MONEY LAUNDERING, money laundering process

 

MONEY LAUNDERING:

The process of making huge amounts of money generated by criminal activity – such as drug trafficking, terrorist funding, corruption, etc – appear as if it is generated from a legitimate source.

HOW MONEY LAUNDERING GOT THE NAME MONEY LAUNDERING:

• The process of money laundering is not new to the people as its a common tendency of people to hide money earned from illegitimate sources .
• But the term money laundering got its name "Money laundering" because of drug dealer Al Capone.
• Al-Capone in early 20th century used to invest the illegal money in  buying the laundries in cash invisible. 
• These laundries became the front for investment of his money earned from illegal activities.
•  And it was because of the investment of this illegal money by al Capino in laundries ,the process got its name "Money laundering" as if the dirty money was cleaned by the process of investment in Laundries.

The basic money laundering process has three steps:

Placement: 

• This is the first step of money laundering in which dirty money is initiated to get legitimate.
• In this, the launderer deposits the dirty money into a legitimate financial institution.
• This process of depositing the money is a repeated process and deposits are in the form of cash
• This is the most dangerous stage of the laundering process as large amounts of cash are visible
• The role of banks is very crucial in this stage as banks must be cautious of such high value cash transactions and report high-value transactions.

Layering: 

• This process is to change the form of deposited money in the first stage .
• Deposited Money is transacted through various financial instruments to change its form and make it difficult to track.
• Layering can include several bank-to-bank transfers, wire transfers between different accounts in different names in different countries
• These deposits and withdrawals at this stage constantly vary in terms of amount, currency of the money in an order to manipulate the system.
• This is the most complicated step in any laundering scheme, and it makes original dirty money as difficult to track it .

Integration: 

• This is the final stage of making dirty money to clean money.
• At this stage, the money appears to come from a legal transaction and enters the mainstream economy.
• The money finally is used for entering into mainstream economy by getting invested in any economic activity.
• This stage makes the illegal money the legal money as it is now part of mainstream Economy.
• The preferred economic activities where this money is invested are restaurants, nightclubs, charity trusts casinos art or jewelry etc .

Place of Effective Management (PoEM) ,PATENT BOX REGIME

 

Taxation of MNC's is very contentious issue . Residential status of a company is crucial in deciding of tax rates. Place of Effective Management (PoEM) is one such arrangement which defines the residential status of a company and thus taxability of a company .

Place of Effective Management (PoEM) : 

• Place of Effective Management (PoEM) is an internationally recognized test for determining the residential status of a company incorporated in foreign jurisdiction. 
• This concept is crucial for all the tax treaties entered into by India as it helps to implication of taxes on companies.

INDIA AND Place of Effective Management (PoEM):  

• Under Income Tax Act, 1961, it is very important to determine the residential status of any person as it helps in determining the scope of taxable income in India.
•  Until 2015, the concept of determination of residential status of foreign companies was very simplified and a company was considered as Indian resident if:

• It is incorporated in India; or 
• Its control and management is situated wholly in India. 
• Therefore, most of the companies used these simplified provisions as a loophole to prevent residential status in India by shifting insignificant or isolated events related to control and management outside India in tax havens.
• The objective of shifting residential status to outside India is merely to reduce tax liablity as Corporate tax in India is one of the highest rates in comparison to Tax havens.

NEED OF REVISITING THE DEFINITION OF Place of Effective Management (PoEM) : 

• The existing definition of Place of Effective Management (PoEM) was manipulated by companies.
• Companies having shell companies in tax havens have structured their operations in such a manner that  companies were present or active in a country without paying applicable taxes. 
• Company were having key managerial people stationed in India with substantial asset base and operations  in India but selling goods through a subsidiary in Tax haven.
• As per the definition of Place of Effective Management (PoEM) , companies claimed that it has no effective management in India and hence, it could end up paying very little tax.

