The BMR View

UnFINA and Money Laundering in India

Introduction

While a lot has been said and written about Undisclosed Foreign Income and Assets (Imposition of Tax) Bill (UnFINA) over the last few days, most of this is based on the bill’s

sections, directives and penalties, as cleared by the Cabinet. The conversations around UnFINA have been relegated to the number of years of imprisonment, fines and percentage of penalties. In our view this has led to a case of missing the forest for the trees.

It is amply clear, that the law has been taken, in places, from the existing Income Tax Act, 1961 and hence by that singular measure, isn’t radically new. Our politicians and bureaucrats had either the foresight or were faced with black money related issues, at the time of enactment of the Income Tax Act in 1961. This shouldn’t come as a surprise, especially since the first major law targeting Black Money came into play with the Bank Secrecy Act, 1970 (USA). It is well known that the Hawala route of financial transfers was prevalent during medieval times and restricted even by roman laws. In short, this is an old issue, which has been recognized and dealt with under modern laws for over 50 years.

At present, a number of Acts influence the spectrum of issues related to Black Money

} The Income Tax Act, 1961 } The Customs Act, 1962 } Narcotic Drugs and Psychotropic Substances Act (NDPS), 1985 } Prevention of Corruption Act, 1988 } The Benami Transactions (Prohibition) Act, 1988 } Foreign Exchange Management Act (FEMA), 1999 } Prevention of Money Laundering Act (PMLA), 2002 } Companies Act, 2013

Any new law or directive which seeks to influence Black Money, should be innovative and radical enough to affect major evolutionary change. UnFINA seems to take incremental steps at best and widen the regulatory net against Money laundering.

Black Money does not have a legal definition on a specific dimension but is prevalent enough in public consciousness for us to discuss the nuances of underlying issues. For our purposes it may be defined as income illegally obtained or not declared for tax purposes. Black Money is usually looked at through the moral prism of ‘Good Vs Evil’. The truth is that our financial infrastructure, convoluted tax policies, economic history, growth issues, terrorism and political requirements are factors in this increasingly complex issue. Having said that, Black Money should be seen under two broad themes of ‘Redeemable’ & ‘Infected’.

While the former is Black Money which has been created out of income or asset on which taxes have not been paid for profit motive, the Infected Black Money is related to ‘Proceeds of Crime’ i.e. income generated from nefarious, anti-national and illegal activities such as drugs, human trafficking, terrorism, corruption etc. It is worthwhile to note that the principle behind major AML (Anti Money Laundering) Compliance norms across the world along with bi-lateral agreements are aimed at tackling the ‘Infected Black Money’ issue rather than ‘Redeemable Black Money’.

UnFINA, despite being uninspired and conventional, seems to be the bellwether for the proactive approach of the new government. Considering the general intent of the BJP led NDA government and the immense public pressure to act on Black Money, the proposed law could be the first of many steps taken in dealing with inherent structural issues while clearly differentiating and defining the two variants of Black Money.

Major features

Coverage1. The Act will apply to all persons residing in

India. Provisions of the Act will apply to both undisclosed foreign income and assets

2. Will also apply to banks and financial institutions aiding in concealment of foreign income or assets of resident Indians

3. Addresses the liability of a manager of a company. Such manager, present during the financial year shall be jointly and severally liable for the payment due, if the amount cannot be recovered from the company

4. Provisions made for partnerships and limited liability partnerships (LLP) in alignment with the existing laws of liability

5. For an LLP, the onus is on the concerned partner to prove that non-recovery cannot be attributed to any neglect, misfeasance or breach of duty on his or her part in relation to the affairs of the partnership

6. Failure to report balance of bank accounts above INR 5 Lakh (in aggregate) will lead to penalty and prosecution

7. Provisions also apply to beneficial owners and other ultimate beneficiaries

8. Extensively covers companies, organizations, associations, trusts, HUFs and individuals

Compliance Window1. A compliance window of 3 to 6 months may

be provided before the additional punitive measures become effective

2. Undisclosed foreign income or assets shall be taxed at a flat rate of 30%. Along with this an equal amount as penalty will be charged effectively leading to a 60% charge on the total undeclared amount during the compliance window

3. No exemption or deduction or set off of any carried forward losses may be admissible under the existing Income tax Act

4. Declarations will not be admissible as evidence for the purposes of prosecution under Income Tax Act, Wealth Tax Act, Foreign Exchange Management Act, Companies Act or Customs Act

5. This is not an amnesty provision but a compliance window as penalties (30% tax+ 30% penalty= 60% charge) will be in effect during the window and increased in totality (30% tax + 90% penalty = 120% charge) post closure of this window

