An Analysis of Section 68 of the Income Tax Act, 1961 vis-à-vis Penny Stocks

Advocate Arjun Gupta has examined the taxability of gains arising from penny stocks in the light of the recent amendment to section 68 of the Income-tax Act and judgements of various Courts. He has argued that the amendment imposes an impossible burden upon taxpayers and is unworkable. He has also argued that certain judgements of the High Courts require reconsideration

1. Introduction

The term ‘Penny Stock’ has hitherto not been defined under any Indian enactment currently in force but has often been made the subject of extensive tax litigation currently in process. The term could be defined as ‘a stock traded at a price which is unusually low’ thereby deriving its identity.

The usual course adopted by the tax authorities is to tax the Long Term Capital Gain (“LTCG”) or the Short Term Capital Gain (“STCG”) arising upon the sale of these stocks at abnormally high prices, under Section 68 of the Income Tax Act, 1961(the “Act”). According to the Assessing Officer, the modus operandi adopted by the taxpayer in such cases is to first route unaccounted money through operators/entry providers/associates who inflate the price of the stock exponentially and then sell the same penny stock at that inflated price.

It is not just a single investor who drives up the price but a host of other persons/entities who do so, constituting a racket. The parties involved in such a racket arrange a series of transactions in order to drive up the price of a particular penny stock. These entry providers are awarded a commission for their illegal activities. The exit providers are the purchasers of the stock while the so called ‘beneficiaries’ are the holders of the stock who offload their shares and earn illegal capital gains.

The capital gain arising on account of these transactions is enormous, and for those stocks held for over a year, the capital gain would altogether be exempt by virtue of Section 10(38) of the Act provided the transfer was effected before April 1st, 2018. The results are that once the price of the penny stock crashes on account of the offloading of shares, other investors of the stock are left high and dry while the assessee enjoys tax free gains and gets his unaccounted money which is invested, laundered or accounted for.

This mechanism has not only caused deep infusions of black money into the market but has also had the double effect of allowing taxpayers to evade taxes on a large scale under the guise of LTCG. Therefore, such a device of routing unaccounted income through the medium of the stock market by purchasing and selling shares is clearly prohibited and must be dealt with appropriately.

2. Discussion

A BRIEF EXAMINATON OF THE SCOPE OF SECTION 68 OF THE ACT

– Section 68 of the Act reads as follows:

“Cash credits.
68. Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year :

Provided that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless—

 (a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and

 (b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory:

Provided further that nothing contained in the first proviso shall apply if the person, in whose name the sum referred to therein is recorded, is a venture capital fund or a venture capital company as referred to in clause (23FB)of  section 10.”

Section 68 casts a burden upon the assessee to prove the source of any sum found credited in its books of account. In order to attract Section 68 of the Act, the tests laid down by various courts including the Hon’ble Supreme Court in a recent judgment of Principal Commissioner of Income Tax (Central) – 1 Vs. NRA Iron & Steel Pvt. Ltd. [2019] 412 ITR 161(SC), are that the identity and creditworthiness of the investor/creditor and the genuineness of the transaction are required to be proved. Once these three ingredients have been satisfactorily explained to the Assessing Officer, the burden is then upon the Revenue to disprove the genuineness of the transaction.

The two provisos to Section 68 of the Act were introduced by the Finance Act, 2012 w.e.f. 1-4-2013. The Memorandum of Objects and Reasons thereto states that the reason for introducing these provisos was to place an additional onus upon closely held companies since the share application money, share capital, share premium, or any other such similar amounts received by these companies is usually received from private persons known to them, and therefore such persons investing in these companies must also be required to explain the amounts invested to the satisfaction of Assessing Officer, in order to avoid the rigour of the section. At the same time, it was also made clear that nothing contained in the said provisos will apply to a well regulated entity, such as a venture capital fund or a venture capital company registered with the Securities and Exchange Board of India(SEBI).

The amendment was made with a view to overcome the judgment delivered in Commissioner of Income Tax vs. Lovely Exports (P) Ltd.[2008] 299 ITR 268 (SC), wherein the Supreme Court had held that if the share application money had been received from alleged bogus shareholders, then their assessments could be reopened in accordance with law. This had the effect of exonerating the assessee company with respect to the funds in the form of share application money/share premium received by it.

