We Hate Taxes


Ramesh: “If black money was an Olympics event, India would have won a gold medal. The second best Russia has 4 times lesser deposits. U.S. is not even in the top five! India has more money in Swiss banks than all the other countries combined!”
Suresh: Woah! How do you know all this?
Ramesh: Baba Ramdev’s status update this morning. 

We Indians love ‘black money’, not just because we are corrupt and like being the rebels wearing a Che Guevara Tshirt (No, wait. Who is that?), but because we love how effortless it is to blame the government for it, or how through forwarded WhatsApp messages we all become experts on how India could have been, if this money was brought back. Black money is now found in every election manifesto and it creates a unique paradox amongst our politicians, who are now working night and day to get this black money back into India. Swiss bank secrecy laws, you say? No, they are working to get their own stashed away money back before it gets caught. In these interesting times, let’s jump onto the bandwagon and understand how black money really works.

The estimates as to how much of it there really is keeps on fluctuating but let’s just settle at: it’s a lot. As per the Swiss Federal Banking Act, revealing a client’s identity is a criminal offence, punishable by imprisonment. (Read here, for the why: http://bit.ly/1F0OxGN) So illicit wealth was stashed here from across the globe, no questions asked. Through time though, the problem of tax evasion became rampant and through the collective efforts of a lot of economies and the creation of the Organisation for Economic Cooperation and Development (OECD), the Swiss government has slowly given in. So while our authorities are busy figuring out who holds what account in Switzerland, most of that money will already be withdrawn from there. But then where does it go? Back into India. But its still illegal, isn’t it? Nope. But then is that a good thing? Nope.

Indians have heard the politicians’ call and have brought back this money into India, all fresh and laundered. Money laundering is a three step process:

  1. Placement: The total amount of illicit cash is divided into smaller bundles, just as low as the banks will accept them as deposits without asking for your PAN card or notifying the government. These bundles are then deposited in a number of banks accounts in a number of different names by different people (called smurfs)
  2. Layering: This money is now moved around like crazy so that it becomes difficult to follow the transactions and it becomes impossible to trace the source of this money. This may include a series of activities like converting the money into another currency, buying financial instruments, buying other assets like land and cars etc.
  3. Integration: Basically collecting your laundry back, as legitimate money.

Now there are numerous methods to perform these three steps. (For details read: http://bit.ly/1fan8jl) Let’s consider a simple example: I purchase a restaurant from my legal wealth. Now, I might serve food to a few customers and ostensibly run a business, but along with that I inflate every bill that I generate, I create fake invoices and show a highly inflated revenue on paper. I may get only one customer a day, but in the books it might be the most successful restaurant in the area. I have simply hidden my illicit wealth between some legitimate source of income to make it appear entirely legitimate. (Breaking Bad fans will relate) This job becomes even more easier when you’re dealing with movie theatres or barber shops because no one can really say that a Mr Sharma didn’t ge his hair cut today.

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Yet, there are some Indians who are brazen enough to evade taxes in the face of the government, without the latter being able to do anything about it. Indians have had a long obsession with the Swiss (blame it on Yash Chopra and DDLJ), but the real deal is in other places, namely Mauritius and some other tax havens. In the 1990s, India signed a ‘Double Taxation Avoidance Treaty’ with Mauritius wherein it was agreed that all capital gains tax accruing from transactions from investors in Mauritius to India, will be taxed in the former. (Reasons for this agreement?) Interestingly, Mauritius only charges a just-there 3% capital gains tax. Not coincidentally then, the highest volume of FIIs and FDIs into India come from Mauritius. No, not because Mauritians love to invest abroad, but because Indians register shell companies or companies that just exist on paper in Mauritius, stuff their money into them as its capital and then buy Indian securities showing them as foreign investment. Voila! Tax evaded. So much so that once, the finance ministry of India even expressly told the Parliament, when quizzed about the alleged irregularities in the ownership of some of the teams in the IPL, that the trail led to Mauritius and a few other destinations. To add insult to injury, it is extremely difficult for the Indian government to stop this, since international treaties cannot be unilaterally abrogated and any retreat from India’s side will allow China to woo the island nation.

After discussing illicit, underhand skullduggery then illicit yet not illicit, brazen evasion, lastly lets talk about legal ways to avoid tax. Tax avoidance- in contrast with tax evasion- is a commercial activity whose only purpose is  to  obtain  a  tax  benefit.  The  transaction  lacks commercial substance and there is a misuse of the tax provisions in terms of exploitation of loopholes. For example, a firm sets up a factory X in an under-developed, tax-exempt area. It then diverts its production from factory Y located in a non-tax exempt area but shows the same as manufactured through factory X.

We certainly hate taxes. According to estimates, the total amount of money laundering in the world is equal to 5% of the GDP of the world, much greater than the GDPs of a number of countries. Well, hopefully with more and more economists in the block, like Ramesh and his idol, we are headed towards better times.

(originally published in Artha- The Annual Economics journal of the Economics Society SRCC)


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