BLACK MONEY IN INDIA - 1

Black Money in India: Obstacles for Retrieval and Solutions to end it

By John Samuel Raja D and M Padmakshan
It's a telling statement that the government's two biggest successes in catching Indians with black
money in offshore banks have been the result of information that came to it providentially. In
March 2009, Germany shared a list that contained names of 26 Indians having unreported
accounts with LGT Bank in Liechtenstein. And, earlier this year, France shared details of 700
accounts of Indians in HSBC Bank Geneva. France and Germany bribed staffers of the two
banks for information on their citizens, and India happened to be an accidental beneficiary. The
Indian government says once its new and improved tax treaties with various countries kick in, it
can chase down black money held by Indians on its own.
(Former) Finance minister Pranab Mukherjee is prone to launch into a litany on the tax treaties
being enforced, signed, negotiated or renegotiated by India. When seen along with the tax reform
being undertaken within, he believes, this could be an inflexion point in the drive to recover
black money. Arun Kumar, who has written several books on black money, says it does come
down to the government not because of what it is doing, but because of what it is not doing.
"The problem is political," says the professor at the Jawaharlal Nehru University. Adds a senior
income-tax official in Mumbai, speaking on the condition of anonymity: "The IT department
itself cannot initiate any drive on its own to bring black money stashed in offshore banks as it is a
policy decision to be taken by the Central government."
That wavering intent colours everything the government has done so far on black money, be it on
opening lines of communication outside, or connecting data and transaction sources inside for
solid leads, or empowering tax officers. It's why, as the following two stories show, while UK
and Germany are moving purposefully to bring back billions, India is still flailing around.
Tax Treaties: One Rule for UK, Another for India
The homepage of Switzerland's finance ministry website features two tax treaties the poster boy
of banking secrecy has negotiated with United Kingdom and India this year. The two treaties are
studies in contrast, a proof that developing nations have little leverage with tax havens to part
with information.
The treaty with UK allows London to tax all its citizens holding deposits in Switzerland. That too
retrospectively, which means evaders will have to pay up. And punitively: the principal amount
will be taxed between 19% and 34% depending on how long the deposits have been held. And,
income from deposits will be taxed between 27% and 48%.

This essay appeared in The Economic Times (November 15, 2011).

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So, a UK citizen holding $100 million in Swiss banks will have to pay up to $34 million as tax.
Further, if the deposit earns interest of, say, $10 million, an additional tax of up to $4.8 million
will be levied annually. Of course, if it is legitimate money and has been taxed, the UK citizen
can claim a set off. The UK expects to add 5 billion (about Rs 38,500 crore) to its coffers. On
top of this, each year, UK can seek tax-related information of 500 individuals from the Swiss,
who are complying, as evidenced from Switzerland's offer to make a down payment of 385
million towards unpaid taxes of UK citizens.
While UK's treaty with the Swiss strives for universal coverage of its citizens, India's double
taxation avoidance agreement (DTAA) is selective and puts the onus on Indian authorities to
provide evidence of suspicion. Both treaties have the same point of origin -- the model
agreement of the Economic Cooperation and Development (OECD) - but they are far removed.
Individual, Not Institutional
The Indian government cannot seek information from the Swiss authorities retrospectively. It can
do so only from April 2012, though it's not clear whether this means it can ask for information
only for transactions done after that date. The tax rates are lower: nothing on the principal and
the lowest rate India levies on OECD nations - 10% - for interest income. So, Switzerland
deducts 10% tax on all deposits held by Indians and gives a cumulative amount to India each
year. However, it does not disclose the identity of the deposit holders or how much each held.
The legitimate money seeks a refund for double taxation with the Indian authorities. The
illegitimate money does not mind paying the 10% and staying silent.
To catch them, India will need to know lots about them. It cannot go on what authorities call a
'fishing expedition' and ask the Swiss for, say, information on all deposits held by all Indian
citizens. "It is one request about one taxpayer at a time," says Anupama Jha, executive director of
Transparency International, a notfor-profit anti-corruption agency.
In order to make a successful request, the government needs to furnish specific information. The
OECD 'checklist of information request' has 18 points, which include name of the person,
personal details like date of birth, account number and the bank branch address, and more.
This is the agreement that was revised in 2010 to give it more bite. Jha feels even this will be
"ineffective". "Think of it like this," she says. "Black money is like water running freely through
the pipes, but the tax-information agreement will only allow us to capture this black money like a
slowly leaking tap - drop by drop by drop."

