BLACK MARKET IN CONTEXT OF TAX EVASION AND ITS CONSEQUENCES ON

BLACK MARKET IN CONTEXT OF TAX EVASION AND ITS CONSEQUENCES ON Hina Sarfraz Author is student of LLB (III). She is member of study circle. Tax Evasion in Context of Black Market Black Market as the name suggests appears to be a matter of technical economics, finance and market phenomena. That it is. However, unlike the apparent connotation, this seemingly academic and technical subject has a simple but strong base in the human instinct to maximize financial self interest without regard to the constraints 1of ethics and law. The basis of Black Market is thus, in hearts and minds of men. Statement of the Problem: Pakistan is the country rich in natural and strategic resources. Yet, barring the present day scenario, it remained limping on the road to economic development. Many causes are ascribed to this scenario that range from issues of governance to a number of historical and situational factors. In the recent decades one area of focus in this context has been the role of Black market which is believed to be one of the major challenges for the economy at large. From the onset it is essential to define Black Market in clear terms. 2Slomanstipulates it to be “…( a market) where people ignore the government’s price and quality controls and sell illegally at whatever price equates illegal demand and supply.” The noteworthy content of the definition is the “illegal” aspect. How exactly does the illegality arise, is the next issue that requires attention. Perhaps the best exposition of the “illegality” is that “the underground economy, Black Economy, or Black Market consist of all commerce on which applicable taxes are being evaded. The market include not only legally-prohibited commerce( for example: drugs, prostitution, and gambling activities that are illegal in some countries), but also trade in legal goods and services because some income is not reported and consequently taxation is evaded, e.g., through 3money laundering, payment in cash (which can almost never be traced), or other means”. Thus, whether the economic activities in goods, services or production are in legal or illegal commerce the determining an differentiating factor towards identifying Black Market is primarily the tax-factor. Main Causes of increase in Black Market: The growth of the Black Market is associated with various factors, such as.- , Anomalies in Laws: The problem area pertaining to wealth statements is assets held in the name of some other person. The exact inception of the practice of “ benami”is not known but it is agreed that it has been in vogue from times immemorial and practically in all the countries of the world though under different labels. The practice is not confine to acquiring or holding of property in names other than those of the real owners but also extends to carrying on business in that fashion. Many causes such as fear, avoidance of taxation, fraud etc. account for the adoption of such a course 1 Richard Lipsey, and colins, First Principles of Economics, Second Edition (NY: Oxford University Press, 1994 ), 102. 2 Jhon Sloman, Economics, second Edition (NY. Prentice Hall, 2001) 98 3 Underground Economy Available from and yet all of these may not be illegal and immoral. The practice of “benami” is, therefore, recognized and protected in our system provided it does not offend the provisions of any law. The base of benami, in our system of law, lies in the Trusts Act,1882. There are two types of benami transactions 1- there is a real transaction as, for example, when A sells property to B but the sale deed mentions X as the purchaser. Here the sale itself is genuine, but the real purchaser is B, X being his “benamidar” who in legal terms is known as the ostensible owner. The other type is a sort of sham transaction, as, for example, when A purports to sell his property to B without intending that his own title should cease or pass to B. The fundamental difference between the two types of transactions is that whereas in the former there is an operative transfer resulting in the vesting of title in the transferee, in the latter there is no genuine transfer, there being no passing of consideration. The former type is covered by Section 82 and the latter by 4section 81 of the Trusts Act. Our system of law, therefore, duly recognizes the benami transactions subject to the following main exceptions: i. Bonafide transfer for value from the ostensible owner without notice of the real title of the real\beneficial owner is protected under Section3 of the Transfer of property Act, ii. Purchaser of property from the ostensible owner at court sale under section 66 of the Code of Civil procedure is protected, iii. When the transaction of benami is a fraud upon the creditors of the real owner, and iv. If the transaction is against public policy i.e., the purchaser is illegal or in other words prohibited y law or contravenes the provision of any law. There transactions can be enforced under the law by the real owner under Section 42 of Specific Relief Act by obtaining a declaration from a court of law. Of course in such a case the plaintiff i.e. the real owner has to prove the benami nature of the transaction and even the provisions of the Evidence Act\Ordinance do not stand in his way to give proof of his title as against the ostensible owner\benamidar. The real owner cannot be deprived of hi property in a benami transaction. The tax authorities, at present can utilize the information regarding benami transactions for taxation purposes but they have to prove against the real owner\beneficiary that the property held in the name of somebody else {benamidar) is 5really his. Analysis Of Tax Evasion: There are numerous causes which have contributed to birth an spread of evasion. Historically, the areas comprising Pakistan do not have a tradition of voluntary payment of taxes as the successive conquerors “imposed” taxes on the people and the question of acceptance of these levies by the tillers of the soil or the traders who contributed to the treasuries of the rulers was not even raised. In our history, tax evasion before independence was regarded as virtue- a contribution to the struggle for independence. After independence, the same attitude has continues. In fact, the rich people regard the government as an adversary and the taxes as an instrument of extortion. Even people who are deeply religious and righteous do not regard tax evasion as a vice, much less a crime or sin. 4 Trust Act 1872, Gazette of Pakistan amended adapted 1972. 