Black Money, Money Laundering, Tax evasion – Administrative and legal infrastructure to tackle them – GAAR, PMLA, FIU, ED, FATF

Black money is the money that is unaccounted for, wherein taxes have not been paid on that money. Sources of black money are often illegal, such as crime – trafficking, illegal trade, fraud – and corruption -bribery, leakages from government programmes; but the source of black money can be legal too. To be black, a money just has to be unaccounted for, and untaxed.

Some black money, especially in the poor classes, is unavoidable in any economy. The black money which the government agencies target is that associated with tax evasion and illicit organised crime such as human trafficking. Legal definitions of black money may vary, for example, under the Black Money Act 2015, the term ‘black money’ covers only the ‘undisclosed foreign income and assets’.

Money laundering is the process wherein proceeds of crime are converted into legal money or asset in order to obscure its origin.

Indian legislations to tackle black money, money laundering, tax evasion and tax avoidance:

Income Tax Act 1961

The Income Tax Act, 1961 is the basic law governing levy, administration, collection and recovery of income tax in India. The law has many provisions to deal with issues of tax avoidance. For example, under this law, the ‘place of effective management‘ of a company is considered as ‘residency of the company‘ irrespective of its official ‘legal residency’. This provision is applied to curb the use of offshore puppet companies in low-tax jurisdictions that are misused by businesses to avoid paying tax in India. However, the implementation of such provisions is also hindered when dealing with puppet companies in secrecy jurisdictions such as Switzerland, as lack of information with the enforcement authorities render them powerless.

General Anti-Avoidance Rules (GAAR)

General Anti-Avoidance Rules, issued under the Income Tax Act, allow tax officials to deny tax benefits to a deal if the deal is found to have no commercial purpose other than tax avoidance. The GAAR is a very broad-based law and equips tax officials with wide discretionary powers. GAAR was originally proposed in the Direct Taxes Code 2010, and brought into effect in 2017.

India has double-taxation avoidance agreements (DTAA) with several countries having lower tax rates than of India. Though companies can legally use their tax residency certificates (TRC) to enjoy tax benefits available legally, these agreements are often exploited to avoid (not evade) paying tax in the country with higher tax rates. GAAR provisions can be invoked to deny tax benefits to such transactions.

Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015

The UFIA Act aims to curb black money (undisclosed foreign assets and income) and imposes tax and penalty on such income. It gives an opportunity to the black income holders to reveal black money and pay a flat 30% tax within a compliance window time. It also enhances the monetary penalty to three times the amount of tax evaded, and prescribes a jail term of 3 to 10 years for wilful evasion of tax on foreign income.

Benami Transactions (Prohibition) Act, 1988 – amended in 2016

The term ‘benami’ refers to an asset without a legal owner, or with a fictitious owner. The Benami Act provides for attachment and subsequent confiscation of a benami property (movable or immovable), and prosecution of beneficial owner – the benamidar – irrespective of whether or not he/she is the legal owner.

Foreign Exchange Management Act, 1999

FEMA regulates the Indian foreign exchange market to facilitate and promote orderly external trade and payment. It replaced the earlier stringent Foreign Exchange Regulation Act to enable and liberalise forex transactions. It also turned a forex violation into a civil offence, instead of a criminal offence.

Prevention of Money Laundering Act, 2002 – PMLA

The objective of PMLA is to prevent and punish money laundering. PMLA provides for confiscation of property derived from proceeds of money laundering.

The PMLA has been accused of being very stringent and even draconian for some of its provisions such as:

  • The burden of proof, of a property being lawful, falls on the person who is accused of acquiring it through unlawful means.
  • A statement recorded by an authorised agency officer is admissible as evidence in a court of law.

In November 2017, the Supreme Court struck down a stringent provision of PMLA that denied bail to an accused unless the court was convinced that he is not guilty. The SC held it violative of Article 21 (Right to Life) and Article 14 (Right to Equality).

In 2018, Corporate Frauds were brought into the ambit of the PMLA. The term “Proceeds of Crime” was redefined to allow confiscation of domestic properties of a person if his illegal proceeds are parked abroad.

