Gujarat High Court Dismisses Revenue's Appeal in Penny Stock Case: 10-Year Holding Period Establishes Genuineness of Investment

Case Background and Overview

The Gujarat High Court recently delivered a significant ruling in PCIT Vs Jagat Pravinbhai Sarabhai, dismissing a tax appeal brought by the Revenue under Section 260A of the Income Tax Act, 1961. The dispute centred on whether long-term capital gains arising from the sale of shares of Devika Proteins Ltd. could be legitimately treated as a penny stock transaction and subjected to addition under Section 68 of the Act.

The core question before the Court was whether the Income Tax Appellate Tribunal (ITAT), Ahmedabad had erred in deleting an addition of ₹2,10,474 that the Assessing Officer had made on grounds that the capital gains were bogus in nature and not entitled to exemption under Section 10(38) of the Income Tax Act, 1961.

The High Court ultimately found no substantial question of law arising from the Tribunal's order and dismissed the Revenue's appeal, affirming the concurrent factual findings of both the Commissioner of Income Tax (Appeals) and the ITAT.

Facts of the Case

Return Filed and Assessment Year in Question

The assessee, Mr. Jagat Pravinbhai Sarabhai, filed his return of income for Assessment Year 2011-12 on 29.03.2012, declaring total income of ₹3,11,490. The return was processed initially, but the assessment was subsequently reopened by the Assessing Officer after intelligence was received suggesting that the assessee had engaged in transactions involving shares of a shell company.

Nature of the Transaction Under Scrutiny

The specific transaction that came under the Revenue's scanner involved the sale of shares of Devika Proteins Ltd. The assessee had claimed long-term capital gains of ₹2,10,474 from this sale and sought exemption on the same under Section 10(38) of the Income Tax Act, 1961, which at the relevant time provided exemption for long-term capital gains arising from sale of listed equity shares on which Securities Transaction Tax had been paid.

Assessing Officer's Stand

The Assessing Officer did not accept the assessee's claim. He treated the entire transaction as a bogus penny stock arrangement — a common tax evasion mechanism where individuals allegedly purchase shares of obscure companies at nominal prices, get the price artificially inflated, sell at inflated prices, and then claim the resulting gains as exempt long-term capital gains.

Rejecting the assessee's claim, the Assessing Officer:

  • Categorised the Devika Proteins Ltd. shares as penny stock
  • Treated the entire transaction as non-genuine and bogus
  • Added ₹2,10,474 back to income under Section 68 of the Income Tax Act, 1961 as unexplained cash credits
  • Assessed the total income of the assessee at ₹5,21,964 as against the declared income of ₹3,11,490

Appellate Journey

Commissioner of Income Tax (Appeals)

Aggrieved by the Assessing Officer's order, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals). The first appellate authority took a fresh look at the entire factual matrix.

The Commissioner (Appeals) observed the following crucial aspects: