Issue of Black Money in India

MAY 3

Mains   > Security   >   Money laundering   >   Black money

WHY IN NEWS:

  • Central Board of Direct Taxes (CBDT) has launched an automated dedicated e-portal on the e-filing website to receive and process complaints of tax evasion, foreign undisclosed assets as well as complaints regarding benami properties

WHAT IS BLACK MONEY?

  • There is no official definition of black money in economic theory
  • The simplest definition of black money could possibly be money that is hidden from tax authorities
  • Black money can come from two broad categories:
    • Money earned through Illegal activity
      • Money that is earned through illegal activity such as smuggling, kidnapping etc. is obviously not reported to the tax authorities, and so is black
    • Legal but unreported activity:
      • For example, let us assume that a piece of land is sold, with the payment made in the proportion of 60% by cheque or electronic transfer, and 40% in cash.
      • If that 40% cash component is not reported to the Income Tax Department, then it is black money

SOURCES OF BLACK MONEY

  • Following are some of the mechanisms through which black money is circulated, utilized and the profits earned are further invested in other sectors to generate further money.
  • Real estate:
    • Due to rising prices of real estate, the tax incidence applicable on real estate transactions in the form of stamp duty and capital gains tax can create incentives for tax evasion through under-reporting of transaction price.
  • Bullion and jewellery market:
    • 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 transactions:
    • IPO manipulations, rigging of market such as use of shell companies.
  • Public procurement:
    • Public procurement has grown phenomenally over the years >> and it provides ample scope of corruption due to rigged procurement process.
  • Non-profit organizations:
    • Taxation laws allow certain privileges and incentives for promoting charitable activities which are misused and manipulated.
  • Informal Sector and Cash Economy:
    • Cash transactions, large un-banked and under-banked areas contribute to the large cash economy in India.
  • External trade and transfer pricing:
    • Transfer profit or income to no tax or low tax jurisdictions by MNCs.
    • Developing countries may be losing over US$160billion of tax revenues a year, primarily through transfer pricing strategies.
  • Trade-based Money Laundering (TBML):
    • Disguising the proceeds of crime and moving value through the use of trade transactions in an attempt at legitimizing their illicit origins.
  • Hawala:
    • It is an informal and cheap method of transferring money from one place without using banks etc.
    • It operates on codes and contacts and no paperwork and disclosure is required.
  • Investment through Innovative Derivative Instruments:
    • such as Participatory Notes
  • Tax havens:
    • Tax havens are typically small countries/ jurisdictions, with low or nil taxation for foreigners who decide to come and settle there.
    • Strong confidentiality, very liberal regulatory environment >>  makes them highly desirable locations for multinational entities wishing to reduce their global tax liabilities

