Penny Stock LTCG Cannot Be Taxed on Suspicion Alone: ITAT Ahmedabad Deletes ₹1.17 Crore Addition under Section 68
Penny stock transactions often attract close scrutiny from the Income Tax Department, especially where there is a sharp rise in share price within a short period. The Department may allege that the Long Term Capital Gain is not genuine and represents accommodation entry or unaccounted money routed through stock market transactions.
However, every suspicious-looking transaction cannot automatically become taxable income under Section 68 of the Income-tax Act, 1961.
In DCIT, Central Circle-1(1), Ahmedabad v. Smt. Denisha Rajendra Keshwani, the ITAT Ahmedabad dealt with this important question:
Can the Assessing Officer treat LTCG from sale of shares as bogus merely because the shares belonged to an alleged penny stock company and the price increased sharply?
The Tribunal answered in favour of the assessee and held that where the assessee has furnished proper documents and the Revenue fails to bring direct evidence of collusion, price rigging or cash trail, the addition under Section 68 cannot survive.
For taxpayers facing similar scrutiny, professional handling of an Income Tax Notice becomes very important because the outcome often depends on how facts, documents and legal submissions are presented.
Case Details at a Glance
| Particulars | Details |
| Case Name | DCIT, Central Circle-1(1), Ahmedabad v. Smt. Denisha Rajendra Keshwani |
| Appeal No. | ITA No. 39/Ahd/2021 |
| Assessment Year | AY 2015-16 |
| Forum | ITAT Ahmedabad, “C” Bench |
| Date of Pronouncement | 06 February 2025 |
| Main Issue | Whether LTCG from Kappac Pharma Ltd. shares was bogus |
| Addition Made By AO | ₹1,17,78,534 |
| Section Invoked | Section 68 of the Income-tax Act, 1961 |
| Final Outcome | Revenue’s appeal dismissed; addition deleted |
Background of the Case
The assessee had declared Long Term Capital Gain from sale of shares, including shares of Kappac Pharma Ltd. The Assessing Officer examined the transaction and found it suspicious for the following reasons:
- The assessee purchased 51,000 shares of Kappac Pharma Ltd. on 06.02.2013 at ₹20.59 per share.
- The purchase was through offline mode from Shashwat Stock Brokers Pvt. Ltd.
- The physical shares were later converted into demat form.
- The shares were sold on BSE in November 2014 at around ₹251 to ₹252.50 per share.
- The AO observed that the price rise was steep and not supported by company fundamentals.
- The AO relied on investigation reports relating to penny stock accommodation entries.
- The AO also noted that Kappac Pharma shares were later suspended by BSE.
On this basis, the AO treated the LTCG of ₹1,17,78,534 as bogus and added it as unexplained cash credit under Section 68.
What Was the Assessee’s Defence?
The assessee argued that the transaction was genuine and supported by proper evidence. The major documents relied upon were:
- Bank statements showing payment through banking channel.
- Contract notes issued by broker.
- Demat account statements showing receipt and transfer of shares.
- Evidence of sale through recognised stock exchange.
- Proof of payment of Securities Transaction Tax.
- Audited financial statements.
- Evidence that the assessee was a regular investor in shares, not someone dealing in only one isolated scrip.
This is a crucial practical lesson. In share transaction cases, merely saying “the transaction is genuine” is not enough. The taxpayer must maintain a complete evidence trail.
For correct reporting of capital gains and supporting disclosures in return filing, taxpayers should take expert assistance in ITR Filing, especially where AIS/TIS, demat statements, broker reports and capital gain statements need reconciliation.
CIT(A)’s Finding: Documents Were Sufficient, AO Had No Direct Evidence
The CIT(A) deleted the addition after examining the supporting documents. The appellate authority held that the assessee had furnished sufficient evidence to prove the genuineness of the transaction.
The CIT(A) also noted that the AO had not established any direct link between the assessee and the alleged entry operators. The AO’s conclusion was largely based on general investigation reports and suspicion arising from abnormal price movement.
This distinction is very important.
A general report may alert the Department to examine a transaction carefully. But for making an addition in the hands of a particular assessee, the AO must bring assessee-specific material.
ITAT Ahmedabad’s Decision: Suspicion Cannot Replace Evidence
The ITAT upheld the order of the CIT(A) and dismissed the Revenue’s appeal.
