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Black Money in India

‘Black Money’ can be defined as assets or resources that have neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession.

Several terms with similar connotations have been in popular parlance such as ‘unaccounted income’, ‘black income’, ‘dirty money’, ‘black wealth’, ‘underground wealth’, ‘black economy’, ‘parallel economy’, ‘shadow economy’, and ‘underground’ or ‘unofficial’ economy. All these terms usually refer to any income on which the taxes imposed by government or public authorities have not been paid. Such wealth may consist of income generated from legitimate activities or activities which are illegitimate per se, like smuggling, illicit trade in banned substances, counterfeit currency, arms trafficking, terrorism, and corruption.

In 2009, a four-member task force was set up by L.K. Advani-led BJP had also talked about targeting the "ill-gotten" money stashed abroad, but had made it clear that expats and smaller players should not be taken to task. The panel included the incumbent National Security Advisor Ajit Doval, Lawyer Mahesh Jethmalani, RSS leader S. Gurumurthy and IIM Hyderabad Professor R. Vaidyanathan. Bringing black money stashed abroad has been one of BJP's top war cries since 2009.

There are many estimates of the amount of black money stashed abroad. They vary from 10 % of India's GDP ($100-150 billion) to up to 100 % of GDP. India's premier investigating agency, CBI, however, pegs it at $500 billion, while US think tank Global Financial Integrity puts the number at $440 billion. India's forex reserves, on the other hand, are $350 billion.

US-based GFI estimates that $440 billion had moved out of India in the 10-year period from 2003 to 2012. A large portion of this money comes back to India via round tripping. Tax authorities believe participatory notes are a common route, and no one gets to know the real owner of the money. In 2007, India banned P-notes investments in the stock markets, as it was suspected that terror money was being routed. But amid pressures from foreign investors, the ban was lifted in 2008. This is a derivative instrument issued by FIIs to the investors to invest in country's equity and debt market without registering with the regulator. This means, one can invest in the market without disclosing their identity.

In November 2014, when G20 leaders met at Brisbane, Australia, Modi had made a strong pitch for repatriation of black money and standardisation in sharing information for tax purposes during the plenary session. The 94 member countries had agreed to sort out the norms, start gathering data from January 2016 and, subsequently, share the data from 2017.

'The government must look at ways to tackle the bigger issue of bringing back the money, which many from corporate India have stashed abroad. They are the big fish, not the expats or smaller players,' says Prof. Ashwini Mahajan, national co-convener, Swadeshi Jagran Manch

In addition to wealth earned through illegal means, the term “Black Money” would also include legal income that is concealed from public authorities:

1. To evade payment of taxes (income tax, excise duty, GST, Custom Duty, stamp duty, etc);

2. To evade payment of other statutory contributions;

3. To evade compliance with the provisions of industrial laws;

4. To evade compliance with other laws and administrative procedures.

Factors Leading to Generation of Black Money

Black money arising from illegal activities such as crime and corruption and has an underlying anti-social element involved. The ‘criminal’ component of black money may include proceeds from a range of activities including racketeering, trafficking in counterfeit and contraband goods, smuggling, production and trade of narcotics, forgery, illegal mining, illegal felling of forests, illicit liquor trade, robbery, kidnapping, human trafficking, sexual exploitation and prostitution, cheating and financial fraud, embezzlement, drug money, bank frauds, and illegal trade in arms.

The ‘corrupt’ component of such money could stem from bribery and theft by those holding public office – such as by grant of business, leakages from government social spending programmes, speed money to circumvent or fast-track procedures, avoiding paying fines like Traffic violations and paying cash to police, black marketing of price-controlled services, and altering land use regularizing unauthorized construction.

Significant amount of black money, however, is generated through legally permissible economic activities, which are not accounted for and disclosed or reported to the public authorities as per the law or regulations, thereby converting such income into black money.

The failure to report or disclose such activities or income may be with the objective of evading taxes or avoiding the cost of compliance related to such reporting or disclosure. It may also be the result of non-compliance with some other law. For example, a factory owner may under-report production on account of theft of electricity which in turn leads to evasion of taxes. Generally, a high burden of taxation, either actual or perceived, provides a strong temptation to evade taxes and generate black money.