The proviso to the section requires the investor to further explain the source of the funds invested in the assessee company apart from the basic requirement of the assessee company explaining the nature and source of the funds received by it from the investor. Therefore, what is required to be proven is the origin of the funds upto two stages. Earlier, only the identity and creditworthiness of the investor as well as the genuineness of the transaction were required to be established by the assessee which meant that it was immaterial to show how the funds were received by the investor.

The proviso has therefore cast an additional burden upon the assessee-investee company by requiring the assessee-investee company to know the source of the source, when it is not practical to do so, and to make things worse, instead of taxing the investor bringing in the illegal funds, subject the assessee to tax proceedings by taxing such income as cash credits under Section 68 of the Act.

A Writ Petition under Article 226 of the Constitution of India must be filed challenging the amendment as arbitrary and being in direct violation of Article 14. It is completely impractical to expect the assessee-investee company to know the source of the source and carry out due diligence with respect to funds invested. While the proviso may apply to only closely held companies, it may be misinterpreted to include people other than family, friends and relatives investing in the company for it would be extremely difficult to define ‘family’, ‘relatives’ and especially ‘friends’ who invest in the assessee company, and also to what extent a company may be referred to as ‘closely held’.

There are certain other difficulties arising from the interpretation of this provision, what if the investors are known to the assessee company as friends, relatives or family but the company is not closely held, then will the proviso apply? Further, if the funds are unaccounted, can the assessee company be made liable even though there is no collusion between the parties? Can the assessee be taxed only on the ground that it failed to conduct due diligence with respect to the unaccounted funds invested for which it has provided consideration to the investor in the form of shares or securities? The proviso is unworkable and it is in direct violation of Article 14. It will only cause undue hardship to the assessee, and increase litigation.

In the case of Commissioner of Income Tax Vs. NR Portfolio Pvt. Ltd. (2014) 264 CTR (Del) 258 the scope of the amendment to Section 68 was discussed. Justice Sanjiv Khanna speaking for the Division Bench of the Delhi High Court observed that it is indeed difficult for such companies to explain the source of the source or origin of origin, however, the applicability of the proviso will depend upon the facts and circumstances of the case. Thus, if the assessee is unaware, unconcerned or does not have knowledge of the source of the funds of the investor, the proviso may not apply. However, if the transaction is not an arms length transaction or there is involvement of the assessee in the transaction, the proviso will apply.

With respect, it is impossible to truly ascertain to what degree there is ‘involvement’ between the parties, it may very well be said that there is no involvement or the Revenue may say there is involvement. What is the true nature of the involvement between the parties, i.e how they are involved or known to each other, and whether or not such involvement is sufficient for the funds to be taxed in the hands of the assessee company or to permit an inquiry into the source of the funds invested, would be impossible to establish and also unfair to the assessee company as the funds are to be taxed in the hands of the assessee company. Also, the law cannot possibly be premised upon these trivial factual considerations, as they are not only harsh and oppressive but vague and not capable of precise determination.

To sum up:

(i) Taxing unaccounted funds in the hands of the assessee company by requiring it to have knowledge of the source of the source is not practical.

(ii) An act of collusion needs to be proved to show that the assessee company received unaccounted money in the form of investment and is liable to pay tax on the same. This is very difficult to prove and in most cases the result would be that the assessee had no knowledge of the funds invested.

(iii) Even if the proviso is to be applied based on the facts and circumstances of each case, to prove involvement/knowledge between parties inter se cannot be fastened upon the assessee or the investor, at the most it can be an onus upon the Revenue to establish the same.

(iv) The provision is arbitrary and one sided inasmuch as if funds are received from friends, family or relatives and the company is not closely held, that portion of investment would in all probability escape income tax.

(v) In cases where no collusion is established between the parties, can the assessee company be made liable on the ground that it failed to conduct due diligence of the funds invested? The answer is obviously No. However, then can the assessee company escape payment of tax altogether even if the case falls squarely within the proviso? The proviso would definitely require reconsideration.

(vi) The law cannot be premised on considerations such as proximity of relationship between two persons or their knowledge into each others’ business affairs.

(vii) The proviso in other words is unworkable and impractical and causes undue hardship to the assessee. At the same time it leaves scope for mass litigation and opportunity to exploit its various loopholes.

In view of the above discussion, the provision ought to be struck down as unconstitutional.        

