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  • Tax Matters: How to ensure broker does not misuse demat account?

    Securities Purchased for clients are initially received in the broker's pool account and are transferred to the clients' demat account within a day if thesse are paid for in full

    All my demat accounts are with one broker. I am perturbed because recently the Securities Exchange Board of India (Sebi) suspended a broker. What should I do?

    — Raunak, e-mail

    Sebi on 22 November 2019 barred a big broker from taking new clients for alleged misuse of clients' securities. On 2 December 2019, the NSE and the BSE suspended the membership of the broker based on Sebi's instructions. Funds from sale of securities are initially received in the broker's settlement account. The funds are then transferred to the broker-client account and should reflect in the clients' ledger instantly. The funds are transferred to the clients' bank accounts if the client requests for a pay-out. If there is no request from clients to transfer sale proceeds into their bank accounts, then the balance available in the ledger is to be transferred to the clients' bank accounts every quarter by default.

    Securities purchased, based on instructions from clients, are initially received in the broker's pool account. The securities are transferred from the broker's pool account to the clients' demat account within a day if these are paid for in full. Else, the securities are transferred to the Client Unpaid Securities Account (Cusa). After funds are received from the clients within five trading days, the securities are transferred from Cusa to the clients' demat account.

    Otherwise, the securities are sold off in the market to realise the funds. Don't invest in everything your broker suggests. Use careful discretion. As per the interim order by Sebi, instead of transferring securities purchased based on instructions of clients to the respective client's demat account, the broker illegally pledged them to take loans for its group company undertaking the real estate business.

    Power of attorney (PoA) is an authority given by the client to the broker to act on the client's behalf for buying or selling securities and undertaking incidental activities. The broker misused the PoA given by its clients by illegally selling the securities without the clients' knowledge and got the entire proceeds transferred to its bank accounts.

    Also, the broker house did not transfer the clients' shares to their respective demat accounts and kept them in its pool account. The clients' shares were pledged to secure loans. These shares were transferred to a proprietary account and were sold off-market without clients' knowledge. The funds generated from those transactions were not transferred to the clients' accounts.
    If the pledging had happened in the clients' demat account, they would have received updates about their pledged shares from the exchange.

    Therefore, do not rely blindly on anyone. Research the broker before enrolling with it. Check registration and licenses. A visit to office helps build confidence. Make sure that the personal information provided in the documents is correct and is of active email id or mobile. Check your demat holdings in NSDL and CDSL from time to time. Electronic common account statement, called as e-cas, is shared monthly by the designated depositories through registered email id. The statement includes all the transactions that have occurred in the demat account during the period. The statement updates holdings. Scrutinize bank statements. Cross-check the trades to identify anomalies. If there are discrepancies, get in touch with the broker. Monitor the use of PoA. Ensure compliance of regulatory requirements.

     

    It seems everything under the sun is liable for tax in the goods and services tax (GST) regime. What is the tax on securities lending?

    — Koyal, email

    The Securities and Exchange Board of India (Sebi) prescribed the Securities Lending Scheme, 1997, to facilitate lending and borrowing of securities. The lender of securities lends to a borrower through an approved intermediary under an agreement for a specified period. The condition is that the borrower returns equivalent securities of the same type or class at the end of the specified period along with the corporate benefits accruing on the securities borrowed.

    The transaction takes place through an electronic screen-based order matching mechanism provided by recognized stock exchanges. There is anonymity between the lender and borrower as there is no direct agreement between them.

    The lenders earn lending fee for lending their securities to the borrowers. Approved intermediary is a person duly registered with Sebi under the guidelines or scheme through which the lender will deposit the securities for lending and the borrower will borrow the securities.

    For GST Act, 2017, securities have the same meaning as assigned to them in clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956. Securities, as defined in the clause, are not covered in the definition of goods under Section 2(52) and services under Section 2(102) of the Central GST (CGST) Act. Therefore, a transaction in securities involving disposal of securities is not a supply in GST and, hence, not taxable.

    The definition of services, as per Section 2(102) of the CGST Act means anything other than goods, money and securities but includes activities of using money or its conversion by cash or by any other mode, from one form to another form for which a separate consideration is charged.

    Services include facilitating or arranging transactions in securities. The explanation added to the definition of services from 01 February 2019 is a clarification and does not have any bearing on taxing of lending of securities since 01 July 2017.

