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. Client code modifications are allowed by SEBI/Stock Exchanges only to rectify genuine errors.

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.

The client code modification (CCM) is a practice under which brokers change the client code in sale and purchase orders of securities after the trades are conducted. While it is permissible to rectify inadvertent errors, modifications could be made to manipulate the activities in the market.

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.

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

B’s Loss transferred to A

Modus Operandi – B

Imagine for a moment 2 clients A & B :

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 persons 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 keep away 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 assesseev 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 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).

Broadly distinguish a genuine CCM and non-genuine CCM

The DIT (I & CI) sought expert opinion from NSE to broadly distinguish a genuine CCM and non-genuine CCM. As per NSE, the following constituted genuine CCM.

(i)      Error due to communication and/or punching or typing such that the original client code/name and the modified client code/name are similar to each other.

(ii)     Modification within relatives.

(iii)    Any similar genuine error.

Some of the most popular Non genuine client code modification constituted as under :-

(i)      Percentage of modified traded value is significantly higher than the total traded value of any trading members/clients.

(ii)     Number of modified trades is significant to total number of trades of any trading members/clients.

(iii)    Profit/loss arising on account of all modifications by trading member/client is significant in comparison to the profit/loss in the trades where no modifications have been carried out.

(iv)    Profit/loss arising due to modification is significant.

(v)     Trades have been modified to unrelated parties.

(vi)    Both buy and sell leg of different trades have been modified to same client.

(vii)     The same sets of client are observed to be making profit/loss due to the modifications carried out.

(viii)  Total number of trade modifications increased before closing of the financial year.

It is common knowledge that any transaction either relating to shares or derivatives to be considered as completed and taxable/deductible in the hands of any assessee should compulsorily have the following ingredients i.e.

(i)      A valid transaction must have been executed on the Stock Exchange.

(ii)     The customer of the registered share broker should confirm & agree that the transaction entered into by the broker belongs to him.

(iii)    The payment Ibr purchases and/or receipt of sale proceeds should have happened between the Bank Accounts of the broker & his customer.

(iv)    The above transaction must have been accounted for in the hooks of account of the registered broker as well as his customer.

(v)     The eventual profit/loss on the transactions executed on the Stock Exchange & exchange of monies having happened as well as getting accounted in the respective books of account would eventually result into taxable profit and/or loss in the hands of such customers of the registered broker.

Details about Genuine error

The following trades shall be modified/allowed to be modified, 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 need to be owned up by the Trading Member and have to be transferred to ‘Mistake/Error Account’ of the Trading Member.

Policy for Client Code Modification

Stock Exchanges provide a facility to modify client code after the trade has been executed to rectify

any error or wrong data entry at the time of punching orders. However, such Client Code

Modification is subject to certain guidelines issued by SEBI and the Stock Exchanges in this regard.

“Error Trades” means the trades which will be modified / to be modified / allowed, to be modified

subject to guidelines of the SEBI / Stock Exchanges and this policy. The Exchange has provided the

facility of client code modification only with a view to rectify genuine errors.

The facility is mainly to provide a system for modification of client codes in case of genuine errors

in punching / placing the orders. It is to be used as an exception and not a routine. To prevent

misuse of the facility Stock Exchanges levy penalty / fine for all non-institutional client code

modifications.

This policy is applicable to all Client Code Modifications carried out / to be carried out in any of

the client accounts, subject to guidelines issued by the SEBI / Stock Exchanges from time to time,

in any segment of any exchange of which the company is a Member.

The following client code modifications would be considered as genuine modifications, provided

there is no consistent pattern in such modifications:

(a)    Where original client code/name and modified client code/name are similar to each other but

such modifications are not repetitive.

(b)   Where original client code and modified client code belong to a family. (Family for this

purpose means spouse, dependent parents, dependent children and HUF)

However, there may also be a need to resort to client code modification in following situations:

(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.

The facility for Client Code Modification can be used only in case of Error Trade and the Client

Code Modification shall be carried out only after obtaining approval of any of the Designated

Directors of the Company and in their absence that of Compliance Officer subject to the process as

may be prescribed by SEBI / Stock Exchange.

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:

Proviso to Section 43(5)

PROVIDED that for the purposes of this clause—

(a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or

(b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations, or

(c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; or

(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 stock exchange 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.

However, as per second proviso inserted by the Finance Act, 2018, w.e.f. 1-4-2019, for the purposes of clause (e) of the first proviso, in respect of trading in agricultural commodity derivatives, the requirement of chargeability of commodity transaction tax under Chapter VII of the Finance Act, 2013 shall not apply.

