In November 2012, the Mumbai-based investor raised Rs. 4.41 lakh shares were bought. After about 16 months, he raised Rs. A large part of his holding was sold for more than 92 lakhs. This investment paid off handsomely. The investor claimed that this profit was ‘long term capital gain’ and was not taxable under the rules then in force. But the Income Tax Department did not accept this claim.

The department suspected that these shares were part of a ‘penny stock’ scheme, which was used to artificially generate tax-free capital gains. Department Rs. 92.03 lakh treated the entire sale amount as ‘undisclosed cash credit’ and also added an estimate for payment of commission. The investor challenged these additions. He argued that these transactions were genuine, supported by bank statements, demat records and stock exchange contract notes.

Now, the Income Tax Appellate Tribunal (ITAT), Mumbai has dismissed his appeal and upheld this additional increase made by the department. This case explains why the Income Tax department may raise questions about unusually high returns from shares, even when these transactions are through the stock exchange and the money comes through banking channels.

How an investment of 4.4 lakhs turned into 92 lakh rupees

This matter relates to Sandhya Rakesh Sharma and assessment year 2014-15. As per the tribunal’s order, Sharma bought 21,000 shares of ‘Santoshima Tradelinks Limited’ on November 19, 2012. This share from ‘Silverice Multi Trading Private Limited’ at Rs. 21 were bought off-market (outside the stock exchange). A total investment of Rs. 4,41,000 was.

Later, after corporate restructuring, the name of this company was changed to ‘Sunrise Asian Limited’ (SAL). Sharma sold 18,850 shares in 14 transactions on the Bombay Stock Exchange (BSE) between November 25, 2013 and March 12, 2014. These shares were sold through a registered broker. The average selling price was around Rs 488.50 per share. The total selling price was Rs 92,03,421.

Sharma paid Rs. 88,07,571 declared a long-term capital gain and declared the amount tax-free under section 10(38) of the Income-tax Act. This section was applicable to long term capital gains arising from listed equity shares during that relevant assessment year. The Income Tax Department raised questions as to how the share price rose so much in such a short period of time.

Why did the Income Tax Department suspect penny stock manipulation?

After receiving information from the Investigation Wing of the Income Tax Department in Kolkata, a reassessment of the case was initiated. The investigation revealed a penny stock company named ‘Sunrise Asian Limited’. It is alleged that the operators used this company to show fake long-term capital gains and short-term capital losses. The department examined the company’s share price, trading volume and financial position.

According to the assessment order placed before the tribunal, the share price of the company rose from around Rs 50 to over Rs 615 during the investigation period. This surge in price is not due to any improvement in the company’s financial performance, assets or business fundamentals. The department also found that trading in these shares was very thin. Only 50 to 100 shares were traded on most business days. Often there were only one or two trades in a day, the order said. The share price movement was also often around the circuit limit of 4.9 percent to 4.99 percent.

The Assessing Officer was of the view that the price rise was artificial and the transactions were done in such a way that the investors could claim tax-free capital gains. The order said that this change in share price was not in line with broader market trends. During the investigation, the department also recorded statements of alleged ‘entry operators’ and others.

These statements show how certain companies and stocks were allegedly used to grant ‘accommodation entries’ (fake transactions). Simply put, the department suspected that investors could show huge profits on paper, and at the same time bring their unaccounted money into the banking system in the form of proceeds from share sales.

What did SEBI know about Sunrise Asian?

The tribunal also considered the findings of the Securities and Exchange Board of India (SEBI). SEBI investigated Sunrise Asian Limited and its associated entities for alleged share price manipulation and violation of trading rules. In 2022, Sebi imposed a penalty of Rs 1 crore on the company, five former directors and 80 associated entities jointly, according to the tribunal’s order.

The company and some of its directors were also banned from the securities market for one year. The investigation covered trading activities between October 2012 and September 2015. Sharma’s share transactions took place during this period.

A SEBI investigation found that linked entities allegedly traded among themselves and helped inflate share prices artificially. The probe also identified entities that acted as counterparties in selling shares at inflated prices. The tribunal noted that the investigation revealed a pattern of price manipulation by the company and its associated units. These findings became an important part of the Income Tax Department’s case.

Investor’s Argument: Shares were bought and sold through proper channels

Sharma argued that he was a bona fide investor and had no role in the alleged manipulation. He told the tribunal that the shares were purchased through banking channels and there were documents supporting these transactions.

