Sunday, September 23, 2012


By K P C Rao,


Generation of black money and its stashing abroad in tax havens and offshore financial centers’ have dominated discussions and debate in public Fora during the last two years. Members of Parliament, the Supreme Court of India and the public at large have unequivocally expressed concern on the issue, particularly after some reports suggested estimates of such unaccounted wealth being held abroad.

Two issues have been highlighted in this debate. First, several estimates have been floated, often without adequate factual basis on the magnitude of black money generated in the country and the unaccounted wealth stashed aboard. Secondly, a perception has been created that the Government’s response to address this issue has been piecemeal and inadequate. Thereafter, the then Finance Minister Mr. Pranab Mukherjee has presented a ‘White Paper on Black Money’ to the Indian parliament on 16th may, 2012.

This Paper highlights the different facets of black money and its complex relationship with policy and administrative regime in the country. It also reflects upon the policy options and strategies that the Government has been pursuing in the context of recent initiatives, or need to take up in the near future, to address the issue of black money and corruption in public life.

According to this paper:  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. The 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. The second and perhaps more likely reason is that the wealth may have been generated and accumulated by failing to pay the dues to the public exchequer in one form or other. In this case, the activities undertaken by the perpetrator could be legitimate and otherwise permissible under the law of the land but s/he has failed to report the income so generated, comply with the tax requirements, or pay the dues to the public exchequer, leading to the generation of this wealth.”

A comparison of the two ways in which black money is generated is fundamental to understanding the problem and devising the appropriate policy mix with which it can be controlled and prevented by the public authorities. At the very outset, it becomes clear that the first category is one where a strongly intolerant attitude with adequate participation of all state arms can produce results. Therefore, as accountants it is important for us to understand the intricacies of the transactions in the second category where the issue becomes far more complex and may require modifying, reforming, and redesigning major policies to promote compliance with laws, regulations, and taxes and deter the active economic agents of society from generating, hoarding, and illicitly transferring abroad such unaccounted wealth.


There can be two different ‘modus operandi, involved in the generation of black money. The first is the crude approach of not declaring or reporting the whole of the income or the activities leading to it. This is the likely approach in all cases of criminal, illegal, and impermissible activities. The sophistications in such an approach mostly get introduced subsequently for the purpose of laundering the money so generated with the objective of making it accountable and converting it into legitimate reported wealth that can be openly possessed and used.

The same approach of not declaring or reporting activities and the income generated there from may also be followed in cases of failure to comply with regulatory obligations or tax evasion on income from legitimate activities. However, complete evasion or non-compliance may make such incomes vulnerable to detection by authorities and lead to consequent adverse outcomes for the generator. Thus a more sophisticated approach for generation of this kind of black money is often preferred, involving manipulation of financial records and accounting.

The best way of classifying and understanding the various ways and means adopted by taxpayers for the generation of black money would be the financial statement approach, elaborating different means by which the accounts prepared for reporting and presenting before the authorities are manipulated to misrepresent and under disclose income, thereby generating unaccounted, undeclared, and unreported income that amounts to black money.


Some of these manipulations are explained below:

(a)  Out of Book Transactions

This is one of the simplest and most widely adopted methods of tax evasion and generation of black money. Transactions that may result in taxation of receipts or income are not entered in the books of account by the taxpayer. The taxpayer either does not maintain books of account or maintains two sets or records partial receipts only. This mode is generally prevalent among the small grocery shops, unskilled or semi-skilled service providers, etc.

(b)  Parallel Books of Accounts

This is a practice usually adopted by those who are obliged under the law or due to business needs to maintain books of account. In order to evade reporting activities or the income generated from them, they may resort to maintaining two sets of books of account – one for their own consumption with the objective of managing their business and the other one for the regulatory and tax authorities such as the Income Tax Department, Sales Tax Department, and Excise and Customs Department. The second set of books of account, which is maintained for the purpose of satisfying the legal and regulatory obligations of reporting to different authorities, may be manipulated by omitting receipts or falsely inflating expenses, for the purpose of evading taxes or other regulatory requirements.

(c)  Manipulation of Books of Account

When books of accounts are required to be maintained by taxpayers under different laws, like the Companies Act 1956, the Banking Regulation Act, and the Income Tax Act, it may become difficult for these taxpayers to indulge in out of books transactions or to maintain parallel books of accounts. Such parties may resort to manipulation of the books of accounts to evade taxes.

