India’s Big Government

by Vivek Kaul

  As per the Act, American taxpayers are required to file a new form (Form 8938) declaring their foreign financial assets with a value greater than $50,000. This form needs to be filled up along with the annual tax return. If the taxpayer does not file Form 8938, he could face a fine of $10,000, which could go up to $50,000 for subsequent offences. Any taxpayer who pays lower tax because he does not disclose foreign financial assets could be subject to a penalty of 40 per cent.

  As per FATCA, every financial institution outside the United States needs to figure out whether it has American citizens as clients. Having done that, it needs to report the information to the Internal Revenue Service of the United States, along with what that person holds in that account and the income earned on it. This exchange of data has to be done every year.

  FATCA has been criticised on two grounds. One, it is seen as an invasion of privacy. And two, there is no quid pro quo, i.e., while the IRS of the Unites States is collecting data from foreign financial institutions regarding assets held by Americans, at the same time, it’s not handing over data regarding assets held by foreigners in American banks and financial institutions.591

  Nevertheless, the conventional view that people seem to have is that tax havens are now cooperating with the United States and handing over information regarding their clients. Hence, the question is: If the United States can do it, why can’t India? And the answer lies in the fact that the United States is a global superpower. In 2013, the military expenditure of the United States amounted to $640 billion. This was nearly 36.5 per cent of the global military expenditure of $1.75 trillion. In comparison, the total budget for the Indian defence services in 2015-2016 was around $44 billion (at $1 = Rs. 67).

  With so much money being spent by its government, the military apparatus of the United States can drop bombs anywhere in the world at a few hours’ notice. As David Graeber writes in Debt: The First 5000 Years: “The U.S. Military ... maintains a doctrine of global power projection: that it should have the ability, through roughly 800 overseas military bases, to intervene with deadly force absolutely anywhere on the planet.”592 It is this military might of the United States, and nothing else, that has led to the tax havens cooperating with it.

  Nevertheless, as the Americans like saying, ‘Show me the money’. Or, to put it simply, how much money has the Internal Revenue Service of the United States managed to collect because of FATCA? Jane G Gravelle, writing in a research paper titled ‘Tax Havens: International Tax Avoidance and Evasion’ for the Congressional Research Service, estimates that FATCA is expected to collect “$8.7 billion over 10 years, when compared with [the] estimated costs of international evasion of around $40 billion a year.”593 So, on an average, the United States expects to recover $870 million per year ($8.7 billion divided by 10 years) through FATCA when the international tax evasion by Americans is around $40 billion per year. Hence, the projected recovery rate for FATCA is a measly 2.2 per cent, on an average.

  What this clearly tells us is that even the United States does not expect much out of FATCA, at least not initially. This despite being the only global superpower. In this scenario, how much chance do you think India has of recovering the black money that has left its shores?

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  The black money that leaves India does not keep sitting idle in savings accounts that earn almost no interest these days across large parts of the world. The money is invested in stocks, bonds and mutual funds, like the money on which taxes have been paid. Globally, the returns on this investment were around 5 per cent per year over the past 15 years. It was around 6 per cent between 1980-1990.594

  A return of 5-6 per cent might sound low to an Indian, but when looked at from the point of view of the fact that, during the same period, developed countries have seen low inflation, this is not bad at all. Also, post-2008, after the financial crisis had broken out, the interest rates in large parts of the developed world have anyway been very low. Once this is taken into account, an average return of 5-6 per cent isn’t really that bad. Plus, it is worth being reminded here that this is money on which tax has not been paid.

