Taxpayer declares Rs 4.23 lakh income, faces Rs 1.52 crore tax demand over alleged loan interest earned; ITAT says this

The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has answered this question in favour of the taxpayer. In the case of Dolly Sabharwal vs Deputy Commissioner of Income Tax, the Tribunal upheld the deletion of tax additions running into crores after finding that the department had no independent evidence to prove that the alleged transactions had actually taken place.

The ruling is significant because it reiterates that a loose sheet recovered from a third party, by itself, cannot become the basis for taxing alleged income or expenditure unless it is backed by corroborative evidence.

What was the case about?

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

Dolly Sabharwal had filed her income tax return for AY 2018-19 declaring an income of Rs 4.23 lakh.

The case took a turn in March 2022, when the Income Tax Department carried out a search under Section 132 on another person, Amarjit Singh Sethi. During the search, officials recovered certain documents, including a loose sheet containing calculations of interest on an alleged loan of Rs 6.62 crore said to have been advanced by Dolly Sabharwal to one Shally Thapar.

Based on this document, the Assessing Officer reopened Dolly Sabharwal’s assessment and concluded that she must have received the interest mentioned in the sheet.

For AY 2018-19 alone, the department added Rs 1.48 crore as unexplained money under Section 69A. As a result, her assessed income jumped from Rs 4.23 lakh to over Rs 1.52 crore.

Why did the Income Tax Department make the addition?

According to the department, the principal loan amount had admittedly been transferred through banking channels.

The Assessing Officer therefore presumed that the interest calculations appearing on the seized sheet represented actual interest received by Dolly Sabharwal.

The department argued that the document indicated financial transactions between the parties and treated the calculated interest as undisclosed income.

What did the taxpayer say?

Dolly Sabharwal denied ever receiving any interest.

The borrower, Shally Thapar, also denied paying any interest.

Even Amarjit Singh Sethi, from whose possession the loose sheet was recovered, stated during the proceedings that the calculations were merely notional and arbitrary, and that no such interest transaction had actually taken place.

The taxpayer argued that apart from the loose sheet, the department had no evidence whatsoever to establish that any interest had actually been paid or received.

CIT(A) deletes the addition

The Commissioner of Income Tax (Appeals) accepted the taxpayer’s arguments.

The appellate authority observed that the addition was based only on a loose sheet recovered from a third party and that there was no independent material to prove the alleged receipt of interest.

The CIT(A) also noted that the presumptions available under Sections 132(4A) and 292C generally apply only to the person searched and cannot automatically be extended to another taxpayer. Since there was no corroborative evidence, the addition was deleted.

The Revenue then challenged this relief before the ITAT.

What did the ITAT decide?

The Delhi ITAT dismissed all four appeals filed by the Income Tax Department.

The Tribunal noted that the document had been recovered from Amarjit Singh Sethi, not from Dolly Sabharwal.

It also observed that both Dolly Sabharwal and Shally Thapar had consistently denied that any interest had been paid or received, and that the department had not produced any independent evidence to contradict their stand.

The Tribunal relied on its own earlier decision in the connected case of Shally Thapar, where an identical addition based on the same loose sheet had already been deleted.

Finding no reason to take a different view, the ITAT upheld the relief granted by the CIT(A) and dismissed all four departmental appeals.

Why is this ruling important?

Rajiv Thakkar, Partner, Direct Tax, says courts have consistently held that a loose sheet found during a search on a third party cannot, by itself, justify additions under Sections 69A or 69C against another taxpayer.

“Courts have consistently held that a loose sheet or handwritten document found during a search on a third party cannot, by itself, be treated as sufficient evidence to make additions under Sections 69A or 69C against another taxpayer. Such documents are dumb documents and have no evidentiary value.”

He adds that such documents can support an addition only when backed by independent evidence.

“Courts require the Income Tax Department to establish a clear nexus between the seized material and the taxpayer showing that the transaction actually taken place. Mere suspicion or presumption cannot substitute corroborated proof or notional calculations cannot substitute for evidence of real income or expenditure.”

What kind of evidence should the tax department collect?

The Tribunal found that there was no evidence apart from the loose sheet itself.

According to Thakkar, if the department wants to sustain additions under Sections 69A or 69C, it should collect material that independently supports the allegations.

“The Income Tax Department should collect independent evidence linking the taxpayer with alleged transaction. Such evidence may include bank statements, cash flow records, accounting entries, confirmations from parties, emails, messages, agreements, loan documents, digital records, etc.”

He adds that the department must establish the actual movement of money.

“Without corroborative evidence, a loose sheet remains only a dumb document incapable of sustaining an addition.”

Amit Baid, Head of Tax at BTG Advaya, says a loose sheet may be enough to start an inquiry, but it cannot become the sole basis for a tax addition.

“A loose sheet may trigger an investigation, but it cannot conclude one. The Department must connect the dots to real money, such as bank trails, cash deposits or asset acquisitions matching the figures, statements of the parties actually admitting the transaction, or independent evidence from further enquiry. Without a money trail, the addition collapses.”

What are Sections 132(4A) and 292C?

One of the important legal issues in this case was the scope of Sections 132(4A) and 292C of the Income Tax Act.

These provisions create a legal presumption that documents or assets found during a search belong to the person from whose possession they are recovered and that their contents are true.

However, the ITAT agreed with the CIT(A) that this presumption could not automatically be used against Dolly Sabharwal because no search had been conducted on her.

Explaining this principle, Thakkar says:

“Sections 132(4A) and 292C create a presumption that books, documents, money, assets or valuables found during a search belong to the person from whose possession they are seized and that their contents are true. However, this presumption is generally confined to the person searched.”

He further adds: “This presumption cannot automatically be extended to a third party against whom no search was conducted, since it was never in their possession.”

What lessons does this judgment offer taxpayers?

The ruling provides important guidance for taxpayers whose assessments are reopened on the basis of documents recovered during searches conducted on someone else.

According to Thakkar, taxpayers should carefully examine whether the seized material actually belongs to them and whether the department has any independent evidence.

“Taxpayer must request for the supporting documents, cross examination of any person whose statement is relied upon and point out the absence of nexus with their own affairs.”

He says the ruling can also help taxpayers in similar disputes.

“The above ruling can certainly be cited in similar disputes involving alleged unexplained income, money, or expenditure under Sections 69A or 69C, particularly where the Income Tax Department relies solely on third party documents or statements gathered from a search or survey on another entity.”

Baid says the ruling also sends an important message to taxpayers whose assessments are reopened solely because of documents recovered during searches on someone else.

The judgment reinforces a long-settled principle of tax law: a suspicion, however strong, cannot replace evidence. Where the department seeks to tax alleged unexplained income or expenditure, it must be able to show through independent material that the transaction actually took place, rather than relying only on a loose sheet recovered from someone else’s premises.

Disclaimer: This article is based on the order passed by the Income Tax Appellate Tribunal (ITAT) in Dolly Sabharwal vs Deputy Commissioner of Income Tax. The ruling is specific to the facts of the case. Tax outcomes may differ depending on individual circumstances, and readers should consult a qualified tax professional before taking any decision based on this judgment.

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