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., undertaken 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 (ix) 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).

Client Code Modification cases – A Suggestive Questionnaire

The Assessing Officer may confront to the assessee and asked him to explain the following: -

(i)        Explain the reason and necessity of each client code modification and how the same are in conformity of guidelines of Stock Exchanges.

(ii)       To show cause as to why the amount of profit belonging to you shifted through CCM to other concerns/person should not be added in your income and the commission earned by you for facilitating the shifting the profit/loss of other persons through CCM without the valid reasons and in contravention of Stock Exchange guidelines should not be added to your income.

(iii)      Instances of shifting of losses belonging to you to group companies as well as other persons are also reported. You are requested to explain the same and reply should include the complete details of CCM transactions along with the details of client code, name, address, PAN and account opening form of the beneficiaries. The copy of account of all the entities whose client code was modified is also required to be submitted.

(iv)       You are also requested to submit the complete list of client codes, containing name, PAN and address of persons. The client codes of your group concerns, individuals and related parties are also requested to be submitted.

(v)        You are requested to explain as to why modification through back office operation was undertaken and why the operation could not be materialized through CCM in exchange records.

(vi)       You are also requested to submit the name, PAN and address of the persons to whom profit and loss earned by you was shifted through back office operation along with their copy of accounts.

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 115BBE of Income Tax Act, 1961.

Circular no. MCX/T&S/032/2007 January 22, 2007 Client Code Modifications

In terms of provisions of the Rules, Bye-Laws and Business Rules of the Exchange, the Members of the Exchange are notified as under: Forward Markets Commission (FMC) vide its letter no. 6/3/2006/MKT-ll (VOL III) dated December 20, 2006 and January 5, 2007 has directed as under.

(a)    The facility of client code modifications intra-day are allowed.

(b)   The members are also allowed to change their clientcodes between 5:00 p.m. to 5:15 p.m., in case of the contracts traded till 5:00 p.m. and between 11:30 p.m. to 11:45 p.m. for the contracts traded till 11:30 p.m. on all the trading days from Mondays to Fridays and on Saturdays the same shall be allowed between 2:00 p.m. to 2:15 p.m.

(c)    However, on the days when trading in commodities takes place till 11:55 p.m. the client code modification will be allowed only upto 12:00 p.m.

(d)   At all times, Proprietary trades shall not be allowed to be modified as client trades and client trades shall not be allowed to be modified as proprietary trades.

(e)    In order to ensure that client codes are entered with alertness and care, a penalty on the client code changes made on a daily basis shall be imposed as under:

(f) It is clarified that the facility of client code modification is allowed as an interim measure only upto March 31, 2007 and after this date the said facility will be completely stopped.

National Securities Clearing Corporation Limited  - Circular No. NSE/CMPT/5128 Circular No. NSCCL/SEC/2004/0464, Dated 31.05.2004

To, All Members,

Subject :- Penalty for client code modification

In pursuance of the Bye laws and Regulations of NSCCL and in partial modification to circulars no. NSE/CMPT/4041 dated March 27, 2003 and NSE/CMPT/4991 dated April 16, 2004, it is hereby notified that the penalty structure for client code modification in the capital market (Cash Segment) is being revised. The new penalty structure is as follows:

The above shall be effective from trade date June 01, 2004

No additions if client code modifications done by Stock Exchange member were within permissible SEBI limit

Assessee was a member of recognized stock exchanges and provided trading services in commodity markets through those exchanges. During search, evidence of client code modifications done by assessee and its sister concerns in their own account as well as in accounts of clients was found. It was also found that through client code modifications, profit belonging to assessee was shifted to other persons and assessee had earned commission for facilitating this. Assessing Officer was of view that shifting of client code was not due to genuine reasons but for providing accommodation entries to some persons in lieu of consideration and accordingly, he added a sum of Rs. 8.74 lakhs to total income of assessee. Commissioner (Appeals) deleted addition. It was found that transactions on account of client code modifications done by group concerns were not found to be false or untrue and SEBI or stock exchange had not taken any action treating transactions to be non-genuine. Moreover, volume of client code modifications occurred were within permissible limit allowed by SEBI. Therefore, there was no perversity in order of Commissioner (Appeals) in deleting addition. [In favour of assessee] (Related Assessment year : 2011-12) – [DCIT v. Futurz Next Services Ltd. (2022) 139 taxmann.com 199 : 94 ITR(T) 119 (ITAT Delhi)]

Code modifications carried out by the stock broker should not affect the claim of the assessee unless it is proved that the assessee has colluded with the stock broker in carrying out the modification

Assessee is an individual and is a trader and investor in shares and commodities. During the year under consideration, he had incurred loss of Rs. 1,24,17,318/- in trading in shares and commodities. The Assessing Officer received information from Investigation wing of Income tax department, Ahmedabad that the assessee has obtained fictitious transactions to generate loss of Rs. 1,24,17,318/-. Hence the Assessing Officer reopened the assessment by issuing notice under section 148 of the Act on 29.03.2016. The Assessing Officer completed the assessment to the best of his judgement under section 144 of the Act by disallowing the above said loss.