REVISED DEFINITION OF Place of Effective Management (PoEM) :

The Finance Act, 2015 introduced the concept of Place of Effective Management (POEM) while determining residential status of companies in India and as per amended provisions, a company is considered as resident if:

• It is an Indian Company; or 
• Its place of effective Management in that year is in India

• So at present, if any company is having management and operations in India, along with shell company outside India (just to evade taxes), then as per Place of Effective Management (PoEM), company will be treated as resident of India and hence will be taxed as per tax laws of India.
• It will not be in a position of taking the tax benefits merely by having shell company in tax haven.

 

PATENT BOX REGIME:

• Patent Box regime was introduced in India by Finance Act, 2016 by enacting new Section 115BBF. 
• This box is applicable for all patents registered after April 1, 2016. 
• Under Patent Box regime, any company has to pay 10% tax on total income earned by the   commercialization of patents which are developed and registered in India. 
• The condition is that such patent must have been developed and registered in India under Patents Act, 1970.

NEED OF PATENT BOX REGIME:

• This is a concessional tax regime because otherwise, the 30% Income tax was applicable to income from patents/ royalty / intellectual property in the country. 
• In view of the high tax rates, companies register patent in tax havens.
• Thus the countries where these patents were developed were not benefitted by the patent development, even if the patent were developed in their country.
• Thus, with a view to retain the intellectual property in the country where it was developed and to promote innovation and research, many countries started to introduce beneficial taxation regime for income generated from such Intellectual Property. 

TAXATION, CANONS OF TAXATION,TAX IMPACT,TAX INCIDENCE,TAX SHIFTING,DIRECT TAX,INDIRECT TAX

 

Funds are required by the government to carry out their functions ie developmental as well as day to day functions. Taxation provides funds for carrying out such functions.

TAXATION:

• Taxation is a legal compulsory payment by the citizens to the government.
• There is no quid pro quo relationship between a taxpayer and the collecting authority.
• Taxpayer can neither claim any specific benefit against paid taxes nor it can ask its taxes back if desired services are not provided by the government.

CANONS OF TAXATION:

The most fundamental classification of taxes is based on who collects the taxes from the tax payer.

As Per Adam smith, Taxation should follow the following canon of taxation :

• Canon of ability :taxes should be paid as per the ability .
• Canon of certainty :rate of taxes should be clear with out any ambiguity .
• Canon of convenience :The tax collection method should be convenient so that people can pay taxes easily.
• Canon of economy: Government should impose only those taxes whose collection costs are very less and cheap as there are collection costs undertaken by the government.

Anecdotes related to Taxation: 

In Mahabharat:

Krishna started his campaign against kansa by not paying Income tax imposed by Kansa and krishna argued that kansa has abdicated his responsibility as a king so people should not pay the taxes.

In Ramayana:

• Shri Rama pointed out that it was necessary to collect tax from the subjects.
• But the tax should be taken by a king in the same way as the sun absorbed water from the earth.
• In reservoirs and rivers, where there was more water, it took more; from the land where there was less water, it took little. 
• In the same way it was   also the duty of the ruler to make it clear that the tax collected from the rich people of the state should be distributed equally for the works in the larger interest of the people.

TAX IMPACT:

• The term Tax impact is used to express the immediate result of imposition of  the tax.
• The impact of a tax is on the person on whom it is imposed first.
• Thus, the person who is liable to pay the tax to the government bears its impact.

TAX INCIDENCE:

Tax incidence is liability of the tax payment on the man’ who ultimately bears the

burden of the tax.

TAX IMPACT vs TAX INCDENCE:

• Tax Impact refers to the initial burden of the tax, while Tax incidence refers to the ultimate burden of the tax.
• Tax Impact is at the point of imposition while incidence occurs at the point of settlement.
• Tax impact of a tax falls upon the person from whom the tax is collected and the incidence rests on the person who pays it eventually.
• Tax Impact may be shifted but Tax Incidence cannot be shifted.

TAX SHIFTING:

• Tax Shifting is passing of the tax from the one who first pays it to the one who finally bears it.
• It is through this process of Tax Shifting that the impact of a tax is transformed to Tax incidence.
• Tax Incidence is the end of the shifting process.
• Direct tax are example where Tax impact and Tax incidence are borne by the same person

                                                        while

• In case of indirect taxes, Tax impact and Tax incidence are borne by different person through the process of Tax shifting.

