Tax Fraud

The American Heritage Dictionary defines Fraud as “a deception deliberately practiced in order to secure unfair or unlawful gain”. Fraud always requires a perpetrator, an act of deception by perpetrator with objective to enrich himself, a victim who suffers loss due to the targeted deception by the perpetrator.

But what is the fertile ground for a fraud to happen? The existence of the three conditions“Opportunity”, “Pressure”, and “Rationalization/ Justification” prepares perfect ground for fraud to take place. This is also described as “The Fraud Triangle”.

Every country in the world serves the nation with the help of taxes collected from the society in order to provide the right economic and social infrastructure for the nation to develop and prosper. By paying taxes the “Haves” contribute towards the welfare of the “Have-nots” in any society.

Tax fraud is when someone pays too little tax or wrongly claims a tax repayment by acting dishonestly.(such as declaring less income, profits or gains than actually earned; or overstating deductions) and results in loss to the exchequer.

Tax fraud is an activity commonly associated with an objective to create parallel economy by not paying due taxes and has direct relationship to loss to the Exchequer in its act of collecting due taxes by an entity chargeable to tax in a country.

Tax fraud is a world wide phenomenon and is practised by persons and entities who “HAVE”and not by those who are“HAVENOTS” . Fraud perpetrators are usually very educated, intelligent and persons of great means . Tax fraud by individuals are normally driven by mass rationalisation , pressure of high taxes and living costs and opportunity craeted by maladministration and complex tax mechanism in any country.

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Falsification of medical bills for claiming 15000/- a year as deduction by employees from his gross income in many cases is an example of a fraud by individual in India.

Tax fraud can be committed against any governmental or other organization that collects taxes, including the federal government, state governments, local governments or other taxing authorities.

Common Tax Fraud Methodology

1.Suppression/understating of personal Expenses: An example

The assessee was a member of an HUF of which his father was the Karta. He was married in December 1969 and was employed from 1-1-1970 at a salary of Rs. 4,500 per month. For the assessment year 1970-71, the assessee filed a return showing an income of Rs. 1,40,427. The ITO found that for assessee's marriage an amount of only Rs. 11,500 had been withdrawn from the HUF fund and that for domestic expenses the assessee had withdrawn Rs. 2,850 from his own books. The ITO noted (i) that the assessee had returned substantial income varying from Rs. 1.02 lakhs to Rs. 1.78 lakhs each year; (ii) that the total wealth of the assessee and his wife amounted Rs. 20.61 lakhs besides jewellery and other exempted assets; and that (iii) they were heavily insured and that the assessee was living in a grand style in a palatial bungalow with a number of domestic servants. Keeping in view these factors, the ITO concluded that the disclosed expenditure on account of household expenses and assessee's marriage was insufficient and added a sum of Rs. 21,150 as income from undisclosed sources to cover the shortfall in domestic and marriage expenses. Delhi High Court finally upheld an addition of Rs10, 000/- under section 69C of the Income Tax Act, 1961.

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Yadu hari Dalmia v.CIT, [1980] 4 Taxman 525 (Delhi),HIGH COURT OF DELHI

2.Deliberately underreporting or omitting income

a. The assessee-company H carried on business in gur and shakkar and also had income from commission agency. During the assessment proceedings, the ITO discovered that the assessee had been doing business outside the books of account and in that secret business the assessee had invested certain amount. The explanation furnished by the assessee was not accepted and under section 69, the impugned amount was added to the assessee’s income. The assessee did not deny before the Tribunal that it did indulge in business activities outside the books of account and that during the accounting year under consideration purchases had been made from a party M in the assessee’s own name as well as in a fictitious name. The Tribunal rejected the assessee’s contention that in view of the special course of dealings with the party M, no investment could be said to have been made from its own resources.

