Misuse of exemption on Long Term Capital gains tax for money laundering (Reference p. 82-84 of the Third SIT Report)

This issue was deliberated by SIT during a series of meetings held on 7^th January, 14^th March, 08^th April and 30^th April. In this regard, it is pertinent to mention the observations of the Committee headed by Chairman, CBDT on “Measures to tackle Black Money in India and Abroad” which submitted its report in 2012 and which read as follows :-

“3.22 Investments are made in the secondary share markets with a view to capturing gains. In this market, out of nearly 8,000 listed companies, several scrips are not traded regularly. With the collusion of  promoters, some brokers arrange for price(s) with purchase of such scrips at nominal costs, and sales at  exorbitant prices, with a view to receiving money on sale as ‘capital gain’ when the long term gain is  subjected to a ‘nil’ or nominal rate of tax. The advantage for manipulative taxpayer is that he can launder such sale receipts through payment of no tax.”

SEBI has recently barred more than 250 entities, including individuals and companies, from the securities market for suspected tax evasion and laundering of black money through stock market platforms.  In one such instance price of a scrip rose from ₹ 10.20 to ₹ 489 in 150 trading days – a rise of 4694%. The SIT obtained the background details of these cases and studied them. A typical pattern is observed to be followed in such cases.

• A company with very poor financial fundaments in terms of past income or turnover is able to raise huge capital by allotment of Preferential allotment of shares is made to various entities.
• There is a sharp rise in price of scrip once the preferential allotment is done. This is normally achieved through circular trading of shares among a select group of companies. These groups of companies often have common promoters/directors.
• The scrips with thus artificially inflated price are offloaded through companies whose funding is provided by the same set of people who want to convert black money into white.

There is an urgent need for having an effective preventive and punitive action is such matters to prevent recurrence of such instances.

We recommend the following measures in this regard:

• SEBI needs to have an effective monitoring mechanism to study such unusual rise of stock prices of Companies while such a rise is taking place. We understand that SEBI has a strong IT infrastructure which can generate red flags for such instances. Such red flags could be built upon trading volumes, entities which contribute to trading volume, financial background of firms through their annual returns and any other indicators SEBI may develop. We believe that with effective and timely monitoring by SEBI a significant number of such instances can be checked in time.
•  Once such instances are detected, SEBI should invariably share this information with CBDT and FIU.
• Barring such entities from securities market would not be of strong deterrence in itself. In case it is established, that stock platforms have been misused for taking LTCG benefits, prosecution should invariably be launched under relevant sections of SEBI Act. Section 12A read with section 24 of the Securities and Exchange Board of India Act 1992 are predicate offences.
• Enforcement Directorate should then be informed to take action under Prevention of Money Laundering Act for the predicate offences.

Misuse of Participatory notes for money laundering (Reference p. 79-81 of Third SIT Report)

The Report of the Committee headed by Chairman, CBDT on “Measures to tackle Black Money in India and Abroad” submitted in 2012 observed as follows:

“3.43 A Participatory Note (PN) is a derivative instrument issued in foreign jurisdictions, by a Foreign Institutional Investor (FII)/sub-accounts or one of its associates, against underlying Indian securities.  PNs are popular among foreign investors since they allow these investors to earn returns on investment in the Indian market without undergoing the significant cost and time implications of directly investing in the India. These instruments are traded overseas outside the direct purview of Securities & Exchange Board of India (SEBI) surveillance thereby raising many apprehensions about the beneficial ownership and the nature of funds invested in these instruments. Concerns have been raised that some of the money coming into the market via PNs could be the unaccounted wealth camouflaged under the guise of FII investment. SEBI has been taking measures to ensure that PNs are not used as conduits for black money or terrorist funding. As per SEBI regulations, PNs can be issued to only those entities that are regulated by an appropriate regulator in the countries of their incorporation and are subject to compliance of “Know Your Client” norms. FIIs are also required to declare that these PNs have not been issued to Indian residents or non-resident Indians. Entities issuing PNs are required to submit to SEBI a monthly report which includes details of subscribers and details of securities underlying PNs. Though, the information sought from FIIs issuing PNs are being submitted regularly, the reporting requirements mandated by SEBI presently do not capture details of ultimate beneficial owners of these instruments.”