Held : We noticed earlier that the Assessing Officer has reopened the assessment on the basis of information supplied by the investigation wing of the department that the assessee has generated fictitious loss. It is stated that the assessee is a beneficiary of client code modification, which has resulted in loss. The question as to whether the information received regarding client code modification could be a reason for reopening of assessment was examined by the Hon’ble Bombay High Court in the case of Coronation Agro Industries Ltd v. DCIT (2017) 390 ITR 464 : 82 taxmann.com 75 (Bom.) and it was held as under:-

“(3) The reasons in support of the impugned notice relies upon the information received from the Principal Director of Income Tax that the petitioner has benefited from a client code modification by which a profit of Rs. 22.50 lakhs was shifted out by the petitioner’s broker, resulting in reduction of the petitioner’s taxable income. The only basis for forming the belief is the report from the Principal Director of Income Tax and the application of mind to the report of the Assessing Officer along with the record available with him. This information and application of mind has led the Assessing Officer to form a reasonable belief that there is not only an escapement of income but there has been failure to truly and fully disclose all material facts and information as the modus operandi of shifting profits was not known to the Revenue as not disclosed by the petitioner when the Assessing Officer passed the order in regular assessment proceedings.

(4) We note that the reasons in support of the impugned notice accept the fact that 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 modifications 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.

5. In the above view, prima facie, we are of the view that the impugned notice is without jurisdiction as it lacks reason to believe that income chargeable to tax has escaped assessment.”

The facts in the present case are identical with the facts in the case decided by Hon’ble Bombay High Court. Accordingly, we hold that the reopening of assessment is bad in law. On merits also, we notice that the claim of the assessee is duly supported by various evidences and further the code modifications carried out by the stock broker should not affect the claim of the assessee unless it is proved that the assessee has colluded with the stock broker in carrying out the modification, which is not the case here. Accordingly, we are of the view that the Assessing Officer could not have disallowed the loss claimed by the assessee. Accordingly, we quash the orders passed by the tax authorities. [ In favour of assessee] (Related Assessment year : 2009-10) - [Ankit Girishkumar Vasani v. ITO Date of Judgement : 21.09.2022 (ITAT Mumbai)]

ITAT upheld disallowance of losses by client code modification

In the present case it was found by the Assessing Officer that the assessee has obtained the benefit of accommodation entries by way of client code modification used by the broker namely M/s Mehta Finstock (P) Ltd. Thus the losses claimed by the assessee for Rs. 12,56,760/-, on account of client code modification was disallowed and added to the total income of the assessee. CIT (A) held that Client Code Modifications have been made in as many as 63 transactions, It is difficult to understand how genuine punching errors can occur in such large numbers. One can understand if an error is made on one or two occasions. However, the error in punching on 63 separate occasions in respect of the same broker and client is highly unlikely and suspicious. All the derivative transactions took place with same broker but on different dates. It is very unlikely that the same mistake will be committed by same person on various dates. Especially since the error in. entry of client code has to be corrected on the same date. It is unlikely that the same broker will keep on making error and correcting it again and again within a short span of time. Addition made by the Assessing Officer cannot be taken to be based merely on suspicions, conjectures and surmises, as he has collected information from the National Stock Exchange as well as the appellant’s broker before arriving at his decision.

Held : At the outset, we note that the matter has already been listed for hearing on several occasions but none appeared on behalf of the assessee despite the fact that the notices for hearing were issued at the given address of the assessee. It is the trite law that the assessee should be vigilant enough to pursue the appeal after filing the same. The law assist those who are vigilant in their rights and not those who sleep on their own rights. In the absence of any contrary information available on record and after considering the fact that the Ld. CIT(A) has passed a detailed reasoned order as discussed above, we do not find any infirmity in the order of the authorities below. Hence, the addition of Rs.12,56,760/- made by the Assessing Officer is confirmed and the grounds of the appellant are dismissed. [In favour of revenue] (Related Assessment year : 2009-10) – [Chandresh Luniya v. ITO - Date of Judgement : 31.05.2022 (ITAT Ahmedabad)]

