Window to Launder Cash, Create Loss to Cut Tax
Such trades are played out over a year to avoid capital gains tax, and in most cases, with full knowledge and co-operation of promoters
Mumbai: Sebi’s shock treatment to ‘shell companies’ may have its links to a report prepared last year by the investigation wings of the Income Tax of fices in Mumbai and Kolkata. The tax department had probed how stock exchanges were used to either convert black money into white or escape tax.
The list of shares that were traded to launder money and evade tax were subsequently circulated among tax assessing officers who in the course of inspection and scrutiny spotted transactions that involved purchase and sell of thinly-traded stocks. Income tax files of hundreds were reopened and the information was shared with other government agencies, including ED and SFIO.
Such trades on exchanges are played out over a year to avoid capital gains tax; and, in most cases the back-to-back deals happened with the full knowledge and co-operation of the company promoters as they directly or indirectly control bulk of the equity of these companies.
Here’s how a two-legged transaction is executed. Say, someone with ₹ 50 lakh undisclosed cash wants to legitimise it; there are brokers and agents in the underbelly of the city’s money market who are ready to guide him through the maze.
It begins with a buy trade put through a friendly broker for purchasing 50,000 shares of an illiquid scrip, trading at, say, ₹ 10 a piece. The ‘investor’ pays ₹ 5 lakh in cheque and the shares flow to his demat account. It all looks regular and legal. Over a period of 10 months to a year, the stock price is slowly rigged up (typically by operators acting on the instruction of the promoter) to say ₹ 100. That’s when the ‘investor’ (let’s call him ‘A’) sells the shares to a promoter group firm which sold him the shares. Such a firm could be an entity which is holding the shares on behalf of the promoter. ‘A’ receives a cheque of ₹ 50 lakh (for selling 50,000 shares of ₹ 100 a piece) but simultaneously hands over undisclosed cash (which he is desperate to regularise) along with the fee for the service. Thus ‘A’ first pays a cheque of ₹ 5 lakh, receives a cheque of ₹ 50 lakh and gives back the cash. This cash (collected from ‘A’) soon finds a use.
The artificially high level stock price of ₹ 100 draws another kind of person (call him ‘B’) with a very different intent. While ‘A’ wants to convert his hidden cash into legitimate income, ‘B’ is willing to accept cash with the intention to book some losses that would lower his tax outgo. What does ‘B’ do? He signs a cheque of ₹ 50 lakh to buy 50,000 shares and waits for the stock price to collapse. He then dumps the shares to book a loss. Suppose he sells the shares at ₹ 10; receives a cheque of ₹ 5 lakh (creating loss of ₹ 45 lakh) and collects cash (less the service fee) from the buyer (who had originally sold B the shares).
‘A’ buys low, sells high and regularises undisclosed cash. ‘B’ buys high, sells low, receives cash, and books loss to lower tax.
With the share having slipped back to ₹ 10, ‘C’ enters the picture. Like ‘A’ he too is looking for an avenue to convert some of his black money into white. The cycle is repeated. The same set of transactions are enacted with promoter controlled entities first selling stocks at the bottom to ‘C’, buying them back at the peak a year later and collecting cash from ‘C’.
“But now that Sebi and government agencies are focusing on such trades, it will not be easy to launder money and generate losses using this route. I don’t think such trades are possible without the consent or even active participation of promoters,” said senior chartered accountant Dilip Lakhani.
While for ages launders have preferred (and still do) unlisted paper companies to move money, the exchange platform lent a degree of legitimacy as the dealt prices were the ones that were quoted on the screen. But that window is now closing. It’s time for money handlers to change tack.