RATE OF TAXATION OF INCOME UNDER SECTION 68 OF THE ACT : SECTION 115BBE

Section 115BBE of the Act reads as follows:
“Tax on income referred to in section 68 or section 69 or section 69A or section 69B or section 69C or section 69D.

115BBE. (1) Where the total income of an assessee,—

(a) includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D and reflected in the return of income furnished under section 139; or

 (b) determined by the Assessing Officer includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, if such income is not covered under clause (a),

the income-tax payable shall be the aggregate of—

  (i) the amount of income-tax calculated on the income referred to in clause (a) and clause (b), at the rate of sixty per cent; and

 (ii) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (i).

(2) Notwithstanding anything contained in this Act, no deduction in respect of any expenditure or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a) and clause (b) of sub-section (1).”

– Section 115BBE was introduced by the Finance Act, 2012 w.e.f. 1-4-2013. The total income tax payable by an assessee on any income referred to in inter alia Section 68 of the Act is the aggregate of:

(i) the amount of income tax payable on the income either reflected in the return of income or determined by the Assessing Officer(such that if the Assessing Officer makes a determination under Section 68 of the Act then the income attributable to Section 68 of the Act as reflected in the return would be excluded from the computation), taxed at the rate of sixty percent; and

(ii) the amount of income tax payable on the net amount after his total income has been reduced by the income referred to above.

Before its amendment by the Taxation Laws (Second Amendment) Act, 2016 w.e.f. 1-4-2017, Section 115BBE provided for such income to be taxed at the rate of thirty percent. Further, there was no clarity as regards the quantum of such income subject to tax i.e whether it would be the income as reflected in the return or whether it would be the income as determined by the Assessing Officer. The newly amended Section 115BBE has now clearly provided for the amount of income referred to in Section 68 of the Act that would be subject to tax.

To that extent, it can also be said that the newly amended Section 115BBE has retrospective effect. Sub-section (2) of Section 115BBE also makes it clear that the benefit of any deduction for any expenditure or allowance or set off of any loss shall not be allowed to the assessee in computing the income under sub-section (1) of Section 115BBE of the Act.

RECENT JUDGMENTS ON THE TAXABILITY OF AMOUNTS RECEIVED UPON THE SALE OF PENNY STOCKS

– In a recent decision of the Income Tax Appellate Tribunal (“ITAT”) in the case of Vijayrattan Balkrishan Mittal and Ors. Vs. Dy. Commissioner of Income Tax, Central Circle-8(1)ITA Nos. 3429, 3428, 3427, 3311, 3312, 3313, 3314, 3426, 3264, 3247, 3265 and 3248/Mum/2019 decided on 01.10.2019, it was held that both the authorities below erred in treating the LTCG as unexplained cash credits under Section 68 of the Act. The Assessment years were: 2012-2013; 2013-2014; 2014-2015; 2015-2016. The facts of the case are as follows:

The assessee had applied for 1,50,000 equity shares of Rs. 10/- each of Pine Animation Limited (PAL), a company listed on the Bombay Stock Exchange(BSE). The payment was made to PAL through an account payee cheque for Rs. 15,00,000/-. The assessee filed copies of the share application form and the relevant bank statements before the Assessing Officer and the Commissioner (Appeals) and also before the ITAT. The company allotted 1,50,000 equity shares of Rs. 10 each to the assessee and credited the shares to the assessee’s demat account. The purchase of shares was duly disclosed in the balance sheet for the year ended 31st March, 2013.

Subsequently, the shares were split into Re. 1/- per share by PAL on 21.05.2013. In FY 2014-15 (AY 2015-16) the assessee sold the above shares of PAL on the BSE Platform through his regular broker M/s. Geojit, registered with BSE and also SEBI, the market regulator. The assessee had been dealing in shares through his broker Geojit for the last 10 years. The assessee received the sale proceeds of the shares directly from his broker Geojit and they were credited to his bank account on the date of settlement. Copies of contract notes along with summary and relevant bank statements showing the amounts credited were provided.

Copies of broker’s ledger and Form 10DB was also provided. The transaction of sale of shares had suffered expenses like brokerage, service tax, STT, stamp duty, exchange and SEBI turnover charges, etc. which were specifically shown in the contract notes issued by the broker. The assessee during the year under consideration had earned long term capital gain (LTCG) amounting to Rs. 14,00,76,815/- on the sale of shares of PAL.

