1

Black Money

A Black Hole In Indian Economy

By Ajit Abhyankar and Shinzani Jain

 2

INTRODUCTION 5

CHAPTER I 10

UNDERSTANDING THE PROBLEMATIC OF BLACK MONEY 10

DEFINING BLACK MONEY: 10

BLACK ECONOMY: 13
BLACK ECONOMY – A REALITY OR METAPHOR? 13
PERPETUATORS OF BLACK MONEY: 15
BLACK ECONOMY INTERWOVEN WITH WHITE ECONOMY: 16
SOCIAL-INSTITUTIONAL FRAMEWORK LEADING TO PERPETUATION OF BLACK MONEY: 17
CHAPTER II 22

METHODS OF GENERATION OF BLACK MONEY 22

CHAPTER III 39

BLACK MONEY: HISTORICAL, POLITICAL AND ECONOMIC PERSPECTIVE 39

AT THE DAWN OF INDEPENDENCE - PHASE I (1947-51) 39

CORRUPTION CREEPS IN WITH A SHADOW ECONOMY - PHASE II (1951-65) 40
WIDENING GAP BETWEEN WORDS AND DEEDS - PHASE III (1966-90) 41
BLACK HOLE IN THE OPEN SPACE OF LIBERALIZATION - PHASE IV (1992-2008) 42
CHAPTER IV 44

BLACK MONEY: AN EFFECT OF MYOPIA IN TAXATION 44

INTO THE TRAP OF LOW TAXES AND HIGH BORROWINGS 45

FRBM ACT PERPETUATES THE SAME MYOPIA 46
IS INDIA OVER-TAXED? 48
CHAPTER V 70

THERE AND BACK AGAIN 70

WHY DOUBLE TAXATION AVOIDANCE AGREEMENT? 70

WHAT IS A DOUBLE TAXATION AVOIDANCE AGREEMENT? 72
THE SECRET ENGAGEMENT BETWEEN INDIA AND MAURITIUS: 76
IMPLICATIONS OF TAX LAWS AND PRACTICES IN MAURITIUS: 78
ROUND TRIPPING: 82
TREATY SHOPPING: 85
 3

USE OF PNS: 85
RECENT DEVELOPMENTS ON PNS: 88
WHAT MAKES INDO-MAURITIUS DTAA MORE ATTRACTIVE? 89
WHERE DOES THE ROUND TRIPPED BLACK MONEY GO? 92
CHAPTER VI 96

FINANCIALIZATION 96

NEXUS BETWEEN BLACK MONEY AND FINANCE MARKETS: 97

WHAT IS FINANCE? 97
FINANCIAL ASSET: 98
RATIONALE FOR THE SPECULATIVE FINANCE MARKETS: 100
PERVERSION OF MARKETS: 101
STOCK MARKETS OR STOCK CASINOS? 102
THE PSEUDO NORM OF SENSEX: 104
WHY THE FLOW OF BLACK MONEY IN THE FINANCIAL MARKETS: 105
WHAT IS FINANCIALIZATION? 106
SOCIO-ECONOMIC IMPACTS OF FINANCIALIZATION: 109
CHAPTER VII 111

LEGAL MEASURES AGAINST BLACK MONEY 111

GAAR – AN INSTRUMENT TO ENSURE SUBSTANCE OVER FORM: 112

WHAT ARE GAAR (GENERAL ANTI AVOIDANCE RULES)? 114
INDIAN STORY OF (IN)APPLICATION OF GAAR: 114
EXCLUSIONS OR PROTECTIONS? 116
SPECIAL PROTECTION TO MAURITIUS? 116
FLAWED ECONOMIC POLICY – THE REAL CULPRIT: 117
DTAAS – BEHIND THE SCENES: 118
LIMITING THE ‘BENEFITS’ REAPED UNDER DTAAS: 119
CONFIDENTIALITY NORMS – MYTH AND REALITY! 121
STOLEN ASSETS RECOVERY PROGRAM (STAR): 123
BASE EROSION AND PROFIT SHIFTING (BEPS): 124
GLOBAL FORUM ON TAX TRANSPARENCY AND EXCHANGE OF INFORMATION: 124
AUTOMATIC INFORMATION EXCHANGE – TIEAS – ALSO DISCUSS IF TIEAS HAVE BEEN ANY USEFUL
125
TIEAS: 125
EXPOSURE OF PERPETRATORS - THE UNTOLD STORY: 126
 4

THE TRAGEDY OF ACTION AGAINST BENAMI TRANSACTIONS AND PROPERTY: 127

CHAPTER VIII 129

SO, WHAT NEXT? 129

APPENDIX 1 136

SUPREME COURT: RAM JETHMALANI & ORS. V. UNION OF INDIA & ORS. 136
 5

INTRODUCTION

What is a black hole? Do black holes really exist? Do they exist in the
human world too? Can there be black holes in our economy? Let us
explore.

A black hole is a region in space where the pulling force of gravity is so

strong that light is not able to escape. Because no light can escape, black
holes are invisible. It is for this reason that black holes are extremely hard
to detect and therefore, their existence has to be deduced. They invisibly
exist in parallel to our normal, perceivable world. Another attribute of a
black hole is that it gorges all the worlds around, leaving everything else
in blackness. No wonder, black holes have always been mysterious and a
challenge to mankind.

The tale of Black money around the world economy is similar to black
holes. Just like black holes, it is extremely difficult locate and demarcate
the black economy from the normal, legitimate economy. It is reflected
by the fact that the estimates of black money have always been so varied
and uncertain. Another detriment of black money is that it strongly
attracts the resources and capital from the economy. It thus expands its
boundaries, gradually turning more and more of the economy into black.
Moreover, the black economy does not exhibit itself and has to be
deduced, just like the black holes.

But what is black money? Is it distinctly identifiable? Can money be

converted into black and white off and on? Is whiteness or blackness a
characteristic of the currency or the transaction that creates it? Are black
economy and white economy distinct and mutually exclusive? Is the
problem of black money merely a question oflegal enforcement?
 6

This issue is too important to be left to enforcement agencies alone. It is

too significant and multifaceted to be reduced merely to a scandal. And
yet, the public debate on black money has successfully reduced it merely
to yet another scandal. It has been perceived as an element external to the
economy itself. In reality, black money is generated out of our day-to-day
economic activities. Its foundation lies amongst us. We seem to miss out
on the fact that black money is as integral to the system as the blood cell
is to the body. Because of this integral nature, black money becomes as
dangerous for the economy, as cancer is for the body.

One of the main promises standing on which, the NDA government won
the elections in May 2014 is to bring the black money stashed abroad
back to the country. Immediately after assuming power, the government
formulated an SIT according to the order of the Supreme Court (SC).
This was the same order in which the Court in 2011 had ordered the UPA
government to formulate a Special Investigation Team (SIT). The
government was also asked to hand-over the list of names of account
holders of the bank of Liechtenstein to the SIT. The government had
received this list from the government of Germany under the Double
Taxation Avoidance Agreement. The UPA government during its tenure
by and large remained inactive and the order went into hibernation until
the new NDA Government appointed an SIT, to which all investigations
of black money stood transferred under the court’s orders.

The controversy on black money began to encircle the new government

in October 2014, when they decided to file an application in the Supreme
Court pleading the court to reverse its order of 2011. The argument put
forth was that the government could not disclose the names of
Liechtenstein bank account holders under treaty obligations and
confidentiality norms. This argument, however, earned them a bad name
 7

and criticism from the opposition, media as well as the court. The court
took a strict stance and ordered the government to hand over the list of
the names the very next day. Consequently, the list of names was handed
over to the SIT under a fresh order of the SC.

Unfortunately, most of the public discussions start and end with an

argument on this factsheet. Is the entire issue of black money restricted to
those 627 names presented to the SIT? Will this investigation, if
effective, be enough to solve the issue of black money?

Amidst all the noise, political battles and legal technicalities, the very
problematic of black money and its impact on a common man’s life has
been forgotten.

Black money and a common man? Yes, black money, its generation and
even its operations impact a common man’s life at various stages. Black
money has a direct relationship with the tax revenues of a country.
Therefore, it directly impacts the governance and development of a
country. At a further stage, black money also impacts the financial
markets, investments and the ‘investor’ and ‘business’ sentiments in an
economy. Moreover, in India, the ground for generation and perpetuation
of black money is the development and omnipresence of cronyism.

According to the recent report of an International think tank, Global

Finance Integrity, Rs.28 lakh crore worth money has flown out of India
between 2003-2013. India has been ranked 4 th in the overall international
ranking for the decade (in terms of illicit finance flows). Yet, rather than
trying to curb this generation and illicit outflow of black money from the
country, we have diverted all the attention towards a few names and
controversies.
 8

Interestingly, the SC had beautifully stitched the different facets of this

issue together in the 2011 order. The court extensively dealt with the
major issues of black money such as the duties of a state, the kind of
economic atmosphere created by black money, the relationship between
the lax tax-enforcement and abysmal governance in the country.

However, black money is in fact an issue having a bearing upon the entire
taxation policy of a government. In turn, the taxation policy is a subset of
the economic policy. Thus, the economic policy leaves its mark on the
issue of black money and vise-versa. The economic policy of any
government is ultimately a choice made by it to regulate and direct the
economic system in a particular direction. Also, the economic choices of
a country are inseparable from its socio-cultural-political background.
Thus, a holistic approach is necessary to deal with the issue of black
money.

Good governance and development are the underlined demands of the

people today. Perpetuation of black money and regressive tax policies
continuously deprive the state off the resources necessary to ensure good
governance and all-inclusive development. In the course of this book, we
have tried to understand the problematic of black money. We have also
tried to decipher how the taxation structure, practices and attitude of the
different classes give a boost to the engine of black money. We have also
thrown light on the mechanisms of outflows and inflows (round-tripping)
of black money and its implications on our real and ‘virtual’ economic
indicators such as SENSEX. We have also tried to explore the actions and
efforts undertaken in the wake of an international uproar against black
money, ending with a few suggestions on the actions required.
 9

The SC in its 2011 order highlighted that the black economy in India is a
product of the unholy nexus between the lawmaker, law-keeper and the
law-breaker. Let us try to decode this unholy nexus step by step.
 10

CHAPTER I
UNDERSTANDING THE PROBLEMATIC OF BLACK
MONEY

‘Black money’, ‘black income’, ‘unaccounted wealth’; ‘parallel

economy’, ‘shadow economy’, ‘dirty money’ are the terms we have come
across way too often. They have become so common in our everyday
vocabulary that we no more think about what these terms even mean. In
actuality, the above-mentioned terms are often used interchangeably
without having been distinguished and defined appropriately. However,
such a distinction and definition is necessary for appropriate policy
making and action with respect to the same.

Defining Black Money:

Having browsed through the dimensions of black money in the previous

chapter, let us first understand the meaning of ‘black money’. As defined
by the Finance Ministry in ‘White Paper on Black Money, 2012’, “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 possession1.”

Theoretically, the term black money has two connotations – flow of

income and stock of assets. The concept of ‘flow of income’ means that
they are received in a process and may be spent in a process throughout
the year. Even when spent or retained completely, the aggregate of such
an income would constitute the annual salary or annual profit. A person
earning a salary of Rs.5 lakh per annum or a business unit earning and
annual profit of Rs.10 lakh per annum will both be covered under the
1
White paper on Black Money, Pg. 2,
[http://finmin.nic.in/reports/WhitePaper_BackMoney2012.pdf]
 11

connotation of ‘flow of income’. On the other hand, property is an

objector a claim with a durable commercial value. It represents a stock of
realizable commercial value on a given date. Land, buildings, raw
material, automobiles, shares, securities etc. are examples of such assets.

In principle, the term black money ought to include both the aspects,
classified separately. However, for the purpose of estimation of black
money and policy making, the term ‘black money’ is generally taken as a
synonym of the term ‘black income’ (unless specified otherwise).

In India, the quantum of unaccounted/undervalued wealth is enormous.

‘Benami2 property holding’ is prevalently practiced in order to
camouflage property holding. The same is done to evade stamp duty on
sale and purchase of property, evasion of wealth tax or hiding income
used for making such a purchase of property.

The term black money should be looked at in a broad sense so as to

include black income as well as tax-evaded property. For example,
consider a property (whether movable or immovable), purchased out of
white income. Subsequently, no taxes (such as wealth tax or estate duty,
when payable) are paid on the same. In this case, such a property is
considered as ‘black money holding’.

Now, we proceed to ‘black income’.

Any income on which the taxes levied by the government have not been
paid is called ‘black income’. In simple terms, black income is tax-
evaded income. Black income is generated in two ways. Following are
the two types of black income:

2
Benami holding is holding of a property/income in a fictitious/imaginary name
or in the name of a person who is not the real holder of such a property.
 12

1. The income generated by activities that are illegitimate per se.

Example: the income generated by indulging in activities such as theft,
fraud, smuggling, illicit trade in banned substances, counterfeit currency,
arms trafficking, terrorism, corruption etc.

2. The income generated by activities otherwise legal turns into black

when it remains undisclosed to the tax authorities. Example:

a. When income from a business or profession is suppressed before

a tax authority.

b. When the value of sale/purchase transactions are not disclosed or

are understated in order to evade taxes such as stamp duty, income
tax etc.

Under the Income Tax Act 1961, no distinction had been made between
legal and illegal sources of income for the purpose of levying taxes. Thus,
in India, even the income from illegal activities is taxable. However, it
continues to be illegal and actionable under the appropriate law. The
moment this illegal income is disclosed to the tax authorities for payment
of taxes, it ceases to be black income (but continues to be illegal).
However, such a disclosure of income generated out of illegal activities is
a rare occurrence. Thus, for all practical purposes, all income generated
out of illegal activities is presumed to be black money.

It is important to understand that, the routes that black money takes in its
flow are not restricted to national boundaries. In fact, a significantly large
stock of black money is routed internationally. When this black income
takes an international character, it begins to be known as ‘illicit finance
flows’.
 13

According to a report by the Organization for Economic Cooperation and

Development (OECD):

“Illicit financial flows range from something as simple as a private

individual transfer of funds into private accounts abroad without having
paid taxes, to highly complex schemes involving criminal networks that
set up multi-layered multi-jurisdictional structures to hide ownership3.”

“They may have arisen from illegal or corrupt practices such as

smuggling, fraud or counterfeiting; or the source of funds may be legal,
but their transfer may be illegal, such as in the case of tax evasion by
individuals and companies4.”

Black Economy:

Black economy is a sum total of black income, jobs, trade, occupations,

transfer of money etc., inevitably interconnected with each other, which
are predominantly based on undisclosed income/property. Although it is
known as parallel economy, it has interconnections with the white
income-trade-jobs disclosed before the tax authorities.

Black Economy – A reality or metaphor?

Black income occurs at individual situations in accounts of respective

persons. Now, the question is, ‘how does it turn into black economy’?
The latent reality of black income is nothing but tax evasion. How does it
convert itself into a political economy(a loop of production and
distribution) running parallel to its other i.e. white economy? Is this a
reality or a metaphor?

3
Illicit Finance Flows from Developing Countries: Measuring OECD Responses,
Chapter 1, para 1.2
4
Illicit Finance Flows from Developing Countries: Measuring OECD Responses,
Chapter 1, para 1.2
 14

The distinguishing tendency of tax-evaded income is to give rise to

further tax evasion. A person who spends his black income never creates
a record of his expenditure. The receiver of such money in turn tends to
hide or camouflage such a receipt in his accounts. Thus, he also carries
black income and spends it in black. In this process, a chain of black
income-expenditure-income is likely to be created. For example, a
corrupt government officer does not disclose his black income and
expenditure made out of that. His expenditure on consumption of luxuries
may be shown as white income by the receivers, as it does not create
wealth out of it. However, if he purchases any immovable property or a
durable asset of high value (such as jewelry) or invests in securities or
business as capital, he essentially does so by camouflaging the ownership.
Similarly, all holders of black income are likely to have the same
tendency. There are certain sectors of the economy where one can earn
very high rates of return in a short span of time. Such sectors include real
estate, financial markets and gold. There are strong evidences for
presence of black money in these sectors. These three sectors subsume
black income like a black hole and further accentuate the practice of
earning in black. Here is an example of such an exposure by cobrapost
made in November 2014.

“Cobrapost exposes how 35 real estate companies are willing to take

illicit money and convert it into legit by allowing their clients to buy
properties. Promising to do bulk property transactions ranging from 10
per cent to 90 per cent in black money are two real estate company
CMDs, 10 managing directors, 15 directors and executive directors,
three CEOs and COOs, a president and a vice-president, two AVPs, four
heads of marketing and sales, three general managers, three assistant
general managers and many other senior employees. One employee even
 15

offers to take Rs. 100 crore in black and convert it to white with help
from non-banking finance companies in a clear violation of Income Tax
laws, Foreign Exchange Management Act, Prevention of Money
Laundering Act and others. Senior officials said that accepting payments
in black was nothing new for them and that it was an accepted norm of
the real estate industry. Some of these real estate officials are caught on
camera ready to accept black money abroad via hawala. All this
endorses the fact that rampant use of black money is a well-known reality
of the realty sector in India5.”

Apart from real estate, black money finds refuge in gold stocks as well.
The black money holders in India prefer to store it in the form of gold for
two reasons. (a) The price of gold in India has a tendency to rise at a rate
higher than the normal rate of inflation. (b) It carries lower risk in terms
of detection and can be stored and transferred (without official
documentation) with more ease and no risk of physical deterioration like
currency notes. The skyrocketing imports of gold in India prove this fact
conclusively. For more details, please see Box 1.

Perpetuators of black money:

In India, there is a strong presence of informal sector. This is due to the

backwardness of financial infrastructure, lack of banking habits in people,
high preference for cash transactions, and disorganized small character of
business and trade. Such a system cannot absorb the formal accounting
systems and tax procedures in general. It is not true to say that all the
players in the informal sector are necessarily poor. Some of them are
super-rich, but prefer to operate in absolutely informal 6 demeanor. There
5
http://cobrapost.com/index.php/news-detail?nid=7299&cid=23
6
Formal and informal sectors – In economic terms, formal sector includes the
establishments in which 10 or more persons are employed. All the other sectors
are informal.
 16

is substantial tax evasion of indirect7 (excise, Value Added Tax etc.) as

well as direct taxes (Income tax, wealth tax etc.) there.

Such informal sector not only generates but also absorbs the black
income generated in the formal sector or in the political sphere.
Therefore, two components form a black economy, namely, generation of
black income and the avenues/incentives for its absorption are both
strongly present in India. They reinforce each other. And thus is black
economy generated.

Black Economy interwoven with White Economy:

The white economy and the black economy do not function in isolation
with each other. In fact, in the early days of economic modernization of
India, formal and informal sectors were prominently parallel. Over the
years, there arose a substantial interpenetration between the two.
Surprisingly, for the critics of ‘license permit raj’, after 1992, a
substantial amount of black income started being generated in the formal
sector as well. It led to an unprecedented boom in real estate and financial
markets and illicit finance flows.

The high growth sectors such as real estate, speculative finance and
commodity markets are celebrated as the icons of post liberalization
economic reforms. In the same period we have witnessed an
unprecedented increase in the imports of gold 8. It is an undisputed fact
that such imports as well as the growth of these sectors are due to profuse
absorption of black income in search of high return, high liquidity

7
Direct and indirect tax – In simple terms, direct taxes are the taxes levied on the
income-profit and property of an individual/company/firm. Indirect taxes are
levied on imports, production-sale of commodities and services. For better
understanding, refer to Chapter IV.
8
Refer to Box 1
 17

investments. The interconnecting mechanism between black money and

speculative markets shall be explained in the following chapters.

In a black economy, a nexus of power and money is inevitably formed

between the perpetrators of black money and the state/political authorities
in the form of corruption. It thereby becomes an organic component of
the economy as a whole.

Thus, ‘black economy’ is not a palpable ‘institution’ like the banking

system or the financial system. It has a semi-autonomous character and is
interwoven with white economy.

Social-Institutional Framework leading to perpetuation of black money:

The political economic system in any country is rooted in its history,

culture and social system as well. The perpetuation of huge black
economy in India cannot be understood in isolation with the social
institutional framework inherited from history. Factors affecting the
growth of black economy in India:

Inseparability of business and family:

In India, business is not mutually exclusive from family property. It is not

only the traditional and informal sector that is dominated by family based
units. Even the corporate sector visibly lacks the trend of corporate
identity in business. The highest positions in the top management in
business sector are passed on as inheritance in the controlling family even
with a minority share of investment in the total capital. This fact
vindicates that the tradition of professional management is still not an
established norm even in the big corporate houses barring a few
exceptions.
 18

1. A professional manager in a unit with a strong corporate identity rather

than a family controlled unit is driven by the following principles:

2. Transparency and accountability in terms of procedural norms.

3. Autonomous powers for management.

5. Goodwill of the corporate name.

As a result of these distinguishing features, a professionally managed unit

is more likely to be tax and procedure compliant than a family controlled
business unit in the formal as well as the informal sector.

Due to the absence of professional culture in the top management in

India, control rather than the economic logic of capital, secrecy rather
than transparency and routine path rather than the entrepreneurial venture
forms the cultural norm deciding the business decisions. Therefore, the
conduct of capital in India looks for higher returns by (a) trading profits
rather than value addition, (b) tax avoidance rather than tax compliance
and (c) speculation rather than production. Therefore, a mindset
conducive to generation and channelization of black money into similar
openings is inherited from the socio cultural institution by the business
class in India barring a few exceptions. The perpetual backwardness of
Indian manufacturing sector continues due to the factors stated.

However, it is unrealistic to absolve professionally managed units of tax

evasion altogether and shifting the entire blame on the family based
business units. The intention is to underline the distinguishing features
and tendencies between the two. This understanding is required to have a
rational framework for understanding and dealing with the issue of tax
evasion in India.
 19

Remnants of the feudal mindset:

The Indian Society continues to be driven strongly by the caste-

community based norms and culture. The genesis of this caste-
community based attitude can be traced back to the feudal structure that
the Indian society was built upon. The impressions of this feudal
construct continue to be visible in the day-to-day practices and behavior
of Indians. This construct has essentially prevented the internalization of
the concepts of ‘common national citizenship’ and ‘common social
good’ in the minds of Indians. It has also obstructed the creation of a
modern functioning responsible state even within the limits of capitalism.
Some of the unfortunate ramifications of such a feudally driven mind are
- absolute disregard to one’s fundamental duties and responsibilities, to
public property and a deficiency of civic sense. As a result, the
developing modern state in India lacks the social foundation for law
abidance on one hand and law enforcement on the other. In such a
situation, evasion of taxes levied by the state or even defying any law is
not looked upon as an ‘unethical act’. Nor does it violate our generally
established norms of morality. Such a practice is in fact glorified as an act
of ‘smartness’ leading to a usual unwillingness to pay taxes.
Unfortunately, even the professionals in finance sector such as Chattered
Accountants, chartered secretaries, financial analysts are not completely
free from such a mindset to insist on the practice of tax compliance.
 20

BOX 1.1

Stranglehold of gold around India:

India is the second largest importer of gold constituting about 26% of the global
demands. The import of gold and silver constitute about 12% of our import bill. It
has been causing a substantial increment in Current Account Deficit (CAD) of
India. In simple terms, the CAD is an excess of foreign exchange payments over
the foreign exchange receipts of a country, excluding the imports and exports of
capital.

