[2017] 78 taxmann.

com 115 (Article)

Demonetisation and its Tax Implications

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MEENU GUPTA
CS

Our Hon'ble Prime Minister of India on 8th November'2016 made a historic decision to cease the
existing currency notes of value of Rs. 500 and Rs. 1,000 respectively to be a legal tender with effect
from midnight in order to put the economy on a fast track, weeding out the menace of parallel economic
order, i.e. black money by demonetizing highest demonetization currency thus curbing terrorism,
ensuring social-economic security and stability for investors, promoters and consumers. Cash currency
in this system acts like blood in the body. Corruption, money laundering, unaccounted cash
transactions, Swiss Bank deposits, dowry have creeped in due to this. Nearly 86% of currency in India is
in form of Rs. 500 and Rs. 1000 value out of which around 20-25% is black money kept as wealth which
this PM's big-bang move aims to curb. The article proposes to deal with tax implications of the move
and amendments proposed as anti-black money measures by Government.

Issues and the Impact

In a Country like India where Cash-to-GDP ratio is 12%, the decision of Government to cease Specified
Bank Notes (SBN) came as a surprise to all giving no time/opportunity to black money hoarders to get
their currency converted into other forms of assets. As per RBI rules, total 500 notes in economy
estimated around 16.5 billion while 1000 notes around 7.5 billon can be exchanged to new currency
upto value of Rs. 4,500 per person over the counter of any branch of bank by presenting in person and
also can be deposited in their bank accounts irrespective of value and withdrawn upto Rs. 24,000 per
week till further decided by GOI in consultation with RBI. However, taking benefit of this facility, some
unscrupulous persons started sending daily wage earners on payment/commission to impersonate as if
they are the genuine people requiring exchange which resulted in huge queues outside the bank
branches resulting in genuine persons suffered as whatever new currency notes were available with the
banks got usurped by impersonators. In order to eliminate the malpractice, limit for exchange was
reduced to Rs. 2,000 per person and decided to put indeliable ink on the index figure of person so that
he cannot stand in queue at other place. This step had the desired effect in diminishing long queues in
front of banks.

Now since 50-day window for deposited demonetized notes ended on Dec 30, Indians whoever abroad
during demonetization period have a 3-month grace period till March'31 to deposit junked notes while
for NRIs it is 6 months till June 30. Returning NRIs and Indians will have to physically show junked Rs.
500 and Rs. 1,000 notes to Customs Officials at the Airport and get a declaration form stamped before
they can deposit the demonetised currency in RBI during grace period.

The decision to demonetize currency notes was sudden with only a very few persons were in the know of
such decision coming into operation as per the statement made by an RBI official "Maintaining secrecy
was of paramount importance as any leakage of this information would have rendered this proposal
ineffective. For this to work, it was imperative to catch unaccounted cash holders by surprise." It is
appreciable that during this 50-day deposit window, not even a single incident has taken place though
the general public has been inconvenienced for standing in long queues for getting old currency notes
exchanged for new ones. Whole credit goes to people of India who have happily suffered hardship and
have shown great faith in 50-day promise of Hon'ble PM despite entire opposition political parties
opposing his decision.

Money Hoarders have their 'Jugaad' Ready to launder Black Money

Several "innovative tricks" are used by shopkeepers, traders and some cash hoarders to crack down on
black money. Paying employees advance salaries; buying gold at higher value; asking non-income tax
paying employees to deposit money in bank account, withdraw it and return few months later; and for
some with black money religious places come to rescue. Details of lower strata of society are used by
jewelers to help launder demonetized currency by using back dated bills and splitting bills into small
amounts to avoid PAN card requirement. Income Tax Department conducted atleast 70 raids in last 50
days in jewellery shops, transport companies, entry operators' companies, cooperative banks, tea
gardens, food processing companies and individual businesses in eastern India.

Deposits in Jan Dhan Account : Jan Dhan Accounts were rampantly used by
hoarders to stash unaccounted cash in Bengal of nearly Rs. 58 lakhs to Rs. 1.5 crore.
Deposits in Cooperative Banks : In a specific case, a farmers' cooperative
society in North Bengal deposited Rs. 2 crore using details of 30 farmers, so that no
account gives an abnormally inflated figure.
Fudging Accounting System : Showrooms of jewelers reportedly manipulated
the system by making bogus bills of small amounts because PAN details are required
for high value transactions.
Make false Freight Bills : IT Department has probed atleast 40 transport
companies across West Bengal and northeast India estimating Rs. 10 crore has been
laundered by making fake freight bills in exchange of old currency notes.

Tax non-compliance & Demonetisation

Why the number of Indians who pay tax is so small and there is a lot of corruption. Just look at the
amount of cash we use to conduct our lives. In terms of 'narrow money' which includes coins and notes
in circulation and other currency easily equivalent easily convertible to cash, India has a higher Cash-
to-GDP ratio of 12.8% than all its BRICS. While any payments through bank channels leave a trace,
using cash to pay a bribe doesn't leave any. That is the main reason that people prefer cash. It also leads
to shooting up of prices and is main reason for inflation, especially for assets like real estate and gold.

While stock of black money can be found in real estate, gold and fraudulent transactions, exchange of
the same happens via cash. This black money menace continues despite a benevolent tax regime where
exemptions are almost equal to taxes paid for by corporate India. Absence of estate duty, gift tax,
presumptive acquisition of under-reported assets tie the hands of tax department. The judiciary,
constrained by resources, isn't able to punish economic crimes. For eg. Making acquisition cost of
bonus share zero instead of dividing the original cost over old shares as well as bonus shares has created
the cottage industry of bonus stripping costing the government tens of thousands of crore every year.
Such loopholes have contributed have contributed to lower tax collections.
Poor levels of tax compliance, fake currency and criminal activities probably pushed the government
into taking the measure of remonetisation emphasizing introduction of new Rs. 2,000 notes and
replacement of Rs. 500 notes. Experts supporting the government have hailed remonetisation as a
catalyst that will change India forever. Experts opposing the government have called demonetization a
monumental failure which will plunge the economy in recession for rest of the year. Remonetisation
will not change India unless the mindset of Indians changes towards tax payment. We are a nation of
dishonest taxpayers (except where tax is deducted at source). If people change to be tax compliant and
graduate to Asian Levels, our entire fiscal deficit will disappear. The government will be able to spend
money on social and physical infrastructure and improving governance. It is not the money in the hand
of government, but the change in mindset of people that will change India forever.

The success of remonetisation is dependent upon how majority of citizens accept tax compliance. If they
accept a cash-less economy through digital payments, move all transactions through tax net, become
tax compliant and bear fair share of tax burden, then remonetisation will create faster economic growth
with merger of white and black economies. It will create more resources for banking sector to extend
credit as cash sitting idle or rotating at a slower pace will increase through multiplier effect. Higher
GDP growth and tax collection can lead to a sovereign rating upgrade with a resultant drop in interests
costs.

Anti-black money measures

The timing of announcement of this 'big bang' reform seems clearly in hindsight with massive rollout of
Pradhan Mantri Garib Kalyan Jojana (PMGKY) and has followed the Income Declaration Scheme' 2016
where people were given a window of opportunity to declare their wealth piled through a number of
means. However, despite several steps taken by Modi's government over the past two-and-a-half years,
India's global ranking on corruption had moved only to 76th position from 100th earlier. This shows the
extent of web of corruption in the Country. The disease of corruption is the domain of some vested
people who are flourishing. Some people have misused their positions and benefited. On the other
hand, some people are suffering. Demonetisation is a step which was waiting to happen for a long time
to deal with menace of black money and in view of this, the government and its various agencies are
making efforts to issue various amendments in tax laws to ensure large scale seizure of unaccounted
money like setting up of Special Investigation Team (SIT), Black Money (Undisclosed Foreign Income
and Assets) and Imposition of Tax Act, 2015, Benami Transactions (Prohibition) Act 1988 and proposal
of its amendment vide Benami Transactions (Prohibition) Amendment Bill, 2015, amendments to
Income Tax Act 1961through Taxation Laws (Second Amendment) Bill, 2016.

1. Special Investigation Team (SIT) : Modi Government, in its very first Cabinet
meeting, constituted a Supreme Court-Monitored Special Investigation Team (SIT)
on Black Money which puts a ban on any cash transaction over Rs. 3 lakh and a limit
of Rs. 15 lakh on cash holdings. Limits on cash transactions would discourage white-
collared criminals or hardened criminals from money laundering and dealing in
unaccounted/black money. Unaccounted wealth being held in cash would be
confirmed by huge cash recoveries in numerous actions by law enforcement agencies
from time to time. According to CBDT, total cash seizures was Rs. 514 crore for
2013-14, Rs. 519 crore for 2014-15, and Rs. 471 crore for 2015-16.
2. Benami Transactions (Prohibitions) Amendments Act 2016 : It provides
for imprisonment of 7 years and a fine of upto 75% of Fair Market Value of a benami
property. It also empowers government to confiscate deposits of people using bank
 accounts of others to launder money.
3. Income Declaration Scheme 2016 : The Income Declaration Scheme (IDS)
which opened on June 1'2016 gave a chance to black money holders to come clean by
declaring the assets by September 30 and paying tax and penalty of 45 percent on it.
The Narendra Modi Government wanted to capture the entire parallel economy
flowing in system of Rs. 7 lakh crore in India. Though the Income Tax department
had identified 90 lakh high value transactions without PAN, the final disclosure of
black money was to the tune of Rs. 65,250 crore declared by 64,275 declarants.
4. Pradhan Mantri Garib Kalyan Yojana (PMGKY) : Government sought to
bring to tax all unaccounted money that was flowing into banking system following
the demonetisation drive and has come out with Pradhan Mantri Garib Kalyan
Yojana 2016 to enable people with undisclosed income to come clean so that not only
the Government gets additional revenue for undertaking activities for the welfare of
poor but also the remaining part of declared income legitimately comes into the
formal economy. The declaration can be made in respect of undisclosed income in
form of cash or deposits in an account with bank or post office or specified entity.
The declarant has to pay tax @ 30% plus penalty @ 10% on undisclosed income. A
surcharge of 33% on tax that is 10% (rounded off) is also payable, aggregating to 50%
of undisclosed income. In addition to tax, surcharge and penalty, the declarant will
have to deposit 25 per cent of undisclosed income in a deposit scheme to be notified
by Centre in consultation with RBI. The deposit will bear no interest and shall be
locked in for four years from date of deposit. This amount is proposed to be utilised
for programmes of irrigation, housing, toilets, infrastructure, primary education,
primary health, livelihood etc. so that there is justice and equality.
5. Taxation Laws (Second Amendment) Bill 2016 : In order to keep track of
SBN deposits, Government has swiftly amended Rule 114B of Income-tax Rules,
1962 regarding quoting of PAN number and Rule 114E of the Rules regarding
furnishing of financial information. Information regarding SBN deposits would be
readily available to Tax Department in view of notification no. 104/16 dated 15th
November 2016 whereby a new Sl. No. 12 is inserted in Table in Rule 114E requiring
Banks and Post offices to report cash deposits during the period 9th November 2016
to 30th December 2016 aggregating to Rs. 12,50,000 or more in one or more current
account of a person or Rs. 2,50,000 or more in one more accounts (other than a
current account) of a person. The above AIR statement is to be furnished on or
before 31st January 2017, though the time limit prescribed in respect of other
transactions under Rule 114E is 30th May 2017, showing the intention of Tax
Department to utilise the information regarding cash deposits as immediately as
possible.

Further in view of substitution of Sl. No. 10 in the Table in Rule 114B, quoting of PAN would be
mandatory in respect of cash deposits in excess of Rs. 50,000 on any one day and more than Rs.
2,50,000 in aggregate during the period 9th November 2016 to 30th December 2016, leaving enough
trail for the Tax Department.

There were suggestions that unaccounted SBN can be declared as income of FY 16-17 for tax purposes
and tax paid @30% under Section 115BBE. It was also suggested that in such cases, no penalty can be
levied under the existing tax laws. Government noted the concerns that some of the provisions of
Income-tax Act, 1961 could be used for conversion of black money. The Government, therefore, quickly
proposed necessary amendments to Income-tax Act, 1961 through Taxation Laws (Second Amendment)
Bill, 2016, so as to ensure that defaulting assesses are subjected to tax at a higher rate and stringent
penalty provision. The severity of proposed amendments, shows the seriousness and determination of
government to fight out black money and this change in the scenario needs to be noted. It also needs to
be said that proposed amendments not only eliminate the possible loopholes in law but also effectively
neutralises any scheme or plans to convert black money.

Incomes are at present charged to tax at a flat rate of 30% as per Section 115 BBE, without allowing any
deductions, expenditure or set off of loss against such Incomes. The Bill proposes to insert a new sub-
section (1) containing two clauses in Section 115BBE effective from the Assessment Year 2017-18:

i. Where the total income of assesses includes any income referred to in Section 68 to
69D and reflected in return of income furnished under Section 139;
ii. Where the total income determined by the Assessing Officer includes any income
referred to in Section 68 to 69D, if such income is not covered under clause (a).

It is proposed that in both the above cases, rate of tax will be 60%. Further, it will be subject to
surcharge of 25% of the tax making the total tax and surcharge at 75%. The total tax liability including
education cess will be 77.25%. Further, a penalty @ 10% on the tax payable is leviable under the
proposed Section 271 AAC, aggregating to tax, surcharge, cess and penalty of 83.25%. The penalty
under Section 271AAC as above is not leviable to the extent such income has been included by the
assessee in return of income filed under Section 139 and the tax under Section 115BBE (1)(i) has been
paid on or before the end of relevant previous year. Thus, a penalty can be avoided if tax is paid
voluntarily that too before end of the previous year.

The intention of new clause (a) of Section 115BBE (1) is to secure that even if income under Section 68
to 69D is offered by the assessee in return of income, the rate of tax will be 60% plus surcharge. This
effectively negates the suggestions in some quarters that unexplained income represented by SBN can
be offered as income from other sources for the Assessment Year 2017-18 and tax @ 30% paid under
Section 115BBE as it exists now.

Conclusion

The most direct impact on black economy would be of taxation reform. However, the government and
its various agencies are sparing no efforts to block all escape routes for tax evaders. The decision of
demonetisation is expected to go a long way in nullifying black money hoarded in cash, corruption,
terror financing and fake currency. Despite some temporary downside risks, the drive is expected to
discourage parallel economy bringing in much needed cash into the banking system to widen the tax
base.