(d)  Manipulation of Sales/Receipts

A taxpayer is required to pay taxes on profit or income which is the difference between sale proceeds or receipts and expenditure. Thus manipulation of sales or receipts is the easiest method of tax evasion. Other innovative means may include diversion of sales to associated enterprises, which may become more important if such enterprises are located in different tax jurisdictions and thereby may also give rise to issues related to international taxation and transfer pricing.

In case of use of a dummy / associated entity, there can be a plethora of possible arrangements entered into by such entities to aid generation of black money. In its simplest form, the associate entity may not report its activities or income at all. The main entity may show sales to such a dummy / associate entity at a lower price, thereby reducing its reported profits.

More complex scenarios can emerge if the dummy/ associated entity is situated in a low tax jurisdiction having very low tax rates. Thus the profit of the Indian entity will be transferred to the low tax jurisdiction and money will be accumulated by the taxpayer in the books of accounts of the entity in the low tax jurisdiction.

(e)  Under-reporting of Production

Manipulation of production figure is another means of artificially reducing tax liability. It may be resorted to for the purpose of evading central excise, sales tax, or income tax.

(f)   Manipulation of Expenses

Since the income on which taxes are payable is arrived at after deducting the expenses of the business from the receipts, manipulation of expenses is a commonly adopted method of tax evasion. The expenses may be manipulated under different heads and result in under-reporting of income.

It may involve inflation of expenses, sometimes by obtaining bogus or inflated invoices from the so called ‘bill masters’, who make bogus vouchers and charge nominal commission for this facility.

Any number of more sophisticated versions of manipulation of expenses can also be resorted to by those intending to generate black money. Sometimes it can also involve ‘hawala’ operators, who operate shell entities in the form of proprietorship firms, partnership firms, companies, and trusts. These operators may accept cheques for payments claimed as expense and return cash after charging some commission.

There have been instances of claims of bogus expenses to foreign entities. The payments can be shown to foreign entities in the form of advertisement and marketing expenses or commission for purchases or sales. The funds may be remitted to the account of the foreign taxpayer and the money can either be withdrawn in cash or remitted back to India in the form of non-taxable receipts. Such money may also be accumulated in the form of unaccounted assets of the Indian taxpayer abroad.

(g)  Other Manipulations of Accounts

Besides inflation of purchase / raw material cost, expenses like labour charges, entertainment expenses, and commission can be inflated or falsely booked to reduce profits. In these cases, bogus bills may be prepared to show inflated expenses in the books.

(h)  Manipulation by Way of International Transactions through Associate Enterprises

Another way of manipulating accounted profits and taxes payable thereon may involve using associated enterprises in low tax jurisdictions through which goods or other material may be passed on to the concern. Inter corporate transactions between these associate enterprises belonging to the same group or owned and controlled by the same set of parties may be arranged and manipulated in a way that leads to evasion of taxes. This can often be achieved by arrangements that shift taxable income to the low tax jurisdictions or tax havens, and may lead to accumulation of black money earned from within India to another country.

(i)    Manipulation of Capital

The statement of affairs or balance sheet of the taxpayer contains details of assets, liabilities, and capital. The capital of the taxpayer is the accumulated wealth which is invested in the form of assets or as working capital of the business. Manipulation of capital can be one of the ways of laundering and introduction of black money in books of accounts.

(j)    Manipulation of Closing Stock

 Suppression of closing stock both in terms of quality and value is one of the most common methods of understating profit. More sophisticated versions of such practice may include omission of goods in transit paid for and debited to purchases, or omission of goods sent to the customer for approval. A more common approach is undervaluation of inventory (stock of unsold goods), which means that while the expenses are being accounted for in the books, the value being added is not accounted for, thereby artificially reducing the profits.

(k)  Manipulation of Capital Expenses

Over-invoicing plant and equipment or any capital asset is an approach adopted to claim higher depreciation and thereby reduce the profit of the business. As already stated, increase in capital can also be a means of enabling the businessman to borrow more funds from banks or raise capital from the market. It has been seen that such measures are sometimes resorted to at the time of bringing out a capital issue. At the same time, under-invoiced investments, indicating entry of undeclared wealth, may imply introduction of black money.

