Money Laundering Via Listed Shares

 Under the Indian tax law, long-term capital gains on listed equity shares (capital gains when there is at least a year’s gap between the time a share is bought and when it is sold) is tax-free. This fact is used to launder money as explained by Prashant Kumar Thakur in his book ‘Tax Evasion through Shares’.For example,a broker and his client could strike a deal whereby the broker sells shares in a penny stock to his client for a low price, say a few rupees.The catch here is that the contract note issued to the client is backdated to a year earlier. In the interim, the broker has manipulated the price of the stock up through circular trading — two or more brokers circulate the stock between them each selling at a higher price than earlier. After the client has bought the shares for a few rupees each, he transfers physical cash to the broker who then routes it through a range of accounts. In the final step, the broker ‘buys’ the shares back from his client at the higher price, locking in a long-term capital gain. Essentially, the broker has routed the client’s own money back to him, with the advantage that the client can show this as a legitimate capital gain in his tax return — a gain which is tax free.For this purpose,many CAs control a clutch of listed companies each. 

Investigating a legally created long term capital gain is quite an uphill task for an assessing officer. The difficulty arises because the tax evaders make it appear authentic by following all legal steps.Indeed even when brokers are willing to make statements which go in favour of tax authorities, courts have not always ruled against the buyers of such shares, because of the documentary proofs such as purchase bills and contract notes. When overwhelming documentary evidences are produced by the assessee, the burden shifts on the tax department to explain them. Every time the statements of brokers cannot help the department. Every time the above mentioned evidences can’t be ignored.The tax department has to give reasons for rejecting them. Given the documentation produced by the assessee, the ‘apparent is real’. In other words, unless I-T authorities can prove otherwise, a set of transactions backed up with their documentation has to be taken as genuine.To make things harder to trace,physical shares are demated.

 Money laundering through a preferential issue of shares is an even more sophisticated way. Such issues allow a promoter to sell shares in the company to a group of investors rather than to the public at large. Under preferential issue norms, those shares not issued to the promoter group are locked in for a year. Under the modus operandi, shares are issued through a preferential allotment at a low rate. The cash is paid upfront to the operator, who also controls the company. CAs are happy to provide names and contacts of angadias who will facilitate the physical transfer of cash.After a year, when the lock-in is released, the shares are bought back at a suitably high price. And because of its ‘safety’, CAs asks for a higher rate of commission than normal. While the commission rate on the method involving backdating of contract notes is 3-3.5%, the commission rate for conducting a preferential issue is 6%.

Another method where it’s difficult to question the legality of some types of transactions is  mergers. A private unlisted company issues shares to a number of investors at a low price — such investors are none other than the ones who would like to launder their funds. This private company is then merged into a listed company, and in lieu of the merger, the investors get shares of the listed company. Operators then ramp up the price of the listed entity, enabling investors to cash out and book legitimate capital gains.