What is black money?

Black money is a term used in common parlance to refer to money that is not fully legitimate in the hands of the owner. This could be for two possible reasons.

a)First is that the money may have been generated through illegitimate activities not permissible under the law, like crime, trafficking (human, drugs, arms), terrorism, and corruption, all of which are punishable under the legal framework of the state.

b)Second and perhaps more likely reason is that the wealth may have been generated and accumulated by failing to comply with the tax requirements.

Although black money in India is decades old problem, it has become real threat post liberalization. Illegal activities such as crime and corruption, non-compliance with taxation requirements, complex procedural regulations, cultural and social practices, globalization along with weak institutional, policy, legal and implementation structures have further augmented the black money economy.

Concept of Black Money
Black money is tax-evaded income. It can be earned both through legal and illegal means. Its legitimate source is that the income-earners do not reveal their whole income for tax purposes.

For example, government doctors earning money by private practice even when they get non-practising allowance; teachers earning money through tuitions, examinations and book royalty and not including it in income-tax returns; advocates charging much higher fee than shown in their account books, and so forth.

Its illegitimate source is bribe, smuggling, black-marketing, selling commodities at prices higher than the controlled prices, taking pugree for house, shop, etc., selling house at a high premium price but showing it at much lower price in the account books, and so on.

It is possible to convert black money into white money and vice versa. For example, when a person manages to get the receipt from the shopkeeper by paying sales-tax for a commodity but does not purchase it actually, he generates black money as reimbursement is made to him against the receipt.

The money not actually paid is the black money in this case. In such case, the shopkeeper sells the same commodity to another person without giving him any receipt for it.

On the other hand, if a person purchases second-hand car and pays Rs. 90,000 for it out of white money but gets a receipt of only Rs. 60,000, the balance of Rs. 30,000 becomes black money for the seller. In this case, white money becomes black money.

Magnitude of Black Money
It is not easy to calculate the magnitude of black money in any society. The economists in the United States, the United Kingdom, Norway, Sweden and Italy adopted different measures but could not estimate the amount involved in black money.

Norway and Sweden used questionnaire method for eliciting answers from persons whether they had participated in illegal activities as buyers or sellers.

Italy attempted to estimate the underground economy by finding out the difference between the size of the labour-force officially reported and actually employed. This enabled the authorities to determine productivity in the under ground sector.

The United Kingdom tried to assess parallel economy by comparing the official estimates of the Gross National Product (GNP) made from the consumption side with those made from the income side.

In spite of the varied methods used, it is not possible to estimate the magnitude of black money in a society, even though it is described as a world-wide phenomenon.

It is said to be in operation not only in the developing countries but also in the developed countries like the United States, the United Kingdom, Russia, Japan, Canada, France, Germany, etc.

A study conducted by the IMF about a decade and a half back showed that in regard to the size of the underground money, India holds the first rank followed by the United States and Canada having the second and the third ranks.

Though it is quite difficult to estimate the quantum of black money with accuracy but many attempts have so far been made in India for quantifying it and in most of the cases the findings appear to be far from reality.

However, most of such studies undertaken in our country in recent years put the quantum of black money in the neighbourhood of 40 per cent of gross domestic product (GDP).

Accordingly, Indian Institute of Public Finance and Policy (IIPFP) finds that out of the total amount of black money, 48 per cent is generated from evasion of personal income tax alone, 28 per cent from under-reporting of production and 18 per cent from under- registration of immovable property so that these three main components exhaust about 94 per cent illegal income generation.

Guesstimates based on 'Global Financial Integrity' claim that the amount exceeds 'USD 1.4 trillion' in total.
Swiss Bankers Association and the Government of Switzerland thrashed the reports & said that the total amount held in all Swiss banks by citizens of India is about 'US$2 billion'.

In February 2012, the director of India's Central Bureau of Investigation said that Indians have US$500 billion of illegal funds in foreign tax havens, more than any other country.