Sometimes the procedural regulations can be such that complying with them may increase the probability of further scrutiny and thereby the incidence of the burden of compliance, creating a perverse incentive not to report at all and remain outside the reported and accounted proportion of the economy. Culture and social practices may also play a vital role in deciding the preferences of citizens between tax compliance and black money generation. In a society (many religions or caste or communities) where tax evasion and under-reporting of activities and income is perceived to be very common or the norm, such activities may be considered acceptable and honest tax compliance and paying one’s due share to the public fund may not be considered a virtue. Studies indicate that countries with relatively poor implementation of regulations tend to have a higher share of unaccounted economy, whereas countries with properly implemented regulations and sound deterrence have smaller ‘black’ economies.

Generating Black Money by Manipulation of Accounts

There can be different modus operandi involved in the generation of black money.

1. Not declaring or reporting the whole of the income or the activities leading to it. This is the likely approach in all cases of criminal, illegal, and impermissible activities. The sophistications in such an approach mostly get introduced subsequently for the purpose of laundering the money so generated with the objective of making it accountable and converting it into legitimate reported wealth that can be openly possessed and used.

2. Failure to comply with regulatory obligations or tax evasion on income from legitimate activities. However, complete evasion or non-compliance may make such incomes vulnerable to detection by authorities and lead to consequent adverse outcomes for the generator. Thus a more sophisticated approach for generation of this kind of black money is often preferred, involving manipulation of financial records and accounting. An example could be Doctor or Lawyer receiving most of his fees in cash and declaring token amount to Income Tax and pay token tax even though his life style would indicate income much more higher than what he declared even when tax rate is very low (which used to be high earlier)

3. Financial statement approach, elaborating different means by which the accounts prepared for reporting and presenting before the authorities are manipulated to misrepresent and under-disclose income, thereby generating unaccounted, undeclared, and unreported income that amounts to black money.

4. Tax evasion involves misreporting or non-reporting of the transactions in the books of account. Different kinds of manipulations of financial statements resulting in tax evasion and the generation of black money:

i. Out of Book Transactions

ii. Parallel Books of Accounts

iii. Manipulation of Books of Account

iv. Manipulation of Sales/Receipts/Fees/Income

v. Under-reporting of Production

vi. Manipulation of Expenses (show excessive expenses beyond actually spent)

vii. Bogus bills may be prepared to show inflated expenses (such as purchases or operating costs) in the books

viii. Manipulation of Capital (without evidence to support its source)

ix. Manipulation of Closing Stock (under reporting and/or undervaluation)

x. Manipulation of Capital Expenses (inflating the cost of Capital expenditure and getting back excess amount in “Cash”)

Generation of Black money in Some Vulnerable Sections of the Economy (real estate, the bullion and jewellery market, financial markets such as private money lending, public procurement through government tendering process, non-profit organizations-NGOs, Trusts or Religious Charities)

Land and Real Estate Transactions: Due to rising prices of real estate, the tax incidence applicable on real estate transactions in the form of stamp duty (earlier 13-15% currently 5-9%) and capital gains tax (@ 20% on entire gain in 1 year but people don’t factor in that Income Tax allows Indexation benefits to increase their cost to adjust for inflation) can create incentives for tax evasion through under-reporting of transaction price. This can lead to both generation and investment of black money. The buyer has the option of investing his black money by paying cash in addition to the documented sale consideration (this is feasible where Market prices are much more than Reconer/Circle Rate valuation). This also leads to generation of black money in the hands of the recipient. A more sophisticated form occasionally resorted to consists of cash for the purchase of transferable development rights (TDR) or “Pagdi” property.

Bullion and Jewellery Transactions: Cash sales in the gold and jewellery trade are quite common and serve two purposes. The purchase allows the buyer the option of converting black money into gold and bullion, while it gives the trader the option of keeping his unaccounted wealth in the form of stock, not disclosed in the books or valued at less than market price.

Financial markets: People having cash money could give loans to other needy person and charge exorbitant interest. Normally Interest rate should be 6% higher than what is charged by Banks but they charge much higher interest rates (like 50-90% p.a.) and carryout private money landing activities (which is regulated by state governments). Many people also carryout such money lending activities from their personal bank accounts with their accumulated wealth, and instead of investing in Bank FD they carryout Private money lending activities. “Ponzi” schemes, which pay out returns from other investors’ contributions rather than from actual profits, are not new but campaigners say the problem is worsened in India by fraudsters patronized by politicians. A case in point is Ponzi schemes in West Bengal and famous case of Sahara currently in Supreme Court. Similarly there have been issues with “Chit” Funds, Vishi/Bishi schemes run amongst known trade or family circles where in the operator organises 20 people and each contribute monthly amount and either highest bidder or winner by lottery would receive the monthly contributions.

