Section 10(38) IT Act | ITAT Delhi Upholds LTCG Exemption for Penny Stocks When Documentary Proof Overrides Suspicion : ITAT Delhi

The Income Tax Appellate Tribunal, Delhi, has reaffirmed that genuine long-term capital gains from the sale of shares in penny stock companies cannot be disallowed merely on suspicion or circumstantial assumptions, provided the assessee has discharged the initial burden through verifiable documentary evidence. This ruling reinforces the principle that tax authorities must rely on concrete proof, not conjecture, when challenging exempt income.

Background & Facts

The Dispute

The appellant, Daljit Batra, an individual investor, filed his return of income for Assessment Year 2016-17 on 27.07.2016, declaring a total income of INR 22,29,890. The case was selected for scrutiny under the Computer Assisted Selection System (CASS) due to a high volume of security transactions amounting to INR 11,12,97,473, with a Securities Transaction Tax (STT) payment of 0.1% on the same. No income was declared in respect of these transactions, prompting the Assessing Officer (AO) to initiate inquiries.

Key Facts

• The appellant purchased 2,50,000 equity shares of Anax Com Trade Limited (ACTL) in November 2012 at a cost of INR 2,50,000, paid through HSBC Bank via account payee cheques.
• ACTL underwent a 1:10 stock split, increasing the appellant’s holding to 25,00,000 shares.
• On 09.05.2014, the Bombay High Court approved the amalgamation of ACTL with Yamini Investment Company Ltd. (YICL), resulting in a swap ratio of 10:8, entitling the appellant to 25,00,000 shares of YICL.
• The shares were dematerialized and held in the appellant’s DEMAT account with M/s Religare Securities Ltd.
• During the year under appeal, the appellant sold these shares in multiple tranches between June 2015 and February 2016 through registered brokers M/s Religare Securities Ltd. and M/s Shri Parsaram Holding Pvt. Ltd. on recognized stock exchanges.
• The sale proceeds, totaling INR 10,78,90,609 as long-term capital gain (LTCG), were credited directly to the appellant’s bank account.
• The appellant paid STT on all transactions and claimed exemption under Section 10(38) of the Income Tax Act, 1961.
• The appellant submitted: (i) share allotment letters, (ii) bank statements evidencing purchase and receipt of sale proceeds, (iii) DEMAT account statements, (iv) sale invoices and Form 10DB for STT, and (v) broker ledger accounts.

Procedural History

• 27.07.2016: Assessee filed return of income for AY 2016-17.
• 17.02.2017: Notice under Section 143(2) issued.
• 17.12.2018: AO passed assessment order under Section 143(3), making additions of:
  • INR 10,78,90,609 under Section 68 as unexplained credit (LTCG claimed as exempt).
  • INR 21,57,812 under Section 69C as unexplained expenditure (alleged 2% commission for accommodation entry).
• Total assessed income: INR 11,22,78,310.
• 20.08.2025: Ld. Commissioner of Income Tax (Appeals)-24 upheld the additions.
• 14.05.2026: Appeal heard before ITAT Delhi.

The Parties' Positions

For the Appellant

The appellant contended that:

• All transactions were conducted through regulated channels: registered brokers, recognized stock exchanges, and banking systems.
• STT was paid, DEMAT records were maintained, and all documents were submitted to the AO.
• The appellant is a regular investor with multiple share transactions over years, not a one-time participant.
• The AO made no independent inquiry into the brokers, the company, or the counterparty buyers.
• The SEBI order dated 04.09.2023, which restrained certain persons from trading in YICL, did not name the appellant or his brokers.
• Co-ordinate benches of ITAT Delhi and Mumbai, as well as the Delhi High Court in Pr. CIT v. Krishna Devi, had consistently held that mere suspicion or penny stock status cannot override documentary evidence.

For the Respondent

The Revenue contended that:

• YICL was a penny stock company with no financial backing, making the massive LTCG suspicious.
• The absence of disclosure of exempt income in the return indicated concealment.
• SEBI’s investigation into YICL’s price manipulation created a presumption of sham transactions.
• The AO relied on the investigation wing’s report and the theory of human probability to infer that no prudent investor would invest in such scrips.
• The appellant failed to prove the genuineness of the transaction beyond doubt.

Relief Sought

The appellant sought deletion of:

• INR 10,78,90,609 added under Section 68 as unexplained income.
• INR 21,57,812 added under Section 69C as unexplained expenditure.

The Legal Issue

The central question was whether Section 10(38) of the Income Tax Act, 1961, can be denied to an assessee who has established a genuine purchase and sale of shares through recognized stock exchanges, paid STT, and submitted complete documentary evidence, merely because the company is classified as a penny stock and the transaction occurred during a period of market manipulation by third parties.