In 2013, the CAD was rising exponentially mainly due to indiscriminate imports of
gold. In the wake of this situation, the government had to take certain measures.
The government increased the customs duty three times in the calendar year 2013
and imposed the 80:20 rule. Under this rule, the importers of gold were required to
sell 20% of the imported stock to the jewelry makers. Regulating gold imports by
such measures helped to bring down the CAD from 87 billion dollars to 32 billion
dollars. Surprisingly, on May 21 of 2014, the government eased controls on the
imports of gold, allowing more trading houses to bring in the metal. This move
increased the quantum of gold imports by more than 6 folds, which is apparent
from the fact that gold imports in November were $5.61 billion against $0.83
billion in the same month last year. [Dec 16, Express, Gold imports up 6 fold, trade
deficit hits 18-month high]

The strong preference of Indians to have savings in the form of gold has always
kept the gold prices in India high in comparison with international prices. This has
made the gold imports a lucrative opportunity in India. Over a period of time its
value appreciates without any risk of depreciation. Such an investment offers
almost absolute liquidity, in case needed for business purposes. However, the surge
in the import of gold can be attributed to more than a common man’s affinity to
gold in the form of savings. Such a surge has been possible due to a high demand
for gold from the super-rich possessing high proportions of black income.
21
 22

CHAPTER II
METHODS OF GENERATION OF BLACK MONEY

As discussed in the previous chapter, black money in simple terms can be

defined as ‘the aggregates of income, which are taxable but not reported
to the tax authorities’ or ‘the income that remains unaccounted in the
books of the tax authorities’. There are two ways by which income is
concealed from the tax authorities:

1. Absolute non- disclosure: One way of concealing income is by

simply not declaring or reporting the whole of the income (whether
generated legally or illegally) or the activities leading to it.
2. Partial non-disclosure: Income is also hidden from the eyes of tax
authorities by partial non-disclosure. However, such partial non-
disclosure renders the income highly prone to suspicion and leads
to consequent adverse outcomes. Thus, in this case, more
sophisticated methods of manipulation of finance records and
accounting are adopted.

The method involving accounts and records is complicated. The reason

behind this complicity is that the methods involved in such manipulations
form an intrinsic part of the legitimate systems and are difficult to be
unleashed or disclosed (For example, tax evasion by way of misreporting
or non-reporting of the transactions in the books of account and different
kinds of manipulations of financial statements). Following are the
mechanisms adopted for partial non-disclosure of income.

Tax evasive books of accounts:

It involves processes such as:

a. Out of book transactions:In such transactions taxable receipts or

income are not entered in the books of account by the taxpayer.
Example: One can avoid registration necessary under VAT if the
annual turn over of a business unit is less than a particular amount,
say Rs. 10 lakhs per annum in Maharashtra. In this case, a seller
will try to understate the sales such that the annual turnover does
not exceed Rs.10 lakh. In order to do the same, he may not enter all
 23

his transactions in the account books.

b. Keeping parallel books, where two sets of books of account are
maintained in order to evade reporting activities – one for the
purpose of business management and the other to satisfy the
regulatory and tax authorities.
c. Manipulation of sales, receipts, expenditure:
1. A taxpayer is required to pay taxes on profit or income, which is
the difference between sales and expenditure. The manipulation
of sales or receipts is a common method of tax evasion.
2. 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.
3. Manipulation of expenses is another commonly adopted method
of tax evasion. Inflating expenses under real or false heads,
which results in under-reporting of income or profit. The
evaders also resort to the ‘bill masters’ to obtain bogus invoices
so as to facilitate the inflation in expenses.

Following are simple examples of such manipulations:

1. A is using a building or a land for a business purpose. However, A

doesn’t show this usage of the building or the land in his accounts
as capital or as property.
2. On the contrary, it is also possible that A shows the building or
land (even though not purchased not for the purpose of business) in
his accounts or books in order to charge depreciation in the
expenses of business in his accounts and thereby suppress profits.
3. Another specific mechanism used to evade taxes is elaborated as
follows:
Registration of a business unit depends upon the activities that the
unit undertakes. For Example, a factory employing more than 10
workers will require a registration under Factories Act. In case of a
shop or an office, registration will take place under the Shops and
Establishment Act. Similarly, a unit may require registration under
the special enactments made for specific businesses such as cold
storage, bidi making, sugar cane etc. Some of these acts are central
legislations, administered by the state governments. Others are
state legislations, but administered by the state governments.
 24

However, Income Tax Act is a central enactment governed entirely

by the Central government. In order to evade Income Tax and the
other tax liabilities, a business unit may avoid registration under
any of the above enactments. In other cases, it may file a
registration understating its activities and size. When Income Tax
Authorities attempt to enforce a tax liability on unreported income
or manipulated accounts, the returns filed with the state authorities
are used as evidence to prove the income stated by the said
business unit. Unfortunately, in cases such as this, an
understatement with reference to a state enactment is relied upon
by the courts and the unit succeeds in evading of Income Tax as
well9.

In the methods discussed above, we have restricted ourselves to domestic

boundaries. When the same transactions take an international character
with involvement of multiple jurisdictions and foreign entities etc., the
income generated take the form of ‘illicit finance10’. The detailed
mechanism for the generation of illicit finance is discussed later in this
chapter.

The thin dividing line between tax evasion and tax avoidance (Box 2.1):

(Box 2.1)

International Network of Black Money:

9
Measures to tackle black money in India and abroad, 2012 – CBDT, pg. 7
10
Discussed in Chapter II.
 25

Thus far, we have seen how black income is generated and routed inside the
borders of the country. However, the issue of black money had transgressed the
national boundaries around the world long ago. This international character and
worldwide network of black money has gained recognition as a parallel
economy. How has this been possible? What are the developments and
mechanisms that helped black money take the shape of a parallel black
economy? Let’s now have a look at the routes that black money takes to turn
into illicit finance.

As has been clarified, illicit finance is nothing but the tax evaded income or
funds transferred abroad through complex mechanisms involving criminal
networks that set up multi-layered multi-jurisdictional structures to hide
ownership. India did not suffer as much on account of massive illicit finance
flows until 1990s. However, the development of the liberalized and globalized
trade gave birth to certain unrestrained and unregulated channels that facilitated
the flow of illicit finance from India. This was a result of a gigantic amount of
tax evasion. Following are the routes taken for tax evasion and illicit finance:

1. Money laundering
2. Hawala transactions
3. Tax Havens
4. Transfer Pricing
5. Trade Mispricing

As can be inferred from Box 2, there is a very thin dividing line between tax
avoidance and tax evasion. It must be noted that differentiating the two
phenomena from each other is very difficult and they are in many ways
interconnected. From the above stated methods, money laundering and hawala
are used mostly for the purpose of tax evasion. Whereas, tax havens, transfer
pricing and trade mispricing are majorly used for tax avoidance. Thus, more
often than not, these routes are drastically abused to evade large amounts of
taxes.

Money Laundering:

Money laundering is the process by which the black income, generated out of
illegal activities, is shown to have been generated out of legal/legitimate
sources. A working definition of money laundering adopted by the Interpol
General Assembly in 1995 runs as follows:
 26

“Any act or attempted act to conceal/disguise the identity of illegally obtained

proceeds so that they appear to have originated from legitimate sources11.”

Box 2.2:

Behind the origin of the term ‘money laundering’, there lies an interesting story. Sometime
in the 1930s in the US, some mafia gangsters had set up ‘laundromats’, a commercial
establishment for washing and dying. The black money that was generated out of their
illegal activities such as threats, force, extortion, gambling etc. was disguised by this mafia
under the business accounts of ‘launderomats’. Thus, they succeeded in concealing their
illegal income from the authorities. From then on, all the similar cases came to be regarded
as ‘money laundering’.

The steps involved in laundering of money around the world are –

placement, layering and integration. At the stage of placement, the illicit
money is channeled into the legal financial system such as banks and
other institutions. This is done by generating bank accounts or
investments in the name of unknown or fake individuals or organisations.
At the second stage (layering) the illicit money injected into the legal
financial systems is layered by transferring it to other countries. This is
usually done by moving money to offshore bank accounts in the name of
shell companies12. At the third stage, the money launderer transfers the
illicit money to the banks and financial institutions that guarantee
privacy. Such institutions involve institutions such as Banks in
Liechtenstein, UBS bank in Switzerland etc.

Hawala transactions:

Hawala is a process of transfer of money form one location to another (it

includes money transfer between different countries). It is an informal structure
for funneling money and is much easier as compared to the formal structures of
banking and other transferring mechanisms. This is due to the fact that it does
11

http://www.interpol.int/Public/FinancialCrime/MoneyLaundering/default.asp
12
A shell company is a paper entity created as a proxy for any other business
entity located elsewhere.
 27

not involve complex formalities and happens easily through phones or emails.
Further, the attraction towards hawala transactions is due to the fact that they
are cheap and happen in secrecy. The fee charged by hawala brokers is much
lower than the formal institutions. Following are some identified cases of
hawala transactions:

1. Hasan Ali Khan, a Pune-based businessman, is accused of one of the

biggest tax evasion scams in India. According to reports, he is alleged to
have parked over funds worth Rs.36000 crore in seven undisclosed Swiss
accounts. He was a regular Hawala operator. His operations spread across
many cities such as Hyderabad, Pune and Delhi13.
2. Hawala operators are said to have built deep networks in countries in
South Asia. United Arab Emirates, especially Dubai has come to become a
hub for Hawala transactions. Dubai’s large gold market is the source of
much of the gold sent (both legally and illegally) to India and Pakistan14.

Tax Havens:

Tax havens are such locations where the rate of taxation is kept zero or very low
to attract foreign funds. There is no precise definition of tax havens. They can
be identified by the presence of some basic features. The OECD (Organization
for Economic Cooperation and Development) defined tax havens as the
countries or territories that have the following features15:

 Zero or no taxes
 Lack of effective exchange of information/lack of tax information
exchange with other countries (even if there is exchange about fraud or
money laundering)
 Lack of transparency
 A high degree of bank secrecy
 Lack of real economic activity associated with the income generated
 Small in territorial size and population

A few examples of tax havens are as follows:

13
CBGA paper – tax dodging, pg. 10
14
CBGA (Center for Budget and Governance Accountability) paper - tax dodging,
pg. 10
[http://www.cbgaindia.org/files/recent_publications/Tax%20Dodging.pdf]
15
Organization for Economic Development and Cooperation, Harmful tax
Competition: An Emerging Global Issue, 1998, p-23
 28

By early 1990s, the number of tax havens had grown to around hundred.
Statistics from Bank for International Settlements (BIS) shows that
almost half of International loans and one-third of FDI are routed through
tax havens since early 1980s, avoiding substantial amount of taxes
worldwide16. This evaded tax money is then routed back to the same
country or to other legitimate jurisdictions (countries) by the process
called round –tripping17. The money that is transferred through the
process of round tripping is welcomed in the forms of FDI (Foreign
Direct Investment) and FII (Foreign Institutional Investments). This
process of income generated in black, re-entering economies and the
nature of such investments will be discussed in the coming chapters.

At the moment, it needs to be understood that the high incidence of tax

evasion and lack of transparency underlines that the need of the hour is
for an international regulation on the activities of these tax havens. This
need has been felt by the international community and the issue continues
to be a hot topic amidst international fora such as OECD, G20, United
Nations etc.

Transfer Pricing:

16
“The history of tax havens by Ronen Palan” – as reported in CBGA paper – Tax
Dodging
17
more about the topic will be discussed in the later chapters
 29

Transfer price is the price at which goods and services betweenrelated

entities (business entities related to each other by way of ownership and
management) are transacted. The main branch of the company is known
as the parent company and the other associated branches in other
countries/locations are known as subsidiary companies. For example, a
company in Mauritius has a subsidiary company in India. When the
subsidiary company in India transfers some goods produced in India to its
parent company in Mauritius, the price at which it does so is called the
transfer price. This transfer price is dictated by the Mauritian parent
company and is generally less than the international market prices at
which such a commodity is likely to be sold. This process is usually
adopted in order to evade taxes or transfer profits from relatively high tax
jurisdiction to relatively low tax jurisdictions. Lets understand this
process in detail.

Transfer pricing is a process by which Multinational Enterprises (MNEs)

make huge profits by increasing the price of products or services in low
tax jurisdictions and decreasing the price in the high tax jurisdictions
thereby shifting profits. A low tax jurisdiction is a country or territory
where the rates of taxes are low and a high tax jurisdiction is a country or
location where the rates of taxes are high. Thus, by shifting profits to a
low tax jurisdiction, they make sure that the profits are saved from being
taxed. For example, as explained in the earlier example, consider that an
Indian company (subsidiary company) provides a service to its parent
company based in Mauritius (Mauritius is a low tax jurisdiction). It
provides the service at a price much lower than the market price of the
service as dictated by the parent company. In doing so, it lowers its share
of profit in the Indian Territory and thereby shifts the profits to the
Mauritian territory. Mauritius being a low tax jurisdiction will not tax the
profits as much as they would be taxed in India. In this process, the
company evaded its tax liability in India thereby causing lose to the
public exchequer in India.

The detrimental impacts of transfer pricing are visible when such pricing
of products and services are widely used to evade taxes. In case of India,
this method is extensively used while trading with tax jurisdictions such
as Mauritius, Cayman Islands, and Singapore that have signed Double
Taxation Avoidance Agreements (DTAAs) with India. More about the
 30

DTAAs and their use/abuse will be discussed in later chapters.

Under the transfer pricing rules of several countries, the suitable price
charged in case of transactions should be a fair one18. This is the price that
will be charged between the subsidiary company and the parent company
as if they are unrelated companies. Such a price at which unrelated
companies transact in the open markets is known as ‘Arms Length Price
(ALP)’. However, more often than not, these rules are flouted by
international entities.

When the transfer of goods and services between two related business
entities happens at the market prices, it is acceptable under the law.
However, violation of the same has been visible in the international trade
at a massive scale causing huge revenue losses to exchequers of several
countries. Given this abuse, the OECD released a report called
‘Guidelines for Multinational Enterprises and Tax Administrations’,
laying down a set of guidelines on transfer pricing in 1995 and has been
revising it for better enforcement.

After the liberalization in 1991-92, the Indian Economy got associated

with the globalized world economy. With the skyrocketing rise of cross-
border transactions, it became necessary to incorporate transfer-pricing
rules under the Indian laws. As a result, the Finance Act 2001 was
introduced with transfer pricing legislation vide section 92 to 92F of the
Income Tax Act, 196119.

The problems faced by the Indian tax regime today, is that the laws are
complicated and offer wide lacunae. These loopholes (sometimes created
deliberately), offer wide scope of evasion by hook or by crook. The
Indian exchequer has for long suffered massive loses on account of
transfer pricing. The recent cases, tax evasion by Vodafone India, Shell
etc. through transfer pricing mechanism was challenged by the Income
Tax department of India are glaring examples of the same. These cases
involved tax demands by the IT Department of the magnitude of
thousands of crores. However, these demands were turned down by the
18
“Fair price” is the prevailing market price that the seller charges the buyer who
is not known to the seller. Price manipulation takes place when the seller charges
a lower price to the buyer, or the buyer might offer a higher price to the seller
due to personal relationships to avoid paying taxes. [CBGA – tax dodging]
19
link
 31

Bombay High Court on technical grounds.

Following are some news items indicating the serious and high magnitude
of evasion of taxes through transfer mispricing.
32
 33

Trade Mispricing:

Trade mispricing refers to international overinvoicing/underinvoicing of

imports and exports respectively in order to escape taxes 20. It happens
when the prices of exports or imports are understated or overstated (as
compared to the market prices) in the accounts. For example, lets say a
utensil manufacturer in India sells his pans at the rate of $5 per pan.
Suppose he gets an order of 100 pans from a firm in the US. The Indian
manufacturer would ideally receive a sum of $500 out of this sale.
However, in order to reduce the account of income, the manufacturer
shows the price for each pan to be $3. Thus, the total income from the
transactions comes down to $300 from $500. The manufacturer will show
an income of $300 to the customs officials in India and the rest of the
$200 will be transferred to some offshore bank that guarantees secrecy
(lets say Swiss Bank). This was an example of export misinvoicing.
Similar process is adopted to misinvoice imports too by inflating the price
of imports.

Why do exporters/importers indulge in these practices? The most

important reason, as explained above, is to shift profits from relatively

20
CBGA – tax dodging paper
 34

high jurisdiction areas to low tax jurisdictions by falsification of real

nature of transactions.

Quantum of Black Money in India:

The quantum of black money in any economy at a particular point of time

is difficult to determine. The reason behind this difficulty is that black
economy exists in shadows and is more or less invisible just like a black
hole.The amount of matter swallowed in by the black hole is inaccessible.
Similarly, due to a black out of information, it is highly difficult task to
estimate the quantum of black money in any economy.

As discussed in earlier chapters, a shadow or a parallel economy

inevitably becomes interwoven with the real economy. Thus, it becomes
difficult to distinguish one from another in absolute terms. Different
methods to make estimates have been adopted, however, each method
comes with its own limitation.

 Kaldor’s estimate21:

In 1956, Kaldor estimated that the amount of tax lost through tax
evasion was of the order of Rs.2-3 billion (i.e. Rs.200-300 crore.)

 Wanchoo Committee’s estimate:

Direct Taxes Enquiry Committee22 (Wanchoo Committee) found
that the estimated income on which tax has been evaded (black
income) would probably be:
(a) Rs.700 crore for the years 1961-62.
(b) Rs.1,000 crore for the years 1965-66.
(c) Rs.1,800 crore for the years 1968-69.

 Rangnekar’s Estimate:
Dr. D.K. Rangnekar was a member of the Wanchoo Committee.
However, he dissented from the estimates made by the committee.

21
India Tax Reform (1956)

22
Also known as Wanchoo Committee, submitted its report in
December, 1971
 35

According to him, tax evaded income for 1961-62 was of the order
of Rs.1,150 crore, as compared to Wanchoo Committee’s estimate
of Rs. 811 crore. For 1965-66, it was Rs.2,350 crore, against
Rs.1,000 crore estimated by the Wanchoo Committee. The
projections of ‘black’ income for 1968-69 and 1969-70 were
Rs.2,833 crore and Rs.3,080 crore respectively.

 Chopra’s Estimate:
Mr. O.P. Chopra (a noted Economist) published a series of
papers23on the subject of unaccounted income (black income) for a
period of 17 years from 1960-61 to 1976-77. According to Mr.
Chopra’s study, after 1973-74, the ratio of unaccounted income to
assessable non-salary income has gone up. The Wanchoo
Committee in its study assumed this ratio to have remained
constant. Thus, Chopra’s study estimated unaccounted income to
have increased from Rs.916 crore in 1960-61 to Rs.8,098 crore in
1976-77.

 NIPFP Estimate:
National Institute of Public Finance and Policy conducted a study
under the direction of Dr. S Acharya, formerly a World Bank
official. While preparing the estimate of ‘black’ income, the
study24excluded incomes generated through illegal activities like
smuggling, black market transactions, acceptance of bribes,
kickbacks, etc. Estimates are as follows:

23
Economic & Political Weekly, volume XVII, number 17 & 18 in
April and May, 1982

24
NIPFP, Aspects of Black Economy in India.
[http://www.nipfp.org.in/media/pdf/books/BK_14/Aspects%20Of%20The
%20Black%20Economy%20In%20India.pdf]
 36

 Other Estimates:
As noted above, the NIPFP Report estimates the extent of ‘black’
economy (not counting smuggling and illegal activities) at about
20% of the GDP for the year 1980-81. However, Shri Suraj B
Gupta, a noted economist, has pointed outsome erroneous
assumptions in NIPFP study25. He estimated ‘black’ income as
42% of GDP for the year 1980-81 and 51% for the year 1987-88.
On the other hand Shri Arun Kumar (Professor at JNU)has pointed
out certain defects in NIPFP study and Gupta’s method in his
book26. He estimated the extent of ‘black’ income to be about 35%
for the year 1990-91 & 40% for the year 1995-96.

25
‘Black Income in India’, Sage Publications (1992, first edition)

26
‘The Black Economy in India’ (1999, second edition)
 37

 IMF Estimate:
An IMF study as reported by Rishi and Boyce (1990) 27estimated
the flight of capital from India during the period 1971-86 at
US$20-30 billion, or US$1-2 billion every year. This estimate was
later revised in 200110 to US$ 88 billion over the 1971-97 period.

 Global Finance Integrity (GFI) Estimate –

Global Finance Integrity is an international think-tank that has been
working on the issue of illicit finance since years. According to the
report28, USD 439.59 billion (Rs. 28 lakh crore) worth money has
flown out of India between 2003-2013. India jumped up by one
rank and has been ranked 4th in the overall ranking (in terms of
illicit finance flows) for the decade.

However, the quantum of illicit money having flown out of the

country in the year 2012 has been estimated to be USD 94.76
billion (nearly 6 lakh crores). With this score, India ranked 3 rd in
the list for the year 2012.

27
M. Rishi, and J.K. Boyce (1990) ‘The Hidden Balance-of-
Payments: Capital Flight and Trade Misinvoicing in India,
1971-1986’, Economic and Politcial Weekly, July, pp. 1645-8.

28
Illicit Finance Flows From Developing Countries: 2003-2013
38
 39

CHAPTER III
BLACK MONEY: HISTORICAL, POLITICAL AND

ECONOMIC PERSPECTIVE

The evolution of Black economy in India has been a process with several
stages. The quantum and the penetration of black income have varied at
different times with the changes in the economic policy of the nation. The
development of commerce, industry, banking, urbanization, size of
external trade and the overall development process in general have been
the contributing factors to the generation of black money. To grasp the
issue better, we have divided the process of generation and growth of
black money into the following phases.

[Drivers and Dynamics of illicit finance flows from India, 1948-2008,

GFI, pg. 5.]

At the dawn of independence- Phase I (1947-51)

At the dawn of independence, India had large sterling-pound reserves as

foreign exchange. But, the usage of these reserves was blocked by Britain
by way of certain agreements. These reserves were formed between 1939
 40

and 1945, when India was making large exports to Britain for war
purposes. Thus, very small portion of these reserves could be used for
paying off India’s imports after independence. As a result, after post-
independence and even after the beginning of planning in 1950s, India
had a scarcity of foreign exchange.

