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A 1,000-page Study on Unaccounted Incomes in India Which

Has Not Been Made Public
A K Bhattacharya
Vol. 52, Issue No. 17, 29 Apr, 2017

A K Bhattacharya (ashok.bhattacharya@bsmail.in) is with the Business Standard.

Even as the government has launched a high-profile drive against black money, a 1,000-page study
on unaccounted incomes in India has not been made public for a year now. Produced by the think-
tank National Institute of Public Finance and Policy (NIPFP) at the instance of the UPA government
in 2012, the report was submitted to the government about a year later. You can see the entire
report here [This is a large file (272 mb) and may take time to download]
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A detailed study on unaccounted incomes in India has outlined a multi-pronged strategy that the
government should adopt to curb the generation of black money by professionals, educational
institutions, capital market intermediaries and real estate players.

In addition, the voluminous report running into over a thousand pages makes concrete suggestions
to plug legal loopholes to prevent black money generation through election funding, money
laundering and clandestine transfer of wealth abroad. Equally significant, the report lays down a road
map for beefing up the income-tax department to tackle the menace of black money.

The report has been produced by the National Institute of Public Finance and Policy (NIPFP) at the
instance of the government, which had issued an order in 2012 entrusting the fiscal policy think tank
with this task. The report was submitted to the government about a year later, but its findings are
yet to be made public. Meanwhile even the present government under Prime Minister Narendra Modi
has launched a high-profile drive against black money.
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Page 1 of Executive Summary

It is also significant to note that some of the recommendations made by the NIPFP report seem to
have already been implemented by the government in the last year or so, though after some
modifications. What the fate of the other recommendations to eliminate black money is likely to be,
however, is not clear as of now. Therefore, a quick look at some of the salient recommendations
made by this report could provide a clue to the likely course and direction of government action
against black money in the coming few months.
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Page 2 of Contents

Professionals Under Watch

On the issue of bringing professionals under the tax net, the report has suggested that the Income
Tax Department (ITD) should establish benchmarks relating to the likely range of professional
expenses as a percent of professional receipts in respect of different categories. These benchmarks
can be established based on actual surveys. Cases where expenses claimed by a tax payer exceed
this range should get automatically selected for manual scrutiny. Procedurally also, the report has
sought improvements in the structure of income tax forms for professionals so that there is more
disclosure to establish a linkage between their service tax payments and their professional income.

Stricter Scrutiny for Education Sector

The report has paid a lot of attention to the education sector, where it believes that the prevalence
of capitation fees has led to the generation of black money. It has noted that the Directorate General
of Income Tax (Exemptions) (DGITE) has remained “passive” in spite of the rampant malpractices in
the education sector generating and absorbing large tranches of unaccounted income. Among the
key remedial measures suggested by the NIPFP report in this regard are strengthening and
reorganising the DGITE, compulsory filing of annual returns of income by charitable institutions,
creation of a separate centralised database of charitable institutions and setting up a mechanism of
exchange of information between the Directorate and the various registering agencies of the
charitable institutions.

Robust Laws for Real Estate

The NIPFP report has conservatively estimated black money generation in the transfer of real estate
properties at ₹5.7 lakh crore and has suggested a four-point action plan to tackle this menace. One,
it has suggested that the ITD should create its own system of notifying area rates of urban
immoveable properties. Two, the Income Tax Act (ITA) should be amended to provide that the value
mentioned in the area rates should be deemed to be the transfer value for taxation purposes in
cases where the transfer of property has taken place at a lower value. Three, the difference between
the area rate of a property and the actual consideration received for the transfer should be treated
as income of the purchaser under the law. And four, the definition of capital asset should be
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expanded to include transfer of agricultural land outside the 8-km municipal limit where the
transaction results in the use of the land for non-agricultural purposes.

