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With 99.3% of banned notes back as stated by central bank RBI, can we conclude that demonetisation was for nothing?

With 99.3% of banned notes back as stated by central bank RBI, can we conclude that demonetisation was for nothing?

No, we can’t. This is going to be a long one, so, I humbly request you to kindly bare with me.

(6–7 minute read. Implore you to read till the end.)

Modi, on his 7th Nov speech vaguely referred to 3 target areas which he sought to remedy with Demonetization, which were-

  1. Black Money, primarily.
  2. Terror financing.
  3. Fake note menace.

  1. Black Money
  • The most common complaint against Demonetization has been the return of cash into the system. This has led some people to interpret Demonetization as some sort of a purging exercise and that the resultant money is squeaky clean.

Nothing could be further from the truth.

A bit about how Income Tax works and how long does collection of taxes take

These are some of the modes of collection of income tax-

  • The most unpopular and widely hated way is through the TDS.
  • Applicable to Self Employed Businesses and Professionals- Self Assessment Tax, Advance Tax.
  • Other Routes- Tax Collected at Source.

As you might have gathered, not all people pay taxes properly, as and when they are required to. Therefore, the Income Tax department cross checks the details submitted in the returns with other information that it gets it’s hands on via various routes, inter alia, including submissions from the taxpayer himself. This procedure of ascertaining the correct tax liability is called an assessment.

Assesments can be broadly divided into two parts- Summary Assessment & Scrutiny Assessment.

  • Summary Assessment– sort of like a Preliminary Examination. Mundane Mistakes are weeded out at this stage like arthmetic errors, TDS mismatches and so on. The officials/software could either send a Notice(to request more details) or an order to complete the ‘Summary’.
  • Scrutiny Assessment– This is serious business. The officer goes through every number, every explanation, every justification in great detail. He may call for more information, summon such other people as he may think fit. At the end of this procedure, he issues an order recomputing the Income and imposing such Tax, Interest & penalty, if any.

Typically, it takes close to 2 years for the abovementioned procedure to meet it’s rightful conclusion, which is also the legally allowed time limit for completion(21 months to be precise).

Translated into English, returns filed in the aftermath of Demonetization, the assessments would only be completed by 31.12.2018.

The fun part- the taxpayer, if aggrieved by the order, may prefer an appeal with the higher authorities which could last anywhere between 1 year-5 years, depending upon whose doors the taxpayer chooses to knock.

Therefore, all the post Demonetization proceedings, additions, demand orders, assessments have not even completed 50% of their tax lifecycles. Those are still cruising through stage 2 i.e. the Scrutiny Assessment.

Bonus fact- the order copies of the proceedings upto the Assessment (Summary+Scrutiny) & 1st appellate authority-Commissioner of IT(Appeals)- cannot be made public. Order copies of only the second level appellate authority-ITAT- & above can be made public.

{Therefore, the ones that are claiming that it was a failure would not even have the data required to arrive at such a conclusion}.


Information is king in the world of any law enforcement authority. A return is just one of the many ways the tax department gets its information from. Other prominent places include, inter alia, the authority responsible for registration of sale & purchase of property, Banks & other Financial Institutions, Jewelry merchants, other law enforcement agencies, Businesses & so on. These persons are required to file an additional statement called the Annual Information Return(AIR).

However, in order to bolster the existing framework of the AIR, and, enable the department to get information relating to the deposits during Demonetization, in a time bound manner, new provisions were added. Instance, this-

Cash deposits during the period 9th November, 2016 to 30th December, 2016 aggregating to—
(i) Rs. 12,50,000 or more, in one or more current account of a person; or
(ii) Rs. 2,50,000 or more, in one or more accounts (other than a current account) of a person.
(iii) Cash deposits during the period 1st of April, 2016 to 9th November, 2016 in respect of accounts that are reportable.

Persons who are required to report:
(i) A banking company or a cooperative bank

(ii) Post Master General as referred to in clause (j) of section 2 of the Indian Post Office Act, 1898

By virtue of these provisions, among others, IT department was able to get it’s hands on comparative information, which is capable of being used to fix culpability since the pre Demonetization data could be used to set a benchmark to compare the post demonetization activity with.