Public Procurement: Public procurement is particularly susceptible to corruption such as collusion to fix prices, maintenance of cartels, and other practices that thwart competition and mean that government does not receive value for money in the procurement process. Classic example was 2G auction case wherein many large players played tricks to get spectrum at very cheap price which got cancelled when Supreme Court cancelled the auction. At micro level, most known cases are in procurement of materials by PWD departments where in Suppliers charge higher prices and Contractor under utilises materials causing civil works to deteriorate in few years.

Non-profit Sector (NGOs) -NGOs, Trusts or Religious Charities

Non- government organizations or NGOs are the organizations that work independent of any government and whose purpose is to address the social or political issues. Data has revealed that there is 1 NGO per 600 people in our country.

NGOs have create enough of a stink to taint the rest of the much-vaunted 'Third Sector', says a government-funded body, CAPRAT. Many NGOs receive funding from various Governments (State, Central & local) to implement their public welfare schemes and they submit manipulated documents to satisfy government audits. This has nexus between politicians, political workers, bureaucrats and audits. Former PM Rajiv Gandhi once said that on 15% of government money reaches beneficiaries. Many notable activists have called for NGOs and voluntary agencies to admit that there are skeletons in their cupboards.

Various religious and educational trusts have accumulated crores over the years instead of spending this amount on charitable purposes for which they had sought permission to set up. These donations were received as part of their activities from many sources, which are in the guise of Hawala or bribe or black money and shown as donations received. These Trusts are exempted from taxes. In India, most of politicians and high ranking bureaucrats have their own Trusts to receive money. To curb such practices, the government has already tightened tax rules for trusts. Most anomalies have been found in private unaided educational institutions and religious trusts, especially unregulated ones and many states such as Maharashtra & Karnataka have such Trusts running educational institutions controlled by prominent politicians having reached to power center at Delhi. Many religious Trusts used to show cash donation as part of “Hundi” (cash collection boxes) but government have now put restrictions on cash donations in excess of Rs.2,000/- but it’s difficult to track “Cash & Precious metals” donors in boxes as they are anonymous.

How black sheep launder money via trusts: Let us suppose, a person donates Rs 1 crore black money to a charitable trust that runs an educational institution and the trust uses this money to buy a luxury car in its own name, at least on paper, and hands it over to the donor for his personal use. This is an easy way of tax-free money laundering. Similarly, a religious trust may provide commercial space to the donor on rent without mentioning it in its account books. In some cases, a huge rent business flourished around famous religious places. Trusts charge rent from hotels, but these are treated as donations for tax purposes. In some cases, the dark horse who donated (funded) to get a charitable building constructed is also collecting the rent in cash without showing it in the books of the trust.

Informal Sector & Cash Economy- India’s economy includes a large, cash-dependent informal sector. Cash Economy is not “Black Money” but earnings from Cash economy beyond threshold level would be black money. The informal sector and its workers plus the informal workers in the formal sector constitute the informal economy. In many cases, unlike the formal economy, activities of the informal economy are not included in a country's gross national product (GNP) or gross domestic product (GDP).Even though, Informal or Cash Economy constitutes a large chunk of Indian Economy, Black Money component would be spread amongst huge chunk of population and thus it may not have substantial amount of Black Money escaping tax net and thus minimal Black Money. Remember Individuals are entitled to Basic taxation up to Rs.5 lakh every year and income of most of these people would be below that thrash hold limits. This sector has impact on GDP calculation to certain extent, particularly value added portion of Goods & Services.

Informal Sector: The unorganized sector consists of all unincorporated private enterprises owned by individuals or households engaged in the sale and production of goods and services operated on a proprietary or partnership basis and with less than 10-20 (labor laws not applicable with employees>20) workers.

Sectors: Textile & garments, Neighborhood convenient shops, MSME & SME Units, Fruits & vegetable shops, Pan & Cigarettes, Small vendors, Traders, Wholesalers, Services like Barber, beauty salons, Shoe shops, small food stalls, Private Financing etc.

The other segment is the informal economy consisting of small self-employed traders and business people, and casual workers in the informal or formal sectors. Some individuals may have built up sufficient assets over time to set up small businesses and hence enter the formal sector.

The informal sector consists of enterprises which are labour-intensive. Low-skilled labourers who are desperate enough to work for miserly wages in order to meet their subsistence requirements largely constitute the labour force of unorganised economic activities. Since unorganised firms operate outside of the jurisdiction of corporate law, workers in their employ are assured of neither job-security nor social protection or any other benefits that they are entitled to. Owing to the nation’s mammoth population, an oversupply of menial labour is paving the way for easy exploitation on the part of unconscionable entrepreneurs.

