Entire Penny Stock Sale Proceeds Cannot Be Added Under Section 68: ITAT Mumbai

ITO Vs Shri Ketan Gunvantrai Mehta (ITAT Mumbai)

Summary: The Mumbai Bench of the Income Tax Appellate Tribunal, comprising Shri Narender Kumar Choudhry, Judicial Member, and Shri Gagan Goyal, Accountant Member, dismissed the Revenue’s appeal against the order of the National Faceless Appeal Centre (NFAC)/Commissioner of Income Tax (Appeals) dated 31 August 2023 in the case of Shri Ketan Gunvantrai Mehta for Assessment Year 2012-13. The dispute concerned an addition of Rs.1,93,56,657 under Section 68 of the Income Tax Act, 1961, arising from transactions in shares of Exelon Infrastructure Ltd. The Assessing Officer reopened the assessment under Sections 147 and 148 after receiving information from the Investigation Wing alleging that the company was involved in penny stock transactions. Based on the investigation report, statements of alleged exit providers and analysis of cash trails, the Assessing Officer treated the amount as unexplained cash credit.

The assessee had undertaken two sets of share transactions. In the first, 1,65,085 shares were purchased for Rs.71,87,801 and sold for Rs.96,02,994, generating a profit of Rs.24,15,193. In the second, 1,48,731 shares were purchased for Rs.99,75,388 and sold for Rs.97,40,393, resulting in a loss of Rs.2,34,995. The total sale consideration was recorded at Rs.1,93,44,387, including other charges. The Assessing Officer treated the transactions as involving penny stocks and made an addition of Rs.1,93,56,657 without allowing for the corresponding purchase costs. On appeal, the CIT(A) examined the nature of the transactions, the allegations of share-price manipulation and the assessee’s actual financial results. Although the appellate authority accepted that the scrip was a penny stock and that the assessee had not effectively countered the allegations concerning share-price rigging, it found that the Assessing Officer’s reasoning contained significant factual errors.

The CIT(A) observed that the assessee had earned profits on the relevant transactions rather than merely booking artificial losses, as suggested by the Assessing Officer. The gains had been set off against other short-term capital losses, and the Assessing Officer had not questioned those other transactions or their computation. The appellate authority also considered the possibility that the assessee had participated in the transactions as part of its regular share-trading activities rather than as a participant in an accommodation-entry arrangement. Most importantly, it held that the entire sale proceeds could not be added without considering the purchase consideration. The CIT(A) accordingly directed deletion of the addition. The Revenue challenged that decision before the Tribunal, while the assessee filed a cross-objection substantially supporting the appellate order.

The Tribunal examined the transactions and agreed that the Assessing Officer had incorrectly added the entire sale consideration without accounting for the corresponding purchase prices. It observed that even if both transactions were considered bogus, the amount potentially liable to addition could only be Rs.21,80,198, representing the net result of the two transactions. The Tribunal found no perversity, impropriety or illegality in the CIT(A)’s decision to delete the addition. It therefore dismissed the Revenue’s appeal and upheld deletion of the addition of Rs.1,93,56,657. Since the assessee’s cross-objection merely supported the CIT(A)’s order, it became infructuous and was also dismissed. The decision illustrates the importance of examining actual transaction results and purchase costs before treating the gross proceeds of allegedly suspicious share transactions as unexplained income.

FULL TEXT OF THE ORIGINAL ORDER OF ITAT MUMBAI

This appeal by the Revenue Department and the Cross objection by the Assessee have been preferred against the order dated 31.08.2023, impugned herein, passed by the National Faceless Appeal Center (NFAC)/ Ld. Commissioner of Income Tax (Appeals) (in short Ld. Commissioner) under section 250 of the Income Tax Act, 1961 (in short ‘the Act’) for the A.Y. 2012-13.