The average size of exports-imports (i.e. the external trade sector) in India
was 11.5% of GDP in the period between 1940-50 (refer to column 4 in
the table above). The economy was still backward and agro based. Other
sectors of economy such as industry, manufacturing, service sector etc.
were at a nascent stage. Due to the primitive stage of the economy, the
channels for generation and deployment of black money were not
developed and black money had not yet given birth to a black economy.

Corruption creeps in with a shadow economy - Phase II (1951-65)

This period began with the initiation of the process of five-year planning.
The five-year plans were committed to the development of India with the
public sector and infrastructural development being the foremost
priorities. This was also the time when India had to fight two wars, with
China and with Pakistan. The demands for imports were rising and the
development in manufacturing of exportable commodities was low. As a
result, the trade deficit started rising. India adopted the policy of import
restrictions for two reasons – scarcity of foreign exchange and protection
of domestic industries. The restrictions imposed on imports were severe
and were progressively intensified. As a result, import licenses were sold
by corrupt means. At the same time, since gold prices in India were rising
significantly, smuggling activities began to grow. According to the
estimates, during this period, India lost around 0.2 billion dollars worth
foreign exchange as illicit finance flows annually29. Unfortunately, the tax
revenues of the state during this period were not growing in proportion to
the growing needs and demands of the state. These requirements included
defense requirements and state investment in infrastructural development.
Thus, the fiscal deficit started rising. In order to overcome this situation

29
Estimates quoted from GFI – The Drivers and Dynamics of Illicit
Finance Flows in India: 1948-2008
 41

an attempt was made to increase the tax revenues by increasing the rates
of taxation. But, no sincere efforts were made to widen the tax base.

Widening gap between words and deeds - Phase III (1966-90)

This period is marked by a strong drive to nationalize the finance sector

(banks and insurance), and an intensification of the controls on import
licenses. Also, an establishment of state monopoly over oil marketing,
refining and coal production was witnessed. The mesmerizing political
appeal of slogans like garibi hatao was a distinguishing feature of the
period till 1976.

In 1971, India had to fight yet another war with Pakistan. At the dusk of
this war, Bangladesh was born. This led to an enormous influx of
refugees from Bangladesh. In spite of the political and economic
initiative by the Indira Gandhi led government, the collection of tax
revenues in the country continued to be poor, corrupt and inefficient. The
rates of taxes on higher slabs of income were increased enormously
butthe enforcement of the tax laws continued to be extremely poor. Due
to a strong nexus between the bureaucracy, political leaders and affluent
classes in India rampant tax evasion became the rule of the day.Finally, in
1983, the proportion of direct taxes in the total tax collection reached the
abysmal figure of 17%, which was 35% at the dawn of Independence.
Unfortunately, an attempt to widen tax base was never made along with
the other reforms.

Socialistic slogans, unenforced laws and rampant corruption were the

characteristic features of governance in this period. What appeared on
paper and policy never saw implementation.This resulted in an enormous
rise in fiscal deficit, trade deficit and an outburst of black economy. By
the end of 1988, the figure of illicit finance flows from India increased to
3.5 billion dollars per year. This constituted 35% of our earning from
exports. The underground economy reached almost 50% of GDP. But, the
growth rate of the economy stood at a dismal figure of 4% per annum.

Black hole in the open space of Liberalization - Phase IV (1992-2008)

In the year 1989, India started undergoing the process of financial

liberalization. An ever-increasing fiscal deficit due to low tax revenues
 42

and an unrestrained trade deficit led to a full borne financial crisis. In the
year 1991, India barely had any foreign exchange reservesleft. Even
paying two months of import bill was a challenge.

At the international stage, the Soviet Union was on the verge of collapse
and the socialist economies of Eastern Europe had been dissolved to
embrace a new capitalist order. There was international pressure from the
USA and other imperialist countries to formulate and enforce a new
general agreement on trade and tariff. Now, India faced a new dilemma.

There were two options available. One was to enforce the previous policy
decisions firmly and achieve the targets planned. The other was to
dissolve its planned economic policy altogether and surrender to the
international pressure to enforce the policy of – Liberalization,
Privatization and Globalization. The inclinations of the industrial class
and the higher bureaucracy were clear. The easier option of opening up of
the economy to the package of LPG was chosen.Thus, India opted for the
IMF loan that rescued her from the foreign exchange crisis. The cost of
survival, however, was the terms and conditions imposed by the IMF, i.e.
the LPG package.

As a part of economic liberalization, the customs duty and import

restrictions were substantially reduced. New financial documents such as
commercial papers and deposit certificates were allowed to raise private
sector borrowings in the foreign money markets. Double Taxation
Avoidance Treaties were promoted.Many DTAAs were signed with small
countries with characteristic features of tax havens. Such a process was
accelerated even further after 1991. Thus, the import of capital, goods,
and services was liberalized and this process was made simpler under
such international agreements. The DTAAs will be discussed in greater
details given in the chapters to be followed. The policy and procedure for
investments in stock markets [mainly by Foreign Institutional Investors
(FIIs)] was also liberalized progressively over the years. The inflow and
outflow of finances from the country became unprecedentedly easy and
almost free of the controls.

There were substantial changes in the taxation policy as well. The higher
rates of taxes on the higher slabs of income were brought down
substantially. The income tax rates were fixed corresponding to
 43

international standards, or even lower at times. For example, the highest

tax rate on the highest slab in US and Japan are 40% and 45%
respectively. While in India, the same is 33% including the surcharge.

The liberalization of tax rates, external trade, FDI policy etc. was
expected to result in better tax compliance and widening of tax base. It
was believed that illicit finance outflows were triggered by high tax rates
and allegedly restrictive investment atmosphere in the country till 1991.
However, in spite of almost total liberalization of the economy after
1991, the illicit finance outflows from the country increased from 3.5
billion (between 1982-88) to 8.1 billion dollars per year (between 1992-
2008).

The Indian Economy got progressively integrated with the global

markets. The results were visible in agriculture and finance. The liberal
imports of agricultural products started influencing the domestic prices of
the same products in India. The economic impacts of this development
over the poor farmers in India were severe, leading to an enormous rise in
farmer suicides and indebtedness. The financial institutions, mainly banks
and insurance, remained in the public sector. However, the respective
sectors were opened up for foreign investment with an easy inflow and
outflow of finance from the country. Due to a strong base of the public
sector institutions, the 2008 financial crisis in the US did not affect the
stability of Indian economy substantially.

The round tripping of this illicit finance flows into India started playing a
decisive role in the stock markets in the period particularly after the year
2000. The process of round tripping and its consequences are discussed in
the chapters to follow.
 44

CHAPTER IV
BLACK MONEY: AN EFFECT OF MYOPIA IN
TAXATION

All through these years, the Indian economy has taken several right and
left turns. These turns corresponded both with the changes in the ruling
party as well as the changes within the party ruling. However, the element
consistent through all these years after independence has been deficit
financing. In simple terms, fiscal deficit is the excess of government’s
expenditure over its income. The obvious conclusion is that the
governments have been spending more than their income.

It would not be correct to say that deficit financing is a wrong economic

policy per se. It may prove to be positive, if more government spending
leads to efficient public work and pushes the markets ahead by pumping
purchasing power into the economy. Thus, it can work as a medicine, if
administered with a premeditated plan.However, if deficit financingis a
result of helplessness of a government, incapable of enforcing its tax
laws, it pushes a sinking economy further into a quagmire of deficits.If
this incapability is caused by unwillingness to ameliorate the taxation
system, the country almost reaches a point of no return.Thewound of
deficit financing can cause a nation to bleed indefinitely if the
perpetrators of black money are shielded or facilitated.

Deficit financing has always been a subject attracting public debate in

India. The same debate arises every year when the budget is presented in
the parliament. Hence, it is necessary to revisit the whole taxation policy
and system in India, beginning with deficit financing.

As defined above, fiscal deficit is the excess of government’s expenditure

over its income. It may be a result of:

(a) Higher expenditure,

(b) Lower income,

(c) Both of them together.

 45

Fiscal deficit is met by borrowings from public. However, the debate on

the fiscal deficit in India primarily focuses on reducing the expenditure.
The other possible cause of Fiscal deficit i.e. the lower income of the
government is almost neglected. The fiscal deficit can be reduced by
raising the revenueof the government as well as by rationalizing its
expenditure. However, most of the economists and policy makers
emphasize upon “reducing- government expenditure- at –any- cost” as
the only measure of managing the fiscal deficit and the issue of increasing
the revenues of the government remains absent. The view taken by
economists and the policy makers over fiscal deficit has been a biased
one, leading to a blind spot in the economic policy of the nation.

Into the Trap of Low taxes and High Borrowings

It is true that there is substantial wastage of resources and corruption in

government expenditure. However, in a state such as India, mere
reduction in the government expenditure as a singular object will have a
very heavy socio economic cost. The already dilapidated state of
development and governance in India will be hit severely. In spite of this,
the government has been guided by such a singular expenditure reduction
objective for more than two decades. In particular, in the period post
2000, this objective has turned into the founding pillar of the public
finance policy in India.

As a result, the weaker sections and social sectors such as health,

education and rural development have become perpetual losers, while the
politically connected vocal rich have ended up with more economic might
and protection.

Fiscal Deficit, which is an excess of expenditure over income, is met by

borrowings by the Government either domestic or international. These
borrowings always have a cost i.e. interest. The gravity of the situation
can be better understood afterhaving a look at the figures of the
government borrowings and interest burden caused by it. (table 4.1)

Interest Cost In Comparison with Revenue and New Borrowings Central

Govt.)

Year Interest Revenue Interest New Interest as

 46

Payments Receipts as % of Internal % of New

for the Revenue Market and Borrowings
(Figures in year Receipts External in the year
rupee Borrowings
crores) (Figures made in the
in rupee Year
crores)
(Figures in
rupee
crores)

2013-14 3,80,066 10,29,252 37% 4,65,783 81%

2014-15 4,27,011 11,89,763 35% 4,87,038 87%

Source –Compiled from Reserve of Bank of India Handbook of Statistics on Indian Economy
2014

This table shows the appalling state of the Public Finance in India.
More than 1/3 of the yearly revenue is consumed merely by the interest
cost of the borrowings. Moreover, almost all new borrowings are made
in order to pay the interest on the previous borrowings. The total
outstanding loans of the central and state governments together
constituted 67% of GDP in the year 2014-15.

It is legitimate to expect that the current revenues, mainly tax, should

be sufficient to satisfy the day-to-day governance expenditure of the
government and borrowings should be made to incur capital expenditure
or investment in infrastructure. But the figures show that the government
has been borrowing heavily, not for the capital or infrastructural
investment, but to pay the interest on the previous years’ borrowings. It is
evident that these borrowings are a result of a shortfall on the current
revenue, which is supposed to be tax revenue of the country.

FRBM Act perpetuates the same myopia

In view of the ever increasing Fiscal Deficit situation, and also in

response to the IMF conditions for the loan, India passed a Fiscal
 47

Responsibility and Budget Management Act 2003 (FRBM Act 2003).

This enactment created a statutory limit of 3% of GDP for the Fiscal
Deficit of the Central government and 9% as the limit for the total
borrowings of the central government. Consequently, the state
governments were also required to limit their fiscal deficits to 3 % by
enacting similar legislations at their level. It also provided for
presentation of certain information in the form of statements before the
legislative houses for better understanding of the finances of the
Governments. Putting such statutory limits was unprecedented in the
parliament history of India. Targets were set. Consequently, the
Government at the center brought the deficit down to 2.6 % in the year
2006-07. But after the global meltdown in 2008, the Act has been
suspended for the time being.

In our view the primary issue is the approach of the FRBM Act per se.
The FRBM Act reflected the same bias towards reduction in
expenditure and maintained deafening silence over increasing the tax
revenue. The FRBM Act, while limiting the fiscal deficit, did not provide
for any minimum limits for Tax-GDP ratio even as a norm. Thus, the
concept of the “Financial Discipline” and “Financial Responsibility” in
this guiding enactment had only one agenda – “control expenditure” to
control the Fiscal Deficit.

Thus, whether in the ‘pre-reform’ period of 1970s to 1991 or in the ‘post-

reform’ period till today, a myopic outlook, ignoring tax revenues is pre-
dominant. Due to the total absence of political commitment to increase
the tax revenue, tax evasion continued as the policy and practice of the
rich in the country. It finally culminated into the present scale - the
menace of black money

The issue of black money is deeply connected to the issue of tax evasion.
In India, tax evasion is deep-rooted and all pervasive. Consequently, any
measure against tax evasion has to encompass the whole taxation policy
with all its ingredients such as the tax-base, the rates of taxes, tax
enforcement machinery and the socio-economic consequences of
taxation. Therefore, to address the menace of black money, we present a
holistic but brief discussion on the taxation policy in India and its
alternatives here.
 48

Is India over-taxed?

There is a general impression prevailing in India, particularly amongst the

higher classes, that:

1. India is ‘over-taxed’;
2. The government in India is oversized and needs downsizing.
3. Indian state ‘spends excessively’ on social security and social
sectors.

At this point of time, it is important to have a look at the fundamentals of

the tax structure in India.
The following table (table 4.2) gives the international comparison
between Tax-GDP ratios of various countries, proportion of black money
in the GDP and Expenditure under certain heads as percentage of GDP
along with the number of government employees:

International comparison of taxation, black money and governance:

(Table 4.2)
Number of Government

No. Judges per ten lacks population

population
Number

2007)*
Black Money as the % of GDP (year
Name of Tax- Expenditure as percentage of GDP
the GDP
country ratio

of
Police
per
one
lakh
Total expenditure

Education

SocialSecurity

Brazil 34.80 38.76 5.8 9.07 10.43 5.7 77 193 36.6

Russia 20.07 34.24 4.7 6.23 - 15.1 - 564 40,6

India 17.3 27.35 3.11 1.30 2.28 1.6 13 133 20.7 %

 49

China 19.48 23.10 3.3 5.17 3.66 159 445 11.9

South 27.3 32.39 6.27 8.73 5 3.3 - 317 25.2

Africa

Mexico 21.9 23.51 5.2 6.13 3.23 3.9 - 374 28.8

USA 25.1 42.18 5.35 17.7 9.2 7.2 110 226 8.4
7

EU 39.1 49.1 5.5 9.05 12.63 9.8(UK - 12.2

only) (UK only)

OECD 33.45 46.24 6.1 8.37 13.66 - 16.06

Unweighte
d

Sources-

a. Compiled by CBGA from http://laborsta.ilo.org/STP/guest for data on Government Employees and

http://databank.worldbank.org/ for data on Population.
c.databank.worldbank.org
d. Statistical outline of India 2012-13, Tata Services Limited- Table 251.
*The Shadow Economy by Friedrich Schneider and Colin C. Williams page No. 148 Sourced from
BUHN,Montenegro and Schneider 2010, pp.455 to 461

It can be concluded from this table that:

1. Even though most of the countries referred to in the table are

developed capitalist countries, their tax-GDP ratios and
government expenditure-GDP ratios are substantially higher
than India. Even the countries such as South Africa, China,
Brazil, Mexico are developing countries. Nevertheless, they
are collecting& spending significantly higher proportion of
their GDP as taxes than India.

2. These countries are spending significantly high proportion of

their expenditure on social sectors such as education, health,
and social security.
3. They have a substantially high manpower available in
government service. In India, the number of policemen,
 50

judges and government employees is substantially low in

proportion to its population than most of the countries in the
world.
4. It is evident from the statistics:
a. That India is neither over taxed
b. Nor does the Indian State spend enough to discharge
its responsibility in the social sectors, and social
security.
c. Most importantly, India has a higher proportion of
black money in comparison with its GDP in this
group.
Since 1992, the policy makersin India have been simulating the
privatization-liberalization models on the lines of the countries named
above. And in the same process, they have chosen to downsize the
Government Machinery even further by refusing to fill the vacancies in
the crucial areas of system. The sectors such as Education, Health and
infrastructure are being privatized for the want of financial resources.

In view of the international comparison, it is abundantly clear

that this pathetic situation of the Governance is a result of a
deliberate choice of the Governments in power to ignore the issue of
taxation and tax evasion altogether.

To overcome this perpetual and fundamental malady, it is

pertinent to examine the rationality of the taxation structure and poor
tax enforcement in India with reasons thereof. This will enable us to
determine whether India has further tax potential and if India can tap
this potential.

The section has been divided into the following parts:

a. Understanding the tax structure in India.

b. Tax Base in India.
c. The tax potential of India and how it can be realized.
i. Improving the tax-enforcement.
ii. Restructuring taxation system in India.

A. Composition of Tax structure in India:

 51

1. In order to evaluate the taxation policy, it is necessary to

understand the taxation structure in India. Tax revenue constitutes
about 80% of government’s revenue. It is the most important
resource available with the government. The non-tax revenue of the
government consists of the interest receipts and royalties, dividends
on the investments made etc. Taxes in India are levied as per the
provisions of the Indian constitution as given in list I, list II and list
III of the seventh schedule of the constitution. Under the
constitution the taxes are collected and distributed in accordance
with the following scheme.
2. The main sources of Central government’s tax revenue are Excise
Duty, Customs Duty, Corporate Income Tax, Personal Income Tax,
Wealth Tax Etc.
3. The main sources of state’s tax revenue are Value Added Tax
(Previously Sales Tax), Stamp Duty, Entertainment Tax,
Professional Tax, State-Excise (on items such as liquor etc.).
4. At the lowest level of the government, the local bodies collect their
own taxes, which include Property Tax, Local Body Tax (LBT),
Octroi, Turn Over Tax, Entry Tax.30
5. Under the provisions of Article 280 of the constitution, the
President of India is required to appoint a Finance Commission for
the distribution of the Tax-Proceeds, Grants In Aid and loans from
center to the states.
6. So far it has been observed that Centre has distributed about 30%
of the taxes collected by it amongst the States

30
The actual taxes collected in the respective cities would vary according to
states and the political choices made.
 52

BOX 4.1:

Direct taxes– Taxes such as income tax, corporation tax, wealth tax etc. are called direct
taxes. Direct taxes are those in which the point of incidence of taxation and the burden of
payment of taxes, both lie on the same person. For example – income tax is levied on the
income of the income earner and the burden of payment also lies on him (and the burden
cannot be passed on to anyone else).

Indirect taxes– Taxes such as customs duty, excise duty, Value Added Tax (VAT), service
tax etc. are called indirect taxes. They come under indirect system of taxes as the person on
whom the burden of payment lies, pays the tax not directly to the government, but through
the intermediaries such as traders and producers. Thus, the system under which the incidence
of tax lies at one point, while the actual burden of payment lies at another is called the
indirect system of taxation. VAT is to be paid by the seller of a commodity, while its burden
is passed on to the buyer till it reaches the final consumer who does not sell it further.

Progressive taxation: The system of taxation under which the rate of taxation increases in
accordance with the capacity to pay (such as higher income) is called a progressive system of
taxation. For example – there is zero percent income tax at the income level below 2.5 lakhs
per annum. Between 2.5 – 5 lakhs it is 10%; between 5-10 lakhs it is 15 %; between 20 to 30
lakhs it is 20 % and for income 30 lakhs and above it is 30 %. Therefore, progressive
taxation is based on the principle of equity and social justice.

Regressive taxation: The taxation system wherein the rate of tax does not vary with the
capacity to pay is known as regressive system of taxation. For example – Value added tax,
Customs Duty etc. Here all the classes (from the rich to the poor) end up paying the same
amount of taxes on goods bought. Such a system is called regressive taxation because when a
poor person pays Rs.100 as VAT on the purchase of a commodity, it constitutes a higher
percentage of his income than a rich person paying the same Rs.100 on the same product.

The system of direct taxation is progressive, whereas the system of indirect taxation is
regressive in nature.
 53

B. Tax Base in India:

The tax potential of a country can be understood on the basis of its

present tax base in terms of the number of people and the sections of the
society paying taxes. The tax base is also indicated by the types of tax-
payers (such as companies, individuals, trusts with their respective tax
contributions). Similarly, the different sectors of the economy such as
agriculture, industry, and services with their respective tax contributions
are also required to be taken into account to understand the tax-base of a
country.

1. Division of Taxation – Direct and Indirect

Direct taxes constitute 37 % of the Total Tax Collection in India
while 63% of the total taxes are Indirect Taxes. Even developing
countries given below have substantially higher portion of Direct
Taxes in their total tax collection. For example, South Africa (57.5
percent from direct taxes), Indonesia (55.85 percent from direct
taxes) and Russia (41.3 percent from direct taxes). Thus, they have
a more progressive tax structure due to higher contribution of
Direct Taxes to total tax revenue. All developed countries that are
part of the G20 have greater shares of Direct Taxes in their total
taxes than India, with figures as high as 75.8 percent for USA.

2. Consequences of regressive structure:

The issue of evasion of direct taxes not only deprives the countries
of its resources needed for Governance and development; it further
accentuates the existing inequalities to absurd levels. The irony of
regressive tax structure in India appears more discomforting when
we look at countries having higher proportion of direct taxes also
having a high Tax-GDP ratio. This correlation is not accidental, but
logical. High proportion of direct taxes indicates the realization of
the real tax potential of the country. Indirect taxes can rise with the
growth of the economy. But in developing countries like India with
high-income inequalities (where the economic development is yet
to be kick started), an excessive reliance on indirect taxes would
necessarily lead to a low tax base and consequently low Tax-GDP
ratio.
3. Extremely narrow base of direct taxes:
 54

The tax base of India is said to be very narrow. The following

tables from the TARC Third report reveal this fact.In the very first
paragraph of the chapter on Tax Base, the report has pointed out
the glaring facts in this regard. In the last 10 years, the direct tax
collection has increased by more than 700 percent. But the number
of taxpayers has grown by only about 35 %. India has a
disappointingly small tax paying population. In a population of 120
crores only 3.6 crores are income tax payers. It comes to 3.3
percent of the population. The same figure is 46 % for USA, 75%
for New Zealand, 39%for Singapore.

Percentage of population paying Income Tax (International

comparison)
Name of the Country Percentage of the population
Paying Income Tax
USA 46
New Zealand 75
Singapore 39
India 03.3

4. Income Tax base in India (In Box)

Tax No.ofTaxpayers(Crs.) Percent Percent Tax
Slab of Tax of the collection
payers total Tax (RsCrs.)
Collecte
d
0-5 2.88 88.9 % 10.13 15,010
lakhs
5-10 0.18 5.6 % 14.84 21,976
lakhs
10-20 0.14 4.3 % 12.06 17,858
lakhs
More 0.04 1.2 % 62.96 93,229
than
20 lakhs
Total 3.24 crores 100 100 1,48,073
 55

Source TARC third Report page 794 Table 11.14 based on Parliamentary Standing Committee
Report on Draft Direct Tax Code 2012.

