Farzad Sheriar Jehani Vs ITO (ITAT Mumbai)
Farzad Sheriar Jehani Vs ITO (ITAT Mumbai): A Victory for the Unsuspecting Investor in Penny Stocks
Introduction: In a recent case before the Income Tax Appellate Tribunal (ITAT) Mumbai, Farzad Sheriar Jehani contested an order by the Commissioner of Income Tax (Appeals) challenging additions made to his income for the Assessment Year 2014-15. The dispute centered around the alleged dubious transaction involving penny stocks, specifically the sale of 7550 shares of “Kappac Pharma.”
Background: Farzad Sheriar Jehani, an individual and partner in three firms, declared a taxable income of ₹13,49,630 for the relevant assessment year. The Assessing Officer (AO) scrutinized Jehani’s claim of exempt income of ₹82,52,616 on account of Long Term Capital Gain (LTCG) from the sale of penny stocks. The AO, relying on a report from the Directorate of Investigation, Kolkata, raised concerns about the legitimacy of the transactions, suspecting a pre-arranged scheme to generate bogus LTCG.
AO’s Findings: The AO pointed out that Kappac Pharma’s financial performance did not justify the significant increase in share prices, and the scrip’s trading was eventually suspended by the Bombay Stock Exchange (BSE). Drawing parallels with the modus operandi outlined in the Directorate of Investigation’s report, the AO concluded that the transactions were non-genuine and represented undisclosed income.
CIT(A) Decision: The Commissioner of Income Tax (Appeals) upheld the AO’s decision, relying on the findings from the Directorate of Investigation and citing precedents from various high courts and ITAT decisions involving similar cases of alleged penny stock manipulation.
ITAT Mumbai Verdict: Farzad Sheriar Jehani appealed to the ITAT, presenting documentary evidence, including contract notes, details of issued cheques, and bank statements, to support the legitimacy of the LTCG. The ITAT observed that while the financials of the company did not align with the share prices, there was no evidence linking Jehani to any dubious transactions or price rigging.
The ITAT emphasized that, despite exhibiting characteristics of a penny stock case, there was no material connecting Jehani to any fraudulent activities. It noted that the presumption of Jehani’s involvement was based on human probabilities rather than concrete evidence. Referring to previous judicial decisions, including those by the Bombay and Delhi High Courts, the ITAT held that suspicion alone cannot be the basis for rejecting the taxpayer’s claims.
Conclusion: In its final verdict dated December 22, 2023, the ITAT allowed Jehani’s appeal, deleting the additions made by the AO. The tribunal stressed the importance of concrete evidence in establishing tax liability and reiterated that suspicion or probabilities alone cannot lead to adverse findings against the taxpayer. Farzad Sheriar Jehani’s case serves as a reminder that unsophisticated investors in penny stocks may not be automatically implicated in fraudulent schemes without clear evidence of their involvement.
FULL TEXT OF THE ORDER OF ITAT MUMBAI
1. This appeal is filed by the assessee against order of the Learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi [hereinafter in short “Ld. CIT(A)”] dated 05.2023 for the A.Y. 2014-15.
2. Brief facts of the case are, assessee filed its return of income on 03.2015 declaring taxable income of ₹.13,49,630/- and the return of income was processed under section 143(1) of Income-tax Act, 1961 (in short “Act”). Subsequently, the case was selected for scrutiny under CASS and notices under section 143(2) and 142(1) of the Act were issued and served on the assessee along with questionnaire. In response, Authorised Representative of the assessee attended and submitted the relevant information as called for.
