November 13, 2017
Amidst the dust and heat around tax havens and black money, the Reserve Bank of India is scrutinising dealings under the liberalised remittance scheme (LRS) that allows resident Indians to invest a maximum $250,000 abroad a year.
The regulator is raising new questions — probably driven by suspicion that the window has been misused to launder money.
Many have been asked to explain transactions in offshore unlisted companies set up under LRS, loans to such companies, use of properties purchased abroad and flow of funds from such companies back to India. A few MNC banks are even asking for an undertaking from customers that money remitted to a foreign currency account opened abroad under LRS would not be deployed in onwards overseas investments.
“RBI is raising queries based on the facts of each case. The income from investments through LRS is taxable in India…Technically, the source of income of a foreign company in which investment is made is outside RBI’s overview unless there is some evidence of money laundering,” said senior chartered accountant Dilip Lakhani.
How does one misuse LRS which was introduced in February 2004 to give well-heeled persons a chance to invest a slice of their savings abroad? Here’s what some have done — remit $250,000 to an overseas bank account, buy shares worth $100,000 of an unlisted company set up by service providers in a tax haven and lend the balance $150,000 to the tax haven company which repays the loan from its earnings.
So, how does it generate earnings? That’s where the laundering bit comes in.
Undisclosed wealth stashed abroad flows into the company which shows it as income from some trading activity. Having ‘earned’ the money, the company uses it to repay the loan; thus, $150,000 flows back to the LRS bank account as loan repayment amount. It’s one of the ways to regularise undeclared money lying abroad.
There are more aggressive ways to legitimise and bring back black money from tax havens. “For instance, you can set up a company under LRS using nominal amount.
Thereafter, income streams are generated in this overseas entity to improve its valuation by routing in undisclosed funds. After this, the overseas entity buys back shares from the individual, enabling large amounts to be remitted back to India,” said Moin Ladha, Partner at law firm Khaitan & Co.
NOTICES FROM ED
In order to avoid regulatory attention these transactions are routed through Foreign Currency Accounts created under the LRS.
“This is probably why AD (authorized dealer) banks are obtaining an undertaking from clients who states that the money being remitted to the account will not be used for onward investment overseas,” said Ladha.
As the hunt for black money goes on, persons who used LRS for regular transactions are also being asked to explain the dealings. Last week, many who figured in the Panama list received notices from Enforcement Directorate which has the power to arrest under antimoney laundering laws.
Typically, RBI issues notice seeking details and clarification and also gives opportunity to compound the technical lapses. “But, in case of Panama papers, notices came directly from ED and even to those whose investments were in compliance with RBI regulations,” said Lakhani.
In some cases funds are brought back as FDI (foreign direct investment) to Indian companies. If money flows back as dividend (paid out by an LRS company), it’s taxed at 15%. However, tax can be evaded entirely if the offshore LRS entity invests the amount as equity of a company India. RBI has pulled up many in the past one year with the regulator viewing such transactions as round-tripping of fund.
According to Mitil Chokshi, senior partner at Chokshi and Chokshi, the LRS remittances are being closely examined by RBI across banks for the genuineness of the purpose and remittances.
“There have been strategies by individuals or companies to invest into companies overseas in lower tax jurisdictions with an aim to shift profits but new rules have made it tougher,” said Chokshi.
Taking advantage of tax provisions has been occasionally confused with sharp practices. For instance, several Indian families had bought unlisted firms in British Virgin Islands (BVI), a tax haven, to acquire properties in the UK. BVI became a preferred destination because till mid-2017 BVI holding companies were spared capital gains tax by the British government.
Some of them have also received notices from ED even though the investments were disclosed to the tax department.
ODI ROUTE TO REMIT
Since 2013, individuals remitting money have the option to invest abroad as per RBI rules on overseas direct investment (ODI) which till then applied only to companies for investing abroad. A person who is a sole proprietor in a firm can use this route as ODI rules allow an entity to remit as much as four times its net worth. However, remittance under ODI (unlike LRS) is permitted only for business purpose. Thus, buying properties (through ODI) using an unlisted entity abroad can now be justified only if the investor can explain that the property would be used for business purpose.
[The Economic Times]