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Will anything change?
When India first signed a treaty with Switzerland in 1994, the objective was to stop income from
being taxed twice. The treaty had no provisions to share tax information. After the 2008-09
slowdown, as sentiment turned against tax havens, India started signing tax-information
exchange agreements (TIEAs) (See graphic: New Agreements). Developed by the OECD in
2002, TIEAs are intended to increase the exchange of information between two countries.
Most agreements signed are similar in nature, the exceptions being rich, developed countries like
UK and Germany. Tax Justice Network, a Belgiumregistered independent organisation that is
fighting banking secrecy in tax havens, says countries like Switzerland will agree to the OECD
model for sharing information. But, says R Vaidyanathan, professor of finance at the Indian
Institute of Management, Bangalore (IIM), when actual requests are made to countries, they use
domestic laws to turn them down.
A retired Indian IT official with experience in international taxation matters says the amended
DTAA has a clause that prohibits Swiss authorities from taking cover under local laws. "The
Swiss have to provide information on ownership of bank accounts," he says, not wanting to be
named. "Only when we make a request for information can we test the effectiveness of the
agreement," concedes a current income-tax official on the condition of anonymity.

According to the CBDT spokesperson, the government has initiated about 300 requests so far
and received responses for about 100. "It does not mean the trail stops there," says the same
official. "It could be Mauritius replying that so and so received this much, but has transferred the
money to another tax haven. So, another request will have to be made." The retired IT official
says there is no comparison between the Indian and UK treaties. "The UK has given up its right
to find who has deposits in Swiss bank accounts," he says. "Rather, it has cockaded on filling its
coffer to bridge its fiscal deficit. We seem to have preferred identification of who holds deposits
there."

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Tax authorities: Multiple Indian organisations chasing multiple leads.
Two years after India sought permission from Singapore to conduct investigations there in the
money-laundering case involving Pune-based stud farm owner Hasan Ali Khan, the two
governments are still discussing the request.
A chief commissioner in Mumbai was probing shell companies of a leading corporate to detect
black money parked abroad by it. He was transferred to Chennai.
Be it seeking information or wading through process, be it managing the political pressure inside
or the economic motives outside, life is a series of walls for the authorities. Back home, unless
there is a suspicion of wrongdoing, the trail of black-money detection starts with data on
financial transactions. Poring over this data are two networks that have come up in the past few
years.
The first is the Financial Intelligence Network (FINnet). Set up by the Financial Intelligence
Network (FIU), which collects and analyses information on money laundering and terrorist
financing, FINnet comes under the revenue secretary in the ministry of finance. FINnet collects
suspicious transaction reports (STRs) and cash transactions report (CTRs) in an electronic format
from banks, insurance companies and securities market participants. An example of an STR is,
say, Rs 50 crore coming into a bank account, and quickly going out in even amounts to many
other accounts, while that of a CTR is someone paying cash to buy a luxury car.
After analysing the STRs and CTRs, the FIU forwards them to investigating agencies -- the
Central Board of Direct Taxes (CBDT) for tax-evasion cases and the Enforcement Directorate
(ED) for money laundering ones. Network number two is housed in, and controlled by, the
CBDT, better known as the income-tax department. Called the Integrated Taxpayer Data
Management System (ITDMS), it electronically collates information collected from various
sources of taxation -- like tax deduction at source, e-returns and annual information returns
(AIRs) -- to create a 360-degree tax profile of high net-worth assesses.
The number of STRs received by the FIU has increased from 968 in 2007-08 to 7,027 in 2009-
10. However, according to the Financial Action Task Force (FATF), which is an inter-country
organisation created to tackle money laundering and terrorist financing, it is not commensurate to
the size of the Indian economy.
Information Gaps
The FATF estimates two million to three million proceeds-generating offences in India every
year, including about 80,000 economic crimes.
"Most of the data passed by FIU is information already in the public domain," says a senior IT
official in the Mumbai office, on the condition of anonymity. "Occasionally, they send useful
information." FIU director PK Tiwari declined an interview request.
"For effective tracking of money laundering cases, it is critical to have an integrated information
technology network, which we don't have," says Rahul Garg, partner with
PricewaterhouseCoopers. "For example, the core banking software used by banks does not
interact with income tax, except for AIR." The Mumbai tax official quoted earlier says sourcing
information from tax havens is unpredictable. "It can come in 15 days," he says. "In many cases,
it takes months and years." The key, says another IT official in Delhi, is not to follow all cases.
"Pick a case that will have a good demonstration effect and will act as a deterrence," he says.

