Illegal remittances

Dr Bharat Jhunjhunwala
Narendra Modi has promised to bring back black money deposited by Indian nations in foreign countries. Most welcome! But let this noble resolve not distract from the bigger problem of illegal remittances by big companies, MNCs in particular.
There are three components of illegal remittances. First component is corruption. Politicians and bureaucrats stash their ill-gotten incomes in foreign countries so that it remains outside the reach of the Government of India. Second component is tax evasion. Income from property deals or from sales of goods in No 2 is sent abroad for safe keeping. The focus of present Government is on these two sources of remittances. The third component is more sinister. Money is remitted illegally by manipulating the price at which MNCs transfer goods from their sister concerns in other countries. MNCs buy goods from their sister concerns in foreign countries. They pay more for imports than the actual price. For example a MNC may buy goods worth Rs 1,000 from its sister concern in the Bahamas but pay Rs 2,000. India Rs 1000 transferred illegally in this way. Profits of the India arm of the MNC decrease and the Government is deprived of Income Tax on this. Profits of the Bahamas arm of the MNC increase but the MNC does not have to pay much taxes because rates of income tax in that country are near zero.
The share of corruption in the total illegal remittance appears to be small. The United Nations has set up a panel on Illicit Financial Flows From Africa under the Chair of Thabo Mbeki, former President of South Africa. Mbeki said that two-thirds of these funds originate from MNCs. About one-third arise from criminal activities, including drugs and human trafficking. Only 5 percent are the result of corruption or bribery. Global Financial Integrity has similarly said: “In the cross-border flow of illicit money, we find that funds generated by this means are about 3 percent of the global total. Criminal proceeds generated through drug trafficking, racketeering, counterfeiting and more are about 30 to 35 percent of the total. The proceeds of commercial tax evasion, mainly through trade mispricing, are by far the largest component, at some 60 to 65 percent of the global total.”
The role of MNCs is these illegal remittances from India is confirmed by estimates of outflows. As Stated above the illegal remittance from India has increased more than ten times during the last decade. The coming of MNCs and outflows of illegal remittances increased together. There is a huge role of bad governance in this outflow. It reported that outflows from Mexico decreased after liberalization while those from India increased. This happens because bad governance in India makes it easy for MNCs to bleed the country.
Both Indian nationals and MNCs making illegal remittances often establish ‘shell’ companies in tax havens like the Bahamas. A company is registered there. Names of the owners, however, is kept confidential. The Government of India has no way of knowing that the Company is owned by you. You can remit money allegedly for purchase of software to this shell company. Then you can bring that same money back into India as FDI. MNCs also make such shell companies in countries that have low- or nil rates of taxes in order to avoid paying taxes.
The task before Modi will be to stem these continuing outflows-especially by MNCs. The amount ‘stashed’ by Indian nationals in foreign countries is relatively less as indicated by above estimates. I reckon the total money stashed over two or three decades would be less than the amount being illegally transferred by MNCs every year. In any event, it is much more difficult to identify and bring back the money that has already leaked. It is much easy to stem the outflow being engaged in on ongoing basis by MNCs today.
There are three steps that can be taken up directly by Modi to stem this outflow without requiring any cooperation by foreign Governments. One, MNCs operating in India can be required to disclose detailed Balance Sheets of all their sister concerns operating globally. This will make it possible for our Government to track whether money has been transferred out of India without any consideration. The payments made by the Indian arm of the MNC can be checked against the payments received by the foreign sister concerns. India can then claim taxes on the amounts transferred. Two, the Government can check the value of imports and exports against benchmark prices that are prevalent in the global market. That will expose if over-invoicing of imports and under-invoicing of exports is being indulged in. Three, it can be required that all foreign transactions above a threshold limit shall be reported to the Income Tax Department. Presently banks are routinely required to inform the Department of cash deposits in excess of Rs 50k. A similar provision can be made for reporting foreign transactions. This will enable the Department to track ‘habitual’ remitters of money. These steps can be taken by the new Government at its own initiative.
Two steps that are equally important would require cooperation of foreign Governments. The G-20 have agreed to share information regarding taxes paid by MNCs amongst themselves. India can push for similar bilateral agreements with G-20 as well as other countries so that it can be ascertained whether MNCs are avoiding taxes in India and paying tax at lesser rates that may be prevalent elsewhere. Second, India can push for bilateral- or global treaty to force the tax havens like the Bahamas to disclose the identity of owners of all companies registered in their country. India can push for inclusion of such a provision in the WTO also.
The major conflict here is with the infatuation with FDI. Let there be no doubt that FDI inflows will be hit as soon as the Government takes these steps. Therefore, stemming illegal remittances and attracting FDI simply cannot go together. Modi will have to choose one of the two. India received FDI of Rs 168k cores in 2013. The outward illegal remittances, on the other hand, were Rs 424k cores in 2011. It is obviously more profitable for us to stem the outflow of Rs 424 crores rather than to attract the FDI of Rs 168k crores. Modi need to internalize this.
The hype of bringing back black money stashed abroad is likely to backfire. It will be difficult to track this money, to prove it is illegal, and to bring it back. This will require the cooperation of foreign Governments who have no interest in returning these illegal deposits. It will be more effective to stop the illegal remittances being made by MNCs. Modi must focus here first.
(The author was formerly Professor of Economics at IIM Bengaluru)

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