Fresh Assessment Norms for Capital Markets

For the capital markets, the NIPFP report has a detailed action plan to tackle generation of black
money by the intermediaries. It has concluded that huge volumes of money are generated through
illegal dabba trade, where illegal transactions take place outside the purview of the stock exchanges.
Such dabba trading exposes their participants to huge financial risks, but also results in unlawful
gains since the entire transaction takes place outside the regulations of the stock exchanges without
any scrutiny of regulators or the tax authorities.

Thus, the report has recommended that in order to track dabba trading and crack down on it the ITD
must improve its coordination and information exchange with other regulatory bodies like the
Securities and Exchange Board of India (SEBI) and the Forward Markets Commission. The
investigation wing of the Income Tax Department must be involved with inquiries into dabba trading.

There is a specific suggestion with regard to the mushrooming growth of risky and unregulated
investment products described variously as Ponzi, Pyramid and Multilevel Marketing schemes. The
report has noted that these schemes generate large amounts of black money and the ITD must
proactively associate itself with investigations into these frauds by Sebi. Similarly, cooperative
banks are vulnerable to malpractices associated with money laundering and hence there is need for
strengthening the Know Your Customer (KYC) protocols followed by cooperative banks in particular.
Indeed, the report has called for a comprehensive study of the cooperative banking sector as it views
it as a source of black money generation and money laundering.

Two other broad suggestions have been made with regard to the capital market intermediaries. One,
it has underlined the need for policies to encourage the unorganised sector to seek credit from
formal credit institutions, the absence of which is causing generation of black money and money
laundering. Two, fresh norms need to be put in place to reform the existing funding mechanisms for
capital market transactions so that they encourage bill-based transactions. It has endorsed the use
of an Aadhaar-based identification system so that funding mechanisms could rely on the credit
histories of such capital market participants that wish to enter the markets. The net result of this
exercise would be an accretion to the number of capital market participants in the formal sector, the
report has pointed out.
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How To Root Out Black Money from Elections

In its detailed assessment of how election funding has become a big source of black money, the
NIPFP report has made a series of small but significant recommendations for changing the taxation
system to impart transparency to all financial transactions entered into by political parties and
candidates fighting elections. It has suggested that fulfillment of six specific conditions should be
made compulsory for all political parties before they can claim tax exemptions under the ITA,
provided they are also recognised by the Election Commission (EC) under the relevant laws.

The six conditions include maintenance of books of account by the political parties, regular auditing
of such accounts, disallowing cash contributions above a specified amount, filing of contributors’ list
with the EC, declaration to the effect that all expenses by political parties above ₹20,000 are made
through account-payee cheques and filing of income returns within the prescribed time. A few of
these recommendations have already been accepted by the government, but many of them are yet
to be fully enforced.

The NIPFP report has also laid stress on the role of electoral trusts and insists that they should be
subjected to conditions similar to those recommended for political parties. Exemptions from these
rules for political parties that are not recognised by the EC should be adequately supervised by the
ITD. A separate form for filing income returns should be introduced for political parties and a
centralised assessment of all such returns should be arranged. And even cash contributions below
the permissible level should be subjected to scrutiny.

An interesting suggestion pertains to redesigning the election affidavits filed by the candidates in
elections in consultation with the ITD. While tax exemptions for political donations should be
restricted to only such payments that are made by account-payee cheques, there is also need for a
more regular exchange of information between the EC and the ITD that is available on the basis of
election affidavits and expenditure statements filed by political parties and election candidates. Such
information should also be made available for public scrutiny, the report has noted.

Tackling Hawala and Money Laundering

The NIPFP report has observed that domestic hawala rackets have become an easy and ‘on-demand’
channel for generating black money and has caused huge revenue loss for the exchequer. There is
need, therefore, for systemic changes to raise the cost of indulging in these malpractices to levels
that make them unprofitable. Hawala is defined as a traditional system of cross-border transfer of
money by payments to an agent who ensures that an associate in the relevant country or area
settles the payment to the final recipient.
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Some of the suggestions, many of them draconian in impact, are: declaration of providing
documentary proof of bogus loans, false bills of purchases, expenses, sales etc. as a cognizable
offence under the ITA, empowering the tax authorities to register First Information Reports (FIRs) in
such domestic hawala cases and obtain warrants of arrest from competent courts for arrest and
custodial examination of the accused, prosecution of beneficiaries of the hawala rackets and
amendment of the rules of evidence to allow the income generated from hawala business to be
assessed as taxable income in the hands of the beneficiaries.