Penalties and Prosecution1. The penalty for non-disclosure of income or

an asset located outside India will be equal to three times the amount of tax payable i.e. 90% which is applicable apart from the taxation rate of 30%

2. No deduction, allowance or set-off is permissible. Prosecution is also provided for, which cannot be compounded, unlike other fiscal laws

3. Willful attempt to evade tax, penalty or interest – Rigorous imprisonment for 3 to 10 years (with fine)

4. Willful failure to furnish returns before the end of the financial year - Rigorous imprisonment of 6 months to 7 years (with fine)

5. Failure to disclose all assets and income despite filing returns - Rigorous imprisonment of 6 months to 7 years (with fine)

6. Repetition of an earlier convicted offence - Rigorous imprisonment for 3 to 10 years (with fine)

Notable Details1. Proposed for the financial year 2015-16 and is

likely to be applicable from assessment year 2016-17

2. Seeks to provide for the modes of recovery of tax dues by the Assessing Officer or the Tax Recovery Officer

3. The bill carries safeguards in the form of an appellate machinery

4. The bill proposes to amend the Prevention of Money Laundering Act (PMLA), 2002 to include tax evasion

In essence, the UnFINA Bill provides for separate taxation of undisclosed income in relation to foreign income and assets. It is proposed that such income henceforth not be taxed under the Income tax Act, 1961 but under the provisions of the new

legislation. Combine this with defined punitive measures of penalties & imprisonment and one has (in theory) a potent addendum to the growing net of laws and measures against Money Laundering.

It is expected that the government may provide a compliance window of 3 to 6 months, though it is our view that a window of minimum 9 months be given for those individuals and entities who may want to take the benefit of this one time opportunity, liquidate their assets and bring the same back into the country. It is also important to note that unlike in the past, this is not an amnesty scheme, even though differential rates of penalties are being applied.

The Macro Issues

Funding the Indian Democracy In India, Black Money is used to fund one of the largest ongoing democratic exercises in the history of mankind i.e. Indian Elections. Here, ‘Indian Elections’ stands for the extensive & intensive, year-round activity of electing representatives in the Lok Sabha, State Assemblies, Municipal, Gram, Zila & Block Panchayat, Student & other Unions. It helps to understand exactly where hundreds of political parties get funds for the multitude of activities that need to be undertaken to ensure their political relevance and existence.

An instructive example of this is the estimated INR 30,000 crore (as per a study by Center of Media Studies) which was spent by candidates, political parties, associated organizations and the Government to make the 2014 Lok Sabha Elections possible. This is comparable to the INR 42,000 Cr. spent in the 2012 US Presidential Elections. However, the two largest parties have only declared expenditures of INR 714 Cr. (BJP) and INR 516 Cr. (INC) while the National Exchequer has stated INR 3426 Cr. as the expense on its part. The gap between the total estimated expenditure and the declared numbers should give us an idea of the quantum of Black Money involved. Hence, any law, act or force must look at rectifying this fundamental issue which leads to moral vacuum and leadership deficit in our fight against Money Laundering.

Business Mentality & Taxation Ever since the days of the License Raj, regimes of 100%+ taxation rates and extensive red tapism, the business community has found financial solace in keeping a significant portion of their businesses off-the-books. This enabled them to continue running marginally profitable businesses at best and endemically sick units at worst, while ensuring that they make healthy profits. This culture in turn, continues to flow downstream to suppliers, vendors, distributors and retailers, resulting in a huge chunk of economic activities being unaccounted for. Though tax rates have reduced significantly, businesses along with the entire value chain continue to treasure undeclared profits. Along with simplifying taxation (GST & other measures), reducing the complexities of getting the right approvals and licenses (single window process), the business community needs to proactively rectify the tax evasion culture and wean itself off the need for unaccounted profits.

Carrot & Stick Laws which are designed to bring about a fundamental change in the attitudes and deep-seated motivations of a large set of people, must have an effective reward-punishment mechanism. As of now this bill falls short on this account as it doesn’t have any positive stipulation for compliance except for the 60% charge i.e. 30% tax + 30% penalty (hardly a reward) on declared assets and income. This may sound fair but since this feature already exists in the current laws, its motivating value may be deemed inconsequential. Moreover, the punishment of imprisonment and fines, isn’t a deterrent because versions of this have existed across laws and haven’t been successful, due to ineffective enforcement. It’s like warning thieves not to enter your house because you have a gun, even though you have been robbed scores of times over the last 60 years and have never really used your gun. In fact it may be argued, that you don’t have a gun in the first place.

