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BSE Ltd has suggested to the finance ministry that benefits related to long-term capital gains (LTCG) tax should be removed to curb market manipulation via the stock exchange platform.

In a letter to Manoj Joshi, joint secretary, ministry of finance, the exchange has said that some entities use the preferential allotment route on the exchange platform to benefit from the current tax regulations. Mint has reviewed a copy of the letter.

As per the current tax norms, an individual is not required to pay any tax on gains from equities if the shares are held for a period of more than a year. The tax is intended to encourage long-term investments rather than short-term trading in the capital market.

In its letter, the exchange has highlighted recent actions taken by Securities and Exchange Board of India (Sebi), barring certain companies and individuals from using the stock exchange platform for making illicit gains through LTCG tax benefits.

According to BSE, the modus operandi involves making a preferential allotment to a set of known entities. Such shares are locked-in for a period of one year if allotted to non-promoters. During the period of lock-in, the share prices of the companies are pushed up on low volumes.

“Upon the securities being free of lock-in, entities sell of the same through the stock exchanges by paying the small amount of securities transaction tax (STT) and get the full benefit of exemption from LTCG tax," says the letter written on 8 July.

BSE has suggested to the government that the differential tax treatment for listed and unlisted shares should be removed if this route has to be plugged. Unlisted entities do not enjoy LTCG tax benefits.

“... the current differential capital gains treatment between listed and unlisted securities should be harmonized to prevent any tax arbitrage," it says.

On 30 June, the capital market regulator barred 239 entities, including four companies listed on the small and medium enterprises (SME) platform of BSE, from accessing the securities market till further directions, citing market manipulation activities.

According to the Sebi investigations, after the shares of these companies got listed on the SME platform, some of the entities “manipulated the price/volume of the scrips and then provided profitable exit to preferential allottees and pre-IPO transferees".

“I prima facie find that the preferential allottees, pre-IPO transferees acting in concert with funding group and trading group have used the stock exchange system to artificially increase volume and price of the scrip for making illegal gains and to convert ill-gotten gains into genuine ones," says the order was passed by Sebi whole-time member Rajeev Kumar Agarwal.

The acts and omissions were aimed at generating fictitious LTCG to convert unaccounted income of preferential allottees and pre-initial public offering (IPO) transferees into accounted one with no payment of taxes as LTCG is tax exempt under section 10(38) of Income Tax Act, 1961, it added.

In the past, companies listed on the main board of exchanges have also faced similar investigations. In February, Sebi barred 30 entities from the market after a probe showed that Kamalakshi Finance Corp. Ltd was allegedly misusing the stock exchange mechanism to maximize long-term capital gains.

However, Deven Choksey, managing director at KR Choksey Securities Ltd, said that the LTCG tax benefit should not be abolished as it is an effective way to attract more investors to the capital market.

“As such, only a small percentage of Indians invest in capital market. Just because a small set of entities have misused the system that does not mean the entire market should be disturbed. There will always be loopholes in the system but it should be plugged in a reasonable manner," said Choksey.

BSE chief executive Ashishkumar Chauhan said that the misuse is not due to laxity of the exchanges. “In reality it is a case of regulatory arbitrage. The surveillance systems of exchanges have improved but it is still happening. The alternate is to tax such profits," he said while addressing the media on the sidelines of an event to highlight 100 companies getting listed on its SME platform.

On Thursday, five companies were listed on the BSE segment that was launched in March 2012. The National Stock Exchange of India, which also has a similar SME platform, has a total of six companies listed on its segment.

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