The informal economy is a very important sector of the Indian economy. The National Council of Applied Economic Research estimates that the informal sector-“unorganized sector”-generates about 62% of GDP, 50% of national savings and 40% of national exports (ILO 2002), p. 30. In terms of employment, the informal economy provides for about 55% of total employment (International Labour Organisation 2002), p. 142. Urban areas (especially large cities) attract numerous migrants from both the rural areas and from smaller urban towns and cities in the hope of a better life. Informal economy in India still accounts for more than 80 %of non-agricultural employment. Informality is found in both the traditional informal economy and increasingly through the growth of informality in the formal sector. Informality also has a gender bias. Women are somewhat more likely to be engaged in the informal economy.

Labeled ‘unorganised’, it is far from disorganized: It is organised through business associations, unions and the identities of caste, ethnicity, religion and gender. The founding fathers thought these distinctions would gradually disappear but over time they have mutated and actually strengthened. Some sectors and regions are also ordered through mafia clans. Although almost every citizen of India knows how it works, mentioning this pervasive informality is taboo in the world of policy-makers.

How Government tackles Informal Economy?

1. Demonetisation, the first shock: All enterprises in Informal sectors deal mainly in cash and were caught unaware when Demonetisation was announced on 8th November, 2016. They all rushed to deposit old currency notes and they had to submit their PAN and this all of them were captured in income tax data and were tracked for high volume of cash deposited (beyond Rs.2.5 lakh)

2. The GST blow along with process of eWay Bill: GST’s introduction brought concept of input tax credit whereby the buyer would be entitled to get credits for the taxes they pay. Enterprises in Informal sector without registration will lose out as buyers will avoid them unless the difference is much bigger. This problem was further compounded with later introduction of eWay Bill whereby the vehicle (Truck, Tempo, and courier) carrying the movement of goods from seller to buyer would have to generate eWay bill in GST System thus it became necessary to seek registration and be part of formal economy. GST also introduced valuation system to tackle under invoicing

3. PAN mandatory for many high value transactions. Income tax has mandated that many transactions would require PAN Number before the transaction is carried out.

4. Reporting of high value transactions to Income tax by Banks & enterprises. Many high value transactions have to be reported to Income Tax via annual return by most enterprises. An example is Property transaction above Rs. 50 lakh requires TDS @ 1% (higher TDS @ 5% without PAN @ 20% for NRIs) and Tax Dept. actively tracks sellers for filing tax returns and buyers for their source of investments. Most trade transactions (buying & selling) are now covered by TDS and they are to be reported to Tax Dept.

5. Property valuation: All properties now have government valuation known as Reconer/circle rate and any transaction below that are not allowed to be registered. Sub-Registrar also provides this data about buyers & sellers to Tax Dept.

6. Money Laundering Law has been strengthened along with Benami Transactions law to track Investment in property by Politicians, bureaucrats and industrialists to verify whether the person holding high value properties have known source of income

Tax havens offer a very liberal regulatory environment and allow opaque existence, where an entity can easily be set up without indulging in any meaningful commercial activity and yet claim to be a genuine business unit, merely by getting itself incorporated or registered in that jurisdiction. This makes them highly desirable locations for multinational entities wishing to reduce their global tax liabilities. These multinational entities consisting of a network of several corporate and non-corporate bodies may set up conduit companies in tax havens and artificially transfer their income to such conduit companies in view of the low tax regime there.

Transfer Pricing: Transfer pricing refers to the prices of goods and services that are exchanged between companies under common control. For example, if a subsidiary company sells goods or renders services to its holding company or a sister company, the price charged is referred to as the transfer price. Transfer pricing strategies offer many advantages for a company from a taxation perspective, although regulatory authorities often frown upon manipulation of transfer prices to avoid taxes. Effective but legal transfer pricing takes advantage of different tax regimes in different countries by raising transfer prices for goods and services produced in countries with lower tax rates. In some cases, companies even lower their expenditure on interrelated transactions by avoiding tariffs on goods and services exchanged internationally

Benefits of Transfer Pricing: Transfer pricing helps in reducing duty costs by shipping goods into countries with high tariff rates by using low transfer prices so that the duty base of such transactions is lowered. Reducing income and corporate taxes in high tax countries by overpricing goods that are transferred to countries with lower tax rates help companies obtain higher profit margins.

How multinationals continue to avoid paying hundreds of billions of dollars in tax?