While it may sound wrong to even think of rewarding tax evaders, one has to remember that the ultimate goal of this law is to address a pragmatic issue. The government wants to bring back Black Money to fill its coffers with much needed revenue to rein in deficit numbers and to focus the efforts of Counter-Terrorism, Intelligence, ED, FIU and other agencies on the actual trouble-makers. Offering amnesty at this stage may be difficult since after the VDIS scheme in 1997, the government had been restricted by the Supreme Court on offering any more equivalent windows, atleast for the next 20 years. Having said that, more thought needs to go into incentivizing compliance. If one were to deal with lakhs of tax evaders, the efforts of our limited resources would be futile. Hence, UnFINA should have clearly laid down a better Carrot & Stick policy.

Our Global Connections India has consistently made lots of noise on Black Money being stashed abroad in various tax havens. However, its actions on ground are usually ambiguous and mired in the language of ifs and buts. Last year India did not attend the OECD summit in Berlin where 51 countries signed multilateral agreements on information exchange which may have proven to be instrumental in determining tax evaders and money laundering. At present India is in the process of signing such agreements with countries on a bilateral basis. Progress on this front is being made belatedly but it is difficult to foresee any meaningful information exchange without such agreements and their willful enforcement.

Global Financial Integrity claims that $440 Billion of Black Money has moved out of India over a ten-year period from 2003 to 2012 and has consistently risen on a year-on-year basis. The real test of UnFINA and the entire set of Black Money laws, is to see how much of this money actually comes back in declared form. Our diplomatic and global agreements will go a long way in making this a reality.

Terrorism, Racketeering, Corruption, DrugsThis list is fairly long and equally perilous. It is these set of issues which will ultimately decide the success or failure of our Anti-Money Laundering laws. Make no mistake, ‘Infected Black Money’ is generated through these activities and represents a clear and present danger. Hence any law, which does not address the root causes of funding of these illegal and nefarious activities is window dressing at best.

Global Financial Integrity claims that $440 Billion of Black Money has moved out of India over a ten-year period from 2003 to 2012 and has consistently risen on a year-on-year basis.

The BMR View on UnFINA

The Tax Department

The onus of the workings of UnFINA has been placed on the Central Board of Direct Tax (Income Tax Department) in general and the Tax Assessors in particular. One wonders if Tax Assessors have been or will be, given the tools and means to uncover evidence of Foreign Assets and Income. If not, then it could be work as usual for the authorities who are swamped with paper work and cases on a regular basis. How would a Tax Assessor be able to determine, if someone has a mansion in Barbados or Monaco, sitting out of his office in Patna? How would they conduct such an investigation in the practical sense? What would be the methodology for uncovering fair market value of various assets when they have little information access to foreign markets? While we are sure that provisions are in place to answer these and several other complex questions, it remains to be seen how this plays out once investigations are started in earnest. This is a significant concern since the government doesn’t envision any additional expenditure towards the enactment of this bill.

Part of the Anti-Money Laundering Net

This law may be treated as an addendum to the Income Tax Act and other Anti-Money Laundering influencing laws. The problem mentioned in the full title of UnFINA bill has not been addressed holistically, though to be honest, the solution is not as simple as getting a law passed by the Parliament.

Posturing or Intent of the Government

The Modi led NDA government came to power on a couple of broad themes, and one of them was the issue of Black Money. While it has tried to take the right steps, results in slow moving cases such as the HSBC Switzerland Black Money case has dented the image of the government. Combine this with a feisty Rajya Sabha, and the battering received on the Land Acquisition Bill and, it is fairly easy to understand the need of for a quick yet substantial win. This bill represents such an opportunity especially with the prevelantprevalent public mood. Hopefully, it also neatly underlines the intent of the Government to go after tax offenders.

The BMR View on UnFINA

Banks, Financial Institutions and CA firms to be prepared

Organizations which create value by being closest to money and financial decisions (hence by default to Black Money) need to see the writing on the wall. Globally, they are one of the first few organizations to be affected when it comes to Bribery or Money Laundering initiatives. With their public image at its lowest, regulatory requirements at its peak and increasing multi-country, multi-agency activities in AML, organizations need become compliant one way or another. With the exception of a small sliver of FIs and Banks, there is a long way to go for the rest.

Catching up to the Rest of the World

There is a sense in bureaucratic, security and financial circles that India needs to catch up with the rest of the developed world with regard to our AML compliance norms, if we wish to play with the Big Boys on the Global Financial playing field. This is especially true when it comes to redefining and refocusing AML efforts among banks (especially cooperative banks), establishing the legal definition of domestic PEPs (Politically Exposed Persons), participation in global multi-lateral tax & AML forums along with other global policy initiatives.