On basis of a retracted statement, Assessing Officer held that assessee-commodity broker had done client code modifications for helping clients to divert profits to other persons, in absence of any material or evidence to support alleged unaccounted income, no addition could be made to assessee’s income

Assessing Officer alleged that assessee-commodity broker had done client code modifications for unusually high number of times helping clients to divert their profits to other persons and, thus, assessee had earned unaccounted income from clients. Assessing Officer attributed Rs. 2 crore to assessee based on statement of one NT given on behalf of Kunvarji Finance that income Rs. 12 crore was received which pertained to the assessee, Kunvarji Finance, Kunvarji Finstock etc. However, said NT subsequently retracted from his statement. In case of Kunvarji Finance itself, Tribunal had already found that there was no material or evidence to support additions made by Assessing Officer. Since addition was not based on any material other than disclosure made by NT which was retracted, no substantial question of law arose on its deletion. [In favour of assessee] – [Kunvarji Commodities Brokers (P) Ltd. (2021) 432 ITR 180 : (2020) 274 Taxman 162 : 118 taxmann.com 374 (Guj.)]

Assessing Officer received information from Principle Director of Income Tax (Investigation) that assessee had received bogus loss from his broker by client code modification, reassessment on basis of said information was justified

The reopening of assessment of the assessee was made under section 147 on the basis of the information received from the investigation wing wherein it was pointed out that the assessee has diverted the profit by modifying its code maintained with the share broker.

Held that the Punjab and Haryana High Court has decided the issue in favour of the revenue in the case of Rakesh Gupta v. CIT (2018) 93 taxmann.com 271 (P&H) which was reopened under section 147 based on the same investigation report Income Tax Department. Accordingly the reopening made by the Assessing Officer under section 147 was to be upheld. [In favour of revenue] (Related Assessment year : 2009-10) -  [Chintan Jaswantbhai Shah v. ITO (2021) 125 taxmann.com 439 : 87 ITR(T) 228 (ITAT Ahmedabad)]

Uncorroborated conclusion on tax-evasion, based merely on client code modifications, not tenable

Assessee-Company (Kaizen Stock Trade Pvt Ltd) engaged in the business of dealing / broking in shares.  On the basis of data received from the National Stock Exchange, Assessing Officer for Assessment year 2009-10 noted that there was change in the code of the Assessee maintained with the broker with respect to certain transactions carried out in Futures & Options segment, and due to which the Assessee was able to shift profit of Rs. 1.02 Cr. and loss of Rs. 83.63 lacs. Assessing Officer held that Assessee by way of modification in client codes was trying to evade taxes by booking artificial profits and losses, which had resulted in a reduction of taxable income to the extent of Rs. 1.86 Cr. which was added to Assessee’s total income. On appeal, the CIT(A) deleted the additions stating that AO had made entire additions on presumption without proving that the Assessee evaded taxes. Aggrieved, the Revenue preferred an appeal with ITAT.

ITAT observed that client code modification refers to a change of client codes after the execution of trades and observes that it is subject to certain guidelines. The facility mainly provides a system for modification of client codes in case genuine errors in punching / placing the orders. It is to be used as an exception and not a routine. To prevent misuse of the facility Stock Exchanges levy penalty / fine for all non-institutional client code modifications.

ITAT further noted that mere client code modifications carried out by the broker cannot be the basis to draw an inference against the Assessee. In case of client code modification, the code of the other party is entered at the place of the assessee. Thus, the other party is also required to be investigated over its involvement in such a transaction. Besides this there has to be other corroborative evidence suggesting that there was the exchange of cash among the parties involved in such client code modification. But we note that no such exercise has been carried out by the authorities below. ITAT notes that in absence of any such verification carried out by the Assessing Officer, it was not inclined to uphold the findings of the Assessing Officer.

Further, ITAT observed that the number of transactions in respect of which the client codes were modified are less than 1% of the total transactions, and hence such changes cannot be held to be indicative of a colourable device adopted for shifting out and shifting in the profit/loss.

ITAT further remarked that the changes were not made at the fag end of the year, and therefore it would not have been possible to ascertain its profit / loss in the mid of the year when such client codes were modified. ITAT further stated that it could not be inferred that Assessee resorted to client code modification to reduce taxable income. 

