- DCIT Vs Chetan Rasiklal Shah (ITAT, Mumbai)
- Revenue’s three-pronged challenge
- Penny-stock label versus documentary evidence
- Suspicion may begin an enquiry, but cannot conclude it
- Twenty-one suspicious scrips in a sea of 2,500
- When the entry disappears, its commission cannot remain
- Commercial expediency protects interest deduction
DCIT Vs Chetan Rasiklal Shah (ITAT, Mumbai)
Penny-Stock Suspicion Cannot Buy Evidence-Loss Allowed, Ghost Commission u/s 69C Vanishes & Rs.2.04-Crore Interest Survives u/s 36(1)(iii)
Summary:
Revenue’s three-pronged challenge
The Revenue challenged the CIT(A)’s order deleting three additions made in the case of Chetan Rasiklal Shah for AY 2015-16. The disputed issues concerned the loss claimed from transactions in alleged penny-stock scrips, consequential addition towards supposed commission paid to entry operators & disallowance of interest expenditure of Rs.2,04,23,968 on funds advanced interest-free to M/s Setu Securities (P) Ltd.
The AO relied upon Investigation Wing reports, SEBI material, stock-exchange data, financial weakness of the concerned companies, abnormal movement in their share prices & statements of persons allegedly involved in manipulating penny stocks. According to the AO, the transactions were part of a pre-arranged mechanism devised to generate artificial losses.
Penny-stock label versus documentary evidence
The Revenue argued that the assessee suffered substantial losses in scrips such as Pine Animation, Mishka Finance & Trading Ltd. & Matra Kaushal Enterprises, despite their negligible business activity & weak financial fundamentals. It contended that contract notes, demat entries & routing transactions through a recognised stock exchange could not, by themselves, establish genuineness where the surrounding circumstances indicated price manipulation.
The assessee maintained that he was a regular trader & the purchases and sales were carried out through the recognised stock exchange. The transactions were supported by contract notes, demat statements & contemporaneous records. There was no direct material demonstrating that he had contacted any operator, participated in price manipulation or obtained accommodation entries.
It was further argued that statements of third parties could not be used against the assessee without providing an opportunity of cross-examination. Reliance was placed on the Bombay High Court ruling in Shyam R. Pawar, 54 taxmann.com 108, & the Mumbai ITAT decision in Fairdeal Finn Services Pvt. Ltd., 173 taxmann.com 517.
Suspicion may begin an enquiry, but cannot conclude it
The ITAT acknowledged that the Investigation Wing reports, financial position of the companies & extraordinary price movements were relevant circumstances warranting closer examination. However, such circumstances could not automatically displace direct documentary evidence of actual purchases & sales.
The Revenue failed to establish any specific nexus between the assessee and the alleged operators or accommodation-entry providers. There was no evidence that the assessee arranged, participated in or possessed prior knowledge of the alleged manipulation. The fact that certain scrips were investigated or witnessed abnormal movements could create suspicion, but it could not establish that every person trading in them was necessarily part of the arrangement.
The AO had also failed to identify any defect in the contract notes or demat records. There was no evidence that the shares were not actually purchased or sold, or that the recorded consideration differed from the actual consideration. The Tribunal therefore held that general investigation material could not override the assessee’s transaction-specific evidence.
Twenty-one suspicious scrips in a sea of 2,500
A significant circumstance was the scale of the assessee’s trading activity. He had undertaken transactions in approximately 2,500 scrips, whereas the Department’s allegation was confined to about 21 scrips.
This broader profile demonstrated that the assessee was regularly engaged in share-market transactions & that the disputed trades constituted only a small part of his overall portfolio. Merely because 21 scrips appeared in an investigation did not prove that the assessee entered those transactions with a predetermined intention to manufacture losses.
In the absence of a connecting link between the assessee & the alleged manipulation, the ITAT upheld the CIT(A)’s deletion of the penny-stock loss disallowance. Grounds Nos.1 to 3 of the Revenue were dismissed.
When the entry disappears, its commission cannot remain
The AO had also made a consequential addition u/s 69C, presuming that the assessee must have paid commission to operators for obtaining the alleged artificial loss. The CIT(A) deleted the addition after accepting the underlying transactions as genuine.
