Black Money and It's Sources

1. What is Black Money?

Black money is a term used in common parlance to refer to money that is not fully legitimate in the hands of the owner. This could be for two possible reasons.

⛉ First is that the money may have been generated through illegitimate activities not permissible under the law, like crime, drug trade, terrorism, and corruption, all of which are punishable under the legal framework of the state.

⛉ Second and perhaps more likely reason is that the wealth may have been generated and accumulated by failing to comply with the tax requirements.

 There  have  been  several  estimates  regarding  the  extent  of  black  money  economy  also  called  as  parallel  economy. Some of the estimates suggest it to be as high as up to  fifty to hundred percent.

Although  black  money  in  India  is  decades  old  problem,  it  has  become  real  threat  post  liberalization.  Illegal activities  such  as  crime  and  corruption,  noncompliance  with  taxation  requirements,  complex  procedural regulations, cultural   and   social   practices,   globalization   along   with   weak   institutional,   policy,   legal   and implementation structures have further augmented the black money economy.  

2. Sources of Black Money

As  discussed  above  the  sources  of  black  money  are  broadly  of  two  categories illegitimate  activity  and  tax evasion even if the activity is legitimate. 

In  particular  following  are  some  of  the  mechanisms  through  which  black  money  is  circulated,  utilized  and  the profits earned are further invested in other sectors to generate further money.

▶ Real estate: 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.

▶ Bullion and jewellery market: 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.

▶ Financial markets transactions: IPO manipulations, Rigging of market such as use of shell companies.

▶ Public  procurement: Public  procurement  has  grown  phenomenally  over  the  years in  volume,  scale,  and variety as well as complexity.The Competition Commission of India had estimated total public procurement figure for India at around 10 to 11 lakh crore per year and provide sample scope of corruption due to rigged procurement process.

▶ Non-profit  organizations: Taxation  laws  allow  certain  privileges  and  incentives  for  promoting  charitable activities  which  are  misused  and  manipulated.  Highlighted  by  FATF  as  well.  Used  to  park  funds  of  corrupt politicians and businessmen.

▶ Informal Sector and Cash Economy: Cash transactions, large un-banked and under banked areas contribute to the large cash economy in India.
▶ External  trade  and  transfer  pricing: Transfer  profit/income  to  no  tax  or low  tax  jurisdictions  by  MNCs. Developing  countries  may  be  losing  over  US$160billion  of  tax  revenues  a  year,  primarily  through  transfer pricing strategies.
▶ Trade based Money Laundering (TBML):Disguising the proceeds of crime and moving value through the use of trade transactions in an attempt at legitimizing their illicit origins.
▶ Tax  Havens: Tax  havens  are  typically  small  countries/  jurisdictions,  with  low  or  nil  taxation  for  foreigners who decide to come and settle there. Strong confidentiality or secrecy regarding wealth and accounts, very liberal regulatory  environment  and  allow  opaque  existence,  where  an  entity  can  easily  be  set  up  without indulging  in  any  meaningful  commercial  activity  and  yet  claim  to  be  a  genuine  business  unit,  merely  by getting  itself  incorporated  or  registered  in  that  jurisdiction.  This  makes  them  highly  desirable locations  for multinational  entities  wishing to reduce their global tax liabilities. Multinational  entities  consisting  of  a network  of  several corporate  and  non-corporate  bodies  set  up  conduit  companies  in  tax  havens  and artificially transfer their income to such conduit companies in view of the low tax regime there.

▶ Offshore Financial Centers :Describe themselves as financial centers specializing in non-residential financial transactions but are logical extensions of the traditional tax havens. They have following characteristics: 

• Jurisdictions that have financial institutions engaged primarily in business with non-residents.
• Financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economic.
• Centers which provide some or all of the following opportunities: low or zero  taxation; moderate or light financial regulation; banking secrecy and anonymity.

▶ Hawala: It is an informal and cheap method of transferring money from one place without using banks etc. It operates on codes and contacts and no paperwork and disclosure is required.

▶ Investment through Innovative Derivative Instruments: Such as Participatory Notes.