Understanding Circular Transactions: Meaning, Examples, and Implications

Welcome to our blog post where we will delve into the concept of circular transactions. In this article, we will explore what circular transactions are, their impact on businesses and lending institutions, and why companies engage in such practices. Let's begin!

What Are Circular Transactions?

Circular transactions refer to a type of fake transactions that occur between companies within a single group or under single ownership control. These transactions are designed to create artificial trading activities or manipulate market conditions.

Now that we have a basic understanding of circular transactions, let's take a closer look at some examples, reasons behind their occurrence, and their implications.

Circular Transactions Example

One example of circular transactions involves a group of companies buying and selling shares among themselves without any genuine intention of ownership change. This creates an illusion of trading activities, artificially inflating the value of the companies involved.

Top 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 increase their perceived value, making them more attractive for investments or loans. By inflating their valuation, they can secure higher amounts of financing from banks and NBFCs. Additionally, they may exploit loopholes in tax regulations to claim fake input tax credit and pay less tax. Circular transactions can also serve as a means to launder black money and integrate it into the legal financial system.

The Impact of Circular Transactions on Lending Institutions

Circular transactions have significant implications for lending institutions such as banks and NBFCs. Let's explore some of these impacts:

1. Increase in Non-Performing Assets (NPAs)
2. Loss of Reputation
3. Lending Money for Bad Causes

Engaging in circular transactions increases the risk of non-performing assets for lending institutions. These transactions are often associated with fraudulent practices and can lead to defaults, putting the financial health of lenders at risk. Additionally, institutions involved in such activities may face reputational damage, leading to a loss of trust from stakeholders. Furthermore, financing companies engaged in circular transactions unknowingly support activities that can harm the overall economy.

Educational and Formal Perspective

From an educational and formal perspective, understanding circular transactions is crucial for professionals working in finance, accounting, and auditing. By being aware of the characteristics and implications of circular transactions, these professionals can detect and prevent fraudulent activities within organizations. Moreover, regulators and policymakers can use this knowledge to strengthen regulations and close loopholes that enable circular transactions.

Millennial Perspective

For millennials, gaining knowledge about circular transactions is essential to protect their investments and make informed financial decisions. Understanding the risks associated with circular transactions can help them identify potential red flags when considering investments in companies that may be involved in such practices. By being informed and vigilant, millennials can contribute to a more transparent and ethical business environment.

Conclusion

In conclusion, circular transactions are deceptive practices that involve fake transactions between companies within a single group or under single ownership control. These transactions manipulate market conditions, inflate valuations, and have adverse effects on lending institutions. By understanding the concept of circular transactions, professionals in the finance industry can safeguard their organizations and contribute to a healthier financial ecosystem. Similarly, millennials can protect their investments and promote ethical business practices. Let's strive for transparency and integrity in our financial systems!