2. For brevity, first we are deciding ITA No.3870/M/2023

In this case, on the information received from investigation wing of the Income Tax, Mumbai to the effect that the Assessee has made transaction in penny stock shares of bogus company viz. M/s. Exelon Infrastructure Ltd., the case of the Assessee was reopened by recoding reasons for reopening u/s 147 of the Act and by issuing the notice u/s 148 of the Act. In response to notice u/s 148 of the Act, the Assessee filed this return of income on 06.10.2019 declaring total income at Rs.1796.00. Thereafter various statutory notices were issued, in response to which the Assessee filed the detail and documents as called for.

3. On perusing the details filed by the Assessee, it was observed by the Assessing Officer (AO) that the Assessee had purchased 165085 shares of M/s. Exelon Infrastructure Ltd. @ Rs.33.54 each and on a total consideration of Rs.71,87,801/- and sold the same @ Rs.5817/- each and on a total consideration of Rs.96,02,994/- and consequently earned the profit of Rs.24,15,193/-. The AO further observed that the Assessee has also purchased 148731 shares @ Rs.67.07 and on a total consideration of Rs.99,75,388/- and sold the same during the assessment year under consideration @ Rs.65.49 each and on a total consideration of Rs.97,40,393/- and consequently earned the profit/loss of Rs.2,34,995/-. Thus the total sale consideration from the above two scrips were Rs.1,93,44,387/- (including other charges). The AO considering the said stocks as penny stocks and the findings of the investigation wing, the statement of the exit providers in the survey report, analysis of cash trial etc. ultimately treated the amount of Rs.1,93,56,657/- as unexplained cash credit and added the same to the total income of the Assessee u/s 68 of the Act.

4. The Assessee, being aggrieved, challenged the aforesaid addition by filing first appeal before the Ld. Commissioner, who by impugned order directed the AO to delete the addition by concluding as under:

“5.3. DECISION

5.3.1. The details of the transactions of the appellant in the penny stock which was part of a share price rigging is as under: –

1. Broker- Prabhudas Liladhar Pvt Ltd.

BUY total quantity 247918    Sell out of sold 165085    Profit    Balance stock

Excel Infrastructure Ltd

2. Arcadia Share & Stock Brokers Pvt Ltd.

BUY total quantity 225731    SELL out of sold 148731    Profit    Balance

Excel Stock Infrastructure Ltd.

5.3.2. In this context it is important to mention that the Directorate of Investigation, Kolkata carried out a country wide investigation to unearth the organized racket of generating bogus entries of Capital Gains/Loss () which is exempt from tax or are used to set off the Capital gains. The modus operandi adopted by the operators was to make the beneficiary buy some shares of a pre-determined Penny stock company controlled by them. These shares are transferred to the beneficiary at a very nominal price mostly offline through preferential allotment or off-line sale. The beneficiary (an individual) holds the shares for One year, the statuary period after which LTCG is exempt u/s 10(38) of the Income tax Act, 1961. In the meantime, the operators rig the price of the stock and gradually rise its price many times, often 500 to 1000 times. This is done through low volume transaction indulged in by the dummies of the operator at a pre-determined price. When the price reaches the desired level the beneficiary who bought the shares at a nominal price, is made to sell it to a dummy paper company of the operator. For this, unaccounted cash is provided by the beneficiary which is routed through a few layers of paper companies by the operator and finally is parked with the dummy paper company that will buy the shares. The AO was of the opinion that the appellant is one such beneficiary of such alleged bogus transactions.

5.3.3. In the current scenario, the AO’s contention is that the appellant is an exit provider, thus buying shares at high prices for the others to book bogus gains and bring their unaccounted money into the books. The appellant meanwhile sells the shares at lower prices booking losses so that the losses can be set off against its profits. Thus, the loss booked by share price rigging is considered by the AO as bogus loss. However, this is ridden with factual errors.

5.3.4. The AO erred on two counts (a) there is short term capital gain and not loss from the said transactions as per findings in para 2.4 of the assessment order. The table is reproduced in para 5.3.1., wherein the profit earned is Rs. 26,50,188/- (b) when appellant is earning profit, he cannot be an exit provider and would be only accommodation entry seeker who needs to bring unaccounted income to books in form of bogus profits. In this context, it is seen that the appellant has not shown the income separately but set off the same against other short term capital losses. AO has not questioned the other transactions or calculation of the short-term capital loss of the appellant. Therefore, if the profit/income from these so called non-genuine transactions are to be reduced from the short-term capital loss, it would only increase the short-term capital loss and the purpose/motive behind the share price rigging as discussed in detail by the AO of bringing unaccounted income to books in form of bogus profits is lost.

