Now, I-T Department turns gaze on client code modification to counter tax evasion

The Income Tax Department has sent letters to stock exchanges, asking them to look more closely into cases of client code modifications to help spot tax evasion tactics.

Sources told Moneycontrol that the letter follows the Central Board of Direct Taxes' (CBDT) thinking that too many client code modifications take place on exchanges and that at least some may not be genuine.The source added that starting today (September 16), exchanges have started asking institutional investors the reason for any such modification. This disclosure was being sought for non-institutional investors since July.

The tax department’s letter also says that exchanges should also look into whether requested client code modifications are intended for genuine purposes.

The department’s renewed glare on client code modifications as a method to evade taxes comes after it its success in plugging another loophole on illiquid options.

Modifications in client code – a unique trading id given to all clients -- are required in cases of a manual error on the part of investor or broker while punching in the client code at the time of order. For instance, a broker may have mixed up an order for Client A with that of Client B.

They are more commonplace in the institutional segment when a broker transacts on behalf of a client, only to transfer the securities to the client later. Another case may be when an asset management company purchases a stock for a particular scheme but later decides to allocate it to another scheme, points out a source.

But data with the intelligence and the criminal department of I-T shows that the current framework is not much of a deterrent and that client code modifications in the system are unusually high.Even so, exchange officials, Moneycontrol spoke to said the current penalty structure is enough of a deterrent – in that it puts a sufficient watermark that becomes difficult to clear, and thus disincentivises tax evasion.