The assessee has been taking a common argument against the addition on account of penny stock. The said argument revolves around the violation of the principle of natural justice. The assessee pleads that:

a) The investigation wing report and other documents which is the basis of treating the transaction as bogus by the department is not confronted or provided to the assessee at the time of assessment.

b) Opportunity of cross examining the brokers or other parties on whose statement the department relies upon, is not provided to the assessee.

The above grounds are taken in almost all the penny stock cases. The Tribunal has  been sympathetic to this ground and have followed this well laid down principle of natural justice while granting relief to the assessee in a number of cases. 

However, recently the Delhi High Court has in the case of SANJAY KAUL VERSUS PRINCIPAL COMMISSIONER OF INCOME TAX DELHI held otherwise. While dismissing the appeal of the assessee, the High Court has held that the principle of natural justice is not absolute and the assessee cannot claim it as a matter of right in all the cases. This decision is a major departure to the doctrine of fair play, justice and audi alteram partem. 

Facts of the case:

The Assessee had filed its original Income-tax return on 30.09.2015 declaring total income of ₹ 3,12,59,350/- for the AY 2015-16.  The appellant had earned long-term capital gain (‘LTCG’) of ₹ 4,15,67,925/- on sale of shares in unlisted companies. The appellant further incurred short-term capital loss (‘STCL’) of ₹ 1,57,23,872/- out of which a sum of ₹ 1,22,76,352/- related to purchase and sale of the shares of following three listed companies:

Sr. No. Script STCL (Rs)
1. Cressanda Solutions Ltd. 24,66,430/-
2. Kailash Auto Finance Ltd. 42,52,805/-
3. Matra Kaushal Enterprises Ltd 55,55,067/-
Total 1,22,76,352/-

The Assessing Officer (AO) passed the assessment order disallowing the STCL claimed as set off under Section 70 of the Act, in the computation of income on the ground that it was bogus The AO further made an addition under Section 68 read with 115BBE and ₹3,06,908/- under section 69C of the Act. The CIT(A) upheld the addition made by AO and the ITAT too rejected the appeal although agreed that addition for STCL cannot be made u/s 68. However, it observed that mentioning the wrong section in assessment order would not render the entire assessment as null and void as the AO. Hence, Appellant approached Delhi High Court.

Question before Delhi High Court:

The basic question before the Delhi High COurt was whether the assessee had proved the genuineness of the transaction. The appellant also contested that he was never provided with the material on which the department relied nor provided cross examination of the persons who rendered the statements which was the basis of treating the transaction as bogus.

 Appellant submission:

The appellant raised the following broad arguments to suggest that the transaction was genuine.

1. There is no nexus between the buying and selling brokers since the appellant carried out transactions through registered brokers.

2. The Appellant has discharged its onus and substantiated the claim of STCL arising out of sale of impugned transaction by sufficient documentary evidence filed before the AO, CIT(A) and ITAT.

3. The authorities did not rebut or contradicted the documents produced before them by the Appellant.

4. The ITAT held that Section 68 is not applicable, since it was a case of cash debit and not cash credit, the burden of proof was on the revenue to sustain the addition by leading cogent evidence.

5. The income-tax department failed to gather and produce any credible material in support of treatment of STCL as bogus and therefore, the order of ITAT upholding the additions is unsustainable.

High Court Analysis

The High Court dealt with the various arguments of the assessee while dismissing all the contentions. The Court observed that the AO had explained in detail the general modus operandi of accommodation entry by way of bogus capital gain/loss. For the said purpose the AO had relied upon the report of the Investigation wing.

The AO had also mentioned and highlighted the statement of the persons who claimed to have provided bogus capital gain/loss entries as recorded by the Investigation wing.

The  companies were not having any significant/real business as seen from their financial statement. The price movement of the shares was also found to be unrealistic by the AO. The volume transacted in the impugned script was also very low. There was no history of dividend payout by those companies. It was pointed out that the assessee could not explain why it invested in such a script without knowing the financial performance of the company.

The Delhi High Court dismissed the argument of the assessee and held that the addition was not made solely on the basis of the statement of the persons who control the business of providing accommodation entry but have been corroborated with the material, surrounding circumstance and preponderance of probability.

The High Court has referred to its earlier decision against which an SLP was dismissed by Supreme Court in case of Suman Poddar ITA No. 841/2019 wherein it has observing that there is consistent finding of fact by the Tribunal after analysing the balance sheet and profit and loss statement of Cressanda Solution Ltd which shows that there is astronomical increase in the share price of the said company. It was also observed that the said company is identified by the Bombay Stock Exchange as penny stock used for obtaining bogus long-term capital gain and no evidence of actual sale except contract notes issued by the share broker were produced by the assessee to prove the genuineness of the transaction. Thus, the said transaction was treated as bogus.

