ITAT Mumbai Deletes Section 69C Addition Based Solely on Third-Party Software Data

1. Background of the Dispute

The matter in S. Sagar Enterprise Vs DCIT (ITAT Mumbai) arose from reassessment proceedings initiated for Assessment Year 2019–20 under Sections 147 and 148 of the Income Tax Act 1961. The assessee was carrying on business as a trader in diamonds.

  • The assessee filed its original return of income on 15.09.2019 declaring a total income of ₹1,32,20,680.
  • Subsequently, a notice under Section 148 dated 27.02.2023 was issued, reopening the assessment.
  • In response, on 03.03.2023, the assessee again filed its return of income, reiterating the same declared income.

During the reassessment proceedings, the Assessing Officer (AO) invoked Section 142(1) and completed the reassessment on 08.02.2024. The AO determined the total income at ₹1,38,85,725 by making an addition of ₹6,65,045 under Section 69C, treating the amount as unexplained expenditure.

The core issue was whether this Section 69C addition, based exclusively on data allegedly retrieved from third-party software maintained by M/s. Ratnakala Exports Private Limited (M/s. REPL), could be sustained in law when:

  1. The underlying material was never shared with the assessee, and
  2. The assessee’s request for cross-examination of the relevant persons was denied.

2. Origin of the Alleged Unaccounted Purchases

2.1 Search at M/s. Ratnakala Exports Private Limited

A search and seizure operation was carried out at the premises of M/s. Ratnakala Exports Private Limited (M/s. REPL). During this action, it was reportedly discovered that M/s. REPL was using a separate software system to record unaccounted purchases and sales of diamonds.

On the basis of certain entries in this software, the Department inferred that various concerns, including the assessee, had allegedly engaged in cash transactions that were not recorded in their regular books of account.

2.2 AO’s Finding Against the Assessee

Relying solely on the entries said to be appearing in this unaccounted software of M/s. REPL, the AO concluded that the assessee had made:

  • Cash purchases of diamonds from M/s. REPL amounting to ₹6,65,045,
  • Which were not recorded in the assessee’s books,
  • And therefore constituted unexplained expenditure under Section 69C.

No independent verification, corroboration through the assessee’s books, or confrontation of the material was carried out before fastening this liability on the assessee.

3. Assessee’s Stand Before the AO

3.1 Recorded Purchases and Supporting Evidence

Before the AO, the assessee categorically denied having made any unaccounted cash purchases from M/s. REPL. Instead, the assessee explained that:

  • It had purchased cut and polished diamonds from M/s. REPL during the relevant year for a sum of ₹3,66,451 (as recorded in the books).
  • These purchases were duly accounted as regular purchases.
  • Payments towards these purchases were made through normal banking channels only.

To substantiate the above, the assessee furnished:

  • Purchase invoices issued by M/s. REPL,
  • Ledger account of M/s. REPL in the assessee’s books of account,
  • Confirmation of account issued by M/s. REPL,
  • Bank statements detailing payments to M/s. REPL.

3.2 Evidence of Export and Taxed Income

The assessee further demonstrated that the diamonds purchased from M/s. REPL had been exported. For this purpose, it produced:

  • Export/sales invoices (denominated in foreign currency),
  • Stock records/stock register,
  • Computation and return of income showing that the income from these export transactions had been duly offered to tax.

The Revenue did not dispute any of the following:

  • The fact of purchase of diamonds from M/s. REPL for ₹3,66,451,
  • The fact that these goods were exported,
  • The fact that the related income had already been subjected to tax.

3.3 Request for Material and Cross-Examination

Recognising that the proposed addition was entirely anchored on alleged software data found during the search on M/s. REPL, the assessee: