Black Money : Meaning and Process

                                                                             Defining 'Black Money'

  

 There is no uniform definition of black money in the literature or economic theory. In fact, several terms with similar connotations have been in vogue, including 'unaccounted income', 'black income', 'dirty money', 'black wealth', 'underground wealth', 'black economy', 'parallel economy', 'shadow economy', and 'underground' or 'unofficial' economy. All these terms usually refer to any income on which the taxes imposed by government or public authorities have not been paid. Such wealth may consist of income generated from legitimate activities or activities which are illegitimate per se, like smuggling, illicit trade in banned substances, counterfeit currency, arms trafficking, terrorism, and corruption. 'black money' can be defined as assets or resources that have neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession.

In its 1985 report on Aspects of Black Economy, the NIPFP defined 'black income' as 'the aggregates of incomes which are taxable but not reported to the tax authorities'

Thus, in addition to wealth earned through illegal means, the term black money would also include legal income that is concealed from public authorities:

     to evade payment of taxes (income tax, excise duty, sales tax, stamp duty, etc);

     to evade payment of other statutory contributions;

    to evade compliance with the provisions of industrial laws such as the Industrial Dispute Act 1947, Minimum Wages Act 1948, Payment of Bonus Act 1936, Factories Act 1948, and Contract Labour (Regulation and Abolition) Act 1970; and / or

     to evade compliance with other laws and administrative procedures.

Factors Leading to Generation of Black Money

2.1 Black money arising from illegal activities such as crime and corruption 

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.

2.2 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. For example, a factory owner may under-report production on account of theft of electricity which in turn leads to evasion of taxes. 

2.3 Generating Black Money by Manipulation of Accounts

2.3.1 Out of Book Transactions: Transactions that may result in taxation of receipts or income are not entered in the books of account by the taxpayer.The taxpayer either does not maintain books of account or maintains two sets or records partial receipts only.

2.3.2 Parallel Books of Accounts: This is a practice usually adopted by those who are obliged under the law or due to business needs to maintain books of account. In order to evade reporting activities or the income generated from them, they may resort to maintaining two sets of books of account - one for their own consumption with the objective of managing their business and the other one for the regulatory and tax authorities such as the Income Tax Department, Sales Tax Department, and Excise and Customs Department. The second set of books of account, which is maintained for the purpose of satisfying the legal and regulatory obligations of reporting to different authorities, may be manipulated by omitting receipts or falsely inflating expenses, for the purpose of evading taxes or other regulatory requirements.

2.3.3 Manipulation of Books of Account: When books of accounts are required to be maintained by taxpayers under different laws, like the Companies Act 1956, the Banking Regulation Act, and the Income Tax Act, it may become difficult for these taxpayers to indulge in out of books transactions or to maintain parallel books of accounts. Such parties may resort to manipulation of the books of accounts to evade taxes.

2.3.4 Manipulation of Sales/Receipts: A taxpayer is required to pay taxes on profit or income which is the difference between sale proceeds or receipts and expenditure. Thus manipulation of sales or receipts is the easiest method of tax evasion. Other innovative means may include diversion of sales to associated enterprises, which may become more important if such enterprises are located in different tax jurisdictions and thereby may also give rise to issues related to international taxation and transfer pricing.

2.3.5 Under-reporting of Production: Manipulation of production figure is another means of artificially reducing tax liability. It may be resorted to for the purpose of evading central excise, sales tax, or income tax.

2.3.6 Manipulation of Expenses: Since the income on which taxes are payable is arrived at after deducting the expenses of the business from the receipts, manipulation of expenses is a commonly adopted method of tax evasion. The expenses may be manipulated under different heads and result in under-reporting of income. It may involve inflation of expenses, sometimes by obtaining bogus or inflated invoices from the so called 'bill masters', who make bogus vouchers and charge nominal commission for this facility.

2.3.7 Manipulation by Way of International Transactions through Associate Enterprises: Another way of manipulating accounted profits and taxes payable thereon may involve using associated enterprises in low tax jurisdictions through which goods or other material may be passed on to the concern. Inter-corporate transactions between these associate enterprises belonging to the same group or owned and controlled by the same set of parties may be arranged and manipulated in a way that leads to evasion of taxes. This can often be achieved by arrangements that shift taxable income to the low tax jurisdictions or tax havens, and may lead to accumulation of black money earned from within India to another country.