TYPES OF TAXATION:

Taxation can be in the form of: Direct Tax and Indirect tax.

DIRECT TAX:

• Direct Tax is a tax that is paid directly by an individual or organization to the imposing entity .
• There is no Tax Shifting as tax impact and tax incidence is on the same person.
• A taxpayer pays direct tax to the government for different purposes.
• Tax payment cannot be shifted to another individual or entity.
• Direct taxes include income tax, Property tax, capital gains tax, Direct Dividend Tax, corporate tax etc.
• Income tax is the most popular direct tax.

IMPLICATIONS OF HIGHER DIRECT TAXATION:

• Direct tax collection accounted for 55% in FY 2022-23 which was 4 year high .
• A higher direct tax to indirect tax is considered as progressive in the sense that indirect taxation hurts the poor more intensely.

INDIRECT TAX: 

• Those taxes which are not directly levied on the Income of an Individual.
• This tax is indirectly levied on the Expenses incurred by the Individual.
• This tax is basically levied on the seller of goods but finally it is being paid by the end consumer.
• Examples: GST, custom duty

Global Minimum Tax,Base Erosion and Profit Shifting (BEPS),2 pillar approach in BEPS, INDIA AND BEPS, Digital Tax /GOOGLE TAX OR EQUALISATION TAX:

MNC's across the world are using multiple loopholes in the existing taxation laws of different countries  to evade taxes or paying of less taxes .Governments across the world are concerned about this trend and are aggressively trying to deal with this menace. Global Minimum Tax and Base erosion and profit shifting (BEPS) are such arrangements 

BACKGROUND OF BEPS:

• Large MNC’s have traditionally paid taxes in their home countries or in Tax Havens even though they did most of their business in foreign countries. 
• The countries of consumer base where these MNC’s carry out their business are at loss. 
• Corporate tax rates throughout the world are dropping over the last few decades as a result of competition between governments to promote private investments. 
• Global corporate tax rates have fallen from over 40% in the 1980s to under 25% in 2020 and even to the level of zero in tax havens ending up to “race to the bottom”.

In view of the above,it is evident that countries where MNC's carry out their operations are losing their revenues.To deal with this situations, efforts are undertaken at international level to root out this menace.

Global Minimum Tax: 

• The Global Minimum Tax is designed to tackle the problem of tax losses to the countries affected by profit shifting. 
• Various methods are adopted under the guise of Global Minimum Tax:
• Profit shifting by companies is reduced boosting the government revenue and reducing the wasteful use of resources for tax planning.
• Tax payments are increased from firms that shift profits to low-tax environments from the country of their origin.
• The focus is on reducing the international tax competition amongst the countries to reduce the taxation on MNC's so that countries are motivated to tax multinational profits at higher rates.

Base Erosion in BEPS:

• Company needs to pay tax for the incomes or profits they earn.
• MNCs used sophisticated tax planning practices to avoid tax payments by shifting their incomes to other countries, especially to tax havens (via shell companies) or deducting large interest payments, overhead expenses.
• These practices of shifting the companies to tax Havens erodes the tax base ie the income which is the basis of taxes to be paid, is said to be Base Erosion.

Profit Shifting in Base erosion and profit shifting (BEPS) :

• Tax is levied as a percentage on the income of the company.
• Once the company is shifted to another country or tax haven (s), the tax base is eroded, and  hence the incomes or profits of companies are also shifted to tax havens .
• Tax is not paid to the country of operation rather to the tax havens.

Base erosion and profit shifting (BEPS) : 

Base erosion and profit shifting (BEPS) can be understood from two perspectives:

1. One is common practices adopted by MNC’s that exploit gaps and mismatches in tax rules to avoid paying tax.
2. Other is strategies adopted by countries across the world to check the evasion of Taxes by MNC's.

In October 2021, a historic two-pillar international agreement Base erosion and profit shifting  2.0 was reached among 137 countries of the OECD/G20.

