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Proliferation of Black (Dirty) Money

R. Sudarshan Bala 
on 07 January 2013

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THE EVIL MOTIVE:

From the olden days where the barter system prevailed till the phenomenal phase of technology today, from small traders and merchants to the CEO’s of vast business empires, there has always been a very strong urge to earn profits. Well, this situation can be traced back to World War II. The World War II period was one of the main causes of black money generation because during this period the British Government cut out supplies of industrial goods from foreign countries. So there was a heavy shortage of goods in important product lines. This in turn sharply raised the prices of goods. Also, tax rates were raised on high income and excess profits giving an opportunity to high net worth (income) individuals to evade taxes. This also enabled businessmen to sell goods which were supply deficient in the black market for exorbitant profits. So this became a practice in the future years and has shaken the economy till today and will continue unless the Government comes out with an aggressive action plan to curb black money.

What is Black/Dirty Money?

The money that is generated in the black market and which has partly or fully escaped assessment is termed as Black money. In simpler terms, it means money that is not taxed. The circulation of black money is what is referred to as “parallel economy” or “unaccounted economy” or “unsanctioned economy” or “underground economy”.

Sources of Black money:

The sources of generation of black money could possibly be from impermissible/illegal activities like –

a. Drug/Arms Trafficking

b. Smuggling

c. Prostitution

d. Terrorism

e. Bribery and kickbacks

f. Hawala trade arrangements (i.e., with hawala brokers who transfer funds through the informal banking system only on payment of some commission)

g. Counterfeiting currency

h. Organised Crime (organisations run by criminals for monetary profit)

There could also be other sources like illicit funds floated in India transferred from foreign countries (say, it could happen through foreign direct investment). Also in India, there is a lot of corruption in the public offices itself as apart from their salary they might indulge in “under-the-table-transactions” to earn money which is clearly a source of dirty money.

The Twin Evil: Tax Evasion & Black money:

Generally, black money is generated in two ways –

a. One, money which is generated through illegitimate means such as drug trafficking, smuggling, running brothels, etc.

b. Second, money which is generated through legitimate activities but is not reported and paid to the public exchequer.

The second way of generation is more rampant and would most likely account for the increased accumulation of the black wealth in our economy. Also, in India the tax laws are quite complex to understand compared to the tax laws of other countries. Similarly, the tax rates in India are the highest compared to the rates applicable in other countries. So, our tax culture is such that it imposes a higher burden on assesses which could be the prime reason for their evasion.

As per the “White paper on Black Money” released by Pranab Mukherjee, black money can be generated in 2 ways. One, by manipulating the books of accounts of the taxpayer and second, it can be generated in the vulnerable sections of society. The two ways are briefly explained as follows: 

Black money using accounting manipulations/malpractices:    

Over the years there has been a substantial increase in accounting and auditing standards and very strict disclosure requirements. Sincere efforts were put and are still being put to refine accounting practices and adopt a common practice which is in tandem with global standards. Some of the efforts like convergence of Indian accounting standards into International Financial Reporting Standards (IFRS), Ind AS and also Schedule VI (Revised), etc., are being applied so as to enable more uniformity and transparency in financial reporting. Also, especially after the 1991 reforms on liberalisation privatisation and globalisation (LPG) which allowed greater discretion to companies for expanding their operations and with the removal of trade barriers, businessmen, in order to enable their business grow went to any extent to portray colourful financials to the users of financial statements. Thus they indulged in all sorts of illegal activities and applied a wide range of accounting gimmicks and window-dressing techniques to evade tax and deceive investors. This was due to 2 reasons. One, due to their inability to adopt to the complex accounting laws and second, lack of proper knowledge on reporting requirements on the part of the management thereby leading to poor financial management and with the ever growing urge to make money forced them to cover up their frauds and finally could burst into a corporate scandal (like Enron and Satyam), the worst outcome being liquidation. So here are some of the methods employed by entities which could be used as deceiving instruments to smudge figures:

1. Omission of transactions from the books of accounts which are subject to taxation.

2. Maintaining parallel books of account by taxpayer using one of them for his personal purposes and the other for business purposes.

3. Manipulating sales/other receipts by diverting them to dummy entities (like how Enron created false entities to evade tax.)

4. Manipulating expenses by exaggerating true business expenditures like depreciation to reduce tax.

5. Other manipulations like falsely inflating miscellaneous expenses like entertainment, travelling, etc., to reduce tax.

6. Manipulation of Capital – Capital represents the net owned funds of the company and quibbling with balance sheet figures (like shares issued with heavy premium) to show a healthy position can be a way of money laundering.

7. Through International transactions - diverting goods to associated enterprises situated in lower tax jurisdictions thereby manipulating profits and taxes.

8. Manipulating stock by under valuing them so as reduce the gross profit and thereby taxes.

9. Under – invoicing of receipts by raising a bill for a lower amount and receiving the balance amount through other means enabling a part of it to fall outside the tax net.

