Trading losses in penny shares allowed as AO failed to prove transactions were bogus or manipulative

ITAT Kolkata allowed the assessee's appeal against disallowance of trading losses in penny shares. The AO had treated the transactions as bogus, arguing they lacked commercial prudence being conducted at year-end. However, ITAT found the AO failed to prove the transactions were bogus and noted selective interpretation - accepting gains as genuine while rejecting losses. The tribunal observed that millions of shares were traded in the market with assessee trading only thousands, negating market manipulation allegations. Following precedent in Namokar Builders case, ITAT deleted the addition and granted consequential relief.

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Issues Involved:
1. Disallowance of trading loss on shares.
2. Allegation of sham transactions.
3. Lack of independent inquiry by the Assessing Officer (AO).
4. Reliance on statements not provided to the assessee.
5. Denial of cross-examination of adverse statements.
6. Reliance on third-party reports without independent verification.

Detailed Analysis:

1. Disallowance of Trading Loss on Shares:
The assessee filed a return of income for AY 2014-15 declaring a total loss of Rs. 16,38,240/-. The AO disallowed the entire trading loss of Rs. 1,13,70,981/-, assessing the total income at Rs. 97,32,741/-. The AO doubted the genuineness of the transactions, suspecting them to be artificially designed to offset gains from Eros International Media Ltd. The AO highlighted the poor financials of the companies where losses were incurred and alleged pre-meditation in trading patterns.

2. Allegation of Sham Transactions:
The AO considered the transactions in shares of GBL Infra Ltd., Shree Shaleen Textile Ltd., and Unno Industries Ltd. as sham, based on the poor financial condition of these companies and the suspicious timing of transactions. The CIT(A) upheld the AO's decision, agreeing that the transactions were outside the realm of prudent investment behavior.

3. Lack of Independent Inquiry by the AO:
The assessee argued that no independent inquiry was conducted by the AO to prove his suspicion. The AO relied on an adverse report from the Investigation Wing without making it available to the assessee. The assessee contended that dealing in penny stocks is common and based on market understanding, and the transactions were conducted through recognized brokers and banking channels.

4. Reliance on Statements Not Provided to the Assessee:
The assessee claimed that the AO relied on statements and materials not provided to them, making such reliance inadmissible. The assessee emphasized that their accounts were duly audited, and no fault was found by the AO.

5. Denial of Cross-Examination of Adverse Statements:
The assessee argued that they were not provided an opportunity to cross-examine the witnesses whose statements were used against them. The lack of cross-examination violated the principles of natural justice, making the statements inadmissible for assessment purposes.

6. Reliance on Third-Party Reports Without Independent Verification:
The AO based his findings on a third-party report from the Investigation Wing, without conducting any independent verification. The assessee contended that mere suspicion could not substitute for hard facts, and the transactions were genuine, conducted through recognized stock exchanges and de-mat accounts.

Conclusion:
The Tribunal considered the rival submissions and relevant judicial decisions. It was noted that the AO selectively viewed the transactions, accepting gains but doubting losses without substantial evidence. The Tribunal emphasized the need for independent inquiry and adherence to principles of natural justice. The Tribunal followed the precedent set in similar cases, concluding that the disallowance of trading loss was not justified. The appeal filed by the assessee was allowed, and the impugned addition was deleted, providing consequential relief to the assessee.

Order:
The appeal filed by the assessee is allowed. Order pronounced in the open Court on 23rd July, 2024.

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