LTCG exemption under section 10(38) upheld despite concerns over abnormal share price rise in loss-making company

The ITAT Mumbai upheld CIT(A)'s deletion of addition u/s 68 for unexplained cash credit regarding LTCG exemption u/s 10(38). Despite AO's concerns about abnormal share price rise in Wagend Infra Venture Ltd (a loss-making, non-dividend paying company), the tribunal found AO failed to conduct proper investigation and relied solely on unverified third-party statements. CIT(A) properly examined assessee's submissions, financial transactions, and creditworthiness of investee company. The tribunal noted revenue had accepted similar LTCG on same scrip in assessee's father's case, preventing inconsistent treatment. Appeal decided against revenue.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

a) Whether the addition of Rs. 4,33,71,468/- made by the Assessing Officer (AO) as unexplained cash credit under Section 68 of the Income Tax Act, 1961, on account of alleged bogus Long Term Capital Gains (LTCG) claimed by the assessee on sale of shares, was justified.

b) Whether the AO was justified in treating the shares of M/s Wagend Infra Ventures Ltd. as penny stock and making adverse inferences based on abnormal rise in share price, despite lack of evidence that the company was involved in price manipulation or bogus transactions.

c) Whether the AO's reliance on third-party statements recorded under Section 132(4) without providing the assessee an opportunity of cross-examination violated principles of natural justice.

d) Whether the CIT(A) erred in deleting the addition made by the AO, particularly in light of the Supreme Court's ruling in Sumati Dayal vs. CIT regarding testing genuineness on the basis of preponderance of human probabilities.

e) Whether the assessment proceedings under Section 143(3) read with Section 153A were valid and in accordance with law.

2. ISSUE-WISE DETAILED ANALYSIS

a) Legitimacy of Addition under Section 68 on Account of Alleged Bogus LTCG

Legal Framework and Precedents: Section 68 of the Income Tax Act deals with unexplained cash credits, placing the onus on the assessee to prove the identity, genuineness, and creditworthiness of the source of such credits. The Supreme Court in Sumati Dayal vs. CIT (1995) held that genuineness can be tested on the principle of preponderance of human probabilities but cautioned against additions based solely on suspicion or conjecture. Numerous judicial pronouncements emphasize that additions cannot be made on mere surmises without concrete evidence.

Court's Interpretation and Reasoning: The AO made the addition on the basis that the LTCG claimed by the assessee was not genuine, relying on statements recorded under Section 132(4) and the alleged modus operandi of bogus LTCG transactions involving penny stocks. The AO also noted an abnormal rise in share price as suspicious.

The CIT(A) and subsequently the Tribunal examined the evidence submitted by the assessee, including share application forms, bank statements evidencing payment through account payee cheques, demat account statements, broker ledger accounts showing payment of Security Transaction Tax (STT), and sale proceeds credited through banking channels. The Tribunal noted that the assessee had held the shares for more than 12 months, qualifying for LTCG exemption under Section 10(38).

Importantly, the Tribunal observed that no incriminating material or evidence was found during the search or investigation to link the assessee to any bogus transaction or price manipulation. The AO had not conducted any independent inquiry or inspection to verify the allegations beyond relying on third-party statements and investigation reports. The Tribunal relied on judicial precedents which held that additions cannot be sustained on suspicion, conjectures, or generalizations without direct evidence.

Key Evidence and Findings: The assessee's documentary evidence demonstrated the genuineness of transactions: share allotment through preferential issue, payment through banking channels, dematerialization of shares, sale through recognized stock exchanges, payment of STT, and receipt of sale proceeds in bank accounts. The company's shares were not listed in any official list of penny stocks or under investigation by SEBI. The AO's assumption of a 150-fold price increase was corrected to a maximum price of Rs. 263 (pre-split), and the average sale price post-split was Rs. 54.91 per share.

