How to combat the menace of black money

There is no standard definition of ‘black money’. As such, black money can be defined differently from different perspectives. From a legal perspective, any unaccounted earnings that remain undeclared to the fiscal authorities and on which requisite taxes have not been paid, may be termed as black money.

Origin of black money

There are two ways black money originates in our country. In the first case, black money is generated through perfectly lawful activity, but it is accumulated dubiously by failing to declare income and by evading taxes due on that amount. This kind of black money is found in abundance in sectors such as real estate and construction as well as bullion and gold jewellery, where there are large scale movements of unaccounted funds.

The second and more probable source of black money involves earning money through activities not permitted under the law. Such activities are considered illegitimate in India and may include smuggling, bootlegging, blackmailing, operating prostitution and pornography rackets, indulging in rampant corruption, terrorism, drug trade and other such criminal activities.

A classic case of how rampant corruption in the ministries and government departments leads to generation of black money was witnessed when the Congress-led UPA government, which was in power between 2004 and 2014, distributed scarce natural resources – such as coal blocks and 2G spectrum – to select cronies at the expense of the our country’s national interest. It obviously led to accumulation of black money in the hands of a few.

It is known that banks and financial institutions seek an appropriate debt-equity ratio prior to sanctioning a corporate loan. Many business houses approach banks with a loan application that reflects an inflated cost of project, with overstated cost allocated for capital goods to be procured from foreign/ domestic suppliers and exaggerated cost of construction. By doing so, corporates deceitfully lessen their burden of equity and many a times even steer clear of bringing in any equity in the project. Otherwise, the difference is kept in a concealed foreign bank account and post laundering of the black money component; funds are diverted to an altogether different project.

The modus operandi of such corporate houses, in case of capital goods procured from foreign, is to strike a deal with their own front company (though not a ‘related party’), located in a tax haven nation, which in turn negotiates with the manufacturer/ supplier. Upon receipt of goods in India, the billing is done by the front company by substantially inflating the price. The practice is also resorted to in purchase of indigenous capital goods and construction of building/ plant by availing credit of an amount higher than the actual cost.

In a few other instances, proprietorship firms and even a few corporations falsify the disbursement of salary to employees by showing dummy employees in the books of accounts to enhance the incurred expenses, thus leading to creation of black money.

One of the major poll planks of the new BJP-led NDA government was it would track down and bring back Indian black money stashed in foreign banks and offshore accounts and also curb the avenues for generation of domestic black money. The quantum of domestic black money is currently pegged at 7% of India’s GDP (around US$1.9 trillion in 2013) and it exists mainly due to corruption in high places in the government and the prevalence of large-scale cash transactions as opposed to the use of proper banking channels.

Parking spots for black money

Domestic black money is presumably invested in real estate, construction and the service sector as well as bullion and gold jewellery, which constitute two-thirds of the economy. Meanwhile, a huge proportion of black money also goes out of our country in the form of illicit financial flows across inter­national borders through hawala operators. Thereafter, they end up in foreign tax havens or are held as illicit wealth or deposits in Swiss bank accounts.

Till the early 1980s, the marginal rate of taxation in India being very high – the highest taxation slab was as high as 90% – the tendency of the rich and wealthy was to keep their money abroad, particularly by trade mispricing. A study by Global Financial Integrity says between 2002 and 2011, nearly US$344 billion of illicit money moved from India to various tax havens. Meanwhile, the Associated Chamber of Commerce and Industry of India (Assocham) has pegged the Indian black money stashed abroad at around Rs 120 lakh crore or US$2 trillion.

Surprisingly, a huge amount of black money that goes out of India through the hawala operators are re-routed back into India in the form of foreign money via the Foreign Direct Investment (FDI) route. According to a White Paper on black money published in 2012 by the Union Finance Ministry, the main inflow of FDI in India was caused by the return of black money. FDI statistics perhaps point to this fact.

As per data released by the Department of Industrial Policy and Promotion (DIPP), from April 2000 to March 2011, FDI from Mauritius was 41.80% of the entire FDI received by India, whereas Singapore contributed about 9.17%. So, more than half of the FDI received by India during that period probably was black money subject to “round tripping” and was not real FDI but black money that got laundered into white money and re-entered the country of origin.

Though all of the money from Mauritius and Singapore may not be black money, it would be presumptuous to assume that the rest of the FDI flowing in from countries like the UK, the US, Japan, Germany, Switzerland, the Netherlands, France and Korea is all money, as white as snow.