5 Central Board of Revenue, National Taxation commission Report, December 1986, Islamabad, 112. Commercially, every person engaged in production or distribution of goods is a part of one big machine. His activities are inextricably linked with others and he cannot work or operate in isolation. In an economy where tax evasion has become a norm, it is almost impossible even for the honest ones to pay taxes correctly because they are forced to conceal those transactions which their suppliers or buyers do not want to put on record. Further, in society where the majority of those liable to taxation are evading taxes, those who are not doing so are also regarded as dishonest simply because it is not possible for the tax department to identify the honest tax payer. Thus an honest taxpayer reporting his income correctly is also subjected to similar treatment neted out to the dishonest. He, thus, ends up paying far more than he should have paid which discourages him for being honest and straight forward. In an economy based primarily on cash transactions, tax evasion is easy and its detection by the authorities difficult as cash transactions leave no trace behind. Since assessments are made long after the transactions take place, the authorities are unable to detect those not recorded. The Tax laws provide extensive Tax exempt Sectors. Income from agriculture though under tax net yet escapes major tax burden. In addition, the tax statutes grant exemption to a large number of other sectors like poultry farming, cattle farming, fishing and fish processing etc, apart from tax holidays to a host of industrial undertakings set up in the backward areas. Major parts, of Baluchistan, considerable parts of NWFP and the entire Northern Areas are beyond the scope of Tax laws. Sectoral tax exemptions enable the businessmen to show their taxable income as derived from tax-exempt sources. Also, exempt sectors and areas allow black money to appear as loans from those enjoying income from such sectors or areas. Loans from agriculturists and tribal people have become a common feature in the explanation of assets created with black money. The Tax policies as such need to be reviewed in this perspective, e.g., until the agriculture tax was not strictly enforce industrialists and traders were prompted, owing to lopsided tax policies, to show their income having been generated from agriculture and were exempted from taxation. Even now tax on agriculture sector is significantly lower and this practice of tax evasion still persists. In the public sector government employees are not allowed to work anywhere besides their main office. However, there are many 6persons who work at more than one place and do not report their income from the second job, which remains out of tax net. Repeated amnesties discourage an honest taxpayer who honestly pays taxes every year at the prescribed high rate while those who do not pay honestly pay taxes every year at the prescribed high rates while those who do not pay honestly, earn further income on the evaded tax. Over a period of time, the evaders are far richer than the honest taxpayer and be a worse disincentive for honest taxpayers. In short, the prevailing conditions not only encourage tax-evasion but also positively discourage honest tax-reporting. Forms of Black money: it essentially comprises two forms, firstly, those funds used, employed and generate for and by activities that are outright illegal such as narcotics, prostitution etc. This form of Black Market and its activities escape not only the state 7taxation network but also transcend all borders of regulatory control. The other form, 6 Central Board of Revenue, Natinal Tax Reforms Commission Report, Islamabad, 113. 7 For details see black Markets at www.wikepedia.com. which we are mainly concerned here, is the market which evades the taxation network is otherwise legal activities i.e. through deliberate tax evasion. Since tax evasion is birth point of Black Market. We need to delve into its meaning, forms and consequences. Broadly speaking, tax evasion means evading payment of tax legally payable on one’s genuine taxable income. It is done either by not showing one’s income atall( non- reporting) or showing less income than avoidance which means taking advantage of the loopholes in the law or stretching the rules and regulations without actually breaking 8them. Forms of Tax Evasion: Although it is Not possible to provide comprehensive details of the various methods of tax evasion, an outline of the basic techniques and methods of tax evasion include inter alia, A. Total Non-Reporting: This is the crudest but most prevalent form of evasion. Persons earning taxable income just do not file their returns, some out of ignorance, but mostly it is deliberate. This category includes not only businessmen but persons owning property, shares