Application of Law to Facts: The Tribunal applied the principle that the burden lies on the revenue to prove the transaction as bogus with cogent evidence, which was not discharged. The assessee had complied with the onus under Section 68 by furnishing complete and credible evidence. The absence of incriminating material and the failure to allow cross-examination of witnesses whose statements were relied upon were critical factors leading to the deletion of the addition.

Treatment of Competing Arguments: The revenue's reliance on third-party statements and investigation reports without confronting the assessee or allowing cross-examination was rejected as a violation of natural justice. The Tribunal also distinguished the present case from other penny stock scams by highlighting the lack of evidence linking the assessee to any collusive or manipulative activity.

Conclusions: The addition under Section 68 was not sustainable. The LTCG claimed was held to be genuine and exempt under Section 10(38). The Tribunal upheld the deletion of the addition.

b) Validity of Assessment Proceedings under Section 143(3) read with Section 153A

Legal Framework and Precedents: Section 153A mandates reassessment of income for six assessment years preceding the year of search if undisclosed income is found. The assessment must be based on incriminating material found during the search or related material. The Delhi High Court in CIT vs. Kabul Chawla (2016) held that additions cannot be made arbitrarily without nexus to seized material.

Court's Interpretation and Reasoning: The Tribunal noted that the CIT(A) had upheld the validity of the assessment proceedings, finding no procedural irregularity or violation of law. The AO's additions were to be based on evidence found during search or other material. Since no incriminating material was found against the assessee, the additions could not be sustained.

Key Evidence and Findings: No incriminating material was found during the search at the assessee's premises. The AO's reliance on third-party statements without independent inquiry was insufficient.

Application of Law to Facts: The Tribunal held that the AO's assessment under Section 153A was valid procedurally but the substantive additions lacked evidentiary basis.

Conclusions: The assessment proceedings were valid, but the additions based on these proceedings were not upheld.

c) Violation of Principles of Natural Justice Due to Non-Opportunity for Cross-Examination

Legal Framework and Precedents: The principles of natural justice require that an assessee be given a fair opportunity to contest adverse material relied upon by the revenue. The Supreme Court and various High Courts have held that denial of cross-examination of witnesses whose statements form the basis of adverse findings is a serious violation rendering the order null and void (e.g., Andaman Timber Industries vs. CIT, H.R. Mehta vs. ACIT).

Court's Interpretation and Reasoning: The AO relied heavily on statements of third parties recorded under Section 132(4) without furnishing copies to the assessee or permitting cross-examination. The Tribunal held this to be a violation of natural justice, undermining the validity of the additions.

Key Evidence and Findings: The assessee requested copies of statements and opportunity for cross-examination, which were denied. The statements did not specifically mention the assessee's involvement.

Application of Law to Facts: The Tribunal applied binding judicial precedents holding that such denial vitiates the assessment order.

Conclusions: The AO's reliance on untested third-party statements without affording the assessee an opportunity to rebut was impermissible, contributing to the deletion of the addition.

d) Treatment of Penny Stock Allegations and Abnormal Rise in Share Price

Legal Framework and Precedents: The term "penny stock" is not statutorily defined. Allegations of price manipulation or bogus transactions require specific evidence and cannot rest on suspicion. Courts have held that mere rise in share price, even if abnormal, is not sufficient to disallow LTCG claims without evidence of collusion or manipulation.

Court's Interpretation and Reasoning: The AO alleged that the shares of Wagend Infra Ventures Ltd. were penny stocks with abnormal price rise inconsistent with the company's financials. However, the Tribunal found that the company was not listed in any official investigation or suspension lists by SEBI or stock exchanges and that the price rise was not as exaggerated as claimed.

Key Evidence and Findings: The company's shares were suspended temporarily as a surveillance measure but trading resumed without adverse findings. No evidence was brought on record to show price rigging or manipulation involving the assessee.

Application of Law to Facts: The Tribunal distinguished the present case from known penny stock scams, noting the absence of evidence of collusion or cash transactions. The rise in price alone was insufficient to impugn the genuineness of LTCG.

