The Madras High Court has delivered an important ruling in cases involving alleged bogus Long-Term Capital Gains (LTCG) from the sale of shares, holding that suspicion surrounding unusual or substantial gains cannot, by itself, justify a tax addition without supporting evidence.
In its judgment dated 28 August, a Division Bench comprising Chief Justice Sushrut Arvind Dharmadhikari and Justice G. Arul Murugan dismissed the Revenue’s appeals and upheld the orders of the Income Tax Appellate Tribunal (ITAT) deleting tax additions aggregating to approximately ₹70.95 crore.
The dispute involved Long-Term Capital Gains claimed by taxpayers from the sale of shares in PFL Infotech Limited and Risa International Limited. The taxpayers had treated the gains arising from these transactions as eligible Long-Term Capital Gains and claimed the applicable tax benefit.
Income Tax Department Alleged Accommodation Entries
During the assessment proceedings, the Assessing Officer questioned the genuineness of the share transactions. According to the Revenue, the prices of the shares had witnessed abnormal appreciation and the transactions were allegedly part of an arrangement involving accommodation entries.
Consequently, the Assessing Officer treated the claimed capital gains as unexplained income and made additions of approximately ₹32.90 crore and ₹38.05 crore, respectively.
The Revenue also initiated penalty proceedings under Section 271(1)(c) of the Income Tax Act, 1961, alleging concealment of income or furnishing of inaccurate particulars of income.
The taxpayers challenged the additions before the appellate authorities. The ITAT, after considering the material on record, deleted the additions. The Revenue subsequently approached the Madras High Court challenging the Tribunal’s decision.
Madras High Court: Suspicion Cannot Replace Proof
The central issue before the High Court was whether unusual appreciation in the value of shares, coupled with surrounding circumstances, was sufficient to establish that the LTCG claimed by the taxpayers was bogus.
The High Court answered the question in favour of the taxpayers.
The Bench emphasised the well-established principle that “suspicion, however grave, cannot be equated with proof.” According to the Court, the Revenue must establish a credible evidentiary connection between the taxpayer and the alleged scheme or manipulation before denying the genuineness of a documented share transaction.
The Court noted that the transactions had several important features supporting their genuineness. The shares were traded through recognised stock exchanges, Securities Transaction Tax (STT) was paid, and the sale consideration was received through banking channels.
Therefore, merely because the shares had appreciated substantially could not automatically lead to the conclusion that the resulting capital gains were fictitious.
No Evidence Linking Taxpayers to Price Manipulation
An important factor considered by the Court was the absence of positive evidence connecting the taxpayers with the alleged manipulation.
The Revenue had alleged that the transactions were accommodation entries and that the share prices had been artificially manipulated. However, the High Court found that the Department had not brought sufficient material on record to demonstrate that the taxpayers had paid unaccounted cash to any alleged operator or had personally participated in manipulating the share prices.
The Court also observed that the investigation concerning certain purchasers and alleged operators had not been completed adequately.
Consequently, the surrounding circumstances could create suspicion, but they could not substitute for evidence establishing the alleged transaction arrangement.
Test of Human Probabilities Cannot Eliminate Need for Evidence
The Revenue had relied upon the “test of human probabilities”, a principle frequently applied in income-tax cases to examine whether a transaction is commercially and factually believable.
The Madras High Court acknowledged that the test of human probabilities is a legitimate and useful method for evaluating evidence. However, it clarified that the principle cannot be used as a substitute for positive evidence.
The Court observed that the Revenue must, at the very least, place some material on record connecting the assessee with the alleged design, particularly when the primary documentary evidence relating to the transaction has not been successfully challenged.
This observation is particularly significant in cases involving alleged penny-stock transactions, where the Department may rely heavily on abnormal price movements, statements of third parties or general investigation reports.
Banking Transactions and Recognised Stock Exchange Records
The judgment reinforces the importance of documentary evidence in determining the genuineness of capital-gain transactions.
In the cases before the Court, the transactions were routed through recognised stock exchanges, STT was paid and the consideration was received through banking channels.
The Court therefore found that the Revenue could not disregard these objective circumstances merely on the basis of the steep rise in the share prices.
At the same time, the judgment should not be interpreted as laying down that every share transaction conducted through a stock exchange and banking channels must automatically be accepted as genuine. Where the Department possesses concrete evidence establishing manipulation, collusion, accommodation entries or the involvement of the taxpayer in a tax-evasion arrangement, such evidence can be examined on its merits.
The important principle emerging from the present case is that an allegation of bogus LTCG must be supported by evidence connecting the taxpayer to the alleged manipulation.
Penalty Under Section 271(1)(c) Also Fails
Since the underlying additions were deleted, the connected appeals relating to penalty proceedings under Section 271(1)(c) were also dismissed by the High Court.
The Court accordingly upheld the ITAT’s orders and rejected the Revenue’s appeals.
Key Takeaway for Taxpayers
The decision provides an important judicial reminder for taxpayers facing additions relating to alleged bogus Long-Term Capital Gains.
A steep increase in the market price of a share, by itself, does not establish that the resulting capital gain is fictitious. The Revenue must examine the complete evidence and demonstrate a connection between the taxpayer and the alleged manipulation or accommodation-entry arrangement.
For taxpayers, maintaining proper documentation relating to purchase and sale of shares, contract notes, demat statements, bank records, STT payment and other supporting documents can therefore be crucial when the genuineness of an investment transaction is questioned.
Case Details
Case Title: The Commissioner of Income Tax, Chennai v. Sohanraj Uttamchand
Case Number: T.C.A. Nos. 714 and 721 of 2018
Court: Madras High Court
Judgment Date: 28 August
Issue: Alleged bogus Long-Term Capital Gains from share transactions and consequential penalty under Section 271(1)(c)
Outcome: Revenue’s appeals dismissed; ITAT orders deleting the additions upheld.
Conclusion
The Madras High Court’s ruling reiterates a fundamental principle of income-tax jurisprudence: tax liability cannot be founded merely on suspicion or probability when the Revenue seeks to disbelieve documented financial transactions.
Where a taxpayer produces primary documentary evidence of a share transaction and the Revenue alleges that the transaction is part of a manipulated LTCG arrangement, there must be sufficient material connecting the taxpayer with the alleged wrongdoing.
The judgment therefore serves as a significant reference for disputes involving bogus LTCG, penny-stock transactions, accommodation entries and unexplained income additions.