2016 (2) TMI 825 - AT - Income Tax

Penalty u/s 271(1)(c) - disallowance of loss on the date of conversion of stock-in-trade - Held that - The loss on the date of conversion is supported by the market data available in the public domain, that is, as listed in the stock exchange. At the time of conversion of stock-in-trade, there was no recovery of bad debts up till 3.4.2006 (i.e. on the date of conversion), hence it cannot be inferred that the Assessee had intended to set off the future bad debts recovery from the loss on conversion and later on valuation of the stock at the year end. Another important factor which has been pointed out by the ld. Counsel at the time of the hearing is that, now in A.Y 2015-16 the value of the shares has shot up manifold and if the Assessee has to pay tax now on such shares (which is still being held by the Assessee), then the Assessee will have huge income tax liability of more than ₹ 22.72 lacs whereas, had it been held as investment, then, the entire income would have been exempt u/s 10(38). If we take into account the future event of A.Y 2015-16, when the value of the shares have shot up, then, it cannot be held that the Assessee has planned any colourable device deliberately only to set off the recovery of bad debts. The loss on account of valuation of stock as on 31.3.2007 is actually a book loss as per the market rate. Under these facts and surrounding circumstances the loss on conversion cannot be doubted as all these factors strongly point out that the loss of ₹ 1,83,75,418/- is genuine loss and no penalty can be levied on disallowance of such a loss. The Assessee s explanation and the claim has not been rebutted by bringing any material on record except for rejecting the same on the basis of presumption and surmise that the loss has been shown purely to set off the recovery of bad debts. Thus, the penalty levied on such a disallowance cannot be upheld and same is directed to be deleted on merits. Another important thing which is to be noted here is that, in the quantum proceedings the AO has disallowed the loss on alternate ground also by invoking Explanation to Sec. 73, holding that it is a speculation loss. However, neither in the penalty order nor in the subsequent quantum order this issue has been decided. Therefore, the same cannot be held to be a ground for levy of penalty. Moreover, before us the ld. Counsel had pointed out that in A.Y 2008-09 the AO had disallowed a similar loss as speculative loss by invoking explanation to Sec. 73, however, no penalty proceedings have been initiated. Therefore, on these facts it cannot be held that penalty can be confirmed on this alternate ground taken by the AO. - Decided against revenue

Issues Involved:
1. Levy of penalty under Section 271(1)(c) of the Income Tax Act.
2. Disallowance of valuation loss on converted stock of shares.
3. Allegation of using a colorable device for tax evasion.
4. Application of Explanation to Section 73 regarding speculation loss.
5. Procedural issue regarding the initiation and levy of penalty on different grounds.

Issue-Wise Detailed Analysis:

1. Levy of Penalty under Section 271(1)(c):
The appeal concerns the levy of penalty of Rs. 95,00,000 under Section 271(1)(c) for the Assessment Year 2007-08. The penalty was imposed due to the disallowance of Rs. 1,83,75,418 on account of valuation loss of converted stock of shares from investment to stock-in-trade. The Assessee challenged the penalty, arguing that the conversion and valuation were done in good faith and in accordance with standard accounting practices.

2. Disallowance of Valuation Loss on Converted Stock of Shares:
The Assessee, a member of the Bombay Stock Exchange, converted shares of M/s. Sakuma Exports Ltd. from investment to stock-in-trade through a Board resolution dated 3.4.2006. The shares were valued at the lower of cost or market price as of 31.3.2007, resulting in a valuation loss. The AO disallowed the loss, asserting that the Assessee used the conversion as a device to set off the loss against the recovery of bad debts, thereby reducing tax liability.

3. Allegation of Using a Colorable Device for Tax Evasion:
The AO and the Tribunal held that the Assessee adopted a colorable device by converting investments into stock-in-trade and valuing them at a loss to offset the recovery of bad debts. The Tribunal noted that there was no business operation in shares in the preceding year and no trading in the converted shares during the year under consideration. This conduct was deemed not backed by commercial prudence, suggesting an artificial loss creation to reduce tax liability.

4. Application of Explanation to Section 73 Regarding Speculation Loss:
The AO alternatively held that the resultant loss on valuation of stock-in-trade was covered by Explanation to Section 73, classifying it as a speculation loss that cannot be set off against business income. However, this ground was not pursued in the penalty proceedings.

5. Procedural Issue Regarding the Initiation and Levy of Penalty on Different Grounds:
The Assessee argued that the penalty proceedings were initiated on the ground of 'furnishing of inaccurate particulars of income,' but the penalty was levied for 'concealment of income.' The Tribunal agreed that the initiation and levy of penalty on different grounds were incongruent, rendering the penalty proceedings vitiated. The Tribunal emphasized that the AO must specify the ground for penalty initiation and maintain consistency throughout the proceedings.

Conclusion:
The Tribunal concluded that the Assessee's actions were bona fide and supported by Board resolutions and market data. The penalty levied on the disallowance of the valuation loss was deleted on merits, as the Assessee's explanation was not rebutted by any material evidence. Additionally, the procedural discrepancy in the initiation and levy of penalty further invalidated the penalty. The appeal of the Assessee was allowed, and the penalty of Rs. 95,00,000 was quashed.

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