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Capital gains sop on equity may promote money laundering

Ambarish Mukherjee
Nithya Subramanian

NEW DELHI, March 7

THE Budget announcement allowing capital gains tax exemption on listed equities for a year is all set to open up the floodgates for large-scale conversion of black money to white, according to market sources.

Efforts in this direction are already visible, with a section of market operators renewing their interest in obscure companies listed on various regional bourses.

This situation has risen because the Government has not made any discrimination between shares that are widely held and heavily traded and shares which are illiquid and seldom traded, though both types fall under the category of listed entities.

Most of the companies whose shares could be used in this mass conversion of black money into white are investment companies that functioned as shell companies. Many of them were floated in the mid-90s when the income-tax rate for listed entities was 10 per cent lower than the rate applicable for non-listed entities, the marketmen said.

According to the sources, the modus operandi is simple and does not involve public participation. But huge amounts of unaccounted money could flow into the system, which could become white money without a single rupee as tax being paid to the Government.

The modus operandi, according to the sources, is like this: Person A wants to convert his black money into white. He may already have a shell company, which is a listed entity but quite illiquid and closely held and is quoted at an abysmally low price. If he doesn't, he will ask his broker to spot such a company.

Now, say A buys shares of a company at the market price of Re 1 out of a Rs 10-crore corpus. Being closely held and illiquid, these shares will be sold to him by some associate and will be routed through the exchange by simultaneously punching buy and sell orders through two separate terminals.

Now, he will hold the share for 12 months after which he will sell the shares back to his associate at an increased price of say Rs 20. The purchase would be funded by A himself and thus the money would come back to him as sale proceeds. The gains arising out of such a deal would be exempted of capital gains tax because of the new regulation.

According to the market sources, of the approximately 9,000 listed companies in the country, close to 4,000 companies are shell companies disguised as investment companies, whose shares could be used for this purpose.

While marketmen said the smaller regional exchanges are the initial target, this, if allowed to continue will reach the two premier exchanges as well. But it is unlikely to affect the small shareholders whose interests are limited to active stocks only.

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