Client Code
Modification means modification /
change of the client codes after
execution of trades. Stock Exchanges provide a facility to modify any client code after the trade has
been executed to rectify any error or wrong data entry done by the dealers at
the time of punching orders.
What is Client Code
Modification (CCM)
Stock Exchanges
provide a facility to modify client code to rectify any error or wrong data entry
done by the stock brokers at the time of punching orders.
Purpose of Client
Code Modification (CCM)
For rectifying
“genuine” errors and mistakes that may have occurred during the trading hours.
Admissible upto 30 mts after closing of trading hours. Applicable only in Intra
day transactions.
Details
about Genuine error
The following trades
shall be modify/ allowed to be modify, shall be treated as genuine error and
transferred to Error Account.
(a) Punching
error / typing error of client codes due to any genuine error or mistake in
order entry, while punching the order, by any of dealer.
(b) Trade
entered for wrong client due to any miscommunication from the client
/authorized representative of the client.
(c) Client
code/name and modified client code/name are similar to each other but such
Modifications are not repetitive.
(d) Family
Code (spouse, dependent parents, dependent children and HUF)
(e) Institutional
trades modified to broker error/pro account.
(f) Misinterpretation
of communication as to what Investor speaks and what Dealer listens because of
similar sounding alphas and numbers like ‘B’ is being heard as ‘P’ etc. as
generally the dealing room environment is very noisy.
(g) Shifting
of character positions like 4356 is punched as 4536 or one serial up or down.
(h) Order
getting punched in hurry in the previously retained code. All the front‐end application has
facilities to retain code of last punched order in order entry window and most
of the dealers use this feature to speed up the order entry process.
(i) Wrong
trades due to the mistake of dealers like ‘Buy’ order punched as ‘Sell’ or
error in quantity or prices. Such trades needs to be owned up by the Trading
Member and has to be transferred to ‘Mistake/Error Account’ of the Trading
Member.
KEY NOTE
v
The
modification of client code is to be done, only in exceptional cases and not as
a routine one.
v The reason for
modification has to be ascertained and analyzed and genuineness is to be
established and also its impact on the clients should be studied before the
modification.
v Normally as a
principle, other than for punching errors, no modification of client codes will
be allowed.
Misuse to evade
taxes
Some brokers
transferred Trade gains or losses from one person to another by changing the
client codes, in the garb of correcting an error. These gain or loss book
entries were then used to evade taxes.
CBDT Notification
No. 14/2011, dated 09.03.2011
As per Notification,
Stock Exchanges should ensure the transactions (Cash and F&O) once
registered in the system are not erased. Stock Exchanges to furnish monthly
statement in Form No. 3 BB (Rule 6DDA) and Form No. 3BC (Rule 6 DDC).
SEBI passed order in respect of modification of Client Codes of traders
SEBI passed order
vide WTM/PS/09/DNPD/ April/2012 Dated 11.07.2011 against National Stock
Exchange (NSE) for violating the procedures.
v SEBI is of the
opinion that the number of errors is a
strong indicator whether the errors are genuine or not. If we contrast this to
thousand of errors committed in a month in the case of modification of client
code, it is but obvious that there would have been some other reason than
genuine mistake.
v NSE has taken a
laid back attitude towards the problem and either totally ignored or
perfunctorily imposed minor penalties to the brokers. It failed to apply its
mind to the unusualness of the happenings. I therefore find that NSE acted
negligently in discharge of its regulatory duties.
Modus Operandi – A
What
the Share Brokers actually Do
|
A - wants to book
a loss during March, 2019 i.e. end of Financial Year, as he has already
having substantial taxable profits.
|
B - wants to book
profit through intra day transactions to earn Profits.
|
|
Client Code of ‘A’
with the share broker (for example) is SJ 1234
|
Client Code of ‘B’
with the share broker (for example) is RK 4567
|
B’s
Loss transferred to A
|
‘A’
has not done any transaction during the day but expecting to book loss
through broker by using other client code who incurs loss.
|
B’
buys 1000 shares of 'XYZ Ltd’ at Rs.
100 a share through a broker in anticipation that the price will go up.
|
|
|
Due
to volatile market, ‘XYZ Ltd’ moves down to Rs. 90 a share at the end of the
closing hour.
|
|
Broker
modifies client code of A i.e. SJ 1234 against transaction done by B through
code RK 4567 within half an hour of closing of the day.
|
B’
incurred loss of Rs 10,000/- intra day in sale/purchase of ‘XYZ Ltd’.
|
|
Booked
bogus Loss & set off against Profits ending up paying no Taxes.
|
B’
even though incurred loss, end up receiving cash from ‘A’ through Broker.
|
Modus
Operandi – B Modus Operandi
Imagine
for a moment 2 clients A & B :
|
A -
wants to book a loss (say for example he has already have sufficient Profits
and wanted to close the Financial Year with paying less or no Taxes after
setting off of Profits against acquired Loss).
|
B -
wants to book a profit.
|
v A buys stock 'XYZ
Ltd.' from B at Rs. 100 a share in anticipation that the price will drop to Rs.