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Another problem is that of the 80-odd countries with which India has signed a double taxation
avoidance agreement, a tax information-sharing clause is present only with 28 countries. So, if
money is routed through one of the other 52 countries, the investigating authorities will hit a
dead end.
Poor Prosecution Record
Stashing black money abroad has two stages: evade taxes and 'launder' money abroad. Indian tax
laws make no distinction made between income earned illegally or legally.
Thus, the criminality is tried under the Criminal Procedure Code (CrPC), and money laundering
under the Prevention of Money Laundering Act (PMLA), 2002. ED, which handles money-
laundering cases, is yet to successfully prosecute even one case, according to the FATF.
This is partly because of the way the PMLA Act was structured. Earlier, ED had to wait till the
criminality of illegal activities was established before it could begin its prosecution for money
laundering. Given the slow pace of courts, it ended up prosecuting only two cases till June 2009,
when two crucial changes were made to the PMLA. Now, the ED can start its investigation
simultaneously even as prosecution under criminal offence is under progress. According to the
FATF, ED has initiated 798 investigations, of which, 734 were taken up in the new dispensation.
Out of this, however, it has done just six prosecutions and no convictions.
"Legislation is only a part of the solution," says Arun Duggal, chairman of Shriram Capital.
"Bringing to completion current cases is the key." Duggal, who has worked as a private banker
with the Bank of America, says the record is mixed even in developed nations to recover black
money stashed abroad, especially in corruption-related and tax evasion cases. "It is easy to erase
the trail," he says. "Authorities should not start till they have everything."
Laundering of ill-gotten money is usually done by routing through a layered structure so that it
acquires a legal cover. Along with skill, cracking this requires political will. "It requires a
concerted drive from the government to secure the cooperation of other governments and to
create international consensus on the issue," says the Mumbai tax official.
Means to put an end to black money issue
Here are 10 things the govt could do to come down harder on this economic crime.
1. Lobby to end banking secrecy
Automatic exchange of information between countries can take place in many ways. An example
is the European Union withholding tax, under which EU residents are taxed on their deposits
irrespective of the country within the union they are held in.
That way, taxes cannot be avoided within the 27 EU countries that have agreed to this; the three
exceptions are Austria, Belgium and Luxembourg. India, by comparison, has to make specific --
and detailed -- requests to the same countries for information on its citizens for tax fraud or for
criminal activity.
It can't arm-twist smaller, secretive countries the same way as large, developed economies can.
In the past two years, India has been pressing for greater and easier sharing of tax information
with 75 countries, including 22 tax havens. "The reworking of existing treaties and new tax-
sharing agreements is not going to help at all," says R Vaidyanathan, professor of finance at
Indian Institute of Management, Bangalore.

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"India should push for automatic exchange of information." Vaidyanathan, who has held various
positions with the market and insurance regulators, calls tax havens "financial brothels". "The
sooner we close them, the better." The global antipathy towards tax havens and banking secrecy
is increasing.
At the G20 summit earlier this month, Prime Minister Manmohan Singh called to end banking
secrecy. It will take more than that: a mechanism like the World Trade Organisation to evolve
global consensus or the brute force of a grouping like the G20, which account for about 80% of
the world economy.

