2025 (8) TMI 679 - AT - Income Tax

ITAT upholds Section 68 addition, denies Section 10(38) exemption for bogus LTCG on penny stocks with inflated prices

The ITAT Mumbai upheld the addition under section 68, denying exemption under section 10(38) for alleged bogus long-term capital gains (LTCG). The ... Additions made u/s 68 - bogus LTCG - exemption u/s 10(38) denied - HELD THAT:- As analysed the financial health and the trading history of the prescription companies. Even AO had verified the trade data and proceeded to call out the modus operandi adopted by the assessee, which is akin to the modus operandi of bogus LTCG shares. It is an undisputed fact that the shares were purchased by the assessee in cash and in physical form and the part shares were sold when the price trend was increasing and had not sold when the downward trend started. The price movement of share market behavior of the entities involved in the trade of the script as the share price movement and the profit earned by the beneficiaries were beyond human probabilities, which has already been discussed in detail in the order of assessment And thus it is a clear case of huge capital gain earned by the assessee within a very short period of time by investing in a penny stock whose fundamentals had no support for the premium. It commanded was neither the result of a coincidence nor of a genuine investment activity, but was created through well-planned and executed scheme in which company, brokers and the buyers and sellers of the script worked in tandem to achieve the predetermined objectives Therefore, keeping in view the facts and circumstances of the case in hand, and also while relying upon the decision of the coordinate benches in the case of Manvi Khandelwal and Arihant Kumar Jain [2021 (10) TMI 1251 - ITAT DELHI] wherein same prescription with regard to the same assessment year, which is subject matter of the present appeal has been dealt with. Even Hon’ble High Court has also upheld the order of the Tribunal. Hence keeping in view the judicial decisions as mentioned above and in the absence of any satisfactory explanation offered by the assessee on the vital points raised by the AO, it is not possible to brush aside the well recent orders of the authorities below. Thus, both the authorities below have the cogent reasons for reaching to the conclusion and find it difficult to interfere with the same. With this view of the matter dismiss the grounds raised by the assessee. 1. ISSUES PRESENTED and CONSIDERED 1. Whether the addition of long-term capital gains (LTCG) claimed as exempt under section 10(38) of the Income Tax Act, 1961, arising from sale of shares, can be treated as unexplained cash credit under section 68 of the Act due to alleged non-genuineness of transactions.2. Whether the assessee has satisfactorily explained the nature and source of credited amounts on account of LTCG from sale of shares.3. Whether the transactions involving purchase and sale of shares in certain penny stock companies are genuine or a colourable device to convert unaccounted money into tax-exempt income.4. Whether the Assessing Officer (AO) was justified in relying on investigation reports and statements of alleged entry providers without allowing cross-examination to the assessee.5. Whether documentary evidence such as bank statements, demat account statements, contract notes, and broker affidavits suffice to discharge the onus cast on the assessee under section 68.6. The applicability and effect of judicial precedents concerning genuineness of share transactions, burden of proof, and principles of natural justice in the context of LTCG exemption claims. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 & 2: Applicability of Section 68 to LTCG Claimed as Exempt under Section 10(38) and Explanation by AssesseeRelevant Legal Framework and Precedents:- Section 68 of the Income Tax Act deals with unexplained cash credits, allowing the AO to add amounts credited in the books of the assessee if the explanation regarding nature and source is unsatisfactory.- Section 10(38) exempts LTCG arising from transfer of long-term capital assets being equity shares on which Securities Transaction Tax (STT) has been paid.- Judicial precedents hold that the burden lies on the assessee to prove genuineness of credited amounts; however, once the assessee discharges initial onus by furnishing credible documentary evidence, the AO must produce cogent material to rebut the same.Court's Interpretation and Reasoning:- The assessee produced comprehensive documentary evidence including bank passbook, demat account statements, contract notes, affidavits from brokers, and share transfer documents to substantiate genuineness of transactions.- The AO did not dispute the nature of assets, cost of acquisition, holding period, or sale through recognized stock exchanges; the primary contention was based on suspicion arising from anomalous price movements and investigation reports.- The Tribunal emphasized that mere suspicion or price volatility is insufficient to treat LTCG as unexplained cash credit under section 68 without substantive proof.