3. The assessee is an individual and partner in three (3) firms namely Leopold Café & Stores, New York Café, Leos Boulangerie and assessee has derived incomes under the head Salary, Income from Partnership firm, Capital Gains, Other Sources and Agricultural income. During the course of assessment proceedings, Assessing Officer observed that assessee has claimed exempt income of ₹.82,52,616/- on account of Long Term Capital Gain on payment of STT under section 10(38) of the Based on the information available on record, he observed that assessee has sold 7550 shares of Penny Stock “Kappac Pharma” (suspected scrip) during the current assessment year. The sale value of entire Shares was of ₹.52,27,792/- and assessee had purchased the shares of Parixit Gas Company Ltd. in physical form on 09.10.2012 for ₹.83,050/- and demated the same on 10.01.2013 with Balance Equity Broking (India) Private Limited. The assessing officer has observed that Assessee has declared huge profit in this scrip, hence, he is of the opinion that all these transactions are pre-arranged. The Assessing Officer by relying on the report of Directorate of Investigation, Kolkata to unearth the organized racket of generating bogus entries of Long Term Capital Gain which is exempt from tax. He extracted the various findings from that report and discussed various modus operandi of booking the shares to rigging of the prices and exit prices in his order and exclusively discussed the financial results of the scrip “Kappac Pharma” from financial year 2009 to 2013 and observed that the above said scrip does not have any significant profit, EBIDTA Margin, EPS, bonus, dividend Etc. The extract from the annual report of M/s. Kappac Pharma Limited (in short “KPL”) for the year 2012-13 again being reproduced by him and observing that the increase in the stock price of KPL was not at all commensurate with the purpose of the company.
4. Further, he observed that parameters which are essential for increase of price of shares were not present, still, the share price is increased multi-fold therefore there is artificial increase by circular trading of shares forming Further, he observed that trading of this scrip was suspended by BSE. This itself shows that the above said scrip is traded in the market by artificially hiked the prices to create non- genuine Long Term Capital Gain.
5. After reproducing the sale of shares by the assessee in the open market in his order (Page No. 10) in which Assessing Officer has listed the various quantities, various rates and to various buyers in his order, for the total sum of ₹.52,27,792/-, considering the fact that SEBI after thorough investigations in such penny stock cases has certified that such transactions are rigged and are carried out to convert black money into Accordingly, he considered the above transaction as non-genuine and represents undisclosed income of the assessee liable to be added under the head “Income from other sources” as opposed to submissions of the assessee that section 68 of the Act cannot be invoked as there is no unexplained credits in the accounts and all documentary evidences along with other evidences has been submitted.
6. The Assessing Officer analysed the above said share transactions and came to the conclusion with the following observation: –
“8. Findings and conclusion
8.1 The submissions made by the assessee are considered. From the facts of the case and the discussion in the preceding paragraphs, it is concluded that long term capital gains booked by assessee in his books were pre-arranged method to evade taxes and launder money. Following are the findings and the reasons which substantiate the findings.
a. Mode of acquisition of the shares:
The assessee had purchased 7,550 shares of KAAPAC Pharma Ltd. for Rs 46,700/-. However, it is noticed that the assessee has not purchased of any other scrip in such a huge quantity.
b. Sale of shares and unusual rise in the price:
The assessee has sold the 7,550 shares for total consideration of Rs. 52,27,792/-, thus, resulting in long term capital gain of Rs 51,81,092/-, which is a 112% increase of the cost price, and, as discussed, the rise in share prices is not holding to any commercial principles and market factors.
c. Analysis of transactions:
Facts revealed that such trading transactions of purchase and sale of shares are not been effected, for commercial purpose but to create artificial gains, with a view to evade taxes-
i. Transactions of shares were not governed by market factors prevalent at relevant time in such trade, but same were product of design and mutual connivance on part of assessee and the operators.
ii. The assessee resorted to a pre-conceived scheme to procure long-term capital gains by way of price difference in share transactions not supported by market factors.
iii. Cumulative events in such transactions of shares revealed that same were devoid of any commercial nature and fell in realm of not being bona fide and, hence, impugned long term capital gain is not allowable.
d. Failure of Assessee to discharge his onus:
The assessee has not been able to prove the unusual rise and fall of share prices to be natural and based on the market forces. It is evident that such share transactions were closed circuit transactions and clearly a structured one. The assessee has not submitted any data/information about Kappac Pharma which prompted him to invest in this scrip or which explains the substantial increase in the price of the scrip from 2013 onwards.
e. Ignorance of the assessee about shares and penny stock companies:
Assessee has failed to show having any knowledge about the shares traded and having any knowledge about the fundamentals of the penny stock companies, though, she was summoned u/s.131 of the I.T. Act, 1961 to ascertain whether she possess any knowledge about shares.
f. Financial analysis of the penny stock companies:
The net worth of the penny stock company is negligible. Even though the net worth of the company and the business activity of the company are negligible, the share prices have been artificially rigged to unusual high.
g. Arranged transactions:
The transactions entered by the assessee involve the series of pre- conceived steps, the performance of each of which is depending on the others being carried out. The true nature of such share transactions lacked commercial contents, being artificially structured transactions, entered into with the sole intent, to evade taxes.”