(l)   Generation of Black money in Some Vulnerable Sections of the Economy

While the source of generation of black money may lie in any sphere of economic activity, there are certain sectors of the economy or activities, which are more vulnerable to this menace. These include real estate, the bullion and jewellery market, financial markets, public procurement, non-profit organizations, external trade, international transactions involving tax havens, and the informal service sector.

(m)            Land and Real Estate Transactions

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. This can lead to both generation and investment of black money. The buyer has the option of investing his black money by paying cash in addition to the documented sale consideration. This also leads to generation of black money in the hands of the recipient. A more sophisticated form occasionally resorted to consists of cash for the purchase of transferable development rights (TDR)[1].

(n)  Bullion and Jewellery Transactions

 Cash sales in the gold and jewellery trade are quite common and serve two purposes. 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.

(o)  Financial Market Transactions

 Financial market transactions can involve black money in different forms. Initial public offers (IPOs) offering equity shares to the public at large are also vulnerable to various manipulations that can generate black money for the promoters or operators. Rigging of markets by the market operators is one such means. This may involve use of shell companies and more sophisticated versions of such manipulation may involve offshore companies or investors in foreign tax jurisdictions who invest in shares offered by the IPO and through manipulated trading escalate their price artificially, only to offload them later at the cost of ordinary investors.

(p)  Public Procurement

Public procurement has grown phenomenally over the years – in volume, scale, and variety as well as complexity. It often includes sophisticated and hi-tech items, complex works, and a wide range of services. An OECD (Organisation for Economic Cooperation and Development) estimate puts the figure for public procurement in India at 30 per cent of the GDP whereas a WTO (World Trade Organisation) estimate puts this figure at 20 per cent of the GDP[2]. The Competition Commission of India had estimated in a paper that the annual public sector procurement in India would be of the order of Rs. 8 lakh crore while a rough estimation of direct government procurement is between Rs. 2.5 and 3 lakh crore. This puts the total public procurement figure for India at around Rs. 10 to 11 lakh crore per year.[3]
(q)  Non-profit Sector

Taxation laws allow certain privileges and incentives for promoting charitable activities. Misuse of such benefits and manipulations through entities claimed to be constituted for nonprofit motive are among possible sources of generation of black money. Such misuse has also been highlighted by the Financial Action Task Force (FATF), an intergovernmental body which develops and promotes policies to protect the global financial system against money laundering and financing of terrorism.

A Non-profit Organisation (NPO) Sector Assessment Committee constituted under the Ministry of Finance has reviewed the existing control and legal mechanisms for the NPO sector and suggested various measures for improvement.

(r)   Informal Sector and Cash Economy

The issue of black money is related to the magnitude of cash transactions in the informal economy. The demand for currency is determined by a number of factors such as income, price levels, and opportunity cost of holding currency. Factors like dependence on agriculture, existence of a large informal sector, and insufficient banking infrastructure with large un-banked and under-banked areas contribute to the large cash economy in India.

(s)   External trade and Transfer Pricing

More than 60 per cent[4] of global trade is carried out between associated enterprises of multinational enterprises (MNEs). Since allocation of costs and overheads and fixing of price of product/services are highly subjective, MNEs enjoy considerable discretion in allocating costs and prices to particular products/services and geographical jurisdictions. Such discretion enables them to transfer profit/income to no tax or low tax jurisdictions. Differing tax rates in different tax jurisdictions can create perverse incentives for corporations to shift taxable income from jurisdictions with relatively high tax rates to jurisdictions with relatively low tax rates as a means of minimising their tax liability. For example, a foreign parent company could use internal ‘transfer prices’ for overstating the value of goods and services that it exports to its foreign affiliate in order to shift taxable income from the operations of the affiliate in a high tax jurisdiction to its operations in a low-tax jurisdiction. Similarly, the foreign affiliate might understate the value of goods and services that it exports to the parent company in order to shift taxable income from its high tax jurisdiction to the low tax jurisdiction of its parent. Both of these strategies would shift the company’s profits to the low tax jurisdiction and, in so doing; reduce its worldwide tax payments. In this context transfer pricing has emerged as the biggest tool for generation and transfer of black money. In recent years, after the 9/11 incident in the USA due to intense scrutiny of banking transactions, enhanced security checks at airports and ports, and relaxation of exchange controls, transfer of money through hawala has reduced significantly but now transfer pricing is now being extensively used to transfer income/profit and avoid taxes at will across countries. Also, with the relaxation of exchange controls and liberalisation of banking channels, the popularity of the hawala system for legitimate transfers has reduced substantially. The increasing pressure on financial operators and banks to report cash transactions has also helped in curbing hawala transactions. Tax evasion through transfer pricing is largely invisible to the public and difficult and expensive for tax officers to detect. Christianaid5 estimates that developing countries may be losing over US$160billion of tax revenues a year, primarily through transfer pricing strategies.

