This article is being reproduced in our website with the permission of the author, Dr Arun Kumar.

The Panama Papers trail may or may not result in prosecutions. Liberalised fund flows have not only made India a net loser but they have also changed the notion of what is legitimate.

Out of more than 11 million leaked documents of Mossack Fonseca, a legal firm operating out of Panama, a tax haven, only 36,000 pertain to Indians — 0.33 per cent of the total. This insignificant number contains the names of 500 Indian entities, some of whom have stated that their names have been misused while some others have denied any wrongdoing. Some officials have also argued that the papers need to be studied to distinguish between the legitimate and the illegitimate. This has given a breather to the entities named in the leaked papers. The general impression is that anyone using the tax havens for their financial affairs has something to hide.

The question of legitimacy arises since after 2003 when the Liberalised Remittance Scheme (LRS) was introduced, sending funds abroad for a variety of reasons is not illegal. The amount allowed has varied and at present the limit is $2,50,000. Thus, one could have money in a bank, have a subsidiary, buy shares in foreign companies, etc. The issue remains whether it was legitimately done and if transactions other than the legally allowed ones took place via these instrumentalities. While the names and the year of activity are revealed by the documents, the annual transactions or movements of funds are not known. Thus, even if what has come out in the open was legitimate, what else was done and has not yet been revealed requires investigation.

Liberalisation of fund flows

The Foreign Exchange Regulation Act (FERA), that was in force till 1998, was stringent and did not allow Indians to take money out of the country or to keep funds outside the country without permission. But after the implementation of new economic policies in 1991, FERA was diluted and easier flow of funds from and to India allowed. The Foreign Exchange Management Act (FEMA) was enacted in 1999 and the Prevention of Money Laundering Act (PMLA) in 2005. What was a criminal act under FERA has now become a civil offence.

Trade account convertibility was introduced after 1991 and, subsequently, current account convertibility; but not capital account convertibility. Thus, after 1991, a limited amount of proceeds from international transactions could be kept outside. Committees headed by S.S. Tarapore twice recommended capital account convertibility in 1997 and 2007. However, due to the Southeast Asian contagion in 1997 and the global financial crisis starting 2007, this was not implemented. So, restrictions on Indians taking capital out of the country have remained.

People want to hold funds abroad for many reasons. They may have earned them from illegal sources or want to hide their trail of ownership for business reasons or if they earn the money abroad or purely as a hedge against risk and/or in expectation of higher returns. The first two involve some illegality. The third may also involve some illegality but the last two may be legitimate activities. However, even in a legitimate activity, some rules may be flouted so that illegality occurs and prosecution is called for. For example, taking out money is not illegal but if more has been taken out via under-invoicing of exports and deposited in one’s account or if the money taken out legitimately was used to set up a company or one has not declared the income for tax purposes from the funds taken out, then prosecution becomes legitimate.

A large number of the well-off Indians have used the tax havens to shift funds out of India. The data from the Panama Papers and earlier from LGT Bank of Liechtenstein and HSBC Bank showed that not only big businessmen but also small ones and professionals have indulged in this activity. Politicians and bureaucrats also moved some of their ill-gotten gains abroad. According to our study, the opportunity cost of such funds for the Indian economy amounts to around $2 trillion between 1948 and 2012. A part of these funds have been round-tripped back to India, especially after 1991. While this may be considered beneficial, the outflow has accelerated during this period, so the country continues to lose capital. The reason is that as the flow of funds has been liberalised, it has become easier to mask the illegitimate flows. The fact is that while 6 per cent of the gross domestic product is leaking out of the country via flight of capital, only 2-3 per cent comes into the country as foreign investment (including round-tripping). Not only is India a net loser, liberalised flows have changed the very notion of what is legitimate and what is not, complicating prosecution and confusing the public. Loopholes deliberately created, such as the Mauritius route and Participatory Notes [instruments issued by registered foreign institutional investors to overseas investors who wish to invest in the Indian stock markets without registering themselves with the market regulator] which encourage inflow of capital also encourage more flight of capital. The inflow of such funds also spawns illegality in the country such as drug trafficking. It leads to speculation in the stock markets and makes them unstable. The benefits of liberalisation do not outweigh the loss to society.

Prosecution easier said than done

Given the scale of flight of capital from India, what has been revealed now is the tip of the tip of the iceberg. Panama is only one of the 90 tax havens. Thus, it is likely that the entire financial operations of those whose names have been exposed are yet to be revealed. Further, out of the lakhs of Indians who could be holding funds abroad, data for not even 1 per cent of them have been leaked in all the cases of stolen data or declarations under the amnesty announced last year.

The stolen data, even though sketchy, leave the reader bewildered. The salient feature that emerges is that funds are routed abroad via tax havens and use the process of ‘layering’ to hide the trail. Leaked papers further reveal that Mossack Fonseca was connected to various tax havens (such as British Virgin Islands and the Bahamas) and helped its clients hide their identity. If one works out the proportions, the 11 million documents possibly refer to 1,50,000 entities globally. Many of these entities, though not listed as Indian, could have Indian beneficial owners.

So prosecution is not going to be easy unless the government is proactive and finds out the details of the annual transactions of the 500 entities named (even if the accounts are closed now) and also finds out who else has not been exposed because of ‘layering’. The Panama government, and through it Mossack Fonseca, have to be forced to allow access to more data. The government has to investigate those who have been travelling to Panama or meeting Mossack Fonseca agents in India. That is how Bradley Birkenfeld was caught by U.S. authorities which then led to the prosecution of UBS Bank in 2007.

Even if technically one cannot prove that money was taken out or kept abroad illegally, what is the implication of taking money out to a tax haven and not keeping it in India? Inequity rises when the well-off escape taxation and that leads to poor infrastructure and higher indirect taxes. Indian tax rates are now moderate and hardly a cause for people to take capital out. This rising injustice and inequity due to flight of capital has not spurred action because almost all political parties and/or people close to them are involved in this activity. What has happened in Iceland [where the Prime Minister stepped down after his family was named in the Panama Papers], is unlikely to happen in India.

The problem is in India, and not abroad.

Arun Kumar is Retired Professor, JNU, and was the Indian team member of a global study of tax havens conducted jointly by five institutions.

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