Lawmakers are considering withdrawing the high denomination Rs5,000 currency notes from circulation in order to curb the flow of black money. In the UAE, letters are being sent out to rich foreigners and residents to give proof of their tax status, precipitating a flurry of worry in Pakistan. The government is trying to get a law passed against benami transactions carried out under misleading names. And a new law imposes a 3% tax on real estate in an amnesty scheme hoping to get people to turn black money white, for lack of a better phrase. According to a 2012 report by Bloomberg news, Pakistan’s black economy is probably worth half its 18-trillion-rupee ($200 billion) official gross domestic product.
The government defines ‘black money’ as tax-evaded income. In most instances, it is earned through illicit means; however, the definition of black money also encompasses income earned through legal means on which tax is evaded. It is the income received in cash, not accounted for on the books, and concealed from the government and tax authorities.
Generating black money
Most commonly, black money is generated through some form of corruption. Take for example, income received as a bribe for approving a building sanction plan. This transaction would not take place over a cheque or bank draft. It will not be entered in the books of the receiver and therefore no taxes will be paid on it.
Black money is generated on the sale of assets as well. If the actual value of an asset is higher than the one shown on paper and declared in the income tax return, then the excess is taken in cash and becomes black money as tax was not paid on on it.
Another way to conceal transactions is to avoid making invoices. The income received on that transaction is thus untaxed. These transactions could include a sale of any form of goods or services. We see this most commonly practiced by restaurants, where they give customers the choice to either pay less without an invoice or pay more with the invoice (the amount includes 16% tax). In local jargon, the bills are called ‘kacha’ and ‘pakka’ bills.
Businesses also often create fake expenses to bring down their income to reduce the amount of tax that can be applied. Fictitious expenses conceal some portion of the income on which the tax is not paid.
Conversion of black money
When tax evaders generate black money, they do not deposit the money in the bank out of fear of being caught by the agencies. So they find ways to either hoard the cash or spend it on property or ‘white’ goods. Here are some of the common ways through which black money is converted into white:
Real estate: Real estate is one of the major sectors where huge amounts of black money are parked. People across the world use real estate deals for black money conversions. One practice with regard to this is known as the ‘benami transaction’, through which property is purchased without a name or under the name other than that of the actual purchaser. For instance, Mr. Ali buys a house under the name of Mrs. Ali. The payment is made by Mr. Ali but on paper the property belongs to his wife. The IRS detects such transactions through running a check on income details. If Mrs. Ali does not have any declared source of income, it becomes clear that the payment was made by another person, possibly to hide their black money earnings. In other instances, the transaction may be carried out under a fictitious name. And so broadly speaking benami transactions are used to park untaxed money in the form of real estate, shares, bank accounts, stocks, and other forms of assets.
Hawala or hundi transactions: Suppose a tax evader based in Islamabad has Rs5 million in black money. Since it is black money, depositing it in bank is out of the question. So, he seeks the help of a hawala agent. The agent takes the cash in Islamabad and transfers it in foreign currency to another agent based elsewhere in the world. Then that money is rerouted back as a foreign remittance—which luckily enough are not taxed. The tax evader can get this money back to Pakistan as foreign remittance, Foreign Direct Investment or by investing in shares or property abroad. It is estimated that the hundi and hawala business crossed the $15 billion a year mark during 2015, according to a report released in December 2015.
Agricultural source income: Agricultural income is exempt under Income Tax Ordinance, 2001. And so, people making black money get fictitious receipts to show they have earned income from agriculture. But to show income from agriculture, you must be able to prove you have a piece of land on which you do your farming. If people try to cover their black money like this the chances of being caught are high because they can’t produce evidence to support their claim when the income tax authorities go sniffing.
Gifts: Black money is often declared as a gift received from relatives. But in this case, a relative who has the same amount in white money becomes an accomplice. The accomplice issues a cheque for the amount to show it is as a gift, but they cash back from the black money earner. Any amount of money received from relatives as a gift is exempt from income tax if received through the proper banking channels. The tax authorities strictly investigate such claims to tighten the noose on tax evaders.
Multiple bank accounts: Often tax evaders open multiple bank accounts in the names of their family members and deposit black money here. The income tax authorities will, however, go looking into the sources of these people’s income to unveil such illegal practices.
Prize bonds: Often black money earners buy winning prize bonds from their actual owners at higher prices to convert their black money into white.
Black as black: Often black money is spent in black without being converted into white. People invest in property, spending on weddings and events, buy goods and services such as interior decoration, pay for education expenses, buy gold (instead of accumulating cash, black money is converted into valuable jewelry).
Curbing the menace
The government is looking for ways to bring home ‘black money’ stashed abroad and to discourage the black economy in Pakistan, which weakens the economy at large. The latest development is a 3% property tax.
The Inland Revenue Service is on a constant lookout for tax evaders to keep black money offenders in check. Criminal investigations are opened into possible tax crimes through rigorous audits. The IRS is the only government agency that has the right to investigate possible criminal violations of the tax laws. Other crimes can be investigated by agencies such as the National Accountability Bureau.
The government is, for example, making an effort to introduce new laws. The Benami Transactions (Prohibition) Bill, 2016, was presented before the Senate Standing Committee at the end of November, 2016. Benami transactions can still be identified but properties held in benami cases cannot be confiscated. At present, Pakistan is probably one of the very few countries with no law against benami transactions. If the bill is approved, offenders can face jail time and fines and the government would be able to take the property.
Another way to crack down on black money is to announce amnesty schemes from time to time. The most recent amnesty scheme concerns property law and the insertion of Section 236W in the Income Tax Ordinance, 2001. It is an attempt to bring the black economy accumulated in the real estate sector into the tax net. The new law imposes a 3% tax on the difference between the value of property (set by the federal board of revenue) and the value at which it was registered or transferred. Critics of the scheme believe that a trivial 3% tax would only let black money earners clean their wealth. Supporters argue that tackling the black economy should be the main concern at the moment and the new law clearly supports this effort.
More work is needed on foreign remittances and hawala transactions. Explaining the source of foreign remittances could help rein in hawala transactions. Lawbreakers can easily send black money abroad and then receive it back in the form of foreign remittance. According to a report, foreign remittances in Pakistan averaged $2.5 billion between 2002 and 2016, reaching an all-time high of $5.5 billion in the second quarter of the current year. With figures at such a peak, these transactions need to be kept under close watch.
It would be simpler perhaps to crack down on the winning prize bond trick. The government can stop this if prize bonds are issued after proper registration or transfer in the holder or buyer’s name so that the prizes are only issued in their favour.
Demonetization could be another possible solution. This method has been tried and tested by many countries, including Australia, North Korea, and Russia. Recently, the Indian government decided to withdraw high currency denominations of Rs500 and Rs1,000 notes from the system in an attempt to control black money from being accumulated. This decision rendered 86% of the currency in circulation invalid as legal tender. Following this, Pakistan’s Senate recently passed a resolution seeking the withdrawal of the high denomination Rs5,000 currency notes. It will also encourage the use of bank accounts and e-banking but unlike with India, the currency notes will be given a time period of three to five years for withdrawal from the market.
The writer serves as the deputy commissioner (inland revenue), large taxpayers’ unit, Islamabad, and blogs at www.theislamabaddiaries.com. She can be reached at [email protected]