Tuesday, May 22, 2012

Black Money: Corporate Entities and Securities Markets


The Government yesterday tabled its White Paper on Black Money in Parliament. Billed as the first document to comprehensively tackle the issue, it cites various studies and is replete with data. However, it has already been subjected to criticism from various quarters owing to the lack of details and clarity in solutions to deal with the issue. This post, however, briefly touches upon the role of corporate entities and the securities markets in perpetuating the flow of black money as contained in the White Paper.
The White Paper finds that financial market transactions are used as conduits to route black money using the modus operandi of “round tripping”. For instance, it notes:
2.4.9 The illicit money transferred outside India may come back to India through various methods such as hawala, mispricing, foreign direct investment (FDI) through beneficial tax jurisdictions, raising of capital by Indian companies through global depository receipts (GDRs), and investment in Indian stock markets through participatory notes. It is possible that a large amount of money transferred outside India might actually have returned through these means.
The use of participatory notes (P-Notes) for investments back into India appears quite stark. Since P-Notes are issued by entities outside India, often through multiple-layered holding structures, Indian regulators are faced with difficulties in ensuring transparency and in identifying the ultimate beneficial owners. Despite progressively stronger KYC norms imposed by SEBI to track beneficial ownership of P-Notes, it has had mixed success, primarily owing to the difficulties associated with extraterritoriality of the investment activities in P-Notes. For previous discussions on regulating P-Notes, please see here, here and here.
The White Paper also comments upon the use of complex corporate structures through tax havens to mask financial transactions.
2.9.1 Corporate structuring is a legitimate means of bringing together factors of production in a way that will facilitate business and enterprise and help the economy. However, an artificial personality can also be created of a corporate entity to conceal the real beneficiaries. Opaque structuring through creation of multiple entities that own each other and the secrecy granted by certain jurisdictions facilitate such misuse.
2.9.4 With increasing realisation about the harmful effect of ownership being concealed behind complicated corporate ownership structure, such structure is coming under scrutiny. In the Indian context, it is one of the reasons for the fact that tax authorities are not able to take action in cases where money is prima facie brought back to India through round tripping and other legitimate means and it is expected that efforts taken by India in this regard as also global pressure will provide a check on these tendencies.
The White Paper further fuels the ongoing debate on issues of taxation by referring to the Vodafone case. Again, given that corporate holding structures are established on a cross-jurisdictional basis, regulating the entire chain is an onerous task.
It is quite clear from the report that the issue of black money is quite complex and requires a multi-pronged strategy to deal with. While the White Paper is a first step in documenting the various aspects of the issue, it might required a more concerted action as it involves multiple laws and regulations enforced by multiple regulators.

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