The assessee had 15 lacs equity shares of PAL in earlier years and after holding them for more than a year sold those shares during the year of consideration for a sum of Rs. 14,16,80,449/-. The assessee sold these shares on BSE and paid STT, service tax, stamp duty, etc. The assessee claimed the LTCG as exempt under section 10(38) of the Act.

The ITAT observed that the source of the source of the funds is not required to be explained. It further observed that if the documents such as contract notes, bank account statements coupled with the fact that stamp duty, brokerage, and STT etc. have been paid are all brought on record and established, then there seems to be no reason in upholding the orders of the authorities below.

It further observed that no additions can be based on mere surmises and conjectures and without giving the assessee an opportunity of cross examination. It further observed that since SEBI had exonerated the assessee and no adverse findings were made against the assessee no addition could be levied. It further observed that if the assessee had invested money in the stock market, and there is no collusion established between the parties, it cannot be inferred that the transaction is not genuine. Therefore, the addition was deleted.

On a plain reading of Section 68 of the Act, it becomes abundantly clear that the addition must be based upon credit entries in the books of account. It must be noted that there has been no indication/reference to any examination of the books of account, nor upon the scope of the section in the said judgment. But as rightly held by the ITAT, once the necessary documents are on record, it has been proven that there is no collusion between the parties, and the order of the SEBI has clearly exonerated the assessee and the exit providers, there remains little scope for addition under Section 68 of the Act.

The situation would have been different altogether if the assessee was proven to have rigged prices or caused any kind of fraud with respect to the transaction in question. In such circumstances, the genuineness of the transaction would be in complete doubt thereby attracting Section 68 of the Act. Hence, if there seemed to be any irregularity when the shares were sold, at what dates, how the shares were sold, or whether there was an actively involved racket consisting of operators jacking up the share prices, or even upon the statements of these operators that they were providing accommodation entries to the assessee, the genuineness of the transaction would definitely be an issue giving rise to mixed questions of fact and law whether the addition should be sustained or not.

Also, if the assessee did invest in shares himself using unaccounted money, then the Assessing Officer could have proceeded under Section 69 of the Act dealing with unexplained investments. Therefore, the investment of unaccounted in money in shares would be a separate transaction which differs from the allegation of manipulation of the prices of the stock. The former would fall within the purview of Section 69 of the Act whilst the latter, under Section 68 of the Act. The assessee could be required to show cause as to why addition must not be made under Section 69 at the time of the making of the investment. Nevertheless, the addition made by the Assessing Officer under Section 68 of the Act was deleted.

– In Commissioner of Income Tax-13 vs. Shyam R. Pawar(Income Tax Appeal Nos. 1568, 1569, 1570 and 1571 of 2012) decided on 10.12.2014 [2015] 229 Taxman 256, the Hon’ble Bombay High Court faced the issue of the genuineness of the transaction of dealing in shares on the stock exchange by the assessee. The Assessment years were: 2003-2004, 2004-2005, 2005-2006, 2006-2007.

The facts are that upon an investigation by the Department, the directors of one company viz. Bolton Properties Ltd. were alleged to have floated investment companies to act as exit providers/purchasers of stock. The Assessing Officer sought to tax the assessee for bringing unaccounted money into the market and attempting to launder money. The Hon’ble Court upheld the contention of the assessee that there was some nexus to be established between the assessee and the promoters/directors of the said company to make the assessee liable.

The mere fact that the assessee transacted on the Calcutta Stock exchange, and other minor discrepancies would not favour the case of the Department. The Hon’ble Court came to the conclusion that once all the necessary facts to prove the genuineness of the transaction have been dealt with by the ITAT such as:

(i) how the shares were sold,

(ii) at what consideration,

(iii) at what dates and

(iv) the sums being received by cheque

coupled with the fact that the contract notes, and shares in the DEMAT account etc. were all proven by documentary evidence, there seems to be no substantial question of law arising in the appeals which led the Court to decide in favour of the assessee. The Court came to the conclusion that there was something more which the Department must have unearthed in order to establish even a remote connection with the bogus operators/companies in order to confine the assessee within the tax net.

