Ways to Convert Black money into white used by Indians as per Indian Govt White Paper on Black Money
1 Manipulations of Accounts for Tax Evasion
Any transaction entered into by the taxpayer must be reported in books of account which are summarised at the end of the year in the form of financial statements. The financial statements basically comprise statement of income and expenditure which is called by different names such as ‘Profit and Loss Account’ or ‘Income and Expenditure Account’ and statement of assets and liabilities which is called ‘Balance Sheet’ or ‘Statement of Affairs’. 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 are summarised
1.1 Out of Book Transactions: This is one of the simplest and most widely adopted methods of tax evasion and generation of black money. Transactions that may result in taxation of receipts or income are not entered in the books of account by the taxpayer. The taxpayer either does not maintain books of account or maintains two sets or records partial receipts only. This mode is generally prevalent among the small grocery shops, unskilled or semi-skilled service providers, etc.
1.2. Parallel Books of Accounts: This is a practice usually adopted by those who are obliged under the law or due to business needs to maintain books of account. In order to evade reporting activities or the income generated from them, they may resort to maintaining two sets of books of account – one for their own consumption with the objective of managing their business and the other one for the regulatory and tax authorities such as the Income Tax Department, Sales Tax Department, and Excise and Customs Department. The second set of books of account, which is maintained for the purpose of satisfying the legal and regulatory obligations of reporting to different authorities, may be manipulated by omitting receipts or falsely inflating expenses, for the purpose of evading taxes or other regulatory requirements.
1.3 Manipulation of Books of Account: When books of accounts are required to be maintained by taxpayers under different laws, like the Companies Act 1956, the Banking Regulation Act, and the Income Tax Act, it may become difficult for these taxpayers to indulge in out of books transactions or to maintain parallel books of accounts. Such parties may resort to manipulation of the books of accounts to evade taxes.
1.4 Manipulation of Sales/Receipts: A taxpayer is required to pay taxes on profit or income which is the difference between sale proceeds or receipts and expenditure. Thus manipulation of sales or receipts is the easiest method of tax evasion. Other innovative means may include diversion of sales to associated enterprises, which may become more important if such enterprises are located in different tax jurisdictions and thereby may also give rise to issues related to international taxation and transfer pricing.
1.5 In case of use of a dummy / associated entity, there can be a plethora of possible arrangements entered into by such entities to aid generation of black money. In its simplest form, the associate entity may not report its activities or income at all. The main entity may show sales to such a dummy / associate entity at a lower price, thereby reducing its reported profits.
1.6 More complex scenarios can emerge if the dummy/ associated entity is situated in a low tax jurisdiction having very low tax rates. Thus the profit of the Indian entity will be transferred to the low tax jurisdiction and money will be accumulated by the taxpayer in the books of accounts of the entity in the low tax jurisdiction.
1.7 Under-reporting of Production: Manipulation of production figure is another means of artificially reducing tax liability. It may be resorted to for the purpose of evading central excise, sales tax, or income tax.
1.8 Manipulation of Expenses: Since the income on which taxes are payable is arrived at after deducting the expenses of the business from the receipts, manipulation of expenses is a commonly adopted method of tax evasion. The expenses may be manipulated under different heads and result in under-reporting of income. It may involve inflation of expenses, sometimes by obtaining bogus or inflated invoices from the so called ‘bill masters’, who make bogus vouchers and charge nominal commission for this facility.
1.9 Any number of more sophisticated versions of manipulation of expenses can also be resorted to by those intending to generate black money. Sometimes it can also involve ‘hawala’ operators, who operate shell entities in the form of proprietorship firms, partnership firms, companies, and trusts. These operators may accept cheques for payments claimed as expense and return cash after charging some commission. There have been instances of claims of bogus expenses to foreign entities. The payments can be shown to foreign entities in the form of advertisement and marketing expenses or commission for purchases or sales. The funds may be remitted to the account of the foreign taxpayer and the money can either be withdrawn in cash or remitted back to India in the form of non-taxable receipts. Such money may also be accumulated in the form of unaccounted assets of the Indian taxpayer abroad.
1.10 Other Manipulations of Accounts: Besides inflation of purchase / raw material cost, expenses like labour charges, entertainment expenses, and commission can be inflated or falsely booked to reduce profits. In these cases, bogus bills may be prepared to show inflated expenses in the books.