ITAT dismissed Revenue’s appeal and upheld CIT(A)’s order. – [DC IT v. Kaizen Stock Trade (P) Ltd. [TS-535-ITAT-2021(Ahd)] – Date of Judgement : 03.06.2021 (ITAT Ahmedabad)]

No reopening of Assessment for mere client code modification

Assessing Officer noted that “The assessee’s code was modified 44 times in OCC to shift out profits Rs. 6,42,781 and one time in MCC to Shift in loss of Rs. 4,420/-. The data clearly shows that the modification was not no grounds of feeding in erroneous data.”

Finally while making the addition learned Assessing Officer concluded that : “In view of above, the profit of Rs. 6,47,201/- claimed by the assessee in the above mentioned transactions is treated as a contrived profit artificially generated through the misuse of the CCM. The profit is, therefore, liable to be taxed and added to the total income of the assessee as unexplained investment under section 68 r.w.s. 115BBE of the Income-tax Act, 1961.”

Assessing Officer had completed assessment in terms of section 147 after making addition under section 68 and 69C on the reason that client code modification was allowed to the brokers by the stock exchange, within a limited window of time after business hours, for rectification of any mistakes in punching of the client code while carrying out transaction of purchase and sale on behalf of the customers however in case of assessee client code modification had been done for shifting of the profit or loss. It was held that there was no material to infer that such client code modification had been done with malafide purpose of shifting of the profit or evasion of the tax. There was no material before Assessing Officer to form such a belief that income had escaped due to such client code modification and thus there was no live link between the material before Assessing Officer and inference made. The Hon’ble Supreme Court in the case of Rajesh Jhaveri Stock Brokers (P) Ltd. reported in 291 ITR 500 (SC) had held that for validity of reason recorded it is essential that there should be a relevant material on which a reasonable person could make requisite belief.

Thus, there was no material to infer that client code modification had been done by assessee with malafide purpose of shifting of the profit or evasion of the tax hence, assessment could not be reopened under section 147 in absence of any tangible material to infer that income escaped in the case of assessee. (Related Related Assessment year : 2010-11) – [Stratagem Portfolio (P) Ltd. v. DCIT - Date of Judgement : 15.09.2020) (ITAT Delhi)]

Transactions of purchase and sale of shares was made by assessee through registered stock exchange at prevailing market prices after duly suffering STT and assessee had furnished all primary evidences in form of trade files, contract rates, demat statements and bank statements to prove genuineness of said transactions, loss incurred on such transactions could not be disallowed treating same to be bogus

Assessee, a registered share broker, filed his return claiming loss of certain amount on sale of equity shares. Assessing Officer alleged that he had received an information from investigation wing that assessee had received accommodation entry of bogus/ficticious loss by way of share trading. On basis of same, he held impugned loss claimed by assessee to be bogus and disallowed same. It was noted that assessee had furnished all details of purchase and sale of shares as called for in requisite format by Assessing Officer. Assessee also furnished obligation files of stock exchange and trade files received from stock exchange in which all details were given showing transactions entered into by assessee. Demat transaction and holding statements showing delivery of shares for purchase and sale of shares were also furnished. Assessee also provided copy of bank statements marking payments made to/received from stock exchange in respect of purchase and sale of shares. It also furnished copies of contract notes issued by registered share broker for purchase and sale of shares. It was not case of revenue that assessee had resorted to any client code modification. All transactions were routed through recognized stock exchange with registered share broker at prevailing market prices after duly suffering STT. On facts, Assessing Officer was unjustified in disallowing loss in respect of purchase and sale of shares by assessee treating same to be bogus. [In favour of assessee] (Related Assessment year : 2013-14) - [DCIT v. PRB Securities (P) Ltd. (2019) 176 ITD 649 : 105 taxmann.com 129  (ITAT Kolkata)]

Upholds reassessment on share-trader based on information from investigation wing

Ahmedabad ITAT upholds reassessment under section 147 in case of assessee (earning profits from trading on stock exchanges through registered broker) for Assessment year 2011-12, however grants partial relief on merits; Assessing Officer had reopened the assessment of the assessee based on information received from the investigation wing whereby assessee's name appeared in the list of persons who had misused Client Code Modification (CCM, a facility provided to brokers by SEBI/Stock exchange to set out bonafide errors) for tax evasion by shifting out profits/shifting in losses to reduce their taxable income; Rejects assessee's contention that Assessing Officer had not formed any 'reason to belief' but had merely acted on some abstract information, holds that the reasons recorded by the Assessing Officer clearly show that Assessing Officer had obtained objective details towards modifications in client codes whereby the profits/losses were allegedly shifted; Further, states that, the Assessing Officer at the time of reopening an assessment is not expected to build a full proof case against the assessee and hold it conclusively against the assessee.”, opines that the Assessing Officer was in possession of the relevant information and material germane to the allegation to enable him to hold prima facie belief towards escapement of income; Adjudicating on merits, ITAT notes that the losses resulting from CCM can be classified in different categories based on the extent and magnitude of modification of the client code, directs Assessing Officer to delete additions w.r.t category ‘Distance 1’ - genuine error in punching of client codes of only one digit and category ‘Distance -2’ - since the modification resulted in shifting of profits/losses in both the ways resulting in it being detrimental to the assessee and confirms additions w.r.t other 2 categories. [In favour of Both, Partially] (Related Assessment year : 2011-12) – [Amitkumar Amulakhrai Shah HUF v. DCIT, Bhavnagar [TS-817-ITAT-2019(Ahd)] – Date of Judgement : 18.12.2019 (ITAT Ahmedabad)]