1. This table proves that the tax base in India is not only narrow
in terms of the number of the taxpayers, but also in terms of
the tax collection from the tax-payers.
2. 89% of the Tax-payers contribute only 10 % of the total Tax
Collection
3. While 11% of the taxpayers contribute 90% of the Tax
Collection.
4. This has many implications in terms of evasion of taxes. It
implies that the returns are being filed for the minimum
formal compliance; while the real income of these taxpayers
is not revealed nor is it probed further.
5. It is reported (not given in the table) by TARC in its report
that the number of individual taxpayers having shown their
income exceeding Rs. 1crore is only 43,000. This figure is
ridiculously low when compared to the actual realities.

Number of Corporate Tax Payers (In lakh) (In Box)

Category of Tax No. of corporate Tax- Payers

Payers

Financial Year % of the

Total
2011-2012

Below Rs. 50,000 2.95 lakh 50.43

Rs. 50000 – Rs.5 0.91 lakh 15.55

lakh

Rs 5 lakh- Rs.10 0.96 lakh 16.41

lakh
 56

Rs. 10 lakh and 1.00 lakh 17.09

above

Search and seizure 0.03 lakh 0.51

assessments

Grand total 5.85 lakh 100

Source – Compiled from TARC third report “Tax Administration Reform in India Spirit,
Purpose and Empowerment”, table 11.17, pg. 797

From the above table, it can be inferred that:

1. It is evident from the table that even in the corporate tax
payers, 50% of the companies show their annual profitsas less
than Rs.50,000. And those showing their profits more than 10
lakh are just 17%.
2. The number of the companies registered with the Registrar of
Companies, (2011-12) is 7,20,000; while those filing income
tax returns are only 3,76,000. Thus about 2,44,000 companies
do not file the income returns at all. It should be noted that all
the companies registered under the Companies Act are bound
to pay corporation tax on their profits, @ 30%,irrespective of
the amount of the profit earned.
C. The tax potential of India and how it can be realized.
The following points explain what is the untapped tax potential in
India with supporting statistical evidence. It can be realized mainly
through two processes:
1) Appropriate and stringent tax-enforcement.
2) Taking legislative measures to restart certain taxes with
alternative rate structure.
1. The Tax Administrative Reforms Commission recently submitted
its reports to the Government. Quoting from the report, “The Wall
Street Journal reported in 2013 that there are about 125,000
millionaires in India. On the other side of the wealth spectrum,
reflecting the high degree of inequality in India, 95 per cent of the
country (i.e. citizens-authors) has assets below $10,000. The
existence of this shocking disparity has so far done little to shake
 57

the administration to move towards making HNWIs (High Net

Worth Individuals) pay their rightful tax share to the exchequer. It
is obvious that successive governments have been unable to
achieve progress except perhaps in small, occasional instances.
Thus, in March 2013, as part of the budget, the then Finance
Minister proposed a 10 per cent surcharge that would be applied to
people with annual income of at least Rs.1crore (about $ 176,000).
However, as informed by the Finance Minister to the Parliament,
this would apply only to about 43000 individuals in the whole
country despite the fact that the number of millionaires is believed
to be at least 3 times that.”
2. According to Credit Suisse’s Annual Global Wealth Report of
2013, the number of millionaires in the country is expected to jump
by over 66% to 3.02 lakh by 2018.
3. In India, there is no formal recognition of HNWIs as a category of
taxpayers. The taxpayers in the higher income category are all
pooled at a taxable income above Rs.00 lakh and taxed at the
higher rate of 30 per cent, and a surcharge of 10 percent. The
obverse side of this is that such cases tend to be subject to scrutiny
if they are picked up for audit on the basis of criteria-based risk
assessment. Although there are more such potential taxpayers in
reality, those filing tax returns are only about 43,000 as implied by
the Finance Minister’s statement.
a. This category of taxpayers normally gets substantial dividend
income. Currently, dividend income is tax-free in the hands of
the investor as the company-distributing dividend pays
dividend distribution tax at the rate of 15 per cent. Hence, such
HNWIs are taxed at a lower overall effective marginal rate than
those having little or no dividend income. Many HNWIs use
“Hindu Undivided Family” as a shield to extend their income
falling in the lower category of the tax margin. Similarly, as
already mentioned, India should focus on HNWIs. The wealth
tax base can be increased by comprehensively including
intangible financial assets in the base while raising the
threshold. This would be a significant improvement over the
current collection of approximately Rs.1250 crore from wealth
tax, which is almost negligible.
 58

b. According to India Human Development Report (IHDR) 2011

India has top 5 percent of households possessing 38.3 percent
of total assets, and the bottom 60 percent of households owning
a mere 10.2 percent31.
c. As per the Forbes list the number of dollar billionaires in India
has risen to 55 in 2011 (from 13 in 2003). The combined net
worth of these 55-dollar billionaires stood at over US $ 207
billion (Rs.13, 07,000crore) in March 201132.
d. According to another Global Wealth Report by WealthX, India
counts at least 7730 Ultra-High Net Worth (UHNW)
individuals worth at least US$ 925 billion
(Rs.58,36,700crore)33, while the collection of Wealth Tax was
just about Rs.1000crore in 2011-12. If these individuals are
taxed at the present low rates of Wealth Tax of 1 percent,
around Rs. 58,367crore can be realized annually.
e. Sale of luxury cars can be taken as an indiacator of the income
level of the super rich in the country. A Luxury car is defined
by Forbes magazine on web site
(http://www.forbes.com/2009/12/17/luxury-cars-green-

31
Income Gap between rich and poor has widened, says
Planning Commission, By

Ritika Chopra, Mail Today, New Delhi; Dated: October 23,

2011;

http://indiatoday.intoday.in/story/rich-and-poor-division-
penury-hdr-planningcommission/

1/157212.html

32
Compiled from: Forbes List India’s Richest
http://www.forbes.com/india-billionaires/list/

33
WealthX Report, Pg 46: http://wealthx.com/wealthreport/Wealth-X-
world-ultra-wealthreport. Pdf, Page 12 of 12
 59

business-autos-flint.html ) is a car having a price of $ 40,000

(Rs.25lakh) and above. The annual sale of such cars has
reached 30,000 in India. It is growing at the rate of 15 % on
year on year basis, when the passenger car market segment is
finding it difficult to maintain their existing levels of sales.

f. Is tax collection in India responsive to economic growth in

general or the growth of the rich in particular?
Indian Economy between 2007-12 has been growing at an
annual average rate of 7.6% at constant prices. However, it has
been observed that the rate of growth of tax revenues is lower
than the rate of growth in the GDP. The ratio of the growth in
GDP and the increase in the tax revenues of a country for a
given period is called as tax buoyancy.It appears from the
empirical studies of the economic data that the tax buoyancy in
the post reform period (post 1992) has been lower than the pre-
reform period unto 1990)34. Thus, even when the economy is
growing at a high rate, the tax revenues of the government are
not growing even in the same proportion.

If we put all these facts together, a clear conclusion emerges

that:

1. The richer section of the society has been getting

increasingly high share in the rising national income.
2. However, they end up paying increasingly less proportion
of their rising incomes to the government as tax revenues.
g. According to Global Finance Integrity Report, between the
years 2003-13, $439.59 billions have been taken out from India
as illicit finance, i.e., Rs.28 lakh crores. Between 1948 and
2008, $262 billions were lost. The staggering volumes of such
illicit finance flows are indicative of the mountains of tax-
evaded income generated in the country everyday and managed

Concluded on the basis of - degree of tax buoyancy in India and

34

empirical study published in international journal of applied econometrics

and quantitative studies, vol. 5-2 (2008) UPENDER M; Annual report of
Finance Ministry 2013, pg. 150.
 60

to be taken out for further profit making and tax evasion to the
tax havens all over the world.

h. The rate of savings in India is 30% of GDP, which means

Rs.30 out of national income of Rs.100 are not spent but saved.
The same figures for US and UK respectively are – 17 % and
13%. In India, a visibly high level of income inequality such a
high saving rate indicates that there must be a very high
proportion of taxable income concentrated in the hands of the
top segment of population. This income must be charged at a
high rate of direct taxes. On the contrary, these super-rich
sections of the society are almost untouched by any regime of
direct taxes.
i. From the total domestic savings of the country, which is 30%
of the GDP, household sector contributes 22 percentile points
(more than 2/3) and corporate sector contributes 8 percentile
points (about1/3). However, in the direct tax collection, the
share of personal income tax is 37% and that of corporation tax
is 63%. Thus savings in the house hold sector is 2/3 but tax
contribution is only about 1/335.
j. On this background, it is pertinent to note that almost 3/4 th of
total direct tax collection from OECD countries is from
personal income tax while 1/4th is only from a corporate profit
tax. This shows stricter enforcement of tax regime on the
individuals as well. It is a clear sign of minimum tax evasion.
While in India we find an exactly opposite picture. In spite of
high tax potential amongst a section of population and their
luxurious consumption, the enforcement of tax regime is
extremely poor. If we observe the income tax slabs and the
marginal rates of income tax in the developed capitalist
countries, following facts emerge:
I. The threshold limit for the payment of income tax in
these countries start at a level much below its average

35
Conclusion based on economic survey table 3.3, pg. 58 and table 1.6,
pg. 11 from statistical tables of economic survey, 2013-14.
 61

per capita income than India. For example, in US the per

capita GDP is $53,843 per annum. While the threshold
limit for the payment of income tax starts at $12,000per
annum. However, in case of India, the per capita GDP is
1 lakh per annum. While the threshold limit for income
tax is two and a half times the same, i.e. 2.5 lakhs.
II. The highest marginal rate for personal income tax in
these countries ranges between 35-45%, while it is 30%
in India. The corporate income tax also ranges between
35-45%. While in India it is 33% with surcharge.

k. The number of Micro, Small and Medium Scale

Enterprises(MSME) sector in India contributes 8.7 percent of
GDP, 45 % of manufactured output, and 40% merchandise
exports. However only 6% of these MSMEP enterprises are
registered under the respective legislations applicable to
them(Such as factory-shop-office etc.) It should be noted that
not all people running these units are poor. This non-poor
section is eligible to be brought under the ambit of taxation.
But the compliance of the Value Added Tax, Service Tax and
Excise Duties along with the Income Tax Act is very poor.
A substantial amount of Black Money is generated from this
MSME sector, but goes undetected. This is a result of poor
enforcement of the state regulative legislations, due to nexus
between the local political power, tax authorities and the rich
owners of the MSMEs.
l. However, the dismal reality about direct tax collection stands
in stark contrast with the following facts: The value of gold
import has reached 12% of the entire import bill of the country.
Gold has now become an “investment” to stash black money,
corruption money, which in turn shows the immense tax
potential in the country. No scrutiny has been made on the
purchase and hoarding of gold stocks in India.
m. India has a total of Rs.9.35 lakh crore worth currency notes in
circulation (2012). Of these the Rs.500 and Rs.1000 currency
notes together constitute about 80 % of the share 36 and Rs.1000

36
CBDT report on tackling black money.
 62

currency notes have a share of 32.4 %. With 37 % of our

population below poverty line, it is very clear that a very small
proportion of our population possesses these notes. This is the
conclusive evidence of taxable capacity in India.
n. Revenue Forgone or the concessions in Taxes – Attached to the
annual budget every year is a statement called as Revenue
Foregone.

Revenue Forgone (Tax concessions) as % of gross domestic product

Years Direct Tax Indirect Tax Total

2009-2010 1.8 5.6 7.4

2010-2011 1.3 4.8 6.1

2012-2013 1.0 4.6 5.6

Source- Statement of Revenue forgone, Union Budget 2009-10 to 2012-13 (July 2014), Govt.
of India.

o. It can be noted that a substantial portion of our tax potential is

lost in providing concessions to the taxpayers (whether direct
or indirect). The concessions are aimed at giving promotion to
certain sectors of production, diverting investments to
backward region, encouraging savings etc. In principle, such
concessions, if focused and given to the deserving need not be
objected to. However, as experienceshows, these concessions
given under tax schemes never reach their targets. The TARC
report has observed that many of the exemptions and
concessions given by the department under various schemes
are unjustified and require rationalization. The report also
highlights a misuse of such concessions, which add nothing to
the economy but cause a substantial loss to the government
revenue.
 63

p. Following may be cited as some examples. SEZs, small

enterprises concession, concessions based on backward area
based profits, deduction for technological research,concessions
for housing loans, real estate sector. It is surprising to note
that the revenue foregone in this manner is called as the “tax
expenditure” and not subsidies. While any concessions given to
any other section of the society are categorized as “subsidies”.
They are treated as the burden on the government. But, the
subsidies (mostly reaching) to the offluent section of the
society are known as ‘tax expenditure’. It is necessary to
rationalize the tax concessions in all taxes in the country.It can
fetch a substantial amount of revenue, in addition to sealing
one area of corruption and leakage to the tax regime.
q. Revitalizing the tax enforcement machinery:
Table showing vacancies in the tax collection machinery in
India:
The total vacancies in the tax collection machinery in the
government are 30,789.

It should be noted that the situation at the state government’s

level is even worse than that at the center. Thus, the first step to
curb the menace of black money is to fill up the vacancies in
the tax enforcement departments and improving their integrity,
moral and professional conduct.
r. Property Taxes in India- We have seen that the top 5
percent of households possess 38.3 percent of total assets, and
 64

the bottom 60 percent of households own a mere 10.2

percent37. Under any rational system of taxation, not income
but the ownership of property must also be brought under the
tax net. However in India, taxing property as a part of direct tax
collectionis conspicuously absent. The wealth/property in India
is taxed only at the municipal level, whereas, the tax rates are
extremely low and have no connection with the market value or
the purchase price of the said property whatsoever. There is a
working mechanism and enforcement for taxing the income of
the salary earners and registered industries in the organized
sector. But, there is neither sufficient legal power, nor
mechanism, nor enforcement requiredto tax the property of the
upper section of the society.
s. On the contrary, we see that tax laws like Estate Duty and Gift
tax aimed at taxing the rich on the basis of property received in
succession and gift have been repealed long back(in 1986 and
2000 respectively). Following may be cited as the unfortunate
account of demise of the property taxes in India.
a. Estate Duty Act- Estate Duty (Inheritance Tax) was a tax
on the property transferred by succession. It was a
progressive tax, levied @ the range of 4% to 40 %.
However, it was never enforced seriously. The collection
was extremely poor. Ultimately, it was suspended in
1985, citing poor enforcement as a reason. The

37
Income Gap between rich and poor has widened, says
Planning Commission, By

Ritika Chopra, Mail Today, New Delhi; Dated: October 23,

2011;

http://indiatoday.intoday.in/story/rich-and-poor-division-
penury-hdr-planningcommission/

1/157212.html
 65

additional reason given was also that there is double

taxation on the property, as the same property would be
taxed every year by way of wealth tax as well. It is
ironical to note that the capitalist countries such as US,
France, Japan, which rely on Private Property as the
fundamental institution of the society, levy substantial
tax when any property passes on by succession. But a
socialistic country like India abolished the same back in
1985 without any public debate and knowledge
whatsoever.

Box 4.2

Roosevelt on inheritance tax:

In view of the rising concentration of wealth in India, it is necessary to re-impose

inheritance tax in India. The international experience considering USA, Japan and
EU countries support such an idea unequivocally. Even in India, the policy
experts such as Pratap Bhanu Mehta (President of Center for Policy Research,
Delhi), Mr. Vijay Kelkar (Ex-Finance Secretary, Government of India) have
proposed the re-imposition of inheritance tax. It is worth to quote that Franklin
Roosevelt (Ex-president of USA) had supported inheritance in the following
words, “inherited economic power is as inconsistent with the
ideals of this generation as inherited political power was
inconsistent with the ideals of the generation which established
our government”.

b. Gift Tax – The Gift tax was levied upon the gifts made
by a person from 1958. The purpose of the same was to
cover those who would escape from the net of Wealth
Tax, Estate Duty, or Expenditure Tax under the guise of
transfer of property by way of ‘gifts’. However this tax
had to meet the fate of estate duty. It was abolished in
1998-99 on grounds of poor enforcement and collection.
c. Wealth Tax -Collection of Wealth Tax (which is
supposed to be levied on basis of the property holding,
 66

movable as well as immovable, beyond the prescribed

limit) has stagnated for many years and presently stands
at a ridiculous figure of 1250 crores. There is neither
enforcement nor action against those evading the wealth
tax for years. From the figures given, it appears that the
collection of Wealth Tax has been lost from the
consciousness of the tax authorities. Today, the Wealth
tax is levied at 1 percent above the threshold of Rs. 30
lakh on specified assets. RudarDattain his book in Indian
Economy comments “…the wealth tax, for instance, is
extensively evaded and brings in ridiculously low
revenue. There is no purpose served in retaining such
taxes, which would have been dropped long ago. The
wealth tax, however, has been retained because every
finance minister is under pressure from the left parties,
and wants to give the impression that the rich are taxed
heavily.”

t. International Comparison: The experience of various

countries as shown in the table below, proves beyond doubt
that, India has almost singularly relinquished its right to tax
property except at the municipal level, and in land revenue
where the property is taxed at a miniscule scale and that too
just for managing the local body maintenance expenditure. The
tax called stamp duty is levied as per the value of the property.
But it is payable only when there is sale of the property.
u. It is said that inheritance tax also contributes to increase
donations for philanthropy. According to Warren Buffet, Estate
Tax have resulted in many wealthy families in the US to pledge
large chunks of their wealth to philanthropy43, to spare their
heirs the burden of Estate Tax that can reach up to 55 percent.
[Property tax paper, pg. 16]
 67

v. Convert this chart into a table.

 68

Estate Duty and inheritance tax:

 69

Conclusion:

Therefore, the following conclusions can be drawn on the basis of the

facts presented.

1. The Tax/GDP ratio in India is substantially lower than the

developed as well as most of the developing countries.
2. The proportion of direct taxes in the total tax revenues is also
substantially lower in comparison with the developed countries.
3. Even within the direct taxes, the proportion of personal income tax
is substantially lower when compared with the developed capitalist
countries while the proportion of the corporation tax is
substantially higher.
4. The rich and the super-rich in India are grossly under-taxed in spite
of the enormous potential and possibility for the same when
compared internationally.
5. The collection of tax revenue is not rising in proportion to the rise
in the GDP.
6. The property taxes on the rich in India are almost absent and are
barely enforced.
7. The direct tax base of India is extremely narrow and its potential is
barely realized when compared internationally.
8. The tax enforcement machinery in India is deliberately under-
manned and lacks the necessary will and focus to act against the
menace of black money. Moreover, the ruling parties all through
the seven decades have been visibly lacking the political will to act
forcefully against tax evasion and the parallel economy that it
creates.
 70

CHAPTER V
THERE AND BACK AGAIN

In the earlier chapters, we discussed the meaning and scope of black

money, the methods of its generation and its relationship with the skewed
taxation system of the country. We also looked into the international
channels for black money such as Hawala transaction, Transfer Pricing,
Tax havens etc., that have emerged as framework for a fluid flow of black
money across the globalized economies. The same has been a matter of
great concern for the developed and developing economies around the
world and also international institutions such as the OECD, G20 etc.

At the same time, with the recent political hue and cry on the issue of
black money, there was a frequent mention of India’s Tax Treaties and
relationships with other countries. Double Taxation Avoidance
Agreement is one such statute that governs India’s tax relationships with
other countries. From Pranab Mukherjee to P. Chidambaram to Arun
Jaitley, each Finance Minister during his tenure has based their argument
on the non-disclosure norms under the DTAAs that supposedly bar a free
exchange of information. What do these clauses really mean? What is the
Double Taxation Avoidance Agreement that readily accompanies the
debates regarding black money? What are these relationships that are so
prone to damage that all the successive governments have been hesitant
to touch the confidentiality norms. Let us explore.

Why Double Taxation Avoidance Agreement?

Before starting with the purpose and working of tax treaties and regimes,
it is important to understand the basic principles of international taxation.
How did globalization of world trade change the system of taxation
around different worlds – developing and developed? Following is a brief
note on the basic principles of international taxation.

With liberalization of economies around the world, trade and commerce

also transcended national boundaries. With this development, there arose
a need for a system of global taxation too. In international trade, there are
two ways in which income of a business entity is taxed:
 71

a. Income taxed at source - in this case the income is taxed at the

source at which it is generated. It is based on the principle that the
country that provides the opportunity to earn the income or profit
should have the right to tax it.
b. Income taxed on the basis of residence – in this case the income
is taxed where the business entity/person who receives the income
is based. It is founded on the principle that people/firms should
contribute to the government of the country where they are based
from all the income received by them.

For example:S Ltd. is the subsidiary of a company, H Ltd. S Ltd. is

incorporated at a country Harmoniaand thus is a resident of Harmonia. It
does its business at another country Violini and thus generates
incomefrom Violini. If the income is taxed at Violini (where it is
generated), it said to be taxed at the source. While if the income is taxed
at the Harmonia, it is said to be taxed on the basis of residence (this is
because the S Ltd. is a resident of the country Harmonia).

In case of domestic taxation, both source of income and residence of

income receiver converge, i.e. the country at which they are incorporated
is the same as the country they generate their income from. However, in
case of International trade or investments the two may vary. With the
development of the system of international taxation, the firms/business
entities began to be subjected to taxes both at source and residence. This
resulted in very high rates of taxation on the business entities.

Let us take the example of the above-stated company S Ltd. Let us

assume that the rate of taxation both at Harmonia and Violini is 50%. In
this case, the taxes payable profit of Rs.100 generated in country Violini
will be Rs.50. After paying this tax at Violini, S Ltd. will repatriate the
profits (Rs. 50) to Harmonia (country of residence). The tax payable on
this profit in Harmonia is Rs.25 (at 50%). The total tax paid by the
company S Ltd. is Rs.75 and the profit retained is Rs.25. Thus, the
company S Ltd. is subjected to the ‘jeopardy of double taxation’. In order
to eliminate the jeopardy of double taxation, the principle of ‘avoidance
of double taxation’ was born.

To prevent this double taxation, the League of Nations and its successors
the United Nations and the Organization for Economic Cooperation and
 72

Development (OECD) formulated a series of model treaties, which

provide the framework for international tax regime. These treaties help
mitigate the burden of double taxation by focusing on one form of
taxation and giving up the other. The degree to which this is done
depends on the treaty: capital exporting rich countries prefer the OECD
model treaty, which is more favorable to resident countries, while capital
importing developing countries tend to favor the UN model treaty, which
is more favorable to source countries.

In today’s world, it is true that a group of countries having surplus capital

have an opportunity to develop and command the resources of the world.
While, the developing world or the ex-colonies have a dearth of the same.
Thus, the movement of capital from capital rich countries to capital
deficit countries can help mitigate the phenomenon of unequal
development (in the given conditions). Thus, the role of the Double
Taxation Avoidance Agreement is to eradicate the jeopardy of double
taxation and create an atmosphere favorable for business and investment.
This was the rationale behind the Double Taxation Avoidance
Agreements. Now, let us see how these treaties are put to practice.

