2015 (7) TMI 913 - AT - Income Tax

Profit resulted to the assessee on share transactions through IPOs, - whether is to be assessed as business income or under the head Capital Gains ? - Held that - From the findings of the SEBI, it is implicit clear that both the assessees have indulged in violation of SEBI regulations, while making investments in IPOs. Whatever amounts they have illegally earned, which could be assessed as their income, has been taken away from them. They have already disgorged the amount, though, the payment was made after the close of accounting year, and even after passing of the assessment order. But these payments related to same share transactions, which have given rise to the alleged income in the hands of the assessee. The appeal before the CIT(A) is a continuation of the original proceedings. Before the CIT(A), the assessee have already taken additional grounds of appeal on the strength of the SEBI order. Therefore, we find force in the contentions of the ld. Counsel for the assessee that ultimately no income has resulted to the assessees, out of these share transactions. The income of ₹ 30,98,785/- and ₹ 29,17,331/- is to be excluded from the hands of Smt.Reetaben R. Thakkar and Shri Monal Y. Thakkar respectively in the Asstt.Year 2006- 07. As far as the claim of the assessee with regard to settlement charges are concerned, we find that there is no corresponding income against this expenditure. The income, which we have already excluded, therefore, the assessees cannot claim the expenditure, because, the expenditure has to be incurred for earning some income. Once the income is not form part of the total income, then against that activity, how the assessee can claim that expenditure ? The SEBI has issued a scheme permitting such defaulters to make payment in order to overcome that default. Thus, the payments were not made in violation of certain penalty provisions. In the present case, no such payment was made by the assessees. The assessees have financed certain fictitious entities and benami persons to apply for IPOs. There modus operandi is against SEBI regulatons, particularly, Section 12A of the SEBI Act, and therefore, the payment was on account of violation of provisions of SEBI. The assessees cannot claim that these payments are compensatory in nature. For these reasons we do not find any force in the contentions of the assessees. As far as the appeal of the Revenue in the case of Smt.Reetaben R. Thakkar is concerned, the ld.First Appellate Authority has held that amount of ₹ 5,48,385/- is to be assessed as short term capital gain. We find that the ld.CIT(A) has recorded a specific finding that investment to this is a bona fide investment of the assessees, and it has no link with the other IPOs investments. An assessee could be trader and investor at the same time. For the investment in IPOs. through fictitious entities was considered by the CIT(A) as organized business activity, and rest was as a simple investment. The ld.CIT(A) has rightly treated the assessees as investor qua the surplus amount of ₹ 5,48,385/-. Therefore, we do not find force in the appeal of the Revenue.

Issues Involved:
1. Classification of income from share transactions (business income vs. capital gains).
2. Impact of SEBI disgorgement orders on taxable income.
3. Deductibility of disgorgement amounts as business loss.
4. Allowability of settlement charges as business expenditure.

Detailed Analysis:

1. Classification of Income from Share Transactions:
The primary issue was whether the gains from share transactions through IPOs should be classified as "business income" or "capital gains." The Tribunal noted that the assessees had financed fictitious/benami applicants to apply for IPO shares, which contravened SEBI regulations. The SEBI's investigation revealed that the assessees had made substantial unlawful gains through these transactions. The Tribunal ultimately concluded that the income should be classified as "business income" due to the organized and systematic nature of the activities.

2. Impact of SEBI Disgorgement Orders on Taxable Income:
The Tribunal addressed whether the disgorged amounts (Rs. 30,98,785 for Smt. Reetaben R. Thakkar and Rs. 29,17,331 for Shri Monal Y. Thakkar) should be excluded from taxable income. The Tribunal agreed with the assessees' contention that since these amounts were disgorged to SEBI, no income ultimately resulted to the assessees from these transactions. Thus, the amounts were excluded from the taxable income for the assessment year 2006-07.

3. Deductibility of Disgorgement Amounts as Business Loss:
The Tribunal considered whether the disgorgement amounts paid to SEBI could be allowed as a business loss. It was determined that since the income related to these amounts had already been excluded from the taxable income, the assessees could not claim these amounts as a business loss. The Tribunal emphasized that expenditure must be incurred for earning income, and since the income was not part of the total income, the corresponding expenditure could not be claimed.

4. Allowability of Settlement Charges as Business Expenditure:
The Tribunal examined the nature of the settlement charges paid to SEBI (Rs. 6,20,215 for Smt. Reetaben R. Thakkar and Rs. 5,83,669 for Shri Monal Y. Thakkar). The Tribunal rejected the assessees' claim that these charges were compensatory and not penal. It was held that the payments were made due to violations of SEBI regulations, and thus, they fell under the ambit of Explanation-1 to Section 37 of the Income Tax Act, which disallows deductions for expenditures incurred for any purpose that is an offence or prohibited by law. Consequently, the settlement charges were not allowed as business expenditure.

Revenue's Appeal:
The Revenue's appeal contested the CIT(A)'s decision to accept Rs. 5,48,385 out of the total alleged capital gain of Rs. 36,16,736 as assessable under the head "capital gains." The Tribunal upheld the CIT(A)'s decision, noting that the investment was bona fide and not linked to the fraudulent IPO investments. Therefore, the Revenue's appeal was dismissed.

Conclusion:
- The ITA No.573/Ahd/2010 and ITA No.574/Ahd/2010 for the Assessment Year 2006-07 were partly allowed.
- The ITA No.554/Ahd/2010, ITA No.555/Ahd/2010, and ITA No.786/Ahd/2010 were dismissed.

Order Pronounced:
The order was pronounced in the Court on 24th July 2015 at Ahmedabad.

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