7. By relying on the decision of Hon’ble Supreme Court in the case of Sumati Dayal CIT (214 ITR 801), Durga Prasad More v. CIT and CIT v. P. Mohankala and decision of Delhi ITAT in the case of Hersh Win Chadha v. DCIT (ITA No. 3088 to 3098 & 3107/Del/2015), Assessing Officer made the addition under section 68 of the Act of ₹.52,27,792/- and unexplained cash expenditure under section 69C of the Act to the extent of ₹.1,58,338/- taxable income of the assessee.
8. Aggrieved assessee preferred appeal before the Ld. CIT(A) and raised grounds of appeal and filed detailed written submissions, for the sake of clarity it is reproduced below: –
“WRITTEN SUBMISSION:
1) The Ld. Assessing Officer has treated the stock of shares sold by the assesse as penny Stock and treated the sale proceeds as Unexplained Cash Credit without appreciating that the sales were in fact Long Term Capital Gain (LTCG) and Security Transaction Tax (STT) was paid and by virtue of the same the Long Term Capital Gain (LTCG) is exempt under section 10(38) of Income Tax Act, 1961 and all other compliance have been
2) The Ld. Assessing Officer made the addition in the case of the assessee by relaying on general evidences gathered by various enforcement agencies with regard to transaction done and taking at of prices of so called “Penny Stocks”. Nowhere in the order of Assessing Officer has clearly bring out the role of the assesse in the “Modus Operandi” of purchasing bogus capital gains and also failed to bring out the any evidence which substantiate cash has exchanged between the Seller and Buyer of the share. Since the transaction has been carried out through the common platform of Recognised and Reputed Stock exchange.
3) The Ld. Assessing Officer has failed to bring material on record to support its finding that there has been collusion/connivance between the Broker and the assessee for the introduction of its unaccounted money.
4) The Assessing Officer has considered Long Term Capital Gain as Bogus Purely on surmises and conjuncture (sic), no transaction can be held as bogus unless the same is proved on the basis of sound reasoning and evidence.
5) The Ld. Assessing Officer has neither pointed out any discrepancy in the evidences relied upon by the assessee nor brought out any direct or inference evidence contradictorily to the gaminess of transaction.
6) Nowhere, the Ld. Assessing Officer has alleged that the transaction by the Appellant with these particular broker or share was bogus, merely because the investigation was done by SEBI against Company or its Appellant cannot be said to have entered into in genuine transaction, insofar as, Appellant is not concerned with the activity of the Company and have no control over the same. Further, Ld. Assessing Officer has not brought on record the Final SEBI Order, which also not available on Public Domain:
7) Further, during the course of scrutiny hearing, the Ld Assessing Officer had issued the Show Cause Notice and our client/appellant had also replied in details to explain the point wise answer with necessary judicial pronouncement.
8) Our Client/appellant again reiterates that the explanation provided as above is not contrary to facts and explanation provided during the course of the Scrutiny hearing. Ld. CIT (APPEAL) require to kindly consider the above-mentioned explanations in defence of Investment in Shares of “KAPPAC PHARMA” which is listed and traded in Recognised Stock Exchange.
9) Our Client/Appellant also want to submit the copies of the List of Shareholders for the FY 2012-2013, 2013-2014 which were downloaded from the Ministry of Company Affairs in which the name of the Appellant was also reflected as It had it be a case of Bogus Long-Term Capital Gain from Penny Stock the name of the Appellant wouldn’t have been there in the List of Shareholders for the years mentioned in this earlier paragraph. The List of Shareholders for the FY 2012-2013, 2013-2014.
10) The prayer before your honour, to consider the additional evidence under Rule 46A of the Income Tax Act, 1962 which were not produce before the Ld. Assessing Officer. Kindly consider the same as an Additional Evidence.
11) Further, we are also enclosing list of various judicial pronouncement of High Courts and Tribunals which are listed below.
