2025 (5) TMI 1295 - AT - Income Tax

Denial of LTCG exemption u/s 10(38) - Bogus LTCG arising from sale of shares of a company considered as a penny stock - HELD THAT - No malice or malafide could be attributed on the purpose of assessee venturing into investment in shares of Unno Industries Limited. Moreover the payment for purchase of those shares though allotted to him on preferential allotment basis had been made by account payee cheque and share certificates to that effect were physically received and duly dematted with the registered depository participant. Shares were purchased in assessment year 13-14 after obtaining the approval of the Hon ble Bombay High Court approving the merger. No action whatsoever or adverse inference drawn on the assessee in the year of purchase of shares. When those shares are kept in demat account which were sold by the assessee in the open market after duly suffering STT the same cannot be doubted by the revenue. We find that there is no case for making any addition u/s 68 of the Act in the hands of the assessee by denying the exemption under section 10(38) of the Act for the LTCG on sale of shares of Unno Industries Limited in the facts and circumstances of the instant case. Accordingly the grounds raised by the assessee are allowed.

Summary

The core legal question considered by the Appellate Tribunal (AT) was whether the Learned Commissioner of Income Tax (Appeals) [CIT(A)] was justified in deleting the addition made by the Assessing Officer (AO) on account of denial of exemption claimed under section 10(38) of the Income-tax Act, 1961 (the Act) for long-term capital gains (LTCG) arising from sale of shares of a company considered as a penny stock by the revenue. The appeals pertained to assessment years 2014-15 and 2015-16, and the issues in both years were identical.

The principal issue was whether the LTCG exemption under section 10(38) could be denied on the ground that the transactions were pre-arranged, sham, or accommodation entries, particularly when the shares involved were from a company whose scrip was tainted by SEBI orders and investigation reports but where the assessee was not directly implicated.

Additionally, the Tribunal examined the validity of the AO's reliance on external investigation reports and the non-compliance of the company with notices under section 133(6) of the Act, and whether the assessee's transactions were genuine and supported by evidence.

Issue-wise Detailed Analysis:

1. Validity of Denial of LTCG Exemption under Section 10(38) on Grounds of Pre-arranged Transactions and Accommodation Entries

The relevant legal framework includes section 10(38) of the Act, which exempts LTCG arising from transfer of listed securities subject to satisfaction of conditions such as payment of Securities Transaction Tax (STT). The AO denied exemption by treating the LTCG as unexplained cash credit under section 68, alleging the transactions were sham and pre-arranged based on investigation reports and SEBI orders against the company.

The Tribunal noted that the assessee had purchased shares on preferential allotment basis following a scheme of arrangement approved by the Bombay High Court, paid through banking channels, and held the shares in demat form for over one year before selling part of them on the recognized stock exchange after paying STT. The sale proceeds were received through proper banking channels.

The AO's adverse conclusion was primarily based on external reports from the Investigation Wing (Kolkata) and SEBI orders penalizing the company for violations of PFUTP Regulations, 2003, and the company's non-compliance with notices under section 133(6). However, the assessee was not implicated in these reports or orders.

The Tribunal emphasized that suspicion or surmise, no matter how strong, cannot substitute for legal evidence. The AO had not brought any direct evidence against the assessee to prove that the transactions were not genuine. The AO had accepted the genuineness of the transaction to the extent of the cost of shares (Rs. 3,33,000/-), only disputing the LTCG portion (Rs. 63,06,402/-), which indicated partial acceptance of the transaction's authenticity.

Furthermore, the Tribunal observed that the AO failed to undertake independent enquiry or provide the assessee an opportunity to cross-examine the persons implicated in the investigation reports. The AO also did not issue summons to the company to enforce compliance with notices, nor did he take further legal steps against the company's non-compliance, which was a procedural lacuna.

The Tribunal applied the principle that the burden of proof lies on the revenue to establish that the transaction was a sham or accommodation entry, and in absence of cogent material, the benefit of doubt must go to the assessee. The Tribunal relied on the principle that "suspicion howsoever strong cannot partake the character of legal evidence."

2. Reliance on External Investigation Reports and SEBI Orders

The AO relied heavily on reports from the Investigation Wing and SEBI orders penalizing the company for market manipulation and price rigging. The Tribunal noted that these reports did not name or implicate the assessee in any wrongdoing. The SEBI order imposed penalty on the company for violations of PFUTP Regulations but did not connect the assessee to any manipulative activity.

