SEBI Cracks Down on Misuse of Penny Stocks

Data reveals bogus long term capital gains tax claims being raised through manipulation in penny stock deals.

Tax payers fill up forms before submitting their income tax returns on the last day of filing in New Delhi July 31, 2013. Indian government revenues are expected to increase by 21 percent in the 2013/2014 fiscal year, Finance Minister P Chidambaram said on Wednesday. REUTERS/Anindito Mukherjee (INDIA - Tags: BUSINESS) - RTX125QG

Tax payers fill up forms before submitting their income tax returns on the last day of filing in New Delhi July 31, 2013. Credit: Reuters/Files

The misuse of penny stocks or lowly priced stocks of companies with weak fundamentals by their operators, stock brokers and owners for raising bogus long term capital gains tax benefits has reached alarming proportions and prompted the Securities and Exchange Board of India (SEBI) to act against 13 such companies and debar another 1,336 entities.

This disclosure was made by state finance minister Santosh Kumar Gangwar in reply to a written question in the Lok Sabha on Friday. He said certain companies listed on stock exchanges – which were either non-operational or had weak fundamentals and unsupportive price volume movements – were being misused by some of the entities for manipulations, including tax evasion.

The minister said that the Income Tax Department (ITD) has conducted investigations (including searches and surveys on more than 100 groups during financial year 2015-16 and 2016-17) and in a large number of such cases, action had been taken as per provisions of the Income-tax Act, 1961.

Gangwar said the IT department has also referred to SEBI for more than 140 unique scripts which were “apparently found having been manipulated”. Based on information received from the IT department and also through its own surveillance systems, he said SEBI had passed orders under section 11(B) of the SEBI Act, 1992, in case of 13 such companies and debarred 1,336 entities.

Gangwar also said that in order to further clamp down on such activities, the exchanges had suspended trading in the shares of 203 companies and reduced the price band of 168 companies to the lowest band of 2%.

Incidentally, only earlier this month, it was reported that Bombay Stock Exchange and the National Stock Exchange of India had put 774 companies under a graded surveillance measure as their price movement was not supported by fundamentals.

The move had come soon after the income tax department moved against companies, operators and stock brokers who were manipulating penny stocks to claim bogus long term capital gain tax.

Gangwar said that systems and practices are in place to promote a safe, transparent and efficient market and to protect market integrity. “The systems instituted include advanced risk management mechanisms comprising continuous monitoring and surveillance, various limits on positions, margin requirements, circuit filters, etc,” he said, adding that whenever any violation of SEBI rules and regulations are observed, appropriate action is taken by SEBI.

On why and how these penny stocks are being manipulated, the minister said, “Under the existing provisions of Section 10(38) of the Income-Tax Act, 1961, the income arising from transfer of a long term capital asset, including equity share of a company, is exempt from tax if the transaction of sale is undertaken on or after October 1, 2004, and is chargeable to Securities Transaction Tax under Chapter VII of the Finance (No. 2) Act, 2004.”

Therefore, he said, there is a need “to check the practice of tax evasion by declaring unaccounted income as exempt long term capital gains arising from manipulated transactions in shares of listed companies”.

In order to address the issue, Gangwar said in the Finance Bill, 2017, the Centre has proposed to amend section 10(38) of the Act to provide that exemption under this section for income arising on transfer of equity share acquired on or after 01.10.2004 shall be available only if the acquisition of share (except acquisitions to be notified as exempt to protect genuine investors) is chargeable to Securities Transactions Tax under Chapter VII of the Finance (No. 2) Act, 2004.