Win­dow to Laun­der Cash, Cre­ate Loss to Cut Tax

The Economic Times - - Brands: Creating Desire -

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.

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