Differentiating between ‘Redeemable Black Money’ and ‘Infected Black Money’

If the real underlying issues have to be addressed through this bill then it makes sense to develop an official and public differentiation between the two types of Black Money. Our sense is that, this will enable the Government to showcase quick and big wins while also ensuring compliance of the business community on the whole. What remains to be seen is whether politicians will be brought to book or not.

The BMR View on UnFINA

Redefining Relationships with Countries and Financial Institutions

Without the presence of numerous bi-lateral and multi-lateral agreements with countries, territories and financial institutions globally, our tax and regulatory departments may be shooting in the dark on most accounts. These agreements allow the automatic transfer of information, which is in turn instrumental in building the case for identifying & valuing Income income and Assets assets abroad. Unless UnFINA and other laws are not complemented with this diplomatic ground work, our efforts to assess and deter the flow of black money, to & from India, may be replete with large gaps.

Effective only on Co-ordinated Efforts

Considering the strained resources of agencies such as the ED, FIU, Intelligence, Police, Ministry of Corporate Affairs, Tax Departments and Finance Ministry along with relevant regulators, there has to be extensive cooperation and coordination to get the estimated $4400 billion of black money back to India. Based on the existing mechanisms and government machinery, this seems like a very long shot.

Conclusions

Considering how heavily this bill borrows, in letter, from the Income Tax Act, it may turn out to have the same spirit as well. UnFINA fills a small hole related to foreign income and assets,

at best, among the various laws in India aimed at Money Laundering. Having said that, if the government is genuinely interested in leveraging its power as the dominant political party and can somehow coordinate the varied government agencies to tackle this issue, it may be looking at achieving 5 distinct objectives:

1. Taking the initial steps towards separating ‘Redeemable’ and ‘Infected’ black money to cut the problem down to manageable size

2. Generating much needed revenue for government coffers, using the compliance window

3. Offering businesses, organizations, associations and businessmen the ability clean up their books and initiate a fresh start

4. Redefining, refining and regulating the processes and response of Financial Institutions & Banks to safeguard themselves against Money Laundering

5. Developing focused responses and coordination between agencies to tackle ‘Infected Black Money’

These would be huge wins for the present government and in our fight against Money Laundering.

BMR AdvisorsBMR Advisors is a professional services firm offering a range of Tax, Risk and M&A advisory services for domestic and global businesses of all sizes. The firm enhances value for clients by focusing on solutions that are innovative, yet practical and that can be implemented. This is achieved by blending domain expertise with analytical rigour, while maintaining an uncompromising focus on quality, and by hiring and nurturing high quality professionals with a passion for excellence. BMR is committed to making a difference to clients and to its people, and delivers this through the integrity of its effort and by living its core values.

Risk & Advisory PracticeBMR’s Risk and Advisory practice offers a complete suite of services to Global and Indian companies, encompassing Due Diligence, Process Consulting, Financial Crimes Compliance, Analytics, Advisory and Forensics, to help management make better and informed decisions. We have delivered projects in over 40 countries, exhibited the art of delivering global assignments through our flexible delivery model (co-source, outsource and experts to support specific situations) and provided extensive training to our professionals to adapt to the work and cultural environment of different countries. The ethos of the practice is to take up specific ‘high impact’ assignments for our clients to deliver great results and clarity.

Risk & Advisory Services

} Anti-Money Laundering } Diagnostic Reviews } Anti-Bribery Compliance } Analytics for Risk Management } Fraud & Forensic Review } Data & Database Services } Due Diligence } Securitization } Process Consulting } Business Advisory

Your ViewsWe look forward to hearing your views on UnFINA and how the proposed law may affect your organization, its compliance measures and future activities. Please connect with ‘The BMR View’ team which has been involved in assessing, researching and developing a cohesive & holistic view on the law as well as developing practical applications around it.

Sarabjeet Singh Partner +91 124 669 5044sarabjeet.singh@bmradvisors.com

Abhishek Bali Vice President +91 124 669 5033abhishek.bali@bmradvisors.com

The information contained in this report is for general information purposes only. While the firm endeavors to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the report or the information provided therein. All information contained in this report is acquired from publically available sources and hence any reliance you place on such information is therefore strictly at your own risk and the firm accepts no liability in relation to the use of the report. The firm reserves copyright of this report and hence, does not allow anyone to sell, re-publish or re-distribute the report or derivatives thereof.

© Copyright 2015, BMR Business Solutions Pvt. Ltd. All Rights Reserved