Listed share sale LTCG and 10(38) exemption dispute: "bogus" claim rejected for no incriminating material, 142(3) breach

Whether LTCG from sale of listed shares was rightly treated as bogus and exemption u/s 10(38) denied turned on the absence of incriminating material and lack of statutory compliance. The ITAT held that shares, though acquired off-market, were dematerialized and credited to the DMAT promptly and there was no material showing suspension or listing non-compliance of the scrip. The AO failed to comply with mandatory s. 142(3) by not confronting material relied upon, did not specify the charging provision, and invoked s. 115BBE without establishing ingredients of ss. 68/69 etc., including enquiries on identity/creditworthiness/genuineness, which are impracticable in exchange-traded sales with routed banking receipts; the LTCG addition was deleted. Consequentially, the CIT(A)'s enhancement of presumptive commission u/s 69C was also deleted, and the appeal was allowed.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether the long term capital gain arising from sale of listed equity shares of a company (Capital Trade Links Ltd.) was genuine and eligible for exemption under section 10(38) of the Act, or constituted a bogus accommodation entry liable to be taxed as undisclosed income/"income from other sources" with rate under section 115BBE.

1.2 Whether the assessment and appellate orders denying exemption on such long term capital gain, based primarily on Investigation Wing/SEBI material and "penny stock" allegations, were sustainable in law in the absence of independent inquiry, confrontation of adverse material and opportunity of cross-examination.

1.3 Whether the enhancement by the first appellate authority by adding an estimated commission/brokerage @ 3% of the alleged bogus long term capital gain as unexplained expenditure under section 69C was legally and factually sustainable.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1 and 2: Characterisation of long term capital gain on shares of Capital Trade Links Ltd. and denial of exemption under section 10(38)

Legal framework (as discussed by the Tribunal)

2.1 The Tribunal proceeded on the basis of the conditions for exemption of long term capital gain on listed equity shares under section 10(38): (i) transfer of equity shares on or after 01.10.2004; and (ii) such transfer being chargeable to securities transaction tax (STT). It was noted that these conditions were satisfied and not disputed by the Assessing Officer.

2.2 The Tribunal examined the manner in which the Assessing Officer purported to treat the long term capital gain as bogus income taxable at 60% under section 115BBE, which applies only to incomes covered by sections 68, 69, 69A to 69D. It also examined the mandatory requirement under section 142(3) to grant an opportunity of being heard in respect of material proposed to be used in the assessment.

Interpretation and reasoning

2.3 The Tribunal found that the assessee had furnished extensive primary evidence in support of the purchase and sale of shares of Capital Trade Links Ltd. (CTL), including: purchase documents for 5,00,000 shares acquired off-market for consideration paid through banking channels; demat statement showing credit of 5,00,000 CTL shares in June 2014; contract notes for on-market sales through a SEBI-registered broker on BSE; financial ledger with the broker; and bank statements evidencing receipt of sale proceeds through banking channels after payment of STT and other charges.

2.4 The first appellate authority itself recorded that: the shares were purchased from a named company by banking channels; held for more than 12 months; dematerialized; sold on a recognised stock exchange; STT was duly paid; contract notes were submitted; and sale consideration was received through banking channels. The Tribunal treated these as uncontroverted factual findings.

2.5 The Assessing Officer characterised CTL as a "penny stock" and the gain as a bogus accommodation entry solely on general Investigation Wing/SEBI material and generic modus operandi of penny stock scams, concluding that the price was "rigged and manipulated" and that the assessee had converted unaccounted money into exempt long term capital gains.

2.6 The Tribunal noted that neither the Investigation Wing report nor any SEBI order specifically concerning CTL or the assessee's transactions was brought on record or supplied to the assessee. No independent inquiry was conducted by the Assessing Officer from SEBI, BSE, the assessee's broker, the counter-parties, or CTL itself to discredit the documentary evidence produced by the assessee.

2.7 The Tribunal analysed the note of the Directorate of Income Tax (Investigation) relied upon by the Department, including the table where CTL appeared with status "ASM Stage I" and group "X". It held that this did not indicate that the scrip was suspended, delisted, or in default of listing requirements, and therefore did not support the allegation that the scrip itself was tainted or non-genuine.

2.8 The Tribunal examined CTL's financials as placed on record, noting incremental revenue from operations running into several crores and incremental profits before tax since 2013, and held that the bare assertion that the fundamentals did not support the price remained unsubstantiated on facts.

2.9 As to the allegation of abnormal price rise, the Tribunal accepted the assessee's demonstration that: CTL was listed at around Rs. 98 in June 2014; reached a high of about Rs. 132 over more than two years; and the assessee's sale prices between Rs. 69 and Rs. 95 were not at peak levels. It treated the movement as "range bound" rather than an unexplained spike.

2.10 The Tribunal considered the assessee's status as a habitual investor with an existing portfolio and capital gains in earlier and later years, and distinguished cases where assessees had only single, isolated penny stock transactions. It treated continuous investment activity as a relevant corroborative factor.