As per SEBI (Foreign Portfolio Investor) Regulations, 2014, Foreign Portfolio Investors (FPIs) can issue ODIs to only those entities that are regulated by an appropriate foreign regulatory authority subject to compliance with ‘Know Your Client” norms. SEBI, vide its circular dated November 24, 2014 has further listed set of criteria for the subscribers of P notes or Offshore Derivative Instruments (ODIs).

SEBI has informed that the outstanding value of Offshore Derivative Instruments (ODIs) at the end of February 2015 stood at ₹ 2.715 lakh crores. SEBI has further informed that the top five locations of end Beneficial owner of ODIs were Cayman Islands, USA, UK, Mauritus and Bermuda contributing to  31.31%, 14.20 %, 13.49 %, 9.91 % and 9.10 % respectively of total ODIs outstanding.

It is clear from above than a major chunk of outstanding ODIs invested in India are from Cayman Islands i.e. 31.31 %. This translates to roughly ₹ 85,006 Crores. The Cayman Islands had a population of 54,397 in 2010 according to Wikipedia. It does not seem conceivable that a jurisdiction with a population of less than 55,000 could invest ₹ 85,000 crores in one country.

The main point of the above elaboration is just that it does not appear possible for the final beneficial owner of ODIs originating from Cayman Islands to be from that jurisdiction. 

The following recommendations are made in this regard:

• It is clear that obtaining information on “beneficial ownership” of P notes is of crucial importance to prevent their misuse. SEBI needs to examine the issue raised above and come up with regulations where the “final beneficial owner” of P notes/ODIs are known.
• The information of “beneficial owner” with SEBI should be in form of individual whose KYC information is known to SEBI. In no case should the KYC information end with name of a company. In case a company is the holder of P notes/ODIs, SEBI should have information of its promoters/directors who exercise effective control over the company. In case of Companies/Trusts represented by service providers like lawyers/accountants SEBI should have information on the real owners/effective controllers of those Companies/Trusts. not end with name
• P notes are transferable in nature. This makes tracing the “true beneficial owner” of P notes even more difficult since layering of transactions can be made so complex so as to make it impossible to track the “true beneficial owner”. SEBI needs to examine if this provision of allowing transferring of P notes is in any way beneficial for easing foreign investment. Any investor wanting to invest through P notes can always invest afresh through an Foreign Portfolio Investor (FPI) instead of buying from a P note holder.

Shell Companies and beneficial ownership (Reference p. 73-76 of the Third SIT Report)

The Report of the Committee headed by Chairman, CBDT on “Measures to tackle Black Money in India and Abroad” submitted in 2012 observed as follows:

“3.4. The primary method of generation of black money remains suppression of receipts and inflation of expenditure. The suppression could be over a range of businesses and industrial activities which are covered by what may be called ‘primary’ enactments to regulate sale receipts, actual production, charging amount in excess of statutory amounts, etc.

3.6. However, as manipulation of income is not always possible by suppression of receipts, tax-payers may try to inflate expenses by obtaining bogus or inflated invoices from ‘bill masters’, who make bogus vouchers and charge nominal commission. As these persons are of very modest means, upon investigation, they tend to leave the business and migrate from the city where they operate. This is one of the reasons for a proportion of income tax arrears attributed to ‘assessee not traceable’.

3.7. Similarly, there are other categories of small ‘entry operators’, who provide accommodation entries by accepting cash in lieu of cheque/demand draft given as loans/advances/share capital, etc and thereby launder large sums of money at miniscule commissions. Due to frequent migration, such entry operators escape prosecution under the Income Tax Act. The appellate tax bodies also tend to tax their income at nominal rates. There is no effective deterrence, except for taxing commission on such bogus receipts and tax in the hands of beneficiaries. Providing fake bills and entries need to be dealt with strongly and as criminal offence under the tax laws.”

Use of shell companies to provide accommodation entries to launder black money has been observed in a number of high profile cases investigated or under investigation in the recent past.

