DECCAN INQUIRER
Bi-Weekly e news paper
Editor: Nagaraja.M.R.. .. Vol.19....Issue. 100…..17 / 12 / 2023
.jpg)
To
Smt Nirmala Sitharaman
Union Finance Minister
Government of India
Dear Smt Sitharaman,
I had earlier addressed you vide my letter dated 31-1-2023 (https://countercurrents.org/2023/02/overseas-shell-companies-a-shadow-economy-a-threat-t-national-interest/) pointing out how the government failed to define the term “overseas shell companies” in the Companies Act, SEBI Act and other related legislations, despite admitting to the Parliament as early as 6-2-2018 that there was an urgent need for such a consistent definition, a legislative omission that in turn indirectly helped domestic business houses to park their wealth in overseas shell companies and profiteer at the cost of the domestic economy.
In the same letter, I also referred to the Department of Economic Affairs notification GSR 646(E) dated 22-8-2022 which provided yet another legislative loophole for similar exploitation by domestic private companies.
The Expert Committee constituted by the apex court to examine the implications of the Hindenburg report on the Adani Group, in their findings submitted on 6-5-2023, observed, among others, in [Para 23(b) of their report] that “the very requirement to disclose the last natural person above every person owning any economic interest in the FPI was done away with in 2018” by a SEBI notification (apparently in reference to SEBI/LAD-NRO/GN/ 2018/58. 31-12-2018), suggesting that SEBI created a legislative constraint for itself that came in the way of its subsequent attempts to investigate the post-Hindenburg developments.
In other words, between 2018 and now, a series of legislative gaps either created or left uncovered by the Finance Ministry and SEBI, have indirectly contributed to domestic business houses parking their wealth in overseas shell companies and profiteering at the cost of the domestic economy. This is a matter of serious public concern that calls for an independent enquiry.
May I request the Ministry of Finance to institute such an inquiry to clear the air, not only with reference to the Adani matter but also with reference to overseas shell companies set up by other domestic and foreign-listed business houses operating in India?
Regards,
Yours sincerely,
E A S Sarma
Former Secretary to the Government of India
Visakhapatnam
___________________________
The trail: How is black money made white
By Goutam Das / Sarika Malhotra
A story of shell companies, trusts, hawala, tax havens, consultants and money routing.
Flight of black money in cash is an even more interesting story, especially, by those who amass loads of cash through illegal dealings from big-ticket deals or through bribes. (Photo:Reuters)
A Corporate presentation from 2009 was all praise for Vijay Choudhary. He is "an entrepreneur-par-excellence", a "key driver in the growth of the organisation", and the "driving force behind the momentum of the enterprise". His company, with interests ranging from industrial and engineering services to realty and infrastructure, however, started figuring in the list of top defaulters frequently since then.
Zoom Developers now owes over Rs 2,000 crore to 26 public sector banks. And in July this year, the Enforcement Directorate did something unprecedented by attaching the company's 1,280 acre landholding in California. Over the past several years, Zoom had borrowed heavily citing projects in European countries. The money, allegedly, was siphoned off through many dummy firms - in India, Switzerland and London - and channelled to trusts. Part of the money was used to buy properties. Now, Zoom has taken down its website; e-mail accounts have been disabled; and telephone lines are dead. According to an Enforcement Directorate source, Choudhary is absconding.
Since Indian laws
have restrictions on carrying cash, the most common method is to wear or carry diamond jewellery
Bank loan frauds such as the one by Zoom might be rare, but the modus operandi is similar to most money laundering cases. Investigations into such dealings are almost unheard-of, primarily because it is often impossible for enforcement authorities to follow the complex money trail and bring the perpetrators to book.
A classic black money operator opens many shell companies to route money before it is invested. This is called 'layering', and it helps in covering up the money trail. Assets are rarely in the beneficiary's name and money is moved through jurisdictions where Indian laws are not respected. Over the years, many such perfectly legal but complex financial systems have evolved that help convert black money into white. Professional services firms located abroad, chartered accountants and savvy lawyers, all play a role in covering up the tracks, which perhaps no law - not even India's new antidote to black money, The Black Money (Undisclosed Foreign Income and Assets) Imposition of Tax Act, 2015 - can effectively counter or help unravel.
