Income Tax Department Targets Brokers in Proprietary Trading Abuse Probe

Tax Authorities Intensify Scrutiny Over Suspected Terminal Misuse and Unsecured Loan Masking

India’s Income Tax Department (ITD) has launched a series of targeted investigations into proprietary trading brokers, suspecting that several have misused trading terminals to enable unauthorised third-party trading. According to individuals familiar with the matter, IT notices were issued between February and March 2025 to brokers across the country, many of whom were flagged for unusually large unsecured loan entries in their books, particularly during Assessment Years 2022–23 and 2023–24.

The underlying concern is that these loan entries—some reportedly running into hundreds of crores—were fraudulent, designed to disguise commission income or gains from trades carried out by external entities on the brokers’ proprietary accounts. The IT department is investigating whether these loan entries were used to route payments for unauthorised rental of trading terminals and hawala-based income streams.

Highlights:

• Brokers received IT notices under Section 68 of the Income Tax Act.

• Entries in question involve large unsecured loans without proper documentation.

• Alleged misuse includes disguising commission earnings as third-party loans.

• Income Tax Department may demand back taxes, penalties, and interest on unsubstantiated entries.

Regulatory Red Flags: Section 68 Triggers and Source of Funds Scrutiny

Under Section 68 of the Income Tax Act, if any sum is found credited in the books of an assessee and the assessee fails to offer a satisfactory explanation about its nature and source, the amount can be treated as unexplained income. In many cases flagged by the department, those named as lenders had not filed income tax returns and were unable to prove their financial capacity to provide such large sums.

A tax consultant briefed on the matter revealed that the burden of proof rests squarely on the broker. Authorities are said to be applying a standard three-fold test: identity of the lender, creditworthiness of the lender, and genuineness of the transaction. Where responses have been absent or inadequate, additional notices have been served.

Highlights:

• Section 68 invoked for unexplained credit entries.

• Identity, capacity, and genuineness of lenders under review.

• Several lenders named in brokers’ books have not filed IT returns.

• Tax demand could follow if brokers fail to substantiate entries.

Broader Crackdown on Shadow Proprietary Trading Practices

The issue traces back to a December 2022 exposé by Moneycontrol, which highlighted the rise of a shadow market for proprietary trading. Brokers were allegedly renting out their terminals to jobbers or professional traders, bypassing compliance rules and misusing their own margin capital to allow external trading activity.

In response, SEBI and stock exchanges have grown increasingly vigilant. SEBI is reportedly considering new monitoring tools such as MAC ID-based device mapping and fixed IP monitoring to ensure that only authorised users operate terminals. This comes amid mounting evidence that some brokers have collaborated with external traders to circumvent post-2020 margin tightening rules, accepting fees or profit-sharing arrangements disguised as loans.

Highlights:

• Brokers allegedly let external traders use their proprietary accounts.

• Profits shared or fees received were disguised as unsecured loans.

• SEBI mulls stricter surveillance tools to curb terminal misuse.

• Practice exposes systemic risk and violates disclosure norms.

Compliance Challenges and Legal Risk for the Broking Industry

The broking ecosystem now finds itself under intensified regulatory and tax scrutiny. With SEBI’s repeated warnings and the IT department’s expanded audits, the legal risks for brokers engaged in such practices have multiplied. Notably, under exchange regulations, all users accessing a broker’s proprietary terminal must be disclosed, and brokers found guilty of nondisclosure risk penalties, suspension, or de-registration.

Industry experts warn that unless brokers clean up their compliance practices, they face a growing risk of financial penalties, reputational damage, and even criminal proceedings for aiding unauthorised market participation. Meanwhile, tax authorities are actively mining transaction data to detect more such irregularities across assessment years.

Highlights:

• SEBI rules require disclosure of all proprietary account users.

• Brokers face risk of regulatory penalties and suspension.

• IT department likely to expand probe across brokers and intermediaries.

• Broking community under pressure to tighten compliance mechanisms.