ITAT Denies LTCG Exemption on Penny Stock Gains, Labels Transaction as Manipulated

New Delhi, April 2025 – In a significant ruling that adds to the growing list of judicial pushbacks against tax evasion through penny stocks, the Income Tax Appellate Tribunal (ITAT) has denied Long-Term Capital Gains (LTCG) tax exemption claimed by an assessee under Section 10(38) of the Income Tax Act, citing the transaction as pre-arranged and manipulated.

Background of the Case

The assessee had reported substantial LTCG arising from the sale of shares in a low-value penny stock company, and sought exemption from tax under Section 10(38), which exempted gains on listed securities held for more than a year (prior to its withdrawal in 2018). However, the tax authorities flagged the transaction, suspecting that the gains were not genuine and were part of a tax evasion strategy involving share price rigging.

Key Findings of the ITAT

• The Tribunal observed that the price of the shares had been artificially inflated without any real business justification or financial performance by the company.
• The assessee failed to substantiate the legitimacy of the transaction with credible evidence such as financial reports, board resolutions, or proof of actual trading intent.
• The ITAT emphasized that while documentation may have appeared in order on the surface, the economic reality of the transaction pointed towards collusion and manipulation to generate tax-free capital gains.

Substance Over Form

The Tribunal reiterated the principle of “substance over form”, stating that merely complying with procedural formalities cannot shield a transaction from scrutiny if its substance suggests a colorable device. The ruling underlined that tax exemption benefits cannot be extended to sham transactions, even if executed through regulated stock exchanges.

Broader Implications

This case adds to the growing body of decisions where tax authorities and tribunals are cracking down on bogus LTCG claims, especially those involving obscure penny stocks. In recent years, such schemes have been under the scanner of the Income Tax Department and SEBI, with several transactions being nullified based on price manipulation, lack of volume, and circular trading patterns.

Conclusion

The ITAT’s decision underscores the government’s resolve to curb misuse of tax exemptions through manipulated capital gains, and sends a clear message to investors engaging in such schemes: mere documentation is not enough if the transaction lacks economic credibility.