Black Money and Money Laundering

Black Money

• There is no official definition of black money in economic theory, with several different terms such as parallel economy, black money, black incomes, unaccounted economy, illegal economy and irregular economy all being used more or less synonymously.
• The simplest definition of black money could possibly be money that is hidden from tax authorities.
• A secret study commissioned by the Finance Ministry concluded in 2014 that about 90% of unaccounted wealth, or black money, was lying within India and not outside.

Source of Black Money

• It can come from two broad categories:
  • Illegal Activity:
    • Money that is earned through illegal activity is obviously not reported to the tax authorities, and so is black.
  • Legal but Unreported Activity:
    • The second category comprises income from a legal activity that is not reported to the tax authorities.

Common Sources of Illegal Money

• Trafficking of drug, arms and human beings
• Terrorism
• Tax evasion
• Organised Crime like kidnapping, contract killing, gambling, prostitution, bank fraud etc.
• Money paid to gangsters/ criminals for the safety of business (protection money)
• Money earned through adulterated products, corruption etc.
• Slush funds or Black funds – Secret reserve of money by Corporates for bribery to politicians or donations to political parties
• Capitation fee – illegal fees sought by educational institutions
• Money lenders who charge extremely high interest also called as loan sharks

Process of Money Laundering

There are numerous techniques to launder money. However, money laundering can be broken down into three stages:

Step 1: Placement: Illegal money is deposited into Financial Institutions using different methods. The main aim of this step is to remove the proceeds of crime (illegal money) from the criminal place to avoid detection by legal authorities. Methods or techniques involved in the first phase with Financial Institutions:

• Structuring/Smurfing technique: This technique is very simple just deposit a large amount of illegal money into small amounts of cash in the accounts of unconnected depositors below the reporting threshold limit set by authorities. The person who is involved in the technique is called smurf.
• Using connected accounts: Accounts of relatives, benames, and associates such as shell companies (Fake Companies).
• Multiple legitimate accounts of the same person in different banks and misusing the accounts of Educational Institutions, Non-Profit Organisations, Charity trusts etc.

Step 2: Layering: Untying the illicit or criminal origin of the illegal money through a complex web of financial transactions. The main objective of this phase is to make the source of fund and its ownership untraceable, through multiple layering of a complex network of transactions. Methods or techniques involved in the layering phase with Financial Institutions:

• Remittance Services like Foreign Telegraphic Transfers,
• Bank drafts/money orders,
• Loans to Shell companies and Front Companies

Step 3: Integration: In this step main objective is to paint a legitimate image of illegal money. This is the last stage of the laundering process. After using the above methods of laundering, the illegal money is now circulated into the economy by way of investments, purchase of lands, expenditure or savings.

Techniques of Money Laundering

Deposit Structuring/Smurfing

• This procedure involves making a large number of deposits of little amount below the reporting limit set by authorities, either by countless detached investors or to an extensive number of accounts.

Cash Deposits followed by Telegraphic Transfer

• Large cash deposits might be made by drug traffickers or other people who have smuggled criminal property out of the nation where the wrong doing took place. Frequently the cash deposit is immediately followed by a telegraphic transfer to another person (which could be in the first nation where the wrong doing was detected), in this way bringing down the danger of seizure.

Connected Accounts

• Probably it is troublesome for criminals to open accounts in false names as relevant recognizable proof is necessary to open a bank account. So as the case maybe that accounts may be held in the names of relatives, partners or different persons working for the benefit of the criminal.

Trade Based Money Laundering

• This method simply relies on under or over valuation of invoices to conceal flow of money and making the dirty money coming from legit source of income. These type of laundering techniques is widely used in Gold and Diamond market.
  • Gold: Gold has intrinsic value and a constant market. Country like India which are exporting way more gold than its production generates ample opportunities for laundering activities using gold. Example: Drug trafficking agent pays in the form of gold and then this gold is imported with false invoice.
  • Diamond: The illegal trade of diamonds is an important source for launders and terrorists. Unlike gold which is homogeneous metal (if we cut gold into half , the price is also divided equally) the diamond is a non homogeneous. The value of diamond is very complex even if both the diamonds are same colour, weight and clarity still they are not same as one might be twice the value of other and spotting the value of diamond requires lots of skill. This nature of diamonds helps the launders to easily manipulate the value of diamonds in the invoice. Also, terrorist use illegal trade of diamonds as their source of funds transaction.

Round Tripping through Tax Havens

• Tax Havens are countries with a very low or no tax liability along with minimal paper work. The money is deposited in account of an offshore controlled enterprise and then brought back as Foreign Direct Investment, exempting tax liabilities. Here also the dirty money is mixed and accounts are manipulated to disguise its criminal source. Another variant is to transfer the fund to a law firm or other such organisation as fee charged and then to cancel the retainer. Thereafter the money is remitted as sum received from lawyer as a legacy under will or proceeds of litigation.

Shell Companies and Trusts

• They are just a paper companies/trusts. They may or may not physically exist but they won’t do any productive activities like manufacturing or trading. For example: Mr. Shayam is a money lender, he lends money with a heavy hefty interest rate. But he registered his company as M/s. Shayam Enterprises with sales tax registration and pays sales tax for selling of a commodity. He also files income tax for the net profit in the name of M/s. Shayam Enterprises as a trader. This is also a money laundering process since he is actually a loan shark earning income from the lending at a very high interest rate but he used this fake company to change the source of revenue as earned from a legal trading activity.

Front Organizations

• A company/non-profit organization/trust is used to shield another company from liability and scrutiny and is generally used to launder illegal money. Mostly the business of these companies relates to huge cash transactions. For example casinos, brokerage firms, Chit funds and in some countries banks.

Informal Value Transactions or Hawala

• In India and South Asia, Hawala System is a familiar type of money laundering technique. Hawalas, an Arabic word for a particular international underground banking system is nothing but a parallel illegal banking system. One just needs to Hand over cash to a hawala agent in country A and the agent will arrange it into cash (or at times gold) in country B. The hawala provide the complete service from placement to integration.

Currency Exchange Bureaus

• They are not as heavily regulated as banks, and de facto, at least, may not be regulated at all, so they are at times used for laundering. Substantial foreign exchange transactions are said to be taking place from banks to these small enterprises. A two step process is usually applied in this laundering method. At first, the large amounts of criminal proceeds in local currency is changed into low-bulk foreign currency, preferably US dollar or Euro, for physical smuggling out of the country. In the next step the electronic funds transfer to offshore accounts is done. In a reported case, a currency bureau reportedly exchanged the equivalent of more than $50 million through a foreign bank without registering these transactions in its official records.

Bank Capture

• In this method a financial institution, such as banks, is owned or controlled by unscrupulous individuals suspected of working with drug dealers and other organised crime groups. This makes the process very easy for launderers. They could easily manipulate the records and conceal the illegitimacy of the funds. The complete liberalisation of the financial sector without adequate checks have provided sufficient leeway for laundering.

Credit Card Advance Payments

• A credit card holder may make a large payment with dirty money to the issuing bank, resulting in a negative balance due. The bank then pays out the balance with a check, which can be deposited into a personal account as apparently clean money. Structured cash payments for outstanding credit card balances is the most widely recognized use of Visas for tax evasion, frequently with moderately substantial payments as installments and in some cases, with money installments from outsiders. Another method is to use loans from Visa records to buy cashier’s checks or to wire assets to outside destinations. On some events, loans are kept in investment funds or current records. A substantial number of distinguished situations include the utilization of lost or stolen cards by outsiders.

Black Salaries

• A registered company may have several unregistered employees without any written contract. Then it pays them using illegitimate cash and manipulates the invoices to show revenue generation. Thereby bringing into the system legit cash concealing its identity. Another method applied is paying a higher salary in a cheque and then taking back the amount in cash thereby manipulating the accounts to pay cash for some real estate purchase or hawala transfer.

