2025 (6) TMI 575 - HC - Income Tax

Reassessment notice quashed for penny stock losses without specific evidence linking taxpayer to fraudulent scheme

Sanjay Kaul Versus The Income Tax Officer Ward 24 (4), New Delhi & Ors.

Delhi HC quashed reassessment notice issued to taxpayer for AY 2014-15 based on alleged bogus capital loss transactions in penny stocks. Court held that ... Reopening of assessment - reasons to believe or suspect - Bogus capital gain - penny stock transaction - information received from the Investigation Wing, which reported that the shares of IISL was a penny stock and it was being rigged to provide bogus accommodation entry to the beneficiaries. HELD THAT:- As clear from the information received from the Investigation Wing and Mr. Anil Kedia, that the same was general in nature and did not point towards the involvement of the Petitioner in the arrangement of providing accommodation entry by contriving bogus short term capital loss. From the aforementioned information, it cannot be concluded that all the transactions with respect to the shares of IISL and SRK were sham in nature. Further, there is nothing to show that the information produced above was applicable to the Petitioner. In the reasons provided for issuance of the impugned notice, the AO stated that the Petitioner had purchased the shares of SRK on 21.08.2013 at the average price of Rs. 167.63 per share and sold off at the average price of Rs. 35.05 per share on 24.03.2014, whereas the shares of IISL were purchased on 21.08.2013 at the average price of Rs. 41.10 per share and sold off at the average price of Rs. 8.26 per share on 06.03.2014. The AO concluded that through investments in the said shares, the Petitioner created bogus short term capital loss in order to evade tax liability. Mere purchasing and selling of the shares by the Petitioner would not in itself lead to the conclusion that the transactions were fraudulently contrived to secure accommodation entries for evading tax liability. The conclusion arrived at by the AO is based on the suspicion created by the information that the shares of IISL and SRK are penny stocks. The said information cannot be sufficient reason for the AO to believe that the Petitioner’s income for AY 2014-15 had escaped assessment as it lacked specific material regarding Petitioner’s income escaping the assessment. The impugned notice was issued based on general information derived from the report of the Investigation Wing and the statement of Mr. Anil Kedia, but no specific information regarding the Petitioner’s involvement in the alleged arrangement for evading tax liability for AY 2014-15. Further, the materials based on which the said report was prepared have also not been placed on record by the Revenue. As held in CNB FINWIZ LTD. [2025 (5) TMI 1595 - DELHI HIGH COURT] relying upon the decision of Lakhmani Mewal Das[1976 (3) TMI 1 - SUPREME COURT] the “reason to believe” cannot be conflated with “reason to suspect” in arriving at the conclusion that the Petitioner’s income has escaped assessment for AY 2014-15. As the concluded assessments cannot be reopened merely based on suspicion, we find that there is no tangible material to form the “reason to believe” that the Petitioner’s income has escaped assessment in the present case. Assessee appeal allowed. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Court are:Whether the Assessing Officer (AO) had a valid 'reason to believe' under Section 147 of the Income Tax Act, 1961, to reopen the assessment for the Assessment Year (AY) 2014-15.Whether the impugned notice issued under Section 148 of the Act was based on tangible material with a direct nexus to the Petitioner's alleged escapement of income, or merely on conjecture, suspicion, or general information.Whether the AO's reliance on the Investigation Wing's report and the statement of a third party (Mr. Anil Kedia) constituted sufficient grounds to form a reason to believe that the Petitioner's income had escaped assessment.Whether the reassessment proceedings initiated by the AO complied with the legal standards and judicial precedents governing reopening of assessments.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Validity of 'Reason to Believe' under Section 147 for Reopening AssessmentRelevant legal framework and precedents: The Court extensively relied on the Supreme Court's decision in ITO & Ors. v. Lakhmani Mewal Das, which clarified the scope of 'reason to believe' under Section 147. The Court highlighted that the AO must have tangible material with a rational connection to the belief that income has escaped assessment due to failure to disclose material facts. The Court emphasized that 'reason to believe' is not mere suspicion or conjecture and that reopening cannot be based on vague, indefinite, or farfetched information. The Court also referred to a recent decision of this Court in CNB FINWIZ LTD. v. DCIT, which reaffirmed the requirement of tangible material and a live nexus between the material and the belief of escapement of income.Court's interpretation and reasoning: The Court held that the AO's power to reopen assessment is wide but not plenary, and must be exercised in good faith based on relevant and specific material. The Court underscored that once an assessment is concluded, it cannot be reopened merely on suspicion or general information. The Court analyzed the AO's reasons and found them to be based on general reports and statements that lacked specific application to the Petitioner.Key evidence and findings: The AO's reasons relied on a letter from the Assistant Director of Income Tax (Investigation) and an Investigation Report from the Principal Director of Income Tax (Investigation), Kolkata. These reports flagged certain penny stock companies (IISL and SRK) as involved in rigged trading schemes to provide bogus accommodation entries. The AO also relied on the statement of Mr. Anil Kedia, Director of a brokerage firm, admitting to manipulative trading practices facilitating bogus accommodation entries. The Petitioner traded in the shares of these companies and recorded short-term capital losses.Application of law to facts: The Court observed that the information from the Investigation Wing and Mr. Kedia's statement was general in nature and did not specifically implicate the Petitioner. There was no direct evidence or material linking the Petitioner to the alleged rigging or accommodation entry schemes. The Court noted that the AO's conclusion that the Petitioner's transactions were contrived to evade tax was based on suspicion arising from the nature of the stocks (penny stocks) and the general investigation report, rather than on any specific material against the Petitioner.Treatment of competing arguments: The Petitioner argued that the reopening was based solely on conjecture and that the AO failed to conduct any independent inquiry or produce tangible material linking the Petitioner to the alleged wrongdoing. The Petitioner also emphasized that all transactions were carried out through registered brokers with proper banking channels and that there was no evidence of collusion with the implicated brokerage firm. The Revenue contended that the