2.3.8 Manipulation of Capital: The statement of affairs or balance sheet of the taxpayer contains details of assets, liabilities, and capital. The capital of the taxpayer is the accumulated wealth which is invested in the form of assets or as working capital of the business. Manipulation of capital can be one of the ways of laundering and introduction of black money in books of accounts.

2.3.9 Manipulation of Closing Stock: Suppression of closing stock both in terms of quality and value is one of the most common methods of understating profit. More sophisticated versions of such practice may include omission of goods in transit paid for and debited to purchases, or omission of goods sent to the customer for approval. A more common approach is undervaluation of inventory (stock of unsold goods), which means that while the expenses are being accounted for in the books, the value being added is not accounted for, thereby artificially reducing the profits.

2.3.10 Manipulation of Capital Expenses: Over-invoicing plant and equipment or any capital asset is an approach adopted to claim higher depreciation and thereby reduce the profit of the business. As already stated, increase in capital can also be a means of enabling the businessman to borrow more funds from banks or raise capital from the market. It has been seen that such measures are sometimes resorted to at the time of bringing out a capital issue. At the same time, under-invoiced investments, indicating entry of undeclared wealth, may imply introduction of black money.

2.4. Generation of Black money in Some Vulnerable Sections of the Economy

2.4.1 Land and Real Estate Transactions: 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. This can lead to both generation and investment of black money. The buyer has the option of investing his black money by paying cash in addition to the documented sale consideration. This also leads to generation of black money in the hands of the recipient. A more sophisticated form occasionally resorted to consists of cash for the purchase of transferable development rights (TDR)¹.

2.4.2 Bullion and Jewellery Transactions: Cash sales in the gold and jewellery trade are quite common and serve two purposes. 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.

2.4.3 Financial Market Transactions: Financial market transactions can involve black money in different forms. Initial public offers (I POs) offering equity shares to the public at large are also vulnerable to various manipulations that can generate black money for the promoters or operators. Rigging of markets by the market operators is one such means. This may involve use of shell companies and more sophisticated versions of such manipulation may involve offshore companies or investors in foreign tax jurisdictions who invest in shares offered by the IPO and through manipulated trading escalate their price artificially, only to offload them later at the cost of ordinary investors.

2.4.4 Public Procurement: Public procurement has grown phenomenally over the years - in volume, scale, and variety as well as complexity. It often includes sophisticated and hi-tech items, complex works, and a wide range of services. An OECD (Organisation for Economic Cooperation and Development) estimate puts the figure for public procurement in India at 30 per cent of the GDP whereas a WTO (World Trade Organisation) estimate puts this figure at 20 per cent of the GDP.² The Competition Commission of India had estimated in a paper that the annual public sector procurement in India would be of the order of Rs. 8 lakh crore while a rough estimation of direct government procurement is between Rs. 2.5 and 3 lakh crore. This puts the total public procurement figure for India at around 10 to 11 lakh crore per year.³

2.4.5 Non-profit Sector: Taxation laws allow certain privileges and incentives for promoting charitable activities. Misuse of such benefits and manipulations through entities claimed to be constituted for non-profit motive are among possible sources of generation of black money. Such misuse has also been highlighted by the Financial Action Task Force (FATF), an intergovernmental body which develops and promotes policies to protect the global financial system against money laundering and financing of terrorism. A Non-profit Organisation (NPO) Sector Assessment Committee constituted under the Ministry of Finance has reviewed the existing control and legal mechanisms for the NPO sector and suggested various measures for improvement.

2.4.6 Informal Sector and Cash Economy: The issue of black money is related to the magnitude of cash transactions in the informal economy. The demand for currency is determined by a number of factors such as income, price levels, and opportunity cost of holding currency. Factors like dependence on agriculture, existence of a large informal sector, and insufficient banking infrastructure with large un-banked and under-banked areas contribute to the large cash economy in India.

2.4.7 External trade and Transfer Pricing: More than 60 per cent⁴ 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

2.4.8 Trade-based Money Laundering (TBML): The FATF defines TBML as the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt at legitimising their illicit origins. Factors that facilitate such manipulation include the enormous volume of international trade flow, the complexity associated with financing arrangements and currency exchanges as well as limited recourse to verification procedures between countries.

