ECONOMICS

HANDOUT (Lecture No. 7 & 8)

by Jayant Parikshit

MCQ FOR PRELIMS
Question-1: Consider the following statements regarding the method of generation of black money:
1. All illegitimate money is “Black”
2. All “Black” money is illegitimate.

Choose the correct option:

a. Only 1
b. Only2
c. Both 1&2
d. None of these

Question-2: Which of the following was/were the stated aims of demonetisation carried out in 2016
by GoI?

1. To curb corruption
2. To control Counterfeiting
3. To curb terrorist activities
4. To control the accumulation of “black money”

Choose the correct option:

a. Only 1
b. Only4
c. 1,3 & 4
d. 1,2,3 & 4

Question-3: Consider the following statements.
1. A money supply contraction but only of one type of “money”—cash
2. A tax on unaccounted private wealth maintained in the form of cash

Choose the option which would help you to understand what demonetisation should be seen as
comprising of in the Indian context:
a. Only1
b. Only2
c. Both1&2
d. None of the above

Question-4: Under which of the following condition/conditions, policy makers might resort to
demonetization?
1. Economy is reeling under hyperinflation
2. As an anti-terrorism measure
3. To tackle economic instability
4. Transition to a new legal tender

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Choose the best option:
a. Only 2
b. Only4
c. Both 2 & 3
d. 1,2,3 & 4

Question-5: Demonetisation in India was a dramatic event, which shook the foundations of the
existing system in more ways than one. Consider the following statements about demonetization as
enunciated by Government of India:
1. Demonetisation was aimed at signalling a regime change in India.
2. Demonetisation in India was punitive in nature.

Choose the correct option/options:
a. Only1
b. Only2
c. Both 1& 2
d. None of the above

Question-6: Consider the following statements about black money:

1. Black money is something which refers to a whole range of activities undertaken either illegally or
to avoid taxes.
2. Black Money refers to the sum that we own which is unaccounted.
3. Black money is said to have been generated through illegitimate activities.

Choose the correct statements:

a. Only1
b. Only2
c. 1&3
d. 1,2&3

Question-7: Which sectors act as store house of black money?

1. Land and Real Estate Transactions

2. Jewellery Transactions
3. Non-profit Sector
4. Informal Sector

Choose the correct answer:
a. Only1
b. 1&2
c. 1,2&4
d. 1,2,3&4

Question-8: In its annual report released on 29th August 2018, RBI has given an account of
demonetisation related findings. Consider the following statements in this regard:

1. 99.3% of the Rs15.3 trillion demonetised currency is back in the banking system.
2. Demonetisation may not have done much to curb the generation of new fake currency.

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3. Demonetisation has not made a huge dent in the proportion of high-value notes which are only
a marginally lower now than what it was pre-demonetisation.
4. The Cash-to-GDP ratio of India has returned to being amongst the highest levels of currency
usage in peer emerging market economies (EMEs) and advanced economies (AEs) as well.
5. As per the report, overall, the supply of currency notes declined by 14% in 2017-2018.

Choose the correct option:

a. 1&2
b. 1,2&3
c. 3,4&5
d. 1,2,3,4&5

Question-9: With regard to India’s efforts towards fighting the shadow economy, consider the
following actions/strategies:

1. Joining the global crusade against black money

2. Creating appropriate legislative framework
3. Setting up institutions for dealing with illicit money
4. Developing systems for implementation
5. Imparting skills to personnel for effective action

Which of the above has/have been adopted by India in its effort to fight the shadow economy?
a. Only2
b. 2&3
c. 1,2&3
d. 1,2,3,4 &5

Question-10: Consider the following statements regarding “The Financial Action Task Force (FATF)”:

1. The mandate of the FATF is to counter money laundering, terrorist financing and proliferation of
weapons of mass destruction.
2. The FATF currently comprises 37 member jurisdictions.
3. India is an observer in the FATF. India will get the membership of FATF in January, 2020.
4. FATF releases black, grey & white list to maintain a record of countries that have a poor record
in action against money laundering, terrorist financing and other such crimes.

Choose the correct answer:

a. Only1
b. Only2
c. 1,2&3
d. 1,2&4
e. 1,2,3&4

Question-11: Consider the following statements regarding the impact of “Demonetisation”:

1. Growth of 18% in direct tax collection in 2017-18

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2. Increase in tax base by 1.06 crore people filing income tax returns for the first time in FY 2017-
18.