Himmatram Laxminarain v.CIT [1986] 24 TAXMAN 768 (PUNJ & HAR) HIGH COURT OF PUNJAB AND HARYANA

b. The assessee was engaged in the business of a commission agent and derived income by way of commission from the sale of vegetables and fruits on behalf of the farmers and traders. During the course of survey under section 133A carried out at the business premises of one 'J', certain documents were seized which transpired that the assessee had made sales of apples of certain amount to 'J'. Since the sale was not verifiable, the Assessing Officer had made addition of amount of sale holding that the assessee had made sales to J and invested his own unexplained money in the purchase of apples. The High Court ruled in favor of the revenue. CIT, Chandigarh-II v. Sanjay Chhabra [2012] 21 taxmann.com 221 (Punj. & Har.)

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c. The assessee was a wholesale dealer in liquor. The opening balance as on 1-4-1980 with regard to the two shops of the assessee was shown as Rs. 18,962. No purchases were made for the year before 6-4-1980. In spite of this situation, the accounted sales for the first five days of the year came to Rs. 2, 00,361. The ITO deducted profit at the rate of 5 per cent and called upon the assessee to explain in regard to Rs. 1, 72,761 as was necessary under the provisions of section 69 on the basis of inevitable inference that the amount would have to be understood as concealed income. The High Court Held that what was clear was that there were sales during the period from 1-4-1980 to 5-4-1980, without there being a stock sufficient enough for purchasing the quantity which was admittedly sold. The situation got more than affixed when there was material that the first consignment was received thereafter on the next day on 6-4-1980. 

CIT v. G. Anandarajan [1997] 228 ITR 664 (KER.) HIGH COURT OF KERALA

3. Making false entries in books and records (Bogus Purchases)

The assessee’s originally returned income was of Rs. 2, 10,460. It filed revised returns twice returning income at Rs. 3, 76,920 and Rs. 4, 21,920 before completion of assessment at the higher figure. The Assessing Officer also imposed penalty under section 271(1) (c) having found certain purchases made by the assessee through brokers as bogus, in view of the fact that the assessee had failed to produce the relevant records or whereabouts of the said brokers, as also, on the successive revision of its total income, the assessee having known that the department had discovered the bogus purchases, impliedly accepted the fact of

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concealment during assessment proceedings. The assessee’s appeal against the order of penalty was dismissed by the Commissioner (Appeals) and the Tribunal and the High Court.

Beena Metals v.Commissioner of Income-tax [2000] 111 TAXMAN 46 (KER.)

4.Concealment by Large enterprises (manipulation of the result with transfer price, cost increases such as provisions, optimization); Medium-sized companies (often hidden in presumptive regimes, simple evasion methods such as false invoices):

Corporate fraud in India rose 45% last two years:PTI Jan 14, 2015, 09.00PM IST the Economic Times

NEW DELHI: Corporate frauds rose by over 45 per cent in India in the last two years and the lurking risk has been dissuading global companies from investing in India, said a study.

Corporate frauds arose out of corruption, money laundering, tax evasion, window dressing, financial reporting fraud and bribery due to weaknesses in internal controls, scarcity of resources and over-riding powers of senior management, it added.

5.Providing false information to the I-T department about business income or expenses.

In the famous Satyam Computer Company case the Serious Fraud Investigation Unit concluded that the promoters overstated

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income and paid taxes on inflated income and interest to fool the investors and shareholders.

