While dismissing an appeal filed by a taxpayer, who claimed long-term capital gains (LTCG) exemption of Rs84.79 lakh on the sale of penny stocks, the Mumbai bench of the income tax appellate tribunal (ITAT) ruled that the transactions were 'unnatural, suspicious, and pre-arranged'.
In an order last month, the ITAT bench of Sandeep Gosain (judicial member) observed that the shares were purchased by the assessee in cash and in physical form and the part shares were sold only when the price trend was increasing. "The price movement of share market behaviour of the entities involved in the trade of the script, as the share price movement and the profit earned by the beneficiaries, were beyond human probabilities, which has already been discussed in detail in the order of assessment."
"And thus, it is a clear case of huge capital gain earned by the assessee within a very short period of time by investing in a penny stock whose fundamentals had no support for the premium. It commanded was neither the result of a coincidence nor of a genuine investment activity, but was created through well-planned and executed scheme in which company, brokers and the buyers and sellers of the script worked in tandem to achieve the predetermined objectives," Mr Gosain says in the order.
The case involved Chitra Avdhesh Mehta, who had reported LTCG on the sale of shares of Turbo Tech Engineering Ltd and Kappac Pharma Ltd, purchased in earlier years at Rs12 per share and later sold at an extraordinary price of Rs720 per share through a broker on the stock exchange. She claimed exemption under Section 10(38) of the Income-tax (I-T) Act.
Ms Mehta had earned income from professional fee receipts, short-term capital gains and other sources, and filed her return of income on 26 July 2014, declaring a total income of Rs454,940. Alongside, she claimed exemption under Section 10(38) of the I-T Act amounting to Rs84.79 lakh on account of LTCG from listed securities.
The case was picked up for scrutiny under computer-assisted scrutiny selection (CASS), following which a notice under Section 143(2) was issued on 18 September 2015. Later, a notice under Section 142(1) read with Section 129 was issued on 29 April 2016 seeking further details, as the quantum of claimed LTCG raised suspicion and warranted deeper investigation.
The assessing officer (AO) observed that Ms Mehta sold all 500 shares of Turbo Tech Engineering between 20 June 2013 and 8 July 2013, precisely during a period of rising prices and did not sell during the subsequent downward trend that began after 24 July 2013. Similarly, she sold all 9,000 shares of Kappac Pharma between 24 February 2014 and 28 March 2014, again during an upward price movement, without selling once the trend reversed after 25 April 2014. The AO noted that this selective timing of sales suggested a pre-arranged design rather than natural investment behaviour.
The scrutiny also revealed that the shares of Turbo Tech Engineering were purchased in cash on 12 December 2011 and those of Kappac Pharma on 9 October 2012. However, the shares were not dematerialised until much later, 27 May 2013 for Turbo Tech and 27 December 2013 for Kappac Pharma. The AO pointed out that such delayed dematerialisation cast doubt on the claim that the shares had genuinely been held since 2011 and 2012, especially given that the purchases were made in cash.
After conducting further enquiries, the AO concluded that the abnormal price movements and trading patterns indicated that the transactions were not genuine investments but part of a carefully orchestrated circular trading scheme. The entities involved, he noted, were engaged in creating documentation to support a pre-planned arrangement aimed at converting unaccounted cash into tax-exempt income.
Accordingly, an assessment order under Section 143(3) was passed, treating the claimed Rs8,479,100 as unexplained cash credit under Section 68, and Ms Mehta’s total income was reassessed at Rs8,934,040. These additions were subsequently confirmed by the commissioner of income tax (appeals) (CIT(A)).
On further appeal, the tribunal noted that the shares were purchased in cash, dematerialised only shortly before sale and showed a sharp and unexplained surge in price without any corresponding improvement in the companies’ financials. Referring to the Supreme Court’s landmark ruling in Sumati Dayal vs CIT (1995) 214 ITR 801, the ITAT stressed the importance of applying the 'test of human probabilities' in evaluating such claims.
The bench held that Ms Mehta had not discharged the burden of proving the genuineness of the capital gains. “The banking documents are self-serving, the timing of dematerialisation raises doubts, and the price rise in these obscure companies defies commercial logic,” the order stated.
The tribunal distinguished Ms Mehta’s reliance on favourable rulings such as Pr CIT vs Ziauddin A Siddique (Bombay High Court, 2022) and Pr CIT vs Krishna Devi (Delhi High Court, 2021), noting that those cases involved different factual matrices. Instead, it followed coordinate bench decisions in Manvi Khandelwal vs ITO (Delhi ITAT, 2019) and ACIT vs Arihant Kumar Jain (Delhi ITAT, 2021), both dealing with similar penny stock scrips, where additions had been upheld.
Consequently, the tribunal dismissed the appeal, confirming the addition of Rs84.79 lakh under section 68 for the assessment year 2014–15.
The order reinforces the judiciary’s consistent stance on bogus LTCG claims arising from penny stock transactions, where astronomical price movements in financially weak companies are used as a façade for laundering unaccounted income.