90. But instead the stock moves up to Rs. 110.
v A ends up Profit of
Rs. 10 per share and B ends of Loss of Rs. 10 per share at the end of the day.
v What the broker does
then is to swap the 2 client codes by 4:15 pm - gifting 'A' a loss and 'B' a
profit. Since on the exchange the trades
have been squared, there are no delivery obligations.
Transfer of Loss
Trading Gain/
Trading Losses were transferred from one account (A) to another (B) or vice
versa under guise of rectifying errors. Most common in Derivatives Market under
National Stock Exchange (NSE).
When & where it
happens
An assessee who has
made profits during the year but has not paid any Taxes. At the end of the
year, he believes that he has a huge tax liability as well as interest
liability. He would take/buy loss with his cash unaccounted money from the
person who shift their losses to him through share broker. He will end up
setting off of his profits against losses and end up paying NO Tax.
Stock Exchange
Policy
As per the policy,
the modification (CCM) if any is not permitted across the board and the same is
allowed with restrictions. Only the following types of modifications are
permitted by NSE namely, (i) similarity of names and code numbers - non
repetitive ones and (ii) family codes.
Modifications are
not permitted as a rule but only as exception to the rule.
Onus on the Assessee
v
The assessee cannot simply distance himself from this
major allegation by stating that the Client Modification is the internal matter
of the Broker and assessee has no control. The fact that loss is transferred to
assessee’s code is to the benefit of the assessee who is setting off
against Profits.
v
Assessee being the beneficiary of the impugned loss
and the claimer of the deduction by way of set off against the other income.
v
Share Broker, who is party to such generation of loss,
needs to demonstrate on what basis the client Codes are similar to that of the
assessee as per the Stock Exchange Policy.
(a)
Are the names similar?
(b)
Are the changed clients are part of the assessee’s
family?
(c)
Are the codes similar?
These
are the logical questions which are required to be answered by the claimer of
the deduction (assessee) or generator of the impugned losses (Broker).
Business Income [Section 43(5)]
Section
43(5) of the Income Tax Act’1961:-
“speculative transaction” means a transaction in which a contract for the
purchase or sale of any commodity, including stocks and shares, is periodically
or ultimately settled otherwise than by the actual delivery or transfer of the
commodity or scrips:
Provisio to Section
43(5)
Provided that for the purposes of this clause—
(d)
an eligible transaction in respect of trading in derivatives referred to
in clause (ac) of section 2 of the Securities Contracts (Regulation)
Act, 1956 (42 of 1956) carried out in a recognised stock exchange; or
(e) an eligible transaction in respect of trading
in commodity derivatives carried out in a recognised association [which is
chargeable to commodities transaction tax under Chapter VII of the Finance Act,
2013 (17 of 2013),]]
Ø shall not be deemed to be a
speculative transaction.
Speciman of Details required by Assessing Officer
(A)
Preliminary
Details to be called from the assessee :-
(i) Details
of Share/Derivative/Multi Commodity or any other Trade Transaction during the
year ……..
(ii) Name
and address of the Share Broker (s) through whom Transactions undertaken;
(iii)
Details
of Demat Account and Trading Accounts maintained;
Details of Client
Code allotted to the assessee by the Broker(s);
(i) Ledger account copy with the Broker (s) for
the year under consideration ;
(ii) Contract
Notes of Sale/Purchase of shares/derivatives etc., under taken through the
Broker during the period …………
(iii) Details of Payments Made to the Broker(s) during the year ;
(iv) Details
of Payments received from the Broker (s) during the year ;
(v) Whether transaction with the Broker for the first time or he is a regular client,
furnish complete details of the transactions ;
(vi)
Details
of margin money paid to the broker with sources thereof;
(vii)
Frequency
of Transaction ;
(viii) Details
of Transaction(s) during the year which involve Client Code Modification
undertaken by the Broker;
(ix)
Reason
for Client Code Modification;
(x) Details
of Capital Gain or Capital Loss or Trade Profit or Trade Loss may be provided;
(xi)
The
Gain/Loss involving Client Code Modification may be separately provided;
(B) Details to be obtained from Share Brokers
in respect of assessee :
(i)
Transaction ID
(ii)
Original Client Code
(iii)
Modified Client Code
(iv)
Name of the original client
(v)
PAN of the original client
(vi)
Name of the modified client
(vii)
PAN of the modified client
(viii)
Scrip name
(ix)
Quantity of shares/scripts transacted through
modification
(x)
Rate of (9) above.