- It was noted that the assessee did not maintain books of account, and the credited amounts were directly reflected in the bank account, which cannot be treated as unexplained cash credit per se.Key Evidence and Findings:- Documentary evidence showed shares were purchased in physical form in earlier years, dematerialized, and sold through registered brokers on recognized stock exchanges with STT paid.- Sworn affidavits from brokers corroborated genuineness of transactions.- Subsequent SEBI orders absolved the companies involved from price rigging allegations during the relevant periods.- No direct evidence linked the assessee to manipulation or collusion in price rigging or bogus transactions.Application of Law to Facts:- The Tribunal applied the principle that once the assessee furnishes credible evidence, the AO must bring cogent material to disprove genuineness.- The AO's reliance on investigation reports and statements of third parties without confronting the assessee or allowing cross-examination was held to violate principles of natural justice.- The Tribunal found that the AO's conclusion was based on surmise, conjecture, and human probabilities rather than concrete evidence.Treatment of Competing Arguments:- Revenue contended that the extraordinary price rise and investigation reports indicated sham transactions.- Assessee argued for genuineness supported by documentary evidence and absence of any direct link to manipulation.- The Tribunal favored the assessee, holding that suspicion alone cannot override documentary proof and that procedural fairness was not observed by AO.Conclusions:- The addition under section 68 was not sustainable due to lack of cogent evidence and violation of natural justice principles.- The LTCG claimed as exempt under section 10(38) was held genuine and exempt.Issue 3: Genuine Nature of Transactions in Penny Stock Companies and Allegations of Colourable DeviceRelevant Legal Framework and Precedents:- The Supreme Court has held that tax planning is legitimate only if within the framework of law; colourable devices and sham transactions are not permissible.- The test of human probabilities and surrounding circumstances is relevant in determining genuineness.- Judicial precedents have upheld additions where transactions were found to be pre-planned schemes to convert unaccounted money into exempt LTCG.Court's Interpretation and Reasoning:- The AO and CIT(A) relied on investigation reports indicating modus operandi of bogus LTCG through penny stocks controlled by brokers and entry providers.- The AO noted that shares were purchased in cash, dematerialized only shortly before sale, and sold during rising price trends, not during falling trends, indicating artificial price manipulation.- The assessee was found to be a novice investor investing in loss-making companies with no rational economic basis for such investments.- Statements recorded under section 131 from brokers and entry providers implicated the companies as vehicles for bogus LTCG.Key Evidence and Findings:- Financial statements of companies showed consistent losses and no justification for price appreciation.- Investigation reports and statements of entry providers detailed the scheme of circular trading and accommodation entries.- The assessee failed to satisfactorily explain source of funds and circumstances of purchase and sale.- The assessee's statement during investigation was evasive, particularly regarding identity of sellers and mode of payment.Application of Law to Facts:- The Tribunal and courts applied the test of human probabilities, finding the transactions improbable for a prudent investor.- The pattern of transactions and financial health of companies supported the AO's conclusion of colourable device.- The burden of proof to establish genuineness was on the assessee, who failed to discharge it adequately.Treatment of Competing Arguments:- Assessee relied on documentary evidence and argued absence of direct evidence linking him to manipulation.- Revenue emphasized circumstantial evidence, investigation reports, and financial analysis to demonstrate sham nature.- Courts found the revenue's evidence cogent and the assessee's explanations insufficient.Conclusions:- Transactions involving penny stock companies were held to be colourable devices to convert unaccounted money into exempt LTCG.- Additions under section 68 were upheld in such cases where the assessee failed to prove genuineness.Issue 4: Violation of Principles of Natural Justice - Right to Cross-ExaminationRelevant Legal Framework and Precedents:- Principles of natural justice require that adverse evidence on which an order is based must be confronted to the affected party and opportunity given to cross-examine.- Supreme Court has held that failure to provide such opportunity renders the order a nullity.Court's Interpretation and Reasoning:- The AO relied on statements of alleged entry providers recorded by investigation wing but did not produce them for cross-examination or confront the assessee during assessment proceedings.- The assessee's request for cross-examination was denied or ignored.