2.4.9 Tax Havens: The term 'tax haven' has been widely used since the 1950s. However, there is no precise definition of the term. The OECD initially defined tax havens as being characterised by no or very low taxes, lack of effective exchange of information, and lack of transparency about substantial activities. It listed 35 countries/ jurisdictions as tax havens in the year 2000. The list has changed over time as more tax havens have made agreements to share information.

2.5 Estimates of Black Money Generated in India

Input / output method

One such method is the input / output method. It consists of using the input/output ratio along with the input to calculate the true output. It estimates black money as the difference between the declared output and the output expected on the basis of the input/output ratio. This method is deceptively simple and, though it may have some utility if applied to a uniform industry or a specific sector of the economy, it is unlikely to be of much help if applied to economy as a whole. It also ignores structural changes in the economy including those related to technology.

velocity of money  Method

Another approach, adopted by the monetarists, is based on the fact that money is needed to circulate incomes in both the 'black' and accounted for economies. As the official economy is known, the difference between that amount and the money in circulation could be assumed to be the circulating 'black' component. An estimate of the velocity of money (that is to say the average number of times currency changes hand in a year) enables an estimation of income circulated annually. A comparison of that with the income captured in the National Accounting System (NAS) gives the income which could be estimated as the black money in the economy. However, the assumption that the NAS represents accounted incomes accurately is not always true. Large proportions of income, such as those falling in the unorganized sector, are not accurately captured in NAS, thus there may be upward bias in the estimate of black money so derived.

survey method

Yet another method of estimation of black money is the survey approach wherein sample surveys are carried out. They may be on the consumption pattern of a representative population sample, which is then compared to the total consumption of the country. In this method, the problems consist in getting a truly representative sample, unambiguous set of questions, and the willingness of persons in the sample size to reveal true facts. Often the comfort level with the interviewers is limited as people are unwilling to admit any illegality before strangers

Fiscal approach' method 

There is also the 'fiscal approach' method for estimating black income. The underlying basis of this approach is to view the economy as comprising several sectors, each having its own sets of practices. The contribution of these sectors to black money generation is separately worked out, which when added would give the size of the 'black' economy. However, the manner of identifying the 'black component' in these sectors and the assumptions suffer from inherent subjectivity of the researcher and lack of uniform standards

2.6 Estimates of Black Money Stashed Abroad

 A chain Email, which first started circulating on the Internet in early 2009, states that Indians have more money in the Swiss banks than all other countries combined. It claims that as per a Swiss Banking Association report in 2006, bank deposits in the territory of Switzerland by nationals of a few countries are as under: India, US$1456 billion, Russia, US $470 billion, UK, US$390 billion, Ukraine, US$100 billion, China, US$96 billion.

3. INSTITUTIONS TO DEAL WITH BLACK MONEY

3.1  Central Board of Direct Taxes 

The CBDT, New Delhi, is part of the Department of Revenue in the Ministry of Finance. While the CBDT provides essential inputs for policy and planning of direct taxes in India, it is also responsible for administration of direct tax laws through its Income Tax arm.. Some of its important functions are as follows:

(a)  Policy making:

(b)  Assessment:

(c)  Investigation:

(d)  Collection of Information:

(e)  Collection of Information Involving Cross-border Transactions: 

3.2 Enforcement Directorate

The ED was established in 1956 to administer the provisions of the Foreign Exchange Regulation Act 1973 (FERA). However, FERA was repealed on 31 May 2000 and replaced with the Foreign Exchange Management Act 1999 (FEMA) which came into force with effect from 1 June 2000

The Directorate initiates investigations under FEMA for contraventions relating to foreign exchange transactions generally by resident Indians, including maintenance of bank accounts abroad with unauthorized holdings, on the basis of specific intelligence/information and takes appropriate action as per the provisions of FEMA.

3.3 Financial Intelligence Unit

The FIU-IND was established by the Government of India vide an Office Memorandum dated 18 November 2004 for coordinating and strengthening efforts for national and international intelligence by investigation and enforcement agencies in combating money laundering and terrorist financing. FIU-IND is the national agency responsible for receiving, processing, analysing, and disseminating information relating to suspect financial transactions. It is an independent body reporting to the Economic Intelligence Council headed by the Finance Minister. For administrative purposes, the FIU-IND is under the control of the Department of Revenue, Ministry of Finance.