Armed with a truckload of rich information, the Government has :

  • Identified about 18 L suspect cases where transactions could raise a stink
  • been able to bring close to ₹ 30,000 Crores under tax net by way of disclosures & seizures[1]
  • identified 13.33 L accounts belonging to ~9 L persons, netting ₹ 2.9 L Cr, where notices have been shot off and response has been sought(Yes, scrutiny assessment)[2]
  • unearthed over 14000 properties valuing over ₹ 1 Cr, the owners of which had not even filed Returns of Income. [3]
  • revved up the number of search proceedings(a Raid, sort of) from 447 to 1152 in a pre & post Demonetization context.[4]
  • ramped up the number of surveys by 300% to 12500+(sort of like a Pre-Assessment proceeding that usually leads to reopening of Prior Assessments and admission of concealed Income) [5]
  • managed to achieve remarkable uptick in the Tax Compliance, not just in the number of people filing returns but also the Number of People paying Advance Tax, TDS & Self Assessment Taxes.
  • managed to clock above 15–20% YoY growth rates in collection of Income Taxes. This is no mean feat.[6]
  • managed to steadily increase the buoyancy of tax collections{Growth in Tax Collections/Growth in GDP} to ~1.7(+). Meaning, every % point growth in the GDP will realize a 1.7% growth in the net tax collections.[7] Read more about that here.

TAKEAWAY-

Since most accounts are still in 2nd stage and not yet complete, the process is a long time coming from being able to be judged.

The orders will start going out from mid September & early October extending all the way upto December. This will get reflected in the Tax Collection data of 2018–19 & 2019–2020.

So, everyone claiming that all the money in the banks is now white is either shooting from the hips or woefully ignorant about how assessments work in the context of Income Tax Act.

Rest Assured, the Income Tax department isn’t stupid, and, the money that made it’s way into the Bank is not white!


Second Charge against the exercise was that intermediaries were employed to get in line by the wealthy hoarders of Black Money.

While there is no denying that such a method was used, but, to think that such a crude method was employed to launder close to 16L crores is plain facetious. Not to take away the fact that such crude methods are always fraught with logistical nightmares & could lead to potentially loss of all that money should the conduit turn their backs on the kingpin.

An important aspect of being rich is always being somewhat less stupid. And the above method done on large scale is just plain stupid.

This method could have been employed by the uneducated Slumlords & other hoodlums who have the kind of loyal manpower at their disposal, but the quantum of their collective Black Money might, at best, run into a few thousand crores.

NB: These transactions are subject matter of Benami Transactions Act. If caught, such benamidar will be required to pay around north of 70% in Taxes.

However, a few very efficient laundering schemes that have been extensively used in the past and how have they been bucked in the recent past

  • Using Slumfolk to launder unaccounted cash: Companies followed this smart idea of using less fortunate people with no tax history to launder money.
    The M.O- The errant companies usually gathered a bunch of people, typically slum-dwellers and got their basic KYC done. Then, probably with the help of an employee of the Bank, Companies opened large number of Bank Accounts.
    Thereafter, the companies deposited ~ 2.5 L in the bank accounts, and, using the same money applied for the shares in their own company.
    At this point, the Company is sitting atop (2.5L * No of Inidividuals) of laundered cash. The process however is not yet complete.
  • The companies then makes fake calls for further deposits from the applicants for shares, who do not pay up leading the company to forfeit the application money under the pretext of non payment of calls.
  • Following the above steps, the companies laundered money bucking the legal framework.
  • Bonus: The forfeited money was not taxable under Income Tax(The difference between capital expenditures and revenue expenditures).
    The Income Tax officers could only stand watch since persons making deposits earned less than 2.5L. The Company could not be compelled to give details of the persons making the deposit( This was due to a court ruling).

Post Demonetization:

Cash credits.

68. Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year :

Provided that where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless—

(a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and

(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory

That scam has now been laid to rest!

Method 2: Shell Companies & Value Inflation

Another very rampantly used method. Letterbox companies would be floated, typically in Mumbai, Delhi & Kolkata(most prominent). Shares would be bought for a very nominal sum.
Then, the books would be fudged with bogus transactions thereby strengthening the financial position on paper. Cash would be laundered and deposited into the Bank Accounts. Parallelly, the owners & their representatives would also indulge in fictitious Buy/Sell transactions in shares of company, thereby, perking the value of the share up with every transaction. This way, one step at a time, a lot of cash would be laundered gradually over a period of 3–5 years typically. Then, using the long term capital gains exemption, which was available hitherto, pocket all of the laundered money without paying a penny in Income Taxes. (The long term capital gains exemption is also done away with w.e.f 01/04/2018.)

Post Demonetization:

With the introduction of GST, cooking books has become much more difficult than it already was due to the stringent invoice rules under which issuing invoice with value upwards of 50K/transaction has been made mandatory. Coupled with the mandatory requirement of filing invoice wise details of sales & purchases has dealt a body blow to easy fudging of books. This part has hit a lot of unruly traders in India and had to face stiff resistance before its promulgation.

