Tax avoidance, evasion and black money

Detail

1. Three ways of dealing with tax: planning, avoidance, evasion

	Tax planning	Tax avoidance	Tax evasion
Meaning	Using tax reliefs the way the law intends	Using gaps (loopholes) in the law to pay less tax, against the spirit of the law	Breaking the law to hide income or tax
Legal?	Legal and accepted	Legal in form, but the state treats it as unfair	Illegal, a crime
Examples	Choosing between the old and new income-tax regime; investing in schemes that give a deduction	Routing money through a company in a low-tax country that does no real business	Hiding income, fake invoices, false account books
State response	None needed	Anti-avoidance rules (SAAR, GAAR)	Penalty, prosecution, search and seizure

• Simple test: planning follows both the words and the purpose of the law. Avoidance follows the words but defeats the purpose. Evasion breaks the words.
• Worked example (evasion): a trader earns ₹50 lakh but reports only ₹30 lakh.
• Hidden income = ₹20 lakh.
• At a 30% tax rate, the tax evaded = 30% × ₹20 lakh = ₹6 lakh.
• This ₹20 lakh becomes black money (see Section 4).

2. Anti-avoidance rules

(a) Specific Anti-Avoidance Rules (SAAR)

• These are rules that close one known trick at a time.
• Example: transfer-pricing rules. Two companies in the same group, for example a parent company and its branch abroad, must trade with each other at the arm's length price. This is the price two unrelated companies would agree on.
• Without this rule, a group could sell goods cheaply to its unit in a low-tax country.
• The profit would then show up abroad, and less tax would be paid in India.

(b) General Anti-Avoidance Rule (GAAR)

• GAAR is a broad power. It lets the tax department deny a tax benefit from any deal made mainly to save tax, even if no specific rule covers that deal.
• Where it sits in the law: Chapter X-A of the Income-tax Act, 1961 [2][3]. The Finance Act 2012 inserted this chapter [4].
• When it applies: from AY 2018-19, i.e. income of FY 2017-18 [2][5].

• AY (assessment year) is the year in which the income of the previous year (the financial year) is assessed and taxed.

• The delay: the Shome committee (2012) was an expert committee on GAAR. It recommended putting GAAR off. The government accepted its major recommendations in January 2013 [6].

• Threshold: GAAR applies only when the tax benefit from the arrangement is more than ₹3 crore [6]. This protects small taxpayers from harassment.
• What it targets: an "Impermissible Avoidance Arrangement" (IAA)
• Section 95 lets tax authorities declare a deal an IAA if its main purpose is to get a tax benefit [3].

• In addition, the deal must meet at least one of these tests:

  1. it lacks commercial substance (no real business reason, only paperwork);
  2. it is not at arm's length (terms that normal, unrelated parties would not agree to);
  3. it misuses or abuses the law;
  4. it is not done for genuine (bona fide) purposes.

• What happens if GAAR is applied: the department can ignore, combine or re-label (recharacterise) any step of the deal, or the whole deal, and then tax it as it really is [4].

• Safeguards for the taxpayer:
• The assessing officer must first issue a show-cause notice with reasons.
• The taxpayer gets a chance to prove the deal is not an IAA [6].

• If only one part of a deal is impermissible, GAAR applies only to that part [6].

• Worked example: a company sets up a firm in a low-tax country. The firm has no staff and no office. Its only role is to collect profits and save ₹5 crore in Indian tax.

• ₹5 crore is more than the ₹3 crore threshold, so GAAR can apply.
• The main purpose is a tax benefit, and there is no commercial substance.
• Result: the department ignores the foreign firm and taxes the profit in India.

3. Tax compliance

• Tax compliance is how far people and firms meet their tax duties: registering, filing returns, reporting income honestly and paying on time.
• NCERT view (Class 11, LPG chapter): high income-tax rates were "an important reason for tax evasion".
• Logic: high rate → hiding income pays off more → more evasion.

• Reform: after 1991, rates were lowered and procedures made simpler → honest reporting became cheaper → voluntary disclosure increased.

• Demonetisation (2016) and GST (2017): both are credited with widening the tax net, meaning more people came into the tax system.

• Cash deposited in banks left a record that could be traced.
• GST's input tax credit chain pushes buyers to deal with registered sellers. A buyer can claim credit only for tax paid on invoices that the seller has reported.
• The number of return filers grew.

• Debate: is this real formalisation (small firms truly joining the formal economy) or just more paperwork? Economists disagree.

• Other levers the government uses:

• Faceless assessment: cases are handed out randomly by computer, and the taxpayer never meets the officer. This cuts down on harassment and bribes.
• Wider TDS/TCS:
  • TDS (Tax Deducted at Source): the payer cuts tax before paying you, e.g. an employer cutting tax from salary.
  • TCS (Tax Collected at Source): the seller collects tax from the buyer at the time of sale.
• Data analytics and third-party reporting: banks, registrars and mutual funds report large transactions. The department then matches these reports against tax returns.

4. Black money

• Black money is income or wealth hidden from the tax authorities.
• It can come from a legal activity where tax was not paid, e.g. unreported business income.

• It can also come from an illegal activity, e.g. bribes or smuggling.

