Is Sebi’s tax sleuthing becoming a distraction?
As far as Sebi’s role goes, it might spread itself too thin if it chases every whiff of a tax scandal
Lately, there have been a string of orders by the Securities and Exchange Board of India (Sebi) alleging misuse of stock exchanges for tax evasion. The market regulator’s investigations in these cases are commendable; although, since in some of these cases other investors have not been hurt, the question arises if these tax-evasion related cases are an unnecessary distraction.
In the most recent one, involving four companies listed on BSE’s SME (small and medium enterprises) platform, Sebi barred 239 entities from accessing the markets till further directions.
The order states, in effect, that these entities were involved in converting unaccounted-for or black money into white through stock market transactions. The modus operandi, as alleged, is as follows: A seeming ‘shell company’ makes a preferential allotment of shares to select investors at a pittance just before a public offering on the SME platform. About a year later, when the lock-in for these shareholders has expired, the shares are sold to related entities at a much higher valuation. The outsized gains qualify for exemption from tax, as capital gains on equity shares are exempt, if held for a period of over a year. At some point, it is assumed, these shareholders handed over black money to an intermediary, who facilitates these stock market transactions to convert it into white. The related entities who would have borne losses in these transactions would be compensated in cash. They may even use the reported losses to offset gains made in other legitimate transactions. In other words, the stock exchange system is used by some to convert black money into white and by some others to convert white money into black.
This isn’t very different from old methods of converting black money into white using lottery tickets, for instance. Those with black money would hand it over to people with winning lottery tickets, collect the prize money, and voila, they end up with legal money.
Sebi’s order against the four companies and other such orders shows that it does its homework well, getting into bank transaction details and so on, to establish the links between these related entities. Needless to say, a considerable amount of its man-hours are being expended on these tax evasion cases.
In one such case unearthed by the markets regulator some years ago, however, the Securities Appellate Tribunal had ruled against it, stating that synchronized trades “do not become illegal merely because they were executed for tax planning, as they did not influence the market.” In other words, the tribunal ruled that since legitimate transactions were made on the stock exchange platform and since no other investors’ interests were compromised, there was no violation of Sebi’s regulations. Sebi later challenged this in the Supreme Court; the final decision of the court is awaited.
It’ll be a pity if most of its tax evasion cases end up with a similar fate, after all the effort that has gone into the investigation. Of course, all of this is not to say that Sebi should turn a blind eye to all the hanky panky in the markets it regulates. After all, one of its stated objectives is the regulation of the securities markets. Even if other investors’ interests may not be at risk, the fact that overall market integrity is being compromised is a grave concern.
But there are better ways to handle the menace. Chasing each offender, regardless of the size of the offence, is missing the woods for the trees. If BSE’s SME platform is being used as a platform for tax evasion, then those responsible for the platform should also be taken to task. Not too long ago, Sebi had issued a show-cause notice and later an order warning the National Stock Exchange for its failure to inform the regulator about a high number of client code modifications on its derivatives. News reports suggest that the code changes were essentially done by clients for avoiding taxes. Being front-line regulators, it only seems fair that stock exchanges are expected to play an active role in tracking and checking such practices.
Besides, under the Prevention of Money Laundering Act, 2002, market intermediaries are required to report suspicious trades in a prescribed format. The intermediaries who are being investigated by Sebi in the tax evasion cases can easily be taken to task under these rules, which may work as a far greater deterrent than denial of access to capital markets. According to a former Sebi official, these cases are ripe for action by the Financial Intelligence Unit, which he says appears to be missing from the action entirely. The key, he says, is to go after the intermediaries who facilitate such transactions, rather than hundreds of their customers. It goes without saying that each of these cases can easily be followed up by the income-tax department.
As far as Sebi’s role goes, it might spread itself too thin if it chases every whiff of a tax scandal. The myriad number of cases it has unearthed recently shows that this is a rampant practice. It should instead find ways to address the root causes for the problem and take intermediaries to task.
