Bogus economics: Black money, real estate and tax havens

Buying property in India can be tricky. Speaking to a buyer, who went to negotiate for a farmland in Chhatarpur on the outer edge of the capital New Delhi, exposed the underbelly of India's black economy. He was asked to pay only 10% in white (legal money) and the rest in black (illegal money). After explaining that all his money was white, he was told he would need to pay a fee to get his white money converted to black.

I met another landlord who had just lost his property to government acquisition. He complained that he received much less money than his property was worth. The rule is you can ask for more money if you show that comparable properties were sold above the circle rate, the figure the government uses to curb tax evasion. But often people pay taxes only based on the circle rate. This enables property value inflation and allows black money to enter the property market.

The Central Bureau of Investigation's raid on the homes of Sukh Ram, India's former Telecom Minister, after he was caught in the web of bribery charges and telecom scam shows what unaccounted for corruption money floating in the market looks like. The raid recovered actual bags of cash, jewellery, keys to five bank lockers, records of 19 bank accounts, and property documents of houses he owned in India.

India's property bubble

Sellers demand that 30 to 50% of the property's price be paid in cash. This practice is prevalent in India. Investing undeclared wealth in housing via illicit transactions and lax regulations is considered the safest way to conceal black money.

The flow of black money through land transactions has been widely discussed by investors, tax officials and bankers. Liases Foras Real Estate Rating and Research Private Limited reported that in 2012, about 30% of total transactions in real estate investment were conducted through black money.

In an attempt to regulate the real estate sector, Arun Jaitley, India's Finance Minister, proposed that immovable property worth Rs 20,000 or more cannot be proceeded through a cash transaction. The Finance Bill sought to curb the inflow of black money. Jaitley said, "For any transaction of property valued more than Rs 1 lakh, it would be mandatory to provide details of Permanent Account Number (PAN)". He also proposed that the law should enable the government to confiscate benami property (deals where the identity of the true buyer or seller is concealed), as black money is generated here too.

Tax havens

Tax avoidance is not the same as tax evasion. The former openly takes advantage of legal loopholes to minimise tax burden, the latter deliberately breaks them altogether. They may both be unethical, to varying extents, but only the second is illegal.

In a typical tax haven scheme, a business registers an offshore subsidiary in, say, the Cayman Islands, even though they don't do any actual business there. A paper connection enables the parent company to claim its profits in the subsidiary's home country, where corporates taxes are much lower or non-existent. This isn't always fraud! Depending on whether funds are shuffled or concealed, the paperwork trick may be legal. But it's certainly a misrepresentation of reality. That it's not technically illegal is the problem. The tax system can't possibly carry out its primary function if those with the most money evade their responsibilities. Also, the reality is that sooner or later black money will end up in tax havens if it isn't invested in the property market.

Privacy laws make it difficult to access company books, but to put the colossal scale of this tax sidestepping in perspective, it's reported that Canadian corporations have $200 billion in tax havens, while Indian and American companies have $2 trillion and $2.1 trillion, respectively. If the situation wasn't so harmful it would be comical: the Cayman Islands have more registered businesses than people, with about 100,000 registered businesses to only 60,413, people.

Reluctance to uproot black money

Even when detailed evidence of egregious economical malfeasance is presented on a silver platter, private banks and even governments fail to take action. Banks and politicians are often active participants in the criminal activity, and would do anything but enforce the laws they are breaking. Hervé Falciani's case demonstrates this perfectly. Falciani worked in the Swiss arm of the private bank HSBC. When he noticed highly irregular economic activity he reported it. HSBC did nothing, so he compiled evidence on his own. After two years, he had a list of 130,000 clients (628 from India) from over 200 countries who had potentially engaged in tax fraud. He handed the evidence to French investigators. In response, the Swiss government tried to prosecute him rather than the bank. They attempted to charge Falciani with aggravated industrial espionage, data theft and violation of commercial and banking secrecy, requesting a six-year jail term.

The investigation showed that HSBC deliberately colluded with clients to evade taxes, and even turned a blind eye to the illegal actions of arms dealers. As a result of Falciani's evidence, HSBC was fined 28 million pounds by the Swiss authorities on grounds that "organisational deficiencies" allowed money laundering to take place. Billions of dollars have now been returned to various European countries. But Britain has prosecuted only one of 7,000 British clients on the list, while the man in charge of HSBC at the time, Stephen Green, was knighted and he served as Britain's minister of trade and investment until 2013.

Moving forward

Like many before it, the present Indian government has promised tangible action against black money, but has done little. For starters, it needs to locate the money tucked away, both in India and overseas. Bringing back the black money from abroad would be popular, but concrete steps need to be taken here regarding real assessment of properties at the micro level. For that, corruption must be weeded out. That also is completely based on the black economy. This is a tall order.