The ITAT held that once the Revenue failed to prove the foundational allegation of an accommodation entry, the consequential commission could not survive merely on an assumption that commission “must have been paid”. An addition u/s 69C requires material showing that the assessee actually incurred unexplained expenditure. Since there was no independent evidence of payment of commission, its deletion was upheld.
Commercial expediency protects interest deduction
The AO had further disallowed interest of Rs.2,04,23,968, alleging that interest-bearing funds were diverted as an interest-free advance to Setu Securities. The assessee held 51% shares in that company & both concerns operated in connected fields involving share trading & finance.
Importantly, in the assessee’s own case for AY 2013-14, the Mumbai ITAT had allowed interest on an identical advance to Setu Securities. Applying S.A. Builders Ltd. v. CIT, 288 ITR 1 (SC), the earlier Bench held that advances to a subsidiary or concern in which the assessee had deep business interest could satisfy the test of commercial expediency.
For the year under appeal also, the Revenue produced no specific material showing that borrowed funds were diverted for a non-business purpose. The mere existence of an interest-free advance to a related concern could not automatically justify disallowance. Considering the assessee’s controlling interest, connected business activities & binding factual precedent in his own case, the deletion of Rs.2.04 crore was affirmed.
The Revenue’s appeal was accordingly dismissed in full. The ruling delivers a clear message: a penny-stock investigation may raise an eyebrow, but without an assessee-specific nexus, it cannot erase documented transactions, invent commission expenditure or defeat commercial expediency.
Cases Discussed
- Shyam R. Pawar, 54 taxmann.com 108 — Bombay High Court; relied upon regarding the requirement of specific material connecting the assessee with alleged penny-stock manipulation.
- Fairdeal Finn Services Pvt. Ltd., 173 taxmann.com 517 — Mumbai ITAT; relied upon regarding the insufficiency of general investigation allegations without specific material connecting the assessee with alleged manipulation.
- S.A. Builders Ltd. v. CIT, 288 ITR 1 — Supreme Court; relied upon on commercial expediency and allowability of interest under section 36(1)(iii).
- Chetan Rasiklal Shah’s own case for AY 2013-14, ITA No. 5664/Mum/2016, dated 15.06.2018 — Mumbai ITAT; relied upon concerning allowability of interest on borrowed funds advanced interest-free to M/s Setu Securities Pvt. Ltd.
FULL TEXT OF THE JUDGMENT/ORDER OF ITAT, MUMBAI
This appeal by the Revenue is directed against the order of the learned Commissioner of Income-tax (Appeals) for the assessment year 2015-16. The Revenue is aggrieved by the deletion of the additions/disallowances made by the Assessing Officer in respect of the loss claimed from transactions in certain penny-stock scrips, the consequential addition on account of alleged commission and the disallowance of interest expenditure relating to funds advanced to M/s Setu Securities (P) Ltd. The Revenue has raised six grounds of appeal.
Grounds Nos. 1 to 3 being directed against the deletion of the addition relating to the alleged non-genuine penny-stock loss, Ground No.4 relating to the consequential commission addition, and Grounds Nos.5 and 6 relating to the deletion of the interest disallowance. The Revenue has specifically challenged the learned CIT(A)’s appreciation of the Investigation Wing reports, SEBI orders, stock exchange data and statements of persons relied upon by the Assessing Officer.
2. Briefly stated, during the course of assessment proceedings the Assessing Officer examined the assessee’s share transactions and noticed substantial losses arising from transactions in certain scrips identified by the Department as penny stocks. The Assessing Officer, having regard to the Investigation Wing material, SEBI material, stock exchange data, the financial position of the concerned companies, their unusual price movements and statements recorded during investigation, held that the transactions were not genuine business transactions but were part of a pre-arranged mechanism for generating artificial losses. The Assessing Officer accordingly disallowed the loss claimed by the assessee. He also made a consequential addition on account of alleged commission on the premise that payment of consideration to operators was an integral part of such accommodation-entry transactions. Further, noticing that the assessee had incurred interest expenditure on borrowed funds while advancing funds without interest to M/s Setu Securities (P) Ltd., the Assessing Officer disallowed interest expenditure of Rs.2,04,23,968/- on the ground that the assessee had failed to establish that the borrowed funds had been utilised for his own business purposes.