and other investments and even those drawing salary. Small shopkeepers, vendors, brokers, all belong to this class. Now a large number of daily wage earners like masons, carpenters( even the dock side labour) earn taxable income but file no return. B. Under Reporting: Most of the existing taxpayers resort to this type of evasion. They do file returns and pay taxes but declare only a part of their income. This under=reporting can take the following forms: i. Suppression of transactions: Importers, wholesalers, retailers etc. omit a substantial part of their transactions altogether. They neither record such purchases nor sales correctly. Similarly, manufacturers do not record a part of their production, thereby evading excise duty and sales tax where leviable. The prevalence of this form of evasion became evident when entering the latest amnesty scheme, many parties demanded amnesty against proceedings for evasion of custom duty, excise duty and sales tax. Their main argument was that bulk of the black money represents, evasion of these duties. ii. Under statement of sales: When an importer, producer, wholesaler or a retailer cannot conceal his sales quantitatively, he resorts to understating his sales price. They charge more than the amount for which they issue the receipts. Professionals, doctors, lawyers, architects etc. resort to this method. Many film stars receive a substantial part of their fees in cash as “on-money”. iii. Inflation of purchases: Where for any reason, the sale price is verifiable as in the case of contractors, suppliers etc., the method employed is over-statement of purchases. iv. Inflation of expenses: Like inflation of purchases, overstating the expenses is employed to reduce profits. Some times such expenses are debited although having not been incurred at all and some-times such expenses are debited although having not been incurred at all and some-times the amount claimed is shown substantially higher than the one actually expended. 8 Central Board of Revenue, National Taxation Reform commission Report, Islamabad 106. v. Under invoicing of exports: At times exporters understate the value of exports and receive the difference abroad from the foreign importers. Large export houses usually export to their own concerns abroad thus facilitating the process but commission for obtaining export orders is paid to dummy agents in foreign countries. vi. Over invoicing of imports: where import duty is not charged ad valorem, importers overstate their import price and obtain the difference abroad. Similarly, importers usually receive rebate or discount on their imports abroad. People, who receive commission (usually for indenting) from abroad, keep a part of it outside Pakistan. vii. Miscellaneous methods: a) Good debts are shown as bad debts. b) Capital expenditure is shown as a deductible expense in the revenue account. c) Stocks are under-stated and under-valued in order to conceal profits. C. Diversion of income: This takes many shapes but the more common methods are as follows: i. Acquiring income-yielding assets in the name of dependents or “benamidars” e.g. acquiring property or shares in the name of wife or children or dependents or even non-existent’ persons. ii. Making dependents and “ benamidar” partners in various firms. iii. Creating firms consisting of dependent, relatives or employees. There are very few registered firms all of whose partners are genuine. iv. Contractors showing bogus sub-contracts in the form of relatives/dependents. v. Large firms and private companies create agencies owned by dependents for sale/ purchase of goods dealt in by them or paying large amounts as salary/commission\ rent\ to dependent\ relatives of directors and shareholders. vi. Owners of cinemas, factories, etc. make fictitious leases to firms consisting of their dependents, relatives or give ownership rights to fictitious persons. The income on which tax has been totally or partly evaded is commonly called black money. Part of this money is utilized for consumption and part for hoarding or investment. The black money not consumed is utilized in one or more of the following ways: a) Utilized in business recorded in books which may be in the form of: i. Undeclared stocks ii. Undeclared capital investment iii. Unrecorded trade receivables iv. Fictitious loans/payables b) kept in cash in homes safes or bank safe deposits. c) Converted into gold, diamonds or other valuables. d) Deposited in banks in form of fixed deposit receipts in fictitious names. e) Converted into bearer bonds, Prize Bonds, Saving certificates etc. f) Invested in stocks\shares. g) Invested in real estate. h) Used for private lending. i) Used in furnishing bungalows, purchasing cars and other luxury items. Conclusion and recommendations: Illegal activities such as smuggling, corruption, Black-marketing, narcotics, informal legal jobs etc. constitute the underground economy. These activities are not in the tax net and have significant negative impact on social welfare of the country. Almost all the transactions made in the underground economy are through cash, e.g., payments to the contractual workers, transactions in illegal sales, transactions involved in smuggling and drug trafficking, cash payments to the shopkeepers who do not provide valid cash memos etc. in general, self employed persons are involved in tax evasion and underground economic activities because there is no 9formal system of documentation of self-employed persons and their activities. In attempting to address the challenges posed to the economy by the Black Market, the best referent is available in the form of the factors that promote Black Market activities; thus, the obvious beginning