(xi)
Total Value of transaction
(xii)
Buy or sell
(xiii)
Date of transaction
(C) Details to be obtained from NSE & MCX
(i)
Details of
Client Code Modification of assessee
for the period …….
(ii)
Ledger account of assessee for all exchanges.
(iii)
Master summary of the above client for FY …………….
(iv)
Copies of KYC
forms of the Client.
(v)
Details as to who executed the transactions (broker
details).
(vi)
Complete details of Original Client Code and Modified
Client Code along with name and address of the persons/account holders involved
may be provided.
(vii)
Quantity of shares/scripts transacted through
modification, rates, total value of
transactions entered into by assessee during the year.
(viii)
Details with amount of loss or gain transferred
through Client Code Modification to assessee i.e. Client Code ……...
(ix)
The detailed
data along with financial implications
regarding the client code modifications for separate segments such as
cash, equity derivatives, currency derivatives and all trades in respect of
……….. (assessee) ………..(PAN) …………(client
code).
Taxability
The setting off of
losses through client code modification is not the actual loss incurred by the
assessee. Any setting off of such losses against profits is colourable device
to evade taxes. The difference should be treated as suppressed profit of
Assessee.
The loss is a
non-genuine and fictitious loss which has been acquired by the assessee in
gross misuse of error entry modification with the tacit connivance of the
Broker. The client code modification was being done in cases other than that
for rectifying the genuine errors under the garb of existing practices to evade
Taxes.
Trade loss from CCM
If Loss is claimed
by the Assessee : Whether the said modification to the Client Code was done
with a mala fide intention to generate Trading loss by the assessee by
the collusive arrangement with the broker ? If Yes, the Business Loss is to be
disallowed and Profit to be Taxed without setting off with Trading Losses.
Trade profit from
CCM
If Profit is claimed
by the assessee : Whether the said modification to the client code was done
with a mala fide intention to generate Trading Profit ? It is the situation where profit
shifted from some of the clients by the broker through CCM to set off the
brought forward losses available with the assessee. The Object of shifting of
Profit is to introduce Undisclosed Money into the Capital in the garb of Profit
from Trading. It is nothing but Introduction of Black Money into Capital which
should be taxed as ‘Income from Undisclosed Sources’.
Undisclosed profits
The profit arising
out of the Client Code Modification transactions, wherein client code was
modified later, should be considered as the profit of the assessee and hence
the same should be assessed in its hands as Income from Undisclosed Sources.
Setting off of losses not to be allowed under section 115 BBE of Income Tax
Act, 1961.
Bogus
F&O (Futures and Options) loss proved on large number of sudden client Code
modifications by broker.
The Assessing Officer received information from the office of
DIT(I&CI) Mumbai, vide letter no. DIT(I&CI)/CCM/2014-15 dated
27.02.2015 through learned PCIT that some brokers were misusing the Client Code
Modification facility in the F&O segments on NSE and had created
non-genuine profit and loss. It was observed by the Assessing Officer that
these Loses and Profits were given by these brokers to their different
clients/beneficiaries according to their requirements. The Assessing Officer
observed that clients had taken fictitious loses to set off against their
profits with a view to reduce their tax liability. As per information received
by the Assessing Officer, the assessee was one of the beneficiary of the Client
Code Modification as the name of the assessee also appeared in the
beneficiaries list who had taken fictitious F&O Loses through the broker
Inventure Growth & Securities Ltd. (hereinafter called “Inventure”) ,
during the financial year 2009-10 relevant to Assessment year 2010-11, to the
tune of Rs. 31,98,597.50, which income as per Assessing Officer had escaped
taxation
Further additions as undisclosed income of the assessee to
the tune of Rs. 1,59,930/- being @5% of alleged bogus F&O losses to the
tune of Rs. 31,98,597.50 were made by the Assessing Officer towards commissions
allegedly paid to the broker Inventure by assessee from undisclosed sources for
obtaining these bogus F&O losses were made by the Assessing Officer as the
assessee had failed to prove the genuineness of these F&O losses and
further the brokers had confirmed in an enquiry made by Revenue under section 131(1A)
having received brokerages on these bogus F&O Losses, , vide reassessment
order dated 30.03.2016 passed by the Assessing Officer under section 143(3) r.w.s. 147 of the Act.
