Background SEBI has recently passed
three orders that not only have important implications for securities
markets, but also to the parties under the Income-tax law. These are in
the case of First Financial Services Limited (“First Financial”),
Radford Global Limited (both orders dated 19th December 2014) and Moryo
Industries Limited (dated 4th December 2014). Simply stated, SEBI has
alleged that certain people used the three listed companies to carry out
price manipulation with the objective of creating bogus long term
capital gains so as to evade income-tax. It has also been reported in
Business Standard dated 29th December 2014 that about 100 such companies
are being investigated with the potential amount of such bogus gains to
be about Rs. 20,000 crore. The orders are interim in nature and have
for now debarred the parties from accessing the capital markets and
dealing in securities.
This article discusses the orders and
considers broad tax implications. The allegations and findings in the
three cases are similar and hence only Order in case of First Financial –
has been discussed.
The statements in the orders are
allegations and there are no final findings as of now. However, in this
article, for the sake of simplicity, it has been assumed that the
statements/allegations in such orders are true, though later some of the
challenges that would be faced are highlighted.
Allegations in the orders
SEBI
found a pattern of events in the three companies. To summarise, each of
the three companies made a preferential allotment of shares to select
persons. The shares so allotted were locked in for one year in
accordance with the law relating to such preferential issues. This
period of one year also coincided with the provisions of tax laws that
made gains after such period to be generally exempt from tax. During
this period of one year, SEBI found that the prices of the shares of the
companies on the stock markets were systematically increased by a group
of persons connected with the companies. This increase was by concerted
trading within their group at successively higher prices. The increase
in the price was manifold. For example, SEBI found in First Financial’s
case, the price of the shares increased from Rs. 5 to Rs. 263 in 114
trading days. And further increased to a peak of Rs. 296. The trading
volumes also increased astronomically.
Soon after the lock in
period of one year ended, the preferential allottees started selling the
shares. SEBI found that many of the buyers were linked to the people
who participated in the earlier transactions that helped increase the
price. The allottees made gains that were usually in crores of rupees
for each such allottee.
SEBI noted that while the preferential
allotment were made at a premium, the companies did not have operations
or profitability that would warrant (warranted) such premium.
During
the course of investigation, SEBI attempted to physically trace one of
the companies and its operations. It observed that it could not trace
even its offices at the reported addresses. It also noted that the
companies had stated that the issue of shares under preferential
allotment was for certain stated business purposes. However, the
companies did not use the monies raised for such purposes.
What
is more, in many cases, the amount paid by the preferential allottees
was returned by way of advances directly or indirectly to such
allottees.
SEBI held that there was concerted violation of
several provisions of the SEBI Act and the SEBI (Prohibition of
Fraudulent and Unfair Trade Practices relating to Securities Market)
Regulations, 2003. SEBI thus alleged fraud, price manipulation, unfair
practices, etc. by the Company, its promoters, certain named parties and
the allottees.
Based on such findings, it made an interim and
ex-parte Order prohibiting such persons from accessing the securities
markets and also prohibited them from dealing in securities. An
opportunity was given to the parties to present their case before SEBI
within the specified time.
SEBI alleges that object was tax evasion
SEBI
has repeatedly alleged that the object of the chain of acts was evasion
of income-tax. Further, it has referred matter to concerned
authorities. The following statements of SEBI are relevant:-
“From
the above facts and circumstances it can reasonably be inferred that
the preferential allottees acting in concert with First Financial group
have misused the stock exchange system to generate fictitious long term
capital gains (“LTCG”) so as to convert their unaccounted income into
accounted one with no payment of taxes as LTCG is tax exempt. I prima
facie find that the above modus operandi helped the concerned entities
to pay a lower rate of tax on account of LTCG and helped them to show
the source of this income to be from legitimate source i.e. stock
market. “
“I prima facie find that First Financial group and
allottees used securities market system to artificially increase volume
and price of the scrip for making illegal gains to and to convert
ill-gotten gains into genuine one.”
“….while SEBI would investigate into the probable violations of the securities laws, the
matter may also be referred to other law enforcement agencies such as
Income Tax Department, Enforcement Directorate and Financial
Intelligence Unit for necessary action at their end as may be deemed
appropriate by them.”
