Regulatory oversight allowed illicit money transactions in our financial markets.
The Writ Petition filed by the NDA Government in mid-October consists of two parts. The first part deals with the issue of Double Taxation Avoidance Agreement [DTAA], the information obtained from Liechtenstein through Germany and confidentiality obligations of Indian Government under the said DTAA.
I had dealt extensively on this issue in my article titled “Black Money Issue degenerating into a farce?”
The second part relates to the proposed Inter Governmental Agreement [IGA] with USA. Under the proposed agreement, “information” provided by financial institutions in India will be automatically transmitted to USA with reciprocal obligations for financial institutions in USA to transmit “information” to India.
Now, two questions arise: what constitutes “information” and two, why should such information exchanged be treated as “confidential.” First, let me address the second question. The Writ Petition rightly points out that the IGA mandates that all information exchanged between India and US to be subjected to confidentiality clause of Indo-US DTAA.
Thus the information to be received under the IGA would be dealt as a tax issue, to be dealt with tax laws and tax authorities. Importantly, any breach of confidentiality thereof would violate the provisions of the DTAA and hence the proposed IGA.
It is precisely under these circumstances that the NDA Government approached the Hon’ble Supreme Court seeking clarification whether the Union Government could enter into the proposed IGA with commitment to treat information so received as confidential in light of its earlier order that allowed such information to be made public.
FATCA and its Adverse Implications
Now to the first question that remains unanswered – what constitutes “information” that is sought to be exchanged between the two countries? The answer to this question lies in understanding the imperial demands of the US Law – Foreign Account and Tax Compliance Act [FATCA].
This Law focuses on reporting (i) by the US tax payers on certain foreign financial accounts and offshore assets and (ii) by the foreign financial institutions about accounts held by US taxpayers or foreign entities in which US Taxpayers hold substantial ownership interest.
Therefore, FATCA enables the US revenue authorities to go after US [not Indian] tax cheats not only within US but world over by receiving information from financial institutions across continents. The manner of securing this information is codified thorough IGA as mentioned above.
FATCA also provides the penalty for non-cooperation with US revenue authorities. Accordingly, foreign institutions located outside of USA that do not register and report on information sought face a possible thirty percent withholding tax on certain US source payments made to them or their clients.
No wonder, it is a fact that several countries are queuing to sign the IGA with the US. It is in this context India too is preparing to sign this IGA with US by December 2014. Ostensibly, through the IGA, India seeks to establish a global standard on automatic information exchange that enables her tax authorities to go after tax cheats who park their ill-gotten wealth in tax havens.
But will FATCA read with IGA help us?
From a plain reading of FATCA it is obvious that a majority of Indian tax evaders would have nothing to do with FATCA or for that matter IGA with US. But there is different set of discomfort arising out of this arrangement. FATCA, it may be recalled, requires Indian financial institutions to report to US authorities on details of accounts / assets owned by US citizens or entities in which US citizens hold substantial interest.
This is bound to open the Pandora’s Box in India. For nearly a decade the Manmohan-Chidambaram-Ahluwalia triumvirate have allowed our financial markets to function through a combination of lax regulatory mechanisms and ensuring secrecy on ownership of entities.
This laxity in regulatory oversight in turn allowed dirty-illicit money to enter and exit our financial markets without let or fear of the long arm of the law ever catching them and in a way converted India – yes India – into a mini Switzerland where laundering of illicit wealth could be done with relative ease and possibly with the connivance of the authorities and regulators in India.
Let me amplify. The last decade of India under UPA has seen a proliferation of private banks, aviation, software and consulting companies amongst others. Crucially, these organisations have grown enormously in size and have significant market share and employ large number of people.
Inexplicably, our regulators have often turned a Nelson’s eye to inconvenient questions about ownership of such companies.
Consequently, we are unaware of the beneficial ownership of several corporates which typical of such cases are multi-layered and located in several exotic locations and operated through complex financial instruments across continents which make it impossible to untie and knot and zero in on the ultimate owner.
Consequently, one wonders how India, given her track-record, will provide details about ownership to the US under the proposed IGA!
Another instrument peculiar to Indian financial system is the Participatory Notes [PNs]. Readers may be aware that PNs are derivative instruments issued by FIIs to foreign investors [and note this is not issued to Indian investors under any circumstances] who want to invest in Indian equities, but do not want to register with stock market regulator, Sebi.
Thus, PNs are a contract between a foreign institution and a foreigner outside India to invest into Indian stock markets. Needless to emphasize, the underlying securities of PNs are Indian stocks. But the moot question remains – are the ownership of these PNs really vested with foreigners or could they possibly lie with Indians.
Further, in contrast to the stringent Know Your Customer [KYC] norms laid out for Indians even for opening a bank account, the concomitant norms for PNs are loosely defined by Sebi. Moreover, most of these FIIs operate from the cosy confines of Tax Havens where minor irritants like KYC norms are either absent or are applicable in diluted form.
So a loosely defined Sebi regulation in India coupled with lax norms in tax havens make it a deadly combination for those who generate illicit income in India, take it outside India through the Hawala route and re-route it back to India as PNs or foreign investments.
Given this factual position, experts have been of the view that the PNs [which are issued to entities whose ownership are multi-layered] could be ultimately owned by Indians with their illicit money and not by foreigners as the Sebi regulation mandate.
What if narco-terror money generated within India and taken out of India through the Hawala route re-enters the Indian financial system as PNs? Given the fact that there is no reported case of any direct intervention by our regulators in such scenario for the past decade or so, are we to conclude there is no illicit money generated in India, taken outside India through the Hawala route and brought back into India, PNs or no PNs? Questions that beg for an answer.
It may not be out of place to mention that courts in India have held that Sebi has not prescribed KYC norms to FIIs in the first place for Sebi to demand ownership details of such PNs! Where is the question of adhering to a norm when the norm is absent in the first place? And that is the crux of the issue.
The net result: Indian regulators do not know the names of such investors, or the origin or sources of such funds. Crucially, they can do precious little. No wonder, PNs are referred to also as Phantom Notes.
Now coming back to FATCA what will we tell the US authorities on the ultimate ownership details of PNs or of large corporates and Banks that dominate our financial sector landscape when we ourselves do not know of the same? How do we know that they are not owned by Americans, especially in case where ownership is multi-layered? And should our regulators know of the same, why are they not revealed to ordinary Indians but only to Americans?
Importantly, if the Indian regulators know of the ultimate ownership of these PNs or corporates [and given the fact that any investment arising from Tax Haven is prima facie suspect] what action have they taken on such dubious investment and investors for the past decade or so? In case they belong to neither India not America have we ever passed details to a third country?
Americans, let us not forget, have prepared themselves diligently by chronicling enormous details of their tax cheats. FATCA and IGA are last steps in their operation. While we rush headlong to sign the IGA, we must realise providing details to US Tax authorities about American tax cheats who have invested in India is not going to help us one wee bit in our war against black money.
On the contrary, do we realise we have not yet begun the war on our illicit wealth parked in tax havens, FATCA, IGA and DTAA notwithstanding?
PS: In a country where money laundering of 2G case allegedly occurred in 2007-08 and comes for charge sheet in 2014, what tangible action do we expect even if US provide us some reciprocal information under IGA?