A common belief among taxpayers is that once a payment is made by cheque or bank transfer, the transaction is beyond question. The bank statement shows the amount, the date and the counter-party, so what more could the department need? In practice, many of the largest income-tax additions arise from transactions that were entirely routed through banks: purchases from entry providers, share capital from shell companies, loans that come back as circular funds and gifts from people with no means.
This article explains why a banking trail is only the starting point, what assessing officers and courts examine beyond it, the key Supreme Court decisions on the point, and a practical documentation approach for purchases, loans, capital introduction and gifts. It is written for business owners, finance teams and practitioners preparing for scrutiny.
Key points at a glance
- A bank entry proves that money moved; it does not prove why it moved or that the underlying transaction was real.
- Officers ask four questions: the purpose of the payment, what was received in return, whether it makes commercial sense, and whether the counter-party had the capacity.
- The Supreme Court in NRA Iron & Steel (2019) upheld additions for share capital received through banking channels from entities without creditworthiness.
- In bogus purchase cases, courts have added either the entire purchase or only the profit element, depending on whether the goods were actually received.
- The relevant provisions are Section 68 (now Section 102) and Section 69C (now Section 105) of the Income-tax Act, 2025, besides the general deduction rules.
What does a bank entry prove, and what does it not?
A bank statement establishes three facts: an amount was transferred, on a particular date, between two accounts. It does not establish:
- the nature of the payment (price, loan, capital, gift or refund);
- that goods or services were actually supplied;
- that the payee had the capacity to supply, lend or invest; or
- that the money did not return to the payer through another route.
Income-tax law taxes real income and allows real expenditure. Where the substance of a transaction is doubtful, the method of payment does not settle it.
What do courts say? Key Supreme Court decisions
Durga Prasad More (1971) and Sumati Dayal (1995)
In CIT v. Durga Prasad More, the Supreme Court held that the tax authorities are entitled to look into the surrounding circumstances to find out the reality behind documents, and that apparent is not always real. In Sumati Dayal v. CIT, the Court held that claims must be tested against human probabilities. These principles are applied routinely to transactions that are formally correct but commercially unconvincing.
NRA Iron & Steel (2019)
In PCIT v. NRA Iron & Steel Pvt. Ltd., a company received large share premium through banking channels from companies that, on inquiry, had negligible income and could not be traced at their addresses. The Supreme Court held that the mere fact that money came through banks and investors had PAN and filed returns did not discharge the onus under Section 68, and restored the addition.
Ecom Gill Coffee Trading (2023)
Though a VAT case, the Supreme Court held in State of Karnataka v. Ecom Gill Coffee Trading that invoices and payments by cheque are not sufficient to prove a genuine purchase; the purchaser must also establish the seller's identity and actual movement of goods. The reasoning is frequently cited in income-tax purchase disputes.
How the principle applies to common transactions
| Transaction | What the bank entry shows | What is also examined | Provision (1961 / 2025) |
|---|---|---|---|
| Purchases | Payment to supplier | Delivery, transport, stock records, supplier's existence and filing history | Sections 37 and 69C / corresponding deduction provision and Section 105 |
| Unsecured loans | Receipt from lender | Lender's capacity, source of lender's funds, interest and repayment pattern | Section 68 / Section 102 |
| Share capital and premium | Receipt from investor | Investor's net worth, source of source, valuation | Section 68 / Section 102 |
| Capital introduction | Transfer into business account | Build-up of the balance in the source account | Section 68 / Section 102 |
| Gifts | Transfer from donor | Relationship, occasion, donor's capacity | Sections 56(2)(x) and 68 / corresponding provisions |
Bogus purchases: full addition or profit element?
Purchase disputes show how courts separate the payment from the substance. Two broad situations arise:
- Purchases entirely fictitious: no goods were received, and funds paid to the "supplier" came back in cash. The entire amount is disallowed. The Gujarat High Court upheld such a full disallowance in N.K. Proteins Ltd., and the Supreme Court dismissed the special leave petition in 2017.
- Goods received, but from a different source: sales are accepted and stock is reconciled, but the invoices were obtained from entry providers while goods were bought in the grey market. Courts, including the Bombay High Court in PCIT v. Mohommad Haji Adam & Co. (2019), have restricted the addition to the profit element or the difference in rates, since disallowing the entire purchase would tax gross receipts.
Practical point: Where a supplier is later reported as an entry provider, the most persuasive evidence is independent of the supplier: transport receipts, e-way bills, weighbridge slips, gate entries, production and consumption records, and the onward sale of the goods.
A practical four-question test for every significant transaction
- Why was the payment made? Keep the purchase order, agreement, board resolution or email that records the purpose.
- What was received in return? Keep delivery and receipt evidence for goods, and output evidence (reports, deliverables, timesheets) for services.
- Does it make commercial sense? Price, terms and timing should be consistent with market practice and the business's needs; unusual terms should be explained in a file note.
- Could the counter-party do it? For lenders, investors and donors, keep evidence of capacity: returns of income, bank statements, net worth.
A file that answers these four questions at the time of the transaction usually addresses the officer's queries without the need to reconstruct events years later.
Common mistakes that weaken bank-routed transactions
- Loans received and repaid within days, or circular transfers among related accounts.
- Payments to suppliers whose registrations are cancelled or who cannot be found at their address.
- Cash deposits in the counter-party's account immediately before the transfer.
- Confirmations signed on the same date for multiple years, prepared only for the assessment.
- No agreements for large advances or loans, with interest neither paid nor accrued.
Frequently Asked Questions on Bank Payments and Genuineness
Is a payment through a bank account proof that a transaction is genuine?
No. A bank entry proves the movement of money but not the nature of the transaction. Authorities also examine the purpose, what was received, commercial sense and the counter-party's capacity.
Can the tax department make an addition even if the investor has PAN and filed returns?
Yes. In NRA Iron & Steel (2019), the Supreme Court upheld an addition under Section 68 despite bank-routed receipts from investors with PAN, because their creditworthiness and the genuineness of the transaction were not established.
Is the entire amount of bogus purchases added to income?
It depends on facts. Where no goods were received, the entire amount may be disallowed; where goods were received and sales accepted, courts have often limited the addition to the profit element.
What is the new section for Section 68 under the Income-tax Act, 2025?
Section 68 corresponds to Section 102 of the Income-tax Act, 2025, and Section 69C (unexplained expenditure) corresponds to Section 105.
What documents support a genuine purchase?
Purchase order, tax invoice, e-way bill, transport receipt, goods receipt note, stock register entries and evidence of use or onward sale, together with the bank payment.
Does paying by cheque protect a gift from scrutiny?
No. The donor's relationship, capacity and the occasion should also be established; otherwise the amount may be taxed as unexplained money.
Conclusion
Routing a transaction through the bank is necessary, and cash transactions carry their own restrictions and disallowances. But it is not sufficient. Courts, including the Supreme Court in NRA Iron & Steel, have made clear that the method of payment does not replace proof of substance.
The strongest defence in an assessment is not that everything went through the bank, but that every significant transaction can be explained with documents that show its purpose, its consideration and the capacity of the other party.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.