The Income Tax Appellate Tribunal (ITAT), Mumbai, has held that a partnership firm cannot be saddled with an unexplained cash credit addition merely because the tax authorities doubt the ultimate source of funds in the hands of its partner, when the partner’s identity is established and the capital contribution has been verified.
The bench of Beena Pillai (Judicial Member) and Vikram Singh Yadav (Accountant Member) observed that any further inquiry into the antecedent source of the partner’s funds should ordinarily be undertaken in the partner’s assessment, unless material shows that the money actually belonged to the firm and was routed through the partner.
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The Bench deleted notional interest of ₹4,50,600 on interest-free tenant security deposits, a duplicate cash deposit addition of ₹7,58,500, and an ad hoc expenditure disallowance. However, it remitted the remaining cash deposit of ₹1,60,000 to the Assessing Officer for limited verification.
The appellant/assessee is a partnership firm engaged in construction and real estate, against the Commissioner of Income Tax (Appeals)’s order dated November 26, 2025, for Assessment Year 2017–18.
During the relevant year, the firm earned rental income from portions of a property developed by it. It filed its income tax return on September 22, 2017, declaring a total income of ₹7,29,690.
During scrutiny, the Assessing Officer sought details of capital introduced by the partners, the sources of those contributions, cash deposits, security deposits received from tenants, and supporting bills and vouchers for expenditure.
The assessment resulted in additions of ₹2,73,02,823 towards a partner’s capital contribution, ₹9,18,500 towards cash deposits, ₹4,50,600 as notional interest on tenant security deposits, and ₹1,46,239 as an ad hoc expenditure disallowance. The total assessed income was recorded at ₹2,95,47,850.
The firm subsequently furnished additional evidence under Rule 46A before the appellate authority, including the partner’s bank statements and supporting documents. Although a remand report was obtained from the Assessing Officer, the additions were sustained, prompting the appeal before the Tribunal.
The principal dispute concerned capital introduced by partner Virendra Manilal Shah.
The firm submitted that the partner’s bank statement could not be uploaded during the original assessment because of an inadvertent omission by its consultant. It argued that the capital account had been furnished and that the bank statements were subsequently produced during the appellate proceedings.
According to the firm, the Assessing Officer examined those statements in the remand proceedings and confirmed that the capital contribution had been transferred from Shah’s bank accounts to the firm.
The Revenue maintained that movement of funds through banking channels did not, by itself, establish the partner’s creditworthiness or explain the underlying source of credits in his bank accounts.
The Tribunal found that Shah’s identity as a partner was undisputed and that the Assessing Officer had specifically verified the transfer of capital from his bank accounts. Consequently, the immediate source of the credit in the firm’s books stood established.
On the particular facts, the Tribunal held that sustaining the addition solely because the source of credits in the partner’s bank accounts had not been independently established went beyond the inquiry necessary to determine whether the amount represented unexplained income of the firm.
It clarified that further doubts about the partner’s source could be examined in his hands in accordance with law. A different conclusion could arise if there was evidence that the money actually belonged to the firm and had merely been routed through the partner.
No such material had been produced by the Revenue. Nor was there evidence that the partner was fictitious or that his contribution represented the firm’s undisclosed income.
The Tribunal relied on the coordinate Bench’s decision in MKF International v. DCIT, which had considered the High Court rulings in Nova Medicare v. ITO and Darshan Enterprise v. ACIT.
Applying that reasoning, it directed deletion of the addition under Section 68 relating to Shah’s capital contribution.
The firm’s representative informed the Bench that the Assessing Officer had subsequently rectified the amount under Section 154 from ₹2,73,02,823 to ₹2,37,02,823. The Tribunal therefore directed that relief be granted with reference to the amount subsisting after that rectification.
The separate ground challenging the numerical error became academic.
The Tribunal also examined the addition of ₹4,50,600, calculated at 12% on interest-free security deposits totalling ₹37,55,000 received from four tenants.
The firm argued that these deposits arose from ordinary letting arrangements and that the actual rental receipts had already been offered to tax. Neither the Assessing Officer nor the appellate authority had found that the rent was reduced or understated because of the deposits.
The Revenue contended that the deposits conferred a commercial benefit on the firm and that their commercial justification had not been sufficiently established.
Rejecting the addition, the Tribunal observed that the alleged interest was neither received nor shown to have accrued under any contractual arrangement. There was also no finding that security deposits had substituted or suppressed rental income.
A commercial advantage from an interest-free deposit did not create a right to receive interest, the Bench held. Taxation had to be based on income actually accrued or arisen, rather than a hypothetical return that the firm might have earned.
The ₹4,50,600 addition was accordingly deleted.
Of the separate cash deposit addition of ₹9,18,500, the firm submitted that ₹7,58,500 formed part of the capital introduced by Shah and had already been included in the capital contribution addition.
It also relied on documents concerning a loan obtained by the partner from Shivkrupa Path Peti.
The Tribunal found merit in the duplication argument to the extent of ₹7,58,500. The Revenue had not produced material showing that this amount represented a source independent of the capital contribution already considered.
Since the same amount had been taken into account under the partner’s capital contribution, a further addition as a cash deposit would result in double addition. The Tribunal therefore directed its deletion.
It also observed that production of evidence at the appellate or remand stage could not, by itself, justify sustaining an addition where the evidence was on record and the Revenue had identified no specific defect.
For the balance cash deposit of ₹1,60,000, the Tribunal found that the firm had not established the same degree of correlation with the partner’s capital contribution.
The written submissions referred to available cash-in-hand and a supporting cash book, but the figures required reconciliation.
The Bench restored this limited issue to the Assessing Officer for verification from the cash book and material already furnished. It directed that the firm be given a reasonable opportunity of being heard.
The Tribunal further rejected the 10% disallowance of ₹1,46,239 out of expenditure aggregating to ₹14,62,396.
For the assessment year under consideration, the Bench held that Section 14A could not support the disallowance because the firm had earned no exempt income.
It also found that the Assessing Officer had neither identified any particular expenditure unrelated to the firm’s business nor pointed out a specific defect in the supporting bills and vouchers examined during the remand proceedings.
Of the total expenditure, only ₹800 had been incurred in cash, while ₹14,61,596 had been paid through banking channels. The Tribunal allowed the firm’s ground challenging the ad hoc disallowance.
The order contains an apparent numerical inconsistency: the disputed disallowance is identified as ₹1,46,239 throughout the relevant discussion, while the concluding sentence in paragraph 12.2 mentions the total expenditure of ₹14,62,396 as the amount deleted.
The Tribunal directed the Assessing Officer to recompute interest under Sections 234A, 234B and 234C while giving effect to its order.
The challenge to initiation of penalty proceedings under Sections 270A and 271AAC was treated as premature and was not adjudicated. The general grievance concerning consideration of evidence and the remand report required no separate determination because the substantive additions had been decided on merits.
The appeal was partly allowed for statistical purposes, with only the balance cash deposit of ₹1,60,000 restored for verification.
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