2.11 The Tribunal expressly noted that: trading in CTL shares was neither suspended nor the scrip delisted by SEBI; off-market purchase of listed shares is not per se illegal; and the shares were promptly dematerialized and credited to the assessee's demat account soon after purchase, not parked in any pool account pending sale.

2.12 On the use of Investigation Wing/SEBI material, the Tribunal observed that the Assessing Officer had relied on generalized material and modus operandi and on statements of unidentified entry operators without any nexus shown to the assessee's transactions. No statements or adverse material were confronted to the assessee; no opportunity of cross-examination was afforded; and no specific entry operator or counter-party dealing with the assessee was identified. The Tribunal held that such use of un-confronted and generic material violated the principles of natural justice as well as the mandate of section 142(3).

2.13 The Tribunal highlighted that the assessment order did not clearly disclose under which charging provision the addition was made. The show cause notice referred to treating the LTCG as "undisclosed income/accommodation entry", and the final order described it as "income from other sources" taxable at 60% under section 115BBE.

2.14 The Tribunal reasoned that if the addition was under sections 68/69 etc. (so as to attract section 115BBE), the Assessing Officer was required to examine identity and creditworthiness of the share buyers and genuineness of the transaction. However, in an exchange-traded, demat-settled transaction on a regulated stock exchange, the seller does not have control over nor ready access to the identities or creditworthiness of ultimate buyers. No notices under sections 133(6) or 131 were issued to the broker, stock exchange, depository, or any counter-party. Thus, the jurisdictional factual foundation for invoking sections 68/69 etc. was missing.

2.15 Conversely, if the action was a mere denial of exemption under section 10(38), the Tribunal held that the Assessing Officer's reference to section 115BBE was wholly misplaced; and more importantly, there was no finding that the statutory conditions of section 10(38) (online sale through recognised stock exchange with STT) were not fulfilled. On the contrary, the Assessing Officer had computed the gain by deducting the cost of acquisition from the sale consideration, thereby accepting the purchase as genuine and computing capital gains under sections 45 and 48, but then re-characterised the net gain as "income from other sources". The Tribunal held this to be internally inconsistent and legally untenable.

2.16 The Tribunal also noted that section 142(3) uses the word "shall", making it mandatory (except in best judgment assessments under section 144) to provide an opportunity of being heard on any material gathered and proposed to be used in assessment. In this case, that statutory requirement was not satisfied regarding the Investigation Wing/SEBI materials allegedly relied upon.

2.17 Overall, the Tribunal concluded that the Revenue had not discharged its burden to show that the assessee was a beneficiary of any accommodation entry operation, nor had it brought on record any cogent material linking the assessee's specific transactions in CTL to any bogus scheme. Suspicion arising from generic penny stock reports, price movements or human probabilities could not override documentary evidence and the regulated nature of the transactions.

Conclusions

2.18 The long term capital gain realised by the assessee from the sale of CTL shares, purchased off-market and subsequently dematerialized and sold through a recognised stock exchange after payment of STT, was held to be genuine.

2.19 The conditions of section 10(38) were found to be satisfied; the denial of exemption and re-characterisation of such gain as "undisclosed income" or "income from other sources" taxable under section 115BBE were held to be unsustainable in law and on facts.

2.20 The addition of Rs. 3,03,05,713/- towards alleged bogus long term capital gain was deleted. The same reasoning and conclusion were applied mutatis mutandis to the subsequent assessment year.

Issue 3: Addition of estimated commission/brokerage under section 69C on alleged accommodation entry and power of enhancement

Legal framework (as applied in the judgment)

2.21 The first appellate authority had enhanced the assessed income by estimating "presumptive commission" at 3% of the alleged bogus LTCG and treated it as unexplained expenditure under section 69C, on the premise that accommodation entries necessarily entail payment of commission to entry operators.

Interpretation and reasoning

2.22 The Tribunal noted that this enhancement was entirely derivative of, and consequential upon, the finding that the long term capital gain was bogus and represented an accommodation entry.

2.23 Since the Tribunal held the long term capital gain on CTL shares to be genuine and not a bogus entry, the factual foundation for any commission expenditure on alleged accommodation entries automatically disappeared.

2.24 The Tribunal further noted that there was no material on record to show to whom, when, or how any commission was paid, or even to identify any entry operator dealing with the assessee. The addition was made purely on surmises and general presumptions that accommodation entries require commission, without any evidence of actual expenditure.

Conclusions

2.25 The addition towards estimated brokerage/commission @ 3% of long term capital gain as unexplained expenditure under section 69C, made by way of enhancement by the first appellate authority, was held to be unsustainable as it was merely consequential to the (now deleted) finding of bogus LTCG and unsupported by any independent evidence.

2.26 The enhancement and the corresponding addition of commission/brokerage were deleted. The same conclusion was applied for the subsequent assessment year, where the issue was identical except for variation in quantum.

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