He produced contract notes issued by the broker, demat statements showing stock movements and bank statements showing sale proceeds. His contention was that these transactions were done by a registered broker in the stock exchange. He also said that his name was not in SEBI’s probe and the brokers involved in his transactions were not part of the alleged scam.

The investor further contended that the Income Tax Department relied on the statements of third parties, even though these statements were not shown to him. He said he was not given an opportunity to cross-examine those people.

The tribunal’s order also referred to his contention that despite the availability of supporting documents, the department treated the amount received from sale of shares as ‘unexplained cash credit’.

Why did the tribunal reject the investor’s explanation?

ITAT Mumbai examined the documents and the circumstances surrounding them. He observed that the contract notes, demat statements and bank statements show how the transactions were done. But the tribunal said that these documents alone did not prove that the actual transactions were genuine. The order said that the investor bought 21,000 shares in physical form for Rs 4.41 lakh. Later, it sold 18,850 shares in 14 transactions through BSE.

The tribunal also took into account the extraordinary rise in prices, the weak financial position of the company, the low trading volume and the results of the SEBI probe. He observed that these facts cast serious doubt on the genuineness of the claim of ‘capital gains’. The Tribunal also noted that the Assessing Officer had issued summons to Sharma for personal appearance and verification. As per the order, even after receiving the summons, he did not appear. Written replies were filed by their authorized representatives, but the department said the necessary clarifications and confirmations were not provided.

The Assessing Officer also sent notices to the ‘Exit Providers’ (i.e. those who had purchased shares from the investor). No response was received to these notices. The Tribunal considered these circumstances along with the inquiry material. The Tribunal concluded that the investors could not properly rebut the Department’s findings. The Tribunal upheld the finding that the claimed ‘capital gains’ were not genuine and the transactions were mere ‘accommodation entries’ (sham transactions).

What additional amount was added by the Income Tax Department?

The department received from the sale Rs. The entire amount of 92.03 lakhs was treated as ‘unexpected cash credit’ under section 68. Further, the department estimated a commission of 3% of the proceeds from the sale, which is Rs. 2.76 lakhs. The department’s contention was that entry providers charge commission for making such ‘accommodation entries’. Sharma denied any such commission.

The Tribunal upheld the Department’s finding that the principal transactions were not genuine, and upheld this additional amount. An amount of Rs 56 was related to two shares of ‘Essar India Limited’. The Assessing Officer also questioned the fluctuation in the share price of the company and termed the investment as ‘ambiguous’.

Why were bank statements and demat records not enough?

This case shows that documents proving the transaction of money and shares are not always enough to resolve a tax dispute. The investor’s bank statement may show the sale proceeds and his demat account may also show that the shares were sold in the stock exchange. But still, the Income Tax Department can check whether these transactions were really genuine or not.

In this case, the department raised questions on the company’s financial condition, sudden sharp rise in share price, low trading volume and the results of the investigation. The Tribunal considered all these factors together. The tribunal did not accept the contention that the transactions were genuine as they were done through a broker and the sale proceeds came through the banking system. The tribunal also rejected the investor’s claim that he was not given a fair opportunity to present his case.

The Tribunal found that the Assessing Officer had given opportunities during the assessment process, but the investor had not fully complied with the summons (notice) and had not furnished all the explanations sought. Therefore, the Tribunal finds no merit in this appeal.

What does this decision mean for investors?

The decision does not mean that every investor who gets high returns from a small company will be taxed extra. What matters is whether the investment and sale transactions are genuine and whether the investor can prove them with evidence. A sudden sharp rise in share price may warrant an investigation, especially if the company’s financial performance does not justify the surge.

Investors should maintain records of original purchase of shares, payment, demat transfer, sale and receipt of money. Also, when any notice is received or information sought from the Income Tax Department, it should be responded to and necessary clarifications should be given. If the Department raises any questions based on the evidence found in the investigation or the statements of any third party, investors should look into those allegations carefully and respond with appropriate evidence.

Dinkar Sharma, partner, Jotwani Associates, said in an FE report that investors should not assume that tax-related queries will be resolved just by showing bank statements and contract notes. When any transaction is questioned, investors are required to provide proper records regarding their investments, price changes and source of funds. It is very important to respond to notices in time and keep necessary documents ready.

This decision relates to the assessment year 2014-15 and the tax rules applicable during that time. This should not be seen as a general rule that every penny stock investment or every high-returning stock transaction is a fake. In Sharma’s case, the tribunal observed that the evidence did not support the claim of ‘genuine long-term capital gain’. The ITAT Mumbai dismissed his appeal and upheld the additional tax imposed by the Income Tax Department.