6.Deliberately underpaying taxes owed

On 22-5-1967, the assessee-firm received insurance compensation. The assessee deposited this amount with his bankers. This amount was later on withdrawn by the partners in the ratio of their shares. However, this withdrawal was not entered in the books of account.As a result, the ITO, while assessing the assessee's income for the assessment year 1968-69 could not know of this income and bring it to assessment. On getting information, the ITO issued a notice under section 148 on 31-12-1969. The assessee then filed his return disclosing the factum of receipt of amount from insurance company.In the course of hearing under section 143, the assessee agreed to the inclusion of Rs. 19,257. However, the ITO brought the entire amount of Rs. 28,680 to tax. Thereafter, the assessee was subjected to penalty under section 271(1). The AAC upheld the penalty order. On further appeal, the Tribunal observed that, the conduct of the assessee was contumacious with the sole intention to conceal the income or furnish inaccurate particulars thereof. The Tribunal was, therefore, of the view that the penalty was exigible. The fact that he had been assessed under section 41(1), which was a deeming provision, could not help the assessee because his conduct had been such that it displayed a concerted effort which was well planned to conceal the income or to furnish the inaccurate particulars thereof.Hindustan Tools Mfg. Co. v. Commissioner of Income-tax [1976] 102 ITR 174 (PUNJ. & HAR.)

7.Concealing and Transferring Assets

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In 1965 search and seizure operations had taken place which detected bogus hundi notes. The assessee agreed to surrender Rs. 2, 15,500, Rs. 23, 74,100 and Rs. 28, 46,200 in respect of the assessment years 1960-61, 1963-64 and 1964-65, respectively. Although an opportunity was provided to the assessee pursuant to a notice intending to impose penalty, the assessee did not avail of the opportunity and failed to show that the said amounts did not represent concealed income. Therefore, the Assessing Officer levied penalty under section 271(1) (c). The assessee did not file any appeal against the order imposing penalty. On the assessee's revision petition, the first appellate authority found that the penalties levied by the Assessing Officer were reasonable. However, on the facts and circumstances of the case he reduced the penalty amount to Rs. 1 lakh and, thus, partly allowed the revision petition.Krishna Kumari Chamanlal v.Commissioner of Income-tax [1995] 82 TAXMAN 323 (BOM.)

8.Overstating tax deductions:

In India , tax exemptions and deductions mechanisms are provided in the tax laws and a major area of tax fraud relates to deliberately manipulating and fabricating claims in respect exemptions and deductions. Since, these are detected only on physical examination of evidence, the same can be only reduced today with the help of intelligent, honest and diligent exercise of power by the tax administration authorities.

9.Keeping two sets of books – Rajesh Kumar & Others v. CIT, 287 ITR 91 (SC) :

In this case two sets of books of accounts were seized which revealed deliberate fabrication of income and expense items.

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Few examples of Ways in which assets or income may be fraudulently concealed:

Cash may be diverted to another entity

Inventory may be shipped to an off-site location

Assets or income may be shifted to another entity controlled by the debtor

Sales may not be reported properly

Payment may be made to fictitious persons

Claiming personal expenses as business expenses

Claiming false deductions

Hiding or transferring assets or income

Illegal money laundering schemes

Concealing and Transferring Assets

Some indicators of concealment include:

Transfers of property or large payments to related parties or individuals, such as insiders, shareholders, or relatives.

Frequent and unusual transfers between bank accounts, particularly between business and personal accounts.

Numerous transactions made in cash that normally are made on account (sales, purchases, etc.)

Unusually large and unexplainable payments to vendors.

Concealing and Transferring Assets

Unusual or rapid reductions in assets.

Increases in operating losses that are not explained by economic factors.

Inconsistencies between financial statements or tax returns and the official forms filed for the bankruptcy or records filed in divorce cases.

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Travel to offshore tax havens or locations that allow secret bank accounts.

Missing, inaccurate, or damaged records.

Money Laundering Process

AN EYE OPENER FACT:

India loses 14 trillion rupees ($314 billion) from tax evasion annually and 800 billion rupees a year because of corporate tax incentives ( eg. Tax holiday)

Areas of Tax frauds in India

In India, Department of Revenue, Ministry of Finance, government of India regulates the direct tax and indirect tax regime in respect of Union taxes such as Income Tax, Service Tax, Excise and Customs, Stamp Duty. In addition the States also impose and regulate taxes like VAT, stamp duty, entry tax etc. and Tax fraud can occur in connection with all these taxes.