Black money generated in the vulnerable sections of the society:

It is very difficult to chase dirty money in India as it is hugely populated and if we try so will end up in a “wild goose chase”. But we can surely point at some industries (sections) in our economy which is very vulnerable to excessive circulation of black money. They are explained briefly as follows:

Real Estate:

This industry produces a lot of black money which could be due to reasons like growing transaction costs (like registration charges), heavy paperwork, long approval process (faster approval is possible only through bribery), etc. This tempts buyers and sellers to evade stamp duty and capital gains tax respectively. India is ranking 94th among other countries for its black money circulation in the real estate industry.   

Jewellery and Bullion:

A cash – and – carry business like jewellery gives a lot of room for manipulation.  There is a huge amount of black money which is being generated as persons with large accumulated black wealth can convert them into gold while traders could keep them as unaccounted stock or undervalued stock to reduce taxes.

Public Procurement:

The industry is on the growth path and as per the recent statistics is growing at 10-11 lakh crore per year and with increasing supplier malpractices and defective pricing it gives a lot of room for creation of black money.

Financial Markets:

The industry is highly vulnerable to black money circulation as it is experiencing  malpractices like price rigging (manipulating prices of securities to attract investors), wash trade, bear raid, etc. Malpractices can also take place during major fund raising activities like Initial Public Offering (IPO), etc.

Non profit organisations:

The Indian taxation laws specify a good amount of privileges and exemptions to charitable institutions and trusts. So, such benefits given to them may be misused or funds could be misappropriated to some activity not specified in the Charter of the institution/trust to make unwarranted profits. Also, the profits might not be invested for promoting the business objects of the company.

Unorganised sector and Cash economy:

This sector is considered as the driver of economic growth. It is agriculture dependent and it consists of a wide range of people like fruit vendors, cobblers, handloom weavers, barbers, carpenters, auto drivers, workers in oil mills, etc. This sector is very complex and faces a lot of economic dynamism. As millions of transactions take place in this sector and cash, being the mode of payment it is subject to grave risks of circulation of black money.

Black money generation in international transactions through clandestine channels and creation of Tax Havens:

“The law of transfer pricing defines ‘International Transactions’ as any transaction between two or more associated enterprises situated in different countries in terms of a property that is tangible or intangible, a service offered by the company, or any form of lending money, etc.” So multinational companies having associated enterprises spread across varied geographies could their divert earnings (profits) to the said associated enterprises situated in no or low tax jurisdictions to evade tax thereby adding to the black wealth of our economy. Also this erodes the income tax base of our country. The Government are taking sustained efforts to strengthen governance by broadening the transfer pricing code so as to avoid more and more money getting deposited in foreign tax havens (countries which have no or very low tax) and to ensure that cross – border transactions do not escape assessment.

The Indian transfer pricing provisions require that either or both of the associated enterprises should be a non – resident. But the Finance Bill, 2012 has extended the scope of transfer pricing regulations to include transactions with domestic entities also (applicable from A.Y.2013-2014).

Therefore, black money generated in this way causes huge revenue loss to the government and with emerging MNC’s in India and varied cross – border dealings, the government must come out with very stringent laws by entering into more tax treaties with different countries (tax havens like Bermudas, Bahamas, Switzerland, etc) to avoid any mispricing of transfers.

Current Status of Black money in India:

India, no doubt is one of the most corrupted economies in the world. Some facts about India as per some recent statistics are:

a. India ranks 8th among 150 other countries which have the highest amount of black wealth accumulated in them.

b. India is one of largest depositors of illicit money in offshore tax havens and developed country banks with a total deposit of $500 billion.

c. As per the recent stats given by Swiss Bank the quantum of bank deposits held by Indians in their names and in their benami names in Swiss bank was around 12,740 crore at the end of 2011 which is around 13 times larger than our country’s foreign debt.

d. Also, as per the Global Financial Integrity (GFI) report, “the present value of illicit assets held abroad account for around 72% of India’s underground economy ($462 billion) and which has estimated to be around 50% of India’s GDP (Total value -  $640 billion.)”

The status of black money in India is quite alarming as it tops the list in almost all the black money reports issued by banks. If this much money is deposited in just one tax haven, imagine how much would be deposited in the rest of the world!

Conclusion:

The urge to make more profits never stops which is the main reason why people are tempted to commit fraud. The generation of black money is a very major issue as it involves public money which should be kept safe and must not be allowed to launder. It could take some years to even trace out the countries in which India’s black money is floated. The government, no doubt is taking sustained efforts to fight against the corrupt economic structure. But only with extensive refinement of various laws (especially laws applicable to vulnerable sections of society) coupled with strong anti – corruption strategies and anti money laundering regulations it is possible for India to show any signs of improvement from the current scenario. This would instill more discipline and governance in the overall economic structure enabling India to elevate its status to a ‘developed’ country.

WRITTEN BY:

R. SUDARSHAN BALA (CA IPCC)




Category Income Tax
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R. Sudarshan Bala 

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