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Using Stocks To Launder Money


Avinash Celestine is on roll. In a long but very readable piece, he talks about how money is converted from Black to White using stocks.

At the helm is the fact that long term capital gains in stocks are tax free. Using that, all you have to prove is that you bought a stock more than a year back, and its sale at any level of profit gives a gain you don’t have to pay tax on.

In a second step, you need companies whose stocks can be manipulated. With reasonable capital, this is quite easy, because less than 10% of stocks trade more than Rs. 1 crore (10 million) a day, and most penny stocks trade at less than 100,000 rupees a day.

Brokers either issue back-dated contract notes, or use physical shares, or even tell clients to wait a year for the conversion. The “black” cash is given to the broker. At the right time, multiple dummy client accounts are used – probably benami – to rig the price of the share up through circular buying for which you don’t need much money. The buying frenzy can take a stock to a ludicrously high level.

And then the shares of one customer are sold. The profits are tax-free, and the money has been “converted”. The cost – possibly a charge of 5-10%.

In April last year the shares of a company called Global Securities, listed on theBombay Stock Exchange (BSE), were trading in a band of Rs 15-25 a share. Daily volumes during the month varied wildly — from a few hundred shares, to a few lakh. The company’s net profit in 2012-13 was to the tune of around Rs 3.9 lakh.

Between April 2012 and March 2013, the price of the stock rose slowly but steadily. It peaked at Rs 151 per share in early March 2013 before falling sharply. Between late May and December, volumes in the stock averaged a few hundred to a few thousand a day. From January onwards, volumes soared to as much as a few lakh shares before dropping steeply after April 1 this year.

What Avinash hasn’t written is that the buyer at the “top” is probably a broker or another customer who will see the price drop soon after his purchase and book a short-term capital loss which can then be adjusted against other short-term capital gains.

What is to be noted is that money isn’t easily converted this way. One person may have got clean money from his dirty notes, but another person will have to take his dirty notes. However, cash is big in this country – from daily purchases at kirana stores, to paying drivers and maids, to paying labourers at construction sites, cash is used. And below the 50,000 limit, there aren’t any questions by the tax department.

This scheme probably works for small types of conversion – of less than Rs. 5 crore or such. If amounts are larger, it is probably easier to route the money abroad and bring it back in as “legitimate” investments, even disguised as FIIs. Why else do you think our markets tank whenever anyone questions the real source of FII investments?

The black to white conversion happens in the stock market because of incentives. Tax-free exits after one year? FII capital gains are tax free? 150% depreciation for investing in a windmill? (See what happened to Suzlon after that tax loophole was removed) SEZ income is tax free?

While we have to promote exports and all that, we also need to keep a handle on what these “tax havens” do for our credibility. Better enforcement would help – and it’s happening – but it’s important to catch big fish and demonstrate our seriousness. People fear enforcement when the powerful go to jail. If their connections couldn’t protect them, the smaller fry will think, we better get *our* act together.

For you proper tax paying public: If you don’t understand this game, at least understand that small stocks that go up 10x in price are probably not a good investment. Don’t be a sucker.


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