– In Sanjay Bimalchand Jain L/H Shantidevi Bimalchand Jain vs. The Pr. Commissioner Of Income Tax I, Nagpur & Another [2018] 89 taxmann.com 196 (Bom), the Hon’ble Bombay High Court held that the assessee had been engaged in a dubious share transaction of trading in penny stocks and that he was liable to be assessed under Section 68 of the Act. The facts are as follows:

The assessee purchased two penny stocks of Kolkata based companies i.e., 8000 shares at the rate of Rs.5.50 per share on 8.8.2003 and 4000 shares at the rate of Rs.4/- per share on 5.8.2003 from Syncom Marketing Pvt. Ltd. And of Skyzoom Distributors Pvt. Ltd. The payments were made by the assessee in cash. The addresses of both the companies as well as the broker Global Stock and Securities Ltd were the same.

The authorized signatory of both the companies was also the same person. Both the companies with another company, viz. Khoobsurat Limited, Kolkata and the assessee received the shares of the new company in the ratio of 1:4 of the number of shares of the previous two companies held by the assessee. The assessee sold 2200 shares at an exorbitant rate of Rs.486.55 per share on 07.06.2005 and 800 shares on 26.06.2005 at the rate of Rs.485.65. the shares were sold through another broker, viz. Ashish Stock Broking Private Limited.

The proceeds from the aforesaid sale transaction were directly credited by the broker in the Savings Bank Account of the assessee in the Union Bank of India. The assessing officer held that the aforesaid transactions of purchase of two penny stock shares for Rs.60,000/-, the merger of the companies with a new company and the sale of the shares for Rs.11,58,930/- fell within the ambit of adventure in the nature of trade and the assessee had profited by Rs.13,98,930/-. The assessing officer, therefore, brought the aforesaid amount to tax under the head ‘business income’.

The Hon’ble Court notes that the assessee could not justify such a rapid increase in the prices of the stocks, that the assessee had not an inkling of what transpired after he invested in the stocks, that the entire transaction was dubious and most importantly, that the facts were properly examined by the authorities below. The Hon’ble Court upheld the orders of the authorities below and upon consideration of the above facts and in the circumstances of the case, held that no substantial question of law arose in the appeal and dismissed the appeal.

The order passed by the Hon’ble Court in my opinion, is irrational and contrary to law. The genuineness of the transaction is not a question of fact but a necessary ingredient under Section 68 of the Act and therefore, a question of law. There must have been some real nexus between the assessee and the companies and brokers to attract Section 68 of the Act. Firstly, the assessee is not required to explain how the price of the share rose so high when it is already on record that all the assessee has done is to simply invest in the stock.

Once that is shown, whether or not the addresses of the two companies and the broker were the same would make no difference as long as the assessee has not been found to have rigged the prices of the stocks. It could be possible that the assessee had no knowledge of the addresses of the two companies and the brokers being the same. Unless some evidence is brought on record to show that the assessee was directly linked with these parties beforehand, it cannot be said satisfactorily that the assessee was involved in such a racket.

There is no mention of such evidence in the order of the Hon’ble Court. In fact, the Hon’ble Court adverts to the fact that the assessee did not have an inkling of what was taking place after he had invested his money. Under what circumstances then, is the assessee liable? There is complete anonymity between the parties transacting on a public stock exchange. Unless there was an established racket formed for the specific purpose of jacking up share prices, an ordinary investment cannot go to dispute the genuineness of the transaction.

At the most, the matter could have been remanded to the Assessing Officer to look into the possibility of a stronger nexus between the parties. Further, the order notes that the assessing officer classifies the income as business income, but the order does not specify under what circumstances the income can be classified as business income and not LTCG. Therefore, surely the Hon’ble Court could have entertained the appeal since there was nothing in the orders of the authorities below to disprove the genuineness of the transaction vis-à-vis the assessee. The facts themselves could not conclusively make the assessee liable under Section 68 of the Act.

– In Commissioner of Income Tax  vs. Jamnadevi Agrawal and Ors.  [2010] 328 ITR 656 (Bom), the facts are as follows:

The Respondent-Assessee had purchased 30,000 shares of M/s Authentic Investments & Finance Ltd. on 8th April, 1999 @ Re. 0.98 per share. These shares were claimed to have been sold on 7th July, 2000, 14th July, 2000 and 21st July 2000 at an average value of Rs. 33.81 per share. In the assessment year in question, the assessee offered to tax the capital gains arising from the sale of the above shares, amounting to Rs. 9,84,909 as a long-term capital gain.