  Furthermore, it is difficult for government authorities to track down the ultimate owner of such an investment. Let’s try and understand this through an example. Take the case of a British individual holding Google shares in his Swiss bank account. The American authorities can see that a foreigner has an investment in Google. Hence, it is a liability for the United States. The Swiss authorities see that some Google stock has been deposited with them. At the same time, they know that the stock belongs to a resident of the United Kingdom. Hence, it is neither an asset nor a liability to the Swiss. The British authorities should record the stock as an asset, but they don’t, simply because they don’t know that the British resident has an investment in Google.595

  What makes the situation even more difficult in the Indian case is the fact that a lot of black money that goes abroad comes back to India through a process known as round-tripping. In fact, the Finance Ministry’s White Paper on Black Money makes this point in the context of foreign direct investment:596

  The two topmost sources of the cumulative inflows from April 2000 to March 2011 are Mauritius (41.8 per cent) and Singapore (9.2 per cent). Mauritius and Singapore, with their small economies, cannot be the sources of such huge investments, and it is apparent that the investments are routed through these jurisdictions for [the] avoidance of taxes and/or for concealing the identities from the revenue authorities of the ultimate investors, many of whom could actually be Indian residents, who have invested in their own companies, though a process known as round-tripping.

  A similar sort of round-tripping also happens in the stock market through an instrument known as Participatory Notes (PNs). As the White Paper points out:597

  Investment in the Indian Stock Market through PNs is another way in which the black money generated by Indians is re-invested in India. PNs, or Overseas Derivative Instruments (ODIs), are issued by FIIs [i.e., Foreign Institutional Investors] against underlying Indian securities, which can be equity, debt, derivatives, or even indices. The investor in PNs does not hold the Indian securities in her/his own name. These are legally held by the FIIs, but she/he derives economic benefits from fluctuation in prices of the Indian securities, as also dividends and capital gains, through specifically designed contracts.

  This makes the issue of trying to recover the black money that has left Indian shores even more complicated. Nevertheless, this did not stop the Narendra Modi government from coming up with the foreign black money Act, which was passed by Parliament in May 2015.

  The Act states that undisclosed foreign income as well as assets will be taxed at the rate of 30 per cent without allowing for any exemptions or deductions which are allowed under the Income Tax Act of 1961. This will be accompanied by a penalty equal to three times the amount of the tax. Hence, the tax and penalty on undisclosed overseas income as well as assets can amount to as much as 120 per cent (30 per cent + 90 per cent). Furthermore, the amount of tax to be paid on foreign assets will be computed on the basis of its current market price and not the price at which it was bought.

  Nevertheless, there was a way out of this. The foreign black money Act came into effect from June 1, 2015. The government offered a short compliance window, of until September 30, 2015, which would allow those with undisclosed foreign assets and income to declare them, pay a tax of 30 per cent and a penalty of 30 per cent. The Act also has a provision which allows the government to charge a penalty of Rs. 10 lakh for the inaccurate disclosure of foreign assets, along with a rigorous imprisonment of six months to seven years the first time around. Second and subsequent offences are punishable with fines of Rs. 25 lakh to Rs. 1 crore and a rigorous imprisonment of three to 10 years.

  On the face of it, the Act seemed like an honest attempt to crack down on the black money that had already left the country and that might leave the country in the days to come. But there are several questions that crop up
here. Why was a short compliance window being offered? It makes the taxpayers who have been honestly declaring their income (foreign and domestic) as well as assets till date look a tad stupid. Just because someone is willing to pay a fine of 30 per cent and declare his foreign assets, does that make him less guilty? Or is this another tax amnesty scheme in disguise being offered by the government?

  Taking advantage of the compliance window, 638 declarants declared assets and income of Rs. 4,147 crore in total. This meant that the government was able to collect around Rs. 2,488 crore (60 per cent of Rs. 4,147 crore) as tax revenues. Thus, around Rs. 3.9 crore of tax and penalty was collected on an average from each declarant.

  For all the hype and hoopla that has surrounded black money since Narendra Modi came to power, this is peanuts. And given this, a collection of Rs. 2,488 crore is basically a bad joke, especially once you take into account the tremendous amount of political capital that the Narendra Modi government has spent on the black money issue.