5.3.5. Further, the AO has discussed how the movement of money is not real, as the receipts are sent back in cash. When purchase and sale money is not real, there is no question of taxing sale proceeds. The outcome which is sought to be incorporated into the books, the bogus loss or profit is what is to be tackled. Therefore, the addition of entire sale proceeds is incorrect.

5.3.6. There is no doubt that the share was a penny stock and appellant has not been able to counter the AO’s arguments on share price rigging with any evidence relating to: a) the financials of the company, its profits/assets/cash flows and the link to the share prices (b) growth of the company in relation to the rise in share prices (c) the sustained level of share pricing across years and such other aspects to prove his stand of it not being a penny stock. Thus, the appellant in effect has agreed that these are penny stocks wherein share prices are rigged. However, this does not take away from the appellant’s argument that he was not part of the nexus and did not benefit in the same manner as other operators in view of the facts discussed above. The appellant has stated that this share trading was undertaken in the regular course of share trading business and is not one-off transactions with motive to indulge in the rigging nexus. That is a likely scenario considering the volume of transactions and that the appellant seems to have got onto the market trend to make a quick profit. Even otherwise, as discussed in paras 5.3.3 and 5.3.5, the appellant’s benefit out of such bogus transactions in terms of taxable income is not visible and the action of adding entire sale proceeds without consideration of purchases is without basis. Therefore, the AO is directed to delete the addition.

6. The Ground No. 3 is general in nature and need not separately adjudicated. In result, appeal is Allowed.”

5. The Revenue Department, being aggrieved has preferred its appeal being ITA No.3870/M/2023, whereas the Assessee has also preferred the cross objection being CO no. 135/M/2024 which is more or less in support of the impugned order.

6. We have heard the parties and perused the material available on record. Though the Ld. Commissioner held the aforesaid scrip in which the Assessee had transacted as penny stock, however, deleted the addition by considering the peculiar facts and circumstances that the Assessee has traded in the said shares in the regular course of share trading business and not done transactions with motive to indulge in the rigging nexus i.e. a material scenario considering the volume transactions and the Assessee seems to have caught on to the market trend to make quick profit, even otherwise the Assessee’s benefit out of such tax transactions in terms of taxable income is not feasible and the action of adding entire sale proceeds without consideration of purchases is without basis.

6.1 We observe from the assessment order that the Assessee had purchased 1,65,085 shares of M/s. Exelon Infrastructure Ltd. on a consideration of Rs. 71,87,801/- and sold the same on a consideration of Rs.96,02,994/- and consequently earned the profit of Rs.24,15,193/-. Further, the Assessee had also purchased 148731 shares of M/s. Exelon Infrastructure Ltd. on a consideration of Rs.99,75,388/- and sold the same on a consideration of Rs.97,40,393/- and consequently suffered the loss of Rs.2,34,995/-. If we consider both the sale transactions as bogus, still the addition can only be made of an amount of Rs.21,80,198/-. It is also admitted fact that the AO has not considered the purchase price of the shares. On the aforesaid analyzations, we are considered view that the ld. Commissioner has rightly deleted the addition under consideration; hence decision of the Ld. Commissioner in deleting the addition in hand needs no interference as the same neither suffers from any perversity nor impropriety or illegality. Thus, the impugned order is upheld and the Revenue’s appeal i.e. ITA no. 3870/M/2023 stands dismissed.

7. Coming to CO no. 135/M/2024 filed by the Assessee, we observe that the same is more or less in support of impugned order. As we have upheld the impugned order while adjudicating the Revenue’s appeal, hence the instant CO has become infructuous and therefore the same is dismissed.

8. In the result, instant appeal and CO filed respectively by the Revenue Department and the Assessee, stands dismissed.

Order pronounced in open Court on 29.11.2024.