₹55L LTCG Denied: ITAT Busts Fake Penny Stock Deal

The misuse of penny stock transactions to claim tax-free gains has been under the Income Tax Department's radar for many years. In a recent case, the Ahmedabad Bench of the Income Tax Appellate Tribunal (ITAT) delivered a significant judgment disallowing a Long-Term Capital Gain (LTCG) exemption of ₹55.52 lakhs. The Tribunal found that the claim made by the taxpayer was bogus, part of a fabricated transaction, and aimed at converting unaccounted money into tax-free income.

This case sets a powerful precedent in the ongoing battle against black money circulation through manipulated stock market entries. Let's explore what happened in this case, the reasoning behind the tribunal's decision, and what lessons investors and taxpayers can learn.

Background of the Case

• Assessee: Mr. Chimanbhai Chhaganbhai Pokal

• Claimed Exemption: ₹55.52 lakhs under Long-Term Capital Gains (LTCG)

• Shares Involved: M/s. Neo Polymers Pvt. Ltd., later merged into Vindus Holdings Ltd.

• Transaction Type: Off-market purchase of penny stock shares and later sale through the demat account

The assessee purchased 3,750 shares of a lesser-known company, Neo Polymers, through an off-market transaction in 2009. These shares were allegedly acquired partly in cash and partly by cheque (delayed). After an amalgamation of Neo Polymers into Vindus Holdings Ltd. in 2010, the shares increased to 18,750 and were later sold for over ₹59 lakhs, claiming LTCG exemption.

However, on closer examination, the Income Tax Department found the entire transaction suspicious.

Investigation Findings

The Assessing Officer (AO) initiated scrutiny based on credible information received from the Directorate of Investigation, Kolkata, which had uncovered large-scale manipulation in penny stocks to generate fictitious LTCG.

⚠️ Key Red Flags in the Transaction:

1. Suspicious Entry Provider:

   • The transaction involved Mr. Ashok Kumar Kayan, a known accommodation entry provider, who admitted to issuing fake LTCG entries for various taxpayers.

2. Unusual Profits Without Business Substance:

   • The company in question, Neo Polymers, had weak financials, negligible business operations, and no valid reason for its stock price to skyrocket.

3. Backdated and Off-Market Transactions:

   • Shares were bought off-market, without exchange record, and documentation inconsistencies were evident.

   • Demat records showed credit in February 2010, while share certificates were dated November 2010 — clearly pointing to backdating.

4. Family Pattern of Similar Transactions:

   • Several family members of the assessee had similar transactions, all showing identical patterns of buying penny stocks and claiming LTCG exemption.

5. No Track Record as an Investor:

   • The assessee was not an active investor and had no history of stock trading. A one-off investment yielding a 15x return is highly improbable in such cases.

Contention by the Assessee

The assessee challenged the addition by filing an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)]. Key arguments included:

• He had followed all required procedures for buying and selling shares.

• The statement of Mr. Ashok Kayan should not be used against him, as no cross-examination was allowed.

However, the CIT(A) rejected the appeal, holding that:

• The transaction was part of a pre-designed penny stock scam.

• The gains were engineered to convert unaccounted income into LTCG.

• The cross-examination was not essential, as the conclusion was not solely based on Kayan’s statement, but on a range of corroborative evidence.

ITAT’s Final Decision

A two-member bench comprising Shri Siddhartha Nautiyal (Judicial Member) and Shri Narendra P. Sinha (Accountant Member) upheld the findings of both the AO and the CIT(A).

✍️ Key Points by the Tribunal:

• The transaction lacked economic substance.

• The massive capital gains made from a loss-making penny stock defied logic and market reality.

• The assessee's argument regarding cross-examination was rejected.

• The Tribunal cited the Supreme Court ruling in Sumati Dayal v. CIT, which permits using the test of human probability and surrounding circumstances to assess the genuineness of transactions.

👉 Result: Appeal dismissed, and the LTCG exemption of ₹55.52 lakh was disallowed.

Why This Case Matters

This case is a wake-up call for those who attempt to exploit stock market loopholes to evade tax. The ITAT ruling confirms that:

• Paper trails are not enough — transactions must be genuine and supported by commercial reality.

• Off-market penny stock dealings with abnormal returns are likely to come under the scanner.

• The burden of proof lies with the taxpayer to establish the legitimacy of capital gains.

• Human conduct and logic are valid parameters to question the truth of an apparent transaction.

FAQs: Penny Stock LTCG and Tax Scrutiny

❓ What is a penny stock?

A penny stock is a low-priced, highly volatile stock, often with poor financials and low market capitalization. These are frequently used in tax evasion schemes due to ease of price manipulation.

❓ Is LTCG on listed shares taxable?

Prior to April 2018, LTCG on listed equity shares held for over one year was exempt from tax under Section 10(38) of the Income Tax Act. Now, LTCG exceeding ₹1 lakh is taxed at 10% without indexation.

❓ Can ITD reject LTCG claims?

Yes. If the Income Tax Department finds that a transaction is fictitious, pre-arranged, or lacks commercial substance, it can disallow the LTCG exemption and treat it as unexplained income.

❓ Can the taxpayer demand cross-examination of entry providers?

Only in certain situations. If the department’s case is entirely based on a third party's statement, cross-examination may be necessary. But if the case is built on multiple facts and evidence, cross-examination may not be mandatory.

❓ What are the consequences of such bogus claims?

Bogus LTCG claims may result in:

• Tax demand on added income

• Interest and penalties

• Prosecution in extreme cases

Conclusion

The ITAT Ahmedabad ruling in the case of Chimanbhai Chhaganbhai Pokal reinforces a powerful message: the Income Tax Department and judicial forums are well-equipped to see through artificial arrangements disguised as genuine investments.

As taxpayers, one must remember that tax planning is legal, but tax evasion is not. Claiming exemptions through manipulated penny stock gains might seem easy, but the risk is extremely high — including financial penalties and legal consequences.