Income Tax: Can a third-party document alone lead to a tax demand? ITAT says no

The Delhi bench of the Income Tax Appellate Tribunal (ITAT) has ruled that the Income Tax Department cannot make additions for alleged undisclosed income merely on the basis of a loose sheet recovered during a search on another person unless it has independent evidence proving that the transaction actually took place.

The ruling came in the case of Dolly Sabharwal vs Deputy Commissioner of Income Tax, where the department sought to tax alleged interest income running into crores after relying on a handwritten calculation sheet recovered during a search on a third party. The Tribunal upheld the order of the Commissioner of Income Tax (Appeals), which had deleted the additions after finding no corroborative evidence to support the department’s claim.

Why was the taxpayer served a ₹1.52 crore tax demand?

The dispute relates to Assessment Years (AYs) 2018-19, 2019-20, 2020-21 and 2022-23.

For AY 2018-19, Dolly Sabharwal filed her income tax return declaring an income of ₹4.23 lakh. During a search conducted under Section 132 on another individual, the Income Tax Department recovered a loose sheet containing interest calculations on an alleged loan of about ₹6.62 crore purportedly advanced by Sabharwal.

Based on the handwritten calculations, the Assessing Officer concluded that the taxpayer had received interest income that was not disclosed in her return. Accordingly, the department added around ₹1.48 crore as unexplained money under Section 69A, taking her assessed income to over ₹1.52 crore. Similar additions were made for the other assessment years.

The taxpayer denied receiving any interest. The alleged borrower also denied making any interest payment. Even the person from whose premises the document was recovered stated that the calculations were merely notional and did not represent actual financial transactions.

The Commissioner of Income Tax (Appeals) accepted these arguments and deleted the additions, prompting the Revenue to challenge the order before the ITAT.

Why did the ITAT rule in the taxpayer’s favour?

The Tribunal dismissed all four appeals filed by the Income Tax Department, holding that the additions could not be sustained merely on the basis of a document recovered from a third party.

It observed that the loose sheet was not found in the taxpayer’s possession and that both the taxpayer and the alleged borrower had consistently denied any payment or receipt of interest. More importantly, the department had failed to produce any independent evidence, such as bank statements, accounting records, cash trail or other material, to establish that the alleged interest transaction had actually taken place.

The ITAT also relied on its earlier ruling in the connected case involving the alleged borrower, where additions based on the same loose sheet had already been deleted.

Further, the Tribunal agreed that the presumptions available under Sections 132(4A) and 292C of the Income Tax Act generally apply only to the person from whose possession the documents are seized and cannot automatically be extended to another taxpayer.

The ruling reinforces that while documents recovered during a search may justify further investigation, they cannot, by themselves, form the basis of tax additions. The Income Tax Department must establish the alleged transaction through independent and corroborative evidence before treating it as undisclosed income.