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Tax Evasion Through Shares
Tax Evasion Through Shares
Tax Evasion Through Shares
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Tax Evasion Through Shares

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Tax Evasion Through Shares provides a very useful guide for officers of income tax department to catch the tax evaders who uses share transactions as medium to either evade tax or money laundering. The book , divided in three parts , includes many case laws which have to be consulted while framing assessment of share related cases.

The author has also provided insights on tax evasion through derivative transactions and use of closely held companies shares to convert black money to white.

The book is written by a tax officer who has devoted twenty years in investigating, enquiring the tax evasion and finally bringing evidences against the tax evaders. The book is primarily a guide for officer of Income Tax Department for investigation in share related cases. The books not only describe the ways of tax evasion, but how to detect, enquire and assess such cases.

LanguageEnglish
Release dateSep 10, 2013
ISBN9781301858125
Tax Evasion Through Shares
Author

Prashant Thakur

Prashant Kumar Thakur was born in Sitamadhi district of Bihar and was brought up in Dhanbad from where he completed graduation from P.K.Roy Memorial College.His ancestral place is Village Hansopur in Samastipur district.He started his career as a reporter with a regional English newspaper The New Republic , but quit the job after two years. In 1993, he joined Income Tax Department and took voluntary retirement from the department effective from 01/10/2013.He is visiting faculty to National Direct Tax Academy where he is being invited since 2008. The recent visit was on 8th to 10th July 2013 for taking up sessions on Taxation of Merger & De-merger cases and other topics for batch of newly promoted Assistant Commissioners of Income Tax.He has also been invited for taking up sessions in Direct Tax Regional Training Institute situated at Kolkata,Chennai, Banglore,Lucknow and Pune.He is passionate about tax laws , writes books ,desires to blog on it,fascinated about internet and mobile technology .He is living in Kolkata , India with his parents , his better half -Alka and two lovely kids-Nishant & Sonali.

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    Tax Evasion Through Shares - Prashant Thakur

    Bogus Purchase Of Shares to Reduce Business Profit

    This tactics is almost similar to conventional tax evasion by purchase of bills of goods, but with a little twist. Bogus purchase of share means showing share purchase without actually purchasing any share. Since the actual purchase is not made, there can be no question of sale of such shares. Therefore, those shares are carried to closing stocks. One of the most popular methods of valuation of closing stock-cost or market price, whichever is lower [Chainrup Sampatram v. CIT [1953] 24 ITR 481 (SC), A.L.A. Firm v. CIT [1991] 189 ITR 285 (SC)], is then followed by the assessee. The devaluation in share price i.e difference between purchase price of shares and the closing price of same shares, is used to adjust the profit of other business carried by the assessee.

    Let us take an example to understand this technique. Mr X is a share dealer and during FY 2009-10, he found that he had earned profit of Rs 60 lakhs. However, he wanted to file return for Rs 5 lakhs. Therefore, his problem was to reduce 55 lakhs of income. Finally when his profit and loss account was prepared, it showed profit of Rs 5 lakhs only. He prepared profit and loss account as under

    The problem of Mr X–the tax evader was solved without giving even a small hint as far as his P & L account was concerned.

    Can you detect such cases?

    Two reasons why such cases can be detected with a little work are :

    First is that he woke up very late to evade tax. This casual approach brings him face to face with two genuine problems. After 31st March, he can neither show any acceptance of delivery of shares nor can he make any payments by cheques. Therefore, purchase is shown on credit side and he is also without any evidence of delivery.

    Second reason is that share trade in India is fully computerized and requires involvement of third parties like stock exchange or depository participants or banks. These third parties can be helpful in gathering evidences to prove the wrongs perpetrated by the tax evaders.

    Steps to Catch Them !

    Therefore, one can detect such tax evasion cases by following steps :

    1. Ask for certain details in a particular format.

    2. Analyse the details.

    3. Enquire & collect evidences.

    4. Dealing with different scenarios.

    5. Summing up & assessments

    First two steps are required to identify such cases, third step is necessary for collecting evidence and the last two to counter alibis of assessee and finalise the findings.

    Step 1: Ask for certain details in a particular format

    The easiest method to detect cases of bogus purchases is to ask assessee to submit details in following format u/s 142(1) of the IT Act. The reason for invoking section 142(1) is that under this provision, an A.O is legally entitled to ask for information in the format he desires.

    i) Details of closing stock of shares

    ii) List of trade creditors with details of purchases made for which payments are due.

    iii) Copies of demat transaction statement for the period under consideration.