point is the regulatory milieu and in this context the tax system. Remove Loopholes in Laws: The controls in matters such as those falling in the domain of Benami transactions, Trust Act and other laws that provide grey areas to the tax evader and Black Market operator, can be made more effective by providing in the law that holding of a property liable to taxation in the name of another (benami) without showing it in the wealth statement filed with the IncomeTax Department by real owner would be a penal offence. In that event, the transaction should also be made unenforceable by the real owner as against the bemanidar. This would not offend the constitution. Provisions having similar import also exist in the Indian Income-tax law. - It may be pointed out that in Pakistan, assets are also held by taxpayers not in the name of any benamidar in the legal sense of the word but in the name of non-existent\ bogus persons. This is quite common in respect of bank deposits and shares. This practice can be checked by providing in the law that in cases where any assets are found to have been held in the names of non-existent\bogus persons, the aets involved may be forfeited by the Government. Improvement in labour laws: requires introducing laws favourable to the labour and compliable for the employers. Improved Documentation: the best weapon against continuing unhindered growth of the informal sector in laws enected to promote stringent documentation of as many economic activities as it feasible. These laws then nee to be enforced strictly so that they become a deterrent to migration to the informal sector. In Pakistan, uptill 2001 when the Income-Tax Ordinance of 2001 superseded the Ordinance of 1979,only corporate & 9 M. Ali Kemal, A Fresh Assesment of the Underground Economy and Tax Evasion in Pakistan: Causes, Consequences, and linkages with the Formal Economy professional entities like doctors\architects were required to maintain books of accounts and related documentation. Thus all taxpayers other than companies, doctors & architect could claim before the ITO they did not maintain any accounts\documentation whatsoever and the income tax assessing officer then would have no option but to determine the assessee’s total income in his best judgment. After the enactment of the Ordinance of 2001 however every tax payer is required to maintain accounts and documentation as prescribed by FBR for different categories of assessee’s. Taxation Reforms:- Tax system should be simple and easy to understand because loopholes in the complex tax system tempt people to evade taxes which they might pay otherwise. - Reduce the rate of direct taxes -Broaden tax base to compensate for reduction in rates -Integrate tax reforms with macro-economic reforms. Many an economic initiatives fails due to lack of congruence between the two. - Re-enact the Wealth Tax Act. It would also be very good idea to revive the wealth Tax Act originally enacted in 1963, albeit with very low rates of wealth tax. Such low rate would force taxpayers to declare all assets formally, including immoveable property that has become a heaven for funds that have suffered no tax and have been contrived illegally through the informal sector. Efficient Enforcement: Firstly, through checking and containing corruption -Effective monitoring by inter-alia integrating various departments such as excise, property registrars, etc with the taxation system. NTN and NADRA records can be linked through an information management system. Economic and Financial Regulations: Pre-dominance of cash transactions in trade and commerce is one of the main factors which assist under-reporting of income because such transaction are by their nature difficult to trace. As the system of tax assessment is based on a re-construction of past events, the scantier the surviving data or secondary evidence regarding the past situation, the more difficult it is to make a sound assessment. Attempts have been made in past by the income tax authorities to devise such mechanisms as may assist them in enforcing recording of cash transactions. The introduction of mechanical and electronic Cash Registers, and more so the mandatory maintenance of accounts envisaged in the latest CBR regulations, can serve the same purpose as these machines also permit easy verification of the periodic sale-volume. It is, therefore, suggested that use of Cash Registers may be made obligatory in certain types of businesses and the cost incurred compensated by allowing it as revenue expenditure over a period of two years instead of allowing it as depreciation allowance over a number of years as at present. Another remedy for this problem would be to put some legal restraint on the unlimited quantum of transactions which can be made in cash. This could be made effective by providing incentive to the buyer and seller in the form of tax rebates. Bibliography: -Trusts Act 1872 -Wealth Tax Act -Income Tax Ordinance -Law of Benami Transactions 1952 -NTRC (1986) Final Report of the National Taxation Reform Commission. -Sloman, John., Economics, Second Edition, Prentice Hall, NY. -Lipsey, Richard and Colins, First Principles of Economics, Oxford, 1994. -Ghausi, Sabihudin., The Hidden National Wealth, Dawn September 25, 2006. -Kemal, M.A., Underground Economy and Tax evasion in Pakistan, PIDE R.R. No 183,2003. -Kemal, M.A., Fresh Assessment of the Underground Economy and Tax Evasion in Pakistan:Causes. - Net Browsing List of Abreviations: CBR Central Board of Revenue ILO International Labour Organisation ITO Income Tax Officer NAB National Accountability Beareau NADRA National Data Base Registration Authority NTN National Tax Number FBR Federal Board Of Revenue