SEBI’s reversal trade settlement causes loss to Income Tax Department

And it has reached such a scale that market regulator SEBI has chosen to offer a one-time settlement to nearly 15,000 practitioners of the technique, instead of fighting long drawn-out cases in the court. These trades took place on the BSE’s derivatives segment between April 2014 and April 2015.

Tax evasion through bogus trades in thinly traded options contracts has become the preferred route for tax evasion because of the restrictions of client code modification, which was earlier the most common route for tax evasion/money laundering.

And it has reached such a scale that market regulator SEBI has chosen to offer a one-time settlement to nearly 15,000 practitioners of the technique, instead of fighting long drawn-out cases in the court. These trades took place on the Bombay Stock Exchange’s (BSE) derivatives segment between April 2014 and April 2015.

Modus operandi :- Consider Person A wants to fake a loss of Rs 10 lakh (to reduce his tax outgo) while Person B wants to launder Rs 10 lakh of ill-gotten money.  A friendly broker will put A and B on the opposite of a series of trades in some options contracts that no sensible trader will touch. The trades will be matched such that B makes a profit of Rs 10 lakh and A will show a loss of the same amount. SEBI calls such trades as reversal trades, which were pre-mediated. Later, B will return the money to A in cash or some other way.

SEBI says the trades are not genuine, and imposes a penalty, and usually, the trader will challenge the order. The trader’s contention is that his broker put in the trade, so he was not aware of the counterparty. He invested his idle funds for the short term, and that neither the exchange nor his broker had warned him about the trades.

Such trades are not so much SEBI’s problem as much as they are a headache for the Income Tax (IT) department. While the SEBI charges these entities for unfair trade practices, the main motive of these trades is to dodge the taxman, not to manipulate the prices and mislead other investors.

For a while after 2011 when SEBI imposed a penalty on client modification, the value of ‘modified’ trades fell, but they seem to be picking up again. The Central Bureau of Direct Taxes (CBDT) in a letter to NSE in June last year pointed out that brokers modified client codes in trades worth Rs 78,131 crore in 2018 alone.

As a fallout, the CBDT now demands more information from stock exchanges on all transactions, covering both cash and derivatives markets, where client codes have been altered.

The SEBI statement says that a “uniform consolidated settlement factor of 0.55 in all cases wherein the entities had executed reversal trades, would be applicable while arriving at the indicative settlement amounts.”

This can be taken to mean that for Rs 100 of notional profit or loss, those accused of having done bogus trades will have to pay Rs 55 as settlement. That could pinch, but whether it will be a sufficient deterrent, depends on how much it affects the economics of such trades.

The Unfair Trade Practices Rules allow SEBI to impose a penalty as high as Rs 25 crore or three times the amount of profits made out of such practices.

Tax offenders are exploiting a particular loophole in SEBI regulations which allows them to indulge in an unfair trade practice while being able to show that it did not hurt other investors. The regulator will need to find some way to fix this.

At a time when tax collections are already low because of the comatose economy, plugging this leakage would help a great deal.

 

Source: CNBC TV18

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