IMPACT OF BLACK MONEY

  • Threat to financial sector for the country:
    • Higher volumes of black money activities erode depositors and creditors' confidence as the frauds result in mistrust and loss of reputation
  • Data gaps:
    • Rise of parallel economy will lead to underestimation of GDP >> ill-focused economic policy
  • Affect welfare expenditures:
    • Tax evasion leads to reduced tax collections and reduced fiscal capacity of government >> This adversely impacts developmental and welfare expenditures reduced economic growth + increased poverty.
  • Diversion of resource to unproductive sectors:
    • Higher prevalence of black money incentivizes diversion of productive resources to sterile investments such as real estate, gold, jewelry. Thus, distorting saving and investment pattern.
  • Liquidity issues:
    • Laundered funds are unstable source of funding and a sudden withdrawal causes liquidity problems
  • Reduce economic growth:
    • Increase in conspicuous consumption >> increase in inflation >> increase in interest rate >> high cost of borrowing >> lower investment decreased economic growth.
  • Erode entrepreneurial spirit:
    • Black money threatens financial stability of legitimate businesses that cannot compete with lower priced goods and services that businesses with laundered funds can offer. Thus, undermines free enterprise.
  • Burden on government machinery:
    • Combating tax evasion and money laundering requires expenditure on tax administration, audit, prosecution, putting a pressure on already limited government revenues.
  • Social effects
    • Tax evasion leads to redistribution of income from the honest to dishonest leading to breach of horizontal and vertical equity between members of the society.
  • Political consequences
    • Tax evasion >> Non- achievement of the state's fiscal target >> voter's dissatisfaction >> political instability.
  • Corruption
    • Bribery becomes rampant at all levels
    • eg politicians, bureaucrats, accountants, financial institution, corporates >> crony capitalism + money power in election >> impacts the democratic fabric.
  • Threat to national security
    • Undisclosed money flow in economy may be used to finance criminal or terrorist activities.
    • Organized crime syndicates may infiltrate large financial institutions and acquire control over large enterprises/sectors through investment of the laundered money.
  • Threat to external sector
    • Large scale movement of illegal funds from one jurisdiction to another ('capital flights') may create exchange rate volatility
    • For example: Round tripping from Mauritius led to Rupee appreciation, making Indian exports less competitive, globally.
  • Decrease in country's reputation
    • Reputation as money laundering haven may lead to loss of international trust, and reduced access to world market and financing to legitimate businesses