2. Bribe for information

Germany bribed a former LGT bank official to get data on bank deposits held by its citizens in
the Liechtenstein-based bank. Similarly, France paid off an official of HSBC Geneva to obtain
data on bank accounts of its citizens in the Swiss Bank. There were Indians on both these lists,
and their names -- 26 in LGT and 700 in HSBC -- reached the government in India, and action is
underway. This has, by far, proven to be the most effective route. The protocol and restrictions in
tax treaties signed by India make information flow a slow process, and recovery an unlikely
outcome. "Most communications are under DTAA (double tax avoidance treaty)," a senior
income tax official based in Mumbai, on the condition of anonymity. "Sometimes, information
flows through diplomatic channels also."
"Looking for suspicious transactions is like trying to find a needle in a haystack," says Arun
Kumar, professor of economics in the Jawaharlal Nehru University. "Better would be to steal the
data from the bank by bribing officials." Indian tax laws allow for payments to informers that
result in successful tax demand and collection.
3. Set up a website for whistleblowers
Not everyone involved in an illegal transaction is a willing accomplice," says Arun Duggal,
chairman of Shriram Capital. "Having a whistle-blower website, with the promise of anonymity,
will help in gathering crucial data." Duggal, who earlier worked in the private banking division
of Bank of America, says the information provided on the website can be screened by a team of
experts, who will undertake further investigation to expose the corruption. At present, India does
not have a whistle-blower law. The government has introduced The Public Interest Disclosure
and Protection to Persons Making the Disclosures Bill, 2010, in the Lok Sabha. It is yet to be
passed.

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4. Make political funding transparent
Cash funding of political parties by companies and rich individuals is a fertile point of origin for
corruption in policy making, as well as generation or usage of black money. For example, a
company interested in a mining licence or an industrialist seeking favourable terms on debt
restructuring. Current laws exempt a political party from paying tax on the donations received by
it. Also, a political party can accept donations above Rs 20,000 only in cheque. According to the
Association for Democratic Reforms (ADR), a non-profit, the cheque receipts of political parties
covered a wide range (See table: Cash is King...).
This means parties were getting a significant chunk of their disclosed deposits either as small
contributions or as large amounts that were unaccounted for. "We all know political parties spend
more than what they declare," says Bibek Debroy, professor at the Centre for Policy
Research. The ADR and National Election Watch make several suggestions to clean up political
funding. One, they want cash contributions banned; deposits should be made only through
cheques or demand drafts, and donors should furnish their Permanent Account Number (PAN).

Two, an independent body should assess if donors to a political party received any gains when
the party came to power. Three, the Comptroller and Auditor General (CAG), the government's
auditor, should audit the accounts of political parties. "Have a proper disclosure and auditing
mechanism, with stringent penalty clauses," says Debroy.
5. End political interference in investigative agencies
Political interference is very much present in the department," says the Mumbai tax official. "For
example, a posting in Mumbai is usually not possible without political influence." Kumar of JNU
goes so far as to say that the problem (failure to nab black money) is "problem". He says
investigation agencies have access, but governments tend to use this public information for
private gain. According to Kumar, full operational freedom with no political interference to
investigating agencies is the key for a successful anti-black money strategy.

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Further, he adds, it should be supplanted with lateral hiring of experts from outside government
service. The staffers in investigative agencies dealing with tax evasion and money laundering are
usually from the Indian Revenue Service (IRS). "They are highly skilled people capable of doing
the job," says the Mumbai tax official. Adds Kumar: "What they lack is an understanding of the
latest techniques adopted by fraudsters and latest tools like IT." And the support of, or shelter
from, the political class.
6. Make IT Systems talk to each other
The recent Karnataka Lokayukta report on illegal mining pointed out how India's central bank
might be inadvertently aiding money laundering by illegal miners because of its inability to
match two databases -- one from the customs authorities and another from the banks. Those are
not the only links that ought to be talking to each other, but are not.
Another instance is the income tax department creates complete tax profiles of high net-worth
assesses. But it cannot talk to the core banking software, which has a record of all banking
transactions. "IT systems don't talk to each other," says Rahul Garg, leader direct tax,
PricewaterhouseCoopers.