The same was accepted. Subsequently, on 20th Jan, 2005, there was a search action in the case of various Assessees belonging to a group known as the Haldiram Group. It appears that on 30th March, 2005, the group offered additional income of Rs. 2 crores, out of which Rs. 3 lakhs were offered in the hands of the Assessee for the assessment year 2004-05 and Rs. 7 lakhs for the assessment year 2005-06.

The Hon’ble Bombay High Court held that merely because some transactions undertaken by the assessee are off-market transactions, that per se would not make the assessee liable under Section 68 of the Act when there is documentary evidence to show that the shares were bought at the rates then prevailing in the market. Further, the Hon’ble Court held that the balances lying to the credit in the buyers’ bank account cannot be relied upon since the transactions were undertaken at market price and therefore, as rightly held by the ITAT, the balances were not attributable to the assessee. Thus, the Hon’ble Court found no merit in the contentions made by the Revenue and dismissed the appeals as not involving any substantial question of law.

Thus, it can be seen that where off-market transactions are undertaken at the rate prevailing in the market, there can be no doubt cast upon the genuineness of such transactions. Such transactions are genuine transactions and not sham transactions.

– In the case of Suman Poddar vs Income Tax Officer(ITA 841/2019), the Hon’ble Delhi High Court and the ITAT have both held in favour of the Revenue. The Assessment Year is 2014-2015. The facts of the case are as follows:

The assessee had booked Long Term Capital Gain (LTCG) of Rs. 73,77,806/- and sought exemption under Section 10 (38) of the Act. The Assessing Officer on consideration of replies and responses of assessee and in pursuance of notices issued to assessee, computed the net taxable income at Rs. 78,74,456/-. M/s Smartchamps IT and Infra Ltd. being the investee company had merged with M/s Cressanda Solutions Ltd. There was a gain of 4910% over a short period of 5 months from the date of allotment of shares (21.02.2013 and 18.07.2013 to 12.09.2013-date of sale) of Cressanda Solutions Ltd. against the purchase of 15,000 shares of Smartchamps IT and Infra Ltd. on 22.09.2011.

The Court/Tribunal has held that inspite of the various documentary evidence produced by the assessee, the transaction in question cannot be termed as a genuine transaction. This for the reasons, that there cannot be any person willing to purchase such shares at such an exorbitant price when the company is nothing but a penny stock company. That the overwhelming evidence produced by the Department goes to show that the assessee was engaged in a transaction with a view to launder money and pay no tax on LTCG. That the balance sheet of the investee company shows that it is a penny stock company, and that such a rapid increase in the share price of the company is totally unjustified and therefore such a transaction is not a genuine one.

With respect, the findings of the High Court as well as the ITAT are fallacious and each of the findings above can be rebutted. Even shares of a penny stock company can be purchased at very high prices when prospective investors are interested in purchasing the stock on account of the rapid increase in its share price. The rapid increase in the price of the stock can be due to a multitude of factors and may even be caused through an illegal racket specially meant for hiking prices. But the assessee must be shown to be complicit in such dealings, otherwise no liability can be fastened upon him, for he is then only an ordinary investor.

The Delhi High Court has completely ignored the vital application of law propounded by the Supreme Court in several cases that the preliminary onus of proving the basic facts lies on the assessee, who has satisfactorily discharged it by producing the relevant documents such as cheques, DEMAT a/c statements, bank statements etc. However, once discharged, the onus shifts to the Revenue, and it is then required to prove the alleged dealings/involvement of the assessee with respect to the transaction in question. The ‘overwhelming evidence’ produced by the Revenue has not even been reproduced or discussed in the order of the ITAT or judgment of the High Court and they have instead relied upon basic facts such as rapid increase in share prices etc. to come to its conclusion. The real question is whether the Revenue has concrete evidence to disprove the genuineness of the transaction, and if there is no real nexus between the evidence and the involvement of the assessee then the assessee cannot be liable and the transaction must be regarded as genuine.

A Special Leave Petition(SLP) was filed challenging the judgment of the Delhi High Court. The same was dismissed without granting special leave to appeal. In the case of Kunhayammed and Ors. vs. State of Kerala and Ors[2000] 245 ITR 360(SC), it was held that if the SLP is dismissed without granting leave to appeal, the appellate jurisdiction of the Supreme Court has not been invoked and the judgment/order of the lower authority does not merge with the order of the Supreme Court rejecting the SLP. Therefore, the mere fact that the SLP has been dismissed would not render the appellant remediless.