Choose the correct option:

a. Only1
b. Only2
c. Both1&2
d. None of these


QUESTIONS FOR MAINS

Question-1: Define Black Money. How is black money generated? What are the steps to control it?

Question-2: What is the magnitude of black economy in India? What has been India’s policy to combat
black money? How far have we succeeded in controlling it?

Question-3: Define “Money Laundering”. Explain the various stages of money laundering.

Question-4: What are Tax heavens? Who do they help in creation of black money?

Question-5: Explain the following terms:

a. DTAA
b. FATF
c. Treaty Shopping
d. Round Tripping

Question-6: How successful was demonetization in solving the issue of:

1. Black Money
2. Fake Indian Currency
3. Terror Financing
4. Corruption

Question-7: Define “Demonetisation”. What are the circumstances leading to such a move by
government? Critically evaluate the outcome of DeMo.

Question-8: Discuss the long-term benefits & short-term costs associated with recent events involving
demonetization.

Question-9: Was the government push towards digital economy an abrupt and one-off move? What
role can Digital India programme possibly play in India’s governance and efficient service delivery?

Question-10: Can mobile act as an instrument of financial inclusion? What are the challenges in its
implementation? [Extra Question]

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CONCEPT OF BLACK MONEY




BLACK MONEY

1.
1. Unaccounted
2. 2.Illegitimate

GENERATION OF BLACK MONEY

2 WAYS TO GENERATE BLACK MONEY

1. Crude Method 2. Sophisticated

SOME GENERAL METHODS OF BLACK MONEY GENERATION

1. Out of Book Transactions:

! This is one of the simplest and most widely adopted methods of tax evasion.
! Transactions that may result in taxation of income are not entered in the books of account by
the taxpayer.
! Example: small grocery shops, unskilled or semi-skilled service providers, etc.

2. Parallel Books of Accounts:
! In this case, the entities maintain two set of records/accounts: one for their own consumption
with the objective of managing their business and the other for the regulatory and tax
authorities.

3. External trade and Transfer Pricing:
! For example, a foreign parent company could use ‘transfer prices’ for overstating the value of
goods and services that it exports to its foreign affiliate in order to shift taxable income from
the operations of the affiliate in a high tax jurisdiction to its operations in a low-tax jurisdiction.

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TRANSFER PRICING
! Transfer pricing can be defined as the price paid for goods transferred from one economic unit
to another, assuming that the two units involved are situated in different countries, but belong
to the same multinational firm.

BASE EROSION & PROFIT SHIFTING (BEPS) PACKAGE

! Definition: BEPS refers to tax planning strategies that exploit tax rules to artificially shift profits to
low or no-tax locations or to erode tax bases. Some of their methods are illegal but, generally, they
are not illegal.

! Members: Inclusive Framework on BEPS brings together over 130 countries and jurisdictions to
collaborate on the implementation of the BEPS Package.

! BEPS Project (2013-2016):
" It has been designed by the OECD and has received the approval of the G20.
" It aims at creating global standard rules for checking taxation avoiding practices by MNCs.
" BEPS package provides 15 Actions

CURRENT AFFAIRS: 2019 NEWS

! On 28-29 May 2019, the OECD/G20 Inclusive Framework met in Paris, with 289 delegates
from 99 member jurisdictions and 10 observer organisations taking part.
! The key outcome of that meeting was the agreement of a Programme of Work to Develop a
Consensus Solution to the “Tax Challenges Arising from the Digitialisation of the Economy”,
which will achieve a consensus-based, long-term solution by the end of 2020.

Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion
and Profit Shifting (MLI)

! After this convention (MLI), 90 countries have now implemented the automatic exchange of
financial account and tax information. The convention enables all signatories to meet treaty-
related minimum standards that were agreed as part of the BEPS package.
! MLI was signed by India in Paris on June 7, 2017.
! India has ratified the MLI, will enter into force for India on October 1, 2019, and its provisions
will have effect on India's DTAAs from FY 2020-21 onwards.
! Out of 93 Covered Tax Agreements (CTAs) notified by India, 22 countries have already
ratified the MLI as on date and the Double Taxation Avoidance Agreement (DTAA) with these
countries will be modified by MLI.

