Buying shares in cash? You are still eligible for LTCG exemption

Can a taxman disallow exemption of long-term capital gains (LTCG) earned merely because the shares were originally purchased in cash? Let's find out.

A taxpayer filed her return of income for the assessment year 2014-15 within the due date declaring income from salary, house property, and other sources and also income from investing in shares. She claimed exempt income under the relevant provisions of the Income Tax Act in respect of the LTCG derived from the sale of two specific listed company's shares. The sale of shares was affected in the stock exchange through a registered share broker after paying STT (Securities Transaction Tax). The taxpayer had claimed long-term capital gains to the extent of Rs 43.55 lakh as exempt. 

During the course of assessment, the tax officer demanded the submission of details in relation to these transactions. The tax officer observed that the share prices of both the scrips sold by the taxpayer had moved up substantially without having any financial strength. The tax officer's observation of the price trends for the two scrips led him to a conclusion that prices of these shares were artificially hiked to create non-genuine LTCG to the beneficiaries. 

The taxpayer had submitted all relevant evidences for purchase of shares made in cash, along with sale contract notes together with bank statements and demat statements as evidence that the entire transaction of sale of shares had been routed through her regular and disclosed bank statements. 

Relying on the investigation reports for the two specific companies where it was held that these companies were penny stock companies and have been used by different stock brokers to provide bogus LTCG to various beneficiaries. Based on this, the tax officer held that the tax payer's transactions were a sham and hence ruled that the LTCG was unexplained cash credits and made additions to her income accordingly to the extent of Rs 43.55 lakh to be taxed at the rate of 30%. 

The first appellate authority, during the first appeal, agreed with the tax officer's view and ruled that the documents submitted as evidence to prove the genuineness of the transaction are make-believe documents to cover up the true nature of the transactions. 

When the matter came up before the Delhi Tribunal, the taxpayer submitted that the tax officer has not been able to point out any defect, error or flaw in the evidences furnished, either by the tax officer or the first appellate authority. 

The taxpayer also argued that as the shares were sold on a recognised stock exchange through a registered stock broker, the prices of shares listed on the exchange are not in control of the taxpayer. In addition to this, no allegations have surfaced on record that the taxpayer was involved in the price manipulation of the said scrips. The taxpayer relied on various case laws where it has been held that once the shares are sold through a stock exchange and sufficient documentary evidence have been produced in order to support the genuineness of the LTCG claimed exempt, addition of this income cannot be made without rebutting documentary evidences and without conducting an investigation to discard these documents. 

The Tribunal observed that share prices depend upon innumerable factors and perception of the investor and not alone on the financial performance of the company. On the tax officer's objection that the shares were purchased in cash and were dematerialised a few days back only from the date of sale, the Tribunal ruled that there is no law which prohibits the purchase of shares in cash and this cannot be the sole reason of drawing an adverse inference. Regarding the demat of shares, it was ruled that it is the option of the buyer of shares to keep the shares either in demat form or paper form. Merely because the shares were dematted at a later stage cannot be a reason for considering the transaction as a sham. 

Accordingly, the Delhi Tribunal ruled in favor of the taxpayer and deleted the addition made by the taxman. 

The writer is a Sebi-registered investment advisor