Suppression of income – Future and options – Shares and derivatives – Client code modifications (CCM) – Burden is on the assessee to establish that the client code modifications have been done on the behest of the assessee – Addition cannot be made as suppression of income of the assessee

It was held that the transactions were supported by bills/contract notes and the assessee couldn’t have done any client code modifications. The data provided by the Assessing Officer neither pertained to assessee nor any modification was carried out on behest of the assessee. There is nothing on record to establish that the loss transactions were not genuine. Further, assessee is not a registered broker and thus, could not modify the client code. Nothing has been brought on record by the Assessing Officer to prove that the modifications have been done on the behest of the assessee and thus, the assessee couldn’t be held responsible for the modification to the client code. Tribunal also held that no nexus can be established with the losses suffered by the assessee. The connivance/collusion of the assessee with the share broker could not be established. Accordingly, the deletion of addition by the CIT(A) is affirmed. (Related Assessment Year : 2010-11)—[DCIT v. Vipul D. Shah – Date of Judgement : 03.07.2019 (UR) (ITAT Mumbai)]

No ‘loss dis-allowance’ based on presumption that assessee misused ‘Client Code Modification’ facility

Hyderabad ITAT deletes loss disallowance on account of Client Code modification [CCM] in case of Canara Securities (assessee, engaged in the business of investment banking), rejects Assessing Officer’s stand that assessee had contrived losses by using  CCM facility for Assessment year 2010-11, holds that Revenue failed to bring on record any specific instruction given by the assessee to the broker for carrying out the said malpractice; During relevant Assessment year, DIT(Investigation) had submitted information to Revenue that the broker with whom the assessee was dealing was involved in CCM, subsequent to which, assessee’s case was reopened under section 147/148 (beyond 4 years' time frame),on the ground that the assessee had 'selectively shifted out the ascertained profits and shifted in only ascertained loss', and thus availed the benefits of reduction in taxable income; At the outset, acknowledges that as the information was received by Revenue from an authentic source, there existed a 'reason to believe' that in assessee’s case there may have been escapement of income and hence the reopening was justified; On merits, observes that, (1) when genuine errors are noticed by the brokers themselves, then, they can modify such errors suo-moto, or (2) when some genuine mistakes are brought to the notice of broker by the client, it may be done only in writing and with the specific request for such changes in the clients code; Takes note that assessee had brought on record a letter copy from its broker, whereby it was reflected that the assessee has not made any specific request on any of the CCM, therefore states that the, CCM made by the broker are made by broker itself.”, also notes that in the given case no investigation was carried out on the broker by Assessing Officer. [In favour of assessee] (Related Assessment year: 2010-11) – [Canara Securities Ltd. v. DCIT(C), Hyderabad - [TS-391-ITAT-2019(HYD)] – Date of Judgement : 03.07.2019 (ITAT Hyderabad)]

Upholds addition of bogus F&O losses being inflicted by mis-use of Client Code Modifications [CCM]

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 Losses 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 losses 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 Losses 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 is 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 and 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 find 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. [In favour of revenue] (Related Assessment Year : 2010-11) - [Time Media & Entertainment LLP v. ITO Date of Judgement : 18.06.2019 - (ITAT Mumbai)]

Future and options – Shares and derivatives – Client code modifications (CCM) – No stretch of imagination can any Assessing Officer consider a transaction on the stock exchange as income of a person other than the one who has either actually received monies in his bank account (In case of profit) and /or paid any monies from his bank account (in case of loss) – Burden is on Assessing Officer to establish that the losses were purchased or that there was payment in cash/cheque for such favours – Client code modification within 1% of is absolutely normal