Reasons & Methods

Weak Surveillance System

Rampant corruption in Tax Department

Complicated tax law and filing mechanism

Overbilling of purchase of raw material

Dummy salary entries created  

False petty expense entries ( person expenses as business expenses)

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Lobbying to government

Bribery of tax officials

Economics of tax evasion

In 1968, economist Gary Becker first theorized the economics of crime. It deals with the evasion of income tax. According to them, the level of evasion of income tax depends on the level of punishment provided by law.

Income tax evasion appears to be positively influenced by the tax rate, the unemployment rate, the level of income and dissatisfaction with government.

Other forms of tax evasion (e.g. VAT) Major falsifications (increase of VAT credits, sales without invoices)

Indian black money From Wikipedia, the free encyclopedia

In India, Black money refers to funds earned on the black market, on which income and other taxes have not been paid. The total amount of black money deposited in foreign banks by Indians is unknown. Some reports claim a total exceeding US$12.4 trillion are stashed in Switzerland.[1] Other reports, including those reported by Swiss Bankers Association and the Government of Switzerland, claim that these reports are false and fabricated, and the total amount held in all Swiss banks by citizens of India is about US$2 billion.[2][3]

In February 2012, the director of the Central Bureau of Investigation said that Indians have $500 billion of illegal

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funds in foreign tax havens, more than any other country.[4]

[5] In March 2012, the Government of India clarified in its parliament that the CBI Director's statement on $500 billion of illegal money was an estimate based on a statement made to India's Supreme Court in July 2011.[6]

Government response

The level of evasion depends on a number of factors, one of them being fiscal equation. People's tendency to evade income tax declines when the return for due payment of taxes is not obvious.(Invisible)

Evasion also depends on the efficiency of the tax administration. 

Corruption by the tax officials often makes control of evasion difficult. Tax administrations try to decrease these corruptions. These include, privatization of tax enforcement, tax farming, and institution of Pre-Shipment Inspection (PSI) agencies.

Efforts in Reducing and Controlling Frauds:

Through creation and simplification of Laws like Prevention of Money Laundering Act, Black Money Bill, FEMA, etc

Through Regulators like SEBI, CBDT, CBEC, and Investigators like CBI, Financial Intelligence Unit, NIA, Enforcement Directorate

Pre-shipment Agencies like SGS, Cotecna etc. are employed to prevent evasion of customs duty through under-invoicing and misdeclaration.

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Black money: Sebi bars 260 entities; suspects money laundering, tax evasion

In its biggest ever crackdown for suspected tax evasion and

laundering of black money through stock trading platforms...

By: PTI | New Delhi | December 19, 2014 10:34 pm THE

Financial Express In its orders, Sebi said that the modus operandi of the barred

entities typically involved stock market dealings aimed at evading long-term capital gains tax and showing the source of income as legitimate from stock markets.

“… the schemes, plan, device and artifice employed in this case, apart from being a possible case of money laundering or tax evasion which could be seen by the concerned law enforcement agencies separately, is prima facie also a fraud in the securities market in as much as it involves manipulative transactions in securities and misuse of the securities market,” the regulator said.

Sebi bars 129 entities; suspects money laundering, tax evasion

PTI Apr 18, 2015, 02.30AM IST The Economic Times MUMBAI: In a fresh crackdown on suspected evasion and

laundering of black money through stock markets, regulator Sebi today barred Mishka Finance and Trading Ltd and 128 other entities from the securities market.

While the total amount involved could not be ascertained, these entities are estimated to have shown fictitious capital gains to the tune of Rs 254 crore and just 29 of them made unlawful gains to the tune of Rs 92 crore on an investment of just Rs 2 crore.

