Penny Stock LTCG: ITAT Mumbai Clarifies That Exemption Cannot Be Denied Merely on Investigation Report

Background of the Dispute

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) dealt with three interconnected appeals concerning alleged penny stock transactions for A.Y. 2014-15. The appeals were filed by:

  • Suresh M. Jain HUF
  • Heena Suresh Jain
  • Rameshkumar Mohanlal Jain

All three matters involved a common controversy: whether long-term capital gains (LTCG) on sale of listed shares, claimed as exempt under Section 10(38) of the Income Tax Act 1961, could be treated as bogus merely on the basis of an Investigation Wing report and categorized as unexplained income under Section 68, along with a further notional addition under Section 69C for alleged commission.

The lead appeal was that of Suresh M. Jain HUF, and the Tribunal’s reasoning in this case was applied identically to the other two appeals, as the facts, scrip and legal issues were the same.

Facts in the Lead Appeal: Suresh M. Jain HUF

Return Filing and Scrutiny

  1. The assessee filed a return of income for A.Y. 2014-15 on 26.07.2014 declaring total income of ₹3,74,610.
  2. The case was selected for scrutiny under CASS. Notices under Section 143(2) and Section 142(1) were issued and duly served.

Transactions in Shree Shalin Textiles Ltd.

During assessment, the Assessing Officer (AO) noticed that the assessee had dealt in shares of Shree Shalin Textiles Ltd., a listed company subsequently described by the Investigation Wing as a “penny stock” involved in price rigging, with trading in this scrip having been suspended on the Bombay Stock Exchange.

Key transactional facts as noted:

  • Original purchase: 485 shares at ₹20 per share on 05.12.2011.
  • Bonus issue: 9500 shares issued on 16.04.2012 in the ratio 1:19, resulting in 9985 shares.
  • Share split: On 07.03.2013, face value split from ₹10 to ₹2, converting 9985 shares into 49,925 shares.
  • Sale: 49,925 shares sold during May–June 2013 through BSE at an average rate of around ₹59.15, generating total sale proceeds of about ₹29,64,910 (AO recorded total sale around ₹30.77 lakh in one place and used ₹29,64,910 for addition).

The assessee had claimed LTCG on these shares as exempt under Section 10(38).

Evidence Filed by the Assessee

In support of the LTCG claim, the assessee contended that it was a regular investor in shares and furnished detailed documentation, including:

  • Physical share certificates bearing transfer endorsements in the assessee’s name.
  • Demat account statements reflecting credit of shares and subsequent debit on sale.
  • Contract notes issued by a SEBI-registered stock broker showing trades executed on the stock exchange and evidence of STT payment.
  • Bank account statements showing sale proceeds received via normal banking channels.
  • Earlier income tax returns where the acquisition of these shares had already been disclosed in A.Y. 2012-13 (year of purchase).

The assessee argued that:

  • Shares were held for more than 12 months prior to sale.
  • Sales took place online through a recognised stock exchange.
  • STT, stamp duty and other statutory levies were duly paid.

Assessing Officer’s Conclusions

Despite the above evidence, the AO rejected the assessee’s explanation and treated the LTCG claim as part of a tax evasion scheme structured through penny stocks. Relying heavily on Investigation Wing reports from Mumbai and Kolkata, the AO summarized his findings as follows:

  • The purchase, bonus issue and split resulted in a very low initial cost and disproportionately high sale consideration, allegedly achieved through rigging of prices in the scrip of Shree Shalin Textiles Ltd.
  • The AO concluded that the assessee’s gains were not the result of genuine market-driven transactions, but part of a pre-arranged accommodation entry mechanism designed to:
    • Convert unaccounted cash into exempt LTCG, and
    • Launder money through artificially inflated share prices.

Key additions by the AO

  • Entire sale proceeds of ₹29,64,910 treated as unexplained cash credit under Section 68.
  • Notional commission @ 2% of sale proceeds added as unexplained expenditure under Section 69C on the assumption that such commission must have been paid to entry operators for arranging bogus LTCG.

The AO also stressed:

  • Alleged lack of commercial rationale for the transactions.
  • Sharp price rise not supported by the company’s fundamentals.
  • Assessee’s alleged failure to demonstrate that the price movement was driven by genuine market forces.
  • General findings of the Investigation Wing regarding the modus operandi in penny stock manipulation.

Order of the Commissioner of Income Tax (Appeals)

On appeal, the Ld. CIT(A) confirmed the AO’s additions and dismissed the assessee’s appeal. The key reasons recorded by the appellate authority included:

  1. Off-market purchase in cash
    • The purchase of shares was stated to have been made in an off-market transaction at ₹20 per share on 05.12.2011.
    • The Ld. CIT(A) compared this with the BSE quoted high/low price (₹73.65) for December 2011 and doubted the genuineness of purchase at such a low price.
    • The assessee did not file a conventional purchase invoice for the off-market acquisition.