    Let us say, in response to such a query u/s 142(1) Mr X–the businessman submitted following details about transactions in shares

    Step 2 : Analyse the details

    (i) : Concentrate on big purchases

    Segregate data related to all big purchases of shares which have not been sold or only a very small percentage of total purchase is sold. For example, in the aforesaid chart, shares which have been purchased during the year and not sold are :

    (ii) :Try to find out answers of following questions

    1. Are these shares listed on NSE, BSE or regional stock exchanges? [Refer to Part III for more on listing of shares]

    2. Are these shares well known?

    3. Whether diminutions in the value of these shares as on the last day of the year are very high?

    4. Are these shares purchased on credit?

    A share listed on regional stock exchange on which there is very high diminution in value and if such share is purchased on credit, it is most likely to be a bogus share purchase.

    The aforesaid chart shows that out of five shares, two of them are well known, i.e., Mukta Arts and Reliance Petro and both are listed companies. Even the closing stocks value of those two shares has reduced only marginally. Therefore, both these shares have to be left out of scrutiny angle. Rest of the three shares have to be taken up for further enquiry & investigation because it is apparent that total devaluation on account of these three shares totals to Rs 45,87,000.

    Once you filter out the shares fit enough for deep investigation, concentrate all your efforts to find out answers to the genuineness of purchase of those shares

    Step 3: Steps to enquire into & collect evidences

    Enquiry and collection of evidences involve following steps

    i. Analyse demat transaction statement.

    ii. Write a letter to the stock exchange

    iii Send a letter to the broker

    iv Take a peep into broker’s demat account

    v. Examine books of account of the Broker.

    i. Analyse demat transaction statement.

    Demat transaction statement is like a passbook of shares. (Read more about demat transaction statement in Part III of the book). If the assessee has done any mischief, he will not submit the transaction statement and will always pray for more time. Therefore, in the very first notice u/s 142(1), you must ask for demat account number and name with address of the depository participant (DP) with whom he maintains demat account. The details furnished can be utilised at this stage. If you know the DP address, send a letter u/s 133(6) and ask for transaction statement related to the assessee for financial year.

    Peruse the transaction statement of the assessee to find if the shares were credited in his account, three or four days after the date of purchase (i.e, transaction date) shown in the contract note. If you do not find entry of shares on the date or even in any month of the relevant financial year, then this is the 1st evidence on record that no transaction in those shares had taken place. Now, your work has increased manifold

    (ii) Write a letter to the stock exchange

    Stock Exchange is a prime witness to the transaction in shares through broker. Therefore, a confirmation from stock exchange is of great help. Note that, since no person can transact without Broker filling his /her PAN in order form, PAN is the single most important data to establish authenticity of the trade. Here is a suggested format for writing a letter to stock exchange

    "Please confirm that M/s XYZ broker has purchased shares of

    …………………on……………for his client named ……………………having

    PAN…………………… in settlement number ………………… vide Trade No

    ………………………………….

    Please also confirm if the transaction was done on delivery basis. If yes, please furnish date, quantity; demat account number in which such delivery was made.

    In case the broker has made the transaction for any person other than mentioned above, Give name and PAN of that person. You are also requested to give the demat account number along with DP name & address of the aforesaid broker, both for his client A/c/pool a/c and self account.

    (iii) Send a letter to the broker

    Send a letter u/s 133(6) to the broker who issued contract note asking following question:

    1. Have you purchased shares for …………… having address

    ……………………….. on date ………….. If yes, please furnish ledger copies of the assessee for the FY ………

    2. Did you purchase shares through stock exchange or through Off market?

    3. If shares have been purchased from any person other than stock exchange, give name, address, details of payment, the date of delivery taken in your accounts

    4.When were shares delivered to assessee and in which demat account?

    5. Enclose your Demat Transaction Statement for period under consideration.

    In all probabilities, if the broker has done some mischief, he will not answer the notice u/s 133(6) or he may shirk from answering. In that case, issue him notice u/s 131 of the I T Act and ask questions given above including documents required for investigation.

    (iv) Take a peep into broker’s demat account

    1. Write a letter u/s 133(6) to the depository of the broker for the demat transaction statements of the broker-personal as well as pool account, related to the impugned shares for the relevant financial year.

    2. Peruse the demat transaction statement of the broker. If you do not find any incoming shares or any credit in brokers account on that day or even within few days after the date, additional evidence will be on record that no purchase was made by the broker even off-market. [Read SEBI Circular MRD/DoP/SE/DEP/Cir-3/2004 dt 24.08.2004]

    3. Also note the balance of shares being shown in brokers demat accounts in impugned share. If you do not find any balance before the date on which the assessee claimed to have transaction, this finding would be very useful against the broker’s alibi that the transaction was executed off-market.

    Step 4 : Dealing with different scenarios

    The result of the letter u/s 133(6) to the stock exchange has to be properly analysed. There may be different types of confirmations from the stock exchange. For example, stock exchange may confirm that :

    Scene (i): The said transaction had taken place.