THE FLIGHT
Before professional services are sought, a high net worth individual would typically plan his modus operandi. It begins with black money generation - a company could either indulge in "master roll fudging" where wages and employment figures are inflated, like in the case of the erstwhile IT poster boy Satyam where 13,000 fictitious employees were created, or through under-invoicing. Unaccounted cash transactions are also rampant in businesses with recurrent underhand dealings, such as in medical or engineering schools where a certain number of seats are allegedly sold for cash, mining and, of course, in the form of kickbacks and bribes accepted by bureaucrats and politicians. Shailendra Kumar, in his book 'Its Raining Black!' chronicles many generation tools, from "the game of cricket, the shiny yellow metal, or the clinking of glasses of whiskey".
Once black money is generated, a businessman often prefers trade mispricing as the vehicle to siphon money out of the country.
But, how does trade mispricing work? Sample this: An Indian company, either promoter-owned or registered under a shell company typically located in Kolkata, can start by importing everything from heavy machinery to software - say, an ice cream machine, which costs $100,000. The company quotes an inflated price of $1 million. The manufacturer of the machine or its suppliers may not want to produce a fake voucher with the inflated price. Therefore, another shell company will be set up offshore, for instance in Dubai. It will first import the ice cream machine at the original price, and then sell it to the Indian company for $1 million. "No one will have an inkling about the fact that the Dubai company is also related to the promoters. The Indian company next remits $1 million to the Dubai shell. This is done through a banking channel," says Jagvinder Brar, Partner of Forensic Services at consulting firm KPMG.
There are shell companies in Mumbai and Surat, too, but Kolkata became the epicenter since the 1980s. One of the oft-cited reasons on why Kolkata flourished was because operators in the city charged less commission.
Similarly, one can import software - get a shell company in Singapore or Hong Kong to send a blank CD. "You declare that you have received a proprietary software and it costs $200,000. Even on a small scale, you can remit the money abroad. The claim is backed up by the invoice and a genuine courier," says Brar.
MUST READ: Your complete guide to the black money puzzle
The popular strategy for Zoom Developers, for example, was to channel the money through many shell companies across several countries. "There are about 90 tax havens. One can move money from India to the Bahamas, to St. Kitts, to Cayman Islands (the world's fifth largest international financial centre) and, finally, to Switzerland (a country that reportedly manages one-third of the world's private wealth). You keep closing the shell companies once the money is transferred," explains Arun Kumar, a former professor at Jawaharlal Nehru University's Centre for Economic Studies and Planning. "This layering process hides the real beneficiary of an account. That is why the Bofors kickbacks could never be tracked."
'The layering process hides the real beneficiary of an account. That is why the Bofors money trail could never be tracked,' says Arun Kumar, former professor, Centre for Economic Studies and Planning, JNU
Flight of black money in cash is an even more interesting story, especially, by those who amass loads of cash through illegal dealings from big-ticket deals or through bribes. Business Today met a middle-aged lawyer at a posh Delhi locality. By his own admission, a veteran in advising the Capital's bigwigs on such transactions. Much like the layering process of black money, his office is layered too. We are guided through three doors before we reach his cabin. He sits there, in a white shirt, keeping an eye on every section of his den through closed-circuit cameras placed at various vantage points. It is 10.30 pm, and a visitor waits at the reception - a tall man with a moustache and a diamond stud.
"Hawala and diamonds," he says, in a matter-of-fact way, when we asked what he advises clients looking to transfer cash abroad. Again, the modus operandi is simple. Since Indian laws have restrictions on carrying cash of over Rs 20 lakh, except in special circumstances such as medical treament, the most common method is to wear or carry diamond jewellery of, say, Rs 50 crore, and fly to Dubai. The diamond can then be sold and the cash deposited in a bank. "The banking system in Dubai, typically, asks no questions. Once the money is in the banking channel, the process of layering follows," says the lawyer.
Today, Dubai is the world's third-largest diamond trading hub. As per Rapaport data, official diamond imports to Dubai and UAE have increased from $884 million in 2004 to $5,021 million in 2013, and diamond exports from the two neighbours have shot up from $1,669 million to $7,300 million in the corresponding period. "Dubai is not a diamond polishing hub. Why is it importing or exporting as much? No one is looking into it," says Martin Rapaport, Chairman of the Rapaport Group, and founder of Rapaport Diamond Report.
Hawala transactions are even easier. The customer pays a simple fee to the Hawala agent and gets the money out to his chosen jurisdiction.
AT YOUR SERVICE
It is incredibly easy and cheap to set up a shell company abroad. It costs as less as $500. Some countries allow companies to be set up through websites. But most Indians prefer layering services to be rendered through chartered accountants, lawyers and professional services companies.
Switzerland has a host of companies that provides professional services to manage the wealth of high networth individuals across the world. Services can range from acting as professional trustees of trusts to incorporating companies and holding structures. They provide administrative services, including directors and secretaries for these companies, and that of the trusts. Other services include assistance while meeting with bankers. In some cases, the packages of services offered are transparently displayed on their websites along with the rates for each service. One such company is SwissIndependent Trustees, which claims to "deal with the formation of trusts and companies in several jurisdictions" and promises "exacting detail and meticulous execution".
Yet another company is the Portcullis Group, which "is a one-stop service provider that is secure, cost effective, confidential and internationally compliant". It offers shelf companies in British Virgin Islands, Samoa, and Seychelles. Shelf companies are legally formed firms, which are inactive but can be purchased to start a business right away.
In tax havens, professional beneficiary services is an organised industry and are bound by the laws of the land. The chances of these firms perpetuating fraud are negligible and that explains their popularity. "These companies are legal entities and are bound by professional beneficiary agreements, which act on clients' instructions and maintain 100 per cent confidentiality," says another Delhi-based corporate lawyer, who did not wish to be identified. "Since the beneficial owner of the trust is a foreigner, there is no way to know whose money is being handled."
Some banks allow 'numbered accounts', where the account holder is identified by a number rather than his name. "Blind shields are created through trusts in these jurisdictions to protect the identity of the ultimate beneficiary. The trust deed always remains a private document," the lawyer adds.
THE RETURN
Many professional services companies also advise on converting black money to white. While the money is typically used to buy property abroad, holidaying, or on heathcare, children's education and buying jewellery, they are also routed back to India.
The return journey of black money typically has a sequence. Money is parked in a trust-friendly jurisdiction, such as Switzerland, before it is moved to a tax-efficient country such as Cyprus, where the taxation levels are very low, or have no taxes. It is then routed to a tax-friendly country like Mauritius, before reaching the final destination in India. India has a Double Taxation Avoidance Treaty (DTAA) with Mauritius.
According to experts who track black money, foreign direct investment is the favourite tool.
"There are advantages when you bring in FDI through Mauritius. When you sell shares, you can avoid capital gains tax. And, any money that comes in as FDI is presumably clean money. This is happening now. It can happen in IT-ITES, manufacturing and even in the restaurant sectors," says Brar of KPMG.
'When you bring in (money in the form of) foreign direct investment through Mauritius, it is presumably clean,' says Jagvinder Brar, Partner, Forensic Services, KPMG
Trade mispricing, the very tool used to siphon off money, can also play an important role in bringing money back into India. Instead of inflating invoices, a business can under-invoice and export machinery or software. But, how does one convert black into white in India? There are several options. Some are less tax efficient and may involve forgery. One can open a company to sell bags or a restaurant. The business may not take off, but the owner can still show cash sales of Rs 1 lakh to Rs 2 lakh a day. Slowly, but surely, all money would be legitimate one day!
That's a game many Indians have perfected. Law enforcement agencies will find it tough to catch up - not just because of the layering process, but also due to the number of people involved. At an estimated 56 per cent of the GDP, the black money conundrum appears systemic.
BT met a former customs commissioner, who now practices law, Krishna Pratap Singh, at a five-star hotel in New Delhi. He laid out many reasons why the law will find it difficult to catch up. It is difficult to detect over- or under-invoicing of products by Customs. It is even more difficult if it's a sale of software, which can be delivered over e-mail. "The ED is understaffed," he reveals, adding: "The veil is lifted only in cases of very intensive investigation and when the State seriously wants to act."
___________________________
Six ways in which black money is created
1/8 Six ways in which black money is created
Black money is turning out to be big issue with many political leaders and civil society members speaking a lot about it. ET brings out the ways in which the black money is created.
2/8Method 1: Multi-level marketing scheme
A recent trend is to use international debit or credit cards issued by offshore banks. This enables easy usage.
STEP 1: A group of individuals float a multi-level marketing scheme or investment scheme promising extraordinary returns to investors.
STEP 2: Investors deposit cash or cheques in bank accounts floated by the firm. The firm, in turn, issues them post-dated cheques. STEP 3: The firm transfers the money to personal bank accounts of the promoters.
STEP 4: The promoters wire transfer the money to an offshore bank account in a tax haven. They wire transfer it again to another offshore bank account, in another tax haven, to widen the trail.
STEP 5: The offshore bank issues a credit or debit card valid anywhere in the world, which a promoter can use for transactions.
LIVE EXAMPLE:
In 2009, India's Financial Intelligence Unit (FIU) received suspicious transactions report from banks that a large number of deposits had been made in a few accounts. Further investigation revealed these accounts had a common permanent account number (PAN), address and contact numbers, and that it was a multi-level marketing scheme promising extraordinary returns. As explained above, the firm transferred the money collected to personal bank accounts of its directors.
Fifteen operators floated 10 firms, which in turn opened 35 bank accounts in 11 different banks. One operator alone received Rs 130 crore in his accounts over a period of 16 months, and the state police have attached Rs 190 crore of assets in various locations.
INDICATORS: Lifestyle beyond known sources of income
Ownership of assets abroad, but not declared in tax returns
Large inter-account transfers with no economic rationale
Cash transactions with unknown persons
Withdrawal of large foreign remittance in cash
3/8Method 2: Disguised ownership
Increasingly, criminals want to own legitimate business. It could be to earn a return or to convert black money into white. A typical example of how this is done:
STEP 1: Criminal X generates Rs 10 crore in cash from illegal activities in India, and wants to 'launder' it abroad. He uses the 'hawala' route to transfer the money: he gives the Rs 10 crore cash to a local hawala operator. The operator, for a fee, arranges to deposit the sum in an offshore bank account belonging to a company floated by X.
STEP 2: The offshore company buys shares in a domestic company promoted by X, that too at steep valuations
STEP 3: The domestic company pays a high salary and dividends to X. Black becomes white, and X can show the money as income.
INDICATORS: International corporate structure with no visible benefits
Shares of domestic companies sold at higher valuations
Tax returns don't support capital contribution by investors
Large cash holdings
Offshore companies will do business outside the country where it is formed. Such companies can be run by a nominee director and are often not required to publish annual accounts.
4/8Method 3: Mixed sales
Mixing illicit money sources with legit ones is a popular method because it's hard to detect, especially if there is a large cash component in the legal business.
STEP 1: Illegal money is mixed with actual sales, by depositing in the company's bank account. The cash deposit will be justified as legitimate business income, say, cash receipts in restaurant.
STEP 2: The company projects the fabricated sales as total income and files an income-tax return. However, it avoids paying tax on the total income by showing losses in other business lines or by showing fictitious deductions.
STEP 3: Black has become white, and promoters can use it to buy assets.
INDICATORS:
Large increase in cash turnover and sales
No commercial reasons for money inflows
Promoter has poor knowledge of business
Transactions don't have supporting documents, and don't fit the company's profile
Costs incurred but no corresponding increase in turnover
5/8Method 4: 'Smurfing'
This type of transaction is usually done to evade notice by authorities monitoring transactions above a certain threshold.
STEP 1: X deposits illegal proceeds into many bank accounts. The amount transferred is below the threshold level for reporting suspicious transactions. If Rs 10 lakh is the threshold level, deposits will be for Rs 9 lakh. This is called 'smurfing'.
STEP 2: The money is transferred from these multiple accounts to an offshore bank account to take the trail away from the source.
STEP 3: A loan agreement is signed between the holder of the offshore bank account and X.
STEP 4: Once he receives the money, X can spend the money to purchase assets.
INDICATORS
Cash received from countries with high level of corruption
Concealed transportation of cash
An occasional high cash transaction
Deposit is made in accounts of 'straw men' or nominees
LIVE EXAMPLE
A suspicious report was raised against a securities market firm that a large number of cash deposits were made into the company's account and that it was subsequently transferred to another entity in the same business. It was found that both companies had a common address and a common person was operating both accounts.
FIU found 78 bank accounts related to the two entities where there was a substantial cash transaction. FIU passed on the information to the Central Board of Direct Taxes (CBDT), which unearthed an all-India network of money laundering through 236 bank accounts. The companies were set up by a chartered accountant to conduct share-broking activities, but many firms were neither brokers nor sub-brokers.
The modus operandi was to move cash between different companies, showing non-existent share trading to claim a speculative loss or gain for customers. Software used by legal brokers was installed to generate bills so that it looks genuine.
6/8Method 5: Trade mispricing
Traditionally, goods exported and imported were either priced lower or higher to enable money laundering. Or, goods exported were different from the description. Below is a description of an actual case investigated by FIU, which got a suspicious report that a cab rental firm received Rs 100 crore as advance payment for export obligations that did not relate to its line of business. The company had also issued cheques of small value (less than Rs 10,000) to various people.
During investigation, it was found the chairman of the firm had several international bank cards. Fake invoices to show diamond purchases of Rs 188 crore were also recovered during the searches. No purchases were made. The company received Rs 300 crore from buyers in three overseas locations: Singapore, Dubai and Hong Kong. Interestingly, receivers of export shipments were different from people who sent advance payments.
With current technology, the Organisation for Economic Cooperation and Development (OECD) says it's easy to modify invoices or produce fictitious invoices. And corporations are easy to set up to show that they have received goods.
INDICATORS:
Discrepancies between customs filings and invoices
A country is not known for import and export of goods
Large difference between declared and market value
Payments made by an offshore company
Commission paid to third parties with no supporting documentation
7/8Method 6: Money transfers to benami entities
This case was outlined by the Karnataka Lokayukta while probing illegal mining in the state. With demand for iron ore skyrocketing, Eagle Traders & Logistics (ETL), a company owned by sitting Karnataka MLA B Nagendra, devised an ingenious route to source and export iron ore illegally through a network of companies.
STEP 1: ETL agrees to source from associates like Swastik Nagaraj and Karapudi Mahesh, whose job was to illegally mine iron ore from mines. The job of these associates was to create layers to mask the actual source, for which, they were paid "risk money".
STEP 2: Iron ore sold to exporters, who deposit the money in one of the five bank accounts of ETL.
STEP 3: ETL transfers money to Swastik and Karapudi. In one of the five ETL bank accounts alone, there was a combined credit and debit of Rs 649 crore between September 2007 and February 2011.
STEP 4: Swastik and Karapudi issue cheques to persons who may be either fake or under benami names or unregistered dealers of iron ore. These individuals make withdrawals on the same date, in most cases in denominations of Rs 9 lakh. The same happens on the credit side.
8/8The case of Janardhana Reddy-promoted Obulapuram Mining Company
The case of Janardhana Reddy-promoted Obulapuram Mining Company:
Tracing black money is a task made difficult by intricacies employed by offenders, as this case involving Janardhana Reddy-promoted Obulapuram Mining Company (OMC) documented by the Karnataka Lokayukta shows
1. UNDER-INVOICING
OMC exports 852,000 tonnes of iron ore at below market price to GLA Trading International, a Singapore-registered company
2. FAMILY PLAN
JANARDHANA Reddy is the director of GLA, which is owned by GJR Holdings International, a company registered in Isle of Man. GJR is, in turn, owned by Interlink Services Group, which is registered in Virgin Islands. Both Isle of Man and Virgin Islands are tax havens. GJR refers to Gali Janardhana Reddy and GLA to Gali Lakshmi Aruna, Reddy's wife.
3. TAX EVASION
GLA sells iron ore to outside party at market price. It pockets the profit, that too inflated, instead of Indian entity OMC. It can move the profit to its companies in tax havens, which are owned by Reddy family members. The under-invoicing in India in two years when Reddy was the director of GLA is estimated at Rs 215 crore. Due to underinvoicing, OMC under-paid customs duty and corporate tax.
4. BLACK TO WHITE
IF the IT department failed to detect the under-invoiced portion, it would have returned to India as a foreign investment—black becomes white. tax impact will be lower.
_________________________
How shell companies turn black money of India Inc, politicians into white and vice versa
By AVINASH CELESTINE
Companies with no assets except on paper, fake addresses and whose ultimate owners are difficult to trace are hardly a staple of exotic tax havens only.
On May 19, 2010, one of India’s largest engineering and construction companies paid a small amount — around Rs 1.38 crore — to a Kolkata-based company. The money was ostensibly payment for a contract that the Kolkata firm had fulfilled. For the engineering firm, the money was less than the average revenue it earned in an hour over the course of that year.
But as income tax sleuths later discovered, the way that money flowed to the Kolkata firm, through it, and then out of it, provided an all-too-rare insight into a business that has always existed in the shadows. It’s a business that serves the needs of India’s biggest and most well-known companies, and in many ways is essential to the way Corporate India functions. A trade that has existed for decades, it became an organised business in Kolkata around the 1980s.
At the heart of this business, and what ensured its survival and growth, is the reality that the Indian economy has a kind of dual personality, split as it is, into the ‘white’ and the ‘black’ economy, with cash transactions (though not always of an illicit nature) dominating the latter. But these economies don’t exist separately from each other. They drive each other, and feed off each other, and money flows from one into the other, depending on the economic cycle and entrepreneurs’ ‘animal spirits’.
The Kolkata company, and thousands of others like it across the country, sit squarely at the junction between white and black. They perform what is an essential function — that of converting, or laundering, black money to white. But they do the reverse as well, converting white money to black. And in the same way that a stockbroker brings together buyers and sellers of a share, and ‘makes’ markets, such companies, and the people who operate them, bring together buyers and sellers of another, much sought-after commodity.
Cash for Pay-offs
When the infrastructure company mentioned earlier wrote a cheque to the Kolkata company — call it LNP Ltd (not its real name) — it received its money back in the form of cash, say investigators ET Magazine spoke to. “Many infrastructure or construction companies in this country operate in an environment where they have to make payments in cash to various players,” points out an income tax official.
Such cash payments are necessary to pay off everyone from a local politician or bureaucrat opposing a project, to even a local Naxalite commander. But being a company which prepares formal accounts that are audited and will be pored over by investors, it has to account for that money, even if it involves such minor amounts. The cheque that the infra company wrote was recorded in its books as a commission payment.
This then was the first leg in a series of transactions, and it involved the conversion of white, accounted-for money, into black. The infrastructure company is now out of the picture, having achieved what it set out to do, while keeping any future over-eager auditors happy. And in the process it is able to claim the ‘expenditure’ in its tax return as well. It’s interesting to note that on the eve of the transaction, LNP Ltd’s own profit and loss account showed a total income of Rs 190 crore for 2009-10, on an asset size of Rs 37 crore.
LNP Ltd ‘invested’ the money it earned from the transaction, through another intermediary company, into a set of four other companies. Those companies accounted for such investment as share capital. It’s worth noting that all of these are transactions that occur only on paper, with no real cash flow or assets backing them.
But what the operator has done is infuse capital, on paper, into a set of companies that are now ready and waiting for a new set of owners. Such companies will be sold off to anyone looking to launder black money, converting cash they have into an asset that has documentation backing it, and can be audited by anyone who cares to look.
A buyer starts off by buying the shares of such a company at a steep discount to the ‘paper’ value of the company. He pays, say, one rupee for a share, which on paper, is worth fifty rupees. This is the white money leg of the transaction, and in effect, is the commission paid to the operator (in this case the commission is 2%). All that remains is for the black money to be brought in. How does that happen?
A manual that the Gujarat income tax department prepared for its officers, and which devoted an entire chapter to such companies, summarised the tried-and-tested way of doing so: “The method...entails breaking up large amounts of money into smaller, less suspicious amounts. In India, this smaller amount has to be below Rs 50,000 as deposit of cash below this amount does not require providing PAN of the depositors. The money is then deposited into one or more bank accounts either by multiple people or by a single person over an extended period of time. Also, even larger amounts are deposited in the banks with PAN numbers of individuals who are mostly illiterate and work for these...operators for small salary or commission. The money is then routed through paper companies controlled by these operators.”
These paper companies then invest this money into the target company as share capital. Money laundered. And while this last step seems a tad labour-intensive, even this process can be speeded up and costs cut, if bank officers are amenable enough (a recent investigation by Cobrapost revealed the role banks had to play in money laundering). And it is the operators who will carry out this last step for their customers. This, in a nutshell, is how the process works. At the start and end of the process are ‘customers’ who have opposing aims. Between them sits the operator who brings the two together.
On Paper
On February 14, 2008, 18 companies based in Delhi, Mumbai, Guwahati but predominantly in Kolkata invested Rs 10 crore in a company called Ganga Builders. Registered at the same address as some of the companies who invested in it, Ganga Builders was a company floated in 1982. Between 1982 and 2007, little is known of what business the company did.
On the exact same day that this transaction happened, another much bigger one took place -- one which was to eventually catch the eye of a range of investigative agencies including the Central Bureau of Investigation (CBI) and the Income Tax Department. That was principally because of the person at the centre of the investigation --Jagan Mohan Reddy, son of former Andhra Pradesh chief minister YSR Reddy. Seventeen companies, many of them belonging to wellknown industrial groups, injected a total of Rs 121.24 crore into Jagathi Publications, the flagship media company owned by Jagan Reddy.
Ultimately, according to news reports, the CBI would go on to investigate a total of over Rs 1,100 crore worth of investments into Jagathi over a period of years. Among those Valentine’s Day investors into Jagathi in 2008 were a smaller clutch of Kolkata and Mumbai-based firms and this is where their paths cross with Ganga Builders. For many of the investors into Ganga, and many of the investors in Jagathi, were common.
Ganga then went on to buy the shares of Jagathi over 2008-09, though the exact amount it invested could not have been more than a few crores. Currently all the shares of Ganga are now held by a clutch of other ‘paper’ companies. But more than the transaction, Ganga, and its sister companies, exemplified the classic traits of such companies.
Income tax investigators visited Ganga’s address, situated in an office complex in a commercial area in the heart of Kolkata. It was an address that the company shared with a few other paper companies who had invested in Ganga. All they found was a single office with a peon who confirmed that the companies indeed operated from there, but could give no other details about its owners.
At some point after this, Ganga’s address changed, and a new set of companies was moved to its old address. Ganga itself was exiled from the heart of the city to an industrial area on the far outskirts of the city in Budge Budge in the North 24 Parganas district bordering Kolkata.
ET Magazine visited both the old and new address of Ganga Builders. At the old address, it found the office locked. When it attempted to visit the company’s new address in Budge Budge, the trail ran cold. It could not locate the plot in the industrial area where the company said it resided, and workers at other units in the industrial complex could not even direct this reporter to the address given in the company’s regulatory filings.
“Often the directors of such companies are cooks or drivers or peons of the person who really runs the show,” says a senior IT official. Such directors, who can be appointed to dozens of such companies, have little clue about what these companies are used for. There is little else about these companies that is ‘real’. Addresses are fake, or function merely as ‘postboxes’ to receive mail. Financial accounts are largely fictitious and rarely backed up by actual assets or cash flow.
“These companies are incorporated by taking care of all formalities such as registering with RoC [registrar of companies] but having only postal addresses with no real office or employees. The directors of such companies are again individuals who are mostly illiterate or semiliterate and work for the...operators for small salaries or commission,” says the income tax manual. But what about the auditors?
Origins
Auditors play a special role in the story of the rise of the shell company business or, as is known colloquially, the ‘jamakharchi’ or ‘accommodation entry’ business (so called because such companies provide paper entries on companies’ accounts to facilitate the movement of cash). As IT sleuths describe it, the rise of the jamakharchi business occurred in Kolkata at some point in the 1980s and grew to be a business managed by a group of chartered accountants in that city (though CAs are not the only ones who provide such services).
“Some CAs only do this kind of work here,” says an IT official. And even paper companies require work. They have to be set up (often with just a few thousand or a few lakh rupees in initial capital), and have to regularly submit regulatory filings with the RoC, even if they do no business. Such companies therefore are managed by the CA and his staff.
When ET Magazine compiled a tentative list of companies managed by the same operator who ran LNP Ltd in 2010 (said to be one of the city’s largest such jamakharchi operators), by tracing companies with related directorships and addresses, it came up with a list of well over 100 companies. All these companies had two common characteristics — one, they were all registered with the RoC of West Bengal. Second, almost none of these companies were listed as ‘defaulters’ with the RoC. In other words, their paperwork was clean and they had been regular in filing their annual paperwork with the registrar.
According to the information the IT department has, the operator who set up LNP Ltd runs a set of well over 200 companies. While few CAs are willing to talk about the business on or off record, there is evidence in income tax cases over the years to glean an understanding of how the business is run. In February 2004, for instance, the Income Tax Department searched the premises of Pawan Kumar Ruia, founder of the Kolkata-based Ruia group. Ruia started his career as a CA in Kolkata and a senior income tax official describes him as a “brilliant man”.
According to excerpts of the report on the 2004 search, which were quoted as part of an Income Tax Appellate Tribunal (ITAT) order, “Mr Ruia took up activity in the eighties and by now he has floated hundreds of companies. The purpose of floating these companies was to meet the demand of those beneficiaries who wanted to buy some readymade companies. These companies were sold to different beneficiaries as commodity for a lump sum amount... The real game was played with the companies who were formed and used for the purpose of giving entries. These companies were formed in batches. The bank accounts of all these companies were intentionally opened in one branch. The process of forwarding entries in the beneficiaries was done by ‘layering’ the cheques i.e. cheques were routed through many paper/dummy companies of Shri Ruia before reaching its destination the beneficiaries. This is done by way of simultaneous clearance cheques drawn by one company favouring other through a series of credit/debit entries to hoodwink the Department.”
The order concerned a company which had allegedly benefited from Ruia's 'services' — the ITAT eventually ruled in favour of it and against the tax department. ET Magazine found no evidence that Ruia himself was ever prosecuted for allegedly providing such ‘services’. Questions submitted to Ruia did not elicit comment. Even if a CA audits, and signs off on the accounts of a paper company, it’s not necessarily the case that he is part of the game. While there are CAs who run and maintain a set of dummy companies, at the other end of the spectrum is a clutch of auditors who, desperate for business, are willing to sign the books of a paper company without asking too many questions.
“The fact is that business is so bad in this city, and there are so many CAs, that you will find people willing to sign off on a company’s accounts for as little as a thousand rupees or even less,” says an accountant who began auditing the financials of a company a year or two after that entity was involved in certain transactions to route funds to a senior political figure. This CA incidentally earns most of his income not from auditing companies but from holding coaching classes for aspiring accountants sitting for the CA exam. Until ET Magazine met him, and described the transactions to him, the CA claimed he had no clue about the bona fides of the company.
“When you are earning such little money, where is the incentive to even ask probing questions of a company’s accounts,” he asks. The CA says he came into the picture when another person, who worked for another accounting firm, was put in touch with him through an acquaintance. “This person asked if I would be willing to audit a bunch of companies and I saw no harm in it,” he says. “But for such little money I don’t need the headache,” he added, saying he was not going to audit these companies again. “But many people don’t have the luxury of saying no.”
“Kolkata has always been a hub for CAs, but with the industrial decline of the city, there is less work and many CAs have de facto entered this business,” says an IT official. He adds that while the jamakharchi business has now moved well beyond the city into places like Delhi or Mumbai, there are differences in the ‘commission’ charged: “In Kolkata, the commission can be around 2% plus an additional half percent for keeping the regulatory paperwork up to date,” he says. “In Mumbai, it will be higher.”
One interesting fact: despite the state’s supposed industrial decline over the years, the number of new companies registered with the RoC of West Bengal in 2010-11 was comparable with that of more industrially vibrant states (see Corporate Growth...). But the average authorised capital of new companies in the state was far less — only Rs 18 lakh, compared with Rs 40-50 lakh in the other states.
Corporate Growth by the numbers
Catching Them
The problems for authorities when faced with such companies are both legal and logistical. Take the Madhu Koda case for instance. When investigators began looking into the trail of funds linked to the former Jharkhand chief minister, they ran into a massive logistical exercise —the CM’s accountant Manoj Punamiya had routed cash through more than 200 companies.
Payments were layered — instead of funds being routed from A to Z directly — they were routed from A to B, B to C, D to E and so on, eventually to Z. “It was found that there were as many as 17 steps in which funds were transferred across accounts of various companies in the space of a single day,” said an IT official. And even if you painstakingly go through each of those layers, you can hit a brick wall — an investor located in an offshore tax haven like Cayman Islands or Mauritius.
"Politicians started using such companies from about 2005 and started parking scam-tainted money in them," says Kirit Somaiya, the founder of the Investors' Grievance Forum, which supports the interests of small investors. But layering of funds — moving cash from source to beneficiary indirectly through a number of intermediaries rather than just one or two — isn’t done just to create a lot of work for investigators. It performs a legal function as well.
The legal defence of such companies is summed up in a statement that former Samajwadi Party senior politician Amar Singh gave to the newsmagazine Tehelka in context of an investigation that the publication ran into various funds routed into Singh’s companies from a series of other entities, again many of them being based in Kolkata. “All this money received by my companies came through cheques. There is not even a single transaction that was done in cash. The law point is well established.
The recipient of the cheque is not responsible for any illegality or tax evasion done by the giver. It’s the issuer of the cheque who has to explain the source of his money,” Singh told the magazine. In other words, you can ask Singh about the source of his funds, but you cannot ask him about the source of his investors’ funds, because that is not his responsibility.
But starting this year, it may become harder to make this claim; a recent amendment to the Income Tax Act requires private companies to prove the source of their funds, and even the ‘source of the source’.
Another amendment requires that funds entering a private or public unlisted company’s books from the issue of shares at prices well above fair market value will be treated as income and be subject to tax. IT officials hope that with these amendments, the jamakharchi business will take a serious hit. But then again, don’t rule out the odds of enterprising accountants and business persons unearthing new and innovative ways to route illicit funds.
One last bit of information about LNP Ltd, with which we started off this story. In 2011, it acquired new investors, changed addresses and got a real job. It is currently part of a joint venture manufacturing high security number plates in various states.
__________________________
Comments
Post a Comment