Punjabi is a beautiful language. There seems to be an amusing adage in Punjabi for almost every interesting situation. One such adage talks about a blind man distributing sweets but somehow ending up giving it all to his own children. In January this year, Chairman SECP who is said to be a former broker, in a letter to Chairman FBR proposed a host of steps to revive the stock markets.
These proposals were accepted in totality by the Finance Minister a week later. Since then, what a magnificent spring it has turned out to be for the stock markets! The main proposal is to allow anybody to make investments in the stock market without any questions being asked by FBR about the source of money being invested. Section 111 of the Income Tax Ordinance allows FBR to tax income, assets and investments of a person whose nature and source remains unexplained. SECP has sought suspension of section 111 on investments made by anyone in the stocks till June 2014.
The premise as explained by SECP is that the money which will be invested in the stocks is that money which was made by the "investors" during 36 years when there was no Capital Gain Tax (CGT) on stock trading. Hence they had not declared this income although under law they were still required to. It is claimed that if the investors invest that money back in stocks, FBR would ask the source under section 111 and since no record was kept, the investors will not be able to prove a lawful source. However, as an assurance, the capital market regulator has stated that all money made during these 36 years in the stock market was legitimate money.
It is also proposed that NCCPL which is the clearing company for shares traded on the stock exchanges should act as the withholding agent for FBR on CGT. NCCPL would assess and deduct the payable CGT and that would be the full and final recovery of tax. After 2014 all gains made from trading in stock exchanges would be considered as legitimate money and its source would deemed to be capital gain. For this purpose, the highest value of a person's portfolio of shares anytime during the 27 months period would be deemed to be the value of his portfolio.
The devil, they say, is in the detail. All this is perfect except for the following few issues. 1. The amnesty amounts to rewarding bad corporate and tax behaviour, ie not maintaining proper record.
2. If no record was kept by the "investors" of the gains made during these 36 years, how can the regulator be so sure that the money which was made is legitimate? What about money made from insider trading, market manipulation, fraud and deceit, misappropriation of shares and funds of investors? Considering that all these offences fall in SECP's domain, should this statement be considered as an official pardon?
3. As far as institutional investors are concerned, they are required by different legal regimes to maintain proper record of their investments and profits. Money is made by brokers not only through proprietary trading (ie trading done on their personal behalf), but also through financing of trades (providing badla), investment advisory, commission on client trading and portfolio management etc. Since only capital gain on proprietary trading was exempt from tax, there ought to exist proper record of all income from other heads. Only the remaining income if any, can be claimed to have been made through capital gain. Therefore, should this amnesty be afforded to all investors or only individual investors? Secondly, can the capital market regulators give an assurance that institutional investors including brokers were not dealing in the market in benami names of individuals thereby bypassing the reporting requirements? Is this also an amnesty for the negligence and dereliction of duty by the regulators ie not enforcing the reporting requirements?
4. The assumption that all money invested in the stocks till June 2014 would be money made from capital gains is misleading as no check is proposed to that effect. In fact such a check cannot be placed if the basis for this amnesty ie investors did not maintain proper record is accepted. Resultantly, the money which may be invested could be from any source, including drug trading, smuggling, terrorism etc, which raises the issue of whitening of black money and money laundering.
5. Unless all money made over 36 years (which is to be invested back) is lying hidden somewhere, out of reach and knowledge of FBR, the supposition that section 111 would become applicable upon it being invested back is misleading. Section 111 applies to all unexplained money, however or wherever it is made or invested and not just on stock trading. Hence if that gain was invested anywhere during these 36 years, eg immovable property, section 111 would've become applicable then also. Therefore if FBR did not apply section 111 at that time, why is the fear that it would apply it when this money is invested back in stocks?
Also, this justification that investors are afraid to invest due to FBR is belied by the fact that although the amnesty is proposed to be implemented from 1st April, 2012, the stock market, since the announcement of the amnesty, has already gone up by nearly 2000 points and the trading volumes have more than doubled.
6. In order to counter the fear of black money being invested in the stocks, it is proposed that any money invested to avail this scheme would have to remain invested in the stock market for a cumulative period of 120 days during the 27 months period. However, investment for four months would not deter people if their black money is being whitened and in addition they are also making a handsome and legitimate profit on the stock trading. In fact this proposal is designed to keep the black money invested in the market for longer period for the benefit of market participants and regulators who make profit and charge fee on basis of market trades.
7. NCCPL may be made a withholding agent but to give it the powers of assessment of tax is beyond the scheme of tax laws. Secondly, NCCPL is owned and controlled by stock exchanges which, in turn, are owned and controlled by the market participants. This is a case of conflict of interest and amounts to giving the power of assessment and recovery of tax to the tax payers/assesees.
8. The proposal that the highest value of a person's portfolio of shares anytime during the 27 months period would be taken as the value of his portfolio for purposes of legitimacy is self-serving and can lead to irrational and risky investments. This proposal is an incentive for people to invest on borrowed money, which is provided by the brokers in form of badla. It is also an incentive for unscrupulous elements to manipulate the market to increase the value of their portfolios.
9. The defence that it is only a tax benefit and all other regulatory regimes will apply to check black money being invested in the market is also misleading. These regimes will not work for following reasons.
(i) If the money being invested in the stock market is black money, whose source is suspicious or not known, it is the brokers, their agents, NCCPL, stock exchanges and banks who are required under the Anti-Money Laundering Act, 2010 (AML Act) to report it to Financial
Monitoring Unit (FMU) set up under the AML Act. However, except for banks, all other reporting entities are owned or controlled by the stake holders who are the largest investors and also have a direct interest in high trading volumes. Secondly, the AML regime has been in place for years. How many cases of money laundering in the stock market have been reported, investigated and prosecuted till date? The answer is not even one!
(ii) Offence of money laundering under AML Act only occurs when proceeds generated through certain offences, known as predicate offences (which are enumerated in the AML Act) are laundered. However, this list of predicate offences does not include:
(a) any corporate crimes;
(b) the offence of fraudulent misappropriation of client shares by the brokers under CDC Act 1997;
(c) offences relating to NBFCs, ie leasing, housing finance, mutual funds etc;
(d) insurance crimes under Insurance Ordinance, 2000;
(e) offences under the Modaraba Ordinance 1980;
(iii) The only offences, under a law which is administered by SECP, included in the list of predicate offences are the ones in the Securities & Exchange Ordinance, 1969 (SEO).
However, insider trading which was a criminal offence under SEO was converted into a civil/regulatory offence in 2008 and therefore is not deemed to be included in the list. Hence laundering of money made through insider trading does not amount to money laundering.
The one criminal offence remaining in the SEO is market manipulation under section 17, which is deemed to be a predicate offence for the purposes of AML Act. This is a non-cognisable offence, ie the court cannot take cognisance of the offence of market manipulation unless SECP being the relevant investigation agency brings the matter to it.
However, SECP has not been declared as an investigation agency under AML Act, which means that although it can investigate and prosecute the offence of market manipulation, it however cannot investigate and prosecute the ancillary offence of laundering of money generated through market manipulation. Hence not even one offence of laundering of money made through corporate and capital markets crimes can be brought against the offenders.
10. The timing of these proposals and the consequent hype in the market, without these having even being implemented, is quite interesting if seen in the context of the Corporatization and Demutualization Act passed by the Parliament. This law, which will convert the exchanges from not-for-profit guarantee limited companies to for-profit companies limited by shares, requires the exchanges to be valued for the purposes of issuance of shares against membership cards owned by brokers. Therefore a dead market was in no one's interest. (The writer is a partner at AQLAAL Advocates, Islamabad)
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