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TAX HAVENS
! There is no precise definition of the term.

! Loosely speaking, a tax haven provides facilities that enable people to escape the laws, rules and
regulations of other jurisdictions elsewhere, using secrecy as a prime tool.

! Examples: Cayman Islands, British Virgin Islands, Bermuda, Bahrain, Barbados,
Switzerland, Luxembourg, Grenada, Guam, South Korea, Macau, Marshall Islands, Mongolia,
Namibia, Palau, Panama, Saint Lucia, Samoa, Trinidad. The list is dynamic in nature.

! Characteristics of Tax Havens:
1. Small jurisdictions
2. Low or nil taxation
3. Secrecy
4. Liberal regulation

! EU list of Non-Cooperative Jurisdictions:
" In December 2017, the EU released the EU Grey list & blacklist of tax havens.
" This list is part of the EU's work to fight tax evasion and avoidance and aims to create a
stronger deterrent for countries that consistently refuse to play fair on tax matters.

Current Affairs: 2019

! United Arab Emirates, Switzerland and Mauritius have been removed from EU List of
Non-Cooperative Jurisdictions.
! Jurisdictions that remain blacklisted are Belize, Fiji, Oman, Samoa, Trinidad and Tobago,
Vanuatu and the three U.S. territories of American Samoa, Guam, and the U.S. Virgin
Islands
! Around 30 jurisdictions remain in Grey List.

! In 2016, the “Panama Papers,” leak revealed the offshore holdings of more than 140 public
officials and politicians worldwide—and the banks that assisted them. The Panama Papers also
disclosed about 214,000 offshore tax haven entities. The information was dug up from 11.5
million files from the databases of the firm Mossack Fonseca.

SHELL COMPANIES
There is no clear definition of Shell Company in Company’s Act or any other Act.

! Organisation for Economic Co-operation and Development ("OECD") defines 'shell companies'
as a firm that is formally registered, incorporated, or otherwise legally organised in an economy
but which does not conduct any operations in that economy other than in a pass-through
capacity.
! The shell companies include multiple layers of companies that have been created for the
purpose of diverting money or for money laundering.

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! Most shell companies do not manufacture any product or deal in any product or render any
service. These companies conduct almost no economic activity.
! They are mostly used to make financial transactions. Generally, these companies hold assets
only on paper and not in reality.
! However, not all shell companies may be money laundering vehicles.

Task Force on Shell Companies:

! In the conext of DeMo, ‘Task Force on Shell Companies’ under the Joint Chairmanship of
Revenue Secretary and Secretary, Ministry of Corporate Affairs was constituted in February,
2017 with a mandate to check in a systematic way, through a coordinated multi-agency
approach, the menace of “Shell Companies”.

! As per the findings of the task force:

1. Task force has created a database of shell companies and divided the companies into 3 lists:
a. The Confirmed List: Confirmed shell companies
b. The Derived List: Companies having common directors with shell companies
c. The Suspect List: Showing some indication of being a shell company

2. Databases have been compiled, more than 2 lakh (two lakh) companies have been identified
and their names been struck off the Registrar of Companies("RoC") under Section 248 of the
Companies Act, 2013 ("Act").

MONEY LAUNDERING
! Money-laundering is the process that disguises illegal profits without compromising the
criminals who wish to benefit from the proceeds.
! Using money laundering channels, the origins of the illegal funds remain hidden and are
integrated into legal business and into the legal economy.

STAGES OF MONEY LAUNDERING: Money-laundering is a dynamic three-stage process that

requires:

1. Placement
2. Layering
3. Integration

1. Placement: In this stage, cash is moved away from its source. The dirty cash is placed into
circulation through financial institutions, casinos, shops and other businesses, both local and
abroad. It includes methods like physical illegal movement of currency, currency smuggling, and
putting money in banks etc. which have links with criminals.

2. Layering: This is the second stage in money laundering where attempts are made to distance the
money from its illegal source through layers of financial transactions. Examples of Layering

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 include: Sending funds to different onshore and offshore bank accounts, Letters of credit, Bank
Guarantees, etc.