What is a Double Taxation Avoidance Agreement?

In simple terms, a Double Taxation Avoidance Agreement (DTAA) is an

agreement between two countries to ensure that same income (generated
through any business transactions) is not taxed twice/doubly taxed in both
the countries. Thus, the company that has a residential status in a country
would be subject to tax as per the tax laws of that country. The concept of
‘residential status38 in a country’ may vary according to legal
interpretations for different countries. Usually, the resident status of a
business entity is determined by the location of its ‘effective control and
management’, i.e. the country where the company’s Board of Directors
(BOD)/Executive Directors (ED) make their decisions. Further, this
company is entitled to claim tax credits39 from other
jurisdictions/countries as per the DTAA with the concerned jurisdictions.
38
For more information of the resident status – turn to Box – resident status
39
Tax credit is the amount of money that a taxpayer is able to subtract from the
amount of tax that they owe to the government. Unlike deductions and
exemptions, which reduce the amount of income that is taxable, tax credits
reduce the actual amount of tax owed to the government.
 73

Let us understand this in terms of our previous example. Lets say that
countries Harmonia and Violini have signed a Double Taxation
Avoidance Agreement. S Ltd. (the subsidiary company and a resident of
Harmonia) makes an investment in the country Violini and earns some
profit out of it. By the virtue of the DTAA between Violini and
Harmonia, S Ltd. will be liable to pay tax on the profit to country
Harmonia only (since it is a resident of Harmonia), at the tax rates levied
in Harmonia.

However, in order to avail the benefits under the DTAA, the non-resident
business entity needs to prove its resident status to the government of the
concerned country. The requirements to prove the residential status
depend upon the provisions of bilateral agreements signed by the
concerned countries. For example, in India it is mandatory for non-
residents to produce a Tax Residency Certificate (TRC) from the home
country revenue authority to avail the tax treaty benefits. The format of
the TRC is prescribed by the Indian Revenue Authorities by issuing
guidelines.

The format and guidelines for the issuance of a Tax Residency Certificate
are determined by the concerned jurisdictions and are updated from time
to time. Amongst other things, the principle of beneficial ownership is
factored in while determining the resident status. The beneficial owners
of the property are the beneficiaries who ultimately use or enjoy the
benefits of the assets.

The benefits DTAAs are available only if the recipient of such income is
the beneficial owner of such income. While issuing a TRC to any
company in a country, it is necessary to examine whether the said
company has an independent operative existence and independent
decision making powers in that country. In certain cases, such a company
is just a proxy ‘created’ and registered so as to benefit the ‘real owner’
residing in another country. Such an entity is called a‘paper entity’. A
paper entity is different from the beneficial entity, i.e. the beneficial
owner. Taking our previous example into account, in case it is found that
S Ltd. is just a paper entity and the real control of the operations is
governed from an outside country by the real owner or the beneficial
owner. Ideally, S Ltd. will not be issued a TRC of Harmonia.
 74

India has signed DTAAs with 88 countries. 85 out of these 88 agreements

have been enforced. The jurisdiction and rates of taxation applicable on
the operations conducted and income earned are determined by these tax
treaties. Under the Income Tax Act 1961 of India, there are two
provisions, Section 90 and Section 91, which provide specific relief to tax
payers to save them from the jeopardy of double taxation. Section 90
provides relief to those taxpayers who have paid taxes to a country with
which India has signed a DTAA. However, even the residents of a
country that has not signed a DTAA in India get certain reliefs. Such
reliefs are provided by Section 91 of the Income Tax Act 1961.

A list of the countries with which India has signed a DTAA and their
subsequent modification status is given below.
75
 76

However, India shares special DTAA relationships with some countries

such as Mauritius and Singapore, which happen to come very close to
being tax havens. Let us learn more about these special relationships.

The secret engagement between India and Mauritius:

The Government of India entered into a Double Taxation Avoidance

Agreement with the Government of Mauritius on April 1, 1983. The
 77

purpose of this Agreement, as specified in the preamble, is "avoidance of

double taxation and the prevention of fiscal evasion with respect to taxes
on income and capital gains and for the encouragement of mutual trade
and investment". However, following fact that resulted from this tax
relationship between India and Mauritius are startling enough to suspect
that there’s a lot more to the story than this.With a lion’s share (38%) of
equity inflows into India since liberalization, Mauritius remains the top
investing country for India during the period from August 1991 to March
2013.

In the earlier chapters, we discussed how tax havens are used to route
black money abroad. We also discussed the process of layering through
which, these illicit funds (which are nothing but the tax evaded income
from India) are concealed from the authorities in India and the traces
erased. Now, let us throw some light on how this illicit finance finds its
way back to India where it originated. There is an intricate connection
between – the flight of illicit finance out of India, the Indo-Mauritius
DTAA and the tremendous amount of investment from Mauritius finding
its way into India. Let us now identify and understand this connection.

It has been argued that the bilateral treaty between India and Mauritius
has helped attract foreign investors to the Indian capital market since
 78

1992 when it was seen as a facilitator for greater capital inflows into
India to mitigate the Balance of Payments (BoP) crisis faced by India
during 1990-91. Capital from Mauritius has since then found its way back
to India in the form of Foreign Direct Investment (FDI), Foreign
Institutional Investment (FII), Participatory Notes (PNs) etc. In fact, this
inflow of capital from Mauritius can be termed as ‘Round Tripping of
black income’ or ‘Treaty Shopping’ (these processes are discussed in
detail later in this chapter). Mauritius has thus continued to be very close
to India since almost three decades now. What about Mauritius makes it
so special? Where does Mauritius get the capital to invest in India from?
Following factors might lead us to an answer.

Implications of tax laws and practices in Mauritius:

The taxation structure, DTAAs and the provisions of the Companies Act
in Mauritius facilitate the transfer, routing and round tripping of black
income from India as well as other countries. Not only black income, but
white income is also attracted to Mauritius and is routed to destinations
such as China, India, Thailand etc. In order to understand the ‘incentives’
for routing of ‘investments’ through Mauritius, let us compare the
relevant tax structure and Company Law provisions in India and
Mauritius.

Issue India Mauritius

Incorporation – 2 persons required for Only 1 person or 1

minimum membership a private company
(recently, one person
company has also been
allowed);
7 persons required for
a public company
director is sufficient
for Global Business
Company 1 (GBC 1)
and Global Business
Company 2 (GBC 2)

Confidentiality All documents filed GBC 2 companies are

with the registrar are not required to file
public documents and their documents with
 79

are available for public the Registrar of

viewing. Every Companies. They have
company has to file to file it with Finance
certain documents with Services Commission
the registrar while in Mauritius. This is to
private companies are provide complete
exempt from filing of confidentiality to all
certain documents. the information
However, such an pertaining to GBC 2
exemption is to save companies (names of
smaller companies the share holders and
from undue burden of directors, their share
complying with holding, the assets,
excessive liabilities, profits of
documentation. More the company, taxes
so, the information so paid etc.) Therefore, a
filed with the registrar person operating
is also available for through the company
public viewing to can remain hidden
anyone at the fromthe public eyes
registered office of the unless,the Mauritian
company at a nominal Government
charge. investigates it or unless
the information is
The information being demanded under Tax
publicly available Exchange Agreements.
facilitates intervention
from the appropriate
interested parties,
including the
government without
any special
requirement to
commence formal
investigations and
formal demands for
information exchange.
 80

Resident Status A company A GBC 1 company is

incorporated in India is treated as a resident of
considered to be a Mauritius and is
resident of India for all eligible to enjoy
legal purposes DTAA benefits.
including taxation. However, a GBC 2
company is not
considered to be a
resident of Mauritius
even though
incorporated and
registered in Mauritius.
It is not entitled to
claim DTAA benefits.
It can be inferred that
GBC 2 companies
might operate as shield
for High Net Worth
Individuals (HNWIs)
for holding their tax-
evaded assets/income
from all over the
world. By not being
covered under DTAA
and still enjoying
complete tax
exemption in
Mauritius with full
confidentiality, such
companies can offer
the best shelter for tax-
evaded income. It is
probable that such
 81

‘companies’ purchase
Participatory Notes
(PNs) from GBC 1
companies (FIIs) and
route their tax-evaded
income from world
over to capital markets
such as India for
earning tax free capital
gains and other profits
(at the tax rate of 3%).

Thus, the arrangement

of GBC 1 and GBC 2
companies is suitable
to hide and channelize
the tax-evaded income
to the most profitable
destinations with
further tax benefits.

Taxation On all profits earned GBC 2 companies are

by any company a flat absolutely exempt
rate of 30% is charged. from income tax in
In case of foreign Mauritius. GBC 1
companies, this rate is companies are taxed at
40%. Additionally, the rate of 15%.
companies need to pay However, a GBC 1
taxes on dividend company gets an 80%
distribution, stamp discount on its tax for
duty on sale and deemed foreign taxes
purchase transactions paid. So in effect, this
as per the Stamp Duty company pays 3% tax
Act. On short-term (which is 80% of 15).
capital gains, tax is
charged at the rate of Other taxes such as
20%. capital gains tax,
 82

stamp duty, tax on

dividend distribution
etc. are not levied.
Moreover, the
expatriate officials of
GBC 1 companies are
given 50% exemption
in their income from
Mauritius.

An observation of the regulatory and taxation framework of Mauritius

makes it evident that such a structure has been created to facilitate
parking of illicit funds from across the world and then route it back to the
white economies around the world. From low taxation to confidentiality
norms and opaqueness in the system, the structure makes the round
tripping of funds possible and relatively easy.

Round Tripping:

Round tripping is a process by which the illicit finance (which is nothing

but the tax evaded income) transferred abroad is brought back to the
country where it was generated. Due to the presence of features such as a
low tax regime, liberal business atmosphere and a DTAA, Mauritius has
been a favorite round-tripping center for India. The strikingly high
quantum of FDI and FII flowing into India from Mauritius is a
manifestation of the same. An example of the ingenious mechanisms
formulated to facilitate round tripping of illicit finance out of and back to
India through Mauritius is discussed below.

By the virtue of Article 13 of the DTAA between India and Mauritius,

capital gains derived by a resident of Mauritius by sale of shares shall be
taxable only in Mauritius according to Mauritius tax laws. Further,
circular 789 was issued by the Central Board of Direct Taxes (CBDT) in
the year 2000 to clarify the interpretation of this provision. It was
clarified in the circular that:
 83

1. India has given up its right to collect taxes on capital gains from a
resident of Mauritius; and
2. The TRC issued by the Mauritian authorities will be the conclusive
proof (indisputable) of residence in Mauritius.

Thus, a Mauritian resident earning capital gains is supposed to be taxed in

Mauritius on the principle of residence. However, it is important to note
that Mauritius does not tax capital gains under its domestic laws. As a
result, the capital gains earned by a resident of Mauritius will neither be
taxed in India nor in Mauritius. Thus, Mauritius becomes an ideal
destination providing tax-free exits from any investment structure in
India. For foreign institutional investors (FIIs) intending to trade in Indian
equities, Mauritius provides an alternative with minimum cost in terms of
tax when compared to other available jurisdictions.

Over the years, investigations have revealed that instead of Double

Taxation Avoidance, the treaty has been abused as a tool for Total
Avoidance of Tax by persons/firms from India round-tripping funds. It
has been observed that several of the investments made in India from
Mauritius are those by shell/shelf companies 40, in order to avoid paying

40
A shell/shelf company is a corporation without active business
operations or significant assets. Shell companies are not necessarily
illegal or illegitimate, as they often serve an important for potential
startups. Sometimes, they may be used as a front in tax evasion. Shell
companies however are legal entities in most countries, although they are
known to be used in black or gray market activities.
 84

taxes in India. This issue has been raised and discussed time and again by
the Indian Tax authorities, the government and the courts including the
Supreme Court of India. The same has been discussed in detail later in
this chapter. In the meantime, let us look at some recent updates on
probes on round tripping in India.

In a recent case, FSA led SEBI to investigate into how Anil Dhirubhai
Ambani Group (ADAG) round-tripped of funds amounting to $ 25 crores
from India through Mauritius41. ADAG had used a Mauritius based fund,
Pleuri to invest as much as $250 million in Reliance Communications
shares in India posing as an FII. To disguise the fact that the funds were
being sourced from ADAG group, Pleuri Cell E (activated for the ADAG
group) issued shares to third party banks. These banks in turn issued
structured notes to the ADAG group with the shares of Cell E as the
underlying security. Thus, the legal owners of the shares of Pleuri were
the banks, but the beneficial owners were the ADAG companies42.

It should be noted that, after the investigations, SEBI initiated

proceedings. These proceedings however, ended up in a settlement
through a consent procedure in 2011. Following this consent award two
ADAG companies ended up paying a consent fee of Rs.50crore. Consent
award is the award (judgment) passed by a court adopting the terms of
settlement between two contending parties. A consent award does not
imply an admission or a denial of wrongdoing.

Let us look at another example. In April 2014, the market regulator

Security and Exchange Board of India (SEBI) had issued notices to a
number of major Indian corporate houses including United Spirits,
Unitech, Essar, GMR, and Sterile. The notices were sent on the grounds
of suspicion on stock price manipulation and possible insider trading
through funds parked abroad. The notice was based on the report sent by
the former market regulator of the United Kingdom, Financial Services
Authority (FSA) in 2010. The concerned companies, predictably, denied
any wrongdoings. Following the probe, in November 2014, SEBI
approached the Enforcement Directorate (ED) to investigate if there was
41
http://www.thehindubusinessline.com/markets/roundtripping-sebi-issues-
notices-to-five-major-corporate-houses/article5912100.ece
42
http://www.thehindu.com/business/companies/ubs-pleuri-and-reliance-
adag/article3483686.ece
 85

any violation of Foreign Exchange Management Act (FEMA) in this

matter43.

Treaty Shopping:

Controversies regarding misusing DTAA treaties between countries have

proliferated increasingly. The DTAAs have moved beyond the
boundaries of their concerned countries and have started serving business
entities coming from third party countries as well. This process is known
‘treaty shopping’. Treaty shopping is defined as “Arrangements through
which persons who are not entitled to the benefits of a tax treaty ‘create’
certain arrangements in order to access these benefits.” In other words, a
business entity from a third party country seeks to avail the benefits of a
DTAA existing between two nations. It does so by setting up a shell
company in a country having liberal/zero tax laws and has DTAAs with
other countries. Treaty shopping is a practice of tax avoidance since such
practices may not be illegal, but unethical. As the residents of the third
party countries go on looking for such favorable locations with DTAAs
with the others, for the purpose of their plans for tax avoidance, they are
said to be shopping for the treaty benefits.

Let us understand this better with an example of a real case. In 1996, the
Authority for Advance Ruling44 (AAR) in the Natwest Ruling held that
Natwest Bank (London) routed investments in theequity capital of HDFC
Bank (India) through itsMauritius-based subsidiaries. It was observed that
Natwest Bank held all the shares of the Mauritius-based subsidiaries that
were investing in shares of HDFC Bank. It was further inferred that it was
Natwest bank, and not its Mauritius subsidiaries that had real and
beneficial ownership of the assets of the Mauritius-based companies,
including the shares of HDFC Bank. Thus, the AAR in the ruling
concluded that such a structure was formulated purely for the purpose of
avoiding taxes in India.

43
http://www.thehindubusinessline.com/markets/stock-
markets/roundtripping-of-funds-sebi-writes-to-ed-seeking-probe-into-big-
firms/article6538658.ece
44
Authority for Advance Rulings (AAR) has been constituted under IT Act 1961. The
purpose was to help non-resident Indians to ascertain their Income-tax liability, to
plan their Income-tax affairs and to avoid long drawn and expensive litigation.
 86

Use of PNs:

An FII registered with SEBI may raise its funds by issuing Participatory
Notes (PNs) to the global investors. Such funds may be raised with a pre-
declared and focused purpose of their investment in Indian capital
markets. Such raising of funds is known as issue of PNs. Following is a
discussion on the meaning and implications of PNs. Further, we also
discuss how PNs are being massively used to channel the black money
stashed out of the country back to the country making it ‘appear white’.

Thus, a Participatory Note (in Indian context) is a derivative instrument

issued in foreign jurisdictions, by a SEBI registered Foreign Institutional
Investor (FII) or its sub-accounts or one of its associates, against
underlying Indian securities. The underlying Indian security instrument
may be equity, debt, derivatives or may even be an index. PNs are also
called offshore derivative instruments.

PNs are issued by registered FIIs to those overseas investors who wish to
invest in Indian stock markets without registering themselves with SEBI.
The overseas investor buying the PN does not get the ownership of its
underlying Indian security. The ownership remains with the FII. The PN
holder does not enjoy any voting rights in relation to the underlying
security/shares. However, the investors in PNs derive the economic
benefits of investing in the security without even holding it. For example,
when an Indian-based broker firm buys India-based securities and then
issue participatory notes to foreign investors, the investors have the right
to enjoy the dividends or capital gains arising from the underlying
securities even without formally holding them.

Being derivative instruments and freely tradable, PNs can be easily

transferred. Thus, they can be used to create multiple layers in order to
disguise the real beneficial owner. PNs are issued outside India. The FIIs
that issue PNs act as mini-exchange overseas. Thus, these transactions are
outside the purview of SEBI surveillance. The actual transactions in the
underlying are executed by the FIIs entirely at its discretion and there is
 87

no correspondence between transactions in the underlying instruments

and issuance of PNs.

Thus, PNs have the following features:

Anonymity: Any entity investing in participatory notes is not required to

register with SEBI, whereas all FIIs have to compulsorily get registered.
It enables large hedge funds to carry out their operations without
disclosing their identity.

Ease of trading: Trading through participatory notes is easy because they

are like contract notes transferable by endorsement and delivery.

Tax saving: Some of the entities route their investment through

participatory notes to take advantage of the tax laws of certain preferred
countries.

It is important to note that due to these characteristics of PNs, they are the
most important conduits to round-trip the black money parked abroad
back to India.

PNs constituted about 40% of the FIIs coming into the Indian stock
markets in the decade of 2001-1045. And recently, it constituted around
19.5% in the year 2011-12 and 10% in the year 2012-13. However, it is
worth noting that the government has not banned the PNs, in spite of
persistent demand from the official organs.

International Monetary Fund (IMF) in its paper “Use of Participatory

Notes in Indian Equity Markets and Recent Regulatory Changes”
published in 2007 observed as follows46:

45
Pg. 871, 66th revised edition, Datta Sundaram on Indian Economy.
46
IMF working paper - Use of Participatory Notes in Indian Equity Markets and
Recent Regulatory Changes, Manmohan Singh, Pg. 4
 88

Thus, the increasing bias of investors’ towards hedge funds/unregistered

FII, rising proportion of anonymous investment flowing into Indian
equity markets through PNs and the Mauritius connection have time and
again prompted the Indian authorities and regulators to tighten the reins
on astray investments. The Reserve Bank of India has consistently asked
for a ban on PNs since December 2003 when the total FII capital was
around $20 billion.

Recent developments on PNs:

However, due to the rising internal as well as international pressure

against routing of black money through tax havens certain administrative
measures have been taken. SEBI through some efforts has tried to curb
these mal-practices under the garb of PNs and ODIs (Offshore Derivative
Instruments). In November 2014, SEBI issued a circular that imposes
significant restrictions on the issue of ODIs by FPIs (Foreign Portfolio
Investors). In a measure intended to align the applicable eligibility and
investment norms between the FPI regime and the ODI route, SEBI has
prescribed that an FPI can issue ODIs only to subscribers that meet the
eligibility requirements under the SEBI (Foreign Portfolio Investor)
Regulations, 2014.

The above circular can prove to be instrumental in regulating a fairly

significant market for ODIs. SEBI’s circular makes the ODI process more
 89

transparent as only investors that qualify to register as FPIs would be

entitled to take up ODIs. This is a welcome move from the perspective of
transparency. It also puts a significant onus on FPIs to ensure they issue
ODIs only to qualifying investors, which might mean tightening of the
KYC (Know Your Customer) norms. There has been some tightening on
other incidental aspects as well. For instance, ODIs will be counted (in
terms of beneficial ownership) for determining the maximum limits for
investment by FPIs in Indian companies.

However, in order to ensure the success of the move, a stringent

enforcement of the provisions of the circulars is a must. Moreover, we
need to remember that this is just the tip of the iceberg. Many more
sincere efforts will be required to deal with the larger issue of black
money.

What makes Indo-Mauritius DTAA more attractive?

We have seen that Mauritius is the single largest contributor of FDI and a
highly significant contributor of FII to India. Although, India has DTAAs
with 88 countries, why is Mauritius preferred by the overseas investing
institutions over the other tax havens such as UAE, Singapore as well as
other countries having DTAAs with India.

Apart from the tax benefits, the DTAA between India and Mauritius has
unique provisions as compared to India’s DTAA with other countries. For
example, a DTAA with the UAE recognizes a company to be a resident
company onlyif it is incorporated, managed and controlled wholly in the
UAE. Strict interpretation of the word ‘wholly’ by Indian Authorities has
led to some UAE companies being denied the benefits even if a small
degree of control is exercised outside UAE. By contrast, a Mauritius
entity carrying out the same activities would not be liable to any taxation
on capital gains under the India – Mauritius DTAA, nor would it be
subject to any ‘primary purpose’ test or rigid controls regarding
management of its affairs.

For a Singapore based company to secure a resident status of Singapore,

they are required to undergo a ‘conduit/shell test’. Such a company
should either be a listed company on a recognized Singapore stock
exchange or it must expend more than USD 200,000 on its operations in
 90

Singapore. On the contrary, as discussed above, the Indian government

has virtually freed the Mauritius-based entities from any such
examination (by virtue of circular 789 of 200047).

The Indo – Mauritius DTAA has been a center of controversy for several
years. The legitimacy and constitutionality of several provisions have
been challenged and debated over and over. The most prominent
argument put forth in defense of the Indo – Mauritius DTAA (in its
current form) is that it forms a source of large investments to the country.
And thus, any effort that even comes close to amending the agreement is
vehemently criticized by the investors and the government alike. Such
has been the scenario for the past 22 years at least.