The Tribunal held that such external information could only give rise to suspicion but cannot be the sole basis for adverse inference against the assessee without corroborative evidence. The Tribunal underscored that the assessee's transactions were in the open market through recognized brokers and dematerialized shares, which is prima facie evidence of genuineness.

3. Non-compliance of Notice under Section 133(6) by the Company and Its Effect on the Assessee

The AO issued notices under section 133(6) to the company, which were not complied with. The AO questioned the assessee's claim of ignorance about the company's directors, arguing that the assessee could not have been allotted shares preferentially if he did not know the directors.

The Tribunal rejected this reasoning as unrealistic, noting that the assessee was a minority investor and could not be expected to ensure compliance by the company's principal officers. The Tribunal further observed that the AO did not take steps to issue summons to the company or pursue legal consequences for non-compliance, which would have been the correct course of action.

Thus, the non-compliance by the company could not be held against the assessee, who had made payment through banking channels and held shares in demat form.

4. Application of Precedents and Judicial Discipline

The Tribunal relied on a decision of the Hon'ble Jurisdictional High Court in a case involving similar facts, where the Court held that the AO's conclusion of sham transactions based solely on price fluctuations and investigation reports without independent corroborative evidence was unsustainable. The High Court emphasized that the AO's reliance on suspicion and conjecture without material evidence was erroneous.

The Tribunal distinguished a decision of the Hon'ble Calcutta High Court cited by the revenue, which required the assessee to prove the genuineness of price rise in adverse market conditions. The Tribunal held that the Jurisdictional High Court's decision prevails over that of a non-jurisdictional High Court and must be followed to maintain judicial discipline, as per Supreme Court precedent.

The Tribunal also noted the Supreme Court's principle that where conflicting High Court decisions exist, the construction favorable to the assessee should be adopted.

5. Assessment Year 2015-16

The facts and issues for assessment year 2015-16 were identical to those of 2014-15. The Tribunal applied the same reasoning and conclusions mutatis mutandis to the subsequent year.

Conclusions:

The Tribunal concluded that the AO's addition denying exemption under section 10(38) was based on suspicion, surmise, and reliance on external reports without direct evidence implicating the assessee. The assessee had discharged the initial onus under section 68 by demonstrating identity, genuineness, and creditworthiness of the transaction.

The Tribunal held that the LTCG arising from sale of shares of the company was rightly exempted under section 10(38) and the addition was rightly deleted by the CIT(A). The appeals filed by the revenue were dismissed.

Significant Holdings:

"Suspicion howsoever strong cannot partake the character of legal evidence."

"The entire addition has been made in the hands of the assessee merely on suspicion, surmise and conjecture without bringing on record any material or evidence as to how the assessee herein was involved in the alleged connived transactions."

"If the genuineness of the transaction is to be doubted, the Learned AO ought to have doubted the entire sale consideration receipt of Rs. 66,39,402/-. Whereas in the instant case, he has doubted only to the extent of long-term capital gains earned by the assessee to the tune of Rs. 63,06,402/- on the ground that the same is not genuine."

"The AO's reliance on the report of the Investigation Wing and SEBI orders without any direct evidence against the assessee is insufficient to draw an adverse inference."

"The assessee, being a minority investor and a mere gullible investor, cannot be held responsible for the non-compliance of notices by the company."

"The decision of the Hon'ble Jurisdictional High Court would have higher precedence value than the decision of Hon'ble Non-Jurisdictional High Court on the Tribunal."

"Where there are two conflicting decisions of various High Courts, the construction that is favourable to the assessee should be adopted."

"The learned ITAT, being the last fact-finding authority, on the basis of the evidence brought on record, has rightly come to the conclusion that the lower tax authorities are not able to sustain the addition without any cogent material on record."

In sum, the Tribunal affirmed the principle that mere suspicion or adverse reports against a company do not suffice to deny exemption to an investor unless direct evidence against the investor is established. The genuineness of the transaction must be judged on the basis of evidence, not conjecture, and the burden lies on the revenue to prove the transaction is a sham or accommodation entry. The Tribunal dismissed the appeals of the revenue and upheld the exemption claimed under section 10(38) for both assessment years.