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Decoding the Grey: ITAT Upholds Revenue’s Stance Against Penny Stock Schemes


In the case of Brajesh Narnolia v. Income-tax Officer[i], the Kolkata Bench of the Income Tax Appellate Tribunal (‘ITAT’) addressed the issue of disallowance of exemption claimed under s. 10(38) of the Income-tax Act, 1961 (‘Act’) on long-term capital gains (‘LTCG’) earned from the sale of shares. This section historically exempted gains from taxes if derived from the transfer of listed securities held for over a year, but scrutiny arises in cases involving 'paper companies'—entities potentially created to facilitate fraudulent financial manoeuvres. The ruling illuminates the crucial aspects of assessing the genuineness of investor and investee companies and underscores the impact of judicial precedents on handling similar cases.

Brief Facts

  • Mr. Brajesh Narnolia (‘Assessee’) purchased equity shares of Sulabh Engineers & Services Ltd. (‘SESL’) at Rs. 74.30 per share and subsequently sold them in two parts, 2,000 shares at Rs. 242.28 per share and 4,000 shares at Rs. 243.02 per share. He claimed an exemption under s. 10(38) of the Act, for the LTCG arising from these sales.

  • The assessing officer (‘AO’) denied the exemption, citing Pr. CIT v. Swati Bajaj[ii] of the Hon’ble Calcutta High Court (‘HC’) wherein SESL was identified as one of several ‘paper companies.’ Despite the Assessee's argument that his profit was modest and his investment should be considered innocent, the AO disallowed the claim, a decision which was upheld by the Commissioner of Income Tax (Appeals) (‘CIT(A)')

  • Accordingly, the Assessee filed an appeal before the ITAT against the decision of the CIT(A).


  • The ITAT upheld the decision of the CIT(A) denying the exemption claimed by the Assessee in respect of the LTCG arising from the sale of shares in SESL.

  • The ITAT referred to the precedent set in Swati Bajaj (supra), wherein a large number of companies, including SESL, were found to have manipulated stocks. Despite the Assessee’s claim of innocence and lack of direct involvement in price manipulation, the ITAT found no error in the decision of the CIT(A).

  • The ITAT emphasized that the genuineness of an investee company cannot be determined solely based on the magnitude of profit earned by the investor. Thus, even if an investor earns a modest profit, it does not automatically validate the transaction, especially when the investee company has been identified as a paper company.

  • The ITAT noted that SESL was among a list of companies flagged by the HC as ‘bogus,’ and the Assessee’s investment could not be considered genuine merely because the profits were lesser than might be expected in a fraudulent arrangement.


The ITAT's decision serves as a crucial reminder of the inherent complexities within judicial assessments of financial transactions involving alleged paper companies. The case reflects the critical need for meticulous evidence evaluation beyond mere profitability or investor declarations. Such scrutiny ensures that the authenticity of transactions in volatile market sectors is rigorously verified, safeguarding the financial system from potential manipulations.

Further, the ruling underlines the essential role of regulatory bodies in maintaining market integrity. By highlighting the potential for innocent investors to be caught in schemes orchestrated by manipulative entities, it calls for enhanced regulatory measures. Proactive oversight and thorough due diligence by regulatory authorities are imperative to prevent the proliferation of fraudulent schemes that can erode investor confidence and destabilize the financial ecosystem.

The ITAT's ruling in this case marks a significant moment in financial jurisprudence, emphasizing the necessity of a detailed and context-sensitive approach to legal and regulatory oversight. This case not only reaffirms the importance of individual case analysis in judicial proceedings but also highlights the broader need for regulatory vigilance. As financial markets evolve, the continuous adaptation of regulatory frameworks will be crucial in upholding transparency and protecting investor interests, thus ensuring a stable and equitable financial landscape.

End Notes

[i] [2024] 159 1525 (Kolkata - Trib.) [17.01.2024]

[ii] [2022] 139 352/288 Taxman 403/446 ITR 56 (Cal.)

Authored by Priyavansh Kaushik, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.


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