Changing the colour of money

TAXATION

The refrain among financial consultants is that the size of the parallel economy in India is as high as 40-60 per cent of the country's gross domestic product (GDP) of around Rs 14.5 lakh crore (1993-94 prices) or Rs 22 lakh crore (at 2002-03 prices).

So what are the "legal and common" methods used to evade tax and convert black money into white? There are so many, they seem to outnumber the legislations framed to curb them.

This article is not a guide to convert black money into white. There are enough tax consultants who can do a better job for a fee. But on Union Budget eve, the subject makes for some interesting reading.

For this article, interviews with a half-a-dozen professionals from the accounting and legal professions were conducted to understand how the entire process works. Of course, for obvious reasons, these gentlemen and ladies do not wish to be named.

On the basis of this, the following were found to be some common methods used for generating black money (through tax evasion) and converting the same into white.

Forming a dummy software exports company - Sec 10A of Income Tax Act Income from software exports are fully exempt from tax. The only pre-condition to avail of this relief is to register the unit with the Software Technology Park of India (STPI).

A tax consultant says if anyone wants to bring black money into the regular monetary system, all it takes is registration of a software firm with an STPI. Next, the hawala route is taken to move money out of the country. The final step in this is to raise invoices for 'software services rendered' and bring the money back into the country.

Says a tax consultant: "This is not to say that all companies registered with the STPI are using this modus operandi. But this is one method some companies adopt to convert black money into white."

The entry business
This is one of the oldest tax evasion ploys. If revenues generated attract taxes beyond a 'comfort' level, there are a number of persons and agencies who provide expenditure entries in the assessees' books of accounts.

Fictitious bills are raised to be accounted as expenditure, such as consulting and marketing services, and a large portion of the topline is skimmed off. Of course, these 'entries' cost a reasonable commission.

Agriculture income
Agriculture income is not taxable. Hence, this is used as a means to cover income earned outside agriculture also. Of course, proof of land holding must be produced. Under normal conditions, few tax officers insist on visiting an agricultural property and see whether it exists and whether any income was actually earned from the land.

Those who are doubly careful would claim that the land was given on lease to some farmer and the lease income from such letting out is also exempt from tax.

Bill trading
This one is pretty similar to entry business. Bills are produced in support of fictitious consumption (inputs in manufacturing process). The consumption of inputs is shown as second sales and, hence, attracts only 1 per cent sales tax. With such a small tax liability, cost of production is boosted up hence, lower profits leading to lower or no tax at all.

Gifts from NRIs
Income earned by non-resident Indians (NRIs) is not taxed in India. And gifts again are not taxed. If one can settle a liability of an NRI within India, then he can will 'gift money' of equal amount, which will go untaxed. One tax consultant says double tax agreements also provide for administrative co-operations between revenue officers in the two countries to check on the NRI and his tax records.

But these services are seldom used and, hence, remain only on papers.

Transfer pricing
The 'secret formula' that goes into making of your favourite soft drink can be made to attract a large sum as royalty. This large sum of money can be used to knock off a tidy sum from the topline, leading to lower profit, and hence, lower tax.

There are, however, laws that make audit of transfer pricing mechanisms mandatory. Moreover, strictly speaking, this is not tax evasion but tax avoidance as such income will get taxed in the company's original country of location.

Throw lavish birthday or anniversary parties
This one, according to a leading tax lawyer and company law consultant, is the favourite. A businessman or politician who wants to bring black money into the system throws a lavish party to celebrate a birthday or wedding anniversary.

Each of the guests (which may run into a large number) is shown as gifting a humble sum of say Rs 1,000. Gifts need not be given a receipt and do not attract tax. And bad money enters the legitimate system.

Over-invoiced export income - 80HHC Income Tax Act and exemptions for small scale industries (SSIs)
The tax exemption under section 80HHC of the Income Tax Act is coming to an end in the next Finance Bill. But many a tax consultant agrees to the fact that exports in many cases are over-invoiced and a good portion of the taxable income escapes the tax net.

A similar ploy is the cover of available for being a small-scale (SSI) unit. Relief from excise duty is available to SSIs up to, say a turnover of Rs 1 crore. Each time the topline crosses this mark, a new unit is formed and billings above the exemption amount are done in the name of the new company. A consultant on excise and customs law says, "There will be dozen SSI units doing the same business, from the same premise, using the same machines and labour."

The list is endless. The methods listed above are some of the commonly used ones. Multiple bank accounts, each in different names, escape tax on interest income.

Banks, except in extreme cases, do not exchange data on account holders. Since interest income above certain limits (Rs 2,500) alone attract tax at source, account holders escape this by opening multiple accounts in different banks.

Similarly, income from renting out property is also broken into multiple parts, say in the name of the spouse and children. There are so many methods that P C Parekh, a chartered accountant in Ahmedabad put it all in black and white "" he wrote a book, "Tax Planning for Secret Income (Black Money)".

Of course the Institute of Chartered Accountants of India (ICAI) initiated disciplinary action against him. After striking his name off the member list for six months, ICAI has now referred the matter to the high court. The February 2004 issue of 'The

Chartered Accountant', the ICAI's monthly journal, carries a detailed account of this case.

Parekh, in the very first page of his book, says: "(This is) a book indispensable to every businessman, industrialist, government servant, private employee, contractor & engineer, government minister, politician, limited company, partnership, doctor, lawyer, actor, film wallahs, tax practitioners, chartered accountants, Indian and foreign citizens "" in non-technical & easily understandable English - (Income-Tax; Wealth-Tax, Gift-Tax; Estate Duty).

The book was first published in January 1982 and went into second edition in the October of that year clearing any doubts about its success among the targeted community.

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The road frequently travelled

• Software exports: Forming a dummy software exports company to avail benefit of Section 10A of Income Tax Act
• Entry business: Fictitious bills are raised to be accounted as expenditure to prune top line
• Agriculture income: Since normally no tax officer will insist on visiting agriculture land, the ploy is most commonly used
• Bill trading: Bills are produced in support of fictitious inputs in manufacturing process.
• Gifts from NRIs: If one can settle a liability of an NRI within India, then he can 'gift money' of equal amount, which will go untaxed.
• Transfer pricing: Large sum as royalty can be used to knock off a tidy sum from the top line
• Birthday or anniversary parties: Each of the guests is shown as gifting a sum of say Rs 1,000. Gifts need not be given receipts and do not attract tax