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Investment in Penny Stock- Bogus or Cash Credit U/s. 68?

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Investment in Penny Stock- Bogus or Cash Credit U/s. 68?

Now-a-days Income Tax department investigates alleged trading/investment in shares and securities with collusion/connivance with any listed companies or with share broker by conducting Search/ Survey or by asking details u/s 133(6) of the Income Tax Act 1961.
Income Tax department has various sources from where information can be received; such source of information can be obtained from Securities Exchange Board of India (the “SEBI”) in case of manipulation in capital market .
SEBI first conducts enquiry on its own for alleged involvement of share broker or listed companies in alleged price manipulation of the shares, and after conducting enquiry of alleged collusion/connivance, SEBI passes an order debarring / imposed monetary penalty, as the case may be, on the entity involve in the manipulation, thereafter it shares the information/list with other agencies like Income Tax Department. On receiving such information, IT Department investigates upon the assessee involved in the manipulation and tries to prove the LTCG /STCG as bogus or non genuine as added u/s 68 as Cash credit
Modus Operandi of such share broker/companies are as under:
Type 1)
The purchases are usually accompanied by a backdated contract note showing the purchase of shares by the assessee at less than a rupee or just a few rupees per share, as they were quoted earlier. The purchase consideration could have been paid either in cash or by cheque. The shares are usually stated to have been purchased in physical format and then converted into electronic form. After a year or so, the assessee sells such dematerialized shares in secondary market at the prevalent price and receives payment through cheque thereby converting black money into white. Depending upon how far the contract note for purchase of such shares was backdated, the assessee launders the money by either paying zero or 15% capital gain tax.
The general modus operandi are as follows:-
1. With the collusion of broker, shares of an unknown company with dubious background are purchased for miniscule consideration. The broker usually issues a fake contract note.
2. The counterparty is/are usually not traceable or is related to the broker and the broker undertakes off-market transactions to accommodate the assessee.
3. After a year, the shares are sold back by the assessee through the same broker. In the meantime, the share prices are rigged by the concerned broker to an abnormally high level.
4. The shares are now sold by the assessee and sale consideration is received. The sale consideration is in fact first paid by the assessee in cash to a trusted confidante of the broker. This cash consideration which is introduced in a banking channel by routing through a number of accounts, finally reaches the accounts of the broker. With this amount, the broker pays the consideration to the assessee.
5. Thus the assessee’s own cash is introduced and comes back in the form of long term capital gain thereby claiming concessional tax rate.
6. For arranging these transactions, the broker typically charges commission.
Type 2)
In this type of collusion/ connivance Listed Companies which are not actively traded (Penny stock) on stock exchanges, first raise the funds through series of preferential allotments. Sometime they also issue bonus shares. Consequent to the preferential allotments and bonus issues, the share capital of these companies increased manifold. On reviewing the financial statements of these companies it can be observed that their profit after tax(PAT) and earning price per share(EPS) is constant or consistently decreasing or not justify the increase in the price of the share.
1. Investor/ Trader identifies the penny stock or illiquid stock with the low price, and then arrange for a meeting with the promoter /management of the company.
2. Financial performances of these companies are constant or even declines year by year.
3. Management of the company promises to issue shares on preferential allotment basis when price of the shares is very low.
4. As agreed between company/promoter and investor, the company issues shares to its investor based on the agreed terms with the lock in period of 1 year as per SEBI guidelines.
5. Sometime after issue of preferential allotment of share, company also give Bonus shares.
6. Company increases the price of its share, either by circular trading or by other manipulation to manifold.
7. Investor sells the shares after the lock in period is over and claims for Long term capital gain exemption.
8. This way black money is converted into white money. And for doing this company charges commission from its investor.
Now the question is that, Do all the investments made by the investor is seen from the eye of suspicion? Answer is no, it is not necessary that all the investment made in penny stock is treated as bogus or treated as cash credit u/s 68 of the income Tax Act 1961. There are various case laws which are in favour or the assessee, which help assessee to present its case of genuine investments, are as under:-
1. High Court of Gujarat in case of Commissioner of Income-tax-I Vs. Maheshchandra G. Vakil [2013]40 326 (Gujarat) held that Where assessee proved genuineness of share transactions by contract notes for sale and purchase, bank statement of broker, demat account showing transfer in and out of shares, as also abstract of transactions furnished by stock exchange, Assessing Officer was not justified in treating capital gain arising from sale of shares as unexplained cash credit.
2. High Court of Gujarat in case of Commissioner of Income-tax-I Vs. Himani M Vakil [2013]10 326 (Gujarat) held that where assessee duly proved genuineness of share transactions by bringing on record contract notes for sale and purchase, bank statement of broker and demat account showing transfer in and out of shares, Assessing Officer was not justified in bringing to tax capital gain arising from sale of shares as unexplained cash credit.
3. Tribunal at Kolkata in case of DCIT vs Sunita Khema in ITA nos 714 to 718/ kol/2011 has held that :-
The AO cannot treat a transaction as bogus only on the basis of suspicion or surmise. He has to bring material on record to support his finding that there has been collusion/connivance between the broker and the assessee for the introduction of its unaccounted money. A transaction of purchase and sale of shares, supported by Contract Notes and demat statements and Account Payee Cheques cannot be treated as bogus.
4. Tribunal at Mumbai in case of Tekchand Rambhiya HUF in ITA nos 930/Mum/2012 has held that the Hon’ble High Court, in the case of CIT vs. Jamnadevi (328 ITR 656) has observed in paragraphs 11 & 12 as under:
“11. We see no merit in the above contentions. The fact that the assessees in the group have purchased and sold shares of similar companies through the same broker cannot be a ground to hold that the transactions are sham and bogus, especially when documentary evidence was produced to establish the genuineness of the claim.
