ITA Affirms Disallowance of Long Term Capital Gains Exemption for Non-Genuine Share Transactions in Penny Stock Companies

Introduction

The case of Atmiben Alpitkumar Doshi vs. The Income Tax Officer, Himmatnagar adjudicated by the Income Tax Appellate Tribunal (ITA), Ahmedabad Bench on January 30, 2023, addresses the contentious issue of disallowing Long Term Capital Gains (LTCG) exemption under Section 10(38) of the Income Tax Act for shares deemed non-genuine. This case revolves around the appellant’s claim of LTCG from the sale of shares in Kappac Pharma Limited, which the Assessing Officer (AO) contested as being part of an arranged accommodation entry, leading to the disallowance of the claimed exemption.

Summary of the Judgment

The appellant, Atmiben Alipitkumar Doshi, invested in 5,000 shares of Kappac Pharma Limited on April 2, 2012, at a price of Rs.20 per share, which was higher than the prevailing market price of Rs.17.45. The shares were acquired through off-market transactions involving cash payments. On March 27, 2014, the appellant sold 2,000 shares, realizing substantial LTCG. The Assessing Officer objected to the genuineness of the transaction, citing the high purchase price and the scrip’s status as a penny stock under investigation, leading to the denial of the LTCG exemption under Section 10(38). The appellant contended that the Assessing Officer’s stance was based on conjecture without concrete evidence, arguing that all transactions were genuine, properly documented, and compliant with legal requirements. Referencing several precedents, including the Delhi High Court’s decision in the Udit Kalra case, the appellant sought to overturn the disallowance. The ITA, however, upheld the Assessing Officer’s decision, accepting that the higher-than-market purchase price in a penny stock context, coupled with ongoing investigations and the scrip’s suspensions, indicated non-genuine transactions. The Tribunal found the appellant’s explanations insufficient to counter the substantial doubts raised by the AO, thereby dismissing the appeal.

Analysis

Precedents Cited

The appellant relied on several key precedents to bolster the argument for recognizing the LTCG as genuine:

Prakash Javia HUF v. ITO (ITA No.464 & 465/Ind/2019, Indore Bench): This case highlighted the necessity of concrete evidence in establishing the authenticity of capital gains claims.
Ayushi Jain v. ITO (ITA No.2551/Kol/2018, Kolkata Bench): Emphasized the requirement for detailed documentation and evidence to support the genuineness of share transactions.
PCIT v. Jagat Pravinbhai Sarabhai (R/Tax Appeal No.332 of 2022, Gujarat High Court): Addressed the importance of scrutinizing share transactions in penny stock companies to prevent tax evasion through bogus entries.
Smt Reshmiben Pa. Kanugo v. ITO (ITA No.2131/Ahd/2018, Tribunal Order dated 28.02.2022): Reinforced the stance against non-genuine share transactions, especially in the context of inflated purchase prices.
Udit Kalra, 2019(4)TM/834 (Delhi High Court): Specifically dealt with the Kappac Pharma Limited scrip, deeming such transactions as non-genuine and bogus.

Legal Reasoning

The Tribunal meticulously examined the factual matrix surrounding the appellant’s transactions. The key aspects influencing the decision included:

Overpriced Purchase: Acquisition of shares at Rs.20 when the market rate was Rs.17.45 raised suspicions of non-genuine transactions, potentially indicative of accommodation entries.
Off-Market Transactions and Cash Payments: The mode of purchase, involving significant cash and off-market dealings, lacked transparency and deviated from standard stock exchange operations.
Penny Stock Status: Kappac Pharma Limited’s classification as a penny stock and its suspension from trading exacerbated doubts about the authenticity of share price appreciations.
Absence of Concrete Evidence: The appellant failed to provide substantial evidence refuting the AO’s claims, relying instead on general assertions of legitimacy without addressing specific allegations.
Precedential Support: The Tribunal upheld existing judicial precedents that favor stringent scrutiny of transactions in volatile or scrutinized stocks to prevent tax evasion.

Based on these factors, the Tribunal concluded that the appellant’s LTCG claim lacked sufficient corroborative evidence to be deemed genuine, thereby validating the Assessing Officer’s disallowance under Section 10(38).

Impact

This judgment reinforces the rigorous standards applied by tax authorities and tribunals in evaluating the authenticity of capital gains, especially in scenarios involving:

Penny Stocks: Shares of companies with low market capitalization or those under regulatory scrutiny are subject to heightened examination to deter tax avoidance.
Overpriced Transactions: Purchases at prices significantly deviating from market rates can attract disallowances and penalties if deemed non-genuine.
Documentation and Evidence: Taxpayers must maintain comprehensive and transparent records of their transactions to substantiate claims of genuine capital gains.

Furthermore, the decision underscores the judiciary’s inclination to support tax authorities in cases where taxpayer claims appear unsubstantiated, thereby narrowing avenues for evasion schemes under the guise of legitimate investment profits.

Complex Concepts Simplified

1. Long Term Capital Gain (LTCG)

LTCG refers to the profit earned from the sale of an asset held for more than a specified period (typically one year for shares). Under Section 10(38) of the Income Tax Act, certain LTCGs are exempt from taxation if specific conditions are met.

2. Section 10(38) of the Income Tax Act

This section provides exemption from tax on LTCG arising from the sale of equity shares or units of equity-oriented mutual funds, provided Securities Transaction Tax (STT) has been paid.

3. Section 68 of the Income Tax Act

This section deals with circumstances where the source of income is unexplained. If an individual has unexplained income exceeding certain thresholds, it can be presumed as undisclosed income and taxed accordingly.

4. Penny Stock

Penny stocks refer to shares of small companies that trade at low prices per share. These stocks are often volatile and carry higher risk, making them susceptible to price manipulation and fraudulent activities.

5. Accommodation Entry

A financial transaction where one party provides funds to another, typically under the guise of a loan or investment, but with the intention of disguising the true nature of the transaction, often for tax evasion or money laundering purposes.

Conclusion

The ITA’s decision in Atmiben Alipitkumar Doshi vs. The Income Tax Officer serves as a pivotal reference for the treatment of LTCG in the context of non-genuine share transactions, particularly within penny stock companies. By upholding the disallowance of LTCG exemption under Section 10(38) based on substantive examination of transaction authenticity, the Tribunal reinforces the necessity for taxpayers to ensure transparency and genuine intent in their investment activities. This judgment acts as a deterrent against potential tax evasion schemes that exploit inflated share transactions and underscores the imperative for maintaining accurate and verifiable financial records to substantiate capital gains claims.