Tax havens have become a defining feature of the global financial system. Multinational companies can use various schemes to avoid paying taxes in countries where they make vast revenues. In this countries with a higher share of FDI from tax havens report profits that are systematically and significantly lower, suggesting these profits have been shifted to tax havens before being reported in high-tax countries. There are 3 main channels that multinationals can use to shift profits out of high-tax countries: debt shifting, registering intangible assets such as copyright or trademarks in tax havens, and a technique known as “strategic transfer pricing”.

To see how these channels work, imagine that a multinational is composed of two companies, one located in a high-tax jurisdiction like India (company A) and one located in a low-tax jurisdiction like Bermuda (company B). Company B is a holding company and fully owns company A. While both companies should pay tax on the profit they make in their respective countries, one of the three channels is used to shift profits from the high-tax country (India in our case, with a corporate income tax rate of 30%) to the low-tax country (Bermuda, with a corporate income tax rate of 0%). For every dollar shifted in this way, the multinational avoids paying 30 cents of tax.

Debt-shifting is when company A borrows money (although it does not need to) from company B and pays interest on this loan to company B. The interest payments are a cost to company A and are tax-deductible in India. So they effectively reduce the profit that company a reports in India, while increasing the profit reported in Bermuda.

In the second channel, the multinational transfers its intangible assets (such as trademarks or copyright) to company B, and company A then pays royalties to company B to use these assets. Royalties are a cost to company A and artificially lower its profit, increasing the less-taxed profit of company B.

Strategic transfer pricing, the third channel, can be used when company A trades with company B. To set prices for their trade, most countries currently use what’s called the “arm’s length principle”. This means that prices should be set the same as they would be if two non-associated entities traded with each other.

But, in practice, it is often difficult to determine the arm’s length price and there is considerable space for multinationals to set the price in a way that minimises their overall tax liabilities. Imagine company a manufactures jeans and sells them to company B, which then sells them in shops. If the cost of manufacturing a pair of jeans is US$80 and company A would be willing to sell them to unrelated company C for US$100, they would make US$20 in profit and pay US$6 in tax (at 30%) in India. But if company A sells the jeans to its subsidiary company B for just US$81, it only makes US$1 in profit and so pays US$0.3 in tax in India. Company B then sells the jeans to unrelated company C for US$100, making US$19 in profit, but not paying any tax, since there is no corporate income tax in Bermuda. Using this scheme, the multinational evades paying US$5.7 in tax in India for every pair of jeans sold.

Offshore Financial Centres: Some of the old tax havens have adopted the more benign designation of ‘offshore financial centre’ (OFC) and tend to describe themselves as financial centres specializing in non-residential financial transactions. However, with their array of secrecy provisions that lack regulation, the zero or near zero taxation imposed by them, and lack of adequate capital controls, they are logical extensions of the traditional tax havens.

The illicit money transferred outside India may come back to India through various methods such as Hawala, mispricing, foreign direct investment (FDI) through beneficial tax jurisdictions, raising of capital by Indian companies through global depository receipts (GDRs), and investment in Indian stock markets through participatory notes. Manipulation could be by Way of International Transactions through Associate Enterprises, external trade, international transactions involving tax havens, and the informal service sector.

Estimates of Black Money Generated in India

A secret study commissioned by the Finance Ministry concluded in 2014 that about 90 % of unaccounted wealth, or black money, was lying within India and not outside. This report was among the inputs that likely prompted the Narendra Modi government to go ahead with its November 2016 decision of invalidating, or ‘demonetising’, around 85 % the currency in circulation.

The said “secret” government report, is actually assimilation of studies conducted by three premier economic Institutions. This report on black money was ready by December 2014 but its existence had been kept under wraps. The three Institutes, which made the report on black money, are: (i) The National Institute for Public Finance and Policy (NIPFP) – concluded that between 1997 and 2009 the flow of illicit money out of the country was 0.2 % to 7.4 % of India’s Gross Domestic Product (GDP). (ii) The National Council of Applied Economic Research (NCAER) – concluded that the total amount of illicit wealth or black money, accumulated outside India between the years 1980 and 2010 was in the range of $384 billion (approximately Rs. 27 lakh crore at the exchange rate) to $490 billion. The NCAER also concluded that it would be about 2.8 % of the GDP. (iii) National Institute of Financial Management (NIFM) — estimated that the total outflow of black money between 1990 and 2008 was Rs 9,41,837 crore, or $217 billion. The NIFM’s estimation was based on the then-current values. It said that the black money lying outside India amounted to 10 % of the Indian economy.

The Reserve Bank of India in its annual report confirmed that 99.3 % of the banned notes had returned as against an overwhelming expectation that nearly Rs. 3-4 lakh crore will be extinguished outside the banking system.

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