Circular Trading in Companies: Everything You Need to Know

Circular Trading has been ever existing in the Indian Market, but many tend to believe that it only takes place in the stock market. However, that is not the case, Circular Trading can also take place into companies or trading businesses. Before we further get into the depth and analysis of circular trading, let’s start with the basics and try to understand the following aspects.

What is Circular Trading in Companies?

Circular Trading is a type of scam that takes place when a company tries to create a flow of fake sales transaction with its collusioned parties by producing fake invoices. Now, we all wonder, why do they do that? What is the illegal advantage of it?

Circular Trading: It’s illegal Advantages

This type of scam basically creates a huge financial impact on companies’ accounts. This approach of fraud helps companies to inflate their turnover, gain larger loans from financial institutions or banks and also avail GST credits on every lap of transactions done, ultimately raising the black money.

How Circulation Trading takes place in companies? (With example)

We have got a fine example to illustrate how Circular Trading takes place. For instance, there are 3 companies, Company A, Company B, and Company C.

Let’s say Company A is into steel supplies, the Company A sells goods to Company B and Company B sells the same goods to Company C and finally, Company A purchases the exact goods from Company C, hence completing the cycle. But in reality the goods are not moved from one company to another, it’s just the illegitimate transactions created through fabricated invoices which are produced between the companies. Here, Company A, B, and C all are collusioned and involved in the conspiracy.

Generally, this is not the desired pattern for the flow of goods if the transactions are authentic. However, the cycle becomes much more complicated to analyze with the involvement of more than 3 dealers.

Understanding Input Tax Credit

In February, 2019, The Indirect Tax Department raided several suspected companies from different states involved in circulation trading. It is said to be these companies prepared doctored invoices of INR 25,000 crore to avail advantage of GST credit or input tax credit.

Input Tax Credit is a mechanism where a company at the time of paying tax on output, can claim the tax that have already paid on inputs. For instance, a manufacturing company has a tax payable on output (Final product) is INR 500 and tax paid on inputs (Purchases) is INR 300. Here, this manufacturing company can claim input credit of INR 300 and will be taxed only the difference amount that is INR 200.

Consequences

Circulation trading is a serious offense as it is non-bailable and cognizable offense, where a police department has the authority to arrest without a warrant and can begin an investigation without any permission of a court if the amount surpasses beyond INR 5 crore.