For the past couple of months, the newspapers are full of reports about various types of scams and frauds—the Commonwealth Games’ inflated expenses, the 2G scam, the Adarsh Society scam, the housing loan kickbacks and the Karnataka land allotment scam, among others. One finds it difficult to even comprehend the magnitude of the mind-boggling amounts involved. Given past history, the perpetrators may ultimately escape or get away with a light punishment. Most taxpayers would wonder whether they even get away from paying tax on such ill-gotten gains?
There are provisions to tax illegal income. In the past, the courts have held that all income is taxable, whether earned by legal means or illegal means. In fact, the Supreme Court had held that while taxing illegal income, the expenditure incurred to earn that income was an allowable deduction. The ratio of that decision was nullified a few years ago through the insertion of a provision denying deduction of expenditure incurred for any purpose that is an offence or prohibited by law. Therefore, the entire gross amount of illegal income earned is now taxable, irrespective of whether it has been spent or not, or whether the loot has been shared with others.
The legal expenses incurred by the scamsters to defend themselves would also not be a deductible expense as it cannot be said to have been incurred to earn such illegal income.
What kind of income is taxable? There are also provisions to tax investments, money, bullion, jewellery or other valuable articles which a person is found to be owning, and the source of which he is not able to explain. Therefore, if an asset was acquired out of unaccounted money, the value of such asset can be taxed as income. Similarly, if an expenditure is incurred by a person, the source of which cannot be explained by him, such expenditure is taxable in his hands. Even a bribe paid by a company, which it has not accounted for in its books, can be taxed as its unexplained income.
Of course, where a valuable property is allotted by the government at a throwaway price (as in the case of the Adarsh scam), such benefit cannot be taxed. There was a provision to tax such benefits, introduced in the Finance Act, 2009, which was deleted by the Finance Act, 2010 before it became applicable. The reason for such deletion was that it would have affected a large number of genuine buyers of immoveable property, who booked a house under construction or agreed to purchase a house, which appreciated by the time they got its possession.
Theory versus practice: In theory, therefore, most illegal income is also subject to tax. In actual practice however, it is rarely that one comes across instances where such ill-gotten incomes are actually taxed and the taxes thereon recovered. If at all any action is taken against such persons, such action is taken in a manner where the tax demanded is struck down in appeals at the higher level on technical grounds. Is this on account of the influence wielded by such persons? The tax appellate process is also so long-winded and clogged with appeals filed by the tax authorities that it takes decades for tax disputes to be finally settled, by which time the magnitude and gravity of the crime also fades in most people’s memory.
The problem also is that the ill-gotten money is often invested in the names of relatives and friends of the perpetrators. The tax authorities are very often unable to track such diversion of funds, and to prove the lack of a valid source of income of the asset holders. The Benami Transactions (Prohibition) Act was enacted in 1988 for this purpose. There are provisions in this Act to acquire properties held benami (i.e. in another person’s name), but these provisions have not yet been notified as coming into force, almost 22 years after the law was enacted. Perhaps, the government has realized that given the tendency of bureaucrats to extract their pound of flesh, inherent safeguards have to be built into this legislation to ensure that it is not misused to harass the innocent. If so, why have such provisions at all, which are not practical?
Problem persists: The Direct Taxes Code also does not contain any solution to this problem. On the other hand, one often hears and reads of the ordeal that genuine small taxpayers are subjected to under these provisions for taxation of unexplained assets. It is perhaps the manner in which our tax laws are administered and the mindset of the tax authorities, rather than the tax laws themselves, which need to undergo a radical change.
Of course, the real problem with the increasing number and magnitude of scams is that these involve diversion of government funds (actual or potential) to private hands. Effectively, all the taxpayers bear the brunt of such diversion of government funds, through higher taxes (present or future), and taxpayers are, therefore, the ultimate victims of such scams. Are the taxes that we pay in India the price for civilization or for scams?
Gautam Nayak is a chartered accountant.
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