In March 2012, the government of India clarified in its parliament that the CBI director's statement on $500 billion of illegal money was an estimate based on a statement made to India's Supreme Court in July 2011

Sources of Black Money

As discussed above the sources of black money are broadly of two categories- illegitimate activity and tax evasion even if the activity is legitimate.

In particular following are some of the mechanisms through which black money is circulated, utilized and the profits earned are further invested in other sectors to generate further money.

1.Real estate: Due to rising prices of real estate, the tax incidence applicable on real estate transactions in the form of stamp duty and capital gains tax can create incentives for tax evasion through under-reporting of transaction price.

2.Bullion and jewellery market: The purchase allows the buyer the option of converting black money into gold and bullion, while it gives the trader the option of keeping his unaccounted wealth in the form of stock, not disclosed in the books or valued at less than market price.

3.Financial markets transactions: IPO manipulations, rigging of market such as use of shell companies.

4.Public procurement: Public procurement has grown phenomenally over the years – in volume, scale, and variety as well as complexity. The Competition Commission of India had estimated total public procurement figure for India at around 10 to 11 lakh crore per year and provides ample scope of corruption due to rigged procurement process.

5.Non-profit organizations: Taxation laws allow certain privileges and incentives for promoting charitable activities which are misused and manipulated. Highlighted by FATF as well. Used to park funds of corrupt politicians and businessmen.

6.Informal Sector and Cash Economy: Cash transactions, large un-banked and under-banked areas contribute to the large cash economy in India.

7.Trade-based Money Laundering (TBML): Disguising the proceeds of crime and moving value through the use of trade transactions in an attempt at legitimizing their illicit origins.

8.Tax Havens: Tax havens are typically small countries/ jurisdictions, with low or nil taxation for foreigners who decide to come and settle there. Strong confidentiality or secrecy regarding wealth and accounts, very liberal regulatory environment and allow opaque existence, where an entity can easily be set up without indulging in any meaningful commercial activity and yet claim to be a genuine business unit, merely by getting itself incorporated or registered in that jurisdiction. This makes them highly desirable locations for multinational entities wishing to reduce their global tax liabilities. Multinational entities consisting of a network of several corporate and non-corporate bodies set up conduit companies in tax havens and artificially transfer their income to such conduit companies in view of the low tax regime there.

9.Investment through Innovative Derivative Instruments: Such as Participatory Notes (P-notes).

10.Hawala: It is an informal and cheap method of transferring money from one place without using banks etc. It operates on codes and contacts and no paperwork and disclosure is required.

Detrimental to economic health:

• There is a distortion in investment in economy. With black money the investment is made in high end and luxury goods.
• Huge loss of taxes amounting to billions.
• Black money leads to further corruption by creating a vicious cycle.
• Generating black money means that quality is compromised in public sector projects where black money is used to manipulate tenders and offer kickbacks.
• Investments that must have been made in the country giving the necessary boost to economy are invested elsewhere.
• Since, RBI cannot control the black money cash flow in economy, it dilutes its policies targeting inflation.
• High prices of real estate especially in big cities are due to deep pockets filled with black money.
• Forward trading of goods by cash rich speculators cause fluctuation in prices due to hoarding.
• National security is threatened because black money is used to finance criminal activities. Black money generated from drugs and smuggling is being used to operate terror networks.

Steps taken by government to curb black money generation and flow

Tax Reforms: Tax deduction at source in which the tax is deducted from the payment itself by the payee.
Voluntary Income Disclosure Schemes: The government allows reporting black money generated through tax evasion in a given time frame.
Removing currency after certain time: So that unaccounted wealth is either brought into economy or becomes useless.
Encouraging Cashless transactions: Government has recently announced tax benefits for making online payments.

