The Madras High Court has held that a steep and commercially inexplicable increase in the price of shares cannot, by itself, justify treating the resulting long-term capital gains as bogus when the transactions are supported by stock exchange records, demat statements and banking documents.

The Bench of Chief Justice Sushrut Arvind Dharmadhikari and Justice G. Arul Murugan observed that the “test of human probabilities” is a valid tool for evaluating evidence, but it does not relieve the Income Tax Department of its obligation to produce positive material connecting the assessee with the alleged share-price manipulation.

The bench upheld the deletion of penalties imposed under Section 271(1)(c) and set aside related reopening and reassessment proceedings to the extent that they were founded on the assessment orders overturned in the principal appeals.

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The batch of appeals and writ petitions arose from transactions in the shares of PFL Infotech Limited and Risa International Limited during Assessment Year 2014-15.

In the first case, the assessee, engaged in property development and investment, declared a total income of ₹11.88 crore. During scrutiny, the Assessing Officer noticed that the assessee had sold 7,72,000 shares of PFL Infotech Limited for ₹34.68 crore and claimed the resulting long-term capital gain of ₹32.90 crore as exempt under Section 10(38).

A survey under Section 133A was conducted at the assessee’s business premises on July 19, 2016, following market intelligence about suspected manipulation in the price of PFL Infotech shares.

The Assessing Officer found that the share price had risen from ₹22.38 to ₹760 despite the company allegedly lacking adequate financial standing or credible business fundamentals. The officer also relied upon the assessee’s lack of previous experience in share trading, the investment having allegedly been made on an undisclosed oral tip, and contradictory statements given by some purchasers.

Based on these circumstances, the Assessing Officer concluded that the transaction was an accommodation entry intended to convert unaccounted money into exempt long-term capital gains. The sale proceeds were consequently treated as unexplained cash credit under Section 68 and, in the alternative, as business income taxable under Section 28.

In the connected case, another assessee claimed exemption on long-term capital gains of ₹38.05 crore arising from the sale of 7,50,000 shares of Risa International Limited. The shares had been allotted at ₹10 each pursuant to a scheme sanctioned by the Bombay High Court and were subsequently sold at prices reaching ₹600 per share.

The Assessing Officer relied upon the unusual price movement and the statement of Prasanta Bose, a director of Shallot Vincom Private Limited, through which some of the purchases were alleged to have been routed. The gain was similarly added as unexplained cash credit under Section 68.

The Commissioner of Income Tax (Appeals) confirmed both additions. However, the Income Tax Appellate Tribunal deleted them and directed that the gains be treated as exempt long-term capital gains under Section 10(38).

The department argued that the assessees had earned extraordinarily high gains from shares of companies possessing negligible turnover, negative reserves and no credible underlying business activity.

It contended that the increase in PFL Infotech’s share price from ₹22.38 to ₹760 and the rise in Risa International’s share price from ₹10 to ₹600 could not have occurred in the ordinary course of genuine market trading.

The Revenue also relied upon statements from certain purchasers and intermediaries. One purchaser reportedly denied buying PFL Infotech shares despite departmental records showing a transaction with the assessee. Some other individuals allegedly stated that their demat accounts were operated by a third party in return for commission.

In the Risa International matter, the Department relied extensively upon the statement of Prasanta Bose, who allegedly admitted that companies associated with his group had been incorporated to provide accommodation entries in penny-stock transactions.

The Revenue invoked the Supreme Court’s decisions in CIT v. Durga Prasad More and Sumati Dayal v. CIT, arguing that apparent documentary compliance could not be considered conclusive when the surrounding circumstances rendered the transactions inherently improbable.

The assessees maintained that the Department’s conclusions were founded entirely on suspicion and that no concrete evidence connected them with any scheme to manipulate the share prices.

They pointed out that the shares were bought and sold through recognised stock exchanges, Securities Transaction Tax was paid, and the sale consideration was received through regular banking channels. The transactions were also supported by contract notes and demat statements.

It was further submitted that the purchasers were anonymous third parties who had acquired the shares through the stock exchange platform. The assessees could not be expected to investigate the financial credentials of buyers with whom they had no direct dealings.