Udit Kalra vs. ITO (Delhi High Court)
s. 10(38) Dogue Capital Gains from Penny Stocks: It is intriguing is that the company had meagre resources and reported consistent losses. The astronomical growth of the value of company’s shares naturally excited the suspicions of the Revenue. The company was even directed to be delisted from the stock exchange. The assessee’s argument that he was denied the right to cross-examine the individuals whose statements led to the Inquiry and ultimate disallowance of the long term capital gain claim is not relevant in the wake offindings of fact.
The Pr Commissioner Of Income Tax … vs Prem Pal Gandhi C/O KcTower Chd (Punjab /Haryana High Court)
The assessee purchased shares of a company during the assessment year2006- 2007 at Rs. 11/- and sold the same in the assessment year 2000-2009 at Rs. 400/- per share. In the above case, namely, ITA-18-2017 also the assessee had purchased and sold the shares in the same assessment years. The Assessing Officer in both the cases added the appreciation to the assessees’ income on the suspicion that these were fictitious transactions and that the appreciation actually represented the assessees’ income from undisclosed sources, in ITA-18-2017 also the CIT (Appeals) and the Tribunal held that the Assessing Officer had not produced any evidence whatsoever in support of the suspicion. On the other hand, although the appreciation is very high, the shares were traded on the National Stock Exchange and the payments and receipts were routed through the bank. There was no evidence to indicate for instance that this was a closely held company and that the trading on the National Stock Exchange was manipulated in any manner.
Prakash Javia, Indore vs Acit-4(1), Indore on 25 May, 2021
The Tribunal upheld appeal made by assessee on all grounds raised by the assessee in support of their case and against the revenue. Also, it submitted that the Kappac Pharma Limited is neither included in the list of Shell Companies nor has been struck off from the Registrar of companies. Reliance placed on decision of LT.A.T., Mumbai in the case of Shakti Hardware Collections Private Ltd. 6301/Mum/2014 dated 31.01.2018.
It is also submitted that the alleged information received by the Ld. AO from investigation wing about the company Kappec Pharma Limited was never made available to the assessee which violates principles of natural justice and thus renders entire proceedings as vold. Reliance placed on the Judgment of Hon’ble Supreme Court in the case of Sona Bullders [2001] 119 Taxman 430. Further, it is submitted that no material was found by the Id. AO which could establish that the assessee had converted unaccounted money into accounted money by managing bogus LTCG.
Reliance placed on judgment of Hon’ble Delhi High Court in the case of Krishna Devi ITA No. 125 of 8/16/22, 2020 dated 15.01.2021 & Judgment of Hon’ble Bombay High Court in the case of Uttamch and Jain [2009] 182 taxman 243 dated 02.07.2009
Principal CIT Hitesh Gandhi in ITA No. 18/2017, dated 16-2-2017 (Punj.&Har.);
The Tribunal upheld the findings recorded by the CIT(A). It was categorically recorded by the Tribunal that as noticed by the CIT(A), in the remand report the Assessing Officer was not able to contradict the facts regarding purchase of shares and sale thereof. Further, it was recorded that the assessee had sold shares through MTL shares and Stock Broker limited which is a SEBI registered Stock Broker. The payment for sale of shares was received through banking channels. All the documentary evidence being in favour of assessee, the deletion of the addition made by the CIT(A) was upheld by the Tribunal.
The findings recorded by the CIT (A) and the Tribunal are pure findings of fact which have not be shown to be illegal, erroneous perverse by the learned counsel for the appellant. He has also not been able to produce any material on record to controvert the said findings. Thus, no Substantial question of law arises. Consequently, finding no merit in the appest by Revenue and the same la dismissed.
