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Why black-ka-white through stocks won't stop

By Debashis Basu
February 16, 2017 11:46 IST

Debashis Basu lists various reasons why laundering through the stock market thrives.
Illustration: Dominic Xavier/

 Illustration: Dominic Xavier

Under the 2017-18 Budget provisions, equity shares bought on, or after October 1, 2004, would attract capital gains tax, if securities transaction tax (STT) had not been paid at the time of purchasing the shares.

Bonus shares, shares from public offers or stock options, on which we pay no STT, would not attract this provision.

So, whom does this provision target?

Those who buy into illiquid and closely-held listed stocks (khoka companies) through a preferential allotment (on which no STT is paid), hold them for over a year and book tax-free income as long-term capital gains (LTCG).

How big is the menace?

Speaking at a post-Budget seminar, Central Board of Direct Taxes Chairman Sushil Chandra said, 'I can tell you that last year.... We detected bogus long-term capital gain of Rs 80,000 crore.'

He explained the modus operandi as 'creation of a 'khoka' company, putting some worthless investment, showing great appreciation in that, listing the company on stock exchange and then quickly getting out of it by encashing the high valuation.'

This is incorrect. Contrary to what the CBDT chairman says, it is not easy to list a khoka company anymore.

The beneficiaries (black money holders who wish to procure entry of LTCG to convert cash into tax-free gains) and market operators, work only with already listed dormant companies whose share price is low and listing is only in name.

There are no public shareholders. The existing shareholders move out and the beneficiaries buy the shares, often through preferential allotment.

Since it is a preferential allotment, they don’t pay STT. This is where the new Budget measure plans to catch them.

After this, the operator starts ramping up the share prices to astronomical levels through 'circuitous and prearranged transactions', as described in an investigation report by the directorate of investigation of the income tax department, Kolkata.

'It is here that the surveillance mechanism of the stock exchange has either failed or the persons responsible for surveillance have consciously allowed the manipulations to happen,' says the report.

Note that this black-ka-white game is as much a surveillance failure of the Securities and Exchange Board of India, as tax evasion.

After a year, the operator tells the beneficiaries to arrange the cash to be laundered and hand it over to his contact persons.

Various small players ('entry-operators', who create false book entries) convert this cash into cheque transactions and transfer it all to an account of the dummy buyer of ramped up shares.

Note that this conversion of cash into cheque, though false book entries, is central to the operation and it signals a complete breakdown of the official surveillance system that should easily flag this.

At the final stage, the operator tells the beneficiary and instructs his stock broker (who is fully in this game) to sell a specific quantity of shares at a specific price and time, in a very carefully timed transaction where two sets of people have to enter data and hit the keyboard simultaneously (usually to a count of three) to ensure their entries match.

The operator charges a commission in cash to conduct this laundering operation.

To summarise, here are various reasons why laundering through the stock market is thriving.

One, there are many listed khoka companies. This is a legacy issue that hasn't been addressed well by Sebi and stock exchanges. The government needs to push both.

Second, price-rigging is rampant. If Rs 80,000 crore of capital gains can be generated through the stock market, it reflects a complete breakdown in Sebi's market surveillance system.

Indeed, according to a recent Delhi high vourt judgment, the tax department cannot label money laundering through the stock market as a sham transaction merely on suspicion.

This is why Sebi's role in establishing price manipulation is key to stop the LTCG scam.

Three, the most crucial part of the laundering scheme is depositing the black cash received from the beneficiary into bank accounts, which is then paid out to the beneficiary, to buy the rigged up shares from him.

It is extraordinary that such dubious operations are rampant in various cities, mainly Kolkata, the capital of such 'routing' transactions.

How do thousands of shell companies and bank accounts get past, strict KYC, Prevention of Money Laundering Act, and I-T scrutiny?

None of these three systematic weaknesses are addressed by the change in the Budget provision.

Besides, what the Budget has tried to plug, can be easily bypassed.

The beneficiary can simply buy low-priced shares of the khoka companies through the stock market trading system, pay STT and escape the provision. They can avoid making preferential allotments.

Meanwhile, many legitimate preferential allotments, may get affected. But that is a different story.

The problem of tax evasion and laundering through the market would not be fixed, unless pressure is brought on Sebi.

Debashis Basu is the editor of


Debashis Basu
Source: source