Base erosion and profit shifting (BEPS) has two pillars :

PILLAR 1 (MINIMUM TAX AND SUBJECT TO TAX RULES):

• Governments can fix local corporate tax rate to attract MNC's, but if companies pay lower rates in a particular country, their home governments could “top up” their taxes to the 15% minimum.
• This minimum taxation is to neutralize  the advantage of shifting profits and hence demotivate companies to shifting their offices to Tax Havens.

PILLAR 2 (REALLOCATION OF AN ADDITIONAL SHARE OF PROFIT TO THE MARKET JURISDICTIONS):

• Portion of MNEs’ profits (25% of the largest multinationals’ so-called excess profit) is allocated to the market or destination countries .
• Destination countries are based on where consumers or users are located, rather than solely on physical presence.
• By doing this, countries which are giving incomes to the MNC's will be benefited.

INDIA AND BEPS :

India is actively participating in the implementation of Base erosion and profit shifting (BEPS).In 2016, India adopted Equalisation levy .

Digital Tax /GOOGLE TAX OR EQUALISATION TAX: 

• Equalisation levy, introduced in 2016, is a unilateral amendment to the domestic tax provisions to implement  BEPS Action Plan 1. 
• Equalisation levy was introduced in India  to tax the digital Economy.
• Equalisation levy was levied at 6% of the total business transactions done for online and digital advertisements.
• Equalisation levy is applicable to B2B services and goods only and NOT on B2C {Business to Consumer} goods and services. 
•  The tax is applicable to only those companies which have no permanent physical establishment in India.  
• Its scope was widened in 2020 and it was  levied at 2% on the consideration amount paid to non-residents who own, operate or manage an e-commerce facility or platform. 

Once India implements the two-pillar tax package, it will have to withdraw the equalisation levy (EL), which earned the government a revenue of about Rs 5,000 crore in 2022-23,”

SPECIFIC ANTI AVOIDANCE RULE (SAAR),GENERAL ANTI AVOIDANCE RULE (GAAR),

 

To deal with the issues of Tax evasion by MNC's, various methodologies were adopted by Governments across the world .Various anti avoidance rules were implemented by  the Government of India to check the Tax avoidance. Specific Anti Avoidance Rule (SAAR), General Anti Avoidance Rule (GAAR), Arm Length Pricing, Advance Pricing Agreement and Safe Harbor were such prominent methodologies  to deal with Tax Avoidance.

SPECIFIC ANTI AVOIDANCE RULE (SAAR):

• Anti avoidance rules are basically divided into two categories—General and specific.
• Specific Anti Avoidance Rule (SAAR) was operational before General Anti Avoidance Rule  (GAAR).
• General Anti Avoidance Rule (GAAR) refers to legislation dealing with “general” rules, while Specific Anti Avoidance Rule (SAAR) refers to legislation dealing “specific” avoidance. 
• The prevailing law deals with instances of specific tax abuse and the general tax avoidance is addressed by judicial doctrine.
• Specific Anti Avoidance Rule (SAAR ) provides for a set of rules which target specific ‘known’ arrangements of tax avoidance. 
• They specifically lay down the conditions where they may be invoked.

GENERAL ANTI AVOIDANCE RULE (GAAR):

• General Anti Avoidance Rule (GAAR) is an umbrella tool for checking aggressive tax planning especially those business transactions which are entered into with the objective of avoiding tax. 
• The General Anti Avoidance Rule  (GAAR) itself is an unconventional type of tax legislation; bringing tax avoidance under the scrutiny of tax officials.
•  It has been introduced in India due to VODAFONE case ruling by the Supreme Court. 
• General Anti Avoidance Rule  (GAAR) has been implemented from 1^st of April 2017 on the recommendation of Shome committee.

ISSUES WITH GENERAL ANTI AVOIDANCE RULE (GAAR):

• The concern is about the arbitrary usage of the powers that the officers might have under General Anti Avoidance Rule  (GAAR) 
• The line of difference between an objectionable and a permissible avoidance is very thin.
•  There is also another fear that tax officers can harass people using this law.