  In February 2016, the Modi government came up with a plan to tap into the domestic black money pile. The Finance Minister, Arun Jaitley, in the budget speech made on February 29, 2016, proposed to offer “a limited period Compliance Window for domestic taxpayers to declare undisclosed income or income represented in the form of any asset and clear up their past tax transgressions by paying tax at 30 per cent, and surcharge at 7.5 per cent and penalty at 7.5 per cent, which is a total of 45 per cent of the undisclosed income”. People with black money were given a four-month window between June and September 2016 to come clean on their domestic black money. How this played out we shall look at in the conclusion to the book.

  So, if you have black money and are willing to pay 15 per cent extra over and above the top tax rate to the government, the laws of the land won’t apply to you. As Jaitley further said in his speech: “There will be no scrutiny or enquiry regarding income declared in these declarations under the Income Tax Act or the Wealth Tax Act, and the declarants will have immunity from prosecution. Immunity from [the] Benami Transaction (Prohibition) Act, 1988, is also proposed, subject to certain conditions.”

  In an interview to the national broadcaster Doordarshan, Jaitley later said: “It’s not a VDIS (Voluntary Disclosure of Income Scheme), and it is not an amnesty.” Like a good lawyer, he did not specify what the scheme really was.

  Despite what Jaitley said, the scheme was basically an amnesty scheme. Before June 2016, a person evading income tax and found with black money had to pay a penalty of 100 per cent to 300 per cent of the tax evaded. In case of the ‘Income Declaration Scheme’ of 2016, a tax of 30 per cent along with a 7.5 per cent surcharge and a 7.5 per cent penalty had to be paid, which works out to an effective tax of 45 per cent. This is much lower than the 100 to 300 per cent penalty that needs to be paid normally.598 If this isn’t amnesty, then what is?

  The last time an amnesty scheme was offered to those who had black money was in 1997. The scheme was called the Voluntary Disclosure of Income Scheme (VDIS). In fact, the trouble started with the name of the scheme itself. What those with black money had to declare was the wealth they had accumulated by not paying taxes, and not their income.

  A tax of 30 per cent had to be paid on undeclared assets. This rate of 30 per cent applied to the value of the asset in the year the transaction had taken place and not the market value of the asset at the time of declaration. This meant that the effective rate of tax was much lower than 30 per cent, once the appropriate market value of the asset was taken into account.599

  In fact, this was the major structural problem with the scheme. As Kumar writes:600

  Rs. 10,000 crore of taxes were collected through it…. Rs. 33,000 crore worth of assets were declared under the scheme, but the present value of these assets may have been many times this amount. Since detailed data will never be revealed, the exact amount will not be known. The implication is that the State, which went down on bended knees, was again cheated…. An estimate is difficult at [the] best of times…. In brief, 1 per cent of the black wealth may have been revealed.

  Also, it is worth mentioning here that the 30 per cent had to be paid out of the current income. Given this, the collection of regular income tax in the year 1997-1998 was impacted. Furthermore, the Comptroller and Auditor General (CAG) looked into the VDIS and made a few very interesting observations.

  The CAG report pointed out that the VDIS “provided the declarants with an opportunity for widespread misuse by undervaluation of jewellery, bullion, shares and real estate, and also the ‘creation’ of capital loss to set off against income in future years”.601

  Over and above this, the report made a very interesting point which Messrs. Jaitley and Co. should be aware of. As the report pointed out: “The track record of [the] declarants showed a clear scenario where they were found to have taken advantage of earlier Amnesty Schemes too…. The Scheme was not in the interests of revenue and, in fact, it provided one more opportunity to dishonest assesses to pay tax at a preferred rate and then retire to the old habit of concealing income.”602

  The focal point being that, as long as people anticipate that an amnesty scheme will be offered in the years to come, they are unlikely to be honest about the taxes that they pay.

