India’s finance ministry has submitted to stock market regulator Securities and Exchange Board of India (Sebi), a list of 20 stock brokers who played a role in money laundering by making fictitious claims of long-term capital gains. The ministry wants the regulator to take appropriate action against these brokers, said an official at the ministry who did not wish to be identified.
The ministry declined to share the names of any of the brokers in the list, but the official said most of the brokers are from Mumbai and that some instances of the misuse of the exemption on long-term capital gains tax dated back to 2003-04. Mint had previously reported that the income tax department had detected tax evasion of more than Rs114 crore related to this, of which eight cases in New Delhi alone were responsible for Rs110 crore.
Mint had also previously reported the mechanism through which the stock market and the tax exemption on long- term capital gains can be used to launder money. Individuals and companies do not need to pay tax on income earned (or gains) from the sale of shares if they are held for at least one year.
The exemption on such long-term capital gains was introduced in the financial year 2004-05 and the income tax department says that tax evasion through this route has increased since then.
The laundering exercise involves two parties, the ‘operator’ and the ‘beneficiary’. The ‘operator’ acquires control of the share capital of a company with low paid up equity whose shares trade at a very low price (these are called penny stock in market parlance). The prices of these stocks are increased 20-30 times their original value through circular trading involving the operator’s associates. Once the stock is trading at a high price, the operator transfers the physical shares to the beneficiary in exchange for an equivalent cash consideration (thus, if the shares are trading at Rs120, the beneficiary pays the operator Rs120). These shares are accompanied by a backdated contract note or bill showing the sale of shares to the beneficiary at an earlier date (before the operator started ramping up the price of the stock). The beneficiary pays the operator only the amount shown in this bill through a cheque; the rest is paid in cash which is usually unaccounted money.
India doesn’t allow shares to be sold in physical form; the beneficiary sends the shares to depositories to be dematerialized (or converted into electronic form). The beneficiary then sells the shares in the secondary market at the still-ramped up prices and receives a payment through cheque. This converts his black money into white, and because the contract is back dated, showing that he acquired the shares a year ago, he is eligible for an exemption on capital gains.
The income tax department, which reports to the finance ministry, first tracked down instances of the misuse. Now, the ministry has sent a list of brokers who served as Rs.operators’ to Sebi.