Sucheta Dalal :Plug The Loophole To Stop Money Laundering
Sucheta Dalal

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Plug The Loophole To Stop Money Laundering  

Jul 26, 2004


Union finance minister P Chidmbaram defended the imp-osition of a Securities Trans-action Tax (STT) saying it is “neat, efficient and easy to administer” and it “prevents tax avoidance by bringing everybody into the tax net”.

His statement is entirely correct, but hectic activity by the ingenious tax-avoidance industry suggests that strong follow up action is required to ensure that STT does indeed bring “everybody into the tax net”.

Over the last two days, several brokers say that they have received several calls from members of regional stock exchanges such as Saurashtra & Kutch, Kochi and Bangalore to tell them how they can launder black money without attracting the attention of tax authorities. These are marketing calls by regional stock exchange members who want metro-based brokers to route the ‘money-laundering’ business to them on a fee-sharing basis.

Here is how it will work. While the national stock exchanges, which account for the bulk of trading activity are fully automated and provide clear audit trails, the same is not true for regional bourses. Many regional bourses have remained alive by setting up subsidiary companies, which in turn are members of the national bourses. Members of the regional stock exchanges, in effect, operate like sub-brokers of the subsidiary firm that is listed on the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE).

For the record, the concept of regional stock exchanges becoming members of the large national bourses was always fraught with problems and was thoughtlessly approved by the capital market regulator in a misguided attempt to keep the smaller bourses alive. Over time, some brokers of such exchanges have acquired a direct membership to the national bourses, or turned into franchisees for the larger brokers. Others, however continue to operate through the subsidiary. The structure is complex and open to mischief because the regulator has had little time to focus on their operations or inspect their books. Mumbai brokers narrate several instances where members of such subsidiary firms openly flout regulatory requirements and issue bill and contracts to investors through their individual firms as sub-brokers. This is clearly barred, but the practice continues unchecked and ensures that the audit trail vanishes along the way and protects the identities of clients.

One broker says, “SEBI registers sub-brokers, collects a registration fee and forgets all about them”. He says that many market operators who have been implicated in various financial scams and barred from the capital market merrily operate through such subsidiaries and have successfully avoided detection.

The reduction in short-term capital gains tax to 10 per cent has opened a big opportunity to a variety of tax-evaders to launder black money. This is clearly apparent from the information provided at websites such as A recent posting says: “The government does not propose to place any restrictions on the kind of stocks on which short-term capital gains will be taxed at the reduced rate of 10 per cent proposed by the Budget. This is good news for those who see this concession as a relatively convenient method of converting black money into white”.

• Cut in short-term capital gains tax enables tax-evaders to launder money

• It’s the regional bourses that could be the leakage point

• One way out is to restrict the capital gains concession to national bourses

“The conversion of black money into white in the guise of short-term capital gains entails tax arbitrage, the benefit being a minimum of 22 per cent — the difference between the minimum tax rate of 35 per cent applicable on current income and the expenditure on short-term capital gains tax, brokerage, etc. The benefit would be higher depending on the vintage of black income declared, the manner in which it is revealed and the corresponding level of penalty applicable”.

The website goes on to say that a “finance ministry source” had clarified that the finance ministry “has no intention to limit the short-term capital gains concession to a limited number of scrips”. It adds, “The MoF feels that the benefit of short-term capital gains should be extended to all the scrips traded across the stock exchanges (emphasis ours)”. And that, “A negative view of any stock or group of stocks would be initiated only after data proves manipulation. Corrective action in the form of barring illiquid stocks would only be taken if the players in the market resort to any malpractice and the MoF feels that such practices are creating aberrations”.

Isn’t that nice? The finance minister may like to start by investigating who is the “MoF source” providing such helpful clarifications on laundering black money. And it probably explains why regional stock exchanges are so confident about getting this business. Clearly, somebody has set the stage for the government to act surprised about money laundering through regional bourses so that the stable doors can be locked only after the horses have bolted.

It suggests that the ‘loophole’ has been deliberately built into the announcement. And it reminds us of the previous Voluntary Disclosure Scheme (during Mr Chidambaram’s previous stint as FM), which had a similar loophole allowing large amounts of money to be laundered by faking the vintage of jewellery or gold and silver coins when certified by conniving chartered accountants. This allowed conversion of black money at as little as three to 10 per cent tax.

A stock broker says: “If they don’t provide such loopholes, how will politicians launder their ill-gotten wealth?” He thinks that this measure is in lieu of the black money scheme that the United Progressive Alliance has included in its Common Minimum Programme.

Ironically, while a gaping hole has been provided through the short-term capital gains tax, Mr Chidambaram’s budget has also provided draconian powers to Income Tax officials to arrest tax evaders. And Vijay Kelkar’s report on tax reforms wants an elimination of tax exemptions that will only force law-abiding citizens to pay more tax.

There is a simple way to plug this loophole; it is to announce that the 10 per cent short-term capital gains tax benefit will only be available for trades on the NSE or BSE. If no such clarification is issued, then the government’s intentions and motivations will be clear enough.

Writer’s e-mail: [email protected]

-- Sucheta Dalal