Everything You Need to Know About Circular Transactions - Are They Legal?

Circular transactions have become a hot topic in the financial world due to their controversial nature. These transactions involve fake transactions between companies that are part of a single group or under single ownership control. While circular transactions can have various motives, it is crucial to understand their legal implications.

Circular Transactions Example

Let's take a closer look at a circular transaction example to understand how it works. Imagine Company A and Company B are both owned by the same individual. In a circular transaction, Company A might sell a product to Company B at an inflated price, creating the appearance of revenue for both companies. However, in reality, no real value is exchanged, and the transaction is merely a manipulation of financial records.

Top Reasons Why Companies Indulge in Circular Transactions

There are several reasons why companies engage in circular transactions, despite their legal and ethical concerns. Some of the main motives include:

1. To shoot up the valuation of the companies: Circular transactions can create an artificial increase in the value of the involved companies, making them appear more valuable than they actually are.
2. To avail higher loans from banks or Non-Banking Financial Corporations (NBFCs): By inflating their revenue and assets through circular transactions, companies can deceive financial institutions into granting them larger loans.
3. To avail fake input tax credit and pay less tax: Circular transactions can be used to manipulate tax credits and reduce the tax liabilities of the involved companies.
4. To pump in black money into the legal financial system: Circular transactions provide a means to convert black money into legitimate funds through the manipulation of financial records.

The Impact of Circular Transactions on Lending Institutions

Circular transactions not only affect the involved companies but also have a significant impact on lending institutions. Some of the consequences for lending institutions include:

1. Increase in Non-Performing Assets (NPAs): Circular transactions can lead to an increase in NPAs for banks and NBFCs. When companies default on loans obtained through fraudulent means, it results in a higher number of NPAs.
2. Loss of reputation: Lending institutions can suffer a severe blow to their reputation if it is discovered that they granted loans based on false financial information provided through circular transactions.
3. Lending money for bad causes: Circular transactions can enable companies to obtain funds for illicit activities, such as money laundering or financing illegal operations.

It is essential for lending institutions to strengthen their due diligence processes and identify warning signs of circular transactions to mitigate these risks.

Is Circular Trading the Same as Circular Transactions?

While circular trading and circular transactions may seem similar, they are distinct concepts. Circular trading refers to a fraud scheme that creates artificial trading activity by passing shares among a closed group. This manipulation can deceive investors and artificially inflate the market value of the shares involved.

On the other hand, circular transactions primarily involve fake transactions between companies within a single group or under single ownership control. The motive behind circular transactions is often to manipulate financial records and deceive stakeholders, including lenders, investors, and tax authorities.

How Circular Trading Works

Circular trading operates by creating a cycle of share purchases and sales among a closed group of individuals or entities. This activity gives the appearance of active trading and generates false market demand for the shares involved. As a result, the share price is artificially inflated, allowing the manipulators to profit when they eventually sell their shares to unsuspecting investors.

How Circular Trading Manipulates the Market

Circular trading can have significant consequences for the overall market. Some of the ways in which circular trading manipulates the market include:

• Artificially inflating share prices: By creating false demand for shares, circular trading can drive up share prices, making them appear more valuable than their true worth.
• Deceiving investors: Circular trading can deceive investors into believing that a particular stock is in high demand and likely to generate substantial returns. However, when the manipulators eventually sell their shares, the market value can plummet, resulting in significant losses for unsuspecting investors.
• Undermining market integrity: Circular trading undermines the integrity of the market by creating a false perception of active trading and distorting supply and demand dynamics.

The Legal Implications of Circular Transactions

Now, let's address the critical question - are circular transactions legal? The answer is straightforward - circular transactions are illegal and considered fraudulent activities. They involve deception, manipulation of financial records, and misrepresentation of financial information.

Engaging in circular transactions can lead to severe legal consequences for the involved parties. Authorities worldwide are actively working to detect and prosecute individuals and companies involved in circular transactions.

Educational and Formal Perspective

From an educational and formal perspective, it is crucial to understand the complexities and risks associated with circular transactions. Educational institutions and formal training programs should incorporate discussions and case studies related to circular transactions to raise awareness and promote ethical financial practices.

Millennials and Circular Transactions

Millennials play a vital role in shaping the future of the financial industry. As the next generation of business leaders and consumers, millennials should be aware of the risks and implications of circular transactions. By staying informed and promoting transparency and ethical business practices, millennials can contribute to a more secure and trustworthy financial ecosystem.

In conclusion, circular transactions are a type of fraudulent activity involving fake transactions between companies within a single group or under single ownership control. These transactions have significant legal and ethical implications, impacting both the involved companies and lending institutions. Circular trading, although distinct from circular transactions, shares the common theme of deception and manipulation. It is crucial for individuals, businesses, and educational institutions to be aware of the risks and consequences associated with circular transactions and promote ethical financial practices.