- The Tribunal held that such reliance on untested statements violated natural justice and could not form basis for additions.Key Evidence and Findings:- Statements of witnesses were extracted in assessment order without confrontation.- Assessee's repeated requests for cross-examination were not granted.Application of Law to Facts:- The Tribunal applied the principle that untested statements cannot be used as primary evidence against the assessee.Treatment of Competing Arguments:- Revenue argued that statements formed part of investigation and were admissible.- Assessee emphasized denial of fair opportunity and procedural irregularity.- Tribunal sided with assessee, emphasizing procedural fairness.Conclusions:- Assessment order based on untested statements without cross-examination was held invalid.Issue 5: Sufficiency of Documentary Evidence to Discharge Onus under Section 68Relevant Legal Framework and Precedents:- Documentary evidence such as bank statements, contract notes, demat statements, and affidavits can discharge initial onus under section 68.- Once initial onus is discharged, AO must bring contrary evidence.- Mere suspicion or adverse financials do not suffice to reject documentary proof.Court's Interpretation and Reasoning:- The assessee produced comprehensive documentary evidence showing purchase and sale of shares through banking channels and recognized brokers.- The Tribunal noted absence of any specific defect or discrepancy in the documents.- The AO's failure to conduct independent enquiry or confront documentary evidence was noted.Key Evidence and Findings:- Bank passbook, demat account statements, contract notes, share certificates, transfer forms, and sworn affidavits were on record.Application of Law to Facts:- The Tribunal held that such documentary evidence sufficed to discharge onus unless rebutted by cogent evidence.Treatment of Competing Arguments:- Revenue relied on circumstantial evidence and investigation reports.- Assessee relied on documentary proof and procedural lapses by AO.- Tribunal found documentary evidence credible and unrebutted by reliable contrary evidence.Conclusions:- Documentary evidence produced by assessee was sufficient to discharge onus under section 68.Issue 6: Application of Judicial Precedents and Principles of LawRelevant Legal Framework and Precedents:- Supreme Court decisions on tax planning, burden of proof, and colourable devices.- High Court and Tribunal decisions on genuineness of share transactions, especially in penny stocks.- Principle of human probabilities and surrounding circumstances in assessing transactions.- Requirement of fair opportunity and cross-examination per natural justice.Court's Interpretation and Reasoning:- The Tribunal carefully considered conflicting precedents, distinguishing cases on facts.- Where transactions were supported by credible evidence and no direct link to manipulation was found, additions were deleted.- Where transactions involved undisclosed cash, evasive statements, and consistent losses of companies, additions were upheld.- The Tribunal emphasized that suspicion alone cannot override evidence and that procedural fairness is paramount.Key Evidence and Findings:- Multiple coordinate bench decisions were examined, some favoring assessee on similar facts, others upholding additions where evidence of sham transactions was stronger.Application of Law to Facts:- The Tribunal applied settled principles to the facts, balancing evidentiary requirements and procedural safeguards.Treatment of Competing Arguments:- Revenue relied on investigation reports, financial analysis, and human probabilities.- Assessee relied on documentary evidence, absence of direct link to manipulation, and procedural lapses.- The Tribunal differentiated cases on merits and evidence, applying legal principles accordingly.Conclusions:- Judicial precedents support both deletion and upholding of additions depending on facts and evidence.- Procedural fairness and cogent evidence are essential for sustaining additions under section 68. 3. FINAL CONCLUSIONS - Where the assessee produced credible documentary evidence of purchase and sale of shares through recognized channels, and no direct evidence of manipulation or collusion was found, additions under section 68 were not sustainable.- Where transactions involved purchase with undisclosed cash, dematerialization after purchase, evasive statements, and companies with poor financials, transactions were held to be colourable devices, and additions were upheld.- Reliance on investigation reports and statements without allowing cross-examination violates natural justice and renders additions unsustainable.- The burden of proof lies on the assessee to prove genuineness once suspicion arises; failure to discharge this burden justifies additions.- The Tribunal applied principles of human probabilities and surrounding circumstances but emphasized that suspicion alone cannot substitute for evidence.- The present case was decided in favor of the assessee due to credible documentary evidence, lack of direct incriminating material, and procedural lapses by AO.