3. Integration: The final stage is where the money is returned to the criminal from what seem to be
legitimate sources. The criminal proceeds are now fully integrated into the financial system and
can be used for any purpose. For example, the purchases of property, art work, jewellery, or
high-end automobiles etc.

DOUBLE TAXATION AVOIDANCE AGREEMENTS (DTAAs)

! DTAA is a bilateral economic agreement between two nations that aims to avoid or eliminate
double taxation of the same income in two countries. A DTAA applies in cases where a tax-payer
resides in one country and earns income in another.
! DTAAs can be either comprehensive, i.e. covering all types of income or specifically target
certain types of income.
! Under Section 90 of the Income-tax Act, 1961, India can enter into an agreement with a foreign
country or specified territory for the avoidance of double taxation of income, for the exchange
of information for the prevention of evasion.
! India has Double Taxation Avoidance Agreement (DTAA) with more than 100 countries.

Current Affairs:

! The Government of India and the People's Republic of China have signed a protocol on 26
November, 2018, to amend the Double Taxation Avoidance Agreement (DTAA) for the

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 avoidance of double taxation and for the prevention of fiscal evasion with respect to taxes on
income. Further, the Protocol incorporates changes required to implement treaty related
minimum standards under the Base Erosion & Profit Shifting (BEPS) Project.

! A DTAA between India and Hong Kong has come into effect from Nov 30,2018, which would
stimulate more the two-way flow of investments and help curb fiscal evasion with respect to
taxes on income.

! India & Mauritius renegotiated their 1982 tax treaty in 2017

TREATY SHOPPING
! Suppose there is an investor in USA , who wants to invest in India. Instead of investing directly, the
investor tries to look for a country like Mauritius, which has a tax treaty with India.

! The objective is to find a tax treaty that can be used to lower the tax payable on the income arising
from that investment.

! This process of channelizing investment through a third country only to take the benefits of tax
treaties of that country is called treaty shopping.

ROUND TRIPPING
! In round tripping, a domestic investor of India would first take his/her funds to Mauritius and
establish a shell company there so as to acquire the legal identity as a resident of Mauritius.

! Then the investor would bring the money back to India disguised as foreign investment and thus be
able to take advantage of the benefits available to investors from Mauritius to India.

FINANCIAL ACTION TASK FORCE (FATF)

! The Financial Action Task Force (FATF) is an inter-governmental body established by the G-7
Summit in 1989. The objectives of the FATF are to set standards and promote effective
implementation of legal, regulatory and operational measures for combating money laundering,
terrorist financing and other related threats to the integrity of the international financial
system.
! The FATF is therefore a “policy-making body”.
! Members: 37 (includes India) member jurisdictions + 2 regional organisations (GCC and European
Commission)
! FATF Observers: Indonesia
! FATF maintains two different lists of countries:
1. Grey List: identifies countries or jurisdictions with strategic weaknesses in their measures
but that have provided a high-level commitment to an action plan. Example: Pakistan
2. Black List: Despite the commitment, they don’t do enough. Example: Iran and North Korea
(DPRK).

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CASE STUDY: PAKISTAN

! Pakistan was placed on FATF’s grey list for terror financing in June 2018.
! Pakistan had been put on notice to be blacklisted by October 2019 if it did not curb money
laundering and terror financing.
! It was given a 15 month and 27-point action plan that was to be implemented by September
2019.
! An assessment of its action plan has found that Pakistan addressed only five out of the 27 tasks
given to it in controlling funding to terror groups like the Lashkar-e-Taiba and Jaish-e-
Mohammad, responsible for a series of attacks in India. FATF has declared that if by February
2020, Pakistan doesn't make significant progress, it will be put in the 'Black List.

INDIA’S FIGHT AGAINST BLACK MONEY

1. THE BLACK MONEY (UNDISCLOSED FOREIGN INCOME & ASSETS) AND IMPOSITION OF TAX ACT,
2015
! The scheme was launched to bring back black money stashed in foreign countries and tax
havens.
! The government provided a window for one-time compliance - between July 1 and September
30 in 2015 - for taxpayers to declare their undisclosed foreign assets.
! Around 650 persons made declarations of the undisclosed money worth Rs 4,100 crore
deposited in foreign banks.
! The Act also had various stringent provisions for penalty and prosecution of foreign black
money holders unearthed during future investigation by the tax department.

