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Revenue Department unearths Rs 8,200-crore tax evasion, illiquid options trading scam on BSE

I-T Department, SEBI also involved in the probe. Syndicate of share brokers and entry operators said to be behind these dealings. I-T Dept searches 22 brokerage houses in major cities. West Bengal said to be the hub. Department submits an initial report to SEBI for further investigations

October 19, 2020 / 12:12 PM IST

The Revenue Department is investigating a probable tax evasion scam to the tune of Rs 8,200 crore, against several individuals and entities for long term capital gains tax evasion by indulging in a reversal of options trade on the Bombay Stock Exchange (BSE) in illiquid options, sources told Moneycontrol.

More details of the scam, which, probably, is more than 10 years old, are still being unearthed by the Income-Tax (I-T) Department.

Moneycontrol has reviewed the initial report submitted by the I-T Department to capital markets regulator Securities and Exchange Board of India (SEBI) last month for further investigations. In fact, the department has identified about 20,000 such beneficiaries.

Details of the scam unearthed after the investigation wing of the I-T Department launched ‘Operation Falcon’ in July 2019, and searched 22 brokerage offices in various cities, including Mumbai, Kolkata, Kanpur Hyderabad and the Nation Capital Region (NCR).

Responding to a set of queries emailed by Moneycontrol, the BSE: “The BSE is not privy to any such report or antecedents. In view of the same, BSE will not be able to comment on the same."

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It must be noted that BSE, the oldest stock exchange in Asia, stopped allowing such trades in 2014.

In recent years, the exchange has introduced a raft of of measures aimed at improving efficiency of trade and offering more choice to investors. BSE has introduced products that allow high speed as well as facilitate seamless trading across platforms.

BSE illiquid options tax evasion

Many brokers admit involvement

Brokers, in statements, have admitted to I-T officials about the tax evasion in the F&O segment, and have even admitted to charging 2-3 percent commission in cash for executing such trades.

The department has found out that a certain syndicate of share brokers and entry operators, who record the profit/loss of various entities in lieu of unaccounted cash commission, are behind these dealings.

Entry operators are those who provide invoices of profits and loss, by generating bills.

According to a source, initial investigations have found out that many taxpayers have evaded tax to the tune of Rs 1,200 crore by claiming long- term capital gains tax on investments in two penny stocks.

Reversal trade in illiquid stocks on the BSE for about Rs 3,500 crore, reversal trade in currency derivative options about for Rs 1,500 crore and evasion of about Rs 2,000 crore by reversal trade in currency options on the United Stock Exchange, now merged with the BSE, accounted for the rest of the Rs 8,200 crore.

SEBI also involved in the probe

The I-T authorities are working closely with capital markets regulator Securities and Exchange Board of India (SEBI) this time to make the probe more effective.

West Bengal is the hub of this tax evasion. A source in West Bengal told Moneycontrol on the phone that a "syndicate of brokers are well- connected with the local machinery. In fact, many brokers have even filed a First Information Report (FIR) against I-T officials who searched their premises in December 2019”.

The modus operandi

The trade by loss-making entities contributed anywhere between 70 to 100 percent of the total traded volume on the contracts on those days.

In the first leg of this reversal trade, the entities would sell options without any corresponding off-setting position in the underlying scrip. The options were sold at an unreasonably low price, sometimes even below the intrinsic value. In normal conditions, the minimum price, which the option seller would demand to take the risk of writing the option, would be equivalent to the intrinsic value of the option.

In the second leg, the same option will be subsequently bought back by the same entity on subsequent trading days at a substantially higher price than the sale price.

On the majority of occasions, the number of options bought and sold by the loss-making entities of a contract was identical. However, there was a significant difference in the sale value and buy value of the trades, resulting in significant losses to the company and profits to the options writers.

While the price of the underlying asset had remained almost unchanged during the period when the positions were kept open by the entities on both sides of the trade, the entities indulged in a reversal of trade, with no justification. The entities were seen trading repeatedly in ‘deep-in-the-money’ and ‘deep out-of-the-money’ options that are otherwise very thinly traded.

SEBI has been passing orders against several entities, including those connected to this scam, on options trading in illiquid stocks on the BSE. It introduced the SEBI Settlement Scheme 2020 (end of October 31, 2020), which offers a one-time settlement opportunity for entities that executed reversal trades in the stock options segment of BSE.

The I-T Department had found tax evasion through the exchange platforms earlier, too. It had, in 2013, unearthed around Rs 70,000 crore worth long-term capital tax gains through penny stocks, and, prior to that, tax evasion of around Rs 55,000 crore on the National Stock Exchange (NSE) through unique client code (UCC) modification in 2010.

In 2018, after the I-T Department found a large number of client code modifications, it sought a report from the NSE and it is analysing the reason for the modifications.

This time, however, the I-T  Department and SEBI are working in close coordination. Market experts feel that without SEBI’s assistance, such cases by the I-T Department would prove to be weak in the courts.

Options, option writers, in-the-money, out-of-the-money

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset

A writer (sometimes referred to as a grantor) is the seller of an option who opens a position to collect a premium payment from the buyer. Writers can sell call or put options that are covered or uncovered.

A call option is in the money (ITM) if the market price is above the strike price. A put option is in the money if the market price is below the strike price. An option can also be out of the money (OTM) or at the money (ATM).
Tarun Sharma
first published: Oct 19, 2020 11:51 am

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