Arguments Presented

For the Appellant

The appellant’s counsel relied on multiple precedents to argue that the burden of proof under Section 68 is discharged once the assessee provides credible documentation of purchase, holding, and sale. The appellant submitted:

• Allotment letters and bank statements proving acquisition.
• DEMAT statements and broker contract notes proving holding and sale.
• STT payment receipts confirming compliance with Section 10(38).
• The fact that the transaction occurred through SEBI-regulated intermediaries.
• The absence of any adverse findings against the appellant in SEBI’s order.
• The Delhi High Court’s ruling in Pr. CIT v. Krishna Devi that human probability cannot override documentary evidence.
• The ITAT’s own decisions in Sujit Madan v. DCIT and Rajendra Kumar Mundra (HUF) v. ITO, which held similar transactions as genuine.
• The principle that the jurisdictional High Court’s view prevails over non-jurisdictional decisions (Union of India v. Kamalakshi Finance Corporation Ltd.).

For the Respondent

The Revenue argued that:

• The absence of disclosure of exempt income in the return indicated an intent to conceal.
• The sharp rise in YICL’s share price without financial justification indicated a sham transaction.
• SEBI’s investigation into YICL’s price rigging created a presumption of illegitimacy.
• The AO’s reliance on the investigation wing’s report and the theory of human probability was justified.
• The appellant failed to explain why he invested in a company with no financials.

The Court's Analysis

The Tribunal conducted a meticulous review of the evidence and the legal framework governing Section 10(38) and Section 68. It emphasized that the initial burden on the assessee under Section 68 is to explain the nature and source of credit. Once this is done through credible documents, the burden shifts to the Revenue to disprove the explanation.

"The assessee has discharged the burden cast upon him to establish the transaction of sale of shares of YICL as a genuine transaction. There is no direct or indirect evidence against the assessee brought on record by the AO to allege the transaction as a sham transaction."

The Tribunal noted that the AO made no independent inquiry under Section 133(6) or Section 131 against the brokers, the company, or the purchasers. Notices issued to third parties were returned unserved, yet the AO proceeded on assumptions.

The Tribunal distinguished the SEBI order, which targeted specific persons involved in manipulation, none of whom were the appellant or his brokers. The appellant’s purchase occurred in 2012, well before the SEBI investigation period (Sept 2013 - Jan 2014), and the sale occurred in 2015 - 2016, after the alleged manipulation had ceased.

The Tribunal further held that the mere fact that a scrip is a penny stock does not render all transactions in it suspect. The price movement was determined by the open market, not by the appellant. The appellant had no control over the scrip’s valuation.

"The shares were sold through a recognized, registered share broker in the recognized stock exchange in the open market after duly suffering STT. Hence, there is absolutely no reason for the lower authorities to doubt the transaction carried out by the assessee."

The Tribunal also highlighted the inconsistency in the Revenue’s position: the appellant’s brother, who sold identical shares in the same company, had his LTCG accepted as genuine in a reopened assessment. This undermined the Revenue’s claim of fraud.

The Tribunal relied on the Delhi High Court’s judgment in Pr. CIT v. Krishna Devi, which held:

"The theory of human behavior and preponderance of probability cannot be cited as a basis to turn a blind eye on the evidence produced by the assessee."

The Tribunal concluded that the Revenue’s case was built on suspicion, presumption, and circumstantial inference, not on evidence. The appellant’s documentary trail was complete, consistent, and verifiable.

The Verdict

The appeal of the assessee is allowed. The addition of INR 10,78,90,609 under Section 68 and INR 21,57,812 under Section 69C are deleted. The long-term capital gain of INR 10,78,90,609 is held to be genuine and exempt under Section 10(38). The assessment is to be reopened to reflect the correct income.

What This Means For Similar Cases

Documentary Evidence Trumps Suspicion

• Practitioners must insist that tax authorities produce concrete evidence of collusion or fraud before invoking Section 68 or Section 69C.
• Merely labeling a scrip as a "penny stock" or citing SEBI investigations against unrelated parties is insufficient to deny exemption under Section 10(38).
• All documents - share allotment letters, DEMAT statements, broker contract notes, bank trails, and STT receipts - must be systematically compiled and submitted.

Jurisdictional Precedents Are Binding

• When a jurisdictional High Court has ruled in favor of the assessee on identical facts, lower tribunals and other benches must follow it, even if non-jurisdictional benches have ruled otherwise.
• The Union of India v. Kamalakshi Finance Corporation Ltd. doctrine must be invoked to resist inconsistent rulings from other jurisdictions.

The Burden of Proof Shifts to the Revenue

• Once the assessee provides a complete paper trail, the Revenue must prove the transaction is sham through independent investigation.
• Failure to issue notices to brokers, clearing houses, or counterparty buyers renders the Revenue’s case legally untenable.
• Assessee’s regular trading history and absence of cash transactions further strengthen the case for genuineness.

No Automatic Disallowance for Non-Disclosure of Exempt Income

• Failure to disclose exempt income in the return does not equate to concealment or fraud.
• Section 10(38) is a statutory exemption; non-disclosure is a procedural lapse, not a substantive offense.
• The AO must distinguish between non-disclosure and concealment of income.

Brokers and Stock Exchanges Are Protected Intermediaries

• The seller in a stock exchange transaction does not know the buyer.
• The clearing corporation acts as an intermediary; the seller receives proceeds from the exchange, not from the buyer.
• This structural reality negates any allegation of collusion or accommodation entry.