee was reopened u/s 148 of the Act on the basis of the allegation that the assessee had claimed purchases from Kanheya Exports which was not a genuine entity. During the course of scrutiny assessment proceedings, the assessee furnished audited books of account, ledger accounts, purchase bills, bank statement and certificate from the auditor. The Assessing Officer also conducted physical verification from supplier and collected statement from the controller of the entity. Finally, the Assessing Officer held the expenses of Rs. 2,14,810/-claimed by the assessee to be not genuine and disallowed the same u/s 37 of the Act.
5. Assuming jurisdiction conferred upon by provisions of section 263 of the Act, the PCIT issued a show cause notice to the assessee stating that the disallowance was to be made u/s 69C and not section 37 and higher rate of 60% as per section 115BBE of the Act was applicable instead of normal rates and thus the assessment order was prejudicial to the interest of the Revenue.
6. Reply of the assessee did not find any favour with the PCIT, who was of the firm belief that the assessment order dated 27.03.2023 is not only erroneous but also prejudicial to the interest of the Revenue and set aside the order for fresh adjudication. The PCIT was of the view that the decision of the Hon’ble Supreme Court in the case of N K Proteins was not followed by the Assessing Officer, Assessing Officer failed to conduct proper enquiry and normal rate of tax was incorrectly charged by the Assessing Officer instead of special rate of 60 u/s 115BBE.
7. Before us, the ld counsel of the assessee argued that the assessment order was not erroneous as the Assessing Officer has taken a possible view and conducted adequate enquiry. The ld AR further contended that there is no mandate in law that all the disallowance of business expense is to be made u/s 69C only. The ld AR argued that the reliance on the decision of NK Protein is not entirely correct and that the PCIT failed to point out enquiry not conducted by the AO. The ld AR relied on the decision taken by hon’ble Supreme Court in CIT v. Amitabh Bachchan 384 ITR 200 (SC); Malabar Industrial Co. Ltd. v. CIT  66 (SC) Hon’ble Rajkot ITAT Bench in the case of Shashikant Bhavajjibhai Rajpara v. Pr. CIT [IT Appeal No.59/RJT/2022, dated 22.3.2023] and Vijubha Jitubha Jadeja v. Pr. CIT 615 (Rajkot – Trib.)/ITA 105/RJT/2022, dated 2.8.2023.
8. Per contra the ld DR heavily relied on the order of the PCIT.
9. We have heard the rival submissions and have perused the materials on record. All that we have to see is whether the Assessing Officer has examined the issues considered by the PCIT in holding that the assessment order is erroneous and prejudicial to the interest of the Revenue. The quarrel is in respect of directions of the PCIT to the Assessing Officer to conduct required enquiry and pass fresh assessment order.
10. In our considered opinion, in this case, the Assessing Officer disallowed 100% purchases and PCIT has not doubted the same. Only issue is whether disallowance should be u/s 37 or 69C. Against this, Assessing Officer gave specific finding that as per his opinion, disallowance should be u/s 37 of the Act. Thus, possible view has been taken by Assessing Officer and in such cases, Courts have taken consistent view that action u/s 263 is invalid. The our view is fortified by the Hon’ble Supreme Court decision in case of Malabar Industrial Co. Ltd and Amitabh Bachchan (supra). The Assessing Officer has accepted a possible view and the PCIT wants to impose his view on the possible view taken by the Assessing Officer, which is against the cannons of law.
11. We are further of the considered view that Section 37 of the Act is specific provision which disallows business expense when it is found to be not wholly and exclusively for business. In contrast, section 69C applies where the explanation of assessee regarding nature and source of expense was not satisfactory to Assessing Officer. In this case, the nature of expense i.e. purchases and source of expense i.e. bank payments are not doubted. Only doubt was regarding genuineness of expense and thus disallowance has been correctly made u/s 37 by AO. Our views are fortified by Hon’ble Rajkot ITAT Bench in the case of Shashikant Bhavajjibhai Rajpara and Vijuba Jutubha Jadeja (supra) where it was held that if purchase is held to be bogus then it is case of “no expense” and in such a position, disallowance cannot be u/s 69C of the Act.
12. We also find that the PCIT’s observation that the Assessing Officer has incorrectly ignored to apply ratio laid down by Hon’ble Supreme Court in N. K. Proteins Ltd. v. Dy. CIT 22 (SC) is not valid. The said decision was a non-speaking order where the Hon’ble Supreme Court dismissed SLP filed by the assessee against the order of the Hon’ble Gujarat High Court and it is a settled law that such an order does not get binding force not covered under the doctrine of merger finds force. The question before Gujarat High Court was regarding quantum of addition of bogus purchases i.e. 100% or 25% and section of disallowance (s.69C or s.37) was never in dispute.
13. We also find that the Assessing Officer had, in re-assessment u/s 143(3)/147 conducted physical verification from supplier, collected statement of alleged controller of supplier, considered reply of assessee and thereafter passed order disallowing expense u/s 37 of the Act. Thus, observation of PCIT that there is lack of enquiry on the part of AO, is not justified. We further find that the PCIT has failed to point out enquiry not conducted by Assessing Officer.
14. Considering the facts of the case in hand, in totality, in light of the judicial decisions discussed hereinabove, we set aside the order of the PCIT and restore that of the Assessing Officer dated 27.03.2023 framed under section 147 r.w.s 144B of the Act.
15. In the result, appeal of assessee in ITA No. 2178/DEL/2025 is allowed.