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The trail: How is black money made white

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) 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.

(Graphic: Anand Sinha)

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.

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."