The strategy to curb this menace has to be twofold:

• Proactive detection of creation of shell companies: This would involve intelligence gathering through regular data mining and dissemination of information gathered to various law enforcement agencies for active surveillance.
• Deterrent penal action against persons involved in creation of shell companies and providing accommodation entries.

The following recommendations are made in this regard:

• Proactive detection of creation of shell companies: Serious Frauds investigation office (SFIO) under Ministry of Company needs to actively and regularly mine the MCA 21 database for certain red flag indicators. These red flag indicators could be based on common DIN numbers in multiple companies, companies with same address, same contact numbers, use of only mobile numbers, sudden and unexpected change in turnover declared in returns etc. These indicators are  illustrative in nature and the SFIO office can prepare a set of indicators based on its own experience and consultation with other law enforcement agencies like CBDT, ED and FIU.
• Sharing of information on such high risk companies with law enforcement agencies : Once certain companies are identified through data mining above, the list of such high risk companies should be shared with CBDT and FIU for closer surveillance.
• In case after investigation/assessment by CBDT, a case of creating accommodation entries is clearly established, the matter should be referred to SFIO to proceed under relevant sections of IPC for fraud. SFIO should also refer the matter to Enforcement Directorate for taking action under PMLA for all such cases of money laundering.
• It has also been observed that in many cases of creation of shell companies the shareholders or directors of such Companies are persons of limited financial means like drivers, cooks or other employees of main persons who intend to launder black money. Section 89(1) and 89(2) of the Companies Act, 2013 provides for persons to declare if they have “beneficial interest” in the shares of the Company or not. Section 89(4) enjoins the Central Government to make rules to provide for the manner of holding and disclosing beneficial interest and beneficial ownership under this section. The Ministry of Company Affairs may frame such rules at the earliest.

Action under PMLA for Trade Based Money laundering:

Section 132 of the Customs Act has been made a predicate offence through the Finance Bill 2015. Section 132 of the Customs Act reads as follows:

“132. False declaration, false documents, etc.-Whoever makes, signs or uses, or causes to be made, signed or used, any declaration, statement or document in the transaction of any business relating to the customs knowing or having reason to believe that such declaration, statement or document is false in any material particular, shall be punishable with imprisonment for a term which may extend to 1[two years], or with fine, or with both.”

Thus any declaration of mispriced goods is a punishable offence under this Act.

SIT realizes that Trade Based Money laundering through mispricing of imports/exports is a major means of taking money out of this country. A strong deterrent action is needed to curb this menace. The SIT thus recommends that  all cases of Trade based money laundering detected by DRI where violation of section 132 of Customs Act ,above the threshold provided for in Part B of Schedule of PMLA, has been found must be shared by DRI with the Enforcement Directorate to enable ED to take action under Prevention of Money Laundering Act.

Use of cash in Black economy (Reference p. 4-6 of Third SIT Report)

Suggestions, made in Paras: 4 & 5 at Chapter: III of the Second Report of SIT, are reproduced as under:––

(i)   “4. It is suggested that for regulating the possession and transportation of cash, particularly putting a limitation on cash holdings for private use and including provisions for confiscation of cash held beyond prescribed limits, provision in the Act should be made. It is to be stated that a number of European countries bar any cash transaction above a particular limit. This can be done in India too. Again, while implementing the suggestions, to ensure that small transactions, which make a bulk of common man’s daily transactions, are not affected and for that, a threshold limit could be kept.

Further, for holding of cash/currency notes also, there should be a limit, by prescribing a reasonable threshold, may be ₹ 10 lacs or ₹ 15 lacs. This would control holding of unaccounted money to a large extent. This would also control transfer of unaccounted cash from one destination to other, which at present is rampant, may be by Angadias or by other means.

5.  The aforesaid suggestion is also in conformity with the observations in the case of Rajendran Chingaravelu vs. UoI, in CA No.7914 of 2009; ORDER DATED November 24, 2009 (320 ITR 1)) by the Hon’ble Supreme Court. Therein, it had been observed that “The nation is facing terrorist threats. Transportation of large sums of money is associated with distribution of funds for terrorist activities, illegal pay offs, etc. There is also rampant circulation of unaccounted black money destroying the economy of the country.”

