Introduction
Penny stocks, often associated with small, illiquid companies, have been a subject of concern due to their susceptibility to price manipulation. The Income tax Act, 1961, contains provisions such as Section 68 (Unexplained Cash Credits) and Section 10(38) (Exemption on Long Term Capital Gains LTCG) to prevent tax evasion through sham transactions involving these stocks. The recent judicial pronouncements discussed below reaffirm the stance of revenue authorities in curbing tax evasion through fictitious capital gains.
Case Law Analysis
1. PCIT Vs Swati Bajaj (Calcutta High Court), IA No. GA/2/2022, Dated:14/06/2022
Facts of the Case
The assessee invested in shares of a company (‘S’), purchased for ₹1 lakh.
Within a short period, despite a recessive market trend, the value surged abnormally, and the shares were sold for ₹29 lakhs.
The assessee claimed LTCG exemption under Section 10(38) of the Incometax Act, 1961.
The Assessing Officer (AO) received an Investigation Wing report indicating that the prices of shares of certain penny stock companies, including ‘S’, were artificially rigged to facilitate bogus LTCG claims.
The AO, upon scrutiny, found the transaction to be nongenuine and made additions under Section 68, treating the LTCG as unaccounted income.
Contentions of Revenue
The assessee failed to establish the creditworthiness of the companies involved in these transactions.
The steep rise in stock price within a short period, in contrast to general market trends, was highly suspicious.
Mere documentation such as bank statements, purchase/sale records, and Demat account details were insufficient to prove the genuineness of the transaction.
Ratio Laid Down by the Tribunal
The burden of proof under Section 68 lies on the assessee to substantiate the legitimacy of the share transactions.
The Tribunal emphasized that paper-based documentation alone is not conclusive proof of genuine transactions, especially when market trends contradict such price movements.
In cases where artificial price rigging is evident, revenue authorities have the right to deny LTCG exemption and treat the income as unexplained cash credit.
Decision of Tribunal and High Court
The Tribunal initially ruled against the revenue, interfering with the Commissioner’s assumption of jurisdiction under Section 263.
However, the High Court overturned this decision, holding that the Commissioner was justified in invoking Section 263 since the AO had overlooked the fraudulent nature of transactions.
It was held that Assessing Officers must take note of investigation reports on penny stocks and initiate inquiries instead of accepting claims at face value.
Conclusion: This case sets a precedent that unexplained stock price fluctuations and suspicious LTCG claims warrant strict scrutiny by tax authorities, upholding the revenue’s stance.
Facts of the Case
The assessee purchased shares of HPC in 2013 at ₹5 per share.
In a short span, the price escalated steeply to ₹591.74 per share, generating LTCG of ₹1.17 crores.
The AO denied the LTCG exemption under Section 10(38) based on an investigation report identifying HPC as a company involved in creating bogus LTCG transactions.
The assessee failed to provide rationale for investing in a company without evaluating its financials.
SEBI had already issued an order restraining HPC from accessing the securities market due to fraudulent activities.
Contentions of Revenue
The unrealistic price appreciation of shares indicated price manipulation.
The assessee failed to prove the genuineness of the transaction and the legitimacy of the funds used.
The SEBI ban on the company further validated the AO’s suspicion of bogus transactions.
Transactions executed through account payee cheques alone do not establish genuineness in cases of artificial price manipulation.
Ratio Laid Down by the Tribunal
The Tribunal upheld that a steep and unexplained rise in share prices, when coupled with investigation reports and regulatory action, strengthens the revenue’s case.
The burden lies solely on the assessee to demonstrate the authenticity of share transactions.
Bank transactions alone cannot validate the genuineness of an entry when other factors indicate a fabricated transaction.
As the assessee failed to discharge the onus under Section 68, the additions made by AO were justified.
Decision of Tribunal
The Tribunal upheld the AO’s decision to treat LTCG as unaccounted income under Section 68.
It ruled in favor of the revenue, confirming that the transactions were sham in nature.
However, an addition under Section 69C (Unexplained Expenditure) was deleted as the bogus share purchase occurred in an earlier assessment year.
Conclusion: This ruling further reinforces that unsubstantiated LTCG claims from penny stocks must be carefully scrutinized and denied when evidence suggests price manipulation.
Implications for Revenue
1. Strengthened Power of Assessing Officers:
These judgments reinforce the AO’s authority to deny LTCG exemptions if the assessee fails to prove the genuineness of share transactions.
2. Use of Investigation Reports as Crucial Evidence:
The Investigation Wing’s findings on penny stock manipulations carry significant weight in establishing fraudulent claims.
3. Onus on Assessee to Prove Transactions:
The burden of proof under Section 68 is on the taxpayer. Mere documentation does not suffice if surrounding facts suggest fabricated transactions.
4. Recognition of Market Trends and Regulatory Actions:
Unnatural stock price movements, SEBI restrictions, and lack of financial diligence by investors indicate potential tax evasion schemes.
5. Preventing Revenue Loss through Bogus LTCG Claims:
These rulings help in curbing tax evasion by ensuring that fraudulent stock market gains do not enjoy tax exemption under Section 10(38).
Conclusion
The judgments in Swati Bajaj and Sangeeta Devi Jhunjhunwala provide strong precedents in favor of revenue in cases involving penny stock manipulations. They reaffirm that:
Artificial stock price inflation cannot be used to generate taxfree LTCG.
The onus is on the taxpayer to substantiate the genuineness of stock transactions.
Assessing Officers are justified in making additions under Section 68 when transactions appear suspicious.
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