ITAT Mumbai Deletes Ad-Hoc Disallowance on Labour Expenses; Holds Suspicion Cannot Replace Proof

The Income Tax Appellate Tribunal (ITAT), Mumbai Bench “E”, has deleted an ad-hoc disallowance of ₹16.71 lakh sustained by the Commissioner (Appeals), holding that labour expenditure cannot be disallowed merely on suspicion in the absence of cogent evidence.

The assessee, engaged in the business of manufacturing and trading gold jewellery, had claimed labour expenses of ₹4.92 crore. The Assessing Officer (AO), based on bank analysis and verification reports, treated payments made to five labour contractors as non-genuine, primarily noting immediate cash withdrawals after cheque deposits and absence of contractors at recorded addresses. Consequently, the AO disallowed ₹1.67 crore as bogus expenditure.

On appeal, the Commissioner (Appeals) accepted the business model and evidentiary documentation but sustained a 10% disallowance (₹16.71 lakh) on a protective basis.

Before the Tribunal, the assessee demonstrated that all payments were made through banking channels, supported by invoices, confirmations, and statutory compliance. The Tribunal noted that the books of account were not rejected under Section 145(3), and no discrepancy in stock or turnover was identified. It further observed that all contractors responded to notices under Section 133(6), and no material evidence established any round-tripping of funds.

Crucially, the Tribunal held that in the jewellery industry, immediate cash withdrawals by labour contractors are commercially plausible, given the nature of payments to small artisans. It also found deficiencies in the verification exercise, including incorrect address identification.

Rejecting the “split-the-difference” approach adopted by the Commissioner (Appeals), the Tribunal held that once the expenditure is accepted as genuine, partial disallowance without evidence is arbitrary and unsustainable in law.

Accordingly, the Tribunal deleted the entire addition and allowed the appeal.