February
16, 2017 11:46 IST
Debashis
Basu lists various reasons why laundering through the stock market
thrives.
Under
the 2017-18 Budget provisions, equity shares bought on, or after October 1,
2004, would attract
capital gains tax, if securities transaction tax (STT) had not been paid at the
time of purchasing
the shares. Bonus
shares, shares from public offers or stock options, on which we pay no STT,
would not attract
this provision.
So,
whom does this provision target?
Those
who buy into illiquid and closely-held listed stocks (khoka companies) through a
preferential
allotment (on which no STT is paid), hold them for over a year and book
tax-free
income
as long-term capital gains (LTCG).
How
big is the menace?
Speaking
at a post-Budget seminar, Central Board of Direct Taxes Chairman Sushil Chandra said,
'I can tell you that last year.... We detected bogus long-term capital gain of
Rs 80,000 crore.' He
explained the modus operandi as 'creation of a 'khoka' company, putting some
worthless investment,
showing great appreciation in that, listing the company on stock exchange and
then quickly
getting out of it by encashing the high valuation.'
This
is incorrect. Contrary to what the CBDT chairman says, it is not easy to list a
khoka
company
anymore. The
beneficiaries (black money holders who wish to procure entry of LTCG to convert
cash into tax-free
gains) and market operators, work only with already listed dormant companies
whose share
price is low and listing is only in name.There
are no public shareholders. The existing shareholders move out and the
beneficiaries buy the
shares, often through preferential allotment.Since
it is a preferential allotment, they don’t pay STT. This is where the new
Budget measure plans
to catch them. After
this, the operator starts ramping up the share prices to astronomical levels
through 'circuitous
and prearranged transactions', as described in an investigation report by the directorate
of investigation of the income tax department, Kolkata. 'It
is here that the surveillance mechanism of the stock exchange has either failed
or the persons responsible
for surveillance have consciously allowed the manipulations to happen,' says
the report.
Note
that this black-ka-white game is as much a surveillance failure of the
Securities and
Exchange
Board of India, as tax evasion. After
a year, the operator tells the beneficiaries to arrange the cash to be
laundered and hand it over
to his contact persons. Various
small players ('entry-operators', who create false book entries) convert this
cash into cheque
transactions and transfer it all to an account of the dummy buyer of ramped up
shares.Note
that this conversion of cash into cheque, though false book entries, is central
to the operation
and it signals a complete breakdown of the official surveillance system that
should easily
flag this.
At
the final stage, the operator tells the beneficiary and instructs his stock
broker (who is fully in this
game) to sell a specific quantity of shares at a specific price and time, in a
very carefully timed
transaction where two sets of people have to enter data and hit the keyboard
simultaneously
(usually to a count of three) to ensure their entries match. The
operator charges a commission in cash to conduct this laundering operation.To
summarise, here are various reasons why laundering through the stock market is
thriving. One,
there are many listed khoka companies. This is a legacy issue that
hasn't been addressed well
by Sebi and stock exchanges. The government needs to push both. Second,
price-rigging is rampant. If Rs 80,000 crore of capital gains can be generated
through the
stock market, it reflects a complete breakdown in Sebi's market surveillance
system.
Indeed,
according to a recent Delhi high vourt judgment, the tax department cannot
label
money
laundering through the stock market as a sham transaction merely on suspicion. This
is why Sebi's role in establishing price manipulation is key to stop the LTCG
scam.Three,
the most crucial part of the laundering scheme is depositing the black cash
received from the
beneficiary into bank accounts, which is then paid out to the beneficiary, to
buy the rigged up
shares from him. It
is extraordinary that such dubious operations are rampant in various cities,
mainly Kolkata, the
capital of such 'routing' transactions.
How
do thousands of shell companies and bank accounts get past, strict KYC,
Prevention of
Money
Laundering Act, and I-T scrutiny?
None
of these three systematic weaknesses are addressed by the change in the Budget
provision. Besides,
what the Budget has tried to plug, can be easily bypassed.The
beneficiary can simply buy low-priced shares of the khoka companies through the stock
market
trading system, pay STT and escape the provision. They can avoid making
preferential allotments.Meanwhile,
many legitimate preferential allotments, may get affected. But that is a
different
story.
The
problem of tax evasion and laundering through the market would not be fixed,
unless
pressure
is brought on Sebi.
Debashis Basu is the editor of www.moneylife.in
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