Bombay High Court: Capital Gains Cannot be Added as Unexplained Cash Credit under Section 68 of Income Tax Act, 1961

Bombay High Court: Capital Gains Cannot be Added as Unexplained Cash Credit under Section 68 of Income Tax Act, 1961

The Bombay High Court has observed that capital gains cannot be added as unexplained cash credit for the sale of penny stock under Section 68 of Income Tax Act, 1961.

The bench of Justices K.R. Shriram and Fidrosh P. Pooniwalla has observed that since the shares were purchased on the floor of the stock exchange and not from a broker, payment was made through the banking channel, deliverables were taken in the DEMAT account where the shares remained for more than one year, contract notes were issued, and the shares were also sold on the stock exchange, the long-term capital gains claimed as exempt cannot be treated as accommodation entries.

In the present case, the respondent/assessee had shown the sale proceeds of shares in scrip Ramkrishna Fincap Ltd. (RFL) as long-term capital gain and claimed exemption under the Income Tax Act.

The assessee had claimed to have purchased the scrip at Rs. 3.12 per share in 2003 and sold it in 2005 for Rs. 155.04 per share.

The Assessing Officer (AO) noted that the investigation has revealed that the scrip was a penny stock and the capital gain declared was held to be accommodation entries.

A broker, Basant Periwal & Co., through whom these transactions have been effected, appeared, and it was evident that the broker had indulged in price manipulation through synchronized and cross-dealing in scrip of RFL.

The Securities and Exchange Board of India, had also passed an order regarding irregularities and synchronized trades carried out in the scrip of RFL by the said broker. The assessee’s case was reopened under Section 148.

The AO had rejected respondent’s claim of long-term capital gain and added the same to the respondent’s income under Section 68 of the Income Tax Act, 1961.

The Commissioner of Income Tax (Appeals) (CIT[A]) deleted the addition made under Section 68. The CIT(A) has observed that the AO himself has stated that SEBI had conducted an independent inquiry in the case of the broker and in the scrip of RFL, through whom the respondent had made the transaction. It was conclusively proven that it was the broker who had inflated the price of the said scrip in RFL.

The Court noted that CIT(A) did not find anything wrong with the respondent doing only one transaction with the broker in the scrip of RFL. The CIT(A) came to the conclusion that the respondent brought 3000 shares of RFL to the floor of the Kolkata Stock Exchange through a registered share broker.

In pursuance of the purchase of shares, the broker had raised an invoice, the purchase price was paid by cheque and the respondent brought 3000 shares of RFL to the floor of the Kolkata Stock Exchange through a registered share broker. In pursuance of the purchase of shares, the broker raised an invoice, the purchase price was paid by cheque and the respondent’s bank account has been debited.

The shares were also transferred into the respondent's DEMAT account, where they remained for more than one year. After a period of one year, the shares were sold by the said broker on various dates on the Kolkata Stock Exchange. Pursuant to the sale of shares, the said broker had also issued contract notes and bills for sale, and these contract notes and bills were made available during the course of appellate proceedings.

Moreover, the Court noted that on the sale of shares respondent had effected delivery of shares by way of DEMAT instructions slip and also received payment from Kolkata Stock Exchange. The cheque received was deposited in respondent’s bank account.

In view thereof, the CIT(A) had observed that there was no reason to add the capital gains as unexplained cash credit under Section 68 of the Act.

Furthermore, the Income Tax Appeals Tribunal (ITAT) while dismissing the appeals filed by the department, observed that the shares were purchased by the respondent on the floor of the stock exchange and not from the broker; deliveries were taken, contract notes were issued, and shares were also sold on the floor of the stock exchanges.

Accordingly, the bench upheld the ITAT’s ruling and dismissed the department's appeal.