If taxpayer cannot justify rise in share price of Penny Stocks, it means gains are bogus

Swati Bajaj, a resident of Calcutta, the City of Joy, is an intrepid investor in Penny stocks. In March 2012, she came across a research report issued by a prominent share analyst and research company named M/s. Abrams Consultancy Services Private Limited, which recommended a "buy" call on shares of a company named Surabhi Chemicals which was quoted on the BSE on 16.03.2012 at Rs. 200/- per equity share.

Bajaj bought 500 equity shares of Surabhi Chemicals for Rs. 1,00,000 and the payment was made through account payee cheque. The shares were bought through M/s Horizon Financial Consultant Private Limited, said to be a very reputed equity brokerage house.

The company thereafter allotted bonus shares in the ratio of 9 shares for every 1 share held. The equity shares of the company were also sub-divided. The result was that Bajaj's holding of 500 equity shares in Surabhi Chemicals blossomed into a massive treasure trove of 50,000 equity shares.Her effective purchase price was only Rs 2 per share (penny stock).

Swati Bajaj's good luck continued to hold. The stock price continued to surge on the bourses even though the general market trend was recessive. On the passing of one year from the purchase, she decided to encash her gains and sold her entire holding for a grand sum of Rs. 29,23,500 resulting in an eye-popping gain of 2823%.

However, the ITO and the CIT(A), as is their wont, played spoil-sport. They alleged that Bajaj "had indulged in manipulation of the share prices of Surabhi Chemicals and Investment Limited with a view to record fictitious Long Term Capital Gains of Rs. 28,23,500/- claiming these as exempt from taxation". The capital gains was treated as "unexplained income" and taxed at the full rate.

To add insult to injury, Bajaj was also accused by the ITO on concealing her income and was threatened with levy of penalty.

Thankfully, the Tax Tribunal came to the rescue of Bajaj and other beleaguered investors and held that as the transaction was done through the stock exchange and was evidenced by contract notes, proper documentary evidence undertaking purchase/ sale of the shares through registered brokers by banking channels, D-Mat statement etc, there was nothing to pinpoint anything against the assesee.

However, this law has been torpedoed by a distinguished Bench of T.S. SIVAGNANAM, J and HIRANMAY BHATTACHARYYA, J of the Calcutta High Court, SPECIAL JURISDICTION (INCOME TAX) in the case of PRINCIPAL COMMISSIONER OF INCOME TAX FIVE, KOLKATA VERSUS SWATI BAJAJ.

The Court held that when a claim is made for LTCG or STCL, the onus is on the assessee to prove that credit worthiness of the companies whose shares the assessee has dealt with, the genuineness of the price rise which is undoubtedly alarming that to within a short span of time.

It was held that the assessee cannot escape from the burden cast upon him and unfortunately in these cases the burden is heavy as the facts establish that the shares which were traded by the assessees had phenomenal and fanciful rise in price in a short span of time and more importantly after a period of 17 to 22 months, thereafter has been a steep fall which has led to huge claims of STCL. Therefore, unless and until the assessee discharges such burden of proof, the addition made by the assessing officer cannot be faulted.

It was also observed that with such financials and affairs of business, purchase of share of face value Rs. 10/- at a high rate by any person and assessee's contention that such transaction is genuine and credible and arguing to accept such contention is a fallacy.

It was also held that this cannot be case of intelligent investment or simple and straight case of tax planning to gain benefit of long term capital gains earnings of huge gainss over short periods is against human probability and defies business logic of any business enterprises dealing with share transactions net worth of company is not known to assesses. Even brokers who coordinated transactions were also unknown to assessee. All these facts give credence to unreliability of entire transaction of shares giving rise to such capital gains ratio.

It is worth noting that the High Court of Bombay in Sanjay Bimalchand Jain Versus Pr.CIT has also held that the entire capital gains claim were to be treated as fictitious and bogus. The fantastic sale price was not at all possible as there was no economic or financial basis to justify the price-rise, the assessee had indulged in a dubious share transaction meant to account for the undisclosed income in the guise of LTCG.