Also, a Special Task Force under the joint chairmanship of the Secretaries of the Ministry of Corporate Affairs & the Ministry of Finance was constituted in order to tackle the shell company problem. And, the Government and it’s agencies have:

  • Struck off 2.25 L companies off the register of companies.[8] [9]
  • Disqualified over 3 L directors for not failing to comply with the requirements of the Companies Act, 2013[10]
  • Invoked the Serious Fraud Investigation Office to look into the matters of the companies[11]
  • made it mandatory to disclose the amount of cash deposited during Demonetization on their Balance Sheet & Profit & Loss Accounts[12]
  • Put out a list of companies you should be wary of dealing with[13] check for companies in your area using the link.
  • Put out a list of Directors who are disqualified from holding Directorships[14]You can check the names of the Directors from your area using the given link.
  • Outlawed having more than 2 layers in their Corporate Structure for the purpose of Investment in order to curb obscure corporate structures.[15]
  • Constituted a super regulatory-NFRA- authority to keep the CA, CS, CWA in check.
  • via the Enforcement Directorate, conducted raids across the country at over 110 locations spanning all major metro cities. Benami Transactions will be invoked on whoever is found guilty.[16]

Method 3: Treaty Shopping

Another time tested way was to route the money out of India by Hawala networks, and then bring the money back into India via shell companies registered in Tax Havens such as Mauritius, Cyprus and some times, Singapore. The exemption from payment of any tax in India was the chief allure of the famed Mauritius route. However, the Mauritius route was sealed in May of 2016. Other routes also followed suit behind it.

Sealing of these tax-free routes has probably had an effect on the levels of deposits in the Swiss Banks.[17] [18]


2. Terror Financing

I’m no expert on issues concerning national security, so I would refrain from making long commentaries on the efficacy of the exercise.

However, I would like to quote a few news pieces in order to drive home a point that demonetization indeed had a good effect on Terror Financing as well.

  • A record number of over 276 maoists had surrendered post Demonetization. This was unprecedented.[19] [20] (Don’t go by the headlines for link no. 20. That’s the Indian Media for you)
  • The Insurgency in NE India & Maoists were set back by 800 Crores due to Demonetization [21]
  • Kashmiri Militants- were in a real scramble. They had to resort to robbing ATMs, Banks and also stealing guns because, there’s no Azaadi without the money [22]
  • 90% decrease in stone pelting incidents: DGP, J & K.[23]
  • NIA got it’s hands on incriminating material leading to several raids across Delhi-NCR and the epicenter of Terror itself-Srinagar, J & K. Led to the busting of Hawala networks which contributed to the above decrease and led to arrests of several people connected with the Money trail.[24]

Normally, this is the Hurriyat time of the year, when it issues a calendar for protest dates, and detailed SOPs. Coincidentally, this is also the time of the year when Kashmir gets a lot of tourist footfall. Therefore, Hurriyat’s M.O is to choke the population of the cashflow and income, in order to get them to revolt and do nasty things destroying their collective futures. However, we have not heard a lot of untoward incidents this & the previous years as compared to the 2016 year.


3. Counterfeit Currency, High Value Notes

Counterfeit notes have shown a marked decline from being pegged at 7.62 L pieces in pre-Demo days to 5.21 L pieces in the post demo phase. That’s a neat ~32% gain.[25]

  • #Introduction of a Higher Value currency
    • This is another pet peeve of the critics of the demonetization. This is a legitimate concern since it makes hoarding black money twice as easy as it was with 1000 notes.
    • However, the post Demonetization phase is seeing a steady decline in the High Denomination Notes as a % of Total Notes in circulation.
      The pre demonetization High Denomination Notes to Total Notes stood at 86.4%, while, the post Demonetization one stands firm at 80.4%.[26]
  • #The Infamous ₹ 2000 note
    • The supply of 500 is being beefed up by the month. 500 now stands at double the demonetization levels at 42+ %.[27] [28]

4. But Black Money doesn’t exist in the physical form. It exists in the form of Real Estate, Jewelry etc.

  • This claim is a valid one. However, artificial inflation can be kept up only if the cash is in steady supply. But, post demonetization, the system was in a state of supply shock due to which the realty developers undersold their assets leading to the fall in prices of various assets. Perhaps, Real Estate was the hardest hit sectors.
    This is the reason why property prices fell after demonetization.[29]
  • Acclaimed property consultants and researchers claimed that price of properties could fall by as much as 30% due to Demonetization.[30]
  • Demonetization also hit the secondary market pretty bad leading to cheaper properties thereby making lives easier for the homebuyers.[31]
  • Thereafter, the government passed the Real Estate (Regulation & Development) Act, which has made further strides in formalizing the sector & protecting the Buyer. Under RERA, the builder is required to deposit 70% of the booking money in an escrow account and issue a receipt to the Buyer. This gives an idea of the Revenues of the Builder by simple extrapolation.