In this case there was an unusual
and sudden spurt in client code modifications in the month of March 2010
undertaken by Brokers in Stock Exchanges. The assessee had also suffered
F&O Loss of Rs.31,98,597.50 through Broker Inventure for transactions
undertaken through NSE in the month of March 2010 which were inflicted by
client code modifications undertaken by Brokers with Stock Exchanges and which
were held to be fictitious losses by authorities below. The assessee
transactions in F&O segment also happened in the month of March 2010. The
transactions inflicted through client code modification incurred through Broker
Inventure in the month of March 2010 itself were as high as 92.2% of total
transactions executed by assessee with broker Inventure on quantum of loss
ratio basis.
In large number of client code
modifications, there are no similarity between wrong code and correct code and
secondly there are repetitive client code modifications. Thus, client code
modifications are tainted with collusive action and manipulations & shall
go out of the protection granted by the circulars of NSE/SEBI.
The matter reached Ld. CIT(A) at the behest of the assessee.
The assessee reiterated before learned CIT(A) that these F&O losses are
genuine but it did not found favour with Ld. CIT(A) , who was pleased to
dismiss the appeal of the assessee on merits as well challenge raised by the
assessee to the reopening of the concluded assessment by Assessing Officer under
section 147 of the 1961 Act. Aggrieved
by an appellate order dated 31.07.2017 passed by learned CIT(A), the assessee
has filed an appeal with tribunal. The appellate order of learned CIT(A)
stood affirmed and appeal of the assessee stood dismissed. (Related Assessment Year : 2010-11)
[Time Media & Entertainment LLP v. ITO Date of
Judgement : 18.06.2019 - (ITAT Mumbai)]
Client code
modification – Information from investigation wing regarding evasion of tax by
assessee – Notice is held to be valid
Dismissing
the petition the Court held that: there was a direct nexus or live link between
the material coming to the notice of the Assessing Officer, namely, the
material submitted by the Investigation Wing, and the formation of the
Assessing Officer’s belief that there has been escapement of income. Details of
the client code modification were furnished in the information. The information
was in respect of several brokers. The information pertaining to the assessee’s
broker was culled out and tabulated. There were 74 cases of the assessee’s
broker having modified the assessee’s
transactions. The information was directly on the issue of the transactions. It
could not by any stretch of imagination be said to be vague, indefinite or
distant. Reasons to believe were there. The reasons were based on tangible
material. The return and account books of the assessee had not undergone
scrutiny at the time of assessment. The information was specific and not vague.
A reasonable person could form an opinion on the basis of the material. The
information received could form the basis of reason to believe that income had
escaped assessment and the reopening was not on mere suspicion. Hence, the
assumption of jurisdiction was in accordance with law. (Related Assessment year
2009-10)
[Rakesh
Gupta v. CIT (2018) 405 ITR 213 : 303 CTR 670 (P&H)]
Losses
cannot be treated as Bogus merely for client Code Modifications
Assessee under consideration has done the
transaction through recognised stock exchange and produced before us the
contract notes, details of the transactions, and details of payment through
account payee cheques. We note that transactions have been carried out through
proper banking channels/account payee cheques, through the existence of the
brokers and stock exchangeand these facts were not disputed by the ld DR for
the Revenue. In the assessee’s case, the Assessing Officer treated the
transactions as bogus only on the basis that the broker,M/s. Sunchen Securities
Ltd., has been blacklisted by SEBI and its registration was cancelled
subsequently. The fact that the registration has been cancelled subsequently
does not mean that the transactions are invalid. The assessee cannot be
punished for the default of the brokers and therefore the share transactions
cannot be held to be bogus. (Related Assessment year 2008-09)
[Manoj Kumar Damani v. ACIT – Date of Judgement
: 23.05.2018 (ITAT Kolkata)
Punjab & Haryana High Court dismisses assessee’s
writ (engaged in trading of shares through his broker) for assessment year
2009-10, upholds reassessment proceedings under section 147/148, rules that
there was a direct nexus/ live link between material submitted by Investigation
Wing and the formation of Revenue’s belief that there has been escapement of
income on account of Client Code Modification for shifting losses and
manipulating assessee’s income.
[TS – 239 High Court – 2018 (P&H)]
Reassessment
- After the expiry of four years - Brokers client code modification - Failure
by assessee to substantiate loss by producing evidence - Assessee participating
in reassessment proceedings without pressing its earlier objections raised,
reassessment was held to be valid
Dismissing
the petition, that the Assessing Officer had received credible information
regarding income escaping assessment for the relevant assessment year. He had
applied his mind to it and had informed the assessee of his intention to invoke
section 148 of the Income-tax Act, 1961 and had given his reasons for doing so.