1.11 Manipulation by Way of International Transactions through Associate Enterprises: Another way of manipulating accounted profits and taxes payable thereon may involve using associated enterprises in low tax jurisdictions through which goods or other material may be passed on to the concern. Inter-corporate transactions between these associate enterprises belonging to the same group or owned and controlled by the same set of parties may be arranged and manipulated in a way that leads to evasion of taxes. This can often be achieved by arrangements that shift taxable income to the low tax jurisdictions or tax havens, and may lead to accumulation of black money earned from within India to another country.
1.12 Manipulation of Capital: The statement of affairs or balance sheet of the taxpayer contains details of assets, liabilities, and capital. The capital of the taxpayer is the accumulated wealth which is invested in the form of assets or as working capital of the business. Manipulation of capital can be one of the ways of laundering and introduction of black money in books of accounts.
1.13 Manipulation of Closing Stock: Suppression of closing stock both in terms of quality and value is one of the most common methods of understating profit. More sophisticated versions of such practice may include omission of goods in transit paid for and debited to purchases, or omission of goods sent to the customer for approval. A more common approach is undervaluation of inventory (stock of unsold goods), which means that while the expenses are being accounted for in the books, the value being added is not accounted for, thereby artificially reducing the profits.
1.14 Manipulation of Capital Expenses: Over-invoicing plant and equipment or any capital asset is an approach adopted to claim higher depreciation and thereby reduce the profit of the business. As already stated, increase in capital can also be a means of enabling the businessman to borrow more funds from banks or raise capital from the market. It has been seen that such measures are sometimes resorted to at the time of bringing out a capital issue. At the same time, under-invoiced investments, indicating entry of undeclared wealth, may imply introduction of black money.
2. Converting Black money into white through various sectors of the economy
2.1. 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 and capital gains tax 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 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)1.
2.2 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 convertingblack 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.
2.3 Financial Market Transactions: Financial market transactions can involve black money in different forms. Initial public offers (I POs) offering equity shares to the public at large are also vulnerable to various manipulations that can generate black money for the promoters or operators. Rigging of markets by the market operators is one such means. This may involve use of shell companies and more sophisticated versions of such manipulation may involve offshore companies or investors in foreign tax jurisdictions who invest in shares offered by the IPO and through manipulated trading escalate their price artificially, only to offload them later at the cost of ordinary investors.
2.4 Public Procurement: Public procurement has grown phenomenally over the years – in volume, scale, and variety as well as complexity. It often includes sophisticated and hi-tech items, complex works, and a wide range of services. An OECD (Organisation for Economic Cooperation and Development) estimate puts the figure for public procurement in India at 30 per cent of the GDP whereas a WTO (World Trade Organisation) estimate puts this figure at 20 per cent of the GDP.2 The Competition Commission of India had estimated in a paper that the annual public sector procurement in India would be of the order of Rs. 8 lakh crore while a rough estimation of direct government procurement is between Rs. 2.5 and 3 lakh crore. This puts the total public procurement figure for India at around 10 to 11 lakh crore per year.3
2.5 Non-profit Sector: Taxation laws allow certain privileges and incentives for promoting charitable activities. Misuse of such benefits and manipulations through entities claimed to be constituted for non-profit motive are among possible sources of generation of black money. Such misuse has also been highlighted by the Financial Action Task Force (FATF), an intergovernmental body which develops and promotes policies to protect the global financial system against money laundering and financing of terrorism. A Non-profit Organisation (NPO) Sector Assessment Committee constituted under the Ministry of Finance has reviewed the existing control and legal mechanisms for the NPO sector and suggested various measures for improvement.
2.6 Informal Sector and Cash Economy: The issue of black money is related to the magnitude of cash transactions in the informal economy. The demand for currency is determined by a number of factors such as income, price levels, and opportunity cost of holding currency. Factors like dependence on agriculture, existence of a large informal sector, and insufficient banking infrastructure with large un-banked and under-banked areas contribute to the large cash economy in India.