Reporting Requirements under PMLA: Under the provisions of PMLA, banking companies and financial intermediaries (including Non-Banking Financial Companies (NBFC) are required to verify identity of clients, maintain records, and furnish information in prescribed format to the Financial Intelligence Unit – India (FIU-IND). They are required to adhere to KYC (know-your-customer) norms, AML (anti-money laundering) standards, and CFT (Combating of Financing of Terrorism) standards based on the FATF guidelines.

Organisational setup and international initiatives to tackle money laundering, black money, tax evasion and tax avoidance:

Financial Intelligence Unit – India (FIU-IND)

FIU-IND is the nodal agency for managing the Anti-Money Laundering Ecosystem in India. It receives information from various entities in financial sector (such as banks, NBFCs) under the PMLA, and disseminates this information to relevant intelligence/law enforcement agencies for investigation and further action. FIU does not investigate cases, not does it take enforcement action on its own.

FIU-IND reports to the Economic Intelligence Council (EIC) headed by the Finance Minister. Economic Intelligence Council (EIC) is the apex government body overseeing government agencies responsible for economic intelligence and combating economic offences in India.

Enforcement Directorate

Enforcement Directorate is the law enforcement and economic intelligence agency under the Department of Revenue, Ministry of Finance. It enforces two key laws:

  • Foreign Exchange Management Act, 1999 (FEMA) – a civil law.
  • Prevention of Money Laundering Act, 2002 (PMLA) – a criminal law.

International:

Financial Action Task Force on Money Laundering (FATF)

FATF is an international watchdog to combat money laundering and terrorism financing. It was initially established in 1989, as an initiative of G7 countries, to combat money laundering; later its scope was expanded to combat terrorism financing. It is headquartered at the OECD, Paris.

FATF issues AML (anti-money laundering) standards and CFT (combating financing of terrorism) standards, which are followed by financial entities and banks across the world and enforced by national laws enacted by the FATF members. Members of FATF include 35 countries + European Union + Gulf Cooperation Council (GCC). Prominent non-members include Pakistan, Iran.

Central Board of Direct Taxes (CBDT), Ministry of Finance is India’s official FATF unit.

BEPS Action Plan – by OECD

BEPS – Base Erosion Profit Shifting – refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations, thus avoiding paying tax in the home country. The BEPS Action Plan is an initiative of the OECD that seeks to close gaps in international taxation. As part of the plan, MNCs (multinational corporations) are required to furnish information, about their operations in all countries, to the country of residence of the top parent company. This is called Country by Country Reporting (CbCR), and is implemented by the national laws enacted by the individual countries (including members as well as non-members of OECD). Individual countries can have information sharing agreements that help each of them ensure better tax compliance.

Tax Information Sharing Agreements

Tax information sharing agreement between USA and India: USA has tax information sharing agreements with several countries, including India, under its Foreign Account Tax Compliance Act, 2010 (FATCA). These information sharing agreements enable automatic exchange of financial information between USA and India. Under the rules of the Indian markets regulator Securities and Exchange Board of India (SEBI), Reporting Financial Institutions (including banks, investment traders, etc.) are required to present certification of their compliance with FATCA on an annual basis.

Related Information, and Glossary:

  • Tax havens are countries with low levels of taxation, and/or secrecy jurisdiction. The secrecy jurisdictions undermine regulations of other countries/jurisdictions, making them redundant and leaving their enforcement agencies powerless due to lack of information about financial transactions.
  • Tax evasion – not paying tax that is due – is illegal.
  • Tax avoidance – avoiding paying tax through legal means such as investing in provident funds, or by exploiting gaps in Double Taxation Avoidance Agreements (DTAA).
  • Transfer Pricing refers to the rules and methods for pricing transactions between enterprises under common ownership or control. Companies legally do this to minimise payable taxes. The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle – which states that parties to a transaction should be independent or on an equal footing.
  • Corporate veil – Companies are entitled to corporate veil, based on the principle that a company is a legal entity distinct from its shareholders or subsidiaries. A corporate holding structure is considered a single economic entity, but each company within the structure is considered a separate legal entity. This limits culpability. For example, a parent company is not legally responsible for any unlawful activities of the subsidiary, unless the latter turns out to be a sham (bogus entity or shell company).
  • Controlled Foreign Companies (CFC) are entities which are located outside India in a low tax territory but effectively controlled by parent company in India or Indian residents. The term finds mention in the Direct Taxes Code.

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