Union Budget 2017-18: Jaitley tightens screws on money launderers using stock market

Moneycontrol BureauThe Finance Ministry has tweaked the rules relating to long term capital gains tax to make it harder for high networth individuals who launder black money through fake long term capital gains.At present, gains on equity investments held for more than a year are not subject to capital gains tax.From April 1, 2018, only those investments in equities will be eligible for long term capital gains, where securities transaction tax (STT) has been paid. In other words, only shares bought through the stock exchange platform will be eligible for long term capital gains tax.However, shares acquired in initial public offerings, follow-on public offerings, bonus issue, rights issue and FDI route, where the shares are directly credited to the investors’ demat accounts will be exempt from this rule.“It has been noticed that exemption provided under section 10(38) is being misused by certain persons for declaring their unaccounted income as exempt long-term capital gains by entering into sham transactions,” the Budget memorandum says.“With a view to prevent this abuse, it is proposed to amend section 10(38) to provide that exemption under this section for income arising ng on transfer of equity share acquired or on after 1st day of October, 2004 shall be available only if the acquisition of share is chargeable to Securities Transactions Tax,” the memorandum says.

Say investor X has undisclosed income on which he wants to avoid tax. He gets in touch with company Y which can help generate fake long-term capital gains. Company Y issues shares at Rs 10 each and makes a preferential allotment to X. The shares are directly credited to the demat account of X.The money which Y gets from X for the shares is routed back through a web of companies to X.A year later, entities associated with Y manipulate the stock price and double the price to Rs 20. X sells his shares to these entities, who play the role of exit providers, on the stock exchange and gets the payment for it in cheque. X then pays an equivalent amount to the exit providers in cash. Recently, capital and commodities markets regulator SEBI had written to the Directorate of Income Tax saying that it cannot impound or disgorge gains generated by entities trying to launder undisclosed income through stock market transactions.The I-T department had flagged off some 32,000 entities to SEBI, saying they were evading taxes by faking long term capital gains.SEBI said that tax evasion was outside the purview of its regulations. Another reason the regulator could not disgorge the profits is that no common investor was been adversely impacted by the bogus trades.SEBI can only take action where it can prove that the stock prices had been manipulated.Since the last leg of the fake capital gains transaction happens in cash, it is hard for the regulator to prove the fraudulent nature of the deal