Exposed: INR 8200 CRORE tax evasion, reversal trade in illiquid stocks on BSE

Exposed: INR 8200 CRORE tax evasion, reversal trade in illiquid stocks on BSE

A scam involving the evasion of nearly INR 8,200 CRORE in long-term capital gains tax by several individuals and entities is being investigated by the Revenue Department. The said individuals and entities are suspected to have evaded tax by engaging in reversal of options trade in illiquid stocks on the Bombay Stock Exchange (BSE).

The Income-Tax (I-T) Department is uncovering further details of the scam which is possibly over 10 years' old. The I-T Department is working closely with capital markets' regulator Securities and Exchange Board of India (SEBI) to render the investigation more effective. The preliminary report - submitted last month to the SEBI by the I-T Department – is said to have found 20,000 such beneficiaries.

The scam came to light after the I-T Department's investigation wing in July 2019 started "Operation Falcon" and rummaged 22 brokerage offices across Mumbai, Kolkata, Kanpur, Hyderabad and the National Capital Region (NCR). While the BSE refused to comment on the matter, several brokers confessed to I-T officials about tax evasion in the F&O segment. Some even acknowledged charging a 2 to 3 per cent commission in cash for carrying out such trades. A certain consortium of share brokers and entry operators which documents the profit/loss of various entities in place of unaccounted cash commission is suspected to be behind these trades.

A source in West Bengal reportedly revealed that a consortium of brokers was well-connected with the local machinery and that several brokers had filed a FIR against the I-T officials who searched their premises in December 2019.

Initial investigations found several taxpayers to have evaded INR 1200 CRORE in taxes by claiming long-term capital gains tax on investments in two penny.

Reversal trade in currency derivative options for about RS 1500 CRORE; reversal trade in currency options on the United Stock Exchange, now merged with the BSE, for about RS 2000 CRORE; and reversal trade in illiquid stocks on the BSE for about RS 3500 CRORE accounted for the rest of the RS 8200 CRORE. Nearly 70 to 100 per cent of the total traded volume on contracts was contributed by the loss-making entities' trade.

The modus operandi of the reversal trade comprised the first phase where entities sold options sans the corresponding off-setting position in the underlying scrip. The options were sold at ridiculously low prices, sometimes even lower than the intrinsic value. The second phase involved the same options being subsequently bought back by the same entities on subsequent trading days at prices considerably higher than the sale price.

In most cases, the loss-making entities of a contract bought and sold an identical number of options. However, there was a sizeable difference in the sale- and buy- value of the trades, leading to sizeable losses for the company and sizeable profits for the options' writers. The entities were found trading recurrently in "deep-in-the-money" and "deep-out-of-the-money" options which are otherwise traded very thinly.

This isn't the first time the SEBI and I-T Department have unearthed tax evasion through reversal trade. In 2019, SEBI introduced a one-time settlement opportunity for entities executing reversal trades in the stock options' segment of the BSE. Back in 2013, the I-T Department uncovered long-term capital tax gains through penny stocks to the tune of INR 70,000 CRORE. In 2010, the I-T Department exposed tax evasion to the tune of INR 55,000 CRORE on the National Stock Exchange through unique client code (UCC) modification.

This time around, the I-T Department and SEBI are working in close coordination. According to market experts, such cases by the I-T Department would prove to be weak in courts without the assistance of SEBI.