On money laundering, the NIPFP report has noted that organised tax evasion should be included in
the list of “predicate offences” under the Prevention of Money Laundering Act of 2002. Predicate
offences are crimes that are a component of a more serious criminal offence. Thus, making
organised tax evasion a predicate offence would attract more severe and deterrent penal provisions
under the law. Similarly, the scope and applicability of the money laundering law should be
expanded to include illegal or questionable transactions in commodity exchanges.

Calling for a robust institutional framework against money laundering, the report has suggested the
setting up a trade transparency unit to check trade-based money laundering, amending the Customs
Act to make proxy imports and exports a criminal offence, strengthening of the financial intelligence
unit to ensure timely dissemination of information among all departments concerned and the
institution of a structured mechanism to ensure proper coordination between the Enforcement
Directorate and the respective law enforcement agencies dealing with various predicate offences at
the Central and state levels.

Illicit Funds Abroad & Amnesty Schemes

The NIPFP report has also dwelt on the incidence of illicit funds held abroad by Indian individuals and
entities. It has studied the various steps being initiated by developed countries to counter the illegal
flight of money abroad and based on that suggested a set of measures. The first step it has
recommended is to focus on the need for curbing outflow of unaccounted money abroad. Only when
such outflows are curbed that any step to bring back illicit money held abroad would make sense,
the report has concluded.

In this context, the report has strongly opposed open-ended amnesty schemes as they achieve the
objectives only when the tax evaders are aware that the government already has the information
about their illicit wealth. Therefore, the government must first obtain information about the
undisclosed assets held by Indians abroad and then only can it consider a carefully calibrated
amnesty scheme. It has also suggested that immunity, if at all, should be granted only from
prosecution, provided full taxes are to be paid along with interest and penalties. The government’s
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income declaration schemes in the last year seem to have been influenced by the specific
recommendations of the NIPFP report.

In a novel suggestion, the report has underlined the importance of framing regulations in India on
the lines of the Foreign Account Tax Compliance Act (FATCA) already enforced by the United States
(US) government on all its resident individuals and entities having income within the US or from
abroad. Such a law in India would help the government obtain information on Indians’ assets abroad.
It has therefore argued that an FATCA-like law could be considered in India after suitable
modifications.

A Revamped Income Tax Department with Reskilled Tax

Officers

A suggestion with controversial implications is that the Income Tax Department should be permitted
to purchase information about Indians’ wealth kept abroad. Reward schemes to tap such information
should also be considered, it has argued, even though it is widely believed that similar provisions in
the past have led to what is popularly described as “tax terrorism” or harassment of taxpayers.

With a view to strengthening the government’s enforcement machinery for detecting unaccounted
incomes, the NIPFP report has suggested that the Income Tax Department should have a centralised
Taxpayer Service Programme, which should be supervised by a directorate of taxpayer services. It
has also laid emphasis on augmenting information gathering system by expanding the list of
transactions where quoting of the Permanent Account Number (PAN) should become mandatory and
by including more types of transactions to be filed under the Annual Information Returns. With minor
modifications, some of these recommendations have already been incorporated in the income tax
rules from the current year.

A new area of focus, according to the report, should be third-party information discovered during
search cases by making them part of the Individual Transaction Statements and open-sourcing of
information gleaned from reports available in the public domain e.g. government databases, web-
based research databases and commercially available electronic compilation of information.

