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February 7, 2021

Delhi HC deletes addition of LTCG on alleged ‘penny stocks’

by CA Shivam Jaiswal in Income Tax

Delhi HC deletes addition of LTCG on alleged ‘penny stocks’

Penny stocks are a form of market traded security which attracts minimal pricing. These securities are mostly offered by companies with lower market capitalisation rates. Therefore, these are also called nano-cap stocks, micro-cap stocks, and small-cap stocks, depending on the company’s market capitalisation. Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price. Long-term capital gains (LTCG) are derived from assets that are held for more than one year before they are disposed of. 

Let us refer to the case of Principal Commissioner of Income Tax vs Smt Krishna Devi where the issue under consideration pertained to applicability of LTCG on penny stocks.

Facts of the Case

  • The Respondent-Assessee was an individual who had derived income from interest on loan, FDR, NSC and bank interest under the head of income from other sources.
  • During the scrutiny proceedings, the AO noticed that for the relevant year under consideration, the Respondent had claimed exempted income of Rs. 96,75,939 as receipts from Long Term Capital Gain [LTCG] under Section 10(38).
  • He concluded that the assessee had adopted a colourable device of LTCG to avoid tax and accordingly framed the assessment order under Section 143(3) at the total income of Rs. 1,09,12,060, making an addition of Rs. 96,75,939 under Section 68 read with 115BBE on account of bogus LTCG on sale of penny stocks of a company named M/s Gold Line International Finvest Limited.

Appeal to Commissioner of Income Tax (Appeals) [CIT(A)] and Income Tax Appellate Tribunal (ITAT)

  • The appeal before the CIT(A) was dismissed and additions were confirmed with the observation that the Respondent had introduced unaccounted money into the books without paying taxes.
  • Further appeal filed by the Respondent before the learned ITAT was allowed in her favour, and the additions were deleted vide the Impugned Order.
  • Aggrieved by the aforesaid findings, the Revenue filed the instant appeal before the High Court (HC)

Observations of the High Court (HC)

  • It was easily discernible that in the instant case, the AO had proceeded predominantly on the basis of the analysis of the financials of M/s Gold Line International Finvest Limited.
  • His conclusion and findings against the Respondent were chiefly on the strength of the astounding 4849.2% jump in share prices of the aforesaid company within a span of two years, which was not supported by the financials.
  • On an analysis of the data obtained from the websites, the AO observed that the quantum leap in the share price was not justified; the trade pattern of the aforesaid company did not move along with the sensex; and the financials of the company did not show any reason for the extraordinary performance of its stock.
  • HC had nothing adverse to comment on the above analysis, but were concerned with the conclusion drawn by the AO that the Respondent had entered into an agreement to convert unaccounted money by claiming fictitious LTCG, which was exempt under Section 10(38), in a pre-planned manner to evade taxes.
  • The AO extensively relied upon the search and survey operations conducted by the Investigation Wing of the Income Tax Department in Kolkata, Delhi, Mumbai and Ahmedabad on penny stocks, which sets out the modus operandi adopted in the business of providing entries of bogus LTCG.
  • However, the reliance placed on the report, without further corroboration on the basis of cogent material, did not justify his conclusion that the transaction was bogus, sham and nothing other than a racket of accommodation entries.
  • HC did notice that the AO made an attempt to delve into the question of infusion of Respondent’s unaccounted money, but he did not dig deeper.
  • Notices were issued to M/s Gold Line International Finvest Limited, but nothing emerged from this effort.
  • The payment for the shares in question was made by Sh. Salasar Trading Company. Notice was issued to this entity as well, but when the notices were returned unserved, the AO did not take the matter any further.
  • He thereafter simply proceeded on the basis of the financials of the company to come to the conclusion that the transactions were accommodation entries, and thus, fictitious.
  • The conclusion drawn by the AO, that there was an agreement to convert unaccounted money by taking fictitious LTCG in a pre-planned manner, was therefore entirely unsupported by any material on record.
  • This finding was thus purely an assumption based on conjecture made by the AO.
  • This flawed approach formed the reason for the ITAT to interfere with the findings of the lower tax authorities.
  • The ITAT after considering the entire conspectus of case and the evidence brought on record, held that the Respondent had successfully discharged the initial onus cast upon it under the provisions of Section 68.
  • There was no dispute that the shares of the two companies were purchased online, the payments were made through banking channel, and the shares were dematerialized and the sales were routed from the demat account and the consideration was received through banking channels.
  • The above noted factors, including the deficient enquiry conducted by the AO and the lack of any independent source or evidence to show that there was an agreement between the Respondent and any other party, prevailed upon the ITAT to take a different view.
  • Appellant was not able to point out any evidence whatsoever to allege that money changed hands between the Respondent and the broker or any other person, or further that some person provided the entry to convert unaccounted money for getting benefit of LTCG, as alleged.
  • In the absence of any such material that could support the case put forth by the Appellant, the additions could not be sustained.
  • Appellant’s submissions relating to the startling spike in the share price and other factors was enough to show circumstances that might create suspicion.
  • However, HC decided an issue on the basis of evidence and proof, and not on suspicion alone.

According to the HC, the ITAT, being the last fact-finding authority, on the basis of the evidence brought on record, had rightly come to the conclusion that the lower tax authorities were not able to sustain the addition without any cogent material on record. HC found no perversity in the Impugned Order. Thus, the HC deleted the addition of LTCG on alleged ‘penny stocks’

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