2. INCOME DISCLOSURE SCHEME (IDS), 2016
! Window: 1st June 2016 to August, 2016
! People and entities could reveal black money earned till 2016 and pay 45% payment including
tax plus surcharge and a penalty.
! The tax payable was 45%, i.e., 15% more than the normal tax rate of 30%.
! 71,726 declarations disclosing undisclosed income of Rs 67,382 crore were made by black
money holders.
! The government has collected over Rs 12,700 crore tax under the IDS.

3. PRADHAN MANTRI GARIB KALYAN YOJANA (PMGKY), 2016
! The government offered a “last window” to people with unaccounted wealth to come clean
or face stringent penalties while inviting others to blow the whistle.
! Window: December 17, 2016 till May 10th 2017
! The government had also set up an email address — blackmoneyinfo@ incometax.gov.in —
where people could send information on those having black money and are trying to launder it.
The email id was monitored by a cell that took immediate action based on tips.

! Features & Terms of the scheme: “Taxation and Investment regime” under PMGKY.

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 " Those who declare cash deposits under this were levied a charge of 49.9%, which breaks
down into:
a. 30% Tax
b. 33% Surcharge (of the taxed amount)
c. 10% Penalty

" In addition to this, 25% of the amount declared went into the non-interest bearing
Pradhan Mantri Garib Kalyan Deposit Scheme, 2016, for four years.
" Part of PMGKY’s proceeds would be used for the benefit of the poor.
" Declarations were confidential and those taking advantage of it would escape prosecution.
" If the declarant refuses the option of using the government deposit scheme, 85% of the
amount will be deducted as taxes and penalties.
" For money that is found in raids, taxes and penalties of nearly 90% of the amount will be
levied, leaving just 10% with the owner.

! Recovery = Black money worth Rs 4,900 crore was disclosed by 21,000 people under PMGKY.
The Income Tax Department collected a tax of Rs 2,451 crore.

4. PAN MANDATORY FOR HIGH VALUE TRANSACTIONS
! Permanent account number (PAN) is now quoted compulsorily for all transactions above Rs.2
lakh from January 2016 and is applicable on all sale and purchase of goods and services and for
all modes of payment.
! PAN is already a must for almost all financial sector transactions, car purchases and to buy
immovable property above a certain limit.

5. LIMITATION OF BENEFIT CLAUSE (LOB) TO PREVENT TREATY SHOPPING
! Foreign investors who seek tax exemptions in India should produce proof of residence
documents of their home country.
! The Limitation of Benefit (LoB) Clause is attached by the treaty parties in their bilateral DTAAs.
! Example: India- Mauritius and the India-UAE treaties

DEMONETISATION OF Rs.500 & Rs. 1000 NOTES

INDIA’S EXPERIENCE WITH DEMONETISATION
1. January 12, 1946
2. January 16, 1978
3. November 8, 2016

OPERATION CLEAN MONEY (OCM)

! OCM was initiated by the government to check black money post demonetization.

! Two Phases of OCM - OCM has two phases:

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 1. January 31st,2017: for e-verification of large cash deposits made during the period from 9th
November to 30th December 2016. According to the government, as many as 17.92 lakh
people were identified for unexplained deposits post demonetisation and the income tax
department had identified one lakh suspected tax avoidance cases.

2. April 14th, 2017: IT Department launched it to detect the flow of black money into the banks
after demonetization. A comprehensive risk assessment framework had been developed to
identify cases with different levels of risk (High, Medium, Low, and Very Low). During this
phase, 5.56 lakh new persons had been identified whose tax profiles were inconsistent with
the cash deposits made by them during demonetization period.

Demonetization and Black Money

DeMo as supposed to bring an end to the black money problem in India. However, almost 99% of
the money was deposited back to RBI. The statistics revealed that either the hoarders found a way
to legitimize their black money or did not hold them in the form of cash. But this was known before
too. Black money hoarders do not hold the money in cash according to several finance experts.

DeMo & Fake Indian Currency Notes (FICN)

As per RBI REPORT -Aug30, 2017:

! During 2016-17, the detection of counterfeit notes was 20.4 % higher than the previous year.
! As per RBI report, the detection of Rs.500 & Rs.1000 notes almost doubled in 2016-17
compared to 2015-16.