Dipesh Ramesh Vardhan vs. DCIT (ITAT Mumbai)
s. 10(38)/68: Bogus Capital Gains from Penny Stocks: The AO has not discharged the onus of controverting the documentary evidences furnished by the assessee and by bringing on record any cogent material to sustain the addition. The allegation of price rigging/manipulation has been levied without establishing the vital link between the assessee and other entities. The whole basis of making additions is third party statement and no opportunity of cross-examination has been provided to the assessee to confront the said party. As against this, the assessee’s position that that the transactions were genuine and duly supported by various documentary evidences, could not be disturbed by the revenue
DCIT vs. Rakesh Saraogi & Sons (HUF) (ITAT Raipur)
s. 10(38) Bogus Capital Gains Penny Stocks: Assuming brokers may have done manipulation, assessee cannot be held liable when the entire transaction is done through banking channels duly recorded in Demat accounts with Govt depository and traded on stock exchange Nothing on record to suggest assessee gave cash and purchased cheque from broker (Sanjay Bimalchand Jain (Bom HC) distinguished)
Ramprasad Agarwal vs. ITO (ITAT Mumbai)
s. 10(38) Bogus capital gains from penny stocks: If the holding of shares is D-mat account cannot be disputed then the transaction cannot be held as bogus. The AO has also not disputed the sale of shares from the D-mat account of the assessee and the sale consideration was directly credited to the bank account of the assesse. Once the assesses produced all relevant evidence to substantiate the transaction of purchase, dematerialization and sale of shares then, in the absence of any contrary material brought on record the same cannot be held as bogus transaction merely on the basis of statement of one Anil Agrawal recorded by the Investigation Wing, Kolkata wherein there is a general statement of providing bogus long term capital gain transaction to the clients without stating anything about the transaction of allotment of shares by the company to the assessee.
Since there is no Substantial Question of Law, and in lieu of the explanation and documentary proof submitted, submit a humble prayer to consider the above mentioned points while disposing of the Appeal favourably.”
9. CIT(A) after considering the findings in the assessment order which is based on the investigations of Directorate of Investigation, Kolkata and further, analyses of the Assessing Officer, Ld. CIT(A) dismissed the appeal filed by the assessee by relying on the decision of Hon’ble Punjab and Haryana High Court in the case of CIT v. Prem Pal Gandhi and decision of Bangalore ITAT in the case of MK Rajeshwari v. ITO [TS – 9007-ITAR – 2018 (Bangalore)], in the case of Poonam Gupta v. DCIT [TS-6399-ITAT-2021 (Bangalore)] and decision of the Hon’ble Supreme Court in the case of Suman Poddar v. ITO (2020) 268 Taxman 320 (SC).
10. Aggrieved assessee is in appeal before us raising following grounds in its appeal: –
“1. Addition u/s 68 Rs.52,27,792/-
1.1 The Learned CIT (A) erred in upholding the addition made by the Assessing Officer (AO) under section 68 of the Income Tax Act, 1961 on an erroneous basis that the investment made in KAPPAC PHARMA LTD shares and Long Term Capital Gain on share is considered as not explained although all the necessary evidence was filed in the course of proceedings.
1.2 The Learned CIT (A) failed to appreciate that the provision of section 10(38) of the Income Tax Act, 1961 are attracted since the Appellant has offered explanation about the nature and source of investments supported by all documentary evidence as requested by learned CIT(A) which the learned CIT(A) erred in not considering these evidence.
1.3 The Learned CIT (A) erred in treating the isolated transaction of purchase of Shares in 2012 and sale thereof in 2014 resulting in long term capital gain of Rs. 52,27,792/- as business profit and not as Capital Gain as claimed by the asseessee Appellant although Capital Gain have been accepted all throughout in other Long Term Capital Gain Share transaction The learned CIT (A) erred in considering the finding which is on protective basis 2. Addition u/s 69 C: Rs 1,58,338/-
2.1 The Learned CIT (A) erred in upholding the addition made by the Assessing Officer (AO) under section 69C of the Income Tax Act, 1961 on an erroneous basis that the estimated commission le. 3% of Rs 52,27,792/- by treating same as unexplained expenditure is without any evidence and same is arbitrary.
3. No Opportunity of Cross Objection
3.1 The Learned Assessing Officer did not provide with documents and statements relied upon while passing the adverse order, thus not giving any opportunity of cross examination as well as cross objection on the same. Hence there is a Gross Violation of Principal of Natural Justice to the appellant.
The appellant prays for following reliefs :
(a) This Hon’ble Tribunal be pleased to direct the AO to delete the addition made u/s. 68 and 69C of the Income Tax Act, 1961.
(b) Any other relief, which the Hon’ble Tribunal deems fit.