3. During the course of hearing before us, the learned Departmental Representative (“ld.DR”) strongly supported the assessment order and submitted that the learned CIT(A) had failed to appreciate the cumulative effect of the material brought on record by the Assessing Officer. According to the ld.DR, the Department had undertaken a detailed investigation into manipulation of penny stocks and had identified a modus operandi whereby prices of illiquid companies having negligible financial fundamentals were artificially increased within a short period and thereafter allowed to fall, enabling beneficiaries to book artificial profits or losses. It was submitted that the assessee had incurred substantial losses particularly in the scrips of Pine Animation, Mishka Finance and Trading Ltd. and Matra Kaushal Enterprises, notwithstanding the weak financial position and negligible business activity of the companies concerned. The Revenue relied upon the Investigation Wing report, statements of operators/persons connected with the alleged manipulation, SEBI material and the abnormal movement of the relevant scrips. It was contended that the fact that the purchases and sales were carried out through the stock exchange and were supported by contract notes and demat entries could not, in the circumstances, be regarded as conclusive proof of genuineness. The Revenue further submitted that the assessee was an experienced participant in the securities market and that it was commercially improbable for such a person to make substantial investments in companies having negligible financial standing and business activity when their share prices were exhibiting extraordinary movements.
4. Per contra, the learned Authorised Representative (“ld.AR”) supported the order of the learned CIT(A) and submitted that the assessee was a genuine investor/trader and that the transactions had been carried out through the recognised stock exchange. It was submitted that the purchases and sales were duly supported by contract notes, demat statements and other contemporaneous documentary evidence and that there was no direct allegation or material demonstrating that the assessee himself had participated in the alleged manipulation. It was contended that even if allegations existed against the concerned companies or certain operators, such allegations could not automatically be extended to the assessee unless the Department established a specific connection between him and the alleged accommodation-entry providers. The ld.AR also submitted that the statements of third parties relied upon by the Assessing Officer could not be effectively used against the assessee in the absence of an opportunity of cross-examination. Reliance was placed upon the decisions of Bombay High Court in the case of Shyam R. Pawar, 54 taxmann.com 108 and the coordinate bench of the Mumbai tribunal in the case of Fairdeal Finn Services Pvt. Ltd., 173 taxmann.com 517, on the proposition that an Investigation Wing report or general allegation of manipulation, without specific material establishing that the assessee’s transactions were part of the manipulation, could not justify treating otherwise documented share transactions as bogus.
5. We have carefully considered the rival submissions and perused the material available on record. Grounds Nos.1 to 3 are inter-connected and, therefore, are being adjudicated together. The short question arising for our consideration is whether, on the totality of the material available on record, the loss claimed by the assessee from the impugned transactions represents a genuine business loss arising from normal market transactions or whether the transactions were part of the mechanism for generating an artificial loss, as alleged by the Assessing Officer. We have also considered the submission of the ld.AR that the transactions were carried out through the stock exchange and were supported by contract notes and demat records. Such contemporaneous documentary evidence is relevant and material in determining the genuineness of a share transaction. While surrounding circumstances may justify further scrutiny, suspicion arising from the nature of a scrip or its price movement cannot by itself displace direct documentary evidence of actual purchase and sale.
6. In the present case, the Revenue has relied upon the Investigation Wing material, SEBI material, the financial position and business activity of the relevant companies, the movement of their share prices and statements of persons said to be involved in the alleged modus operandi. However, the material as reflected before us does not establish a specific nexus between the assessee and any alleged operator or accommodation-entry provider. There is no direct material demonstrating that the assessee himself participated in, arranged, or had prior knowledge of the alleged manipulation. The fact that the relevant scrips may have been investigated or that their prices exhibited unusual movement may justify suspicion, but it does not, without a specific connecting link, establish that every person who traded in those scrips was a participant in the alleged arrangement.
