2022 (6) TMI 670 - HC - Income Tax

Assessees cannot escape Section 68 addition for bogus LTCG from penny stocks despite having incorporation details and PANs

The HC upheld the AO's addition under Section 68 regarding bogus LTCG claims from penny stock transactions. The court found that assessees failed to prove ... Long Term Capital Gains claimed under Section 10(38) challenged as bogus - Burden of proof under Section 68 / identity, genuineness and creditworthiness - Reliance on circumstantial evidence, human probabilities and preponderance of probabilities - Admissibility and evidentiary role of departmental investigation report - Principles governing non-disclosure of investigation material and prejudice test - Validity of exercise of revisional jurisdiction under Section 263 - Permissible use of inferential reasoning where direct proof of prior meeting of minds is lackingLong Term Capital Gains claimed under Section 10(38) challenged as bogus - Burden of proof under Section 68 / identity, genuineness and creditworthiness - Whether the Tribunal was justified in deleting additions and treating claimed LTCG as genuine in the face of findings by the Assessing Officer and CIT(A) that the gains arose from rigged penny stock transactions - HELD THAT: - The Court held that the Tribunal erred in reversing the concurrent findings of the Assessing Officer and the CIT(A). The assessing authorities had recorded proximate factual material - violent and unexplained rise in price of thinly traded 'penny' scrips, bell shaped trade pattern, links with an investigation into accommodation entry modus operandi and absence of commercial or financial fundamentals supporting the price rise - and applied the test of human probabilities and preponderance of probabilities to conclude that the claimed LTCG were tainted. The Court reiterated that where a taxpayer claims exemption (Section 10(38)) but large, unusual gains in poorly capitalised/illiquid scrips are shown, the initial onus to demonstrate identity, genuineness and creditworthiness rests on the assessee; absent satisfactory explanation, the AO may treat the sums as income from undisclosed sources under Section 68. The Tribunal's common order applied precedents without critically examining the factual matrix and therefore amounted to a perfunctory and perverse interference with the fact finding authorities. [Paras 10, 36, 37, 99, 101]Tribunal's deletion of the addition was set aside; the assessments as affirmed by the CIT(A) restoring additions under Section 68 were held valid.Admissibility and evidentiary role of departmental investigation report - Principles governing non-disclosure of investigation material and prejudice test - Whether the Directorate of Investigation's report could be relied upon by the assessing authorities and whether non furnishing of the full report/record to assessees vitiated the assessments - HELD THAT: - The Court declined to treat the investigation report as a mere inadmissible third party write up. The report, circulated by the Directorate of Investigation and containing annexures, was a legitimate starting point for scrutiny and for identifying patterns and beneficiaries; it formed part of the material on which assessing officers acted. At the same time the Court applied the test of prejudice: nondisclosure will vitiate only if the assessee shows actual prejudice to defence. Here, assessees were not named in the report, were given notices and opportunities to produce documents, and did not demonstrate specific prejudice flowing from non supply or absence of cross examination of witnesses. The Court therefore held non furnishing did not invalidate the enquiries and the AO/CIT(A) could rely on the report as corroborative material. [Paras 56, 57, 58, 65, 67]The investigation report was admissible as material and nondisclosure of the full report or non production of witnesses did not vitiate the assessments in absence of demonstrated prejudice.Reliance on circumstantial evidence, human probabilities and preponderance of probabilities - Permissible use of inferential reasoning where direct proof of prior meeting of minds is lacking - Whether circumstantial evidence and inferential reasoning could sustain findings that transactions were stage managed to generate bogus LTCG - HELD THAT: - The Court affirmed that where direct evidence of a prior meeting of minds is rarely available, a reasoned inferential process drawn from foundational facts (volume and pattern of trades, proximity of buy/sell, repeated involvement of certain brokers, abnormal price movements not supported by company fundamentals) is permissible. Citing K.R. Ajmera and related authorities, the Court held that the test is one of preponderance of probabilities and that a reasonable/prudent person may infer manipulation from the totality of circumstances. Given the report's project scale findings and the factual matrix in the individual assessments, the AO/CIT(A)'s reliance on circumstantial material to treat the gains as tainted was upheld. [Paras 69, 72, 75, 76, 99]Circumstantial evidence and inferential reasoning were held sufficient in the facts to sustain the additions; the assessees' explanations failed to discharge the onus under Section 68.Validity of exercise of revisional jurisdiction under Section 263 - Whether the Commissioners' assumption of jurisdiction under Section 263 to set aside assessments was justified - HELD THAT: - The Court examined the material on record and found that in the cases where s.263 was invoked the assessing