12. From the documents produced before us, which were also in the possession of the Assessing Officer, it is seen that the shares in question were in fact purchased by the assessees on the respective dates and the company has confirmed to have handed over the shares purchased by the assessees. Similarly, the sale of the shares to the respective buyers is also established by producing documentary evidence. It is true that some of the transactions were off-market transactions However, the purchase and sale price of the shares declared by the assessees were in conformity with the market rates prevailing on the respective dates as is seen from the documents furnished by the assessees. Therefore, the fact that some of the transactions were off-market transactions cannot be a ground to treat the transactions as sham transactions. as a sham transaction.
Thus the fact that some of the transactions were off marked transaction cannot be a ground to treat the transaction In view of the above facts and discussion, as well as the decisions of the Hon’ble jurisdictional High Court, we are of the considered opinion that the assessee has discharged its onus of proving the fact that shares were purchased by the assessee in the year 2002 which were dematerialized in the Demat account of the assessee on 23/5/2003 and therefore these shares were held by the assessee up till the same were sold from the Demat account of the assessee. The transaction of holding shares are reflected in the Demat account and the sale of shares are also through Demat account and consequently the transaction cannot be doubted as sham or bogus transaction.
2. High Court of Rajasthan at Jodhpur in case of CIT Vs. Smt Sumitra Devi in ITA 54/2012 has held that:-
True it is that several suspicious circumstances were indicated by the AO but then, the findings as ultimately recorded by him had been based more on presumptions rather than on cogent proof. As found concurrently by the CIT(A) and the ITAT, the AO had failed to show that the material documents placed on record by the assessee like broker’s note, contract note, relevant extract of cash book, copies of share certificate, de-mat statement etc. were false, fabricated or fictitious. The appellate authorities have rightly observed that the facts as noticed by the AO, like the notice under Section 136 to the company having been returned unserved; delayed payment to the brokers; and de-materialisation of shares just before the sale would lead to suspicion and call for detailed examination and verification but then, for these facts alone, the transaction could not be rejected altogether, particularly in absence of any cogent evidence to the contrary.
6. High Court of Allahabad in case of CIT Vs. Udit Narain Agarwal in ITA 560 of 2009 has held that:-
The Tribunal has upheld the finding. It had held that the assess was in possession of the shares in question and had sold the said shares in course of ordinary transaction of sale of shares at stock exchange and if the broker did not file any evidence since the same were seized by the Revenue Department, there is no fault with the assessee. From the aforesaid facts it is clear that the shares in question were allotted to the assessee in the public issue which were held in demat a/c of Stock Holding Corporation of India Ltd. The shares were transferred to Abhipra Capital Ltd. The sale consideration was received by demand draft. Therefore, the transaction in question cannot be said to be fake and is a genuine transaction. The Tribunal has not committee any error in upholding the order of CIT(Appeals) on this point.
7. Tribunal at Mumbai in case of ACIT Vs Shri Ravindrakumar Toshiwal in ITA nos 5302/Mum/2008 has held that :-
AO has treated the said transactions as bogus transactions on the ground that (a) The sale transactions were not on the floor of the ASEL but were off market transactions; (b) The address of the M/s Buniyad Chemical Ltd. and M/s Talent Infoway Ltd. was the same and the contact person for M/s Buniyad Chemical Ltd. on the floor of ASEL was Shri Mukesh Chokshi. (c) Mr. Mukesh Chokshi had stated that the sale proceeds have been paid to the assessee through the funds provided by the assessee.
As regards point (a) above, we find that the issue is covered by the decision of the Tribunal in the case of Mukesh R. Marolia wherein it has been held that off market transaction is not a unlawful activity and there is no relevance in seeking details of share transaction from stock exchange when the sale was not on stock exchange and relying upon it for making addition.
As regards points (b) & (c) above, we find that the assessee has filed relevant documentary evidence before the AO but the AO has failed to consider the same. The CIT[A] in his order has considered the said evidence and has come to the conclusion that the share transactions are genuine. However, as held by the Tribunal in the case of Rajinidevi A. Chowdhary vs ITO in ITA 6455/M/07 dated 30.04.2008, which is on similar set of facts, the AO could have verified from the Registrar of companies as to whether the shares have been transferred and the names of the shareholders in whose names shares have been transferred. The decision of the Tribunal in the case of Rajinidevi A. Chowdhary has also been upheld by the jurisdictional High Court as taken note of by this Tribunal in the case of Shri Pinakin L. Shah in ITA nos 3030 & 3454/M/08 dated 14.07.2009, to which one of us i.e. the Judicial Member, is a party. In these facts and circumstances of the case, we do not see any reason to interfere with the order of the CIT[A] and the same is upheld.
To conclude assessee need to maintain the following documents in order to prove genuineness of the investments:-
Basic documents
Source of the investments made.
Business activity of the investor
Contract note for purchase of investment made and sell of investment
Bank statement reflecting payment and receipt of sale of investments
Demat statement to prove delivery of shares.
Ledger copy of share broker a/c.
Copy of ledger a/c of source of investment.
Additional Documents/information which can even help during investigation
To prepare the justifcation/ reason to buy shares of that company?
Name and address of the person who has recommended the purchase of shares.
Analysis of financial performance before purchase of share.
Copy of share purchase agreement, if any.
Reason for selling the shares.Business of the investor/company investing the shares.?
The frequency of analysis of performance of the investee company and kinds of analysis assessee did,
How did assessee place the purchase orders with broker? To whom did he speak / instruct for placing the orders?
How was the payment made/received to/from broker?
What is the status of that demat account ?
Source of source , if possible.
Justification in case of delay in dematerialisation of shares, since it is one of the main ingredient to prove backdated purchase of shares

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