7. We are also unable to accept the proposition that the surrounding circumstances relied upon by the Revenue are sufficient to override the contemporaneous evidence produced by the assessee. The purchases and sales were carried out through the recognised stock exchange and were supported by contract notes, demat records and other transaction documents. The Revenue has not pointed to any defect in those records, any evidence showing that the shares were not actually purchased or sold, or any material establishing that the consideration recorded in the transactions did not represent the actual consideration.
8. We have also considered the decisions relied upon by the ld.AR, particularly Shyam R. Pawar and Fairdeal Finn Services Pvt. Ltd. The proposition emerging from the submissions before us is that an addition cannot be sustained merely on suspicion or on the basis of a general investigation report without material connecting the assessee with the alleged manipulation. In the present case, the Revenue has established circumstances surrounding the relevant scrips, but has not established the necessary factual link between those circumstances and the assessee’s conduct. The documentary evidence evidencing the actual purchase and sale therefore cannot be disregarded merely because the relevant companies or their scrips were the subject of investigation.
9. Another factor supporting the assessee’s claim was the overall scale of his share-trading activity. The assessee had undertaken transactions in approximately 2,500 scrips, whereas the Department’s allegation of manipulation was confined to only about 21 scrips. This broader trading profile was relevant because it demonstrated that the assessee was regularly engaged in genuine share-market transactions and that the impugned transactions formed only a very small part of his overall activity. Therefore, the CIT(A) was justified in considering the transactions in the 21 identified scrips in the context of the assessee’s much larger portfolio of approximately 2,500 scrips. The mere fact that 21 scrips had been identified in an investigation did not, by itself, establish that the assessee had entered into those transactions with a predetermined intention to generate artificial losses. There had to be some specific material connecting the assessee with the alleged manipulation or operators. The absence of such a nexus, coupled with the availability of contract notes, demats records and other contemporaneous evidence, supported the assessee’s explanation.
10. Having considered the entire material in its totality, we are of the considered view that the Assessing Officer did not bring sufficient specific material on record to establish that the impugned transactions undertaken by the assessee were part of an arrangement for generating an artificial loss. The Investigation Wing material, abnormal price movement and financial position of the relevant companies may constitute circumstances requiring examination, but they do not, in the absence of a specific nexus to the assessee, establish that the assessee’s documented transactions were non-genuine. The learned CIT(A), therefore, was justified in giving due weight to the contemporaneous contract notes, demat records, the actual execution of the transactions through the recognised stock exchange, the absence of a specific connection with the alleged operators. We find no reason to interfere with the relief granted by the learned CIT(A).
11. Accordingly, the finding of the learned CIT(A) deleting the disallowance of the loss arising from the impugned penny-stock transactions is upheld. The Revenue has failed to establish, on the material available on record, that the loss claimed by the assessee was an artificial or non-genuine loss. Consequently, Grounds Nos.1 to 3 raised by the Revenue are dismissed.
12. Ground No.4 relates to the consequential addition made by the Assessing Officer on account of alleged commission. The Assessing Officer had proceeded on the basis that if the loss claimed by the assessee was generated through an accommodation-entry mechanism, the persons facilitating such accommodation would have received consideration by way of commission. The learned CIT(A) deleted the addition because he had accepted the underlying share transactions and the resultant loss as genuine and consequently found no basis for the commission addition. The Revenue has challenged the said finding by contending that payment of commission was a general feature of the alleged arrangement.
13. We have already held, while adjudicating Grounds Nos.1 to 3, that the Revenue has failed to establish that the impugned share transactions were non-genuine or that they formed part of an accommodation-entry arrangement. Once the foundational allegation of an artificial loss is not established, the consequential commission addition cannot survive merely on the assumption that commission would necessarily have been paid. We are conscious that an addition under section 69C requires material to support the conclusion that expenditure was actually incurred. No independent material establishing payment of commission by the assessee has been demonstrated before us. The learned CIT(A) was, therefore, justified in deleting the consequential addition. Ground No.4 of the Revenue is accordingly dismissed.