(emphasis supplied)
Violation of securities laws for tax evasion
While
the objective of the exercise, as SEBI alleges, is tax evasion, the
concern of SEBI arises because this involves abuse of the capital market
for achieving such objects. The following remarks of SEBI make this
clear:-
“I am of the considered view that the schemes, plan,
device and artifice employed in this case, apart from being a possible
case of money laundering or tax evasion which could be seen by the
concerned law enforcement agencies separately, is prima facie also a
fraud in the securities market in as much as it involves manipulative
transactions in securities and misuse of the securities market. The
manipulation in the traded volume and price of the scrip by a group of
connected entities has the potential to induce gullible and genuine
investors to trade in the scrip and harm them.”
“SEBI strives to
safeguard the interests of a genuine investor in the Indian securities
market. The acts of artificially increasing the price of scrip misleads
investors and the fundamental tenets of market integrity get violated
with impunity due for such acts. Under the facts and circumstances of
this case, I prima facie find that the acts and omissions of First
Financial group and allottees as described above is inimical to the
interests of participants in the securities market. Therefore, allowing
the entities that are prima facie found to be involved in such
fraudulent, unfair and manipulative transactions to continue to operate
in the market would shake the confidence of the investors in the
securities market.”
“Unless prevented, they may use the stock ex-change mechanism in the same manner as discussed hereinabove for the purposes of their dubious plans as prima facie found in this case. In my view, the stock exchange system cannot be permitted to be used for any unlawful/forbidden activities. Considering these facts and the indulgence of a listed company in such a fraudulent scheme, plan, device and artifice as prima facie found in this case, I am convinced that this is a fit case where, pending investigation, effective and expeditious ?preventive and remedial action is required to be taken by way of ad interim exparte in order to protect the interests of investors and preserve the safety and integrity of the market.”
(emphasis supplied)
Further implications
Much will depend on what further findings are made in the investigations. As of now, while the findings are substantial, many of them are circumstantial. Further, they do not implicate all the parties in the same manner.
The profits made, as per the orders, aggregate to nearly Rs. 650 crore for these three companies. It appears that the sales of the shares took place in the financial year ended 31st March 2013. Thus, it is very likely that the parties would have already filed their income-tax returns and claimed benefit of exemption for the profits such long term capital gains. If the transactions are held to be bo-gus, then not only it is possible that the amounts may be subject to full tax, but there could be levy of interest and penalty. It is possible that there may be prosecution too. Even the parties who are alleged to be indirectly involved in such cases may be acted against for participating in the alleged conspiracy of tax evasion.
However, much will also depend on the final findings not just of SEBI but of the income-tax department. It would also have to be seen what is the final outcome of the proceedings before SEBI. In case some or all of the findings against some or all of the persons are found to be false, these may also have impact on the tax proceedings.
It is likely that there would be prolonged proceedings pursuant to such orders. It is possible that appeals before the Securities Appellate Tribunal and/or the Courts may be made by the parties concerned. There would also be completion of investigation and final orders passed by SEBI. These orders could then be the subject of further appeals.
Presently, SEBI has made certain interim orders of prohibition to the parties concerned. However, SEBI will certainly pass more comprehensive orders after completion of investigation. While one will have to wait and see the nature of the orders passed, the powers of SEBI, as amended and enhanced from time to time, are quite comprehensive and elaborate.
The following are some of the powers that SEBI has:-
Power to debar the parties concerned generally from accessing the capital markets for a specified period of time.
Power to prohibit the parties concerned from dealing in securities for a specified period of time.
Power to levy penalty on the parties. This could be upto 3 times the amounts involved.
It is even conceivable that SEBI may disgorge the amounts of profits made.
Power to suspend/cancel the registration of intermedi-aries involved.
Power to prosecute the wrong doers.
It has several other powers too. The various powers of SEBI that have been increased from time-to-time would not only be in full display, but be tested before the courts.
Conclusion
The findings of SEBI, if found true, can have far reaching effects. The scope of the orders is quite broad and large amounts are involved. At the same time, considering the complexities involved, it is also likely that the proceedings before SEBI and income-tax department could take a long.
Concerns about use of capital markets for tax evasion purposes have been often expressed even before there was concessional treatment of tax of gains. These orders establish that regulatory and investigating agencies are active and effective in implementing the law in the interest of good governance.
