Cash deals help share traders skip short term capital gains tax

Santosh Nairmoneycontrol.comA report in the Mint today suggests huge underreporting of short term capital gains by stock market traders in financial year 2011-12, going by the number of individuals (5.9 lakh) who filed for short term capital gains or losses with the number of demat accounts (around 2 crore) that year.Short term capital gains—investments of less than one year--on listed stocks are taxed at 15 percent. Even after adjusting for the number of inactive demat accounts, the volatile market that year, and many traders holding on to their stocks for more than a yearthere is reason to believe that many traders would have underreported their short term gains.And there are plenty of ways to suppress your profits or show losses that exist only on paper.The filings in the subsequent years could be higher, now that the authorities are trying to plug the holes in the stock market system, as well as coming down hard on those evading capital gains tax through share transactions.And yet, brokers say there is a thriving cash economy in the stock market, which allows big traders and high networth individuals to escape the taxman’s glare.The modus operandi is simple: many brokers transact for their big clients in cash instead of cheque, in clear violation of the SEBI rules. If the client makes money, the broker gives him the profit in cash. If the client loses money, he pays it to the broker in cash. Such an arrangement helps the big traders because they don’t have to disclose the income at all. Given the nature of this arrangement, there is no paper trail to link the client to the broker.For the stock exchange and the Income Tax authorities, the broker is doing only proprietary trades, i.e he is doing the trades for himself and not for any client. For such cash deals, the broker charges a higher commission instead of the standard 10-25 paise which is the usual commission for large trades. The broker’s challenge is to keep balancing his books constantly, and hoping that all his bulge bracket clients do not make too much profit. If that happens, he will be liable to pay capital gains on those trades since for the Income Tax, he is the one doing all the trades.The broker’s best outcome is some of his clients making money and the others losing an equivalent amount. That way the money from the clients who make a loss can be paid out to those who make a profit. It is never that perfect, but the broker is fine as long as his clients do not make outsized profits.“But even if the profits are huge in some years, it is not a big problem,” says a broker who is familiar with such arrangements.“You can always hire the services of an ingenious chartered account to balance your books,” the broker says, adding that it is unlikely that the I-T department is completely unaware of such deals.