It can always file a review petition before the concerned High Court which has passed the impugned judgment and such a petition must be entertained. The mere dismissal of the SLP would only mean that the Supreme Court does not deem it fit to interfere or invoke its appellate jurisdiction as the case is not fit for examination by the Supreme Court on the merits or otherwise. However, if the Apex Court records any observations in such an order, then those observations must be regarded as the law of the land under Article 141 and must be followed by every judicial authority in the country. However, if leave to appeal is granted, the appellate jurisdiction of the Supreme Court is invoked and the jurisdiction of the High Court to entertain a review petition is lost, because the Supreme Court has then taken cognizance of the matter.

In Khoday Distilleries Ltd. and Ors. vs. Sri Mahadeshwara Sahakara Sakkare Karkhane Ltd. [2019]262 TAXMAN 279 (SC); (2019)4 SCC 376, a three judge bench of the Supreme Court held that a review petition can be filed and if it has been filed and dismissed, that judgment can be challenged before the Supreme Court even though the SLP was dismissed earlier. Also, a party is free to first file a review petition and thereafter file an SLP against the impugned judgment passed in the review petition. In other words, it would make no difference when the SLP is filed. Further, the observations in the case of Kunhayammed(supra) were affirmed and reiterated.

Therefore, it is open to the assessee to file a review petition before the Hon’ble Delhi High Court and an appeal against such a judgment is maintainable before the Apex Court.

In a very recent decision of P. Singaravelan & Ors. vs. The District Collector, Tiruppur & Ors. decided on 18.12.2019, a Division Bench of the Apex Court reiterated the observations made in Kunhayammed(supra) and held that mere dismissal of an SLP by a non-speaking order does not attract the doctrine of merger.

3.  Miscellaneous

Question:

Do the Assessing Officers tax the entire proceeds arising from the sale of penny stocks or are their assessments confined to only the capital gain arising from the sale of these stocks?

Answer: If the Court holds that the funds invested in these penny stocks is unaccounted money, then it would be correct to tax the entire sale proceeds as income under Section 68 of the Act. This for the reason, that if an investor has say invested Rs.100/- in a penny stock trading at Rs. 2/- and has sold the penny stock at Rs. 30/- within a short span of time and received Rs. 1500/-, he has made gains of Rs. 1400/-. If the Rs. 100/- invested is unaccounted money and he has shown to have rigged the stock’s prices, the entire proceeds of Rs. 1500/- must be brought to tax.

Once the genuineness of the transaction is in doubt, any income received thereon must be taxed since the credit entries in the books of account would comprise of both the capital gain as well as the proceeds. Once the transaction as recorded in the books of account is not a genuine transaction, the sums representing the credit entries must be brought to tax. It is common for the Assessing Officers to tax the entire sale proceeds and not just the LTCG or STCG arising upon the sale of penny stocks.

Question:

If SEBI has exonerated the assessee whether that per se can be used as evidence to prove that the transaction was genuine?

Answer: Once SEBI has passed an order exonerating the assessee, that order would be final and would warrant no interference. Ordinarily no appeal is filed against an order of the SEBI itself exonerating the assessee. SEBI cannot appeal against its own order. The same can therefore be used by the income tax authorities/fora as evidence to determine the liability of the assessee.

4. Conclusion

The issue of the manipulation of the prices of penny stocks lies squarely on the genuineness of the transactions undertaken with respect to these stocks. Unless some cogent, clear evidence is led to establish such price rigging or manipulation of prices, these activities seem entirely justifiable and Section 68 of the Act cannot be attracted. The assessee cannot be blamed for investing his hard earned money in a stock, be it a penny stock or otherwise, to only be subject to tax proceedings causing undue hardship to him.

Unless it is shown that there is some nexus between any operators who have rigged prices as well as exit providers and the assessee, merely because the assessee has invested in a penny stock would under no circumstances make the assessee liable under Section 68 of the Act. As shown above, the connection between the parties must be established to disprove the genuineness of the transaction. Evidently, there is no straightjacket formula to be applied to these cases, as their fate rests only upon their own unique facts and circumstances.

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