Round-Tripping
Punit Bhandari
Punit Bhandari, is a Qualified Chartered Accountant-
Senior Partner, M/s Bhatia Bhandari Associates
His Expertise: Taxation, Audits, SAP Implementation & Non-Resident Investment Solutions
Introduction
Round-tripping is an unethical practice in which a firm sells assets to another entity with the intent to repurchase them later. This artificially inflates sales and income figures without any real economic activity, deceiving stakeholders. In trading, round-tripping is the practice of repeatedly buying and selling the same securities to increase transaction volumes and create a false impression of market demand. This distorts market perception without affecting the true worth of the underlying companies.
Both types of round-tripping misrepresent a company’s financial health or market activity, frequently deceiving investors, authorities, and the public. Such practices are deemed dishonest and illegal in many jurisdictions.
Purpose of Round-Tripping:
- To inflate revenue to illustrate the organization’s growth.
- To demonstrate that the firm does more business than its
- To move money for personal gain through shell transactions.
- To convert black money into lawfully earned money.
- To profit secretly by manipulating stock prices and engaging in insider trading.
Why Round-Tripping is Problematic:
- Artificial revenue inflation distorts sales and profit figures, making a company appear healthier than it is.
- Misleading Investors: Investors make judgments based on false performance, which can result in poor investments and financial losses.
- Stock Price Manipulation: Inflated revenue can artificially boost stock prices, compromising market fairness.
- Fraud Risk: It is frequently tied to financial fraud and money laundering operations, which harm the company’s reputation.
- Regulatory Penalties: If identified, directors and auditors may face fines, legal action, or even criminal accusations.
- Long-Term Collapse: Companies that rely on round-trip frequently fail when the truth is revealed (e.g., Enron, Satyam).
Red Flags in Round-Tripping:
- Unusual Related Party Transactions: Frequent sales or purchases involving sister firms or shell corporations that lack a clear business purpose are considered unusual related party transactions.
- Circular Transactions: Usually at comparable values and times, money or items go in a circle, from point A to point B to point C, and back to point A.
- No Real Cash Flow: Reports of high income but no accompanying cash inflow imply that the transactions are merely paper-based.
- Unusual Revenue Spike: An abrupt, inexplicable rise in sales during a quarter that isn’t accompanied by a corresponding expansion in operations (such as capacity or manpower).
- Recurring Transactions with the Same Counterparties: recurring business dealings with the same customers or suppliers, particularly when those parties are unknown or difficult to track down.
Detection Methods in Round-Tripping:
- Cash Flow Analysis: This process involves comparing reported revenue with cash flows to identify discrepancies, since genuine sales generate revenue.
- Network mapping: Tracing the connections between entities involved using data analytics—this often reveals shell companies or common directors.
- Related Party Disclosures: Looking for hidden relationships in related party disclosures and account notes.
- Third-Party Confirmations: Asking suppliers or clients if transactions took place as reported frequently reveals fraudulent invoicing.
- Regulatory Surveillance: Organizations such as the Income Tax Department, SEBI, and RBI keep an eye out for indications in stock price movement, foreign direct investment, and cross-border flows
- Use of Technology and AI: Modern audit tools use machine learning to detect anomalies, patterns, and transaction loops.
Famous Round-Tripping Cases:
1. The Classic Case of Accounting Round-Tripping: Enron (USA):
Round-tripping played a major role in the Enron scandal, one of the most well-known corporate scams in history. To sell energy contracts and other assets, the U.S. energy giant Enron established a network of Special Purpose Entities (SPEs), which it eventually bought back through dubious means. Without any real economic activity, this gave the appearance that income and profits were increasing. Although growth was reported in the company’s financial accounts, it was a cycle of fictitious transactions. Following its discovery in 2001, Enron filed for bankruptcy, shareholders lost billions of dollars, and the auditing firm Arthur Andersen collapsed because of its role in concealing the fraud.
2. The Case of Satyam Computers (India): Using Fake Sales to Round-Trip:
One of the top Indian IT companies, Satyam Computers, was implicated in a huge accounting scam in 2009 that cost ₹7,000 crore. By drafting fictitious client contracts and transferring funds between Satyam and promoter-affiliated companies, the company overstated its income, which was indicative of round-tripping. It was not a classic round-tripping instance, but it did include fabricating business transactions that were looped back or reversed. Red flags included insider engagement, uneven growth relative to competitors, and excessive profitability with little cash reserves. After Ramalinga Raju, the chairman, came clean, Tech Mahindra eventually bought the business.
Legal Provisions & Penalties:
1. Section 129 of the Companies Act of 2013 requires that the books of accounts present an accurate and impartial picture of the financial situation.
2. Fraud is punishable under Section 447 if round-tripping is used to create false accounts.
a. Penalty: Up to ten years in prison.
b. Penalties for fraud can be up to three times the amount involved.
3. Section 12A of the SEBI Act of 1992 and the PFUTP Regulations forbid unfair and deceptive business activities, such as round-tripping, circular trading, and false financial statements.
a. Penalty: Three times the profit from the fraud or a monetary fine of up to ₹25 crore. Incarceration, prosecution, and prohibitions from the capital markets.
4. The Foreign Exchange Management Act (FEMA) of 1999 is relevant when round-tripping with foreign countries is involved (such as the Mauritius route). It prohibits reinvesting Indian funds abroad to avoid paying taxes or FDI regulations.
a. Three times the amount involved is the penalty.
b. Forfeiture of property.
c. Enforcement Directorate (ED) compounding or prosecution.
Conclusion:
Round-tripping, which is frequently done to manipulate revenue, avoid taxes, or launder money, is the practice of moving funds or assets through multiple businesses before returning to their source. Although it may appear lawful, round-tripping is generally unethical and raises concerns regarding fraud. Transparency and compliance with financial regulations are essential for businesses to avoid fines because regulatory authorities view them as suspicious.
For any clarifications or queries, please feel free to reach out to us at admin@fintracadvisors.com
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