            This is known to all concerned and, therefore, suggestion made above, be implemented.”

(ii)  On the afore–quoted suggestions, the response, given in the aforesaid Office Memorandum of CBDT, is reproduced as under:––

“The recommendation has been referred to Department of Economic Affairs (DEA) for taking appropriate action and submitting feedback to the SIT. It was ascertained from Shri Manoj Joshi, Joint Secretary concerned on 7^th April 2015 that the proposal has been sent by DEA to various Departments/Ministries (including MHA) for inputs which are awaited.”

(iii)   SIT is awaiting the response of the concerned Departments, as the large cash amount is normally used in illegal transactions such as, those involving, payment for drugs/narcotics deals, corruption/bribery, cricket betting and use of huge cash during elections, etc.

(iv)   According to SIT, if holding of cash is restricted and regulated, to a large extent, it would control circulation of black money within the country and discourage stashing of money abroad.

(v)   In the meeting held on 30^th April, 2015, the concerned Joint Secretary, Mr. Manoj Joshi remained present and he stated that the aforesaid issue would be decided as early as possible.

Generation of black money in education sector and through donations to religious institutions and charities (Reference p. 84-86 of the Third SIT Report)

SIT sought the response of the Government through the Revenue Secretary on the following points:––

• “It is a known fact that well–known schools and colleges are accepting large donations by cash. That cash normally would be unaccounted money. For controlling such transactions, there should be specific provision that donation shall not be accepted by cash and whosoever accept it, would be punishable under the Prevention of Corruption Act, as if he is “deemed to be a public servant”.
• Large amount is donated to various religious institutions or charities. Nobody can object for charity donation but at the same time, that when large amount is donated, it should be only accounted money and that payment should be by account–payee cheque to the charity or the institution. Even if gift of jewelry is made to the charity or institution, it should be by mentioning donor’s name and his PAN Number.”

CBDT informed on details of searches/surveys conducted by them with respect to above points related to Education sector and Trusts.  In short, the substance of the brief findings of searches/surveys conducted by the Department of various entities engaged in area of education through the Trust reveals that large unaccounted amount is accepted as donation and in a number of cases, such donations are used for personal benefits and also for tax evasion which results into generation of black money. The report of the said searches in short is at Annexure: A to this report.

As stated earlier, the person who accepts the donation and the donor requires to be prosecuted under Prevention of Corruption Act. For this, it would require legislative change which is necessary because now–a–days, donation to educational institutions which are in demand, is rampant. In some cases, it goes to ₹ 1 crore and more. This would go long way in curbing the generation and circulation of black money.

Further, considering the aforesaid report, it appears that in number of cases, assessment is not finalized. Hence, CBDT should take appropriate action for expeditious finalization of the assessment, and if required, punitive action may be taken.

CBDT shall also share the aforesaid report/information with the concerned agencies so that other agencies can also take appropriate action under the relevant law.

Necessity for establishment of additional Courts for deciding the pending cases under the Income Tax Act, 1961 (I.T. Act) (Reference : Page IV of Executive Summary of Third SIT report and extracts from First and Second SIT reports)

(a)   In Para: 4 at Chapter: VI of the First Report dated 13^th August, 2014, it was inter–alia reported that,

“… … approximately 4,939 cases are pending for disposal before the Metropolitan Magistrate, Mumbai since more than 10 years. If these cases are decided immediately, it would have its own deterrent effect. For this purpose, Additional Chief Judicial Magistrates are required to be appointed, as there is heavy work load in the Metropolitan Magistrate Courts, Mumbai.

For expediting the cases, if five additional Courts of Additional Chief Judicial Magistrate are constituted which try the aforesaid pending cases under Income Tax Act, 1961, the decision in the said cases would have its own impact. After deciding income tax cases, cases under Customs & Excise Act, 1996 can be dealt with by the said Courts……..”