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  In 2011, the Congress-led UPA government had asked three institutes, the National Institute of Public Finance and Policy (NIPFP), the National Institute of Financial Management (NIFM) and the National Council of Applied Economic Research (NCAER), to estimate the total amount of black money in India. The reports from these institutes have still not been put up in the public domain. “Reports received from these institutes are under examination of the government,” Finance Minister Jaitley told the Rajya Sabha in May 2015.

  The Hindu newspaper had accessed the NIPFP report in August 2014. The NIPFP puts the size of the black money economy at around 75 per cent of the GDP. This estimate is much bigger than the previous estimates.603 The last official study for estimating black money had been carried out by the NIPFP way back in 1985 on the request of the Finance Ministry. The study put the size of the black money anywhere between 15-21 per cent of the GDP.

  If we compare the 1985 study figures to the latest NIPFP black money figure, there has been a huge jump in the generation of black money, with the black money economy now accounting for nearly 75 per cent of the GDP. One explanation for this rise is the rise of the services sector over the last thirty years. The share of the services sector in the GDP has risen from 40.4 per cent in 1985-1986 to 59.9 per cent in 2013-2014. As Kumar points out: “The services sector lends itself to black income generation, since a) valuation of activity is difficult, and b) it has a large component of the unorganised sector in it.”604

  The new NIPFP report, referred to above, states that real estate remains the biggest source of black money transactions. The amount of black money from real estate is estimated to be bigger than the plan expenditure of the government. The plan expenditure is essentially money that goes towards the creation of productive assets through schemes and programmes sponsored by the central government. The plan expenditure of the government for the financial year ending March 31, 2013 had stood at Rs. 4,53,327 crore. Now that is a huge amount of money.

  The other major sectors generating black money are private education and mining. Politicians running this country have significant interests in real estate, mining and the education business. The report estimated that, in 2012-2013, the capitation fees collected by private colleges on what are known as management quota seats had stood at Rs. 5,953 crore.

  The other major black money spinners are the subsidies given by the government. The Hindu reported, regarding the new NIPFP report, that: “Diversion of subsidised kerosene to the open market is estimated to have generated as much as Rs. 11,910 crore.”605 This was half the total amount of the kerosene subsidy provided in 2013-2014.

  It wouldn’t be surprising to know that black money is being generated from other subsidies offer
ed by the government as well. In fact, the Economic Survey of 2015-2016 reveals that 46 per cent of the kerosene distributed through the Public Distribution System (PDS) is siphoned off and sold in the open market. This is true about other subsidised products like rice, wheat, sugar and cooking gas as well.

  These leakages hurt the government in two ways. First, it leads to a major portion of the subsidies being wasted. Secondly, it leads to the generation of black money, and that, as explained earlier in the chapter, has its own share of consequences. The government is trying to tackle this through cash transfers directly to the public instead of following the subsidy route, whereby a product is sold at a lower price for one section of the population.

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  The Annual Report of the Ministry of Finance for 2013-2014 points out that the number of income tax assessees in 2013-2014 had stood at a mere 4.7 crore. The Annual Report for 2015-2016 said that 76.04 lakh new assessees were added during 2014-2015. The increase in the number of assessees during 2014-2015 has been decent, even though the overall number of income taxpayers in a country of around 130 crore people continues to remain low.

  And by laying out the red carpet for the tax cheats who have managed to move their black money abroad or still have it in India, what message is the government sending out to the individuals who have faithfully been paying their taxes? This is not the best way to go about trying to increase the number of people who pay income tax. The point being that the growth of tax compliance is anyway very slow and, on top of that, if the government keeps laying out the red carpet for those who have black money, what future does tax compliance really have in this country?

  Furthermore, as mentioned earlier, the former Finance Minister, P Chidambaram, had said in his February 2013 budget speech that there were only 42,800 people with a taxable income of Rs. 1 crore or more. In April 2016, the top finance bureaucrat Hasmukh Adhia had said: “There are only 1.5 lakh individuals whose total income would be above Rs. 50 lakh.”