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I-T Dept may probe tax evasion through F&O trades
October, 17th 2018

This is not the first time that I-T officials suspected tax evasion through the capital market. In 2014-15, the Director General of Income Tax, Kolkata prepared a report detailing how penny stocks were used for over Rs 80,000 crore in evasion of long-term capital gains.

The Income Tax Department may start an investigation against reversal of trade in the equity derivative segment. The department presented its case to the Central Board of Direct Tax (CBDT) last week and sought trade data from the market regulator, Securities and Exchanges Board of India (SEBI).

The move follows reversal of trade in around 14,000 entities in the illiquid derivative segment of the BSE. An official, on condition of anonymity, said the department is inspecting trade reversal on long-dated derivative contract of NSE, which is usually an illiquid or hardly traded contract.

Sources told Moneycontrol the I-T Department suspects the trade reversal mechanism is being used to evade taxes. “On BSE alone, 14,000 entities have used this platform. These entities are now under the I-T scanner,” the source added.

A query to NSE went unanswered till the time of publication while BSE declined to comment on this story.

"On a daily basis, a number of reversal trade transactions happen on the NSE, which may also be investigated by the I-T Department. The investigation agency should not constrain itself to long-dated or illiquid derivative contracts only," a market source said.

Let’s understand this better with an example. For a derivative trade to be executed, a specific buy quantity by investor A has to be matched with a corresponding sale transaction by investor B. Now, trader A can get into an agreement with B to buy back the illiquid contract any time before expiry at a pre-determined higher price. Now, there will be a profit in the books of A and an equivalent loss in B’s books.

Trader A will now be able to convert his black money into white because of this profit, despite having to pay securities transaction tax and short-term capital gains on this profit. Though trader B incurred a loss, he will be paid off in black and can carry forward this loss for 8 years, which can be set off against future capital profits.

This is not the first time that I-T officials suspected tax evasion through the capital market. In 2014-15, the Director General of Income Tax, Kolkata prepared a report detailing how penny stocks were used for over Rs 80,000 crore in evasion of long-term capital gains.

Later on, SEBI gave a clean chit to entities listed in the report, thus watering down the tax evasion case. The markets regulator at that time mentioned in its internal note to the SEBI board that they are concerned only with price manipulation and not tax evasion as the latter comes under the I-T Department’s preview.

In 2010, unique client code modifications worth Rs 55,000 crore per month were made on the NSE by 82 brokers in the equity, equity derivative and currency segments. This amount collectively is over several lakh crores.

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