(b)  In Para: 13 at Chapter: III of the Second Report (December, 2014), it was reiterated to constitute five additional Courts of Additional Chief Judicial Magistrate. Said Para is reproduced as under:––

“13.  As suggested in first report, at least 5 Additional Chief Judicial Magistrates Courts in Mumbai are required to be established for deciding approx. 5000 pending IT prosecution cases.

It appears that without direction by the Hon’ble Court, it would be difficult to establish 5 Courts as suggested. For the establishment of 5 courts, Central Government shall bear the entire cost.”

(c)  In view of the recommendations made by the SIT in the First and Second Reports, to constitute five additional Courts of Additional Chief Judicial Magistrate; The Revenue Secretary, DoR, MoF, GoI, vide D.O. Letter No.K–11022/27/2014–Ad. ED, dated 09^th March, 2015, requested the Chief Secretary, Government of Maharashtra to consult the High Court of Mumbai for setting up of five additional Courts of Additional Chief Judicial Magistrate.

Thereafter, Chairman, SIT, by a letter dated 26^th March, 2015, requested the Hon’ble Chief Justice of High Court of Mumbai, to look into the matter and give suitable administrative directions for expeditious setting up of the Courts which can continuously try the prosecution under the I.T. Act so that it would have its own deterrent effect.

Action is awaited and it is submitted that if appropriate direction is issued by the Hon’ble Apex Court, the suggestion would be implemented at the earliest.

In addition, in view of the SIT, a suitable direction is required to be issued by the Hon’ble Apex Court to all High Courts and State Governments to allocate suitable number of Judges in the trial Courts trying the Income tax, Customs, Central Excise, Service Tax, PMLA, FEMA, FERA cases to ensure that these cases are disposed off within one year of filing the charge–sheet. Similar directions may be issued to trial Courts to conclude the proceedings of all foreign asset related prosecutions within one year of their launching. This would have its own deterrent effect.

Need for establishment of Central KYC Registry (Reference p. XVI of Executive Summary of the Third SIT Report)

The Second SIT Report in it’s third chapter had observed as follows:

“At present for entering into financial/business transactions persons have option to quote their PAN or UID or Passport number or driving license or any other proof of identity.  However, there is no mechanism/system at present to connect the data available with each of these independent proofs of ID.  It is suggested that these data bases be interconnected.  This would assist in identifying multiple transactions by one person with different IDs.  A central KYC Registry should be established with all law enforcement agencies, Registrar of Companies and financial institutions having access to its database.”

The Department of Revenue has informed that rules for the Central KYC Registry to be framed under Prevention of Money Laundering (Maintenance of Record) Rules have been finalized by the Department and have been sent to Legislative Department for vetting. The rules are expected to be notified shortly. This is expected to expedite the setting up of this Central KYC Registry which shall be an important office to tackle the menace of black money and money laundering more effectively.

SIT insists that Central KYC Registry (CKYC) should be notified as early as possible.

GENERATION OF BLACK MONEY DUE TO CRICKET BETTING (Reference p.68 -71 of the Third SIT Report)

 In the report (February, 2015) namely, “A study on widening of tax base and tackling black money” of Federation of Indian Chambers of Commerce and Industry (FICCI), generation of black money in various sectors of Indian Economy is discussed in detail. Substance of the said Report in relation to generation of black money due to “betting” is as under:––

Betting in sports is illegal in the country, and hence, creates a wide scope for black money generation. In India, only betting on horse racing, lotteries conducted by state governments and casinos in certain states are permissible.

According to 2012 FICCI and KPMG report, betting in India is a INR 3,00,000 crore (Rupees Three Lacs Crores) market and if taxed at a rate of 20 percent, the exchequer can earn revenue of INR 12,000 crore to INR 19,000 crore every year.

Cricket betting is widespread in the country. As there are no legitimate means on placing bets, hence, people resort to illegal channels such as bookies/bookmaker that facilitate gambling by setting odds, accepting and placing bets and paying out winnings on behalf of other people. Illegal betting leads to malpractices such as match–fixing or spot–fixing wherein the bookie fixes the outcome of the event in his favor by having an illegal agreement with the sportsperson. This leads to bettors being cheated at the hands of bookmakers, thereby enabling them to earn huge sums of black money.