STEPS TAKEN

  • Preventive measures
    • Rationalization of taxes:
      • Measures for expansion of tax base and lowering of tax rates.
      • Introduction of Goods and Service Tax (GST)
      • Reduction of corporate tax rate
    • Policy measures for improving tax compliance:
      • GAAR (General Anti-avoidance rule):
        • To check aggressive tax planning/treaty abuse
      • DTAA amendments with Singapore, South Korea, Cyprus, Mauritius
        • To enable levy of taxes in the country where income is generated rather than the country of residence of the company.
        • Included 'Limitation of Benefit' clause >> Deters treaty abuse and limits benefits to residents of two countries only
      • Advance Pricing Agreements (APA)
        • Agreement between tax payer and tax authority on an appropriate transfer pricing methodology over a fixed period.
      • Project Insight
        • ICT based initiative for strengthening non-intrusive, information driven approach for improving tax compliance.
      • Base Erosion and Profit shifting
        • BEPS-G20 initiative to ensure that profits are taxed where economic activities are performed and where value is created.
      • Place of Effective management (PoEM)
        • Income Tax Act was modified to provide that if 'place of effective management' of a company is in India, it will be considered 'resident' of India and taxed accordingly.
    • Promotion of digital economy:
      • Waiver of Merchant Discount Rate (MDR) on card transactions
      • Introduction of new modes of digital payments such as UPI, Bharat Bill Payment System (BBPS) etc.
      • Dis-incentivizing cash transactions >> through Imposition of 2% tax on cash withdrawal of over 1 crore from a bank account
      • Schemes such as ‘Lucky Grahak Yojana’ and ‘Digi Dhan Vyapar Yojana’ >> to give cash awards to consumers and merchants who utilize digital payment instruments
  • Punitive measures:
    • Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015
      • To specifically deal with black money stashed away abroad.
    • Amendment to Prevention of Money Laundering Act 2002
      • The Act aims to prevent money-laundering and to provide for confiscation of property derived from money-laundering
      • It is amended in 2019 to enable confiscation of property equivalent in value held within the country where proceeds of crime is taken/held outside the country
    • Benami Transactions (Prohibition) Amendment Act, 2016
      • Enable confiscation of Benami property and prosecution of benamidar and the beneficial owner.
    • The Foreign Exchange Management Act, 2000, (FEMA):
      • Facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India
    • The Smugglers and Foreign Exchange Manipulators Act, 1976 (SAFEMA)
    • The Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPSA)
  • Institutional measures:
    • Economic Intelligence Council (EIC)
      • Apex forum, chaired by Union Minister of Finance, responsible for oversight on government agencies responsible for economic intelligence and combating economic offences in India.
    • Financial Intelligence Unit (FIU)
      • FIU is an independent body reporting directly to the Economic Intelligence Council
      • It is responsible for analyzing and disseminating information relating to suspect financial transactions.
      • It coordinates efforts of national and international intelligence, investigation and enforcement agencies against money laundering and terrorist financing.
    • Enforcement Directorate (ED)
      • It is responsible for enforcement of 2 key acts: Foreign Exchange Management Act 1999 (FEMA) and some provision of the Prevention of Money Laundering Act 2002 (PMLA)
    • Directorate of Revenue Intelligence (DRI)
      • It is an apex anti-smuggling agency of India.
      • It enforces the prohibition of the smuggling of items (drugs, gold, diamonds, electronics, foreign currency, and counterfeit Indian currency
    • National Investigation Agency (NIA)
      • Statutory body formed in 2008 under the NIA Act to combat terror in India.
      • Terror Funding and Fake Currency Cell set up in the NIA to investigate Terror Funding cases.
    • Serious Fraud Investigation Office (SFIO)
      • Probes corporate frauds (including shell companies) in coordination with IT Dept. / CBI
    • Setting up Income Tax Overseas units
      • To unearth black money in Mauritius, Singapore etc.
  • International initiatives:
    • United Nations Convention against Transnational Organized Crime:
      • The Convention urges State Parties to cooperate with one another in the detection, investigation and prosecution of money laundering
      • Parties are also recommended to set up financial intelligence units to collect, analyse and disseminate information
    • Financial Acton Task Force (FATF)
      • It is the global money laundering and terrorist financing watchdog.
      • India has complied with all FATF requirements and Action Plan items.
    • Convention on Mutual Administrative Assistance in Tax Matters
      • It is a convention to facilitate the entering into bilateral tax information exchange agreements between state parties
      • Convention was developed by the OECD and the Council of Europe
      • India ratified the treaty
    • Section 94A inserted in Income Tax Act
      • To black list country as non-cooperating if there is lack of effective exchange of information.
      • Ex: Cyprus was black listed in 2013 and removed last year.
  • Other initiatives:
    • Constitution of SIT on Black Money in 2014
    • Constitution of Multi-Agency Group (MAG)
      • Consisting of officers of CBDT, RBI, Enforcement Directorate (ED) and Financial Intelligence Unit (FIU) to probe Panama papers leak.
    • Income declaration Scheme
      • A window to violators to come clean by paying taxes, cess, and penalty amounting to 45% of total undisclosed income.
    • Demonetisation:
      • It was the biggest blow to black money hoarders across the country.
    • Linking bank accounts with Aadhaar and PAN:
      • Huge success in getting hold of fake or Ghost accounts and tracking big and suspicious transactions.
    • Operation clean Money:
      • Using information on cash transactions & data analytics tools for e-verification of suspect cases.
    • Tightening norms on Participatory Notes by SEBI

WAY FORWARD:

  • Electoral reforms:
    • Elections are one of the biggest channel to utilize the black money. Appropriate reforms to reduce money power in elections.
  • Encourage a shift to a digital economy:
    • This will create an electronic trail for transactions >> which will helps in bringing transparency into the financial transactions of individuals and organizations thereby constraining corruption, criminal proceeds, money laundering etc.
  • Focus must be on prevention of black money generation
    • Because once generated, money is quickly laundered away to become untraceable.
  • Imparting skills to personnel for effective action:
    • Both domestic and international training pertaining to the concerned area.
    • For instance, Financial Intelligence Unit-India makes proactive efforts to regularly upgrade the skills of its employees by providing them opportunities for training on anti-money laundering, terrorist financing, and related economic issues
  • Strict enforcement of tax and other laws
    • Loopholes in tax subsidies and grants to be checked corrected.
  • Robust surveillance system
    • To curb round tripping through shell companies.

PRACTICE QUESTION:

Q. Analyze the adverse impact posed by the unaccounted money in Indian economy?