Flood of cash swamps I-T, overstretched taxmen hunt for signs of evasion

The front line in India’s war on cash is advancing. After people rushed to redeem cancelled currency at banks, authorities are now scrutinising the paper trail for signs of tax evasion—and chasing suspects.

But “Operation Clean Money” is proving an arduous task for a government that struggles, even in ordinary times, to collect what its citizens owe.

“We are not doing 100%. We can’t,” said an official with India’s income-tax department. “We don’t have the resources to look at each and every deposit” that is flagged for investigation.

Prime Minister Narendra Modi sprang the cash plan in November, invalidating 86% of the nation’s paper money by value overnight and giving Indians until Dec. 30 to deposit or exchange their 500-rupee and 1,000-rupee bills ($7.50 and $15).

The economy was sent reeling, but Mr. Modi said the move would flush out tax evaders, corrupt bureaucrats and other cash-hoarding criminals, strengthening the country in the long run.

To trace money back to lawbreakers, officials must now sift through records of millions of bank deposits from November and December. They are first examining large deposits of voided bills made without proper identification, into dormant accounts or into no-frills accounts that are typically used by the poor.

If a deposit is deemed improbably large given the account holder’s reported income, the account holder is given 10 days to explain the source of the cash before being called in for further questioning. Officers may need to wade through webs of transactions, or search homes and offices if they think money is stashed there. Each inquiry could take months.

In the first two months after the cash cancellation, the income-tax department sniffed out a total of $800 million in undisclosed income and seized $76 million in cash.

That is just a modest start, though, in a country where only one in 20 people pays income taxes and revenue from personal and corporate income tax amounts to only 6% of GDP—half the average take in developed nations.

“For several decades, tax evasion for many has become a way of life,” Finance Minister Arun Jaitley said. “This has bred a parallel economy which is unacceptable for an inclusive society.”

India’s overstretched tax department manages to audit just 1.5% of the 40 million returns filed each year.

“We already have this shortage of people at all levels, top to bottom,” said Ajay Goyal, president of the Income Tax Gazetted Officers’ Association, an officers’ union. The department hasn’t stepped up hiring to help work through the flood of deposits, he said.

A spokeswoman for the Central Board of Direct Taxes, which oversees the income-tax department, didn’t respond to queries about staff shortages.

Cash deposits larger than the investigation threshold of 200,000 rupees—roughly $3,000, or nearly two years’ earnings for the average Indian—were made into 11 million bank accounts before the Dec. 30 deadline, Mr. Jaitley said.