It was held that the assessee is not registered broker on the stock exchange. Only the registered brokers can modify client code (CCM) of their own clients. The Assessing Officer has not brought on record to establish that the losses were purchased or that there was payment in cash/cheque for such favours. Assessing Officer has mechanically added amounts as income of the assessee without verifying the records. Tribunal also held that, by no stretch of imagination can any Assessing Officer consider a transaction on the stock exchange as income of a person other than the one who has either actually received monies in his bank account (In case of profit) and /or paid any monies from his bank account (in case of loss) and nothing has been placed on record by the Assessing Officer to demonstrate that any proceedings were ever initiated against the assessee by the SEBI or any stock exchange. Client code modification within 1% of is absolutely normal. Accordingly, the loss is held to be allowable as business loss. (Related Assessment Year : 2010-11)—[DCIT v. Comet Investment (P) Ltd. – Date of Judgement : 13.05.2019 (ITAT Mumbai)]

Client code modification - (CCM) - Shifting of profits - Addition as income on the basis of alleged doubtful transaction is held to be not valid

The assessee is a member of Multi Commodity Exchange of India Ltd (MCX) and National Commodity and Derivatives Exchange of India. The assessee is carrying on trading activities both on derivatives and delivery based transactions on its own account as well as on behalf of various clients. Assessing Officer has added the entire amount of doubtful transactions by way of assessee’s additional income on the basis of client code modification. CIT(A) deleted the addition on the ground that all the clients are having PAN and regularly filing their returns and profits were taxed in their hands. Clients are not related parties. Modification was around 3% of the total transactions. All of them were complied with KYC norms. Tribunal affirmed the order of CIT(A). On appeal by the revenue , dismissing the appeal the Court held that, even if the Revenue’s theory of the assessee having enabled the clients to claim contrived losses is correct, the Revenue had to bring on record some evidence of the income earned by the assessee in the process, be it in the nature of commission or otherwise. Adding the entire amount of doubtful transactions by way of assessee’s additional income is wholly impermissible. The fate of the individual investors in whose cases the Revenue could have questioned the artificial losses is not known. Accordingly, the appeal of the revenue is dismissed. (Related Assessment years : 2006-07, 2007-08)—[PCIT v. Pat Commodity Service (P) Ltd. - Date of Judgement : 15.01.2019 (Bom.)]

Assessing Officer received information from Principle Director of Income Tax (Investigation) that assessee had received bogus loss from his broker by client code modification, reassessment on basis of said information was justified

The Principal Director of Income Tax (Investigation), Ahmedabad, conducted a survey under Section 133-A of the Act at the premises of twelve brokers. During investigation, it was found that Client Code Modification (CCM) was being used as a tool for tax evasion. The losses were being shifted out of the profit of the clients. A detailed investigation report was sent to respondent No.2 in a Compact Disc. In the investigation report, the details of Client Code Modification (CCM) used by the broker of the petitioner were also there.

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. [In favour of revenue] (Related Assessment year 2009-10)—[Rakesh Gupta v. CIT, Panchkula (2018) 405 ITR 213 : 303 CTR 670 : 93 taxmann.com 271 (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 noted that transactions have been carried out through proper banking channels/ account payee cheques, through the existence of the brokers and stock exchange and 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)]

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 : 299 CTR 532 : 82 taxmann.com 78 (Cal.)]

It is a regular practice for the broker to make modifications in the client code after the purchase and sale of securities. The mere fact that there is a client code modification prima facie does not mean that any income has escaped assessment. it appears to be case of ‘reason to suspect’ and not ‘reason to believe’

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. [In favour of assessee] (Related Assessment year : 2009-10) - [Coronation Agro Industries Ltd v. DCIT (2017) 390 ITR 464 : 82 taxmann.com 75 (Bom.)]

Client code modifications done by assessee-share broker were in negligible number, addition made by reversing such modifications was to be deleted

The assessee was engaged in commodity transactions through its broker, ‘KB’. The Assessing Officer concluded that ‘KB’ had carried out clien tcode modifications in active connivance with the assessee which had resulted into the diversion of profits of the assessee to other persons. The Assessing Officer, thereafter, worked out the difference of profits as indicated by the assessee in the books of account and as worked out by reversing the effect of the client code modification, and the difference was treated as suppressed profit of the assessee. The Commissioner (Appeals) having found that total number of client code modifications were in negligible number held that no adverse inference could be drawn on basis of such negligible modification. He also found that addition was in nature of notional income and made by assumption. Thus, he deleted the addition made by the Assessing Officer. Held that there was no reason to interfere with the order of the Commissioner (Appeals). [In favour of assessee] (Related Assessment years : 2005-06 and 2007-08) – [ACIT(C), Ahmedabad v. Amar Mukesh Shah (2017) 81 taxmann.com 450 : (2016) 46 ITR(T) 234 (ITAT Ahmedabad)]