The illicit money transferred outside India may come back to India through various methods such as hawala, mispricing, foreign direct investment (FDI) through beneficial tax jurisdictions, raising of capital by Indian companies through global depository receipts (GDRs), and investment in Indian stock markets through participatory notes. It is possible that a large amount of money transferred outside India might actually have returned through these means.

       I.            ROLE OF THE CMAs

Corruption and fraud are generally interlinked. In fact corruption is a special type of fraud and treated as such in many jurisdictions. Fraud and Corruption both pose serious challenges to audit, as they seek to mislead and distort the true state of financial and non-financial affairs of the entity. Fraud awareness or recognition amongst the CMAs is necessary to play a vigilant role in containing frauds by ensuing correction of system deficiencies and building up effective system controls and checks in the audited entities.

Fraud is most likely to involve deliberate misrepresentation of information that is recorded and summarized by an entity; its impact can be compared to an accounting error and would involve issues such as measurement, occurrence, and disclosure. Fraud poses a serious problem from an audit perspective because it is normally accompanied by efforts to cover/ falsify/ misdirect the entity records and reporting. Thus, fraud can directly affect the financial statements and records of the audited entity.

Any transaction entered into by the taxpayer must be reported in books of account which are summarized at the end of the year in the form of financial statements. The financial statements basically comprise statement of income and expenditure which is called by different names such as ‘Profit and Loss Account’ or ‘Income and Expenditure Account’ and statement of assets and liabilities which is called ‘Balance Sheet’ or ‘Statement of Affairs’. Tax evasion involves misreporting or non-reporting of the transactions in the books of account.  Therefore, it is important for the CMAs to understand the different kinds of manipulations of financial statements resulting in tax evasion and the generation of black money. Hence, the CMAs should remain alert, vigilant and develop a nose to smell these manipulations in the Accounts. It is also desirable to introduce such an orientation to the Audit.

Therefore, examination of system for detection and prevention of fraud and corruption will be an integral part of all regularity audits and also of performance audits. At the commencement of each audit, information about the fraud and corruption awareness, detection and prevention policy and related environment should be collected from the audited entity management. During the course of audit work, the audit teams / officers should be vigilant and seek explanations.

Though corruption is clandestine and takes place outside the books, it is likely to leave tell-tale marks here and there. Even from well-maintained books, a whiff of corruption may rise. Audit can remain alert to such indirect indications and develop a nose to the smell of corruption and therefore, it is desirable for the CMAs to introduce such an orientation to the Audit.

A comprehensive analysis of the factors leading to generation of black money in India along with the various measures attempted to counter it till date makes it apparent that there is no single panacea that can rid society of this menace. At the same time, it is not impossible to curb, control, and finally prevent the generation of black money in future as well as repatriation of black money, if a comprehensive mix of well defined strategies is pursued with patience and perseverance by the central and state governments and put into practice by all their agencies in a coordinated manner. All stakeholders who are likely to benefit from prevention and control of black money generation will welcome and support the important initiative of curbing the black money and provide needed inputs. Let us play our role as CMAs in addressing this gigantic task!

[Published in the Monthly journal 'CIRCUIT' of the Hyderabad Chapter of the ICAI during October & November, 2012]

Source: White Paper on Black Money dated 16th May, 2012 of Ministry of Finance, Department of Revenue, CBDT.

[1] TDRs are rights for construction beyond the usual limits, which can be transferred by the owner. These rights can be made available in lieu of area or land surrendered by the owner.

[2] Report of the Committee on Public Procurement, 6 June 2011( Para 1.5)
[3] ibid
[4]Christianaid, Death and Taxes: The Truth of Tax Dodging, March 2009.

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