The assessee had objected to the reasons furnished by the Assessing Officer for
invoking section 148. The assessee had neither insisted upon disposal of its
objections filed prior to the reassessment nor had pressed its objections but
had participated in the reassessment proceedings. The assessee had also
furnished the documents required by the Assessing Officer in the proceedings
under section 148 after raising the objections. The conduct of the assessee
allowed one to infer that it had waived its rights to have the objections
disposed of, or alternatively, the assessee had withdrawn its objections to the
invocation of section 148. From the reasons supplied by the Assessing Officer
it could be inferred that he had applied his mind to the issue. The assessee
had not demonstrated any material to substantiate that the loss from brokers by
client code modification being booked in its accounts was placed before the
Assessing Officer for consideration and that, the Assessing Officer had taken a
view after production of the material facts by the assessee
[Rampuria
Industries and Investments Ltd v. DCIT (2017) 391 ITR 18 (Cal)]
Mere client code
modification by broker does not mean that any income has escaped assessment
As
a matter of regular business practice, a broker in the stock exchange makes
modifications in the client code on sale and/or purchase of any securities,
after the trading is over so as to rectify any error which may have occurred
while punching the orders. The reasons do not indicate the basis for the
Assessing Officer to come to reasonable belief that there has been any
escapement of income on the ground that the modification done in the client
code was not on account of a genuine error, originally occurred while punching
the trade. The material available is that there is a client code modification
done by the Assessee’s broker but there is no link from there to conclude that
it was done to escape assessment of a part of its income. Prima facie,
this appears to be a case of reason to suspect and not reason to believe that
income chargeable to tax has escaped assessment. It was held that the impugned
notice is without jurisdiction as it lacks reason to believe that income
chargeable to tax has escaped assessment. [Related Assessment Year : 2009-10]
[Coronation
Agro Industries Ltd v. DCIT Writ Petition No. 2627 of 2016 - Date of Judgement
: 23.11.2016]
Client codes modification
permissible having no shifting of profits
It
was held that it is a fact that the movement of prices of commodities cannot be
predicted by anyone with accuracy and hence it is inconceivable or unlikely
that the assessee could have made profits consistently, even if it is assumed for a
moment that the assessee had actually carried out the transactions for its own
benefit. We notice that the assessee has offered explanations as to why it
carried out the transactions in its own code, i.e. since the timing of entering
the transactions is crucial in the online trading, the staffs of the assessee
company found it convenient to punch its own code. Further, it is pertinent to
note that none of the clients, with whom the assessing officer has carried out
the examination, has disowned the transactions. Further, all the clients have
duly disclosed the profits arising from the
transactions as their respective income. However, in the instant case,
the Assessing Officer has not brought any material on record to show that the
assessee had received back corresponding amount equivalent to the amount of
profit claimed to have been shifted to the clients. Hence CIT(A) was justified
in deleting the additions made in both the years under consideration. –
(Related Assessment Years : 2006-07 & 2007-08)
[ITO
v. M/s Pat Commodity Services (P) Ltd. - Date of Judgement : 07.08.2015 (ITAT
Mumbai)]
McDowell & Co.
Ltd. v. CTO 154 ITR 148 (SC), the landmark decision by Constitution Bench
of Supreme Court is squarely applicable. The modus operandi adopted by
the assessees by acquiring Losses or acquiring Profits with tacit connivance
with the Brokers through Client Code Modifications without paying any taxes or
avoid declaring true Profits is nothing but a colourable device as cited by
Hon’ble SC Judgment.
"The taxing
authority is entitled and is indeed bound to determine the true legal relation
resulting from a transaction.
If the parties have
chosen to conceal by a device the legal relation, it is open to the taxing
authorities to unravel the device and to determine the true character of the
relationship.” Hon’ble High Court of Delhi in the decision dated 19.11.2015
reported in ITA 130/2001 CIT v. M/s Abhinandan Investment Ltd., followed
the Supreme Court Judgment while upholding the action of the Assessing Officer
in unraveling colourable device.
It was held that the
“taxing authorities are required to put on the blinkers while looking at the
documents produced before them. They are also entitled to look into the
surrounding circumstances to find out the reality…..”
[CIT v. Durga Prasad
More (1971) 82 ITR 540 (SC) and Sumati Dayal v. CIT 214 ITR 801 (SC)]
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