I-T crackdown: Brokers, investors come under scanner for fraudulent trades

Conducts searches at over 150 places linked to brokers, investors for alleged tax evasion

A large number of brokers and investors are under the scanner of the income-tax (I-T) department for allegedly executing fraudulent trades in illiquid stock options.

According to sources, I-T officials on Wednesday conducted surveys and search operations at about 150 locations across the country, including Delhi, Mumbai, Hyderabad, and Kolkata. “We have launched a probe in the matter following information from the market regulator about irregularities in the equity derivative segment,” said a tax official privy to the development. The official added that this was a fresh probe based on the inspection of certain derivative contracts both on the BSE and the National Stock Exchange (NSE). 

The probe covers trades of the last five years, starting 2014, and will continue for a few more days, sources said.

The I-T department suspects the involvement of over 20,000 entities, including trading members and investors, in the matter, which could have led to tax evasion of about Rs 80,000 crore.

Early this year, the Securities and Exchange Board of India (Sebi) levied a total penalty of over Rs 55 lakh on nine entities for fraudulent trading in illiquid stock options of the BSE. The action had come after the regulator conducted an investigation into the trading activity in the segment from April 2014 to September 2015, after observing large-scale reversal of trades. 

The regulator had observed that entities repeatedly bought and sold stock options and executed reversal trades with the same set of entities for the same quantity within a short span of time with substantial price difference. Later, these entities had created artificial volume in the contracts, which is in violation of unfair trade practices rules. In April 2018, Sebi announced that it had decided to take action in a phased manner against 14,720 entities for fraudulent trade in the illiquid stock options segment. So far, the market regulator had passed more than 60-70 orders against such entities. 

Explaining the modus operandi, the official quoted above said that the profit on sale of shares of listed companies where the securities transaction tax has been paid does not attract long-term capital gains tax if the investment is held for more than 12 months. However, Sebi and the the I-T department have found that this provision is often misused by rigging the prices of illiquid stocks.

"While trying to make Futures and Options segment liquid, bourses had offered incentives to brokers/investors for executing Futures and Options transactions on its platform. Taking advantage of illiquidity, it is gathered that many investors and brokers executed reversal transactions within short span of time at variance with the prevailing cash market prices. This facilitated transfer of profit and / or loss from one entity to another causing potential revenue loss to the exchequer," official said. 

This is not the first time tax authorities are probing the tax avoidance through the capital markets. In 2015, tax department had come across certain instances where operators advise investors to invest in such listed firms, which accordingly allot shares on a preferential basis at a nominal rate. These shares are under a lock-in period for a year. Subsequently, these operators manipulate the scrip price. They also rope in entities to provide the "last traded price" for booking long-term capital gains and also for buying shares at a higher price. The beneficiary pays cash to the operator through a multi-layered structure from the gains made by evading the tax.