The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has dismissed a Revenue appeal and upheld deletion of an addition of ₹1.92 crore towards salary and wages, holding that an Assessing Officer cannot make an arbitrary ad-hoc disallowance of business expenditure without rejecting the assessee’s books of account or bringing specific material on record to establish that the expenditure was not genuine or was not incurred for business purposes.

The bench of Madhumita Roy (Judicial Member) and Krinwant Sahay (Accountant Member) has observed that the AO’s apparent case was that adequate details had not been furnished to substantiate the claim. However, according to the ITAT, the AO did not invoke Section 144 of the Income Tax Act to make a best-judgment assessment, nor did the AO reject the books and estimate the assessee’s net profit.

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The assessee was engaged in the business of collection and recovery services through her proprietorship concern, M/s Masters Management Services. She had entered into contracts with banks, including HDFC Bank, for collecting outstanding dues relating to credit cards, personal loans, consumer durable loans and other accounts where borrowers had defaulted.

According to the record, the business was manpower-intensive. The assessee stated that more than 100 persons were engaged during the relevant year, with around 85% of the manpower deployed in field activities and the remaining 15% involved in office administration. The field personnel were required to meet defaulting customers and persuade them to clear their outstanding dues.

For the relevant assessment year, the assessee claimed salary and wages expenditure of ₹3,21,04,162, compared with ₹1,16,89,605 in the preceding year. The Assessing Officer considered the increase excessive, noting a rise of approximately 174.63% compared with the previous year.

The AO consequently treated only a 10% increase over the previous year’s expenditure as reasonable and made an addition of ₹1,92,45,597 towards the alleged excess salary and wages expenditure.

The assessee had originally filed her return declaring total income of approximately ₹28.63 lakh and claimed a refund of about ₹31.21 lakh. The return was selected for scrutiny under CASS, with the refund claim being one of the issues examined.

During the assessment proceedings, the assessee furnished the return, computation of income, balance sheet, trading and profit and loss account and expense ledgers. The assessment was ultimately completed under Section 143(3) read with Sections 143(3A) and 143(3B) of the Income Tax Act, 1961.

Apart from salary and wages, the AO also made smaller disallowances relating to staff welfare expenses, festival expenses, and tour, travelling, conveyance and telephone expenses. The total income was assessed at approximately ₹2.23 crore, as against the returned income of ₹28.63 lakh.

Before the CIT(A), the assessee contended that the additions were based on conjectures and surmises rather than specific defects in the books of account or supporting documents.

With regard to staff welfare expenses, for example, the assessee had claimed approximately ₹1.69 lakh. She explained that the expenses were connected with the nature of her recovery business, which involved frequent field visits, interaction with customers and meetings with employees and clients.

The assessee also submitted ledger accounts, payment details and invoices from one of her principal vendors. According to her submissions, the expenses included items such as biscuits, tea, coffee and cleaning materials used in connection with the business and office operations.
The assessee argued that the AO had not demonstrated, through independent evidence, that the expenditure was bogus, personal or unrelated to business. She further contended that merely finding the expenditure to be high compared with the preceding year could not justify an arbitrary percentage-based disallowance.

The Commissioner of Income Tax (Appeals)/National Faceless Appeal Centre accepted the assessee’s contention and deleted the additions.

The CIT(A) observed that an AO is generally not justified in making an ad-hoc disallowance without pointing out specific defects or evidence of non-genuineness. If the AO was dissatisfied with particular expenses or documents, the authority could have identified and disallowed the unsupported expenditure rather than applying an arbitrary percentage to the overall claim.

The appellate authority particularly noted that an ad-hoc disallowance based merely on suspicion or the alleged failure to produce every document could not be sustained where the AO had not identified specific defects in the accounts or vouchers.

The CIT(A) further relied upon the Delhi High Court ruling in Principal Commissioner of Income Tax v. R.G. Buildwell Engineers Ltd., where an ad-hoc disallowance had been rejected in circumstances where the books of account had not been rejected. The Supreme Court had dismissed the Revenue’s Special Leave Petition against that decision.

The CIT(A) therefore concluded that since the AO had not rejected the books of account, the additions made on an ad-hoc basis could not be sustained.

The department challenged the CIT(A)’s order before the ITAT, with the principal dispute concerning deletion of the ₹1,92,45,597 addition towards salary and wages.

The Tribunal considered the reasoning adopted by the AO as well as the findings recorded by the CIT(A).

The assessee had argued before the appellate authorities that Section 37(1) permits expenditure incurred wholly and exclusively for business purposes, subject to the statutory restrictions. The submissions also relied upon Supreme Court authorities for the proposition that the Revenue should not substitute its own judgment for that of a businessman in determining how a business should be conducted or what expenditure is commercially appropriate.

The assessee also relied upon judicial principles that business expenditure does not necessarily have to satisfy a test of absolute necessity and that business purposes can be wider than immediate profit-making purposes.

A significant factor in the ITAT’s decision was the fact that the AO had neither rejected the assessee’s books of account nor proceeded to estimate the net profit under the best-judgment provisions.

The Tribunal agreed with the CIT(A) that even where an estimation is permissible, it must be founded upon reasonable and rational material rather than a wild guess.

The ITAT ultimately found no reason to interfere with the CIT(A)’s decision deleting the addition.

The Tribunal’s reasoning reinforces the distinction between a genuine assessment of the allowability of a particular business expenditure and an arbitrary percentage-based disallowance. Where the AO has concerns about an expense, those concerns must be supported by specific defects, evidence or a legally sustainable basis.

The absence of rejection of the books of account was particularly important in the present case. The Tribunal accepted the CIT(A)’s reliance on the judicial principle that an ad-hoc addition cannot be sustained merely because the AO considers the quantum of expenditure excessive.

The Delhi ITAT dismissed the Revenue’s appeal and upheld the deletion of the disputed addition.

The Tribunal pronounced the order in open court on August 13, 2026.

Separately, in relation to the assessee’s claim for TDS credit, the CIT(A) had directed the AO to verify the assessee’s Form 26AS statement and allow credit as applicable. That ground was allowed for statistical purposes.

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