Demonetization and Terror Funding

One of the officially stated objectives of DeMo was its role in curbing terrorism by increasing the
obstacles in terror funding. Terrorist organization were known to use fake Indian currency notes for
funding their projects and the government believed that this could be contained with the help of
demonetization. The Income Tax department seized Rs. 474.37 crore in new and old currency from
November 9, 2016 to January 4, 2017 (the demonetization period). As per MoH Reports, the cash
reserves of several terror groups were severely hit in the early days of demonetization.

Demonetization and Digital India

Pushing India towards becoming a cashless economy was another reason that demonetization was
publicized for. People turned towards digital transactions after DeMo. However, as the flow of cash
into the economy began to increase, the use of these apps and digital wallets saw a slide once again.

OTHER IMPACTS OF DeMo:

DeMo & Agriculture

! Cash is a critical input in the agricultural production process and its unexpected shortage had an
impact at many levels, including a slowdown in employment of labour and a dip in overall farm
incomes.

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! The Economic Survey for 2016-17 also echoed these concerns at that time.

DeMo and MSMEs

! Demonetization had a lasting effect on Indians MSMEs (Medium, Small and Micro Enterprises).
Various medium and small enterprises turned towards digitalization, however, the micro
industries were affected by the worst of its wrath.
! The micro industry owners were clearly unprepared for the effects of demonetization. Many
micro industry workers returned back to villages and the growth rate of these companies went
as low as 1%.
! The MSME sector has been recovering from the drastic changes and its impact on the revenue,
but demonetization forced the MSME sector to be friendlier and more accommodating towards
the digital arenas and made them more accommodating towards change.

DeMo and GDP

! The ban on old notes has been cited as one of the key contributors to the economic slowdown.
With the gross domestic product (GDP) for the April-June 2017-18 quarter slipping to 5.7%, the
reality of the economic slowdown could not be ignored.
! The World Bank had reduced the India GDP growth forecast to 7% for 2017-18 owing to
demonetization and GST (Goods and Service tax). The slowdown was cited as a delayed
consequence of demonetization by the World Bank.

POSITIVES OF DeMo:
1. Tax Base Increased:
! A marked improvement in the level of voluntary compliance
! 1.06 crore people filed income tax returns for the first time in FY 2017-18

2. Direct Tax Collection:
! It increased by 18% in 2017-18.
! DT collections had gone up from Rs 6.38 lakh crore in 2013-14 to almost Rs 12 lakh crore in
2017-18.

3. Operation Clean Money has unearthed large number of persons and clusters having suspect
transactions. These include about 14,000 properties of more than Rs.1 crore each where persons
have not even filed Income Tax Returns.

4. Undisclosed Income under tax net: GoI was able to bring Rs 1.3 lakh crore of undisclosed
income under the tax net. It was done through seizure and attachment of assets worth
approximately Rs 50,000 crore, and compelling the holders of large cash currency to disclose
their source of earning.

5. Detection of Shell Companies: As many as 3,38,000 shell companies have been detected and de-
registered, and their directors disqualified.

6. Digital Payments:

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 ! There was a surge in digital transactions immediately after DeMo. Based on transaction
volume card usage increases by 136% whilst usage of digital wallets went up 72%.
! The levels of digital payment adoption, which were observed to increase post DeMo,
declined once cash made a comeback in the economy, but still stays far above the initial
levels prior to the demonetization.

7. Growth in Formal Financial System: Demonetisation appears to have led to an acceleration in

the financialisation of savings.

RBI REPORT NOVEMBER 2019

On Cash with Public:

! Reserve Bank of India data show that the public held Rs.20.49 lakh crore in cash as of September
2019, which is 13.3% more than the figure for the corresponding month of 2018.
! The data show that the cash held by the public made up 96% of the money in circulation, with
most of the rest deposited in banks. In December 2016, one month after demonetisation and
the enforced deposits in banks, this percentage stood at 83%.

On Digital Mode of Payments:

! Post-demonetisation, there was no option but to turn to digital modes of payments. That has
changed now. Yet, people have realized that digital payment is much more convenient, secure
and much more seamless especially for online purchase.
! As a result, the value of transactions made through the four most popular modes — UPI, debit
cards, mobile banking, and prepaid instruments — has seen robust growth over this three-year
period.

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