A few more hits Demonetization managed:

  • Demonetization led to formalization of savings
    • In and of itself, this is not the mindblowing news you want to hear, however, put in perspective, this is a great inflection point in the economic future of India.
    • The Equity funds saw a steady flow of 2.86 L crores as against 1.35 L crores seen in the previous year.[32] The above was also achieved because of the slash in the Interest Rates on fixed deposits & Savings Bank account.
    • The gross Asset under Management reached 21.41 L crores, an all time high, and the equity AUM reached upwards of 6.5 L Crores.
    • The money in these funds, is then invested in the Public Offerings floated by companies in order to finance their new project requirements. This money is the fuel that propels the economic growth.
  • Demonetization & Interest Rates
    • Awash with funds, the Banks lowered lending rates on fresh loans, thereby making the cost of doing Business cheaper.
    • The RBI had, during 2014–16, reduced 1.75% in repo rates, however, that had translated in only 0.5 % reduction in lending rates.
    • Post demonetization, a mere reduction of 0.25% in repo rates, has resulted in the same effect of reduction of 0.5% in lending rates.[33]

If you have stayed on till here, can only mean either of the two things- You’re one big fan of it, or, a vehement critic. I hope, I have been able to do justice to the sensibilities of both types of people, since I’ve based the entire answer on facts, and not opinions.

They say, it ain’t over till the fat lady sings, and, I can vouch that she hasn’t sung, yet.

In my humble opinion, it would be extremely wrong to proclaim it was all for nothing. The facts are there for you to see. I hope you had a good time reading.

Footnotes

[1] Cash deposits of ₹ 2.89 lakh crore post demonetisation under I-T dept. radar

[2] Cash deposits of ₹ 2.89 lakh crore post demonetisation under I-T dept. radar

[3] Cash deposits of ₹ 2.89 lakh crore post demonetisation under I-T dept. radar

[4] Cash deposits of ₹ 2.89 lakh crore post demonetisation under I-T dept. radar

[5] Cash deposits of ₹ 2.89 lakh crore post demonetisation under I-T dept. radar

[6] What demonetisation did to tax collections

[7] What demonetisation did to tax collections

[8] Ministry of Corporate Affairs (MOCA) identifies more than one lakh directors of shell companies for disqualification

[9] Govt cancelled 2.24 lakh suspected shell companies post demonetisation, disqualified 3.09 lakh directors – Firstpost

[10] Govt cancelled 2.24 lakh suspected shell companies post demonetisation, disqualified 3.09 lakh directors – Firstpost

[11] http://www.mca.gov.in/Ministry/p…

[12] http://www.mca.gov.in/Ministry/p…

[13] Ministry Of Corporate Affairs

[14] List of Disqualified Directors u/s 164 (2)(a)

[15] http://www.mca.gov.in/Ministry/p…

[16] How Modi’s crackdown on shell companies has waged war on black money post demonetisation

[17] Deposits by Indians in Swiss bank accounts down 80% during NDA tenure: Govt

[18] Money held by Indians in Swiss banks fell by 34.5% in 2017

[19] Maoists worst hit by Demonetisation – The Sunday Guardian Live

[20] Maoist papers show how note ban didn’t hurt them

[21] Demonetization has hit terror funding

[22] Jammu and Kashmir bank robberies reflect just how hard militants were hit by demonetisation – Firstpost

[23] 90% dip in stone-pelting incidents in Kashmir in 2017: J&K DGP – Times of India

[24] Hurriyat, hawala raids are a body blow to terror funding network in Kashmir

[25] Cut the politics, D-Street says cash ban was worth it & why!

[26] Cut the politics, D-Street says cash ban was worth it & why!

[27] Reserve Bank of India

[28] Cut the politics, D-Street says cash ban was worth it & why!

[29] http://Property prices fell afte…

[30] Impact of Demonetisation

[31] http://Demonetisation hits secon…

[32] http://Inflows in equity mutual …

[33] The impact of demonetisation on interest rates