Box 5.1

Article 4 of the Indo – Mauritius DTAC defines a resident of one State to mean
any person who, under the laws of that State is liable to taxation therein by reason
of his domicile, residence, place of management or any other criterion of a similar
nature. Foreign Institutional Investors and other investment funds etc., which are

47
for the entire controversy refer to Box.
 91

Box 5.2

Controversies with Mauritius: Part I

Azadi Bachao Andolan Case History:

In the year 1994, the Central Board of Direct Taxes (CBDT) issued Circular No. 682
dated 30.03.1994. This circular clarified that the capital gains of any resident of
Mauritius by alienation of shares of an Indian company shall be taxable only in
Mauritius, according to Mauritian taxation laws and will not be liable to tax in
India. Large number of Foreign Investors invested in India as a consequence. In the
year 2000, some income tax authorities issued show cause notices to a few FIIs asking
them as to why they shouldn’t be taxed on the profits accrued by them in India. The
recipients of these notices were mostly shell companies. This resulted in panic and a
sudden withdrawal of funds by the FIIs. In response to this, the then Finance Minister,
Mr. Yashwant Sinha issued a press note clarifying that the views taken by the IT
authorities did not reflect the policy of Government of India. The Government then
issued Circular No. 789, thereby making the following clarifications:

1. Wherever a Tax Residency Certificate (TRC) is issued by the Mauritian

authorities, such certificate will constitute a sufficient evidence for accepting the
status of residence as well as beneficial ownership for applying the DTAC
accordingly.
2. The residence mentioned above would also apply in respect of income from
capital gains on sale of shares. Accordingly, FIIs etc., which are residents in
 92

Box 5.3

Controversies with Mauritius: Part II

The Delhi High Court's ruling:

The High Court in its judgment of May 31 2002 quashed the said circular as being ultra
vires on two grounds:

1. That a circular cannot interfere with an assessing officer's right to examine evidence
in support of a tax payer's claim; and
2. That, in order to claim treaty benefits, the subject income must be liable to tax in
both the Treaty countries. Since capital gains are not liable to tax in Mauritius, they
cannot be protected from Indian income tax under the Treaty.

The Delhi High Court ruling purports to put an end to Treaty shopping through Mauritius.
The Government of India then moved the Supreme Court by way of a Special Leave
Petition(Union Of India And Anr vs Azadi Bachao Andolan And Anr in 2003).

Supreme Court's ruling:

The Supreme Court of India set aside the Delhi High Court's judgment and held that
Circular 789 issued by the CBDT is valid on technical grounds. Therefore, the Supreme
Court upheld that the tax residency certificate issued by the Mauritian tax authorities
would constitute sufficient proof of residence of an entity in Mauritius.

Where does the round tripped black money go?

So far we have seen how tax evaded income is transferred outside India
in the tax havens. We have also understood the incentives and the
mechanisms offered by the tax havens. However, a more important
question for the economic analysis of black money requires an insight
into the deployment of this money into the Indian economy.
 93

Such money prefers the channels, which give it quicker and higher
returns with highest ease of withdrawal in case of any action by the
authorities. It also expects a relative anonymity or a camouflaged identity
so as to dodge any liability for tax evasion.

The major sector in the Indian Economy satisfying the above expectations
of the round – tripped tax-evaded income back to India is Financial
Markets.

Financial Markets:

Channels such as participatory notes offer the investors - anonymity and

an easy entry into the Indian Financial Markets. Thus, such channels
provide them with an opportunity to get high returns through speculative
trading on stock markets. Similarly, in case of any intervention by the
government adverse to their interests or in anticipation of an unfavorable
development in stock markets, these investments can be easily
withdrawn. Thus, investment in Indian Financial Markets through
participatory notes (purchased in the global markets and routed through
the FIIs) give the tax evaded income from India the anonymity, high and
quick returns as well as the ease to withdraw at any instant.

LikePNs, another form of instruments facilitating this practice is Global

Depository Receipt (GDR). GDR is a receipt issued against the deposits
received by an Indian company in foreign markets. It is a tradable
financial instrument. Certain cases reported to SEBI have shown that the
GDRs issued to the foreign business entities act as a vehicle to route tax
evaded income from India (illegally deposited into foreign banks) back to
India. Thus, Indian companies appearing to have raised foreign loans, use
them for a specified period and refund it back at Indian rates of interest at
the maturity period.

This hypothesis of channelization of black money from India back into

the financial markets through round tripping is confirmed by observing
SENSEX and NIFTY by way of co-relation between FII investment and
the rise and fall of SENSEX and NIFTY. The same can be inferred from
the rising proportion of PNs in the FII investment in India. Factual
evidence supporting the above claims is provided in the next chapter.
 94

Box 5.4

Shell Company:
Box 5.5

Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FII) explained:
A company is called a shell company if it is devoid, more or less, of any actual
business activity. Such a company is used as a front to hide the real, interested
parties to obtain tax concessions fraudulently.
An investment made by a company or entity based in one country, into a company or entity
based in another country is called Foreign Direct Investment (FDI). Entities making direct
investments typically have a significant degree of influence and control over the company
into which the investment is made.

When the investing company holds more than 10% paid up share capital of another
company, the investment is categorized as FDI. Whereas, in case of an investment less than
10%, it is known as Foreign Portfolio Investment (FPI) or Foreign Institutional Investment
(FII).
 95

CHAPTER VI
FINANCIALIZATION

So far we have discussed the meaning and scope of black money, how it
is generated, the paths it takes to leave the country, its connection with
governance of the country and how it re-enters the economy. Now is the
right time to throw some light on the form it takes when it enters.
Moreover, it is crucial to understand the impact it has on India’s
economic and financial structure and in turn, on a common man’s life.

In order to understand this impact, it is necessary to broaden our enquiry

to examine the relationship between black money and finance. We must
also find out how it relates to the total investment sentiment and climate
in the country.

The growing influence of financial institutions in trade and commerce

needs to be scrutinized. Earlier, finance used to be a necessary input for
the promoters to set up and manage their business units. Banks and
insurance companies used to serve the purpose of business by financing
and risk bearing for the same. However, over the past two decades,
finance has taken the grip of trade and commerce by providing credit to
consumers, channelizing savings to profitable opportunities creating a
host of intermediaries between the providers of finance and their ultimate
users. This has made the financial structure very complex while creating a
number of assets and instruments of notional value. This changed
situation has led to a close nexus between black money and the field of
finance.

In order to understand the same, we will first delve into the rational
foundation and limitations of the financial institutional framework in
India. Thus, in this chapter, we will cover:

 The re-entry of black money into India in the form of ‘finance’ for
a trade in financial assets.
 The foundation and rationale of financial markets.
 The process of financialization and black money as its fuel.
 The consequences and socio-economic impacts of financialization.
 Counter-measures.
 96

Nexus between Black money and Finance Markets:

We ended the previous chapter with a discussion on the sectors, which

attract and welcome the round-tripped black money back into the country.
One of the major sectors isthe financial market. This fact can be
confirmed by observing the co-relation between the FII investments and
the rise and fall of SENSEX and NIFTY. It has also been observed that
the influx of Foreign Direct Investment (FDI) and Foreign Institutional
Investments (FII) in India since 1992 has led to the Indian Stock Markets
rise at an unprecedented rate. Further, the study of 25 major falls in
Sensex on in Bombay Stock Exchange indicate towards a strong
correlation between the entry/exit of FII investments and the
corresponding rise/fall in Sensex48. Thus, it is a well-established fact that
the Indian Finance Markets are driven by FIIs and FDIs. As shown in the
previous chapter, black money constitute a significantly high proportion
of this FII and FDI.

It can be argued that, if the black money illicitly transferred out from
India is brought back in the form of FII and FDI, does it not ultimately
help economic development in the country?

That there is a downpour of investment in India is true. But, is this

investment leading to ‘productive development’ in the country? Or is it
merely creating financial bubbles? If so, what really is finance? What is
financialization? Let us now go ahead and decode it step by step.

What is finance?

Finance refers to money and its representatives. There is a thin dividing

line between money and finance. In simple terms, money is a token of the
purchasing power in an economy. It has a universal acceptance in a given
political unit like a country. It has evolved historically and is present in
the form of coins, currency or credit in a bank account. Whatever form it
takes, it denotes a fixed face value. The value of all other commodities
are expressed in terms of that unit, say Rupees, Yens or Dollars. Money is

Soruce- Jitendar Loomba -International Journal of Marketing, Financial Services &

48

Management Research-Vol.1 Issue 7, July 2012, ISSN 2277 3622. (There is ample of
material available to prove the same correlation between NIFTY and FII-FDIs)
 97

the common and ultimate expression of the exchange value of every

commodity in the economy.

The supply of money in a given economy varies as per the changes in

lending by the banks and government policies. The supply of goods
available in the market may not change immediately in accordance with
the change in the money supply. For example, when money supply rises
without a corresponding rise in the production of goods in the same
period, it results into more money chasing the same quantity of goods. It
leads to a rise in prices and this phenomenon is known as inflation.

The word finance is used in several connotations. When money (in the
hands of an individual consumer) is deployed for a particular project or
purpose, it takes the form of finance. Thus, finance is a specific functional
aspect of money. For example, money in simple terms reflects purchasing
power in any economy. But, when the same purchasing power is drawn in
for a purpose such as a project or a business, it requires systematic
organization and utilization of money. Thus, finance is essentially a
matter of organizing and channelizing money to a focused purpose.

In the modern world, such an organization and utilization of monetary

resources requires a creation of new organizational arrangements and
instruments. This requirement led to the birth of financial assets.

Financial Asset:

Generally, a financial asset (for a financial market) is a tradable

monetary claim over:

 A real asset (a stake in the assets-profits of a company or a

warehouse receipt for the goods deposited), or
 An outcome of an event(a bet, to the extent allowed legally), or
 The results of an investment(a mutual fund unit), or
 The performance of a particular economic indicator or
variable (the rise or fall of an index).

A financial asset is salable and transferable. A financial asset can be

created over another financial asset. This is the peculiarity of a financial
asset. Following are some examples:
 98

1.  An institution like a company or government projects are financed

through the creation of tradable claims like shares, debentures, and
government securities.  They are salable and transferable. Thus, they
become financial assets.

2.     A bill of exchange,Mortgages, loans, rights of recovery etc. can be

converted into tradable financial assets. This can happen in case of banks,
mortgage companies, financial institutions etc. These rights over debts
can be transferred to other institutions for a price. Thus, it becomes a
financial asset.

3.     The instruments specially created for stock markets are tradable and
hence known as financial assets. Derivatives and options are a few
examples of the same.

The savings of the society are channelized to the productive social and
economic purposes by converting them into ‘Finance’. The instruments
created in the process are called financial assets. Since the channelization
of the social resources to such projects is through the corporate bodies
such as companies, corporations, or even the government, it requires
public confidence and reliability.

In order to instill such a confidence in the public and maintain an

atmosphere positive for investment, institutions such as stock markets are
created. Stock markets provide a platform for sale and purchase of shares,
securities (of private or public sector) through a reliable and dependable
framework. It creates a market for the financial assets.

Commodity markets are the organized markets where the buyers and
sellers (buying and selling in bulk quantities) of listed primary products
such as tea, coffee, metal, gold, food grains etc., can enter into present or
future deals in the given framework. These markets inform the bulk
producers and consumers about the trends in prices and expectations in
future, as reflected in the future market deals.

Rationale for the speculative finance markets:

 The stock market provides liquidity to the investors through
shares and securities.
 99

In a company, more investors (share holders) are ready to

contribute to the capital if there is a possibility of an easy exit, i.e.
the withdrawal of such an investment as and when required. The
institution of stock markets has evolved out of this very need of
business to grow. It is due to the tradability and transferability of
shares that joint stock companies evolved and became the most
dominant form of business ventures. Similarly, governments could
raise large quantum of public debts required for governance
because of tradable and transferable government securities and
markets thereof. No developed society today, can be imagined
without channelization of public savings to joint stock companies
and government borrowings.

 The farming community, wholesale traders or the business entities

(using primary products) have considerable stakes involved in the
future prices of the products of their interest. They are interested in
protecting themselves against price risks. This process is known as
hedging. Minimization of risks and uncertainty in the future prices
is their primary requirement. Commodity markets provide a
mechanism to facilitate buying and selling of these primary
products in spot and future markets. The buyers and sellers include
the farming community, wholesale traders and business entities
(using primary products) on one hand and the so-called ‘investors’
on the other. These ‘investors’ are neither the farming community
nor wholesale traders nor business entities (using primary
products). They are speculators seeking a profit opportunity
investing in buying and selling contracts, in the commodity
markets – spot as well as futures.

It is believed that in ideal conditions, the participants of the
markets think and act in accordance with the market fundamentals
such as present and expected production, consumption, future cost,
performance, profitability, sustainability etc. The estimates of the
participants reflected in the spot and future markets are supposed to
gradually lead the spot price to an appropriate price based on the
‘wisdom’ of the commodity markets. Thus, in ideal conditions,
 100

such markets facilitate a graded rise and fall in prices through the
process of price discovery.

Perversion of markets:

In reality, the estimates and speculation of the participants are highly

influenced by the speculative atmosphere and behavior of other
participants. Consequently, the prices no more depend upon the market
fundamentals such as production and consumptions and other objective
conditions. A sort of a herd behavior begins to dominate the markets in
the name of price discovery, leading thereby to a sudden rise and fall in
prices. Although avoiding such volatility is the founding principle of
futures and speculative markets, the purpose itself is defeated due to the
erratic herd behavior in speculative markets. Therefore, the very rationale
of futures markets is compromised. Thus, price discovery degenerates
into ‘price invention’.

In case of high speculation in financial markets, ‘fundamentals’ are

scarcely visible. Therefore, the ‘price’ stops corresponding with the
‘value’. This relationship of the value of a share with its price on the
stock markets can be understood through the Price-Earning Ratio (PE
Ratio) and Price- Book Value Ratio (PBV Ratio).

Table Showing P/E and P/BV ratios of Highest Traded Shares

Shares Price/Earning Price/ Book Value Ratio

Ratio

NIFTY 21.04 3.47

(50Highest

Traded Companies

(Average 2012-13)

Sensex 17.19 2.04

 101

(30HighestTraded
Companies)

(Average 2012-13)

The statistical trends with respect to the PE ratio prove that the
speculative markets have almost lost their connectivity with the
‘fundamentals’ or the ‘value’. (For more information on PE Ratio and
PBV Ratio, see Box).

(Matter for Box 6.1)

Stock markets or Stock casinos?

Price Earning Ratio (PE Ratio) – PE ratio is the relation between the
prices of a share of a listed company on the stock market with the
earnings(dividends) per share in the previous year. It shows how much
return the buyer is likely to get by paying the given price.

Lets say that the price earning ratio is 21.04 and you are paying Rs. 100
to buy one share on the stock market. In this case, your earning from this
share at the end of the year is likely to be 100/21.04 = Rs. 4.75. However,
if you put the same Rs. 100 in a savings account in a bank, you get a
higher rate of interest with total liquidity in cash. Then why would you
invest Rs. 100 in a share with the risk of fall in its value and low
liquidity?

It should be noted that the PE Ratio is not calculated for any single
company. Only the statistics from the companies ranked highest on stock
market are taken into account while calculating the PE Ratio. Almost 75
% of the total trading is done over the stocks of these top companies.

Thus, the answer to the above question is that earning dividends is not
the purpose behind trading on the stock markets these days. Shares are
bought and sold in order to earn maximum profit at minimum cost and
 102

time. Thus the only interest that drives stock markets today is capital
gains.

The PE Ratio has lost its relationship with the earnings out of the
investment in any particular share. In other words, shares are being
bought at skyrocketing prices not for earning high dividends but for the
speculative purpose of getting a higher price through a further sale.
Following the same logic, such financial instruments are sold and resold
again and again. Thus, the ever-rising PE Ratios on the stock market for
the highly traded scrips are an evidence of an increasing quantum of
finance being subsumed into the speculative activity on the stock markets.
The same can be inferred from a generally increaing Price- Book Value
Ratio of the highly traded scrips in the stock markets.

Price to Book Value Ratio (P/BV Ratio)- P/BV Ratio indicates the ratio
between prices of a share of a listed company with the Value of a share
computed on the basis of the Book Value of the assets minus all external
liabilities of the company. It highlights the intrinsic value of a share
based on the balanced sheet and projects a comparison between the
value and the price of the share.

However, the P/BV ratio of all the highly traded upon companies rising
to two and half times the book value of the share, and the P/E ratio of the
same reaching 21.04 is a clear sign of a distortion. It proves the prices of
the shares of these companies are not based on the fundamentals of the
book value, or expected earnings as dividends at all. The shockingly high
prices are simply a result of the speculative manipulation of markets for
exorbitant profits. Thus, both the purpose and the rationality behind
investments and the economy stand defeated.

(BOX 6.1 CLOSE)

BOX 6.2 (Open)

Keynes on Speculation

In his Historical Treaties, The General Theory of Employment,

Interest and Money, Keynes says,"Speculators may do no harm as
bubbles on a steady stream of enterprise. But the position is
serious when enterprise becomes the bubble on a whirlpool of
 103

speculation. When the capital development of a country becomes

a by-product of the activities of a casino, the job is likely to be ill-
done... The introduction of a substantial government transfer tax
on all transactions might prove the most serviceable reform
available, with a view to mitigating the predominance of
speculation over enterprise in the United States."

(BOX 6.2 CLOSE)

The pseudo norm of SENSEX:

The rise of Sensex in Indian Stock market has been phenomenal. In

simple terms, Sensex is an index based on the average price of the 30
selected companies on Bombay Stock Exchange (BSE). The prices in
1979 were given the index value of 100. SENSEX was at 1880 points in
1992, and started rising after the liberalization of finance markets and the
economy. Today (January 2015), it has touched 28000. In simple terms, it
means that if the prices of these shares in 1979 were taken as 100, they
have now come up to 28000. This means that there has been an
appreciation by 279 times. In the earlier section we have seen that, this
rise is not a reflection of the book value of these companies. It reflects the
financialization of the economy.

SENSEX is not a representative of the values of all the listed companies

(numbering 5113). It cannot be taken as a barometer for the capital raised
by the companies in India for their expansion or development projects. It
is just an expression of the value, which the ‘investors’ place while
buying those shares from those holding them. Thus, this is called the
secondary market for the share. This ‘investor’s confidence’ is driven by
a variety of factors, as explained previously in the chapter.

Thus, it is clear that such a phenomenal rise in the SENSEX is reflective

of nothing but the speculative implosion of finance on the 30 selected
scrips.

Why the flow of black money in the financial markets:

Such a speculative activity is driven by quick and high rate of returns

with the highest possible liquidity. In other words, this investment is
 104

nothing but, using the funds in anticipation of capital profits to be earned

by the re-sale of those shares. Such high rate of return on the investment
is received in the minimum possible time with the standing opportunity of
liquidating the asset into money at any moment. Thus, it can be inferred
that illicit finance flows, particularly from abroad are tempted by such a
lucrative opportunity. Also, it has been observed that the proportion of
PNs in the FII investments in India rose phenomenally over years till
2010. It is clear that PNs are the best possible investment option for the
black money to be round-tripped to India. The speculative implosion,
which is a synonym of SENSEX in India, is mainly driven by the high
inflow of FIIs, which is partly an expression of round tripped black
money.

At this point, it is important to note that the use of PNs as a vehicle of

black money routed in the Indian financial markets has been objected by
the bodies like SEBI, RBI and the committees such as Tarapore
Committee II (2007) to put a ban on PNs altogether. During the UPA I
regime, at the insistence of the left parties, the government had declared
that no fresh PNs will be allowed and all existing PNs will have to be
repatriated in 18 month’s time. As a result, the SENSEX in three days
between 17 to 19th October 2007 dropped by 2000 points. The market
value worth 2 lakh crores was lost due to this plunge in the SENSEX.
This loss amounted to about 10% of the total market capitalization value
of the concerned companies.

PNs constituted about 40% of the FIIs coming into the Indian stock
markets in the decade of 2001-1049. And recently, it constituted around
19.5% in the year 2011-12 and 10% in the year 2012-13. However, it is
worth noting that the government has not banned the PNs, in spite of
persistent demand from the official organs.

An inflation in SENSEXand NIFTY indicates that the inflow of foreign

investment has a direct co-relationship with these ballooning indices. The
component of PNs, which is the major conduit of channelizing black
money into the Indian Finance Markets, till recently, had a significant
contribution to it.

49
Pg. 871, 66th revised edition, Datta Sundaram on Indian Economy.
 105

What is Financialization?

When the rate of growth of financial assets is higher than the rate of
growth of wealth in the country, this process is known as the
financialization of the economy of that country. It indicates the diversion
of socio economic resources towards the creation of financial assets.

This process can be witnessed in the light of the following phenomena:

1. The market capitalization statistics of stock exchanges indicate the

market value of the shares available for trading on the stock
markets. For example, the market capitalization on BSE was of the
magnitude of 16,98,428 crores in the year 2004-05. It reached
53,48,645 crores in the year 201350. It rose by more than 300% in a
period of eight years.
2. The component of the primary markets, i.e. the capital raised by the
companies through the stock markets is insignificant as compared
to the volume of trading in general. For example, in the year 2012-
13, 69 companies raised capital worth 32,450 crores 51 from the
stock markets, while the value of shares delivered in the year 2012-
13 on all stock exchanges was 9,68,149 crores52. This indicates the
extent of rising financialization, i.e. channelization of an increasing
component of savings-capital towards speculation in financial
assets.
3. It can be observed from the study of corporate balance sheets in
general that the component of investments made by the corporates
is increasing in the total assets. These investments tend to reach the
financial markets through buying and selling by the corporates.
4. Increasing proportion of investable funds of LIC and banks going
to financial markets. (Witnessed by highest growing unit linked
policies of LIC) It should be noted that a substantial amount of
black money is invested in such policies flouting the KYC norms
of the insurance companies. The banks have been facilitating the
channelization of black money right from the services of safe
deposit walls to benami fixed deposite accounts with free

50
table 10, pg. 23, SEBI report
51
SEBI report, table 5, pg. 18
52
Table 12, pg. 28, SEBI report 2012-13 (statistics report)
 106

consultation. The cobrapost journal has exposed multiple of public

and private sector bank officials rendering such services to the
hoarders of black money.
5. Increasing proportion of the share capital of big corporates
(particularly the 30 included in the SENSEX group) are held by
FIIs. For 826 of 5,432 companies listed on BSE for which comparable
data was available for last 40 quarters, FII holdings as a percentage of
total shareholding rose to 14.21% at the end of June quarter (2014),
has more than doubled since quarter ended December 2005 (share
was 13.81%)53.

