ITAT Bangalore Affirms: Tax Authorities Cannot Override Commercial Judgment in Loss Claim

 In a significant ruling that reinforces the sanctity of business decision-making under India’s tax regime, the Bangalore bench of the Income Tax Appellate Tribunal (ITAT) has decisively held that revenue authorities cannot disallow genuine business losses merely by substituting their own view of commercial prudence. The decision in *Instakart Services Pvt. Ltd. v. ACIT (ITA No. 496, 543 & 544/Bang/2025)* marks a crucial check on the expanding scrutiny of intra-group pricing and startup losses.

Background: A Case of "Imprudent" Losses?

Instakart Services Pvt. Ltd., a logistics entity within the Flipkart group, reported a substantial business loss of ₹772.75 crore in its first full year of operations (Assessment Year 2016–17). The Assessing Officer (AO) sought to disallow the entire loss, branding the company’s commercial conduct as "imprudent."

The Revenue’s Allegation: The AO contended that Instakart had deliberately provided logistics services to its group company, Flipkart, at rates below market price while simultaneously paying higher charges to its vendors. This, according to the tax authority, indicated a pre-designed scheme to shift losses and costs to a new entity, thereby reducing the overall tax liability of the group.

The Core Legal Question

The appeal boiled down to a fundamental principle of tax jurisprudence: Do tax authorities have the power to reject documented business losses by second-guessing the commercial wisdom of a taxpayer’s decisions?

ITAT’s Unambiguous Ruling: A Resounding "No"

The Tribunal systematically dismantled the Revenue’s case, reaffirming several bedrock principles of income-tax law:

1. Losses in Nascent Stages are Inherently Commercial: The ITAT recognized that incurring significant losses in the initial years of operation—especially in a highly competitive, capital-intensive sector like e-commerce logistics—is a normal business reality. Such losses, backed by a genuine business model, cannot be equated to tax avoidance or "colourable device" in the absence of contrary evidence.

2. No Defect in Books or Violations Found: The Tribunal noted that all expenses and losses were duly recorded in audited books of accounts. Critically, the AO could not point to any specific defect in the accounts or prove a violation of Section 40A(2) (which governs excessive payments to related parties). The disallowance was based purely on the AO’s perception of imprudence, not on legal non-compliance.

3. The Supreme Court’s "Real Income" Doctrine Invoked: Relying on the landmark judgment in CIT v. A. Raman & Co., the ITAT reiterated that the Income Tax Act taxes real income, not hypothetical or notional income that an Assessing Officer believes could have or should have been earned. The AO’s attempt to impute a different set of profitable transactions was a venture into the realm of hypothetical income, which is not permissible.

4. Selective Analysis Ignored Full Business Context: The Tribunal held that the AO’s comparison of isolated rates was flawed. It failed to account for the integrated business model, the scale of operations, service-level agreements, and the additional costs and responsibilities (like last-mile delivery, technology, and quality control) undertaken by Instakart. A price comparison devoid of a full Functional, Asset, and Risk (FAR) analysis is legally unsustainable.

Reliance on Precedent: Consistency in Flipkart Group Litigation

Strengthening its position, the ITAT leaned on its own co-ordinate bench ruling in Flipkart India Pvt. Ltd. (150 taxmann.com 272). That decision had similarly held that absent specific, identifiable defects, the book results of a taxpayer cannot be disregarded. This creates a consistent judicial view regarding the treatment of losses incurred by group entities in the e-commerce ecosystem during their growth phase.

Key Implications for Businesses and Tax Authorities

The Instakart ruling carries vital implications:

• Boundaries of Revenue Authority Power: It clearly delineates that while the AO has the right to examine transactions for genuineness and adherence to arm’s length principles, this power does not extend to overriding bona fide business decisions or acting as an arbiter of commercial wisdom.

• Protection for Startups and New Ventures: The judgment provides much-needed assurance to startups and new business verticals that incurring initial losses as part of a legitimate growth strategy will not automatically invite tax disallowance, provided transactions are properly documented and audited.

• Emphasis on Holistic Analysis: It warns against selective cherry-picking of data points (like standalone rates) by tax officers. Any challenge to intra-group pricing must be based on a comprehensive analysis of the entire arrangement and commercial context.

• Documentation is Paramount: The decision underscores the critical importance of maintaining robust, audited documentation that clearly reflects the business rationale, FAR profile, and economic substance of transactions.

Conclusion

The ITAT Bangalore’s verdict is a powerful reaffirmation of the principle that the Income Tax Act is not a tool to penalize business judgments that, in hindsight, appear to result in losses. By drawing a clear line between legitimate scrutiny and impermissible overreach, the ruling upholds taxpayer certainty and reinforces that the commercial wisdom of a business, absent mala fide or specific legal violations, remains paramount. For companies navigating aggressive transfer pricing and loss disallowance assessments, this decision serves as a crucial judicial shield.