Debashis Basu: Sebi unclear about penny stock tax evasion issue

A series of actions taken by this government shows that it is keen to ensure that listed shell companies are not used to convert black money into white. To start with, the 2017 Union Budget added a provision by which long-term capital gain (LTCG) will not be tax-free for those who acquired shares on or after October 2004 and hadn’t paid the securities transaction tax (STT). Next, the Prime Minister’s Office (PMO) formed a task force on February 10 to prevent the misuse of 900,000 shell companies for money laundering and tax-evasion. “Harsh, punitive actions will be taken against deviant shell companies which will include freezing of bank accounts, striking off the names of dormant companies, and invocation of Benami Transactions (Prohibition) Amendment Act, 2016,” stated the PMO. These are serious moves from a serious regime but will it work to eliminate the menace of penny stock price rigging? While the government is intent on taking the right steps from New Delhi, it is the actions of the Securities and Exchange Board of India (Sebi) in Mumbai that may put a spanner in the works.

On December 29, 2016, Sebi prepared an Information Memorandum (IM) regarding LTCG (I have a copy of it) which identified four kinds of entities involving in the LTCG scam: One, promoters and directors of listed companies; two, beneficiaries (those converting cash into LTCG), also preferential allottees; three, last-traded price (LTP) contributors, or price manipulators and four, exit providers, who provide an exit to the beneficiaries through the stock exchange. (I am not sure where Sebi has included shell companies that convert the cash into cheques, which is a crucial aspect of the operation and on which the PMO has set up a task force.) Anyway, Sebi took the stand that it could act only against the first and the third sets of entities.

It may be recalled that the Directorate of Investigation of the Income Tax department, Kolkata, had launched an extensive investigation into the LTCG scam, which had written confessions from various entities involved and had passed on the report to Sebi. However, Sebi’s IM says “no documentary/independent evidence in support of the statements of the operators were provided…the statements provided by DIT may not be sufficient to establish connection between the LTP contributors, beneficiaries and exit providers. Moreover, charges made on the basis of the statements of operators/ stock brokers/ front entities of operators etc., provided by DIT may not stand the test of legal scrutiny.” In effect, Sebi has made it clear that the I-T investigation report is rather useless for its investigation. In any case, Sebi “is primarily concerned with violation of securities laws… these cases are mainly resulting in evasion of tax,” says the IM. However, if there is price manipulation, Sebi will act. The question is: Did it? The Sebi IM goes on to list what action it has taken: It passed interim orders in just 12 cases over 2014-16, with 1,834 exit providers whose trade value was just Rs 3,877 crore. In the vast majority of cases, Sebi maintained that it could do nothing. In 43 cases, which were identical to the 12, it did nothing. 

Interestingly, the IM was based on a meeting held on November 21 to standardise Sebi’s actions on the LTCG scam (yes, they have been arbitrary and ineffectual). The meeting had two whole-time members, and top and middle-level officials of the legal, surveillance and investigation departments. A note IES/79/2016 was prepared on November 25. The then chairman, UK Sinha, signed it on November 30. The note recorded that 145 cases were being investigated. Of those, in 55 cases, investigation has been completed. However, Sebi has chosen to act against only 12. Can Sebi act selectively? What about the 43 other cases?

Sure enough, this has boomeranged on Sebi. In early March, when one of the 12 cases involving price manipulation and LTCG evasion came up for hearing before the Securities Appellate Tribunal, the aggrieved party put Sebi on the backfoot, arguing that it was being selective. While denying this, the Sebi affidavit says something quite egregious. It says Sebi will “obtain the approval of the competent authority for clarification of the intention and object of the Information Memorandum”. Remember that the IM was based on the note that was signed by the Sebi chairman himself on November 30. Who then is the “competent authority” above him who can enlighten about the “intention and object” of the IM? 

In short, while the government at the Centre is making all efforts to eliminate the LTCG scam, Sebi continues to be unclear about what it can and cannot do about price manipulation, leading to suspected false booking of tax-free LTCG. There is a reason for Sebi’s lack of clarity. It is simply overwhelmed by the problem. It would be interesting to see how the new chairman handles it.
 

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers