Chasing black money: Need for universal information framework to track illicit fund flows


  • 15 June, 2016
  • Suraj Prasad Jaiswal

There is much anger among the people with regard to black money, also known as Illicit Fund Flows (IFFs). The revelations of Panama Papers, based on the leaked information about the business of Panama-based offshore law firm, Mossack Fonseca, has brought the issue to limelight again. In the wake of the revelations of the Panama Papers, the focus has been, as expected, on the individuals involved, the process of black money generation, the existence of tax havens and the need for governmental action. But one aspect which hasn’t received attention is about the existing regulatory framework to curb the IFFs. An assessment of the existing framework could help us find the reasons as to why the efforts to curb IFFs have not been successful.

The generation and movement of IFFs are made possible because people engaging in these acts are able to hide information from concerned government authorities. In this process, they are helped by tax havens, bank secrecy jurisdictions as well as by the enablers of the IFFs — bankers, accountants, lawyers. These enablers facilitate the creation of anonymous/shell companies to hide the identity of the individual; they also create sophisticated financial and accounting tools to bypass the regulatory supervision. The combination of anonymity, intricate ownership structure and unavailability of information to concerned authorities makes it nearly impossible for IFFs to be detected.

Since these illicit fund flows are transnational in nature, the domestic regulations and efforts are not sufficient. Countries are required to share information and assist each other to tackle IFFs. Below we take a look at the current provisions India has in place, in relation to global cooperation, for dealing with the IFFs.

As noted above, to curb IFFs the foremost requirement is that of the authorities accessing relevant information, many times from a foreign jurisdiction. For a country there are two ways in which it can access information from a foreign jurisdiction — it can either sign a bilateral agreement for Exchange of Information (EOI), or it can sign ‘Multilateral Convention on Mutual Administrative Assistance in Tax Matters’ (MCMAA). Till recently, the bilateral agreements were negotiated with each country individually, so final provisions of agreements depended on the bargaining power of countries.

A study conducted by Centre for Budget and Governance Accountability (CBGA) found that out of more than 110 agreements signed by India, 30-40 per cent had weaknesses which allow the other country to withhold the information requested. The Indian government has taken note of this and it is trying to renegotiate. The other platform for exchange of information is MCMAA, which is an initiative of ‘Global Forum on Transparency and Exchange of Information for Tax Purposes’, an international organisation backed by OECD and G20, with more than 130 member countries, including India. Global Forum is working to create a platform where signatory countries can exchange relevant tax and financial information with each other.

Under these agreements, there are three different ways to exchange information — On Request, Automatic and Spontaneous. The current global standard for EOI has been ‘On Request’, which means if India needs (tax/financial) information related to an Indian entity (individual or firm) from another country, it has to request that country. However, to request for information, India has to provide specific details of the individual/company concerned, such as name, account number, bank name, branch, etc. It means that there is a need to have sufficient information to get any additional information, which to a large extent defeats the purpose of EOI. This anomaly is expected to be fixed with ‘Automatic Exchange’ becoming the global standard for EOI.

Under ‘Automatic Exchange’, the signatory country provides information of all foreign entities to the resident country on annual basis. Under the supervision of Global Forum, 55 countries, including India, have signed to start Automatic Exchange of Information in 2017 with 41 more countries joining in 2018. The catch here is that not every county will be sharing information with each country. That is, after signing MCMAA, each country again has to choose among signatories, with whom it wants to exchange information or not. For example, if India decides that it wants EOI with Switzerland and Britain, it will make a request to both for the same, but both the countries can choose whether they want to exchange information with India or not.

For countries with a strong domestic finance lobby such as tax havens and financial centres, there is a strong possibility that they won’t opt for EOI with countries which may have adverse impact on their business. A study by Niels Johannesen and Gabriel Zucman finds that signing of EOI with a tax haven results simply in transfer of funds to a non-signatory tax haven, pointing to the need for bringing all the countries under the EOI arrangements.

Even a small number of financial centres and tax havens out of the ambit of EOI arrangements will continue to be conduits of IFFs.

Although, having the information agreements is job only half done, there remain two more major hurdles, known as Beneficial Ownership (BO) and Certificate of Residency.

Anonymous companies make it nearly impossible to find the true owner who benefits from the company. For any effort to be effective in curbing IFFs, it is required that BO information is available with government agencies.

Recently there are some encouraging signs on this front as various countries (including UK, France, Netherlands and Australia) have announced bringing regulations for a Beneficial Ownership Registry. Still, much work remains to be done in terms of getting all the countries to have such a registry, as well as bringing various other legal entities, such as trusts and foundations, within the purview of BO. The finer wordings of the legal provisions also need to be scrutinised properly. For example, in many countries Beneficial Ownership is defined as the minimum of 25 per cent holding of shares/capital, which can easily be overcome by showing many family members owning less than 25 per cent or other such arrangements.

The other problem comes from ‘fake certificate of residency’. Under EOI agreements, information are sent to the resident country, but if an Indian citizen/firm first establishes a company in a tax haven and uses it to open an account in Switzerland showing that tax haven as the country of residence, then the information will be sent to that tax haven instead of India, making the entire process futile. In this regard, the multilateral institutes, such Global Forum or G20, are required to take action. Imposing economic/trade sanctions against jurisdictions found issuing fake certificate of residency should prove a strong deterrent.

This article focused only on the global aspect of dealing with IFFs; however the CBGA study also found that India needs to improve significantly on two domestic fronts: first, human resources and institutional capacity at tax department, and speedy trial by judicial system to punish the wrongdoers in effective and timely manner.

A chain is only as strong as its weakest link — world’s favourite detective Sherlock Holmes used to quip. There is no better way to emphasise the significance of every single step and institute involved in the effort to curb the illicit flows. Leaving out even few jurisdictions from EOI arrangements, few countries without Beneficial Ownership registry and a weakness at tax or legal department, will only create new routes for IFFs. The revelation of Panama Papers has helped in creating a worldwide momentum against Illicit Flows. Time is opportune for India to intensify the effort, domestically as well as globally, to curb the menace of IFFs.