6. The volume of trading in the commodity markets has also risen till
2012 at a phenomenal rate. Total Volume of Trade in Commodity
Markets has risen from 77,35,663 crores (in 2009-10) to
1,80,72,419 crores in 2011-12).This is two and half times rise in 2
years. It is already explained in the earlier section that the
commodity markets like stock markets, are necessarily driven by
financial speculation.
7. The speculative financial markets around the world are growing at
a phenomenal rate for the last two decades. In a period of 24 hours
about 5.3 trillion dollars worth of exchange crossed the national
borders. It means that 5.3 trillion dollars are transferred from one
country to the other in a global day54. However, only 1% of these
transfers are connected to the payment of goods and services. Most
of the remaining 99% of the transferred funds constitute
speculative financial transactions.
8. The FOREX market component of India’s speculative finance
market is also growing at a spectacular rate. In the year 2008-09
the total daily turnover of currency futures and options was 1167
crores. It reached 11907 crores in 2013. It is a 10 times rise 55.It
should be noted that this figure is reflective of speculation as there
53
http://www.livemint.com/Companies/hl1vUD7aDkD0jjYw1kAXdN/FIIs-
stake-in-Indian-companies-highest-in-at-least-a-decade.html?
utm_source=copy

54
http://www.risk.net/risk-magazine/news/2293080/fx-now-a-usd53-
trillion-per-day-market-says-bis
55
http://www.nseindia.com/products/content/derivatives/currency/cd_hist
orical_businessGrowth.htm
 107

has been no significant change in India’s foreign trade in this

period.
9. The process of financialization is not merely driven by an
explosion of speculative finance. It involves the tightening grip of
the financial institutions over a large section of the society, trade
and commerce and is increasing day by day. In India, this process
is strikingly visible through the phenomenal rise in non bank
financial intermediaries, microfinance and other financial
institutions including mutual funds. An increasing number of
people are indebted to the financial institutions and are paying an
increasing proportion of their income to the finance companies as
installments.

It can be inferred from the above that the savings in the Indian economy
are being channelized to buying and selling activities on the finance,
commodity and the FOREX markets, which essentially are speculative in
nature. This amounts to a loss of socio economic opportunity to promote
productive and developmental processes in the economy.

The process of financialization is facilitated by the three components:

1. Infusion of speculative investment from overseas sources.

2. Channelization of savings into speculative financial markets
through mutual funds, banks, investment companies as well as by
the individuals on a very large scale.
3. Increasing power of banks for the creation of credit.

Socio-Economic Impacts of Financialization:

Financialization is not merely an economic process. It grips the thought

process of the policy makers and decision makers in the government as
well as the private sector. It creates pseudo norms and pseudo gods such
as SENSEX.The most important priority of the ministries now is pleasing
the sentiment of the investors coming from abroad as well as the domestic
speculative investors. The trends of investment set by FIIs influence the
government policies as well as the investment decisions in the domestic
economy.
 108

Therefore, we witness a rising SENSEX coexisting with a rising rate of

poverty and unemployment in the same economy. A jumping MCMAX
index of the commodity markets with increasing farmers’ suicides stop
pricking the conscience of the policy makers. The infusion and
circulation of black money in the finance and commodity markets is
ignored at a very heavy social cost.

The prices of housing keep shooting up with more number of people

becoming homeless. The imports of gold for speculative purposes create
a demand to convert gold into a tradable financial instrument. All these
are the indicators of financial take-over of the economy. The real assets,
the real production and the real life of the people play a minor role in this
process. In a backward country like India, such a process is possible only
because of four reasons.

1. Thesharply growing inequality with a high concentration of

unproductive (black) wealth in the hands of a few. Such black
income looks for a quick-high return and high liquidity outlets
rather than investments in factories and productive services.
2. Lack of sufficient purchasing power in the hands of a large section
of population to provide a market for the growth of manufacturing
sector.
3. The institutional permissiveness, which has legitimized the black
component of this high wealth to constitute a significant
component of the economy.
4. The overall policy of the government is to infuse an increasing
proportion of borrowings into the hands of people, so as to pump
the purchasing power into the markets. Previously, the policy
emphasis was on increasing government development expenditure,
raising the wages as an input to raise the purchasing capacity of the
people and other empowerment measures. But later, the policy of
the government to withdraw from developmental expenditure (for
want of funds) and deregulate finance has given rise to a surge in
the finance and microfinance lending in the economy.

Ifthese processes remainunchecked qualitatively and quantitatively, they

will degenerate into a total systemic crisis.

Thus, the issue of black money is not merely an issue of tax collection but
 109

also a deep rooted malady which has given an ill turn to our investment
priorities and channelized the savings to wrong and perverse ends making
them pseudo Gods.
 110

CHAPTER VII
LEGAL MEASURES AGAINST BLACK MONEY
As black income began finding its way all across the world from
developed as well as developing countries, an international understanding
and action against the same became an urgent need for nation states. Such
an effort was a necessity to maintain economic governance and tax
regimes in their respective countries. The process of finance
liberalization, relaxation of banking-insurance regulation as well as a
phenomenal rise in the trade in goods and services after 1994 deepened
the contradiction between the mobile global capital and the laws of nation
states whose jurisdiction is limited to specific territories. Additionally,
around the same time, many more countries converted themselves into
low/no tax jurisdictions. As a result, there are more than 69 such low tax
jurisdictions/tax havens in the world today. Similarly, in order to attract
FDI or foreign investment in any form, many developing countries
relaxed their tax laws competitively. Thus, it almost became a global
liberalization competition.

This resulted into a situation where the free-flowing global capital

became the only economic driver calling the shots. From 1970s to 1995,
it was the developing world, which was suffering an erosion of its tax
income. However, after 1995, even the developed world began losing its
ground when capital started flying out from their home countries. This
capital now found a temporary shelter in the newly created tax havens
such as Cayman Islands, Mauritius, Singapore, UAE etc. The massive tax
evasion organized and legalized through these tax havens started
becoming a serious concern even for OECD countries.

Drug rackets, internationally funded terrorism and illicit funds flown out
by the corrupt state leaders posed a serious threat to local governance. All
this culminated into a collective international thinking to counter illicit
finance flows through tax havens.

Thus, the contradiction between the political set up of the world and the
liberalized mobility of capital has created a situation, which has posed a
serious challenge before the world community. Therefore, we find
 111

nations, developed as well as developing, coming together through

United Nations or OECD or G20 along with World Bank to create
focused specialized forums for a untied and concerted action against tax
evasion and illicit transfer of funds all over the world.

Following may be cited as examples of international measures in this

regard:

GAAR – An instrument to ensure Substance over Form:

In the previous chapters, we have discussed the concepts of ‘tax evasion’,

‘tax avoidance’ and ‘tax mitigation’. It is understood that ‘tax evasion’ is
generally the result of illegality, suppression, misrepresentation and
fraud. ‘Tax evasion’ is prohibited under the current provisions of the
Income Tax Act. Tax avoidance is the result of actions taken by the
assesse, none of which or no combination of which is illegal or forbidden
by the law itself. However, when looked at holistically, such practices are
against the intent and spirit of law. ‘Tax mitigation’ is a situation where
the taxpayer legitimately takes advantage of the fiscal and tax incentives
made available to him by the tax legislation. The demarcations look clear
and distinctive on the paper. However, in reality and in practice, it
becomes difficult to draw line between ‘tax evasion’, ‘tax avoidance’ and
‘tax mitigation’. Technically, the terms evasion and avoidance are
different. But, in our view, for all practical purposes, tax evasion and tax
avoidance should be considered as one phenomenon.

The above concepts can be understood through the following example.

1. A person chooses a road with the minimum number of traffic

signals to reach a destination. Such a choice can be equated with
the process of tax mitigation.
2. A person encounters a red signal while commuting to his
destination. In order to avoid this red signal, the person takes a left-
turn (which is not the path he intends to tread), then takes a U-turn
and then takes a left turn again. In doing so, he escapes the red
signal and reaches the original path he intended to take. In this
case, taking a left-turn and a U-turn, although legally permissible,
 112

are calculated actions taken by the concerned person to avoid the

red signal by misleading the policeman. Such a choice can be
equated with the process of tax-avoidance, which necessarily
involves an abuse of the law. In technical terms, it appears to be
correct, but it is motivated by mischievous intentions.
3. A person encounters a red-signal on his way and breaks the signal
to go ahead. This case can be equated with the process of tax
evasion. In such a case, the person has violated the legal provisions
and can be charged for the same.

Tax avoidance and tax evasion are ethically and effectively on the same
ground. Both of these are calculated moves culminating into non-payment
of taxes (payable under the law).

We have already discussed at length how the tax benefits and tax treaties
are subjected to abuse at a massive scale in India and outside. The
loopholes (which are sometimes deliberate) have caused severe erosion of
India’s tax base. Similar situation has been faced by most of the
developed and developing economies around the world. The tax havens
such as Switzerland, Mauritius, Cayman Islands, Luxemburg etc. have
had prominent roles in the same. For over decades, it has been witnessed
that international business entities intending to evade taxes indulged in
creating business structures and arrangements, the sole purpose of which
was evasion of taxes. Thus, the form of such structures was legitimate
according to the black letter of the law. But in substance, they violated
the principles embodied under the laws. The evolution of the processes of
round tripping and treaty shopping are clear evidences of this
phenomenon. These processes have been discussed in detail in the
previous chapter.

However, as the world became conscious of these practices, their

unethical nature began to be widely condemned. As of today, the question
of substance over form has consistently arisen in the implementation of
taxation laws. In order to deal with this situation the model of General
Anti Avoidance Rules (GAAR) has been formulated internationally as a
result of international cooperation against the menace of black money.
 113

What are GAAR (General Anti Avoidance Rules)?

GAAR is a codification of the proposition that while interpreting the tax

legislation, Substance should be preferred over the legal Form.
Transactions have to be real and cannot be looked at in isolation. Only
the fact that they are technically legal under the law does not make them
acceptable with reference to the meaning in the fiscal statutes. GAAR
provisions prevent the assesse form availing the benefits created out of
such concocted arrangements. Thus, the GAAR provisions codify the
substance over form rule.

Tax Evasion is prohibited under the respective national laws. Therefore,

GAAR does not focus on the cases of tax evasion. GAAR provisions
focus primarily on the practices of Tax Avoidance. This is because Tax
Avoidance is a grey area, which requires further scrutiny. Tax mitigation
is permitted under the law and GAAR provisions do not inhibit taxpayers
from organizing their affairs in a normal commercial manner.

The issue of substance over form is precisely the point of tussle between
the interested parties in India and the international pressure to
operationalize GAAR. The government in India shows a bias towards the
investors’ interest in India. But, it cannot bluntly reject the international
pressure to operationalize GAAR. As a result, we see the government’s
effort to ‘somehow’ appear to be active in the implementation of GAAR
while also ensuring that nothing concretely comes out of such ‘make-
believe’ enforcement efforts. In the paragraphs to follow, the readers will
realize the reality behind the façade created over the issue of GAAR by
the Indian government.

Indian Story of (in)application of GAAR:

Interestingly, the story of GAAR in India has been full of twists. Ever
since the announcement of enforcement of GAAR in India, the business
and ‘investing’ community has been jittery and unwelcoming.

The GAAR provisions were introduced in the 2012-13 Budget by then

Finance Minister Pranab Mukherjee. GAAR was to come into effect from
 114

April 1, 2014. The proposal was met with a ‘generated controversy’ in

which the ‘investors’ appeared to be apprehensive.
In order to comfort and pacify ‘investors’, Finance Minister
PChidambaram in January announced the postponement of the
implementation of GAAR by two years to April 1, 2016.
After the GAAR provisions were notified, there was a strong reaction
from the interested parties likely to be affected by these regulations. A
number of representations were made to CBDT. An expert committee
was appointed to go into the demands made through the representations

Box 7.1

In September 2013, the CBDT notified the rules that would govern India’s new
GAAR. (Exclusions to GAAR)

According to the notification, GAAR will not apply to:

An arrangement where the tax benefit arising to all the parties to the arrangement in
the relevant assessment year does not exceed INR 30 million in aggregate.

  A Foreign Institutional Investor (FII):

  Who is an assessee under the Act;

  Who has not taken benefit of an agreement referred to in Section 90 or

Section 90A of the Act;

  Who has invested in listed securities, or unlisted securities, with the prior
permission of the competent authority, in accordance with the Securities
Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and
such other regulations as may be applicable, in relation to such investments;

  A non-resident person who has investment by way of offshore derivative

instruments or otherwise, directly or indirectly, in a FII;

  Any income accruing or arising to, or deemed to accrue or arise to, or received or
deemed to be received by, any person from transfer of investment made before the 30
August 2010.

and clarifications were issued and suitable amendments were made in the
law. For the exclusions as they stand today refer the Box.
 115

Exclusions or Protections?

Ideally, the GAAR notifications in India should have targeted the

deceptive forms created to hide the real interests, operators and the
owners of the illicit finance or black income-investments. But, the
clarifications and exclusions have culminated effectively into protecting
the most frequently used conduits and channels of illicit finance coming
in and going out from India. The exclusion of the companies getting less
than Rs.3crores of tax benefit in one year amounts to exclusion of a large
number of probable tax evaders from the ambit of GAAR. It is shocking
to note that the route of PNs, which is the major channel of round tripping
of India’s black money back to India through tax havens has been out
rightly excluded from GAAR along with all such Offshore Derivative
Instruments (ODIs). To remind the readers, these ODIs remain
anonymous to Indian Tax authorities. It is for the same reason that the
RBI, CBDT as well as experts in the field of finance have consistently
suggested that the issue of participatory notes be prohibited. Surprisingly,
in contrast to such demands from its official organs, the government has
chosen to protect PNs even from a scrutiny under GAAR.

Special Protection to Mauritius?

Also, it should be noted that at the government, bureaucratic and

policymaking level, there is a strong favor for exempting Mauritius
routed investments in India from the application of GAAR. Even though
the government notification in this regard has not given such an
exemption, an expert committee headed by tax-expert Parthasarthy
Shome had categorically recommended an exclusion of Mauritius route
investments and the investments from Singapore under DTAA from the
purview of GAAR. In the year 2000, CBDT had taken actions against
suspicious nature of investments through shell companies from Mauritius.
Mr. Yashwant Sinha, the Finance Minister of India at that point of time,
invalidated these actions. Circular 789 was issued which resulted into
total immunity even to the suspicious investments coming from
Mauritius.

This shows the presence of a strong lobby amongst the policy makers and
bureaucrats favoring the Mauritius route for ‘investments’ (suspicious in
 116

character), despite the presence of a section of bureaucrats in CBDT

taking position against such an abuse of the Indo-Mauritius DTAA.

Flawed Economic Policy – the real culprit:

The reason for which the government seems to have diverted the focus of
GAAR is disturbing in terms of the economic policy. The whole exercise
of signing DTAAs or relaxing the existing DTAAs for the benefit of
foreign investment after 1990s has been carried out solely to increase the
foreign exchange reserves ‘at any cost’. Liberalization of imports and
exports (after 1992) led to a faster and higher rise in imports and
relatively lean increase in the exports from the country. This led to a
widening of the trade deficit. It also led to deficit in the management of
foreign exchange in the current account, which is known as Current
Account Deficit (CAD). In other words, India has been falling short of
foreign exchange reserves before 1991 and it continued to remain trapped
even after liberalization in 1992. The ideal solution to this problem is a
rise in exports and a reduction in imports to the country. However,
instead for working on these lines, the government chose to ‘manage’ the
foreign exchange problem by getting the foreign exchange to pay for the
rising imports. This can be done only by way of loans or capital
investment. For capital investment in the industrial or any productive
sphere, the investor is motivated only by the fundamentals of the
economy and the long-term market potential of the country.

However, the Indian economic conditions were not sufficiently attractive

for FDI in new centers of production for economic activity. Indian
government, despite this knowledge, chose an option to attract foreign
institutional investors in the finance markets. Accordingly, the DTAAs
were suitably interpreted and financial liberalization measures were
adopted (despite oppositions from the official organs such as RBI to some
of these measures). Consequently, the black income holding industrialists
and political leaders found a suitable route to arrange the outflow of
capital from India through legal/illegal channels and its round-tripping
under the umbrella of Foreign Institutional Investment. Any measure to
curb such round tripping is met with an immediate withdrawal of FII
investment in India creating apprehensions for foreign exchange reserves.
Thus, the Indian government succumbs to the indirect pressure of the
 117

round-tripped FII investments. The current GAAR regulations made

under the international pressure have made serious compromises on the
issue of PNs, the backbone of the round tripping of illicit finance in India.

Box 7.2

Substance submerged under form: The Vodafone case

The Vodafone case was litigation that was initiated in the Bombay High Court in
2010, when Vodafone International challenged the jurisdiction of India’s tax
authorities that sought to levy tax on Vodafone’s effective purchase of a
controlling stake in Hutchison’s (better known as erstwhile mobile telephony
provider Hutch) India activities.

The Bombay High Court agreed with the arguments of India’s tax authorities and
held that the capital gain in question arose out of property situated in India and
therefore was taxable in India. This decision was, however, overturned by the
Supreme Court, which reaffirmed that tax related litigation looks to the wording
of law and not to the alleged motive behind it, that the structure of the Vodafone
transaction must be accepted by Indian tax authorities, and they were not entitled
to look beyond and ascertain the economic ‘motive’ of the deal. This case
becomes important in light of the fact that the total tax claims by Indian

DTAAs – behind the scenes:

In earlier sections, we have seen that the modus operandi of channelizing

black income in and out from India hinges upon certain provisions under
DTAAs. The very purpose of DTAA is defeated by its abuse to facilitate
illicit finance flows. Although, the invocation of GAAR is a step towards
sealing the misuse of DTAAs, revisiting DTAAs to overcome the
 118

loopholes is the need of the hour. The most important point of

renegotiation has been the provisions regarding exchange of banking
information along with the names.

In the report ‘Measures to Tackle Black Money in India and Abroad,

2012’, the CBDT reported that India has opened negotiations over the
exchange of banking information along with names with 75 countries out
of which negotiations are finalized with 28 countries and revised
agreements are signed with 7 countries. Out of these 7, the agreements
brought into force are 5. Surprisingly, these 5 include the well-known tax
havens of Switzerland, Singapore and Luxemburg. But, the name of
Mauritius does not figure in the list of the countries with whom the
negotiations are finalized. Moreover, in spite of the enforcement of a new
agreement with Switzerland, India is still not equipped enough to receive
the information about the Indians holding bank accounts in Switzerland
and the transactions through their accounts. The statements made by
Swiss ambassador in India were in complete contrast to the demands
made by India in this regard. It implies that the renegotiated DTAAs are
ineffective and toothless as far as curbing the flow of black income from
India stashed abroad is concerned. This reflects a lack of political
determination and the invincible strength of the international lobby of the
financial institutions sheltering black and illicit finance around the world,
as it exists today.

Limiting the ‘benefits’ reaped under DTAAs:

In earlier chapters we have seen that in India’s DTAA with Singapore and
USA, there are clauses known as Limitation of Benefit Clause (LoB). An
LoB clause ensures that the tax benefits under the DTAAs are enjoyed by
the arrangements satisfying certain eligibility norms. Thus, the LoB
clause in DTAA is a provision to make sure that the residence of business
entities in the countries concerned is substantiated by their conduct,
operations and management.

We are aware of the fact that 40% of FDI and a substantial share of FII
investment into India come from Mauritius. Also, it is widely accepted
that the nature of most of this investment is tainted. In the year 2002, the
Supreme Court had held that due to the absence of a LoB clause in the
 119

DTAA with Mauritius, the tax benefits couldn’t be denied to the

investments coming from Mauritius, even when they were made by paper
entities or shell companies. To quote from the CBDT report:

“Despite our best efforts, we have not been able to introduce LOB
provision in the Indo-Mauritius DTAA as Mauritius does not agree for
renegotiation of the treaty, resulting in substantial loss of revenue to the
exchequer. Not only in Mauritian treaty, but in a number of our other
DTAAs, there are no provisions for LOB and we have not been able to
renegotiate these DTAAs due to resistance from those countries56.”

The Supreme Court judgment in the Vodafone case 57 has interpreted

DTAA with Mauritius in its literal terms. It was held that the treaty
benefits couldn’t be denied to any resident of Mauritius,as there was no
qualifying clause to limit the tax benefits to the entities eligible to avail
the same. In view of the Supreme Court interpretation and the difficulty
in amending all the DTAAs to include the LoB clause, CBDT in its report
of 2012 suggested that the best viable alternative would be to amend our
domestic law, i.e. S. 90 and S.90A of Income Tax Act 1961, to prevent

Box 7.3

Thus, the Supreme Court has held that almost in no case, treaty benefit
can be denied to Mauritian companies, till the DTAA is revised or at the
least, a LOB clause is introduced. It is accordingly proposed that Circular
No. 789 of 2000, which has been issued by the CBDT, should be
withdrawn. However, only the withdrawal of circular would have no effect,
if the ratio of the above decision is applied. In view of the above, it is
proposed that LOB provision may be introduced in the Income-tax Act with
a limited treaty override on this issue meaning that even if there are no
LOB provisions in a particular treaty, the domestic law will take
precedence. Accordingly, the following amendments are proposed by way
of a proviso below sub-section (2) of section 90 and section 90A:
56
Pg. 20, para. 12.10.3, CBDT report
57
Box
“Provided that the benefit of the Agreement, entered into under sub-
 120

paper entities from reaping benefits under DTAA. (Check the

recommendation of CBDT in Box 7.3.

Confidentiality norms – myth and reality!

In the beginning of the book we has a glimpse of the controversy with

regard to disclosure of names of the black money holders in the bank of
Liechtenstein. While in power, the UPA government maintained that it
could not disclose the names in the list as this would lead to a violation of
confidentiality norms in the Double Taxation Avoidance Agreement
(DTAA) under which India had received the names. The NDA
government after assuming power seemed to take the same track and
went ahead to file an application in the Supreme Court pleading the Court
to vary its judgment. Again, the reasons cited were that –

1. The submission of the names would lead to the violation of the non
– disclosure norms in the DTAA under which India had received
the names from the German Government.
2. Such an action would cause an impediment in signing the
Intergovernmental Agreement (IGA) the India was supposed to
sign with USA.

How legitimate are these reasons? Does handing over the names of
foreign account holders lead to a violation of the DTAAs? For an answer,
we need to turn to the Supreme Court’s interpretation of the
confidentiality norms under the DTAAs. The observations by the Court
are as follows:

“We are convinced that the said agreement, by itself, does not proscribe
the disclosure of the relevant documents and details of the same,
including the names of various bank account holders in Liechtenstein. In
the first instance, we note that the names of the individuals are with
respect to bank accounts in the Liechtenstein, which though populated by
largely German speaking people, is an independent and sovereign
nation- state. The agreement between Germany and India is with regard
to various issues that crop up with respect to German and Indian
citizens’ liability to pay taxes to Germany and/or India. It does not even
remotely touch upon information regarding Indian citizens’ bank
accounts in Liechtenstein that Germany secures and shares that have no
 121

bearing upon the matters that are covered by the double taxation
agreement between the two countries. In fact, the “information” that is
referred to in Article 26 is that which is “necessary for carrying out the
purposes of this agreement”, i.e. the Indo-German DTAA. Therefore, the
information sought does not fall within the ambit of this provision58.”

“It does not matter that Germany itself may have asked India to treat the
information shared as being subject to the confidentiality and secrecy
clause of the double taxation agreement. It is for the Union of India, and
the courts, in appropriate proceedings, to determine whether such
information concerns matters that are covered by the double taxation
agreement or not59.”