Conclusions: The allegation of penny stock transactions was speculative and unsupported by evidence. The LTCG claim was held to be genuine.

e) Reliance on Judicial Precedents and Consistency in Treatment of Similar Cases

The Tribunal extensively relied on a plethora of judicial decisions from various High Courts and ITAT benches which consistently held that additions under Section 68 on account of alleged bogus LTCG cannot be sustained without cogent evidence. Reliance was placed on cases where:

• Transactions were supported by documentary evidence including share application forms, demat statements, broker contract notes, and bank statements.
• No incriminating material was found during search or investigation linking the assessee to bogus transactions.
• Revenue failed to provide opportunity for cross-examination of witnesses whose statements were relied upon.
• Alleged penny stock companies were not officially identified or investigated by SEBI or stock exchanges.
• Similar claims in related cases (including the assessee's father) were accepted by the revenue.

These precedents reinforced the principle that suspicion, surmises, and generalizations cannot substitute for evidence and that the burden of proof lies on the revenue to establish the bogus nature of transactions.

3. SIGNIFICANT HOLDINGS

"The addition made by the AO cannot be upheld. The assessee has discharged the burden by submitting the details, evidences on the disputed issue before the AO in lieu of the notice issued u/s 142(1) of the Act, whereas the AO based on the conjunctions and surmises has treated the LTCG as unexplained cash credit u/s 68 of the Act."

"No addition shall be made to the income of any assessee only on the basis of surmises and conjectures because the same is against the provisions of law as well as against the principles of natural justice."

"Not providing an opportunity of cross examination when reliance is placed on certain statement, violates the principle of natural justice as is being held by the Hon'ble Apex Court in the case of Andaman Timber Industries Ltd. Vs, CIT (2015) 127 DTR 0241(SC) and H R Mehta vs ACIT 289 CTR 0561(Bom)."

"The AO has not brought anything contrary on record to prove the assessee wrong. Even though the AO stated that Rajkumar Kedia mentioned the assessee as an entry operator, there is no such reference to the assessee in his statement. Even in the search, no contrary evidences could be detected."

"The transactions of purchase and sale of the shares of the alleged penny stock... were done through stock exchange and through the registered Stock Brokers. The payments have been made through banking channels and even Security Transaction Tax ('STT') has also been paid."

"The Assessing Officer was duty bound to make inquiry from all concerned parties relating to the transaction and then to collect evidences that the transaction entered into by the assessee was also a collusive transaction. We, however, find that the Assessing Officer has not brought on record any evidence to prove that the transactions entered by the assessee which are otherwise supported by proper third party documents are collusive transactions."

"In the absence of any finding specifically against the assessee in the investigation wing report, the assessee cannot be held to be guilty or linked to the wrong acts of the persons investigated."

"The AO's assessment order is flawed by lack of enquiry by the AO... the AO should have done a further analysis and enquired into the genuineness of the alleged transaction."

"The assessee was bound to be provided with the material used against him apart from being permitted to cross examine the deponents. This not having been done, the denial of such opportunity goes to root of the matter and strikes at the very foundation of the reassessment and therefore renders the orders passed by the CIT(A) and the Tribunal vulnerable."

"The Tribunal found that the chain of transaction entered into by the assessee have been proved, accounted for, documented and supported by evidence."

"The addition made by the AO is merely based on suspicion and surmises without any cogent material to controvert the evidence filed by the assessee in support of the claim."

"The assessing officer having failed to bring on record any material to prove that the transaction of the assessee was a collusive transaction could not have rejected the evidences submitted by the assessee."

"The transactions of sale and purchase were as per the valuation prevalent in the Stocks Exchange. Such finding of fact has been recorded on the basis of evidence produced on record."

"The AO has not conducted any investigation or enquiry in respect of the information submitted by the assessee and relied on the information of the third party whose statement was not cross examined."

"The CIT(A) has passed a reasoned and conclusive order. Accordingly we do not find any infirmity in the order of the CIT(A) on this disputed issue and uphold the same and dismiss the grounds of appeal of the revenue."

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