"Many European countries get a 360 degree view of an individual by linking all the IT systems,
including the banking system. In India, banks are linked to the tax department only for payment
of taxes." Government departments, especially customer-facing ones, are computerising their
records, but it's only in the last four or five years.
7. Ban non-profits not filing tax returns
According to the Financial Action Task Force (FATF), as of 2010, India had 2 million non-profit
organisations, but only 71,000 were filing tax returns. Further, home ministry data shows that, as
on March 2009, there were 38,600 NPOs were registered under the law that allowed them to
accept grants from abroad. Such NPOs have to make two filings: with the IT department and the
home ministry. The home ministry says "a great deal" of such NPOs are not filing tax returns;
IIM professor Vaidyanathan says "half of them". This non-compliance assumes importance are
suspected of being used by politicians to route their laundered money back into India, and for
terror funding.
NPOs have received about Rs 60,000 crore of foreign funds between 2001 and 2009, according
to the home ministry. "NGOs are not covered under the Right to Information (RTI) Act," says
Vaidyanathan. "Make them file annual returns to the home ministry on time, or else stop their
foreign funding."
8. Reveal the identity of holders of participatory notes
A known fact in India's stock market is that a majority of foreign investments are routed through
Mauritius -- essentially to take advantage of a tax waiver on capital gains -- and via an
instrument called participatory notes (PNs). It is alleged that Indian politicians and companies
are using this route to legalise money they laundered. PNs are derivative instruments issued by
foreign institutional investors (FIIs) to their clients.
PNs are issued outside India, but they derive their value from Indian shares. The main attraction
of PNs is that investors need not register with the Indian market regulator, Sebi, which does not
come to know who is investing. In August 2007, says Sebi, 52% of FII holdings were in the form

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of PNs. The then-SEBI chairman, M Damodaran tried to curb PNs, but the market tanked,
forcing the government to backtrack. If Sebi were to make identification of ultimate beneficiaries
of PNs a pre-condition to investment, it will cut out the launderers. They will have to register as
FIIs and give details of the people backing them.
9. Define beneficial ownership
Laundering of ill-gotten money is usually done by routing through a layered structure so that it
acquires a legal cover. One common way is to set up a private trust, whose immediate
beneficiary is a holding company. A string of companies, in various tax havens, separates the
holding company from the ultimate individual beneficiaries.
Thus, it is difficult to establish who actually owns the trusts. Under existing regulations, their
names need not be disclosed by the private trust. "Beneficial ownership of trusts is a huge
business globally," says Duggal. "What is the incentive for banks or employees to disclose them?
That's why, globally, the track-record of stolen assets recovery is very poor." Here, income-tax
officials face a problem. Although they have information, as in the Liechtenstein case, that a
person has a bank account as a beneficiary of a trust in a tax haven, it is still not in a position to
prove the account holder is a beneficiary. This involves the cooperation of the country in which
the bank is.
Even if they receive the country's cooperation, unravelling the trust holding remains a complex
task. Even in India, this layered form of holding and ownership is adopted in private trusts. The
government plans to amend the Companies Act to identify beneficial ownership, but it does not
specify how.
10. Abolish stamp duty on real estate
A task force set-up by the Thirteenth Finance Commission had recommended abolishing stamp
duty for the real estate sector and integrate it in the proposed goods and service tax (GST), so
that taxes paid can be set-off. This will lower the tax burden on the real estate sector, which
according to Niranjan Hiranandani, co-founder and managing director of the Hiranandani Group,
accounts for onefourth of the construction cost. This will also encourage people to declare the
actual value of transactions as tax impact will be lower.