Time ripe to walk the 'talk'

In hindsight, ratification of the UN Convention against Corruption (my last fortnight column) appears a well-timed move by India, given flurry of announcements which followed the recently concluded conference seminar on ‘tax policy in the New Global Environment’, jointly organized by the Ministry of Finance and the Organization of Economic Cooperation and Development (OECD). Going by statements made by the President and the FM, India has taken to the task of dealing with the menace of ‘black money’ and ‘money laundering’ as serious business.

The Press release that followed the joint conference acknowledges lack of transparency in tax information exchange and banking secrecy laws as chief contributors to colossal growth of ‘parallel economy’ while the so-called regulated global order caved in the financial crisis.

 

‘Black money’ & ‘money laundering’ – Semantics!

While a lot has been written about the harmful effects of ‘parallel economy’ (or call it ‘hidden economy’, as popularly known in the EU), it is important to see the differing definitions that separates legal parts of the economy from others. The definitions are vague and dichotomy of activities could overlap; a hidden economy in its broadest sense may consist of - a) illegal economy, such as money laundering, smuggling, etc; b) unreported economy including tax evasion; c) unregulated economy, ie economic activities outside regulations. 

Clearly, there is more to formation of parallel economy in India than mere tax evasion and wealth accumulation from unreported activities. Money laundering, although is other side of the same coin; it implies a process by which black money is integrated into the ‘regulated’ economic order, through multi-stage layering of sources with an objective of hiding the ultimate source of funds. Thus, money laundering provides the raison-d’être to black economy.

Whilst money laundering is not a 21st century phenomenon, lack of transparency standards in bilateral and multilateral trade with flourishing offshore banking in tax havens has allowed it to grow unabated in past couple of decades.

The enormity of the unregulated economy in Euro-zone alone is perplexing; a recent study by the Spanish University revealed that size of black economy over 30 EU and other rich nations is close to 20 percent of their GDP, with Bulgaria leading the pack (31 percent); much to surprise, Switzerland is the lowest on this index (8 percent).

Statistics do not paint any better picture in the Indian context either; a task force has pegged the size of black money at USD 1.4 trillion; albeit this is not an official estimate.

Overdose of regulations – Indian dilemma!

Caught in a political storm on corruption, the Government has announced slew of measures over past few months. Whilst renegotiation of extant tax treaties with 78 countries and signing Tax Information Exchange Agreements with treaty as well as non-treaty non-sovereign territories were immediate consequences of G-20 whiplash on tax havens, more recently the Government is seen strengthening the domestic administration. 

In pursuance thereto, the government has set the ball rolling by signing up three leading think-tanks NCAER (National Council for Applied Economic Research), NIPFP (National Institute of Public Finance and Policy) and NIFM (National Institute of Financial Management) to conduct study on unaccounted income generated inside and outside India.

These three agencies have been given 18 months to identify important sectors of the economy in which unaccounted money is generated and suggest administrative and legal measures to curb its generation. It has announced setting up a special wing – Directorate of Income Tax (Criminal Investigation) [DCI] to investigate criminal offences under direct tax laws. The DCI will investigate the source and use of funds involved in such activities.

The move to set up DCI has come weeks after the constitution of a high level committee lead by the Chairman of CBDT, to advise the Government on administrative measures for strengthening domestic laws to stifle growth of black economy, prevent transfer of funds through unscrupulous tax planning and transfer pricing methodologies. Though specified tax evasion actions can result in imprisonment under the extant Income tax law, the proposal to make tax evasion a criminal offence and subject it to harsh punishment could mean potential amendments to the Indian Penal Code.

An announcement to declare recovered money as national asset seems ambitious and reactive as the law makers need to be mindful of fundamental rights of citizens, lack of international precedence and convention. OECD Model Convention talks about freezing and repatriation of assets between countries; 22 countries including Brazil and South Africa (both non-OECD countries) are signatory to the Convention and India should actively explore this option. Ad hoc nationalization goes against the grain of democracy and rules of law, besides departure from international convention.

Government’s timely nod to institutionalization of NATGRID, few days before the OECD conference, will enhance confidence of the international community in terms of India’s desire to promote effective and speedy retrieval of financial and non-financial data by over 10 government agencies (including RAW, Intelligence Bureau, Revenue Intelligence & the Income-tax department).

India is known for its ability to legislate; however, our track record in implementation is dismal. An overdrive to ‘regulate’ may not prove effective unless the ‘intent’ is served by efficient implementation. For example, proposal to set up DCI to investigate into willful tax evasion cases will require more than ordinary administrative measures, safeguards to prevent witch hunting, and absolute independence of the investigative panel.

Let’s walk the talk, for once!

Undoubtedly, the present inflection point in domestic and international cooperation is likely to witness multitude of regulations and new legislations. The key to addressing the issue, however, lies in effective administration of domestic agencies and maintaining healthy dialogue with international agencies such as OECD, G20 and treaty partners.

While negotiation of TIEAs and ongoing re-negotiation of tax treaties to facilitate effective information exchange is remarkable from an Indian standpoint, I reckon next few years should witness more structural changes in the tax administration and investigation wings of the government, to allow independence in implementation of policies.

The author is Partner with BMR Legal and was assisted by Sumit Singhania. Views are entirely personal