If a business takes a loan or advance and pays it back quickly — sometimes within a single day — can the tax department still say "we don't believe this money was genuine, so we're taxing it as your income"? This is exactly the question at the heart of the Merrygold Gems case, which travelled from the Income Tax Appellate Tribunal (ITAT), Surat, all the way to the Gujarat High Court. Both forums answered the same way: no.
Here's what happened, and why it matters, told in two parts — first the ITAT Surat order, since that's where the detailed facts and arguments were thrashed out, and then the Gujarat High Court's final word on the matter.
The Background Common to Both Rulings
Merrygold Gems Pvt. Ltd. is a company trading in rough and polished diamonds. For the assessment year 2016-17, it had filed its return declaring an income of about Rs. 56.5 lakhs. During scrutiny, the tax officer noticed something in the audit report: the company had received deposits of about Rs. 11.57 crores from thirteen different parties, and most of this amount had been squared off (repaid) during the very same year.
Instead of treating this as routine business activity, the Assessing Officer decided to dig deeper — and ultimately added the entire Rs. 11.57 crores to the company's income under Section 68 of the Income Tax Act, the provision used to tax "unexplained cash credits." On top of that, tax was charged at the special higher rate under Section 115BBE.
Part 1: The ITAT Surat Ruling — Where the Real Fact-Finding Happened
Why the Assessing Officer Doubted the Loans
The officer's suspicion rested on three pillars, which are the classic tests applied under Section 68:
1. Identity of the lenders — The officer sent a Ward Inspector to physically visit the addresses of the thirteen parties who had advanced money. The Inspector's report said that in most cases, the premises were either closed, occupied by someone else entirely, or the party simply wasn't found there.
2. Creditworthiness of the lenders — Looking at the lenders' income tax returns, the officer found their profits were quite meagre compared to their revenue, and concluded they didn't have the financial strength to advance such large sums.
3. Genuineness of the transactions — Given the weak financial profile of the lenders, the officer felt the transactions themselves looked doubtful, especially since no interest was charged and there was no formal loan agreement or collateral.
Based on all this, the officer treated the entire amount as unexplained cash credit.
What the Company Had Actually Submitted
The company's case was that this money wasn't a mysterious loan at all — it was trade advances received from customers for supply of diamonds. When the sale didn't go through, the advance was simply returned. To back this up, the company provided:
Complete addresses, PAN details, and company registration data for all thirteen parties
Import-Export Code certificates and VAT/GST registration proof
Bank statements showing money coming in and going back out
Confirmation letters and notarised affidavits from each lender
Replies received from all parties in response to formal notices
The First Appeal: Commissioner of Income Tax (Appeals)
On appeal, the CIT(Appeals) took a much closer look and found some real problems with the Assessing Officer's approach:
Of the thirteen lenders, physical inquiries had actually been conducted for only ten. For the remaining three, there was no adverse finding at all.
On closer inspection, several of these lenders were sizeable businesses — one had gross receipts of over Rs. 500 crores, others had turnovers ranging from Rs. 5 crores to Rs. 100+ crores. They filed regular tax returns, held stock, and had genuine business expenses.
Most importantly: every single advance had been repaid within the same financial year, and mostly within just 30 days. These repayments were verified against both the ledger accounts and bank statements — and the Assessing Officer had not raised a single doubt about the repayments themselves.
Relying on earlier Gujarat High Court rulings — particularly CIT v. Ayachi Chandrashekhar Narsangji — the CIT(Appeals) held that when a loan is repaid and the department doesn't dispute the repayment, that itself is strong evidence that the loan was genuine in the first place. The entire addition was deleted.
The Tribunal's Own Analysis
The Revenue wasn't satisfied and took the matter to the ITAT Surat Bench. Here, the assessee's representative placed before the Tribunal a party-wise chart showing exactly how quickly each advance had come back:
Four parties were repaid within just one day
A few more within 3 to 6 days
Several others within about a month
The rest within a maximum of about five months
Not a single rupee remained outstanding by the end of the financial year.
The Tribunal made a few sharp observations:
Physical inquiries had only actually been done for ten of the thirteen lenders — the report couldn't be treated as adverse for the other three at all.
Detailed financial profiles showed the lenders were real, sizeable businesses, not shell entities.
There was no allegation anywhere that these parties were part of any accommodation-entry racket, nor any evidence of circular transactions.
If the officer genuinely doubted a lender's financial capacity, the correct remedy was to examine that lender's own assessment — not to tax the amount in the recipient's hands without doing so.
Relying on its own precedent and Gujarat High Court rulings (including Ayachi Chandrashekhar Narsangji and CIT v. Ranchhod Jivabhai Nakhava), the Tribunal held that the CIT(Appeals)'s order suffered from no error and dismissed the Revenue's appeal entirely.
Part 2: The Gujarat High Court's Verdict
Unwilling to accept the Tribunal's ruling, the Revenue escalated the matter further — this time to the Gujarat High Court — under Section 260A of the Income Tax Act, framing it as a substantial question of law.
The High Court's analysis was refreshingly direct. It looked at the core, undisputed fact: the loans had been returned within the same financial year, mostly within 30 days, and this repayment had been verified from the ledger account and bank statement.
The Court then turned to its own earlier decision in Dy. CIT v. Rohini Builders — a landmark ruling on Section 68 — which laid down several principles that are worth remembering:
Once a taxpayer discloses the lender's identity (name, address, PAN) and shows that money moved through banking channels, the initial burden under Section 68 is discharged.
A taxpayer is required to explain the source of the credit in its own books — not the "source of the source," meaning it doesn't have to prove where the lender got their money from.
If cash deposits in a lender's own account look suspicious, the correct approach is for the department to examine that lender separately — not to tax the amount in the borrower's hands.
Repayment of a loan through banking channels, especially when the department doesn't dispute that repayment, is itself compelling evidence of genuineness.
Section 68 uses the word "may" (not "shall") when it comes to treating an unexplained credit as income — meaning even an unsatisfactory explanation doesn't automatically result in an addition. The officer still has to exercise judgment.
Applying this reasoning to Merrygold's facts, the High Court found no merit in the Revenue's appeal and dismissed it, upholding the deletion of the entire Rs. 11.57 crore addition.
In Simple Terms
If your business takes short-term trade advances or loans and repays them quickly — with everything reflected properly in your bank statements and books — that repayment itself is one of your strongest defences if the tax department later questions the transaction. This case is a reminder that genuine, fast-moving business transactions should not be mistaken for attempts to introduce unaccounted money.
Income Tax Case Law Deputy Commissioner of Income-tax versus Merrygold Gems Pvt. Ltd.
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