    In that case, just check that demats transaction statement also shows the credit or debit of such quantity of shares. If the shares are indeed reflected according to the contract note details, close the chapter. There is nothing to find out, as far as genuineness of the transaction is concerned. If you wish, go ahead and do what is generally required for PENNY stock. But this is certainly not falling under this technique Evasion Through Bogus Purchase Of Shares?

    Scene (ii): The broker had transacted in that share but not for the person mentioned in the letter.

    In this case, you have just brought 2nd evidence on the record that broker did not purchase the impugned shares for the assessee. It is clear that the assessee in connivance with the broker tried to hoodwink the department by producing fake contract note. You can strengthened your investigation by calling the broker u/s 131 of the I.T. Act by following these steps :

    1.Match the name and the client ID/PAN reflected in stock exchange’s letter with the name and client ID reflected in Broker’s ledger account of shares. You will certainly get the name reflected. If that is true, you have just unearthed 3rd evidence. Impound the share ledger or get the copies of the share ledger duly signed by the broker, because that page will be used as an evidence for your conclusion.

    2. Record the statement of broker/his manager/staff member who appears as an authorized person, asking him to show the entry of the assessee’s transaction.

    Scene (iii): Broker dealt with those shares on that day but deal was squared off.

    If the deal was squared off and the client ID of both the squared off trades match, it means that the assessee cannot get the shares as it were never delivered. Just a speculative transaction was made. Therefore, the assessee can not show the following things in his account in absence of actual delivery of shares

    1. Business gain or loss

    2. Capital gain or loss.

    3. Closing stock out of such purchase

    Scene (iv): No transaction took place in broker’s account.

    Clear denial by the stock exchange is a great evidence in itself for proving the contract note as false, but the assesee and the broker can still make some alibi as a last resort to save themselves. How to deal with such alibis has been described later in this chapter.

    Step 5. Summing up & assessments

    Copies of all the evidences collected from different sources should be given to the assessee with a show cause notice as to why the share purchase shown by him/her/it should not be regarded as a sham/bogus purchase and that the losses on account of such/ bogus purchase should not be disallowed. However, the assessee and the broker may make following arguments as last ditch efforts to save themselves.

    How to counter last ditch efforts of evaders who may argue as follows:

    The shares are not reflected in his demat transaction statement because he(the assessee) did not take delivery from the broker and kept the shares with the broker only, so that whenever he wanted to sell, he would just tell his broker to sell and order will be executed.

    He does not know what the broker has done. He purchased shares from the broker and he is not responsible for any misdeed of the broker.

    Similarly, the broker may say the stock exchange has not confirmed the transaction because he had made off market deal which was not routed through stock exchange.

    There is no reason for accepting the arguments of the assessee or the broker on following grounds:

    1. There are clear evidences on record that authenticity of the contract note is not proved.

    2. Burden of proof [read CIT v. Calcutta Agency Ltd. [1951] 19 ITR 191 (SC)] of purchase is on the assessee. No proof was produced by the assessee or the broker to show that there was actual purchase.

    3. Even broker’s demat account on examination does not show that he had purchased the impugned shares. It is also to be noted that there was no balance of shares in his pool account before transaction dates.

    4. The broker could not show from which party he made the off market purchase and when those shares were delivered to him.

    5. The broker is supposed to transfer the shares from pool account to his client within two days under SEBI’s rule. Why did he not do so? Read SEBI circular on transfer of share by broker to its client MRD/DoP/SE/Dep/Cir-30/2004 (go to Back to Basics)

    6. The assessee could not convince the extraordinary need for authorization to the broker to keep the shares on behalf of him.

    7. The broker could not say under what law he acted as caretaker of the share, if any.

    8. Even the payment was not made by the assessee for the purchase and the delivery was also not made. Therefore, there was no purchase and sale at all.

    Case Laws Reference

    Bogus Capital gains : ACIT .vs Smt. Ranjit Kaur on 11 August, 2005. 99 TTJ 568

    Burden of proof : Lakshimaratan Cotton Mills Co. Ltd. v. CIT [1969] 73 ITR 634 (SC)/, Dalmia Jain & Co. Ltd. v. CIT [1958] 33 ITR 294 (Pat.)/Dey’s Medical Stores Mfg. (P.) Ltd. v. CIT [1986]

    Unquoted Shares & Tax Evasion

    Common ways of routing back the black money (earned profits on which no tax is paid) in business are :

    1. Unsecured loan receipt

    2. Using the concealed income for purchase and showing purchase on credits, i.e, creating fictitious creditors,

    3. Gifts from someone

    4. Investment in immovable properties and undervaluing it.

    5. Earning tax exempt income like agricultural income, LTCG on listed shares etc

    However, this chapter deals with two methods, both involve shares of private limited companies for converting black money into white

    Readers may note that after amendment in section 56(2)(viib) of the I T Act effective from 1st April 2013 (Asst.Y 2013-14) by which share premium without justification is deemed income of the private limited company , practice of conversion

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