The Tribunal made the following important observations:
- The CIT(A) had examined the transaction in detail.
- The assessee had produced bank statements, demat statements, contract notes and audited financials.
- The Revenue did not bring conclusive evidence to rebut these documents.
- The allegation that the assessee traded only in one share was factually incorrect.
- The assessee had been investing in various shares over the years.
- The AO did not examine the counterparty to establish collusion.
- No direct evidence of price rigging by the assessee was brought on record.
- Addition based only on suspicion and generalisation cannot be sustained.
The Tribunal also referred to the Gujarat High Court judgment in Affluence Commodities Pvt. Ltd., where purchase of the same Kappac Pharma shares by the counterparty was treated as genuine. The ITAT observed that if the purchase by the counterparty was held genuine, the corresponding sale by the assessee could not be treated as bogus unless the Revenue proved that the transaction was pre-arranged or collusive.
Why Section 68 Was Not Sustainable in This Case
Section 68 applies where a sum is credited in the books of the assessee and the assessee either fails to explain the nature and source of the credit or the explanation is not found satisfactory.
In practical terms, the taxpayer must establish:
- Identity of the transaction.
- Nature and source of funds.
- Genuineness of the transaction.
- Documentary trail supporting the entry.
In this case, the assessee discharged the initial onus by producing relevant documentary evidence. Once this was done, the burden shifted to the Revenue to rebut the evidence with concrete material.
The AO could not prove that:
- Cash was paid by the assessee to obtain accommodation entry.
- The assessee was connected with entry operators.
- The broker or counterparty acted at the direction of the assessee.
- The transaction was pre-arranged.
- The assessee participated in price rigging.
Therefore, the ITAT held that the addition under Section 68 was unsustainable.
For taxpayers already facing high-pitched demand after such additions, proper response to Income Tax Demand Notice is equally important to avoid recovery pressure and protect appeal rights.
Important Legal Principle Emerging from the Case
The core principle is simple:
A penny stock transaction may justify deeper scrutiny, but it cannot justify addition under Section 68 unless the Revenue brings specific evidence against the assessee.
Suspicion, abnormal price rise, low trading volume or general investigation reports may be relevant starting points. But they cannot become the final proof of bogus transaction.
The Department must connect the taxpayer with the alleged manipulation. Without such linkage, genuine documents like contract notes, bank statements, demat records and STT payment cannot be rejected casually.
Does This Mean All Penny Stock LTCG Claims Are Safe?
No.
This decision should not be understood as blanket protection for all penny stock gains.
Courts have also upheld additions in cases where the Department was able to show strong surrounding circumstances, lack of credible explanation, entry operator links, artificial price movement, weak financials of the company and failure of the assessee to establish genuineness.
Therefore, each case depends on its own facts.
The correct approach is:
- If the taxpayer has genuine documents and no link with manipulation, addition can be challenged.
- If the transaction is only paper-supported but commercially doubtful, litigation risk remains high.
- If there is evidence of cash trail or entry operator connection, the case becomes much weaker.
- If assessment is completed without proper consideration of evidence, the matter can be contested in appeal.
For complex matters involving penny stock additions, bogus LTCG allegations, reassessment or search-related proceedings, a structured Tax Litigation strategy is necessary.
Law Then and Law Now: Section 10(38) and Section 112A
For AY 2015-16, LTCG on listed equity shares was generally claimed exempt under Section 10(38), subject to conditions including STT.
However, the law has changed. Presently, LTCG on listed equity shares, equity-oriented mutual funds and units of business trust is governed by Section 112A.
For current tax compliance, capital gains must be properly reported in the correct ITR form. Capital gain statements should be reconciled with AIS, TIS, broker reports and demat records. Incorrect reporting may lead to mismatch notices, defective return notices or scrutiny proceedings.
This is why careful ITR Filing is essential for investors, traders, HNIs and taxpayers with substantial capital market transactions.
Practical Checklist for Taxpayers Claiming LTCG from Shares
If you have earned LTCG from listed shares, especially from small-cap or thinly traded shares, keep the following documents ready:
- Purchase bills or contract notes.
- Sale contract notes.
- Demat statement showing credit and debit of shares.
- Bank statement showing payment and receipt.