investigation reports and statements constituted tangible material sufficient to form a reason to believe, and that the AO was not required to have proof beyond reasonable doubt at the notice stage.The Court weighed these arguments and found the Petitioner's contentions persuasive, especially given the absence of any direct material connecting the Petitioner to the alleged rigging or bogus accommodation entries. The Court held that the AO's reliance on general reports without specific application to the Petitioner was insufficient.Conclusions: The Court concluded that the AO did not have a valid reason to believe that the Petitioner's income had escaped assessment. The reopening was therefore not justified under Section 147, as the material relied upon lacked a live nexus with the Petitioner's income and was insufficient to form a bona fide belief.Issue 2: Sufficiency and Nature of Material to Reopen AssessmentRelevant legal framework and precedents: The Court reiterated the principle that reopening must be based on 'tangible material' and not on mere suspicion or general information. The Court cited the Lakhmani Mewal Das judgment which emphasized that the reasons for forming belief must have a rational connection to the escapement of income and cannot be vague or extraneous.Court's interpretation and reasoning: The Court scrutinized the Investigation Wing's reports and the statement of Mr. Kedia. While these materials indicated that the scrips of IISL and SRK were used in manipulative trading schemes, the Court found that these materials were general and did not specifically implicate the Petitioner. The Court noted that the Petitioner's transactions were conducted through a different broker and that there was no evidence that the Petitioner was a beneficiary of the accommodation entries described in the reports.Key evidence and findings: The AO's reliance on the statement of Mr. Kedia, who admitted his firm's involvement in manipulative trading, was considered. However, the Court noted that the Petitioner had no dealings with Mr. Kedia's firm and that the statement did not mention the Petitioner. The Court also noted that the Petitioner's trades were properly documented and conducted through registered brokers with payments made through banking channels.Application of law to facts: The Court applied the legal standard that reopening cannot be based on suspicion or general reports without specific material linking the assessee to the alleged escapement. The Court found that the AO's material lacked specificity and did not establish a direct nexus with the Petitioner's income or transactions.Treatment of competing arguments: The Revenue argued that the Investigation Wing's report and the statement of a party involved in manipulative trading constituted tangible material. The Petitioner countered that such general material cannot be the basis for reopening without specific evidence against him. The Court sided with the Petitioner, emphasizing the need for a 'live link' between the material and the belief of escapement.Conclusions: The Court held that the material relied upon by the AO was insufficient to constitute tangible material with a live nexus to the Petitioner's income. The reopening notice was therefore invalid.Issue 3: Compliance with Procedural and Legal Requirements for ReopeningRelevant legal framework and precedents: The Court considered the procedural requirements under the Income Tax Act, including the need for the AO to record reasons for reopening and to provide the assessee with those reasons. The Court also considered the requirement that the AO's belief must be held in good faith and not be a mere pretence.Court's interpretation and reasoning: The Court noted that the AO issued the impugned notice under Section 148 and provided reasons for reopening. However, the Court found that the reasons were based on general information and did not demonstrate an independent enquiry or investigation specifically targeting the Petitioner. The Court also noted that the Petitioner's objections were dismissed without adequate consideration.Key evidence and findings: The Court observed that the AO relied primarily on the Investigation Wing's report and the statement of Mr. Kedia, without conducting any independent verification or inquiry into the Petitioner's transactions. The Petitioner's detailed objections and explanations were not sufficiently addressed.Application of law to facts: The Court held that procedural compliance alone does not validate the reopening if the substantive requirement of 'reason to believe' is absent. The AO's failure to independently verify or produce specific material linking the Petitioner to the alleged escapement undermined the validity of the reopening.Treatment of competing arguments: The Revenue contended that the Investigation Wing's report sufficed as tangible material and that the AO was not required to conduct an independent inquiry at the notice stage. The Petitioner argued that the AO's reliance on third-party reports without specific evidence or inquiry was insufficient and violated principles of fairness and natural justice.Conclusions: The Court concluded that the AO's action did not meet the substantive and procedural standards required for reopening, rendering the impugned notice invalid.3. SIGNIFICANT HOLDINGS'The grounds or reasons which lead to the formation of the belief contemplated by Section 147 (a) of the Act must have a material bearing on the question of escapement of income of the assessee from assessment because of his failure or omission to disclose fully and truly all material facts. Once there exist reasonable grounds for the Income Tax Officer to form the above belief, that would be sufficient to clothe him with jurisdiction to issue notice. Whether the grounds are adequate or not is not a matter for the court to investigate.''The expression 'reason to believe' does not mean a purely subjective satisfaction on the part of the Income Tax Officer. The reason must be held in good faith. It cannot be merely a pretence. It is open to the court to examine whether the reasons for the formation of the belief have a rational connection with or a relevant bearing on the formation of the belief and are not extraneous or irrelevant for the purpose of the section.''The powers of the Income Tax Officer to reopen assessment though wide are not plenary. The words of the statute are 'reason to believe' and not 'reason to suspect'. The reopening of the assessment after the lapse of many years is a serious matter.''Reopening cannot be based on vague, indefinite, farfetched or remote information. The live link or close nexus which should be there between the material before the Income Tax Officer and the belief regarding escapement of income must be present.''Concluded and closed assessments cannot be reopened merely on suspicion.'Final determinations:The AO did not have a valid reason to believe that the Petitioner's income for AY 2014-15 had escaped assessment.The impugned notice under Section 148 was issued without tangible material specifically linking the Petitioner to the alleged tax evasion scheme.The reopening of assessment was therefore invalid and set aside.