Bogus F&O Loss : No protection if client code modifications are tainted with collusive action & manipulations

The assessee case does not fall under the above category of genuine client code modifications allowed by NSE as we have seen that 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 which are tainted with collusive action and manipulations shall go out of the protection granted by these circulars of NSE/SEBI. These aspects requires proper enquiry, examination and verifications which under the circumstances authorities below ought to have done to bring it to logical conclusion and to reach to the end of the financial trail to unearth scheme of tax evasion and avoidance adopted by persons acting in concert including entering into synchronized transactions simultaneously of purchase and sale of the same securities at same time to neutralize the collective profit/loss to zero but at the same time distribute profits/loss separately arising from each of the squared transactions . These requires coordinated enquiries by various agencies to reach to the bottom of the truth. To term all such inconsistencies as are pointed out as mere suspicion shall not be correct as collectively they are pointing towards a collusive and manipulative action on part of certain persons acting in concert to avoid taxation. We are fully aware that suspicion howsoever strong cannot take place of proof but these inconsistencies collectively are on higher pedestal than merely being a suspicions which requires deeper probe to unearth the collusive action on behalf of certain parties acting in concert to manipulate the system to evade and avoid taxes. The assessee has placed reliance on decision of the tribunal in the case of Pat Commodity Services Private Limited(supra) which was decided on its own facts and there were small fraction of transactions effected by client code modification while in the instant case we have seen that large number of transactions with large magnitude were affected by client code modifications in the month of March 2010 which was itself categorized by NSE were effected towards tax evasion . Similarly , the assessee has placed reliance on decision of Hon’ble Bombay High Court in the case of Coronation Agro Industries Ltd v. DCIT (2017) 390 ITR 464 : 82 taxmann.com 75 (Bom.) vide judgement dated 23.11.2016 wherein Hon’ble Bombay High Court was seized with an issue of escapement of income under section 148 of the 1961, wherein Hon’ble jurisdictional High Court held that the notice u/s 148 of the 1961 Act was without jurisdiction as it lacks reason to believe that income chargeable to tax has escaped assessment and on facts it was held that the Assessing Officer is suspecting income to have escaped assessment rather having reasons to believe that income has escaped assessment. These cases relied upon by the assessee were clearly distinguishable and are not relevant for deciding the instant appeal wherein facts are materially different as set out above. For Now, we are of the considered view, the appellate order of the learned CIT(A) cannot be sustain in the eyes of law as it is suffering from serious flaw and is perverse as indicated by us as above, and hence we are inclined to set aside the order of learned CIT(A) and restore the matter to the file of the learned Assessing Officer for fresh adjudication of the issue on merits in accordance with law and in compliance with directions issued by Addl. CIT vide orders dated 22.03.2013 passed under section 144A of the 1961 Act. The Assessing Officer shall admit all relevant evidences and explanations submitted by the assessee in its defense. We order accordingly. (Related Assessment year : 2010-11) – [ITO v. Ninja Securities (P) Ltd. - Date of Judgement : 15.05.2017 (ITAT Mumbai)]

Client code modification up to 1 per cent of total order is absolutely normal, assessee’s client code modification being only 0.94 per cent of total trading transactions, impugned addition was to be deleted

Assessee-company was engaged in business of shares and securities, commodity trading, speculation in shares and commodities, etc. Assessee-company was part of group of companies which included KCBPL. KCBPL was a registered broker in Commodity Exchanges. In course of search at assessee’s group company, KCBPL had done client code modifications for unusually high numbers of time - Assessing Officer was of view that since assessee-company and KCBPL were group concerns, client code modifications was done with intention of transferring profit to some other persons as against assessee. Assessing Officer, therefore, worked out notional profit/loss which could have occurred to assessee had client code been not modified. It was observed that as per MCX, client code modification upto 1 per cent of total order is absolutely normal and broker is permitted to modify client up to 1 per cent without paying any penalty. Since assessee’s client code modification was only 0.94 per cent i.e. less than 1 per cent of total trading transactions, impugned addition was to be deleted. [In favour of assessee] (Related Assessment years : 2005-06 to 2008-09) – [ACIT v. Kunvarji Finance (P) Ltd. (2015) 170 TTJ 345 : 61 taxmann.com 52 : 40 ITR(T) 64 (ITAT Ahmedabad)]

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 noticed 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)]