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Rs 19k cr service tax, central excise duty frauds in 2008-11: CAG

PTI Mar 30, 2012, 09.07PM IST The Economic Times

NEW DELHI: Comptroller and Auditor General of India (CAG) today said that there over 10,300 cases of fraud involving over Rs 19,159 crore in service tax and central excise duty during 2008-11."In central excise, a total 3,690 cases of fraud or presumptive fraud were found during 2008-11 by the department involving duty of Rs 8,497.06 crore. In service tax, 6,655 cases involving tax of Rs 10,662.24 crore were detected during the same period," CAG said in two separate reports.

Black money: ED freezes properties worth Rs 9,003 crore

PTI | Apr 29, 2015, 06.40 PM IST The Times of India.NEW DELHI: In a major action against black money hoarders and money launderers, the Enforcement Directorate (ED) has attached assets to the tune of Rs 9,003 crore and  filed 173 charge sheets in the financial year 2014-15.

The agency, as part of its efforts to crack down on illicit funds in India and abroad, in the last year registered a mammoth 400 per cent rise in the numbers of assets attached, over 500 per cent increase in the number of criminal FIRs lodged, over 600 per cent more numbers of arrests made of people suspected to be involved in laundering crimes and more than 200 per cent jump in the filing of prosecution complaints or charge sheets as compared to the 2013-14 fiscal.

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Rs 4,733 Crore Collected in Taxes via Non-Filer

Monitoring System: Jayant Sinha

Press Trust of India | Updated On: May 08, 2015 21:40 (IST)

New Delhi: Government has collected Rs 4733.61 crore in taxes since 2013 through the non-filer monitoring system that tracks large value financial transactions, including those via credit cards.

"30,68,662 new returns have been filed and additional tax of Rs 4,733.61 crore has been collected from persons identified as non-filers by the Income Tax Department through its NMS in the year 2013, 2014 and up to March 31, 2015 in the year 2015," Minister of State for Finance Jayant Sinha said in written reply in the Lok Sabha.

The non-filer monitoring system (NMS) analyses all databases of in-house and third-party information available with the department to identify persons who have not filed returns even though they have carried out large-value financial transactions.

During 2013, 2014 and 2015 (up to March 31), NMS has identified 12.9 lakh, 22.09 lakh and 44.09 lakh cases, respectively, as non-filers having potential tax liabilities.

WHY of TAX FRAUD

What factors do provide the three elements of tax fraud; i.e. Opportunity, pressure and rationalization also known as the Fraud Triangle, in the Indian taxation context:

Are We Responsible For It?

YOUR PURCHASE ---VAT = WE DO NOT ASK FOR A BILL

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INCOME TAX- are you truly faithful in paying income tax?

Tax evasion VS Tax Avoidance – Greedy are making hay till sunshines, that is taking advantage of the thin line that separates tax evasion and tax avoidance

In USA, tax evasion is a crime --shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both

In INDIA, - shall be charged up to 3 times the amount of income concealed.

In India --Only 2 to 3 percent of Indians pay any income tax. (Around 36 million people)

U.S., about 45 percent of the population pays taxes

Efforts by Government in the direction of reducing tax frauds, corruption and economic extortion:

a. Tweaking the Income Tax Act, 1961 to plug the loopholes facilitating tax evasion, for example recent modification of meaning of “advance in cash for purchase and sale of immovable property”.

B.GAAR though postponed is expected to be made effective to curb the menace of black money

c. In India, Economic Extortion and Bribery are the major contributors to tax fraud. With simplification and online compliance, the impact is expected to reduce substantially

d. Adoption of technology in tax administration and Simplification of laws with rational tax structure is the goal for substantially reducing tax frauds in India

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e. A detailed study in improving the administration of tax regulation in India has been carried out by the Tax Administration Reforms Committee which has submitted its detailed study and recommendations in its first report in 598 pages on 30th May 2014 covering the reasons which facilitate the continuous presence of the three ingredients of Fraud Triangle in Indian Tax Administration and provide space for large scale tax fraud in India.

f. The Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, 2015, popularly known as black money bill was passed in Lok Sabha on Monday the 11th May 2015

g. The government of India is also moving a bill on benami tansactions as The Benami Transactions Prohibition Law to further check the menace of black money and reduce tax fraud in India.

h. Introduction of GST is expected to rationalize the tax impact on Indian public and entities and reduce the involvement of multi layers and complexity in taxation so that administration becomes simpler and allows less space for discretionary corruption.