Legitimate Business Transactions

• Illegitimate money can be added to the cash revenues of a legitimate business enterprise, predominantly those that are already cash intensive, such as restaurants, bars, casino, video rental stores, retail chains, shopping malls etc. The extra cash is simply added to the books. The cost for this laundering method is just the tax paid on the income. The companies whose transactions are better documented, the invoices can be easily manipulated to simulate legitimacy disguising illegal money. Take for example, a used car dealer may offer a customer a discount for paying cash, then report the original sale price on the invoice, thereby disguising the existence of the extra illicit cash. A slightly more sophisticated scheme may allow a criminal to profit twice in setting up a publicly traded front company with a legitimate commercial purpose—first by mixing laundered money with those generated by the legitimate business, and second by selling shares of this company to unwitting investors.

Bank Drafts and Similar Instruments

• Bank drafts, money orders, and cashier’s cheques purchased for cash are useful for laundering purposes because they provide an instrument drawn on a respectable bank or other credit institution and so break the money trail. Breaking this trail is of critical importance to the money launderer, as it makes it impossible – or at least very difficult – for an investigator to establish where laundered funds have ended up. This reduces the ability of law enforcement authorities to seek a judicial order to appropriate such funds.

Remittance Services

• The remittance business receives cash, which it transfers to the banking system of another account held by an associated company in a foreign jurisdiction. There the deposited money can then be made available to the ultimate recipient The criminal organization receives the funds in the designated country in the local currency, which is then sold to foreign business people who need currency to fund the legitimate purchase of goods and exports.

Examples of Sources of Black Money

• Multi-Level Marketing Scheme:
  • International debit or credit cards issued by offshore banks are used to create black money.
• Disguised Ownership:
  • Increasingly, criminals want to own legitimate businesses. It could be to earn a return or to convert black money into white.
• Mixed Sales:
  • Mixing illicit money sources with legit ones is a popular method because it’s hard to detect, especially if there is a large cash component in the legal business.
• Smurfing:
  • This type of transaction is usually done to evade notice by authorities monitoring transactions above a certain threshold.
• Trade Mispricing:
  • Traditionally, goods exported and imported were either priced lower or higher to enable money laundering.
  • With current technology, the Organization for Economic Cooperation and Development (OECD) says it’s easy to modify invoices or produce fictitious invoices.
• Money Transfers To Benami Entities:
  • In a Benami transaction, property is transferred or held by one person and the consideration for such property is paid by another person for whose benefit such property is held.
  • Loss of Revenue:
    • Black money eats up a part of the tax and, thus, the government’s deficit increases.
    • The government has to balance this deficit by increasing taxes, decreasing subsidies and increasing borrowings.
    • Borrowing leads to a further increase in the government’s debt due to the interest burden. If the government is unable to balance the deficit, it has to decrease spending, which affects development.
  • Money Circulation:
    • People generally tend to keep black money in the form of gold, immovable property and other secret manners.
    • Such money does not become part of the main economy and, therefore, remains generally out of circulation.
    • The black money keeps circulating among the wealthy and creates more opportunities for them.
  • Higher Inflation:
    • The infusion of unaccounted black money in the economy leads to higher inflation, which obviously hits the poor the most.
    • It also increases the disparity between the rich and the poor.

Impacts

• Government’s Initiatives:
  • Legislative Action:
    • The Fugitive Economic Offenders Act, 2018
    • The Central Goods and Services Tax Act, 2017
    • The Benami Transactions (Prohibition) Amendment Act, 2016
    • The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015
    • Prevention of Money Laundering Act, 2002
    • Gold Amnesty scheme: This is similar to the Voluntary Income Disclosure scheme to tap black money in income taxes.
  • International Cooperation:
    • Double Taxation Avoidance Agreements (DTAAs):
      • India is proactively engaging with foreign governments with a view to facilitate and enhance the exchange of information under Double Taxation Avoidance Agreements (DTAAs)/Tax Information Exchange Agreements (TIEAs)/Multilateral Conventions.
    • Automatic Exchange of Information:
      • India has been a leading force in the efforts to forge a multilateral regime for proactive sharing of financial information known as Automatic Exchange of Information which will greatly assist the global efforts to combat tax evasion.
      • The Automatic Exchange of Information based on the Common Reporting Standard commenced in 2017 enabling India to receive financial account information of Indian residents in other countries.
    • Foreign Account Tax Compliance Act of USA:
      • India has entered into an information-sharing agreement with the USA under the act.
    • Financial Action Task Force (FATF):
      • India is a member of the FATF.