No Legal Mechanism Existed to Compute Capital Gains on Unlisted OFS Shares Before 2024 Amendment: Allahabad HC Quashes Income Tax Notice [Read Order]

In a recent judgment, the Allahabad High Court (Lucknow Bench) quashed a search and notice, holding that prior to the amendment of Section 55(2)(ac) in September 2024, there was no legal mechanism to compute capital gains on the sale of unlisted shares through Offer for Sale (OFS).

Pramod Swarup Agarwal and Sneh Lata Agarwal, the petitioners, both senior citizens and promoter shareholders of India Pesticides Ltd. They sold substantial shares in July 2021 during the company’s IPO before it was listed on a recognized stock exchange.

They initially paid advance tax but later, after taking expert tax advice, filed returns claiming exemption from capital gains liability due to the absence of a fair market value computation mechanism at the time. They also submitted a written explanation to the jurisdictional assessing officer in January 2023.

Based on this transaction, the Income Tax Department initiated a search at their premises on 12.12.2024 under Section 132 and later issued a notice under Section 131(1A) on 27.01.2025. The petitioners challenged both actions, arguing that the retrospective amendment made on 01.09.2024 could not justify the initiation of search proceedings for past periods when the law itself lacked clarity.

During the hearing, a division bench comprising Justice Rajan Roy and Justice Om Prakash Shukla explained that the "reason to believe" required under Section 132(1)(b) must be based on pre-existing and relevant information, which was missing in this case. It also observed that the department’s satisfaction note, produced in a sealed cover, failed to establish any prior non-compliance or intent to evade.

The court found that there was no basis to believe the petitioners would not produce documents if summoned and the Revenue’s reliance on post-search material to justify the search was expressly rejected.

On the issue of the Section 131(1A) notice, the court ruled that the authorized officer who issued the notice did so after having already conducted the search, which violated the statutory scheme. The court held that such a notice could only be issued before initiating action under clauses (i) to (v) of Section 132(1).

The court ruled that the entire search and the notice were invalid and illegal, lacking the statutory foundation required under the Income Tax Act. The writ petitions were allowed. However, the court clarified that this decision would not prevent the Income Tax Department from proceeding against the petitioners under other applicable provisions such as Section 148, if lawfully warranted.

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