• Sources:

• tax evasion
• corruption (bribes)
• crime (drugs, smuggling)
• real-estate deals, where part of the price is paid in cash "on the side"

• benami holdings

• Studies:

• NIPFP estimate (1985): an early official study of the size of the black economy.

• White Paper on Black Money (2012), issued by the Finance Ministry.

• Responses:

(a) Special Investigation Team (SIT) on Black Money (2014)

• Set up in 2014 following a Supreme Court order.
• Its Chairman and Vice-Chairman are two former Supreme Court judges [7].

(b) Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015

• In force from 1 July 2015 [8].
• It taxes undisclosed foreign income and assets separately from normal income tax [8].
• Punishment: rigorous imprisonment of up to 10 years, and a penalty equal to 3 times the tax [8].

• Example: if the tax due on a hidden Swiss account is ₹1 crore, the penalty can be ₹3 crore, on top of the ₹1 crore tax.

• Wilful evasion of tax on foreign assets is a scheduled offence under PMLA 2002. This means the ED can also act on it [8].

• One-time compliance window: people could declare hidden foreign assets on or before 30 September 2015 [9].

(c) Benami Transactions (Prohibition) Amendment Act, 2016

• A benami transaction means property is held in one person's name, but another person paid for it. "Benami" means "without a name".
• Example: a dishonest official pays for a flat but registers it in the name of their driver.
• The amendment strengthened the original 1988 Act.
• It came into force on 1 November 2016, and the Income Tax Department began action under it from that date [10].
• It is also used against shell companies that hold property for others [11].

(d) Demonetisation (November 2016): covered in the Money note.

5. Money laundering networks

• Money laundering means hiding where illegal money came from by passing it through deals that look legitimate. It has three stages:

Stage	What happens	Example
1. Placement	Dirty cash is put into the financial system	Many small cash deposits into different 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 it as a "loan" or "business profit"

Institutions

• PMLA (Prevention of Money Laundering Act) 2002: the main law against laundering.
• Enforcement Directorate (ED): enforces PMLA. It can attach property and prosecute.
• FIU-IND (Financial Intelligence Unit-India): receives and analyses suspicious transaction reports from banks and other reporting entities, then passes leads to agencies.

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 mutual evaluation is 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 [12].
• India will report back to the plenary after three years [12].
• Strengths: high technical compliance; good use of financial intelligence; taking assets away from criminals [13].
• Gaps to fix: faster prosecution of money-laundering and terror-financing cases; protecting non-profits from misuse by terrorists; better supervision [13].

Hawala

• Hawala is an informal system that transfers money through a network of trusted brokers (hawaladars).
• How it works: broker A in Dubai takes money from a sender. A calls broker B in India. 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.
• It is an offence under FEMA and PMLA.

Shell companies

• A shell company has no real business, no real operations and no real assets.
• It is used for layering, tax evasion and hiding the real owner.
• MCA crackdown (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 [14].
• 3,82,581 companies were struck off over the three years up to 2020 [15].
• 2,38,223 companies were identified as shell companies between 2018 and 2021 [16].

• Other actions included freezing bank accounts and using the Benami Act against deviant shell companies [11].

• Beneficial-ownership rules: a company must disclose its beneficial owner, the real person who finally owns or controls it, and not just the names on paper.

Prelims Hooks

• Avoidance = legal but against the spirit of the law; evasion = illegal. Watch for questions that call avoidance "illegal".
• GAAR sits in Chapter X-A of the Income-tax Act, 1961. It applies from AY 2018-19 (FY 2017-18). Threshold: tax benefit above ₹3 crore.
• Shome committee (2012) was the expert committee on GAAR. It recommended deferring GAAR.
• Impermissible Avoidance Arrangement: its main purpose is a tax benefit, plus one of these: no commercial substance / not at arm's length / misuse of law / not bona fide.
• Black Money Act 2015: in force 1 July 2015; up to 10 years RI; penalty 3× the tax; its offence is a scheduled offence under PMLA.
• Benami Amendment Act 2016: in force 1 November 2016 (a week before demonetisation). It amends the 1988 Act.
• SIT on black money (2014) is headed by two former Supreme Court judges.
• Pairs: PMLA → ED enforces; suspicious transaction reports → FIU-IND; hawala → offence under FEMA + PMLA.
• FATF: India a member since 2010; 2024 evaluation → "regular follow-up" (best category).
• Laundering stages in order: Placement → Layering → Integration. Shell companies mainly serve the layering stage.

Mains Points

• Rates vs compliance: NCERT links high rates to evasion. Moderate rates, fewer exemptions and simpler processes (faceless assessment, the new tax regime) widen the base better than high rates on a few people. This also connects to the global minimum tax debate on profit-shifting.
• GAAR: certainty vs anti-abuse: GAAR protects the tax base. But broad officer discretion can scare away foreign investment. The ₹3 crore threshold, the show-cause notice and the delayed start (following the Shome committee) show the balance India struck.
• Did demonetisation and GST formalise the economy? More return filers and GST registrations suggest a wider tax net. Critics say part of this is compliance on paper, not real formalisation, and that the informal sector bore high costs.
• Black money is a multi-agency problem: tax law (Black Money Act, Benami Act), criminal law (PMLA/ED), company law (striking off shell companies, beneficial ownership) and global cooperation (FATF, information exchange) must work together. FATF's own gap is slow prosecution, which shows that enforcement, not just laws, decides the outcome.