Introduction

In a significant ruling, the Calcutta High Court in PCIT Central-2, Kolkata v. Zulu Merchandise Pvt. Ltd. (ITAT No. 88 of 2025, decided on 01.08.2025) has reiterated that bogus penny stock transactions cannot be claimed as genuine losses under the Income Tax Act, 1961. The Court set aside the order of the Income Tax Appellate Tribunal (ITAT), restoring the assessment and first appellate orders which had disallowed a trading loss of ₹51.33 lakh claimed by the assessee.

The judgment makes it clear that companies cannot rely on banks, Demat accounts, or stock exchanges to mask fake transactions and claim false capital losses. The substance of a transaction matters more than the form or channel used. This landmark ruling highlights that all financial dealings must be genuine, transparent, and supported by credible evidence. Any attempt to manipulate books or generate artificial losses can be rejected by the tax authorities.

Background of the Case

The assessee, a non-banking financial company (NBFC), reported trading losses on shares of Radford Global Limited and Shreenath Commercial, both thinly traded penny stock companies.

On scrutiny, the Income Tax Department noticed red flags:

1. Extremely low trading volumes, showing lack of genuine market activity.
2. Sharp, artificial fluctuations in share prices without any real business reason.
3. Weak financials of the companies involved, with little or no genuine business.

Based on these findings, the department concluded that the claimed losses were bogus and disallowed them under Section 68 of the Income Tax Act (unexplained cash credits).

Company’s Defense and ITAT’s Decision

The company challenged the Assessing Officer’s order before the ITAT, arguing that since trades were executed via recognized stock exchanges and banks, they were genuine. The ITAT relied on past precedents and allowed the claim.

However, the Revenue Department appealed to the High Court, contending that fake penny stock trades can also pass through banks or exchanges and that ITAT had failed to examine the specific facts of the case carefully.

High Court’s Observations

The Calcutta High Court made the following key points:

1. Banks and Exchanges Do Not Prove Genuineness
2. Transactions routed through formal channels may still be pre-arranged or sham.
3. Evidence is Key
4. The company failed to produce proof of genuine trading intent, risk, or business purpose.
5. Facts Trump Past Cases
6. Prior judgments cannot override a fact-specific inquiry. The low trading volumes, manipulated prices, and weak fundamentals of the companies exposed the sham.
7. Restoration of AO’s Order
8. The Court restored the Assessing Officer’s assessment order, disallowing the penny stock losses.

Importance of the Judgment

This judgment holds wide significance for businesses and taxpayers:

1. Maintain Transparency – All financial transactions must be backed by genuine contracts and documentation.
2. Formal Channels Are Not Enough – Banking and Demat entries alone cannot establish authenticity.
3. Tax Authorities Have Wide Powers – They can investigate and reject suspicious claims under Section 68.
4. Protecting Market Integrity – Prevents misuse of penny stocks to fabricate artificial gains or losses.

Example for Better Understanding

Imagine a company buys 100 shares of a little-known penny stock at ₹10 and sells them at ₹15 on the same day, creating a paper loss somewhere else. Even if these trades pass through banks and stock exchanges, they may still be bogus if there’s no real buyer, no market risk, or no genuine business purpose.The Court will always look at the substance and intent behind such transactions, not just the paperwork.

Conclusion

The Zulu Merchandise judgment is not just another tax ruling—it is a powerful reminder that the law focuses on economic reality over façade. The High Court emphasized that trades through Demat accounts, brokers, or banking channels cannot by themselves prove genuineness if human probabilities and common sense suggest otherwise.

In simple words, if a company with no business suddenly shows unnatural stock price jumps and claims large losses or gains, it is a red flag for tax authorities. Sham transactions dressed up with documents will not stand in court.

For ordinary taxpayers, the message is clear: avoid dubious penny stock schemes that promise easy tax benefits. For genuine investors, this ruling is a reassurance that the legal system is actively working to weed out manipulation and protect fairness in the market.

Ultimately, the High Court has reinforced a timeless principle of tax law: substance matters more than form, and reality matters more than appearance.