On the question of strengthening the Income Tax Department, the NIPFP report has listed out a
series of measures so that there is an improvement in its ability to prevent misuse of the taxation
laws and nab the evaders. It has thus called for upgrading systems for information processing and
setting up a specialised directorate for risk management with a clear mandate to proactively identify
and tackle the various risks to revenue. This can be achieved if the proposed directorate closely
studies and tracks information made available in annual information returns and taxes deducted at
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source.

In addition, there is a recommendation for developing a risk management strategy by the Income
Tax Department that should focus on developing a system of identifying search actions which bring
out evidence of major and widespread tax evasion practices in different sectors. The objective would
be to issue alerts to authorities based on such assessments. The proposed directorate of risk
management should also conduct specialised studies on key tax issues in identified sectors through
professional research agencies to supplement its knowledge base. Going forward, the same
directorate should undertake strategic analysis based on its databases so that it could get a sense of
the extent of malpractices in different sectors and of the new trends in tax evasion.

An interesting suggestion is for including tax compliance in corporate governance programmes

stipulated by the government under various provisions of the law. In some foreign countries, tax
compliance is a key component that determines the level of corporate governance among entities.
Similarly, there is need for zeroing in on those entities and individuals who do not file returns, but
are required to do so under the law.

A Better Deal for Big Business

The NIPFP report has also recommended that the Income Tax Department should review the
functioning of the its Large Taxpayers Unit (LTU) that deals with big companies and tax payers with
regard to their tax issues. A key suggestion in this regard is to bring all large taxpayers in sectors
identified by the Income Tax Department to be prone to tax evasion under LTU on a compulsory
basis. At present, LTU coverage is voluntary.

In what will be seen as an industry-friendly suggestion, the report has recommended a move to pre-
assessment identification and resolution of tax compliance risks for large companies through
advance public or private rulings. Such rulings should ideally be given within three months so that
potential tax disputes are resolved before they become arrears.

At the same time, the NIPFP report has also asked for stringent action against large tax evaders by
launching criminal prosecution against them and ensuring their conviction by a court of law. There is
need for raising the level of deterrence so that taxpayers are not encouraged to evade taxes in the
belief that no action is taken against those who have been guilty not paying their tax dues.
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Finally, the NIPFP report has underlined the need for augmenting the competency levels of tax
assessment units and ensuring that the best officers are deployed for carrying out assessment
functions. While software tools for audit of computerised accounts are also needed, there is no
getting away from improving the skills of the manpower undertaking assessment and making sure
the best officers are given this important responsibility.

Widen the Tax Net to Include Agriculture

The NIPFP report has noted that the availability of a large stream of exempted income is a major
source for tax evasion. In light of this conclusion, the report has made a few major recommendations
to increase the reach of the taxman to include agriculture—a sector that has by and large remained
out of bounds for the taxing authorities at the centre and in states.

The report has thus suggested that the government should examine whether the definition of
agricultural income can be amended to restrict the exemption to basic agricultural operation and
processes. In other words, activities where there is a significant amount of value addition after the
produce is brought out from the soil can be excluded from the ambit of agricultural income.

Agriculture in India cannot be taxed by the centre and it is only the states that can consider levying
income tax on farming. However, no state has ever considered taxing the farm sector’s income in
view of the adverse political fall-out of such a move. But the NIPFP report has underlined the need for
taxing income from agriculture and has justified it on the ground that such a move would help curb
generation of black money.

Thus, the report has suggested excluding income from cash crops and similar produce from the
ambit of agricultural income by stipulating that the processes involved therein would not constitute
agriculture. Defending this recommendation, the report has argued that already some courts have
held that the income of multinational firms from growing and selling hybrid seeds is non-agricultural
and hence can be taxed. The report has argued that it is now necessary to actually spell this out by
way of an explanation rather than leave this to further litigation.

The report has also noted that income from farmhouses, particularly those above certain a built-up
area, or in urban areas, or in the vicinity of urban areas should be brought under the tax net. This
proposal appears to have been already accepted by the government and implemented through this
year’s budget after some modification.