Our government’s White Paper further observes, “Mauritius and Singapore with their small economies cannot be the sources of such huge investments and it is apparent that the investments are routed through these jurisdictions for avoidance of taxes and/or for concealing the identities from the revenue authorities of the ultimate investors, many of whom could actually be Indian residents, who have invested in their own companies through a process known as round tripping.”

If secret bank accounts and the tax haven system had been transparent, this money may not have left the shores in the first place. Round tripping and huge amounts of black money movement happens because the compliance costs of round tripping is lower than that of paying taxes, unless the money is illegally earned in the first place. For illegally-earned money, secrecy and concealment is essential and round-tripping is one of the most obvious options for legitimizing the income. The tax havens exist to act as conduits and parking spots for black money.

Another instrument that enables unscrupulous people to generate and launder ill-gotten money anonymously is Participatory Notes. PNs are leveraged instruments involving Indian equity, debt or derivatives issued by Foreign Institutional Investors (FIIs) to individuals and institutions who wish to invest in Indian stock markets without registering themselves with the market regulator, the Securities Exchange Board of India (SEBI).

What worries the SEBI is the source of huge amount of foreign money that flows into the country through this route. More often than not, black money generated in the country is sent out by hawala operators and re-routed by Participatory Notes targeting the Indian capital market in a bid to rig share prices or to manipulate stock market operations.

Strategies to combat the menace of black money

As a first step towards combating the menace of black money, our government has already constituted a Special Investigation Team (SIT) comprising top bosses of the country’s premier investigation, enforcement and intelligence agencies. The officers who form part of the SIT include Secretary of the Department of Revenue, a Deputy Governor of the Reserve Bank of India, Intelligence Bureau Director, Director of Enforcement Directorate, Director of the Central Bureau of Investigation, Chairman of the Central Board of Direct Taxes and the Director of the General Narcotics Control Bureau. Director General of the Directorate of Revenue Intelligence, Director of the Financial Intelligence Unit, Secretary of the Research and Analysis Wing and a Joint Secretary (Foreign Tax and Tax Research) in the Finance Ministry are its other members.

The Terms of Reference for the SIT, issued by the Department of Revenue under the Finance Ministry, states that the elite team will investigate all matters “with respect to unaccounted monies being stashed in foreign banks by Indians or other entities operating in India that may arise in the course of such investigations and proceedings.”

The SIT submitted a report to the court in August 2014 with some details related to over-invoicing of power equipment imports and how this leads to generation of black money. The report has suggested that all bulky imports should be comprehensively scrutinized for over-invoicing and that Double Taxation Avoidance Agreement (DTAA) was not the apt route for fetching requisite data from foreign banks. In such cases, the scrutiny work should be assigned to the squads already working in the field of taxation and revenue intelligence.

The task of managing taxation matters, arising from cross-border deals and transfer pricing, currently lies with the Director of Income Tax (International Taxation), which in turn stands accountable for curbing the cases of black money with more than 50,000 employees. Doubtful financial transactions come under the purview of the Financial Intelligence Unit. Similar other roles are assigned to the Central Board of Excise & Customs, Directorate of Revenue Intelligence and the Central Economic Intelligence Bureau, which are staffed with well-qualified and competent people. However, since India still ranks high when illegal money deposits in foreign banks are taken into consideration, what needs to be done is the overall restructuring of all these departments.

Next, the NDA government needs to take note of the report submitted by the MC Joshi Committee, which advocates rigorous imprisonment under the Prevention of Corruption Act, setting up of the National Tax Tribunal and reporting of bulky financial transactions (global) to the law enforcement agencies (similar to the USA Patriot Act). Our government should also announce a suitable Amnesty Scheme or a Voluntary Disclosure Scheme for those who are ready to reveal their black money records, pay tax and transfer their black money lying abroad into our country.

The RBI’s measure of calling back the pre-2005 currency notes will also help the authorities to get rid of unaccounted money lying with a section of unscrupulous elements. Furthermore, the Whistle Blower laws, which can play a key role in reporting and tax recovery, will have to be reinforced, along with more liability on corporate auditors.

