22 May, 2012

Travel & Tourism Will Feel The Heat of India’s “White Paper on Black Money”

Imtiaz Muqbil

In a move that is set to have a significant impact on the way India, Indian companies and Indian people do business, the Manmohan Singh administration has published a unique battle plan outlining its “crusade” against tax avoidance and evasion.

The “White Paper on Black Money”, published on May 21 goes into copious detail about the “magnitude of black money generated in the country and the unaccounted wealth stashed aboard.” It also outlines the massive efforts being made by the Indian government to track it down in order to mobilise the financial resources it desperately needs to fund its multi-billion dollar poverty-alleviation and development projects.

If the efforts prove successful, they could have a significant impact on the travel & tourism sector, ranging from buying and selling property in India to the millions of dollars Indians spend on foreign wedding parties to the moves being made by High Net Worth Indians to relocate to tax havens such as Singapore to the foreign movie shooting locations sought by the Indian film industry.

The White Paper is a 97-page roundup of how India’s “Black Money” system operates, an eye-opening compendium of the factors that cause it, the means being used to maintain it and the efforts being made to combat it. It identifies the role of Swiss banks as well as multinational corporations in aiding and abetting tax-evasion and avoidance. The end result is a vicious cycle of corruption, political and corporate manipulation of decision-making processes and a widening of the rich-poor income.

The publication will have a global impact because the numerous challenges it identifies are common to many developing countries worldwide. It is also a damning indictment of the global financial and banking sector in perpetuating the problem. Even as global corporations have been calling for governments to lower taxes supposedly in order to boost economic growth, they have been enriching themselves through legal loopholes, largely at the expense of the poor.

It says, “The fight against generation and accumulation of black money is likely to be far more complex, requiring stronger intervention of the state, in developing countries like India than in developed countries. It needs a stronger legal framework, commensurate administrative measures, and a very strong resolve to fight the menace. It also calls for political consensus as well as patience and perseverance.”

The paper notes that the issue of generation of black money and its illicit transfer abroad has gained prominence in the last two years due to the resolve of world leaders, including Indian leaders, to address it effectively. It adds, “Thus a multi-pronged strategy, including joining the global crusade against black money, creating an appropriate legislative framework, setting up institutions for dealing with illicit money, developing systems for implementation, and imparting skills for effective action, is required to deal with the issue of generation of black money and its illicit transfer outside the country, and for bringing it back to India.”

In an introduction to the White Paper, Indian Finance Minister Pranab Mukherjee says, “In the past year the public discourse on the issue of corruption and black money has come in the forefront with the active participation of the civil society and our Parliamentary institutions.”

Designed to dispel the notion that the government is not doing anything about the problem, Mr. Mukherjee says, the “White Paper on Black Money” presents the different facets of black money and its complex relationship with policy and administrative regime in the country. It also reflects upon the policy options and strategies that the Government has been pursuing in the context of recent initiatives, or need to take up in the near future, to address the issue of black money and corruption in public life.”

He writes, “There is no doubt that manifestation of black money in social, economic and political space of our lives has a debilitating effect on the institutions of governance and conduct of public policy in the country. Governance failure and corruption in the system affect the poor disproportionately.

“The success of an inclusive development strategy critically depends on the capacity of our society to root out the evil of corruption and black money from its very foundations. Our endeavour in this regard requires a speedy transition towards a more transparent and result oriented economic management systems in India.”

He says that the steps taken in recent years for simplifying and placing the administrative procedures concerning taxation, trade and tariffs and social transfers on UID based electronic interface, free of discretion and bureaucratic delays, are vital building blocks of the approach for tackling corruption and black money in our country.

“In this past year Government has brought five bills namely, the Lokpal Bill, the Judicial Accountability Bill, the Whistle Blowers Bill, the Grievance Redressal Bill and the Public Procurement Bill, which are at various stages of consideration by the Parliament. The institutionalisation and expansion of information exchange network at the international level is a major step in curbing cross-border flow of illicit wealth and in facilitating its repatriation. While these measures will set the tone for an equitable, transparent and a more efficient economy, there is much that we could do, both individually and collectively, to strengthen the moral fibre of our society.”

Three more detailed reports are due by the end of the year on the magnitude of black money. However the minister said, he had chosen to release the White Paper now in order to “contribute to an informed debate on the subject and a more effective policy response as we move forward.”

Key extracts from the report (which can be downloaded by clicking here)

Factors Leading to Generation of Black Money

Black money arising from illegal activities such as crime and corruption has an underlying anti-social element. The ‘criminal’ component of black money may include proceeds from a range of activities including racketeering, trafficking in counterfeit and contraband goods, smuggling, production and trade of narcotics, forgery, illegal mining, illegal felling of forests, illicit liquor trade, robbery, kidnapping, human trafficking, sexual exploitation and prostitution, cheating and financial fraud, embezzlement, drug money, bank frauds, and illegal trade in arms. Some of these offences are included in the schedule of the Prevention of Money Laundering Act 2002.

The ‘corrupt’ component of such money could stem from bribery and theft by those holding public office – such as by grant of business, leakages from government social spending programmes, speed money to circumvent or fast-track procedures, black marketing of price-controlled services, and altering land use regularizing unauthorized construction. All these activities are illegal per se and a result of human greed combined with declining societal values and inability of the state to prevent them. Factors leading to their generation are both social and administrative.

Black Money and its Estimation

Significant amount of black money is generated through legally permissible economic activities, which are not accounted for and disclosed or reported to the public authorities as per the law or regulations, thereby converting such income into black money. The failure to report or disclose such activities or income may be with the objective of evading taxes or avoiding the cost of compliance related to such reporting or disclosure. It may also be the result of non-compliance with some other law.