According to the assessees, the Department possessed statutory powers under Sections 131 and 133(6) to trace and examine the purchasers. However, several summonses that returned unserved were not followed up, even though the identities of the buyers could have been traced through stock exchange and depository records.

The assessees also argued that the statements relied upon by the Department merely described an alleged general modus operandi and did not name or directly implicate them.

The High Court noted that an appeal under Section 260A can be entertained only when a substantial question of law arises. Findings recorded by the ITAT, as the final fact-finding authority, are ordinarily binding unless shown to be perverse.

A finding may be regarded as perverse when it is based on no evidence, ignores relevant evidence, considers irrelevant material, or reaches a conclusion that no reasonable person properly instructed in law could reach, the Bench explained.

The Court found that the Tribunal had examined every circumstance relied upon by the Assessing Officer and the Commissioner (Appeals). The Tribunal acknowledged that the material might create strong suspicion about the price movement, but held that such suspicion could not replace proof directly implicating the assessees.

The following documentary aspects of the transactions were not displaced by the Department:

• The shares were purchased and sold through recognised stock exchanges.
• Securities Transaction Tax was paid.
• The consideration was received through banking channels.
• The companies’ identity, listing and trading on the stock exchange were not disputed.
• There was no evidence that either assessee paid unaccounted cash to an entry operator.
• No material established that the assessees had entered into an arrangement to manipulate the share prices.

The High Court agreed with the Tribunal that the Assessing Officer did not take the investigation to its logical conclusion.

Although notices under Section 131 were issued to various purchasers, the Department did not pursue the matter when some notices returned unserved. The buyers’ identities could have been traced through stock exchange and depository records, the Court observed.

Similarly, individuals identified by witnesses as the persons allegedly responsible for orchestrating the price manipulation were neither summoned nor examined. No material was produced to establish a direct nexus between those persons and the assessees.

Regarding Prasanta Bose’s statement, the Court found that it established, at best, that a small portion of the total trading volume in Risa International shares had been routed through certain accommodation entities. Even that portion did not disclose a direct or acknowledged connection with the assessee.

The balance sheet of the entity through which the disputed shares were allegedly routed did not show any holding of those shares on the relevant date. This further weakened the evidentiary value of the statement against the assessee, the Court said.

Distinguishing the Supreme Court decisions cited by the Revenue, the Bench noted that Sumati Dayal concerned repeated and improbable horse-racing winnings, while Durga Prasad More dealt with unexplained cash credits that lacked a documentary trail comparable to the present transactions.

Neither judgment laid down an inflexible rule governing gains from listed securities purchased and sold through recognised stock exchanges with supporting contract notes, demat statements and banking records, the Court held.

The Bench observed that the test of human probabilities is useful while appreciating evidence. However, it cannot dispense with the basic requirement that the Department place some positive material on record connecting the assessee with the alleged design, particularly when the primary documents supporting the transactions have not been challenged.

Referring to the Supreme Court’s rulings in Dhakeswari Cotton Mills Ltd. v. CIT, Omar Salay Mohamed Sait v. CIT and Umacharan Shaw and Brothers v. CIT, the High Court reiterated that an assessment cannot be based on pure guesswork, suspicion, conjecture or surmise.

“An addition sustained principally on suspicion, without concrete, corroborated evidence directly implicating the assessee, cannot be allowed to stand,” the Court observed.

The High Court categorically held that mere steep appreciation in a share’s price does not automatically make the resultant capital gain bogus.

Where shares are traded through a recognised stock exchange, consideration is received through banking channels, and there is no cogent finding that the assessee participated in or was complicit in price manipulation, the gain cannot be rejected solely because the increase appears disproportionate to the company’s fundamentals.

At the same time, the Court clarified that it was not expressing any final opinion on whether PFL Infotech or Risa International shares were manipulated by third parties. Its ruling was confined to whether the particular additions made in the hands of the two assessees could be sustained on the evidence available.

The authorities remained free to proceed against other persons if the material gathered during the investigation otherwise justified such action.

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