Anti money laundering policy for the direct taxes regime: three core arguments

Abstract

With increasing globalization and liberalization, the dynamics of financial crimes have undergone tremendous changes and continue to evolve at a rapid pace. Recognizing the close link between the direct taxes regime and money laundering, the role and function of revenue services world over have expanded from the traditional role of countering tax evasion to the active combating of money laundering. Legal frameworks in the Direct Taxes Law and enforcement strategy in the Indian Income Tax Department at present appear to be primarily concerned with preventing tax evasion and bringing unaccounted income and wealth into the tax net. Incomes from all sources is taxable in India, the legal and institutional mechanism in the Income Tax Department does not distinguish between legal and illegal sources of income for the purpose of taxation. All incomes and wealth from both illegal and legal sources are taxed at a uniform rate, whereas expenditure claims based on illegalities are distinguished. When money is derived through illegal sources, say for example from corruption, a primary concern of the recipient is to legitimize the illegal asset by integrating it within the formal economy, mainly to facilitate future handling. Such elements laundering illegal money may view the cost of taxation at 30 to 35% as an attractive price to pay for such legitimization. There are provisions in the income Tax Act which provide opportunities for laundering of illegal source money by claiming tax exemptions and deductions. Such provisions could afford opportunities of laundering by payment of taxes at below the maximum marginal rate and even at zero percent. This study finds certain policy gaps in the provisions and practices of the Income Tax Department and in the context of increasing globalization, this paper argues, such gaps are serious policy concerns. It also identifies the lack of effective Anti-Money Laundering policy initiatives in the Direct Taxes Regime in India. Most of the literature in India on the subject, depending on the scope of study, has defined black money to include income generated from both legal business and illegal activities. The reason why these were included in the definition of black money was because both remain unreported and unaccounted and in effect resulted in tax evasion. The literature indicates that due to their illegal and criminal origin, the bulk of such monies operates in the underground economy and remains outside the scope of taxation. In slight contrast to such established beliefs, this study finds that, part of such illegal monies are subject to taxation, as they are painstakingly clothed in the garb of legitimate businesses, and are offered to direct taxes. This paper brings to fore that the prime motivation of holders of illegal money is legitimization as against tax evasion in the case of legal source black money. For this study, illegal income from proceeds of crime, corruption and illegal activities, which are laundered through the Income Tax Department, is termed as Red Money . This study is on this specific area of Red Money whose behaviour appears to be counter intuitive and contrary to common belief. It aspires to link this behaviour as a factor to be reckoned with, and cover certain policy gaps in the Direct Taxes Regime in India. In view of the lack of availability of reliable data, a qualitative study with a policy perspective was undertaken. With the help of literature review and informal interview with the Revenue officers of the Income Tax Department, Three Core Arguments were formulated. This paper is centred on these three core arguments. To understand the magnitude of the problem and to address the core arguments, certain investigation cases of the Income Tax Department have been analyzed as case study . The case study analysis provides understanding of the phenomena of illegal money vis-a-vis the direct taxes regime in India. It also provides insights into the methods of money laundering through the tax system. A questionnaire survey was conducted among Indian Revenue Service officers involved in direct tax policy formulation and implementation to elicit responses on issues related to the problem and core arguments. The analysis of case study and questionnaire survey responses provided valuable insights and evidence for the core arguments. To understand the global best practices and to have an international policy perspective, anti-money laundering policy initiatives in the US IRS was studied. In the lights of these findings, policy implications for the Direct Taxes regime in India have been presented. The paper closes with concluding thought for future study. More researches on these issues will help building a consensus among the policy makers for appropriate policy responses. Collection of taxes from illegal source money might be enhancing the overall revenue collection of the state, but its adverse impact on the overall economy and security would be far more damaging and destabilizing. In order to effectively prevent Money laundering, this study argues, the basic requirement is to improve particular aspects of Governance. This is a rather broad prescription, but its operative strategy would be to increase the cost of money laundering activities until they become untenable, both in terms of economic viability and criminal risk quotient. Taking references from the US IRS Criminal Investigation, the paper suggests for initiating Illegal Source Financial Crime Program in the Directorate of Criminal Investigation in the Income Tax Department in India. The study recommends authority and jurisdiction for the Indian Income Tax and IRS against money laundering offences. It also recommends initiating a robust system of self reporting and disclosure, third party reporting and disclosure and enhanced monitoring of all suspicious transactions by the Indian income tax department. The biggest benefit of self reporting, and enhanced monitoring, the paper argues, would lie in effecting the ideal solution of deterrence as opposed to detection.