Culture and social practices may also play a vital role in deciding the preferences of citizens between tax compliance and black money generation. In a society where tax evasion and under-reporting of activities and income is perceived to be very common or the norm, such activities may be considered acceptable and honest tax compliance and paying one’s due share to the public fund may not be considered a virtue. Studies indicate that countries with relatively poor implementation of regulations tend to have a higher share of unaccounted economy, whereas countries with properly implemented regulations and sound deterrence have smaller ‘black’ economies.

Real Estate

The real estate sector in India constitutes about 11 per cent of the GDP. Investment in property is a common means of parking unaccounted money and a large number of transactions in real estate are not reported or are under-reported. This is mainly on account of very high levels of property transaction taxes, commonly in the form of stamp duty.

High transaction taxes in property are one of the biggest impediments to the development of an efficient property market. With tax rates of over 5 per cent being imposed as stamp duty on buying of property, which otherwise also involves high transactions costs in terms of search, advertising, commissions, registration, and contingent costs related to title disputes and litigation, the property market remains one of the most inefficient asset markets in India. Unless the underlying distortions in this market are taken care of by appropriate reforms, it may be difficult to prevent such misuse.

One of the measures for deterring use of the real estate sector for generation and investment of black money could be the provision of deducting tax at source on payments made on real estate transactions and mandating it as a pre-condition for registering of the transacted property. The provisions of tax collected at source on the developers of the property can also be considered as a possible policy measure. Electronic payment and electronic reporting can mitigate the compliance burden.

External Trade and Transfer Pricing

More than 60 per cent of global trade is carried out between associated enterprises of multinational enterprises (MNEs). Since allocation of costs and overheads and fixing of price of product/services are highly subjective, MNEs enjoy considerable discretion in allocating costs and prices to particular products/services and geographical jurisdictions. Such discretion enables them to transfer profit/income to no tax or low tax jurisdictions. Differing tax rates in different tax jurisdictions can create perverse incentives for corporations to shift taxable income from jurisdictions with relatively high tax rates to jurisdictions with relatively low tax rates as a means of minimising their tax liability.

Transfer pricing has emerged as the biggest tool for generation and transfer of black money. In recent years, after the 9/11 incident in the USA due to intense scrutiny of banking transactions, enhanced security checks at airports and ports, and relaxation of exchange controls, transfer of money through hawala has reduced significantly but now transfer pricing is now being extensively used to transfer income/profit and avoid taxes at will across countries. Also, with the relaxation of exchange controls and liberalisation of banking channels, the popularity of the hawala system for legitimate transfers has reduced substantially.

The increasing pressure on financial operators and banks to report cash transactions has also helped in curbing hawala transactions. Tax evasion through transfer pricing is largely invisible to the public and difficult and expensive for tax officers to detect. Christianaid estimates that developing countries may be losing over US$160 billion of tax revenues a year, primarily through transfer pricing strategies.

Misuse of Corporate Structure for Generation of Black Money

Efforts made by the Government of India to create greater transparency and facilitate exchange of information need to be carried further. There is also need to create a robust database of remittances made by corporates out of India and carry out an analysis of their backward and forward linkages in order to understand the nature and legitimacy of the transmitted funds. The FIU-IND may be empowered by law to receive reports (similar to other reports submitted to it) on all international fund transfers through the Indian financial system, on the lines of the FIUs of Australia and Canada.

Income Tax Overseas Units

To facilitate international cooperation in areas of exchange of information, transfer pricing, and taxation of cross-border transactions, ITOUs have been opened with the objectives of monitoring issues related to double taxation avoidance, assistance in handling issues arising out of international taxation and transfer pricing, expediting negotiation of TIEAs with tax havens and non-cooperative jurisdictions, facilitating expedient exchange of information, and facilitating mutual assistance in collection of taxes. These units need to be expediently and optimally utilised for matters related to taxes as well as exchange of information in order to curb black money.

The way forward for the ITOUs is coordination with the competent authority office of the foreign country on real-time basis on mutual administrative assistance in tax matters including the exchange of information, assistance in tax collection, simultaneous tax examination, tax examination abroad, and service of documents. The ITOUs will also assist the competent authority with resolving cases under Mutual Agreement Procedures and Advanced Pricing Agreements.

Enhancing the Accountability of Auditors

Unlike many developed countries, Auditors in India have not been requisitely accountable, resulting in frequent undermining of this important aspect. Apart from recent cases of distortionary corporate governance involving highly reputed firms, cases are detected regularly by the regulatory authorities where the Auditors have failed to point out gross violations and even blatant misrepresentations. In the absence of adequate effective provisions, the Auditors are hardly ever held accountable for these lapses.

Another aspect of this problem is the way in which a firm opts for an Auditor in this environment of low accountability and prevalent evasion, since a strict Auditor ready to blow the whistle can hardly expect to thrive amidst competitors, many of whom may be more than willing to cooperate and compromise at different levels. As a result, a very important regulatory tool is virtually losing its role in contributing towards greater compliance. There will be need in future to look into various aspects of the functioning and regulation of the role of Auditors and various other professionals verifying the declarations and statements made by firms and ensure that there are adequate safeguards and sufficient accountability of such professionals.

Protection to Whistleblowers and Witnesses

In India, the law has not been able to provide adequate protection to informants / whistleblowers, nor do government departments have effective witness-protection programmes. As a result, credible information is not forthcoming and witnesses either do not turn up or turn hostile resulting in acquittals in prosecution cases. The DCI in the CBDT has been empowered to run such a programme. Accordingly, a witness-protection law can be considered as an option. Subsequently, witness-protection programmes may need to be implemented by all law enforcement agencies.