Legislative Framework:

• Prevention of Money Laundering Act, 2002 (amended multiple times latest in 2012)
• Lokpal and Lokayukta Act
• Prevention of Corruption Act, 1988
• The Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015
• Benami Transactions Prohibition Act, 1988 amended in 2016
• The Real Estate (Regulation and Development) Act, 2016

International Cooperation:

• Multilateral Convention on Mutual Administrative Assistance in Tax Matters
• Financial Action Task Force
• United Nations Convention against Corruption
• United Nations Convention against Transnational Organized Crime
• International Convention for the Suppression of the Financing of Terrorism
• United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances
• Egmont Group for international intelligence gathering regarding money landing and terrorism financing
• Cooperation through G20, Bilateral agreements.

Recent Steps
1.With the aim of unearthing black money stashed abroad, parliament has passed the Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015, in the parliament. Salient features of the Bill are as follows

• Tax on all foreign income will have to be paid at the flat rate of 30 per cent without any exemption, deduction, and set off or carry forward losses that the Income Tax Act permits.
• Enhanced punishment of jail for 3-10 years for willful evasion of tax on foreign income along with a penalty equal to three times the amount of tax evaded or 90 per cent of the undisclosed income or the value of the asset.
• One - time compliance opportunity: A one-time compliance opportunity to persons who have any undisclosed foreign assets (for all previous assessment years) will be provided for a limited period.Such persons would be permitted to file a declaration before a tax authority, and pay a penalty at the rate of 100%.
• Bill empowers the Centre to enter into agreements with other countries for the exchange of information, recovery of tax and avoidance of double taxation.

2.India is aiming to establish a real time automatic information sharing system by 2017. It seeks to enter into Multilateral Competent Authority Agreement (MCAA). To implement the MCAA, government has amended the IT Act, 2008.

3.Under pressure from India and other countries, Switzerland has made key changes in its local laws governing assistance to foreign nations in their pursuit of black money allegedly stashed in Swiss banks. These amendments, would allow India and other countries to make 'group requests' for information about suspected black money hoarders. Switzerland has disclosed certain names to Indian authorities too.

4.Special Investigation Team (SIT) appointed by government on the directions of Supreme Court on black money.

5.Demonetization: Demonetization is a currency side step. That itself will not fight black income. The most important policy should be tax administration where the tax authorities can monitor expenditure and matching it with income of the respective individuals.

Analysis of the Recent steps by Government

1. In 1997 the amnesty scheme for black money holders got declarations of around Rs 33,000 crore and taxes collected amounted more than Rs 10,000 crore.
2. At present under the Income declaration scheme, Rs 65,250 crore of undisclosed assets were declared in one time compliance window, yielding Rs 29,362 crore in taxes.

Way forward
The black money menace is still untamed and lot more needs to be done to tackle it. Some of the strengthening steps that can be taken are:

1.Appropriate legislative framework related to: Public Procurement, Prevention of Bribery of foreign officials, citizens grievance redressal, whistle blower protection, UID Adhar.

2.Setting up and strengthening institutions dealing with illicit money: Directorate of Criminal Investigation Cell for Exchange of Information, Income Tax Overseas Units- ITOUs at Mauritius and Singapore have been very useful, Strengthening the Foreign TAX, Tax Research and Investigation Division of the CBDT.

3.Developing systems for implementation: Integrated Taxpayer Data Management System (ITDMS) and 360-degree profiling, Setting up of Cyber Forensic Labs and Work Stations, implementation of Goods and Services Tax and Direct Tax Code.

4.Imparting skills to personnel for effective action: Both domestic and international training pertaining to the concerned area. For instance, the Financial Intelligence Unit-India makes proactive efforts to regularly upgrade the skills of its employees by providing them opportunities for training on anti-money laundering, terrorist financing, and related economic issues.

5.Electoral Reforms: Elections are one of the biggest channel to utilize the black money. Appropriate reforms to reduce money power in elections.

Thus, a holistic and all round attack from within and outside the country is the need of the hour. India should quickly take up appropriate reforms at home that will aid in curbing the black money generation and circulation in the country along with the use of bilateral and multilateral mechanisms to deal with round tripping and stashing of money outside the country.

By: Vittal Reddy
(The writer is an IAS mentor)