Money laundering

Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Beyond NCERT

Meaning

Money laundering means hiding where illegally earned money came from, by passing it through deals that look legitimate, so that it finally appears to be "clean" money.

It matters because it lets criminals, corrupt officials and tax evaders use and enjoy their illegal gains openly. It also feeds black money, terror financing and the loss of tax revenue. This is why India has a separate law, a separate enforcement agency and a global watchdog (FATF) against it.

Explanation

How it works: the three stages

Money laundering moves in a fixed order: Placement → Layering → Integration.

Stage	What happens	Example
1. Placement	Dirty cash is put into the financial system (banks and other formal channels)	Many small cash deposits into different bank accounts
2. Layering	The money is moved through many transactions so the trail is hard to follow	Transfers between shell companies, fake invoices, deals across borders
3. Integration	The money comes back looking "clean"	Buying property, or showing the money as a "loan" or "business profit"

• Placement is the riskiest step for the launderer. Cash entering a bank leaves a record, and a record can be traced.
• Layering is the heart of the process. Each extra transfer adds one more link, so investigators need more time to follow the money.
• Integration completes the process. The money can now be spent openly, and it looks like normal income.

Worked example (no new rates, just the flow):

• A trader earns ₹50 lakh but reports only ₹30 lakh. The hidden ₹20 lakh is black money.
• Placement: the trader deposits the ₹20 lakh in small amounts into several accounts.
• Layering: the money moves through a few shell companies against fake invoices for "services" that were never given.
• Integration: a shell company gives the trader the ₹20 lakh back as a "loan". The trader then buys a flat with it. On paper, the flat was bought with borrowed money, not with hidden income.

The main tools launderers use

• Shell companies: a shell company is a company with no real business, no real operations and no real assets.
• Launderers use them mainly for layering.

• They also use them for tax evasion and for hiding the real owner.

• Hawala: an informal system that moves money through a network of trusted brokers (hawaladars).

• Broker A in Dubai takes money from a sender and calls broker B in India.
• Broker B pays the receiver from B's own cash.
• The two brokers settle between themselves later.

• No money physically crosses the border, and there are no formal records.

• Fake invoices and cross-border deals: these create false paper reasons for moving money.

• Real estate and benami holdings: a benami holding is property kept in one person's name while another person paid for it. Both are common ways to "park" the cleaned money at the integration stage.

What makes laundering rise or fall

• It rises when:
• lots of cash is used in the economy, so placement is easy;
• companies can be set up without saying who really owns them;

• informal channels like hawala work without any check.

• It falls when:

• banks must report suspicious transactions;
• companies must disclose their beneficial owner (the real person who finally owns or controls the company, not just the names on paper);
• inactive and fake companies are struck off;
• countries share information and follow common global standards (FATF).

In India

The law

• PMLA (Prevention of Money Laundering Act) 2002 is the main law against money laundering.
• Scheduled offence: a crime listed under PMLA. If someone commits a scheduled offence, the laundering of its proceeds can be pursued under PMLA.
• Wilful evasion of tax on foreign assets under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 is a scheduled offence under PMLA. So the ED can also act on it [1].

The institutions

• Enforcement Directorate (ED): enforces PMLA. It can attach property (legally stop the owner from selling or using it) and prosecute (take the case to court).
• FIU-IND (Financial Intelligence Unit-India): receives and analyses suspicious transaction reports from banks and other reporting entities, then passes leads to the agencies.
• Hawala is an offence under both FEMA and PMLA.

Action against shell companies (Ministry of Corporate Affairs, from 2017)

• In FY 2017-18, Registrars of Companies struck off 2,26,166 companies under Section 248 of the Companies Act, 2013. These companies had not filed financial statements or annual returns for two or more years in a row [5].
• 3,82,581 companies were struck off over the three years up to 2020 [6].
• 2,38,223 companies were identified as shell companies between 2018 and 2021 [7].
• Other steps included freezing bank accounts and using the Benami Act against deviant shell companies [2].

FATF (Financial Action Task Force)

• FATF is the global body that sets standards against money laundering and terror financing. India has been a member since 2010.
• 2024 mutual evaluation (a peer review in which other members check a country's system):
• India's report was adopted at the FATF plenary in Singapore, 26–28 June 2024.
• India was placed in "regular follow-up", the best category. Only four other G20 countries share this status [3].
• India will report back to the plenary after three years [3].
• Strengths: high technical compliance, good use of financial intelligence, and taking assets away from criminals [4].
• Gaps to fix: faster prosecution of money-laundering and terror-financing cases, protecting non-profits from misuse by terrorists, and better supervision [4].

Don't confuse with

• Black money: this is the stock of income or wealth hidden from the tax authorities. It can come from a legal activity where tax was not paid, or from an illegal activity. Money laundering is the process of making illegal money look clean. Black money is often the input, and laundering is what is done to it.
• Tax evasion: this means breaking the law to hide income or tax, for example with fake invoices or false account books. It creates hidden money. Laundering disguises the source of illegal money so it can be used openly.
• Tax avoidance: this means using loopholes in the law to pay less tax. It is legal in form but against the spirit of the law, and GAAR is the answer to it. Laundering is always illegal, and PMLA is the answer to it.
• Hawala: this is one channel for moving money without records. It is a tool that can be used for laundering, but it is not the same thing as the whole three-stage laundering process.

Prelims Hooks

• Stages in order: Placement → Layering → Integration. Shell companies mainly serve the layering stage.
• Institution pairs: PMLA 2002 → enforced by ED; suspicious transaction reports → go to FIU-IND; hawala → offence under FEMA + PMLA.
• Black Money Act 2015: wilful evasion of tax on foreign assets is a scheduled offence under PMLA, so the ED can act on it [1].
• FATF: India a member since 2010. In its June 2024 evaluation (Singapore plenary), India was put in "regular follow-up", the best category, shared with only four other G20 countries [3].
• Shell-company strike-off: done under Section 248 of the Companies Act, 2013. In FY 2017-18, 2,26,166 companies were struck off [5].
• Trap: "In hawala, money physically crosses the border." This is false. No money crosses the border, and there are no formal records.

Mains Points

• Laws exist, but enforcement decides the outcome: India has PMLA, the Black Money Act, the Benami Act and company-law strike-offs. Yet FATF's main gap for India is slow prosecution [4]. Faster trials and better conviction rates matter more than adding new laws.
• Laundering needs many agencies working together: tax law (Black Money Act, Benami Act), criminal law (PMLA/ED), company law (striking off shell companies, beneficial-ownership disclosure), financial intelligence (FIU-IND) and global cooperation (FATF, information exchange) must work as one chain. A weak link at any stage (placement, layering or integration) lets money through.
• Anti-laundering action vs ease of doing business and civil society: strict checks on companies and non-profits protect the system. But too much supervision can burden genuine firms and NGOs. FATF itself asks India to protect non-profits from misuse by terrorists [4], and this has to be done without harming the genuine ones.

Related concepts

• Tax avoidance and tax evasion
• General Anti-Avoidance Rule
• Tax compliance
• Black money
• Hawala
• Shell company
• Benami transaction

Read more

• Tax avoidance, evasion and black money