    Lending of securities is not a transaction in securities as it does not involve disposal of securities. The lender temporarily lends the securities held by him to a borrower. He charges lending fees from the borrower. The borrower of securities can further sell or buy these securities. He is required to return the lent securities after the stipulated period of time.

    The lending fee charged from the borrowers of securities has the character of consideration. This activity is taxable in GST since 01 July 2017. The activities of the intermediaries facilitating lending and borrowing of securities for commission or fee are also taxable separately. The supply of lending of securities under the scheme is classifiable under heading, ‘997119' and attracts GST of 18%.

    From 01 July 2017 to 30 September 2019, GST was payable under forward charge by the lender. A request had to be made by the lender (supplier) to Sebi to disclose the information about borrower for discharging GST under forward charge.

    The nature of tax payable was integrated GST (IGST). However, a service provider who had already paid CGST, state GST or Union Territory GST, treating the transaction as intra-state supply, was not required to pay IGST again in lieu of such GST payments already made.

    From 1 October 2019, the borrower of securities is liable to discharge GST under the reverse-charge mechanism (RCM). The nature of GST to be paid is IGST under RCM. This point has been clarified by a circular on 11 October 2019.

     

    Listed, rated and principal-protected market-linked debentures offering 9.50% yield are available in the market. These are being pitched as better than fixed deposits because of the tax advantage.

    — Sundar Das, e-mail

    The strong surge in the issue of market-linked debentures (MLDs) is due to two factors: the necessity of companies to collect funds in a tight market and investors looking for some extra returns on post-tax basis.

    The supply of money from both banks and mutual funds to NBFCs has dried up after the IL&FS collapse. But NBFCs have to raise money to fund their growth and to redeem existing bonds on maturity. So they have taken the MLD route. Increase in the issues of these products are expected as more NBFCs line up to mop up capital.

    MLDs are of two types: principle protected and non-principle protected. They are issued for a period ranging from 13 months to 60 months. Minimum investment is generally Rs 25 lakh and more. Unlike a bond that pays a fixed interest either monthly, quarterly, half yearly or annually, MLDs do not pay any regular income. Income from an MLD comes only at maturity.

    An MLD is linked to some underlying financial security such as stock market index Nifty or a 10-year government security paper. As there is no income to be had during their tenure, gains from MLDs is ascertained only at the time of maturity, depending on how the underlying asset has moved.

    If the underlying security moves in the opposite direction, investors just get their principal and nothing else. Lower ratings connote higher risk. Though principle protected MLDs are listed on stock exchanges, they are rarely traded. Be prepared to hold on to them till maturity.

    Investors are worried about the increasing risks in the fixed income market. As such, there is a tendency among high net worth investors to pick these MLDs due to the tax treatment they attract. A listed security held for more than 12 months is considered long-term capital asset. If it held for 12 months or less, the listed security is termed as a short-term capital asset.

    Unlisted debentures or bonds and units of debt-oriented mutual funds have to be held for more than 36 months to be considered as long-term capital assets. They will be short-term capital assets if held for 36 months or less.

    The period of holding is the duration the asset is held by the investor immediately prior to its transfer. It is computed from the date on which the asset has been acquired till the date of its transfer. If the asset is acquired other than by means of acquisition, the period of holding is reckoned as per various provisions of the Income Tax (IT) Act, 1961.

    The third proviso to Section 48 of the IT Act states that indexation will not apply to long-term capital gains arising from the transfer of bonds or debentures.

    However, indexation will apply to capital indexed bonds issued by the government and sovereign gold bonds issued by the Reserve bank of India under the Sovereign Gold Bond Scheme, 2015. Short-term capital gains arising from transfer of all of these assets are taxable at the normal slab rates applicable to the person.

    Interest from debentures and bonds is taxable under the head, ‘Income from Other Sources'. It is taxed as per the normal slab rates. Any reasonable expenditure such as commission or remuneration incurred
    for realizing such interest can be claimed as a deduction.

    After the payoff is ascertained just before the maturity of the MLD, if the investor sells the MLD on the exchange close to fair value, the gains so realized are taxed as long-term capital gains at 10%. The remaining amount of money is taxed as interest. For example, an investor does not sell the units but receives the payoff as maturity proceeds. The amount will be taxed as interest as per the applicable rate of tax. MLDs look juicy but are complex products. It's best that lay investors avoid them.

    The replies are only in the nature of guidelines. The tax counsellors and the publication are not responsible for any decision taken by readers on the basis of the same. Readers may e-mail their queries on direct taxation to: tax-matters@capitalmarket.com

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