I-T Survey Finds JM Mutual Fund Allowed “Sham Transactions” to Provide “Fictional Loss”

A survey conducted by the Income Tax (I-T) department in February 2021 on JM Financial Asset Management (AMC) Ltd (JMFL) found several lapses, including manipulated accounting methodology to inflate artificially distributable surplus and payout dividend to investors. Days before the survey, Bhanu Katoch, who has been named as responsible for the planned loss by some key persons, resigned as chief executive (CEO) of JM Financial.

The Survey was conducted as part of the re-opening computation of JM Financial’s income for AY2015-16 and AY2016-17 for the alleged adjustment in a short-term capital loss arising from redemption of mutual fund (MF) units against the long-term capital gains arising from the sale of shares. 

According to the Survey, by deploying unfair and manipulative methods, JMFL rigged distributable surplus. It says, “While accounting net asset value (NAV), JMFL credited income equalisation reserve (IER) account instead of unit premium reserve (UPR) against the Securities & Exchange Board of India (SEBI) guidelines. After declaring a dividend, since there is not enough money to distribute, the capital amount introduced by clients is distributed back to them as a tax-free dividend. Balance is redeemed at a loss since NAV will go down and investors book a short-term capital loss, which looks genuine but is actually fictitious and pre-planned!”

JMFL was aware of the scheme and indulged in it purposefully to avail fictitious loss, the note from the I-T department says.

As per SEBI, UPR should be treated at par with unit capital and cannot be utilised to declare dividends and the AMC cannot distribute dividends from UPR. The AMC can distribute only from the surplus generated by realising gains on investments or dividends received from equity markets in which it had invested. This means the AMC has to invest and make a profit to distribute. 

However, the Survey says that JMFL did not follow the SEBI direction as “first it artificially rigged distributable surplus and then applied the said ratio to future allotted units before the planned dividend distribution rate”. 

Key persons responsible for the management of MF admitted during the Survey that due process of dividend distribution as mandated by regulator SEBI was not followed by them. 

Further, the sales team told the I-T dept about passing on hints to distributors about prospective dividend distribution much in advance to lure prospective clients. These key persons also admitted to creating documents to show that the SEBI guidelines are followed. 

In a communication on 5 February 2021, JMFL informed investors about the resignation of Mr Katoch. It says, “The investors are hereby informed that Mr Bhanu Katoch has ceased to be the chief executive officer of JMFL consequent upon his resignation from the services of the Company.”

As on 30 September 2014, JM Balance Fund-Dividend Option Regular scheme had an asset under management of Rs3.30 crore. And in just two months till 30 September 2014, the distributable surplus of the scheme increased to Rs16.13 from Rs7.82 per unit by realising profitable open positions. 

Next month, in just 14 days, the scheme received an inflow of Rs1,310 crore, taking its closing AUM on 31 October 2014 to Rs1,364 crore. 

In December, the scheme received another tranche of inflow of Rs427 crore in just 11 days till 25 December 2014. The closing AUM as of 25 December 2014 stood at Rs1,776.84 crore.

Between 10th March and 25 March 2015, the scheme received another inflow of Rs1417.31 crore in 16 days. “In fact, the scheme received an inflow of Rs1087.25 crore on 25 March 2015, on the date of dividend distribution. The AUM reached its peak of Rs3,021.68 crore on that date,” the note on the Survey says. 

On that day, JM Financial declared a dividend of Rs8.87 per unit or nearly 40% of the unit value of the scheme, taking the total dividend payout to about Rs1,221.44 crore. After the payout of the dividend, the unit value of the scheme decreased to Rs13.07 from Rs22.02.

In this process, the note on the Survey says SEBI guidelines on crediting a portion of capital into unit premium reserve were violated. 

As per the recorded statements from key persons of JM Financial, “..due process of dividend distribution, as mandated by SEBI guidelines were not followed in letter and spirit. Merely chain of documents was created so as to impress upon SEBI that the guidelines were being followed.”  

“Given the above,” the Survey says, “it can be safely deduced that by deploying unfair and manipulative methods, the mutual fund house has rigged up distributable surplus, in a planned manner.”

To reduce their tax liability, the investors entered these ‘sham transactions’ and received dividends and short-term capital loss. “As a result, the dividend is not eligible for deduction under section 10(35) of the I-T Act and short-term capital loss is also not eligible for adjustment with other capital gains, being generated on account of the sham transaction. In fact, being distributed out of capital itself, such dividend should be reduced from the cost of investment with the resulting reduction in short term capital loss.”

“The conduct of JM Financial highlights that it was well aware of the scheme and indulged in it purposefully to avail fictitious loss…I have reason to believe that by way of the aforementioned modus operandi, the assessee has claimed fictitious short term capital loss and therefore, the assessee has understated his income and/or has claimed excessive loss and accordingly, it is a fit case for the issue of notice under section 148 of the I-T Act,” the survey note from the I-T department says. 

Moneylife had sent an email to JM Financial seeking their response on the survey conducted by the I-T department, action, if any, taken on senior executives and if SEBI has sent any notice to the fund house. 

In an email reply, the JM Financial spokesperson says, “We wish to clarify that the Income Tax department carried out a survey seeking some information with respect to third party investments in JM Financial Mutual Fund schemes. JM Financial Asset Management Company officials provided the information sought by the department and extended complete cooperation with regard to the same. JM Financial Asset Management has always discharged its fiduciary duties and responsibilities in earnest, and consistently followed the accounting methodology and practices in compliance with all applicable laws and regulations. As a policy, we do not comment on matters pertaining to regulatory authorities.”