The proposed levy will be a single tax that will cover all levies at the Centre and state level, including entry tax. It is a value-added tax, which means a levy at each stage of production, sale or consumption will be set off against taxes paid in the previous stage. Through a system of tax credits, those who are in the intermediate stages of a chain of production will get credits or refunds for whatever levies they have paid. This avoids cascading of taxes for the end consumer. Unlike the existing VAT, which is levied only on manufactured goods, GST will also include services.

When the system was first discussed, there was great enthusiasm. But, slowly states started raising objections. One

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reason is that finance ministers would lose control over the taxation system and be unable to give discretionary concessions. The other area of concern is potential loss of revenue from cash cows such as petroleum, which makes up for almost half the revenue for some states. There was also an element of bargaining in the states' objections.

Ultimately, it should result in a lower burden on consumers as the levy will be at the point of sale and central and the state taxes will be merged into one levy.

The incidence of tax in sectors such as real estate is expected to come down by 25% since companies will be able to claim credits or set-offs for taxes they pay on goods and services. In addition, the refund mechanism for taxes paid across the country is expected to be more efficient, thanks to the proposed IT backbone. Currently, industry complains that refunds and credits are tough to claim and even more difficult to get.

The tax system is expected to become more efficient, which should help boost the economy and hence revenue collections. Some estimates say the impact on the GDP growth rate could be between 0.9 and 1.7 percentage points. This will lead majorly in the direction of reducing tax fraud by reducing multiple handlers of multiple layer of discretionary taxation and by reducing incentive for tax evasion by rationalization of the cost of goods and services.

i. The world wide phenomenon is that the maximum frauds are detected by the tips and complaints received of some wrongdoing. This is evidenced by the report to the nations by ACFE. In India recognizing this fact a bill was introduced and an Act was enacted. The Whistleblower Protection Bill, 2011 is a novel legislation that provides for

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the public interest disclosure and protection to whistle blowers. Whistle blowing is the act of disclosing information by an employee or any stakeholder about an illegal or unethical conduct within an organization. Oxford dictionary defines a whistleblower as a person who informs about a person or organization engaged in an illicit activity. The Whistleblower Protection Bill is a bill that seeks to establish a mechanism to receive complaints relating to disclosure on any allegation of corruption or willful misuse of power or willful misuse of discretion against any public servant and to inquire or cause an inquiry into such disclosure and to provide adequate safeguards against victimization of the person making such complaint and for matters connected therewith and incidental thereto.

The Law Commission of India in 2001 had recommended that in order to eliminate corruption, a law to protect whistleblowers was essential. It had drafted a Bill too on this issue. In 2004, in response to a petition filed after the infamous murder of NHAI Official Satyendra Dubey, the Supreme Court directed that machinery be put in place for acting on complaints from whistleblowers till a law is enacted. The government notified a resolution in 2004 that gave the Central Vigilance Commission (CVC) the power to act on complaints from whistleblowers. Since 2004, CVC has received 1,354 complaints from whistleblowers. In 2007, the report of the Second Administrative Reforms Commission also recommended that a specific law be enacted to protect whistleblowers. India is also a signatory (not ratified) to the UN Convention against Corruption since 2005, which enjoins states to facilitate reporting of corruption by public

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officials and provide protection against retaliation for witnesses and experts. The Bill replaces the 2004 government resolution and sets up a mechanism to receive complaints of corruption or willful misuse of power by a public servant. It also provides safeguards against victimization of the person making the complaint.

Thus, the fight goes on against the tax fraud and the objective of substantial reduction of tax fraud is the goal of the nation.

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