Indian Tax Authorities Investigate Prop Trading Brokers Over Misconduct

​India's Income Tax Department has reportedly initiated investigations into several proprietary trading brokers, suspecting them of illicit practices involving their trading terminals. Sources with direct knowledge of the matter indicate that the brokers are suspected of disguising third-party trades as loan entries in their financial records.

According to these sources, numerous notices were issued to the brokers between February and March of this year. These notices highlight unusually large unsecured loan entries, in some instances amounting to hundreds of crores, within the brokers' financial statements. Tax officials suspect that these entries were used to conceal commission income generated from unauthorized traders utilizing the brokers' proprietary accounts.

"IT notices were sent to several brokers in March. A few others were served notices in the middle of February too," a person familiar with the developments stated.

A tax expert familiar with the matter explained that "In the notices, brokers have been asked to explain the amount credited in their accounts under Section 68 of the Income Tax Act." The expert further elaborated that the department became suspicious due to the fact that individuals who purportedly provided these substantial unsecured loans had not even filed income tax returns and were unable to adequately explain the source of their funds.

While the majority of the cases pertain to the assessment years 2022-23 and 2023-24, additional notices have been issued to brokers who failed to provide satisfactory responses to the initial inquiries. Should the brokers fail to adequately substantiate the loan entries, the tax authorities may classify the amounts as unexplained income, potentially leading to demands for tax payments along with penalties and interest.

This alleged misuse of proprietary trading accounts has also raised concerns with the Securities and Exchange Board of India (SEBI) and stock exchanges. SEBI is reportedly considering implementing new monitoring tools to prevent unauthorized usage of trading terminals.

A senior tax officer, though not directly involved in the current probe, explained that under Section 68 of the Income Tax Act, the authorities assess "the capacity of the lender to give loan, identity of the lender and genuineness of the transaction."

Industry sources suggest that some brokers resorted to this practice as a workaround after SEBI tightened margin rules. This involved allowing professional traders to execute trades through the brokers' proprietary accounts, often without providing their own margin, and sharing profits or paying fees to the broker. These arrangements were frequently documented as loan entries or concealed through other accounting methods.

SEBI has previously expressed disapproval of such practices, warning of potential systemic risks and issuing penalties to brokers for misuse of proprietary accounts and failure to disclose user details. Exchange rules mandate that any individual using a broker's terminal for proprietary trading must be formally disclosed to the exchange.