Are Circular Transactions Illegal? Exploring the Fraudulent Practice

Circular transactions have gained significant attention in recent years due to their fraudulent nature. These transactions involve fake transactions between companies that are part of a single group or under single ownership control. In this blog post, we will delve into the world of circular transactions, examining why companies engage in this practice, the impact on lending institutions, and the legality of these transactions.

What Are Circular Transactions?

Circular transactions, also known as circular trading, refer to a fraud scheme where artificial trading activity is created by passing shares among a closed group of companies. These transactions lack any commercial benefit and are primarily conducted to manipulate the market and deceive investors.

Reasons for Engaging in Circular Transactions

There are several reasons why companies indulge in circular transactions:

1. To Shoot up the Valuation of the Companies
2. To avail higher loans from banks or Non-Banking Financial Corporations (NBFCs)
3. To Avail Fake Input Tax Credit and Pay Less Tax
4. To Pump in Black Money into the Legal Financial System

Companies engage in circular transactions to inflate their valuation, making them appear more valuable than they actually are. This can help attract investors and secure higher loans from financial institutions. Additionally, circular transactions can be used to manipulate tax payments by claiming fake input tax credit and paying less tax than required.

Moreover, circular transactions can also serve as a means to inject black money into the legal financial system. By conducting fake transactions, companies can convert their illicit funds into seemingly legitimate assets.

The Impact of Circular Transactions on Lending Institutions

Circular transactions can have severe repercussions on lending institutions:

1. Increase in Non-Performing Assets (NPAs)
2. Loss of Reputation
3. Lending money for bad causes

Lending institutions face a higher risk of non-performing assets when companies engage in circular transactions. These transactions can lead to inflated valuations and unsustainable financial positions, eventually resulting in defaults on loans. This can have a detrimental impact on the financial health of the lending institutions.

Furthermore, lending money for bad causes, such as money laundering or financing illegal activities, can tarnish the reputation of the lending institutions. It undermines their credibility and trustworthiness in the market.

The Legality of Circular Transactions

The legality of circular transactions varies by jurisdiction. In many countries, circular trading is considered illegal and falls under fraudulent practices. Regulatory bodies and law enforcement agencies actively monitor and take action against individuals and companies involved in circular transactions.

In the United States, the Internal Revenue Service (IRS) has implemented a comprehensive strategy to combat abusive tax shelters and transactions. The IRS provides guidance on abusive transactions, enforces regulations governing tax shelters, and maintains a hotline for taxpayers to report abusive transactions.

Similarly, other countries have their own regulatory frameworks and enforcement mechanisms to tackle circular trading. It is crucial for businesses and individuals to be aware of the legal implications and consequences of engaging in circular transactions.

In Conclusion

Circular transactions are fraudulent practices that involve fake transactions between companies. These transactions aim to manipulate the market, inflate valuations, and deceive investors. Companies engage in circular transactions for various reasons, such as increasing valuations, obtaining higher loans, and evading taxes. However, circular transactions have a negative impact on lending institutions, leading to increased non-performing assets and reputational damage.

It is important for businesses and individuals to understand the legality of circular transactions in their respective jurisdictions and comply with applicable laws and regulations. Regulatory bodies play a crucial role in monitoring and combating fraudulent practices, ensuring the integrity and stability of the financial system.