officers had failed to conduct the requisite enquiry in the light of the Directorate's project report and surrounding circumstances. The Commissioner's orders explained why, in his opinion, the AO's orders were erroneous and prejudicial to revenue; substance over form was emphasised and the Court held that the Commissioners had stated reasons and acted within jurisdiction. The Tribunal's interference with s.263 orders was found to be superficial and perverse. [Paras 26, 29, 98, 101]The exercise of revisional jurisdiction under Section 263 by the respective Commissioners was upheld.Final Conclusion: The appeals by the revenue were allowed. The High Court held that (i) the Tribunal erred in deleting additions and in perfunctorily applying precedents without examining the factual matrix; (ii) the Directorate's investigation report and circumstantial material could be validly relied upon where no specific prejudice from non disclosure was shown; (iii) inferential reasoning on preponderance of probabilities can sustain findings of staged/rigged penny stock transactions where assessees fail to discharge the onus under Section 68; and (iv) assumption of revisional jurisdiction under Section 263 in the cases before the Court was justified. Orders of the Assessing Officers and CIT(A) restoring additions were therefore restored. The core legal questions considered in this batch of appeals arising under the Income Tax Act, 1961, primarily revolve around the genuineness of claims of Long Term Capital Gains (LTCG) by various assessees who invested in shares of certain companies, notably penny stock companies. The issues include whether the Income Tax Appellate Tribunal (ITAT) erred in allowing the claims of LTCG despite evidence suggesting manipulation of share prices and bogus transactions, whether the transactions were part of a colourable device to evade taxes, and the validity of the assumption of jurisdiction by the Commissioner of Income Tax under Section 263 of the Act to revise assessments. Further, the legality and evidentiary value of an investigation report prepared by the Income Tax Department's Investigation Wing, and the applicability of principles such as burden of proof under Section 68, the test of human probabilities, and reliance on circumstantial evidence in tax proceedings were also considered.The principal issues can be grouped as follows:(i) Whether the LTCG claimed by the assessees in respect of shares of penny stock companies were genuine or fictitious, involving manipulation of share prices to generate bogus capital gains.(ii) Whether the ITAT erred in allowing the appeals of the assessees by relying on documentary evidence such as contract notes, banking channels, and demat statements without adequately considering the circumstantial evidence and the investigation report indicating rigging and accommodation entries.(iii) The validity and effect of the investigation report prepared by the Deputy Director of Income Tax (Investigation) and whether non-furnishing of the report and non-availability of persons for cross-examination violated principles of natural justice.(iv) The correctness of the assumption of jurisdiction by the Commissioner under Section 263 of the Act to revise assessments on grounds of erroneous and prejudicial orders passed by the Assessing Officers.(v) The legal principles relating to burden of proof under Section 68 of the Act, the role of circumstantial evidence, and the application of the test of human probabilities in tax assessments involving claims of unexplained income.Issue-wise detailed analysis:1. Genuineness of LTCG claimed on shares of penny stock companiesThe Income Tax Department initiated investigation into alleged bogus claims of LTCG involving penny stock companies, including Surabhi Chemicals and Investment Limited. The investigation report, prepared by the Deputy Director of Income Tax (Investigation), Kolkata, identified 84 penny stock companies and detailed the modus operandi of price rigging and accommodation entries. It highlighted the involvement of promoters, brokers, and entry operators in artificially inflating share prices to enable assessees to claim bogus LTCG exempt under Section 10(38) of the Act.The Assessing Officers, relying on this report and applying the test of human probabilities and surrounding circumstances, disallowed the LTCG claimed by the assessees, treating the gains as income from undisclosed sources under Section 68. The Assessing Officers noted the abnormal rise in share prices, the 'bell-shaped' trading pattern, absence of business fundamentals, and the recessionary market trend during the relevant period. They also computed unexplained commission payments to brokers as part of the accommodation entry scheme.The CIT (Appeals) concurred with the Assessing Officers, holding that the documents produced by the assessees-contract notes, bank statements, demat accounts-were insufficient to establish genuineness. The CIT(A) emphasized that the real feature was the manipulated and abnormal price rise and sudden peak in share prices unsupported by economic or financial basis, and thus the transactions were suspicious and dubious.The ITAT, however, allowed the appeals by adopting the reasoning of a Coordinate Bench in Mahavir Jhanwar v. ITO, which held that decisions must be based on evidence and not on suspicion, conjecture or surmise. The Tribunal noted that the assessees had produced relevant contract notes, share certificates, and proof of transactions through registered brokers and banking channels. The