New game at Dalal Street

The Bubble Maker’s (Mr. Chidambaram) decision of making long term capital gain tax free has led to another black to white game at stock market. Here is how it’s played.

Origin:

As you all must be knowing that all Long term capital gain is 100% tax free while short term capital gain is charged to tax @ of 10% only. How can a government that came to power by advertising itself as the Messiah of “AAM ADAMI” can be so against the “AAM AADMI”. In today’s tax regime speculators and gamblers are not supposed to pay tax on their winnings while people who work hard to earn their living are supposed to pay 30% tax on their hard earned money. Hence even people who used to work hard has joined the speculation and gambling bandwagon. Mr. Chidambaram, are you getting any cut from these stock brokers / promoters etc?

Structure of Play:

The operators in the market search for stock which has limited liquidity (stock in which public holding is very less and most of the stock is locked with promoters). Then they collude with the promoters. Operators inform the promoters of their intention to play in the stock and requesting them not to start selling their promoter stake in open market. Now the operators slowly and steadily pick up substantial chunk of the stock from the open market leading to reduced liquidity and buzz around the script. They start buying aggressively at very high price in small lots creating a frenzy in the market leading to small investors entering in the stock. The small investors who are feeling foolish to have missed out on the Bull Run rush to buy the share and lead to further increase in price.

Once price have increase to 2x – 3x of the original price promoters transfer their original holding in the company from one holding company to another. In the process the original holding company makes substantial Long term capital gain which is not taxable. Hence promoters are able to build up substantial white money in their books. This also help promoters who have black money parked outside India get this money back in India in this falling dollar regime.

Gainers:

a) Promoters
1. Able to convert his back money in white money without paying any tax
2. Able to create enough white money in his accounts even if actually he doesnot have the money (super money). This helps in showing promoter contribution in new projects. (Most of you must be aware how promoters escalate the project cost in business plan to get large amount of bank finance and their actual equity contribution is nil).
3. If the promoter is planning to come up with FPO / right issue / IPO for subsidiary or a group company / share swap for takeover etc increased valuation helps.
Promoter can now raise higher bank loan by pledging shares help by second promoter company. As the cost price & market price of these shares is much higher, banks are willing to provide higher loan against higher valuations.

b) Operators
Operators cash out by selling the shares they accumulated at lower price, at high price making substantial short term capital gain. (People must be aware how these days short term capital gain transactions are being traded between businessman who want to convert their black money into white by paying minimal tax and operators who don’t want to pay any tax. These businessmen show these transactions in their own books and pay 10% short term capital gain tax. Rest 90% becomes their white money. They save straight 20% in tax (30% - 10%) which otherwise is payable for business income. On the other hand these operators are not even required to pay 10% tax as the transactions are made in others accounts).

Losers:

Small shareholders: Small shareholder fearing missing the train buys shares at all price and hold on to it once operators have left believing those shares are really worth that much.
Government of India: Huge revenue loss. Everyday we read newspaper where experts calculate and show the expected revenue loss due to tax benefits provided to SEZ. Why no expert provide a figure to the revenue loss suffered due to charging capital gain at 0% or 10% tax rate instead of 30%?

To test the above theory, try to see the market behavior over last couple of years (since capital gain tax laws have changed). Look at those scripts that have increased the most during this time. And look at the movement of promoter holding between various companies of the promoter. Look at the amount of loan raised against the pledge of shares by promoters. I am sure you will find the connection. Another good test would be whether promoters have made these transaction through market or off market. Capital gain tax advantage is applicable to only market transaction. I cant think of any other reason to do a market trasaction for promoter share reorganization as due to STT its works out costlier than off market transactions.

Probable example:

Reliance: Due to separation of Ambani brothers both group has ‘reorganized’ their shareholding structure. They have done away with the maze of holding companies and have made it more transparent. This entailed several transaction of transfer of shares from one holding company to another. Can anybody work out amount of white money created in the process.

Essar: The group has done lot of reorganization over the past two years. It has also raised substantial loan by pledging promoter holding in various companies. And the Essar Oil and other group stock prices sky rocketed in a very small span of time recently. Smells fishy.

Well, this is just food for thought. Please do let me know your arguements if you believe the above is not possible.