“The government cannot bind India in a manner that derogates from

Constitutional provisions, values and imperatives60.”

For the curious readers, the bare text of Article 26 of the DTAA between
India and Germany runs as given in Box 7.4.

It should be noted that the terms of information exchange in the DTAAs

that India has with Mauritius, Switzerland, France and even other
countries are similar in nature. Thus, as far as the legal interpretations are
concerned, even the Apex Court of the country has ruled that Art. 26 acts
as no barrier to disclosing information received to either the SIT or the
Court itself. The compliance of the Court order by the NDA government
was a positive development. This is just the beginning. The battle against
the black hole of black money is long and can be won only through strong
and persistent political will.

58
order, pg 38, para 56
59
order, pg 39, para 56
60
order, pg 61, para 41
 122

Other International Initiatives:

Stolen Assets Recovery Program (StAR):

The Stolen Asset Recovery Initiative (StAR) is a partnership between the

World Bank Group (WBG) and the United Nations Office on Drugs and
Crime (UNODC) that supports international efforts to end safe havens for

Box 7.4

Art 26 – DTAA between India and Germany

“1. The competent authorities of the Contracting States shall exchange such
information as is necessary for carrying out the purposes of this Agreement. Any
information received by a Contracting State shall be treated as secret in the same
manner as information obtained under the domestic laws of that State and shall be
disclosed only to persons or authorities (including courts and administrative bodies)
involved in the assessment or collection of, the enforcement or prosecution in respect
of, or the determination of appeals in relation to, the taxes covered by this Agreement.
They may disclose the information in public court proceedings or in judicial
proceedings.

2. In no case shall the provisions of paragraph 1 be construed so as to impose on a

Contracting State the obligation:

. (a)  to carry out administrative measures at variance with the laws and
administrative practice of that or of the other Contracting State;

. (b)  to supply information which is not obtainable under the laws or in the normal
course of the administration of that or of the other Contracting State;

corrupt funds. The UNODC-WBG StAR initiative is an integral part of

the World Bank Group’s recently approved Governance and Anti-
Corruption Strategy, which recognizes the need to help developing
countries recover stolen assets. The international legal framework
underpinning StAR is provided by the UN Convention Against
Corruption (UNCAC), the first global anticorruption agreement, which
entered into force in December 2005. India signed UNCAC only recently
 123

in 2011.

As per the StAR Report61, three success stories in the past decades have
been Peru, Nigeria and Philippines. But in the past year or so, there
have been more success in repatriation efforts of the Stolen Assets. The
above cases are glaring examples of a world – wide wave against Black
money and its perpetrators. Such success stories also prove that with
sincere efforts and international cooperation the secret world of black
money can be terminated.

Base Erosion and Profit Shifting (BEPS):

Base Erosion and Profit Shifting (BEPS) relates to instances where the
interaction of different tax rules leads to some part of the profits of MNEs
not being taxed at all. It also relates to arrangements that achieve no or
low taxation by shifting profits away from the jurisdictions where the
activities creating those profits take place. The Organisation of Economic
Cooperation and Development (OECD) on 19 July 2013 released its
Action Plan on Base Erosion and Profit Shifting (BEPS). BEPS is also a
focus area of the G20 leaders and negotiations on the same have been
carried out in the G20 summit in Brisbane in 2014.

From an Indian perspective, measures to deal with treaty shopping and

other forms of treaty abuse described above are of great importance.
Equally important is the agreement to implement BEPS measures through
a multilateral instrument as well as thinking on taxation of the digital
economy.

Global Forum on Tax Transparency and Exchange of Information:

OECD, a group of 31 developed nations has taken an initiative in uniting

the international community on the issue of Financial transparency and
exchange of information. It should be noted that the membership of this
forum is made wide and open for developing as well as developed
countries resulting into 122 members including all G20, OECD countries
and even certain offshore financial centers. This group is playing a
proactive role first by evaluating the legal framework necessary for the

61
http://www.unodc.org/pdf/Star_Report.pdf
 124

exchange of information in the respective countries. It is heartening to

note that India has acted as the member secretary of this group.

Automatic information exchange – TIEAs – also discuss if TIEAs have

been any useful

Co-operation between tax administrations is critical in tackling the issue

of tax evasion and protecting the integrity of tax systems. A key aspect of
that co-operation is exchange of information. It is for the same reason that
the OECD endorsed the ‘Declaration on Automatic Exchange of
Information in Tax Matters’. Automatic exchange of information would
allow for “collecting all bank information on non-resident to pass this
information on to the countries of residence of these taxpayers so that
they can no longer hide money on offshore accounts. The leaders in the
G20 Summit, Brisbane in November 2014 committed to put in place a
mechanism for automatic exchange of tax information between member
countries by 2017.

Automatic exchange of information involves the systematic and periodic

transmission of “bulk” taxpayer information by the source country to the
residence country concerning various categories of income (e.g.
dividends, interest, etc.).

TIEAs:

India is negotiating Tax Information Exchange Agreements (TIEAs) with

22 countries out of which 10 agreements have been finalized and only 5
of them have been brought into force. India and Mauritius have agreed to
sign a TIEA. However, such an agreement has not been finalized as yet. It
should be noted that these TIEAs have not proved to be an effective tool
for sharing and exchange of information. Many more sincere efforts are
required to put in place a system that can ensure transparent and effective
sharing of information.

Exposure of perpetrators - the untold story:

The purpose of tax evasion is to avoid the tax liability by any means
possible. In order to realize this motive, multiple arrangements and
 125

entities are created to camouflage the really interested parties and the
beneficiaries. This process of hiding/changing/suppressing/camouflaging
the real owners of the assets or income or their beneficiaries is called as
money laundering. In order to achieve this purpose, a range of fictitious
identities, nominal corporate entities, trusts, firms or businesses are
created. These arrangements are not illegal in terms of their existence and
operations (as in case of the example of Laundromats given in the chapter
dealing with the generation of black money). However, most of them are
mere puppet or paper entities lacking any substance. But, such
arrangements invariably have a human agency as the causal factor and the
beneficiary.

Financial Action Task Force (FATF) is yet another international effort

aimed at the prevention of money laundering. FATF has recommended a
range of measures to prevent and counter the schemes and conspiracies
motivated by money laundering and terrorism. It has proposed standards
for regulating the finance sector for this purpose. One of their major
recommendations is to set up a mechanism that enables reaching up to the
real interests behind the asset and income ownership. They have defined
the beneficial owner as under:

“Beneficial owner refers to the natural person(s) who ultimatelyowns or

controls a customerand/or the natural person on whose behalf a
transaction is being conducted. It also includes those persons who
exercise ultimate effective control over a legal person or arrangement62.”

This suggestion seems very effective as it aims to expose the natural

person operating behind the façade created to ‘manage’ the financial
affairs. Such an exposure makes it possible to bring forth the real interest
in concrete terms. It acts as a real deterrent for the section of society that
undermines all social and national interests in building up financial
empires of their own.

In its report of 2012, CBDT has recommended that this definition be

adopted for the purposes of enforcement of Income Tax Act provisions
against the suspicious investments amounting to transfer or round-
62
[http://www.fatf-gafi.org/media/fatf/documents/reports/Guidance-
transparency-beneficial-ownership.pdf], pg. 8, FATF guidelines on Transparency
and Beneficial Ownership
 126

tripping of black income from India. In the report, CBDT has given the
following proposition.

“It is proposed that section 68 may be amended to provide that if a

taxpayer receives the above referred to foreign investment or donation,
the burden lies on him to prove the identity of the beneficial owner, his
genuineness and his credit worthiness63.”

Even though, India has enacted against money laundering through

prevention of Money Laundering Act 2002. Such a provision to reverse
the burden of proof on the suspicious holding of property has not been
provided for. It is surprising that despite a strong recommendation from
CBDT, the government does not even seem to have thought about the
same. Moreover, it is disheartening to note that the Directorate of
Enforcement had till 2012 registered only 1437 cases for investigation
under the PMLA. During investigation, 22 persons were arrested and 131
provisional attachment orders issued in respect of properties valued at Rs.
1,214 crore. The Directorate has filed 38 Prosecution Complaints in
PMLA-designated courts for the offence of money laundering.

The tragedy of action against Benami transactions and property:

The arrangements created to hide the real interests behind the transfer of
black income using the names of others or using fictitious names to
camouflage their identities are known as benami holding of property.
Benami holding of property is a way the real owners hide their black
income.

In 1988, an ordinance was promulgated to prevent benami transactions or

benami property holding. Subsequently, it was passed in the parliament as
the Benami Transactions (Prohibition) Act, 1988. This Act provided for
confiscation of Benami property (without compensation) and upto three
years of imprisonment as a punishment for benami transactions. This was
a progressive step against generation and stashing of black
money/property. However, the tragedy of this Act is that it was never
armed with the rules required for its enforcement. Ordinarily, the rules for
the execution of any Act are presented along with the act itself. However,
evenafter 26 years since the act was passed, no government has cared to
63
CBDT report, pg. 22, para. 12.10.7
 127

enact the rules and enforce the Act. The UPA government in 2011
brought a bill to replace the Benami Transactions Act. But, even this
effort never saw the light of the day in the parliament after it was sent to
the Select Committee.

None of these facts feature in any of the debates in the media or in the
parliament or in any of the public speeches of these ‘torchbearers’ of law,
order and governance. This clearly shows the policy makers have been
oblivious and uninterested in the fight against black money.
 128

CHAPTER VIII
SO, WHAT NEXT?

So far, we have explored the economic terrains in which black money is

generated. The complexity of the issue is obscuring for a bystander and
challenging for an activist. The questions that essentially emerge out of
this analysis are:

1. Why did our system evolve the way it did?

2. Can it be changed? If so, how and by whom?
3. What are the demands around which the movement should rally?

In our view, the purpose of any theory is not merely to explain and
predict the reality, but to unfold the possibilities for the desired change.

By far, we have looked through the deviations of the system from the
objectives enshrined in the Indian constitution and the planning process
since 1950s. This degeneration finally culminated into an unviable
balance of payment crisis in 1991 and the story thereafter is pretty clear.
India was pushed into embracing the policy of Liberalization,
Privatization and Globalization. This happened partly due to
circumstances and partly due to the active choices made by the forces in
power. The frustration over the corruption ingrained in a controlled
economy allured us to tread through terrains of free markets. However,
this transformation, instead of acting like a medicine turned into yet
another malady. This is vindicated by our experiences through the series
of cyclonic scams such as Harshad Mehta scam, Ketan Parekh scam,
Sahara Scam, 2G scam, coal allocation scam, Satyam scam, gas pricing
scam, toll road scams etc. This reality can be crisply summed up in the
words of RBI governor, Mr. Raghuram Rajan as, “…. Even as our
democracy and our economy have become more vibrant, an important
issue in the recent election was whether we had substituted the crony
socialism of the past with crony capitalism, where the rich and the
influential are alleged to have received land, natural resources and
spectrum in return for payoffs to venal politicians.”

Thus, the policies under the banner of socialism were certainly laying the
foundations for India’s independent economic development but only at a
 129

heavy socio-political cost of nurturing a corrupt section of the politically

active rich. Today, all the scams exhibit deep-rooted cronyism in the
name of free markets and a liberalized policy.

We must understand that any economic system, be it free markets or

controlled markets, carries the imprints of the local conditions governed
by historical-socio-economic institutions. India is not an exception to this
general reality. As a result, the free markets in India degenerated into
economic cronyism. By economic cronyism, we mean the development
of an unholy nexus between the decision makers in the state and the
dominant corporate houses in the supposedly open economy.

During the hay days of license permit raj, there was a disconnect between
the words and the deeds of the state. This resulted in corruption and
generation of black economy. Now, there are no more lofty claims over
ideals. Nonetheless, the ‘free market space’ is seized by the big
corporates, first by pushing the state to take decisions suiting a selected
few and realizing the same in the market space thereafter. The power of
corporates to influence the policies and to reap the benefits thereof, has
led to deepening of corruption, alleviating the quantum of black money
and broadening the detriments of the same to new limits. Consequently,
the proportion of black money as a percent of GDP and also the
proportion illicit finance flows as percent of the GDP have grown to
phenomenally high levels. This level is much higher when compared with
the so-called license permit raj in the pre-reforms period.

Thus, the issue of black money and illicit finance flows is not merely an
ideological issue. It is also an issue of fighting out the Indian version of
the economic systems, which can be labeled as cronyism.

Cronyism in India is a result of the continuation of the nexus of feudal-

power-caste-family, looming over the modern global form of the
economic system called Capitalism. The Indian version of Capitalism has
evolved through the British imperial rule, which was not followed with an
internal decisive conflict between the power-logic and economic-logic in
the society. When both these logics get interwoven in a complimentary
format, it culminates into a crony-economic system. India is a victim of
the same.
 130

Now the question is whether there is any chance of a change in the

system? If yes, how and who will bring about this change?

We are of a firm opinion that, not only the chances, but also the
indications of a change are potential. This is because of many objective as
well as subjective factors.

One of these factors is the global integration. The integration of

economies, even though for profit motives, has created a contradiction
between the economic system and its political governance. While the
capital and investments are becoming global, the laws governing them
continued to be local. Capital, which is globally mobile, has stipulated the
states to relax their taxation laws and regulation. This gradually led to
emergence of tax havens (discussed in earlier chapters). These tax havens
have challenged the efficacy of taxation all around the world. The
widening gap between the growth of mobile capital and taxation has led
to a united international action against tax evasion. Thus, the problem of
black money has also been globalized and India cannot escape from it.
The fight against black money has got two strengthening factors – global
unanimity and global action.

The information technology has made a transcendence of the coordinates

of space and time possible for the movement of capital around the world.
However, the delinquent capital rolling over the rule of law and order
around the world has taken advantage of the contradictions between local
and global. And the disastrous consequences of finance capital have been
experienced and understood by the world now. Thus, information
technology is now being utilized for an efficient exchange of information
to curb tax evasion as well. This information helps the respective
authorities of the states to unveil the real human faces operating behind
the corporate veils. The action against the menace of black money in
India can get international legitimacy, support, as well as the means to
realize it with these global technological advancements. The people’s
movement against black money, if connected well globally, can make a
serious dent in the positive direction.

India has experienced the ill consequences of both types of cronyism - old
as well as new. Today, people are not allured by phrases anymore. They
demand performance and delivery. They want clean and functioning
 131

governments. The recent public outcry against corruption is more than

‘just another protest’. This was experienced in the Assembly Elections in
Delhi in 2014, which was more of a political outburst than ‘just another
election’. That it turned into a Greek tragedy is another issue, though
important and of serious concern. Similarly, the agitation over the
demand for Lokpal, the Right to Information and the Nirbhaya Rape Case
are indicative of the urge to regain the lost democratic space for ‘people’s
voice’.

Therefore, the issue of governance needs to be presented as the

fundamental issue in Indian politics today. People appear to be more than
willing to transcend the limitations of caste, religion and communities;
and stand united for a cause.

The issue of black money is nothing but a subset of the wider issue of
governance. Black money undermines law and governance. It deepens the
inequality in the country. It encourages and protects corruption. A public
demand for universal-quality education, health services, social security,
old age pensions, rural electrification, planned cities, pollution control,
clean water etc. needs to be stitched together to fight the menace of black
money. If the agenda of good governance as a fundamental human right
spreads across the political sphere as the demand of public, the issue of
black money can be the central rallying point for the same.

However strong the potential of an issue might be, it requires an agency

to realize the same. In our view, the people’s organizations in the field of
education, health, rural development, women’s issues, environment
protection, housing for all etc. have been frustrated due to withdrawal of
monetary resources from the government. This brings us to wonder why
the situation has been exacerbated to this extent? The answer obviously
lies in the dried up resources of the government due an ever-rising
evasion of taxes. The fundamental contradiction between the rising
governance expectations of the people on one hand and
thesimultaneously rising tax-evasion on the other amidst the ocean of
prosperity for a few is, in our opinion, going to be the driver for a social
action against black money.

What should be the demands?

 132

No meaningful movement is possible unless it rallies around a set of

viable demands. Here, we are attempting to make a few humble
suggestions in this regard.

Demands –  

Political-

1.     Urgent Political action be initiated on:

a.     Giving highest priority to action against tax evasion at all levels.

b.     Strengthening the SIT against black money with full co-operation
and resources from the Government.

c.      Appointing international investigation teams for investigating into

Tax Havens.

d.     Commencing stringent investigations against and urgent prosecution

of the suspected defaulters.

e.      Formally seeking co-operation from the World Bank and other
international bodies to bring back black money stashed abroad.

2.     National political commitment to take the Tax –GDP ratio of India
to 30% in a period of 10 years and direct tax collection to 67% of total tax
collection.

3.     Initiate a national debate on Taxing Agricultural Income taking

holistic view of the farmers’ issues and tax-mischief by the undeserving
miscreants.

Tax Enforcement

1.     The 30,000 vacancies in Tax Administration and Enforcement be

filled forthwith.

2.      The Administration be revamped qualitatively by training, overseas

investigation teams, information links etc. 

3.     Currency Notes of 1000 and 500 be cancelled and exchanged and
crediting the bank accounts appropriately.
 133

4.     Cheque payments for transactions above Rs.10,000 must be made

compulsory. Agreement involving non-cheque payment in such cases be
made unenforceable.

5.     Wealth Tax be enforced with full vigour, sincerity and seriousness.

6.     PAN based property registers be made compulsory for all local
bodies, Registrar of Documents, and be automatically connected to IT
department.

7.     Auditors of all companies be appointed through a panel governed by

a separate regulator created for the purpose

8.     Participatory Notes be banned as a means of FPI investments.

9.     GAAR be applied in India with full focus and force sealing all
possible loopholes.

10.                        All State Governments be equipped with appropriate

machinery and expertise to enforce their tax laws in consonance with
central departments.

11.                        Ban and monitor import of Gold beyond certain limits

12.                        Tax concessions be re-examined and rationalized to be

reduced to 33% of the present level in 3 years.

Legislative

1.      Rules under Benami Transactions and Property Act

1988 be made immediately.

2.     Money Laundering Act be amended to include a clear

definition of a Beneficial Owner as the natural person.

3.     Estate Duty-Inheritance Tax be levied again.

    International

1. Review of all DTAAs of India with particular emphasis

on total transparency and information exchange.
2. International lobbying against the non-cooperating
 134

countries with regard to information on bank accounts

and other business affairs.
3. DTAAs be amended to give effect to identify the
beneficial owner of transactions before accepting the
residential status of the business entity.
4. GAAR be given full effect at the earliest.
 135

APPENDIX 1
SUPREME COURT: RAM JETHMALANI & ORS. V.
UNION OF INDIA & ORS.

“The paradigm of governance that has emerged, over the past three
decades, prioritizes the market, and its natural course, over any degree
of control of it by the State. The role for the State is visualized by votaries
of the neo-liberal paradigm as that of a night watchman; and moreover it
is also expected to take its hands out of the till of the wealth generating
machinery...64”

“Carried away by the ideology of neo- liberalism, it is entirely possible

that the agents of the State entrusted with the task of supervising the
economic and social activities may err more on the side of extreme
caution, whereby signals of wrong doing may be ignored even when they
are strong. Instances of the powers that be ignoring publicly visible stock
market scams, or turning a blind eye to large scale illegal mining have
become all too familiar, and may be readily cited. That such activities
are allowed to continue to occur, with weak, or non-existent, responses
from the State may, at best, be charitably ascribed to this broader culture
of permissibility of all manner of private activities in search of ever more
lucre. Ethical compromises, by the elite – those who wield the powers of
the state, and those who fatten themselves in an ever more exploitative
economic sphere- can be expected to thrive in an environment marked by
such a permissive attitude, of weakened laws, and of weakened law
enforcement machineries and attitudes65.”

Above – stated excerpts from the landmark order given by the Supreme
Court of India on the issue of black money in 2011 aptly reflect the
degenerating state of affairs in India. This was the same order in which
64
Ram Jethmalani & Ors. v. Union of India & Ors., Pg. 11, para 13
65
Order, Pg.
 136

the Court had ordered the UPA government to disclose the list of names
of account holders of the bank of Liechtenstein. The government had
received this list from the government of Germany under the Double
Taxation Avoidance Agreement. The recent hullabaloo with respect of
black money and the tug of war between the Congress and the BJP is a
consequence the same order.

Through the course of this book, we have consistently emphasized that

the issue of black money is too serious to be reduced merely to political
battles and scandals. It has several dimensions and is as integral to the
political-economic system of the country as a cancer cell to the body.
Interestingly, in its 2011 order, the SC had successfully stitched all the
facets of this issue together. It was reiterated that ‘governance and a life
of dignity is a fundamental right of every citizen of India.’ The
responsibility of the state is to work to ensure that the state treads on the
path of good governance and productive development.

Taking cue of the desperate need of governance measures in the country,

the court asserted that the state couldn’t shy away from its responsibilities
citing the lack of revenues as an excuse. Further, the court also
recognized the inherent relationship between the fast eroding tax base of
the country, the illicit finance outflows from the country and the dried up
monetary resources of the government. Calling for a strong tax collection
and tax enforcement machinery, the court held that –

“The strength of tax collection machinery can, and ought to be, expected
to have a direct bearing on the revenues collected by the State. If the
machinery is weak, understaffed, ideologically motivated to look the
other way, or the agents motivated by not so salubrious motives, the
amount of revenue collected by the State would decline, stagnate, or may
not generate the revenue for the State that is consonant with its
responsibilities…66”

The frustration of the SC with the deliberate laxity and dormant attitude
of the government is clearly visible in the order. As a result, in 2011, the
Court decided to take strict actions and ordered the UPA government to
constitute a Special Investigation Team (SIT) to investigate into the larger
issue of black money stashed abroad in secret banks and brought back to
66
Order, Pg. 13, Para 14
 137

India through tax havens. The SIT so constituted was to be charged with
responsibilities and duties of investigation, initiation of proceedings, and
prosecution with respect of matters concerning:

 unaccounted monies of identified miscreants such as Hasan Ali and

the Tarpurias.
 Other investigations with respect to stashing away of unaccounted
monies in foreign accounts by Indians or other entities operating in
India.
 Any other proceedings with respect to black money.
 Preparing an action plan for creation of necessary institutional
structures to strengthen the country’s battle against generation and
stashing away of unaccounted money abroad.

The SC rightly asserted that the role of the government couldn’t be

reduced to that of a night watchman or merely a facilitator. Denouncing
the concept of a soft state, the court opined that “The more soft the state
is, greater the likelihood that there is an unholy nexus between the law
maker, the law keeper, and the law breaker67.”

The diligent analysis of the problem of black money of the SC and the
spirit of the order is commendable indeed.

67
Order, Pg. 10, para 10.