14. Grounds Nos.5 and 6 relate to the disallowance of interest expenditure of Rs.2,04,23,968/-. The Assessing Officer noticed that the assessee had incurred interest expenditure on borrowed funds while funds had been advanced without interest to M/s Setu Securities (P) Ltd. and held that the assessee had failed to establish that the corresponding funds were utilised for his own business purposes. The learned CIT(A), however, accepted the assessee’s explanation that the advance was made for commercial expediency, taking into consideration, inter alia, the fact that the assessee held 51% shares in M/s Setu Securities (P) Ltd. The Revenue has challenged this finding on the ground that substantial shareholding in the recipient company does not, by itself, establish commercial expediency.
15. The ld.DR submitted that the assessee was paying interest on borrowed funds while simultaneously making an interest-free advance to another entity and that the assessee had not established the necessary nexus between the borrowed funds and his own business. According to the Revenue, the fact that the assessee held 51% shares in Setu Securities only demonstrated that he had a substantial interest in that company and could not, by itself, establish that the advance was made for commercial expediency. The ld.AR, on the other hand, submitted that the assessee had a substantial financial and business interest in Setu Securities, that the company was engaged in a line of business closely connected with the assessee’s own business and that the advance was made for commercial considerations. The Ld. AR relied upon the decision of coordinate bench of Mumbai tribunal in the assessee’s own case for the Assessment Year 2013-14, vide ITA No. 5664/Mum/2016, dated 15.06.2018, where in the ITAT Mumbai upheld the allowability of interest expenditure of Rs. 61.36 lakhs on borrowed funds that were advanced as an interest-free loan to a sister concern M/s. Setu Securities Pvt. Ltd., in which the assessee held 51% shares. The coordinate bench held that since both entities were engaged in the same line of business (share trading and finance), the advance was made out of commercial expediency and the borrowed funds were used for business purposes, not for personal benefit or tax avoidance. Following the Supreme Court’s decision in S.A. Builders Ltd. (288 ITR 1), the ITAT ruled that where a holding company advances borrowed money to a subsidiary in which it has a deep interest, and the funds are used for business purposes, the interest on such borrowed funds is ordinarily deductible under Section 36(1)(iii) of the Income Tax Act, 1961.
16. We have considered the rival submissions. It is not in dispute that the assessee held 51% shares in M/s Setu Securities (P) Ltd. and, therefore, had a substantial interest in the affairs of the said company. It is also the assessee’s case that the business activities of the company were connected with his own business. These are relevant circumstances while considering the plea of commercial expediency. The question, however, is whether the Revenue has demonstrated that the interest-bearing funds were in fact diverted for a non-business purpose. The mere existence of an interest-free advance to a related concern does not, without examination of the surrounding financial position and the actual utilisation of funds, automatically establish that the interest expenditure claimed by the assessee is not allowable.
17. In the present case, the material before us records the assessee’s substantial shareholding in Setu Securities and the similarity or connection between the businesses. The learned CIT(A), after considering these circumstances, accepted the explanation of commercial expediency. The Revenue has not brought on record specific material establishing that the borrowed funds corresponding to the interest expenditure were diverted for the benefit of Setu Securities in a manner unrelated to the assessee’s business. Nor has the Revenue demonstrated that the assessee’s explanation was false or unsupported by the surrounding circumstances. In these facts, the disallowance cannot be sustained merely because the advance was interest-free.
18. We are, therefore, of the considered view that the learned CIT(A) was justified in accepting the assessee’s explanation of commercial expediency on the facts available before him. The Revenue has not established a sufficient factual nexus between the interest-bearing borrowings and any diversion of funds for a purpose other than the assessee’s business. The Cordinate bench of Mumbai tribunal already decided the assessee’s own case for the Assessment Year 2013-14 and allowed the interest expenditure. The facts are similar. The deletion of the disallowance of Rs.2,04,23,968/- therefore calls for no interference. Grounds Nos.5 and 6 raised by the Revenue are accordingly dismissed.
19. In the result, Grounds Nos.1 to 3 relating to the loss arising from the impugned penny-stock transactions are dismissed, Ground No.4 relating to the consequential commission addition is dismissed, and Grounds Nos.5 and 6 relating to the disallowance of interest expenditure are also dismissed. Consequently, the order of the learned CIT(A), insofar as the issues challenged before us are concerned, is upheld.
20. In the result, the appeal filed by the Revenue is dismissed.
Order pronounced in the open Court on 31.08.2026.
