How shares in listed firms are used to convert black money into white

By Avinash Celestine, ET Bureau | 11 Aug, 2013

In April last year the shares of a company called Global Securities, listed on theBombay Stock Exchange (BSE), were trading in a band of Rs 15-25 a share. Daily volumes during the month varied wildly from a few hundred shares, to a few lakh. The company's net profit in 2012-13 was to the tune of around Rs 3.9lakh.

Between April 2012 and March 2013, the price of the stock rose slowly but steadily. It peaked at Rs 151 per share in early March 2013 before falling sharply. Between late May and December, volumes in the stock averaged a few hundred to a few thousand a day. From January onwards, volumes soared to as much as a few lakh shares before dropping steeply after April 1 this year. Global Securities, along with two other companies also listed on the BSE, Finalysis Credit and Guarantee and Aricent Infra, are the subject of a recent complaint to the BSEthat claims that the shares of these companies were traded in a way as to enable brokers to convert client funds from black to white. ET Magazine approached each of the companies asking for a response. Finalysis managing director Sajjad A Qadir said: "Yes we are aware of complaints. We are conducting an inquiry and the authorities too are investigating the matter." A compliance officer of Aricent infra responded: "We have not yet received intimation of any such complaint by the BSE authorities nor we have received any such complaint at our end. We will certainly look into the matter at our end." Communications to the official email IDs of Global Securities and follow-up calls to officials did not elicit a response. In response to a questionnaire, BSE responded: "The exchange routinely receives various letters/complaints on various scrips ... wherever warranted [it] conducts the necessary analysis/ investigation... The exchange does not comment on the status of the investigation of individual cases." Regulators could well find that trading in stocks of these companies was legitimate, and that they were not used by operators to launder funds. But complaints about manipulation of stocks, many of them 'penny' stocks, to enable conversion of black money into white are hardly new. Here's how shares in listed companies are used for conversion:

Black Listing While there are various ways in which this is done, the basic principle arises from the fact that under Indian tax law, long-term capital gains on listed equity shares (capital gains when there is at least a year's gap between the time a share is bought and when it is sold) is tax-free. A broker and his client could strike a deal whereby the broker sells shares in a penny stock to his client for a low price, say a few rupees. The catch here is that the contract note issued to the client is backdated to a year earlier. In the interim, the broker has manipulated the price of the stock up through circular trading two or more brokers circulate the stock between them each selling at a higher price than earlier.

After the client has bought the shares for a few rupees each, he transfers physical cash to the broker who then routes it through a range of accounts. In the final step, the broker 'buys' the shares back from his client at the higher price, locking in a long-term capital gain. Essentially, the broker has routed the client's own money back to him, with the advantage that the client can show this as a legitimate capital gain in his tax return a gain which is tax free. But these time-tested methods are also risky simply because I-T officials and other investigative agencies are well clued into such practices. After all, it doesn't take much for an income tax officer to ask an 'investor' why he is buying into a company which seems to do no business, and whose prospects seem risky. "I-T officers are well aware of this practice and will certainly ask questions," says achartered accountant whom ET Magazine met, while posing as a potential customer for such 'services'. The CA said he, along with a few other fellow accountants, controlled a clutch of listed companies. Backdating a contract note, too, isn't without risk not when demat transaction statements and details of share transactions with the exchange by the broker in

question are likely to reveal the actual dates on which the shares were transacted. Better Ways But proving legally that such purchases were part of a plan to launder black money is difficult. In Tax Evasion through Shares authorPrashant Kumar Thakur, an I-T officer, says: "Investigating a legally created longterm capital gain is quite an uphill task for an assessing officer. The difficulty arises because the tax evaders make it appear authentic by following all legal steps." Indeed even when brokers are willing to make statements which go in favour of tax authorities, courts have not always ruled against the buyers of such shares, because of the documentary proofs such as purchase bills and contract notes. "The department has got statements of these brokers which are used against the assessee," said the income tax appellate tribunal (ITAT), in a case Baijnath Agarwal vs Asst CIT where the income-tax challenged claims of capital gains on penny stocks. "...when overwhelming documentary evidences are produced by the assessee, the burden shifts on the Revenue [department] to explain them. Every time the statements [of brokers] cannot help the department. How could

the above mentioned evidences be ignored? The Revenue [department] has to give reasons for rejecting them. These are important documents, some of them arise under the provisions of the Companies Act." The problem, as the ITAT pointed out, is that given the documentation produced by the assessee, the 'apparent is real'. In other words, unless I-T authorities can prove otherwise, a set of transactions backed up with their documentation has to be taken as genuine. But just to be safe, many operators have gone further, and indeed in the case of some types of transactions it's not clear that any illegality can be proved at all. The CA that ET Magazine spoke with proposed a better way to conduct a money laundering transaction through a preferential issue of shares. Such issues allow a promoter to sell shares in the company to a group of investors rather than to the public at large. Under preferential issue norms, those shares not issued to the promoter group are locked in for a year. "After one year, when those shares are released from lock-in, we will buy them from you," explained the CA. "This is a very safe method to convert funds and everything is legal," he said. Under the modus operandi, shares are issued through a preferential allotment at a low rate. The cash is paid upfront to the operator, who also controls the company. The CA was happy to provide names and contacts of angadias who would facilitate the physical transfer of cash. "As far as I am concerned, the reputation of the top angadias is as good as that of any top-rung bank," he said. After a year, when the lock-in is released, the shares are bought back at a suitably high price. And because of its 'safety', the CA asks for a higher rate of commission than normal. While the commission rate on the method involving backdating of contract notes was 3-3.5%, the commission rate for conducting a preferential issue was 6%.

Completely Legal An I-T officer that ET Magazine spoke to concurred with the view that it's difficult to question the legality of some types of transactions. "There are a number of loopholes in existing tax laws which allow for such transactions to be carried out," he said. One such method is of mergers. A private unlisted company issues shares to a

number of investors at a low price such investors are none other than the ones who would like to launder their funds. This private company is then merged into a listed company, and in lieu of the merger, the investors get shares of the listed company. Operators then ramp up the price of the listed entity, enabling investors to cash out and book legitimate capital gains. Another CA that ET Magazine spoke to pointed out: "In such circumstances, the original share issue in the private company can be looked at. Officers should check whether the money raised from the issue has actually been used for the objects or aims of the issue (e.g. capital investment in a project) which were officially stated. The bank statements will give the true picture." It was such practices that caused the Income-Tax Department to push for provisions such as the General Anti-Avoidance Rule or GAAR. Tax enforcement officers and investigative agencies have their work cut out in cracking down on unaccounted income.