Tribunal found no direct evidence implicating the assessees and held that the general report and circumstantial evidence were insufficient to disallow the LTCG claims.The High Court found the ITAT's approach perfunctory and superficial, noting that the Tribunal did not examine the facts of each case or the detailed findings of the Assessing Officers and CIT(A). The Court emphasized that the assessees bore the heavy burden under Section 68 to prove the identity, genuineness, and creditworthiness of the transactions, especially given the abnormal and rapid rise in share prices of penny stocks. The Court upheld the Assessing Officers and CIT(A) findings, applying the test of human probabilities and surrounding circumstances, and held that the LTCG claims were bogus and rightly disallowed.2. Reliance on the investigation report and principles of natural justiceThe assessees contended that the investigation report was not furnished to them despite specific requests, and that the persons from whom statements were recorded were not made available for cross-examination, violating principles of natural justice. They argued that the report was a third-party document and could not be the basis for adverse findings.The Department submitted that the report was prepared by an authority within the Income Tax department and was circulated to all DGITs for appropriate action. The investigation commenced from the penny stock companies and brokers, not from the assessees, following a 'working backwards' methodology. The report identified modus operandi, involved entities, and provided a cash trail. The Department argued that non-furnishing of the report or non-availability of witnesses did not cause prejudice to the assessees as they were not specifically named or implicated in the report.The Court distinguished the report from the Commission of Inquiry Act reports considered in other cases, holding that it was an internal departmental report and admissible as material. It held that violation of procedural provisions does not automatically vitiate proceedings unless prejudice is shown. The Court applied the test of prejudice and fair hearing, finding no prejudice to the assessees as they were given notices, opportunities to submit documents, and the report did not name them specifically. The Court also held that there is no absolute right to cross-examination in such proceedings, especially where statements do not directly incriminate the assessee.The Court referred to Supreme Court decisions affirming that circumstantial evidence and logical inferences from surrounding circumstances are admissible and relevant in tax proceedings, and that the burden of proof lies on the assessee to prove the genuineness of transactions claimed as exempt.3. Assumption of jurisdiction under Section 263 of the Income Tax ActIn several appeals, the Commissioner of Income Tax invoked powers under Section 263 to revise assessment orders, alleging that the Assessing Officers failed to conduct proper enquiries despite credible information about bogus LTCG claims. The assessees challenged the validity of such jurisdiction, contending that the Commissioner pre-decided the issue and that the assessments were not erroneous or prejudicial.The Court examined the orders passed under Section 263 and found them to be reasoned and not vitiated by pre-judgment. It held that the Commissioner was justified in assuming jurisdiction as the Assessing Officers failed to properly investigate the claims in light of the investigation report and surrounding circumstances. The Court noted that the Assessing Officers had overlooked the fact that the investigation did not commence from the assessees but from the penny stock companies and brokers, and thus they were required to conduct detailed enquiries to verify the genuineness of the claims. The failure to do so rendered the assessment orders erroneous and prejudicial to the revenue's interest.The Court held that the ITAT erred in interfering with the Commissioner's orders under Section 263, as the Tribunal did not appreciate the totality of the circumstances and the complex nature of the transactions. The Court affirmed the validity of the Commissioner's exercise of jurisdiction.4. Burden of proof under Section 68 and application of test of human probabilitiesThe Court extensively examined the principles relating to burden of proof under Section 68, which requires the assessee to prove the identity, genuineness, and creditworthiness of the transactions involving unexplained cash credits or claims of exemption. The Court referred to authoritative decisions holding that the onus is on the assessee to provide a proper, reasonable, and acceptable explanation for the sums credited, failing which the Assessing Officer may treat such credits as income from undisclosed sources.The Court emphasized that the test of human probabilities and surrounding circumstances are relevant in determining the genuineness of transactions, especially where direct evidence is difficult to obtain. The Court held that the Assessing Officers and CIT(A) applied these principles correctly in disallowing the LTCG claims based on the abnormal rise in share prices, the nature of penny stock companies, and the modus operandi revealed by the investigation.The Court rejected the assessees' reliance on mere documentary evidence such as contract notes and bank statements without addressing the suspicious circumstances, and held that the burden of proving the genuineness and creditworthiness is heavy in such cases involving