On the issue of principle of natural justice the High Court observed that though the right to cross examination of the witness is a legal and statutory right it is not a part of natural justice. The High Court relied upon the SC ruling  in case of Andaman Timbers Industries Vs Commissioner of Central excise, Kolkata -II 2016 (15) SCC 785 wherein the Apex Court has held that

“The principles of natural justice do not require formal cross-examination. Formal cross-examination is a part of procedural justice. It is governed by the rules of evidence, and is the creation of the Court. It is part of legal and statutory justice, and not a part of natural justice, therefore, it cannot be laid down as a general proposition of law that the revenue cannot rely on any evidence which has not been subjected to cross-examination. However, if a witness has given a directly incriminating statement and the addition in the assessment is based solely or mainly on the basis of such statement, in that eventuality it is incumbent on the Assessing Officer to allow cross-examination.

Adverse evidence and material, relied upon in the order, to reach the finality, should be disclosed to the assessee. But this rule is not applicable where the material or evidence used is of Collateral Nature. 

Acelegal Analysis:

The hon’ble Delhi High has observed that the transaction cannot be held as genuine merely on the ground that the Appellant has transacted through registered stock exchange through registered stock broker and has placed documentary evidence like broker notes to prove its onus. The Appellant is not a regular investor and has invested in high risk stocks of companies which have no business activity or assets and were identified as ‘Penny stock’ companies used to obtain bogus long term/short term benefits. Incidentally, these are the characteristics in almost all the penny stock cases.

From the analysis of the said decision of the Delhi High Court it is obvious that the court has been prejudiced on the facts of the case. The Court has taken the investigation wing report as the fait accompli. The relative questions of the AO have been granted supremacy over the documentary evidence produced by  the assessee. It’s strange because if the investigation wing report is so sacrosanct and the principle of natural justice does not apply then why go through the process of assessment. The department should just pass an assessment order on the basis of such a report and raise a tax demand. The High Court has missed the point that section 143(2) and 143(3) of the Act provides for opportunity of hearing to the assessee. Such an opportunity of hearing is not an empty formality. Its purpose is to afford a chance to the assessee to produce his evidence and rebut the evidence of the department. In this case  the department did not rebut the evidence produced by the assessee. The assessee wanted to rebut and sought details from AO and also cross examination which the court felt is not necessary. In view of the author this case is a classic example how the procedure enshrined in section 143(2), 142(1) and 143(3) has been grossly misapplied and violated.

Going forward the assessee cannot do well by merely finding faults in the process of assessment carried out by the AO. The Higher courts are not inclined to give relief on the procedural irregularity of the penny stock cases since the allegations against the assessee are specific and of serious nature. Therefore the assessee has to give a go by to the argument of the violation of principle natural justice as its primary ground and rather be ready with the answers on the questions raised by the Revenue while confirming the bogus nature of these transactions. Hence the assessee would do well to break the argument in the following three categories:

A. Support the argument by producing all possible documentary evidence in support of the genuineness of transactions like brokers notes, demat statement, cheque details, bank statement et all.

B. Give cogent reasons for transacting in the particular scrips (penny stocks) and further support the same with material like past transactions, balance sheet of the assessee showing other share transactions, past capital gain offered and accepted by the department etc to prove that he is not a one time investor in the stock market.

C. Take arguments of the procedural infirmities in the assessment procedure by the AO like the statement relied upon is incorrect for the reasons and evidence submitted, subsequent reports of SEBI or other authorities treating certain transactions as genuine.

In the end the penny stock cases are more dependent upon the perception than the law. The Courts are leaning heavily towards the perception and laying down law to support that perception. The strict rules of evidence are not applicable to the Income Tax Proceedings. Therefore, it will be in the fitness of things that either the assessee ensure answers to all questions raised by the department or else opt for the Vivad Se Vishwas Scheme and sleep peacefully. The fight is going to be long!!!

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Name: Acelegal
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Member Since: 25 Apr 2020 | Total Posts: 10
Acelegal is a research based law firm specializing in tax and property laws. The firm has been handling assortment of issues relating to Direct and Indirect tax laws with real estate transactions at the heart of functions. It deal with plethora of issues in tax and real estate matters ranging from d View Full Profile

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  1. ALOKE GHOSH says:

    I appreciate your observations in respect to the judgment of Delhi High Court and it is most unfortunate that without going by the words of the Statutes, the orders are passed in such cryptic manner. Henceforth while representing before the authorities we shall not have to argue on point of violation of natural justice in terms of the judgment.

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April 2021