2.7 External trade and Transfer Pricing: More than 60 per cent4 of global trade is carried out between associated enterprises of multinational enterprises (MNEs). Since allocation of costs and overheads and fixing of price of product/services are highly subjective, MNEs enjoy considerable discretion in allocating costs and prices to particular products/services and geographical jurisdictions. Such discretion enables them to transfer profit/income to no tax or low tax jurisdictions. Differing tax rates in different tax jurisdictions can create perverse incentives for corporations to shift taxable income from jurisdictions with relatively high tax rates to jurisdictions with relatively low tax rates as a means of minimising their tax liability. For example, a foreign parent company could use internal ‘transfer prices’ for overstating the value of goods and services that it exports to its foreign affiliate in order to shift taxable income from the operations of the affiliate in a high tax jurisdiction to its operations in a low-tax jurisdiction. Similarly, the foreign affiliate might understate the value of goods and services that it exports to the parent company in order to shift taxable income from its high tax jurisdiction to the low tax jurisdiction of its parent. Both of these strategies would shift the company’s profits to the low tax jurisdiction and, in so doing; reduce its worldwide tax payments. In this context transfer pricing has emerged as the biggest tool for generation and transfer of black money. In recent years, after the 9/11 incident in the USA due to intense scrutiny of banking transactions, enhanced security checks at airports and ports, and relaxation of exchange controls, transfer of money through hawala has reduced significantly but now transfer pricing is now being extensively used to transfer income/profit and avoid taxes at will across countries. Also, with the relaxation of exchange controls and liberalisation of banking channels, the popularity of the hawala system for legitimate transfers has reduced substantially. The increasing pressure on financial operators and banks to report cash transactions has also helped in curbing hawala transactions. Tax evasion through transfer pricing is largely invisible to the public and difficult and expensive for tax officers to detect. Christianaid5 estimates that developing countries may be losing over US$160billion of tax revenues a year, primarily through transfer pricing strategies.
2.8 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. It is possible that a large amount of money transferred outside India might actually have returned through these means.
2.9 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. It is possible that a large amount of money transferred outside India might actually have returned through these means.
2.10. Trade-based Money Laundering (TBML): The FATF defines TBML as the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt at legitimising their illicit origins. Factors that facilitate such manipulation include the enormous volume of international trade flow, the complexity associated with financing arrangements and currency exchanges as well as limited recourse to verification procedures between countries.
2.11 Tax Havens: The term ‘tax haven’ has been widely used since the 1950s. However, there is no precise definition of the term. The OECD initially defined tax havens as being characterised by no or very low taxes, lack of effective exchange of information, and lack of transparency about substantial activities. It listed 35 countries/ jurisdictions as tax havens in the year 2000. The list has changed over time as more tax havens have made agreements to share information.
2.12 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 IMF has defined OFCs as centers where the bulk of financial sector transactions on both sides of the balance sheet are with individuals or companies that are not residents, where the transactions are initiated elsewhere, and where the majority of the institutions involved are controlled by non-residents. Thus, many OFCs have the following characteristics:
1. Jurisdictions that have financial institutions engaged primarily in business with non-residents;
2. Financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economic; and
3. More popularly, centers which provide some or all of the following opportunities: low or zero taxation; moderate or light financial regulation; banking secrecy and anonymity.
International organizations including the BIS and IMF began to use the term OFC in a more restrictive manner to describe financial services that were evolving in tax haven
2.13 Investment through Innovative Derivative Instruments: With increasing sophistication of derivative instruments, new opportunities for investing and making profits without being subjected to taxes and regulations are also opening up. Such innovative means can also be misused by unscrupulous parties to generate unaccounted income. Some such instruments like participatory notes may not be adequately covered by regulatory mechanisms and their oversight and hence have potential for misuse.
Editorial Note by Tax Heal :-
Since all the above methods were used to convert Black money into White therefore Govt of India declared on 08.11.2016 that old Bank Note of Rs 500 and Rs 1000 will be banned i.e they will not be legal tender. Listen to PM’s address to Nation on Black Money (Hindi) -Bank Note Rs 500 and 1000 Ban 08.11.2016 , PM’s address to Nation on Black Money (English) 08.11.2016
Effect of this withdrawal of old bank notes will be that Now it will not be possible to convert black money into white becase of stringent exchange rules / guidlines by Govt of India for Exchange /Withdrawal , Deposit and Payment of using Old Rs 500 and Rs 1000 Bank Notes . Read Rs 500 and 1000 exchange rules, Withdrawal & Payment limits summary
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