The Indian Premier League (IPL) has been marred by betting and spot fixing scandals and involvement of huge amount of black money. As per news reports, some of the players are paid more than the payment slabs prescribed by the Board of Control for Cricket in India (BCCI), with certain amount paid through legitimate means and some in black. During the IPL 2013 season, in a sport fixing scam, several cricketers were arrested for accepting money from bookies to throw away matches.

In the aforesaid context, in the Judgment rendered in the case of Board of Control for Cricket in India v/s. Cricket Association of Bihar & Ors. [JT 2015 (1) SC 526], the Hon’ble Supreme Court observed that,

“Allegations of sporting frauds like match fixing and betting have for the past few years cast a cloud over the working of the Board of Cricket Control in India (BCCI). Cricket being more than just a sport for millions in this part of the world, accusations of malpractices and conflict of interests against those who not only hold positions of influence in the BCCI but also own franchises and teams competing in the IPL format have left many a cricketing enthusiasts and followers of the game worried and deeply suspicious about what goes on in the name of the game. There is no denying the fact that lowers the threshold of tolerance for any wrong doing higher is the expectation of the people, from the system. And cricket being not only a passion but a great unifying force in this country, a zero tolerance approach towards any wrong doing alone can satisfy the cry for cleansing.”

Further, the Court referred to “fundamental sporting imperatives” stated in the Anti Corruption Code, which is claimed to have been adopted by BCCI. One of the imperatives is:––

“1.1.3  Advancing technology and increasing popularity have led to a substantial increase in the amount, and the sophistication of betting on cricket matches. The development of new betting products, including spread-betting and betting exchanges, as well as internet and phone accounts that allow people to place a bet at any time and from any place, even after a cricket match has started, have all increased the potential for the development of  corrupt  betting  practices…”

Involvement of huge illegal, unaccounted money in cricket betting has been noticed by ED, where betting was being done over internet or using electronic gadgets. It is also stated that some websites (may be outside the country) are providing online betting facilities for various sport events, such as cricket, football, etc.

Considering the aforesaid discussions, it is apparent that illegal activity of cricket betting requires to be controlled by some provisions which are deterrent to all the concerned.

It is true that betting in gambling is a subject on which State Governments have to pass appropriate law, as it is a State subject in the State List (Entry 34). However, considering the fact that large amount of black money is generated and used in this sector, it is suggested that some appropriate legislative directions or rules or regulations are required to be put in place to curb the menace of such betting.

Empowerment of DRI under section 20, 21 and 22 of SEZ Act (Reference p. XVI of Executive Summary of Third SIT Report)

One limitation faced by Directorate of Revenue Intelligence (DRI) in investigating cases of misinvoicing or violations of Customs Act is that presently DRI is not empowered under section 20, 21 and 22 of SEZ Act, to carry out investigation, inspection, search or seizure in the Special Economic  Zone  or Unit without prior intimation or approval of the Development Commissioner. Department of Commerce has so far issued only entry passes for some DRI officers for certain SEZs.

Further, as per the Foreign Trade Policy 2015-2020 announced recently, SEZ has been allowed to avail benefits of Chapter 3 on par with Domestic Tariff Area Units. In effect, SEZ units would avail export incentives available under (i) Merchandise Exports from India scheme (MEIS) or (ii) Service Exports from India Scheme (SEIS). In view of the same, now it has become even more imperative to notify the DRI under the 2^nd proviso of 22 of the  SEZ Act to safeguard the interest of Revenue.

SIT has been informed that this matter has been taken up with the Ministry of Commerce by Revenue Secretary and DRI in the past.

In light of above, it is recommended that Ministry of Commerce looks into the matter urgently and issues necessary notifications under section 20, 21 and 22 of SEZ Act empowering DRI to carry out investigation, inspection, search or seizure in the Special Economic  Zone  or Unit without prior intimation or approval of the Development Commissioner.

MR. JUSTICE M. B. SHAH (RETD.)

CHAIRMAN

DR. JUSTICE ARIJIT PASAYAT (RETD.)

VICE–CHAIRMAN