- Ledger account with broker.
- STT payment proof.
- Capital gain statement.
- Copy of ITR and computation.
- Evidence of regular investment pattern, if available.
- Communication from broker, if any.
- Corporate action records like bonus, split or merger, if relevant.
- Explanation of commercial rationale for investment.
In scrutiny cases, these documents should be presented in a proper sequence with a clear written explanation.
What Should You Do If You Receive Notice for Penny Stock LTCG?
If you receive a notice under Section 142(1), 143(2), 148A, 148 or any other provision regarding share transactions, do not file a casual reply.
A strong reply should include:
- Brief facts of the transaction.
- Date-wise purchase and sale details.
- Source of purchase payment.
- Demat movement of shares.
- Broker details.
- STT and exchange transaction proof.
- Capital gain computation.
- Response to each allegation of the AO.
- Case-law support.
- Prayer for dropping proposed addition.
Professional drafting matters because many additions arise not only due to facts but also due to weak presentation of facts.
For expert assistance in scrutiny assessment, reassessment, faceless proceedings and appeal, you may consult CA Alok Kumar through the Schedule Appointment page.
Key Takeaways from the ITAT Ahmedabad Decision
- Penny stock suspicion alone is not enough.
The Department must prove that the assessee’s transaction is bogus. - Documents matter.
Bank statements, demat records, contract notes and STT proof can strongly support the taxpayer’s case. - General investigation reports have limited value.
They cannot replace assessee-specific evidence. - Price rise alone is not conclusive.
Abnormal gain may create doubt, but doubt is not proof. - Revenue must establish collusion.
Without evidence of pre-arranged transaction, cash trail or link with entry operators, Section 68 addition may fail. - Every case depends on facts.
A well-documented genuine transaction stands on a much stronger footing.
FAQs on Penny Stock LTCG and Section 68
1. Can the Income Tax Department tax LTCG from shares as bogus?
Yes, the Department can examine suspicious LTCG claims. However, it must bring specific evidence to show that the transaction is non-genuine or represents accommodation entry.
2. Is payment through banking channel enough to prove genuineness?
Banking channel is important, but not always sufficient by itself. It should be supported by contract notes, demat statements, broker records, STT proof and proper capital gain computation.
3. Can abnormal rise in share price justify addition under Section 68?
Abnormal price rise can trigger inquiry, but it cannot by itself justify addition unless supported by evidence of manipulation, collusion or bogus transaction.
4. What if the company is named in a penny stock investigation report?
A general investigation report may be relevant, but the AO must still connect the assessee with the alleged manipulation. The taxpayer should respond with complete documents and legal submissions.
5. What should I do if I receive an income tax notice for share transactions?
You should collect all transaction documents and file a detailed reply. If the amount is substantial or the notice alleges bogus LTCG, it is advisable to take professional assistance for Income Tax Notice and Litigation Support.
Conclusion
The ITAT Ahmedabad decision in DCIT v. Smt. Denisha Rajendra Keshwani is an important reminder that tax additions cannot be made merely on suspicion. Even in penny stock cases, the Assessing Officer must go beyond general reports and establish specific evidence against the assessee.
Where the taxpayer has maintained proper records, made payments through banking channels, received and transferred shares through demat account, sold shares through recognised stock exchange and paid STT, the Department cannot reject the transaction without concrete contrary material.
For taxpayers, the lesson is equally clear:
Maintain documents, report capital gains correctly, respond to notices professionally and contest unsupported additions with proper legal strategy.
Verification Sources Used
The ITAT order records the purchase of 51,000 Kappac Pharma shares, demat conversion and sale at ₹251–₹252.50, leading to LTCG of ₹1,17,78,534, which the AO treated as bogus under Section 68. (Income Tax Appellate Tribunal) The Tribunal finally held that the Revenue failed to establish non-genuineness and dismissed the Revenue’s appeal. (Income Tax Appellate Tribunal) Section 68 requires explanation of nature and source of credits; if the explanation is absent or unsatisfactory, the amount can be taxed as income. (Etds) The current law for listed equity LTCG is under Section 112A, with rates/thresholds updated for transfers before and after 23.07.2024. (Etds)
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Also Read – https://caalokkumar.com/my-writing/third-party-diary-tax-addition-svs-projects-itat-hyderabad/
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