alleged accommodation entries and price rigging.5. Reliance on circumstantial evidence and foundational factsThe Court addressed the contention that circumstantial evidence cannot be relied upon without foundational facts. It held that the investigation report and the material collected by the Department constituted foundational facts that justified reliance on circumstantial evidence and logical inferences. The Court noted that direct evidence of prior meeting of minds or manipulation is rarely available, and thus the test of preponderance of probabilities and surrounding circumstances is the appropriate standard.The Court also clarified that the decision in K.R. Ajmera, which sets out factors for inferring manipulative trade practices, remains good law and was not overruled by subsequent decisions. The Court applied these principles to the facts, noting the unusual trading volumes, proximity of buy and sell orders, and steep price fluctuations inconsistent with market trends.6. Treatment of competing arguments and conclusionsThe assessees argued that they were bona fide investors, that the shares were traded on recognized stock exchanges, payments were made through banking channels, and that they relied on expert advice and market reports. They contended that the investigation report was general and not assessee-specific, that non-furnishing of the report and denial of cross-examination violated natural justice, and that the ITAT's order should be upheld.The Department countered that the assessees failed to discharge the heavy burden of proof under Section 68, that the investigation report and the findings of the Assessing Officers and CIT(A) were based on detailed material and application of legal principles, and that the ITAT's order was perverse and superficial.The Court found the Department's arguments persuasive, holding that the assessees had not satisfactorily explained the phenomenal rise in share prices or established the creditworthiness of the companies involved. The Court held that the investigation report was admissible material, that non-furnishing of the report and denial of cross-examination did not cause prejudice, and that the Assessing Officers and CIT(A) had rightly applied the test of human probabilities and burden of proof principles. The Court concluded that the ITAT erred in reversing the orders and allowed the appeals filed by the revenue.Significant holdings include:'The assessee cannot escape from the burden cast upon him and unfortunately in these cases the burden is heavy as the facts establish that the shares which were traded by the assessees had phenomenal and fanciful rise in price in a short span of time and more importantly after a period of 17 to 22 months, thereafter has been a steep fall which has led to huge claims of STCL. Therefore, unless and until the assessee discharges such burden of proof, the addition made by the assessing officer cannot be faulted.''The report has to be read as a whole along with the annexures/chapters. The report prepared by the DDIT is on behalf of the Directorate of Investigation, Kolkata, and this is evident from the report dated 27.04.2015. Therefore, at the threshold it cannot be treated to be a third-party report.''Violation of any and every procedural provision cannot be said to automatically vitiate the domestic enquiry held against the delinquent employee or the order passed by the disciplinary authority except in cases falling under no notice, no opportunity and no hearing categories. The test laid down was whether the person has received a fair hearing considering all things as the ultimate test is always the test of prejudice or the test of fair hearing.''The assumption of jurisdiction under Section 263 of the Act by the respective Commissioners was fully justified and are shown to be proper exercise of power. The tribunal while interfering with the orders of the Commissioner once again posed a wrong question to itself and failed to approach the matter in the proper perspective considering the backgrounds in which the power was invoked.''The Assessing Officers and the CIT(A) have culled out proximate facts in each of the cases, took into consideration the surrounding circumstances which came to light after the investigation, assessed the conduct of the assessee, took note of the proximity of the time between the buy and sale operations and also the sudden and steep rise of the price of the shares of the companies when the general market trend was admittedly recessive and thereafter arrived at a conclusion which in our opinion is a proper conclusion and in the absence of any satisfactory explanation by the assessee, the Assessing Officers were bound to make addition under Section 68 of the Act.''The doctrine of preponderance of probabilities could very well be applied in cases like the present one. We say human probabilities to be the relevant factor as on account of the fact that the assessees are of individuals or Hindu Undivided Families and the trading has been done in the name of the individual assessee or by the Karta of the HUF.''The assessee having not proved the genuineness of the claim, the creditworthiness of the companies in which they had invested and the identity of the persons to whom the transactions were done, have to necessarily fail.''The orders passed by the CIT(A) affirming the orders passed by the Assessing Officers as well as the orders passed by CIT under Section 263 of the Act were proper and legal and the Tribunal committed a serious error in reversing such decisions.'