An area, which most of the time goes unnoticed, is the route used by offenders for moving their black money from India to foreign banks. It is not just the hawala; rather many such ways still remain uncovered. In this context, as recommended by the SIT recently, India should revisit all the Double Taxation Avoidance Agreements (DTAAs), redraft them so as to add new covenants that can allow Indian authorities to pierce the veil and introduce penal provisions to attach the Indian assets of offenders. This is important, because agreements need to be in place with Switzerland under the Automatic Exchange of Information provisions for the Organization for Economic Cooperation & Development (OECD) countries.

A much better option is to pass a domestic law like the FATCA (Foreign Account Tax Compliance Act) introduced by the US. Indian citizens living outside India, who still retain Indian citizenship, should report their financial accounts held outside India to the Indian Revenue Service, and foreign financial institutions should be required to report to Indian authorities about their Indian clients. This will of course need to be moderated in the Indian context, but the principles can remain the same.

Another major recommendation of the SIT is to amend the Prevention of Money Laundering Act so that the Enforcement Directorate (ED) would be able to attach properties of defaulters who do not bring back black money. These are very effective suggestions, but many things will have to be weighed well before any particular option is selected and implemented.

For repatriation of black money stashed in foreign banks, the Union government can also consider promulgating an ordinance to nationalize black money held by our citizens in tax havens abroad and bring the money back into the Indian financial system. The proposed ordinance will be in consonance with the Swiss Federal Act on the Restitution of Illicit Assets Act of October 1, 2010.

Simultaneously, the government should take steps to minimize generation of black money. To begin with, it could put an end to Participatory Notes, the main attraction of which is the anonymity it provides. Because of this, even terrorists are known to park their funds in PN as it enables them to generate and launder their ill-gotten wealth anonymously.

Another source of black money generation that needs to be plugged is the Indo-Mauritius Double Taxation Avoidance Treaty (DTAT). Under this treaty, no resident of Mauritius would be taxed in India on capital gains arising out of sale of securities in India, whereas capital gains arising out of sale of shares or securities for an Indian would be subject to capital gains tax. Currently, as there are no taxes on Mauritius-based FIIs investing in India, the tiny Indian Ocean island nation has emerged as the largest investor in India, accounting for almost half of the country’s FDI. The tax losses to India as a result of the DTAT are estimated at thousands of crores of rupees.

Furthermore, all vulnerable sectors of the Indian economy, for instance bullion trading and real estate, need immediate attention. Under-reporting of transactions, forged paperwork, and parking of illicit money are very common practices in bullion trade as well as in the real estate sector. Similarly, to mitigate corruption, India needs more of economic liberalization with respect to permits, licenses and approvals from government departments.

Finally, some more measures that can be considered for repatriating as well as curbing generation of black money are briefly enumerated below:

  1. Checking and redrafting the existing Double Taxation Avoidance Agreements (DTTAs) in a bid to make them better and with a view to remove confidentiality clauses (wherever possible).
  2. Creating Agreements for Information Exchange where DTAAs are not possible.
  3. Setting up Income Tax cells in key tax havens to work in real time with local authorities.
  4. Making taxes low and penalties high.
  5. Simplifying tax provisions and creating greater incentives to pay tax.
  6. Reducing multiplicity of taxes and eliminating accounting and compliance barriers.
  7. Using all international platforms available to India to fight businesses trying to evade taxes.
  8. Designing Gold Deposit Scheme with complete tax immunity.
  9. Creating agreements of revenue sharing with governments in tax havens like the one that exists between the UK and Switzerland.
  10.  Putting in place a consolidated code for dealing with black money and tax evasion, instead of using different provisions spread across multiple obscure statutes and treaties.
  11.  Creating domestic and international automatic information exchange with banks and payment gateways.
  12.  Creating, strengthening and integrating databases that make it easier for monitoring agencies to do their job.
  13.  Offering amnesty for repatriating black money.
  14.  Pursuing greater economic liberalization, implementing aggressive reforms and reducing license raj.
  15.  In order to curtail the instances of overstating of the project cost while applying for a corporate loan, a statutory agency under the supervision of the RBI should be formed that must work together with the banks to examine and authenticate the pricing of imported capital goods over and above a specified amount. A policy similar to the ‘Transfer Pricing’ between related parties can also be devised. Along with, in all cases of corporate loans, banks must be directed to validate whether or not the loan applicants have brought in the equity amount upfront and the same has been expended prior to disbursement of the loan amount.

102 thoughts on “How to combat the menace of black money

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