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The Securities and Exchange Board of India (Sebi) has asked stock exchanges to crack down on unauthorised client code modifications by brokers after they execute trades on behalf of their customers.
Changes in client codes are allowed for correcting wrong trades, but an investigation by the tax department showed the system is being misused.
The capital markets regulator has asked the exchanges to record the reason behind every modification of client code by brokers, and proactively levy fines on changes the bourses believe are not genuine.
The development comes after the Central Board of Direct Taxes (CBDT) flagged the misuse of client code modification, a practice it said was aimed at avoiding taxes.
The National Stock Exchange (NSE) had applied for the ‘associate member’ status for its commodity segment to help traders on the exchanges get tax benefits.
As part of the approval process, the tax department had inspected the books of NSE.
In a letter dated June 29, 2019, CBDT rejected the bourse’s application on the ground that the exchange lacked the mechanism in place to verify whether client codes in case of only genuine errors were being modified.
Client code is a unique identifier a broker assigns to clients, and this code is mapped to the investor’s PAN and demat account.
The tax department is already probing several instances where business losses incurred by investors were being transferred into specific accounts that made capital gains.
This business loss can be used to offset capital gains and thereby reduce the tax outgo.
Emails sent to Sebi remained unanswered.
NSE declined to comment on the issue.
“After CBDT’s observations, Sebi held a meeting with officials of all the stock exchanges and instructed them to maintain data of the reasons behind every client code modification from mid-September,” said a person privy to the development.
“The regulator also reiterated its stance on the issue, saying client code changes be restricted to errors like fat finger.”
According to CBDT’s letter to NSE, client codes in trades worth Rs 78,131 crore were modified by brokers in 2018 alone.
The tax department also found that the exchange didn’t examine 90 per cent of the client code modifications and in 60 per cent of the cases, the change in client code also led to change in the PAN number, implying the gains or losses were being transferred to a different entity or individual.
“NSE has rectified most of the observations made by CBDT and has reapplied for the associate member status,” said another person with direct knowledge of the development.
“It would be unfair to say these modifications were done to evade taxes since the exchange levies high penalties for such changes, leaving little incentive for investors.”
For each change, the exchange is required to impose a penalty of 1-2 per cent of the total traded value.
It could not be independently ascertained if bourses levy the penalties for unauthorised client code changes.
For instance, if the client code of a trade worth Rs 10 crore was modified, the exchange would levy Rs 10 lakh penalty on it, irrespective of gains or losses for the trader.
“With respect to the levy of 1 per cent or 2 per cent of the trade value as stringent penalty…, it is reported that first, penalty does not make a non-genuine reason genuine,” said CBDT in the letter to NSE.
“The deterrence by levy of penalty is not sufficient.”
Client code modifications happen in both institutional and non-institutional categories, although such instances are more common in the latter.
In the past, the majority of the cases involving client code modifications for tax evasion were in the non-institutional category.
Stock Market
Sebi cracks down on unauthorised client code changes
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