Black money will remain untouched

Gautam Nayak  Live Mint 12 Feb 2014

The recent decision of the Reserve Bank of India (RBI) to phase out certain old currency notes seems to have created some fear in the market as to whether this was a method of unearthing black money, according to newspaper reports. Some reports referred to money moving into immovable properties, gold, etc., as a reaction to RBI’s decision. Are these fears justified and what are the provisions of tax laws relating to unexplained cash found in one’s possession?

The tax law provides that if a person is found to be the owner of any money, bullion, jewellery or other valuable article in a particular year, the amount or asset should either be recorded in her books of account, or she should be in a position to explain the nature and source of its acquisition. If it is not recorded in the books of account and the person is not able to explain in a satisfactory manner as to how she acquired the money or asset, the value of the money or asset can be treated as her taxable income.

This would mean that such an amount would get added to her regular income as undisclosed income. However, income tax would have to be paid on such undisclosed income at a flat rate of 30%, irrespective of whether the person has any other taxable income or not. No deduction for any expenditure would be allowable to the person concerned against such undisclosed income, nor can she set off any losses against it. Therefore, in effect, 30.90% of such an amount or the value of such an asset would end up being paid as income tax.

Would the RBI move result in taxation of such undisclosed cash? If one looks at the RBI announcement, it is clear that the old currency notes can be exchanged for new ones at any bank branch from April to June 2014 without any questions being asked as to the name of the person giving the notes, her Permanent Account Number (PAN), address, etc. One can exchange the notes even at branches where one does not have a bank account. It is only after 30 June that one would have to give the name and PAN to exchange high denomination currency notes. Therefore, any person having undisclosed cash in her possession can easily exchange the old currency notes till June 2014 without disclosing her identity. Therefore, there is no risk till then of such amounts being taxed.

It is only after June that such an exchange would not be permitted without disclosure of identity. It is obvious that any person seeking to exchange old high denomination currency notes for new at this stage, runs the risk of such amounts being taxed as her undisclosed income, unless she is in a position to prove either that the cash is recorded in her books of account or prove from where she acquired it.

What could be the possible reason for this cut-off date of June 2014? The obvious answer that comes to mind is the fact that elections are being held in April and May, and it is a well-known fact that elections in India involve utilization of a large component of black money. Obviously, politicians would have been severely handicapped in their election campaigning had the cut-off date been prior to the elections.

Is such withdrawal of currency notes the best way of tackling the problem of black money? One needs to understand that the greater part of black money is not sitting idle in the form of cash, but is often deployed in productive assets. Even a holder of black money would not like to forego the income that she could earn on such an amount. Therefore, a significant part of such undisclosed wealth is in the form of assets. These include undervalued real estate, undisclosed gold or jewellery, undisclosed foreign assets held abroad, assets and businesses held in names of close relatives and others, etc. This component of black money would not get affected by the withdrawal of old currency notes or high denomination currency notes.

One already notices that there is a significant change in approach of most of the younger generation, which prefers to pay its legitimate taxes rather than go through the hassle and risk of black money. Black money flourished during the era of high taxes, which prevailed in the 1970s and 1980s. Old habits die hard, and even with the reduced reasonable income tax rates, some taxpayers continue to avoid disclosing their true incomes.

What is now needed is a carrot and stick approach. There is definitely the need for a multi-pronged effort in the form of intelligence gathering and follow up on various leads in a systematic manner, to unearth such undisclosed income and assets, besides a crack down on corruption, one of the major reasons for generation of black money. Such efforts need to be accompanied by rational and stable tax policies, which make tax payment easier and less onerous than the risk involved in not disclosing income and assets.