11. At the time of hearing, Ld.AR of the assessee submitted that assessee has transferred 7550 shares of KPL and earned Long Term Capital Gain exemption under section 10(38) of the Act. Further, he submitted that assessee has submitted various documentary evidences in support of the above said transaction and he brought to our notice contract notes of sales of shares [Page No. 43 to 49 of the Paper Book], details of cheque issued by stock broker of the assessee towards sales [Page Nos. 50 to 60 of the Paper Book], bank statements in support of the realisation of the sale proceeds and he submitted that the Long Term Capital Gain earned by the assessee is genuine and not an arranged one as alleged by the tax authorities.
12. Further, he submitted that Assessing Officer and Ld. CIT(A) have not pointed out any discrepancies in the documentary evidences submitted by the Ld.AR of the assessee submitted that without pointing out any discrepancies in the documentary evidences submitted by the assessee the Assessing Officer has heavily relied on the investigations carried out by the Directorate of Investigation, Kolkata. Ld. AR contravened the findings of the Assessing Officer that KPL had made losses consistently over the past years, the increase of share price was not commensurate with the financial results and the purchase of shares of KPL appeared to be a predetermined action of the assessee leading to earning of Long Term Capital Gain by way of dubious methods. The predetermined action with specific intention is one of the circumstances evidences leading to the conclusion that the Long Term Capital Gain earned is not genuine. Further, assessee has not declared any Short Term Capital Gain or business income or exempt income share transactions in the previous assessment years. In this regard, Ld.AR of the assessee submitted as under: –
“The fundamental submission of the Appellant is as follows:
a. If some persons connive to rig the prices of shares of a listed company, that would not mean that every person who sold shares of that listed company on stock exchange, was party to the design of price rigging. Since these shares are listed on the stock exchange, there would always be persons who have sold the shares without being party to the price rigging. The listed shares are available to every owner of shares across the country and it would be unreasonable to proceed on the basis that all such sellers throughout the country have connived to rig the share And, unless there is evidence of a particular person’s connivance, it cannot be assumed that he was party to the design/ price rigging. When the Appellant observed the price of the shares rising, without being aware of the reason for increase in the price, the Appellant started selling these shares. Even if the prices would have risen on account of any alleged price rigging by certain persons, such price would be available to every owner of shares including the Appellant for selling without being aware of the price rigging.
b. The Appellant was not party to the alleged price rigging. Neither SEBI nor any other authority has made any allegation against the Appellant. Even the investigation carried out by the Directorate of Investigation, Kolkata has not found any material showing the involvement of the There is no material to suggest that the Appellant converted his unaccounted cash into long term capital gains.
c. The Appellant was an innocent risk-taking investor who purchased shares with a view to make gains. The decision to sell the shares was taken in order to book the extraordinary gains.
d. The fact that even in a case there is rigging in the price of the shares by certain individuals, there would always be certain innocent investors who sell the shares upon witnessing huge rise in prices without being party to the price rigging, was also acknowledged by the coordinate bench of this Tribunal in the case of Manish Kumar Baid v. ACIT (ITA No. 1236-37/Kol/2017, dated 18th August 2017). Another coordinate bench of this Tribunal in the case of ITO v. Ronak Iqbal Lakhani (ITA No. 835/Mum/2022, dated 17th January 2023) held that “merely because some person misused the share market to rig certain shares in the share market for nefarious purpose, cannot be the ground to draw adverse view against innocent regular investors”.
e. Therefore, in the absence of any material to show the involvement of the Appellant in the alleged price rigging or that the Appellant was party to any wrong doing in any manner, no addition can be made to Appellant’s income.
f. The AO/ CIT (A) have relied on alleged general findings of the investigation report of the Directorate of Investigation, Kolkata. Admittedly, even in the said investigation report, the name of the Appellant does not appear. It is not the AO’s case also that any role is attributed to the Appellant in the alleged price rigging of the shares of KPL in such investigation. The general findings of the investigation report cannot be used to assail even genuine No copies thereof were also furnished to the Appellant which is violative of principles of natural justice.
Factually incorrect statements made by the AO in the Assessment Order
g. The case of the AO is one admittedly based on “circumstantial evidence”. The AO has made the following factual errors in the Assessment Order while constructing a case based on circumstantial evidence:
