ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020

Under the Guidance of M K YADAV

UNIT 1: MONETARY AND CREDIT POLICY

1.1 BASIC CONCEPTS

1.1.1 MONEY
 Money is anything that is generally accepted as a means of payment in settlement of all transactions.
 It can be paper currency, coins, cheques, bank deposits, crypto currency etc.

1.1.2 FEATURES OF MONEY

 Acceptability: Everyone must be able to exchange the money for goods and services.
 Durability: Objects used as money must withstand physical wear and tear.
 Portability: People need to be able to take money with them as they go about their business.
 Divisibility: To be useful, money must be easily divided into smaller denominations, or units of value.
 Uniformity: Any two units of money must be uniform or same in the terms of what they will buy.
 Limited Supply: Money must be available only in limited quantities.

1.1.3 FUNCTIONS OF MONEY

 Primary Functions: Primary Functions are the most important functions of money, these are:
1. Medium of Exchange:
 Because of its general acceptability, money serves as a ‘common medium’ of exchange.
 It provides general purchasing power to the money holders ie. People can directly buy goods
and services from the market without having to convert money into anything else.
 This function has removed the major difficulty of lack of double coincidence of wants
associated with barter system.
 It allows purchase and sale to be conducted independently of each other.
2. Measure of Value (Unit of Account):
 Money serves as a common measure of value (or common denomination) in terms of which
values of all goods and services are expressed.
 This makes meaningful accounting systems possible by adding up values of wide varieties of
goods and services, whose physical quantities are measured in different units.
 This allows for direct comparison between prices of different commodities and determining
their exchange ratios.

 Secondary Functions: These functions are derived from primary functions and, therefore, they are also
known as ‘Derivative Functions’.
1. Standard of Deferred Payments:
 It serves as a standard or unit for the settlement of future monetary obligations.
 This applies to payment of interest, rent, salaries, pensions etc. It has simplified the borrowing
and lending operations.
 Money, through this function, helps in capital formation and economic development of the
economy.
2. Store of Value:
 Money is a way to store wealth i.e. money is an asset.
 Money can be used to transfer purchasing power from present to future.
 This function is derived from the use of money as a medium of exchange.

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1.1.4 TYPES OF MONEY

 Full bodied money:
- It is the type of money whose commodity value is equal to the money value.
- For example, the market value of the silver/copper contained in the coin being equal to the face
value of the coin.
 Token Money:
- It is the type of money whose money value is more than the commodity value.
- For example, paper note of Rs. 2000, its money value is far more than the cost of the paper used to
make the currency.
 Representative Full Bodied Money: It is a type of token money, issued against the backing of equivalent
value of bullion (precious metal) with the issuing authority.
 Fiat Money:
- It is the money which is issued by the order/authority of the government.
- This includes the money that people in a country are legally bound to accept.
 Fiduciary money:
- Fiduciary money is the money which is accepted as a medium of exchange because of the trust of
the payer and the payee.
- For example, Cheques or cryptocurrencies are accepted based on trust, rather than by order of the
government.
 Legal Tender Money:
- Legal tender is any official medium of payment, recognized by law, that can be used to meet a
financial obligation.
- It is the money which can’t be denied in the settlement of a monetary obligation.
- All coins issued under the authority of Section 6 of The Coinage Act, 1906, are be legal tender.
- All banknotes issued by RBI under RBI act, 1934 are legal tender.
- Limited legal tender: Compulsory to accept only up to certain extent e.g. In India, coins function as
limited legal tender. Therefore, 50 paise coins can be offered as legal tender for dues up to ₹10.
- Unlimited Legal Tender: Any amount of obligation can be discharged with it. In India, currency
notes are unlimited legal tender.
- Point to Note: Bitcoin is money (medium of exchange), but NOT legal tender.

Demonetization - When a currency ceases to be legal tender. Cases of demonetization in the past:
 In 1946, when the circulated Rs.1,000 and Rs.10,000 notes were demonetized
 In 1978, when Rs.1,000, Rs.5,000 and Rs.10,000 notes were demonetized.
 November, 2016, when Rs.500 and Rs.1000 notes were demonetized.

What were the objectives of Demonetization?

 Curbing corruption and accumulation of black money.
 Eradicating Counterfeit currency.
 Striking at the root of financing of terrorism and left wing extremism.
 Reducing cash in circulation and promote digitalization of payments to make India a less cash economy.
 Convert non-formal economy into a formal economy to expand tax base and employment.

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What Motivated Demonetisation?

 Increasing currency-GDP ratio – around 12% in 2014-15.
 In general, use of cash declines with development. However, India’s level of cash dependency was higher
than other countries in similar income group. It suggests that some of the cash holdings were not used for
legitimate transactions.
 Lesser soil rates for higher denomination notes indicated that they are less in circulation and hence stored
as Black money.

1.2 MONEY SUPPLY & RELATED CONCEPTS

1.2.1 MONEY SUPPLY
 Money Supply refers to the total stock of all types of money (currency and deposits in banks) held by
the public (including all economic entities except Government and Banks as they are the creators of
currency and deposits).
 Thus, it is the total money in circulation in an economy. It measures the total purchasing power in the
economy.

1.2.2 TYPES OF DEPOSITS

 Demand Deposits Vs. Time Deposits

Sno. DEMAND DEPOSITS TIME/TERM DEPOSITS

1 Payable on demand ie. Depositors can freely
withdraw any or all of the funds from account at
any time (through cheques).
2 Used as medium of exchange – ownership can
be transferred from one to another through
cheques.
3 Offer very high liquidity and ease of access.
4 For eg. All Current accounts, Demand liability
portion of Savings account.
Not payable on demand. Deposits made for a
predetermined period of time (fixed term).
Withdrawal only on maturity.
Cannot be used a medium of exchange.
Not liquid.
For eg. All Fixed accounts, Time liability portion of
savings account

 Current, Savings & Fixed Deposits

Sno. CURRENT ACCOUNT SAVINGS ACCOUNT FIXED DEPOSITS

1 Payable on demand through Payable on demand through Not payable on demand. No
cheques. cheques. cheqeuing facility.
2 Unlimited withdrawals allowed. Restrictions on number of A lumpsum amount is deposited
withdrawals and amount to be for a fixed term to maturity.
withdrawn. Combine features Premature withdrawal attracts a
of Current and Fixed Deposits. penalty.
3 No interest is paid and no Interest is paid on the Earn higher interest rates than
minimum balance is required to deposits. Minimum balance savings account.
be maintained. needs to be maintained with
bank.
4 Overdraft facility available Overdraft facility not available Loans can be taken against the
deposits by the depositor.

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5 Users/Account Holders – Users/Account Holders – Users/Account Holders - Mostly

usually Business firms etc. Mostly Households Households
Mainly used for transaction
purposes or ease of making
business payments

 Recurring Deposits:
- It is a special type of term/fixed deposit where an investor does not need to deposit a lump sum,
rather he/she has to deposit a fixed sum of money at regular intervals (for eg. Monthly) over an
agreed period of time (eg. 2-7 years).
- At maturity, the principal amount and interest is paid to the holder.
- Users/Account Holders – Usually salaried people who need to save regularly.

 Post Office Deposits:

Sno. PO SAVINGS DEPOSITS PO TIME DEPOSITS

1 Payable on Demand through withdrawal slips Not payable on demand.
2 Restrictions on number of withdrawals and Withdrawal only on maturity.
amount to be withdrawn.
3 Cannot be used as medium of exchange. Lack Cannot be used a medium of exchange.
cheqeuing facility.
4 Less liquid than demand Deposits Not liquid.

 Post offices offer a wide range of saving options - Time Deposit Account, Recurring Deposit Account,
Savings account etc. These help in financial inclusion.
 Saving schemes offered buy Post offices are: Public Provident Fund (PPF), Kisan Vikas Patra (KVP),
National Saving Certificate (NSC), etc.

1.2.3 MEASURES OF MONEY SUPPLY

a) M0 or Reserve Money or Base Money or High Powered Money (H)
 M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI
 It is the monetary base of economy.
 It takes into account Producers of Money.
 Money produced by RBI and Government and held by public and banks

b) M1 = C + DD + OD
 C, Currency held by the Public.
 DD, Demand deposits of the people with commercial banks.
 OD, Demand deposits of public financial institutions, foreign central banks, international financial
institutions with RBI.
 M1 is called narrow money because it is the most liquid measure of money supply.
 M1 excludes
- Deposits of Commercial Banks with RBI
- Deposits of Government with RBI
- Inter-bank deposits

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c) M2 = M1 + Savings Deposits with post office saving bank

d) M3 or Aggregate Monetary Resource (AMR) or broad measure of money = M1 + Net Time deposits
with banks
e) M4 = M3 + Total deposits (Saving + Time) with post offices (excluding National Savings Certificates)
 M4 is the broadest measure of money supply

In terms of liquidity  M1 (most liquid) > M2 > M3 > M4 (least liquid)

1.2.4 MONEY SUPPLY & CREDIT CREATION

 Money supply = M0*m, where ‘M0’ is the monetary base and ‘m’ is the money multiplier.
 Money multiplier is the credit creation capacity of banks.
 Determinants of credit creation
1. Currency Deposit ratio (c) = Currency with Public (C) / Deposits with Banks (D)
- Inverse relation  Lower the ratio, greater the credit creation capacity and vice versa.
2. Time deposit ratio (t) = Time deposits (TD) / Demand deposits (DD)
- Direct relation  Higher the ratio, greater the credit creation capacity and vice versa.
3. Reserves Deposit Ratio (r): Reserves with Banks (R) / Deposits with Banks (D)
- Inverse relation  Lower the ratio, greater the credit creation capacity and vice versa.

1.2.5 VELOCITY OF MONEY

 It refers to the average number of times a single unit of money changes hands or is used in an economy,
during a given period of time ie. The rate of circulation of the currency.
 Simply put, it's the rate at which people spend money.
 Thus, a higher velocity is a sign that the same amount of money is being used for a number of
transactions.
 It is also indicative of how much economic activity occurs or is possible at a certain level of money supply.
 It is calculated as, M*V = P*Q (Fisher’s equation)
- M*V = Supply of Money ( M, quantity of money in existence and V, Velocity of Money )
- P*Q = Demand of Money ( P, current price level and Q, real value of output)

1.3 MONETARY POLICY

1.3.1 MONETARY POLICY
 It is the use of instruments under the control of the Central Bank (RBI) to regulate the availability, cost
and use of money and credit in an economy to achieve specified goals/objectives.
 Monetary policy operates through changes in money supply, which influences the aggregate demand
for output in money terms (directly or indirectly).

1.3.2 OBJECTIVES OF MONETARY POLICY

 Through an amendment to the Reserve Bank of India (RBI) Act, 1934 in 2016, it was written into the
preamble of the RBI Act that the primary objective of the monetary policy in India is to maintain price
stability, while keeping in mind the objective of growth.

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1.3.3 WHO OPERATES MONETARY POLICY?

 The RBI is vested with the responsibility of conducting monetary policy under the Reserve Bank of India
Act, 1934. It is announced bimonthly.
 In 2015, The RBI and Government of India (GoI) signed the Monetary Policy Framework Agreement
(MPFA), which made achieving price stability and inflation targeting the responsibilities of RBI.
 In 2016, an amendment to the RBI Act, 1934 gave a statutory backing to the aforementioned Monetary
Policy Framework Agreement and for implementation of the inflation targeting framework.

Inflation Targeting
 It is a monetary policy strategy used by Central Banks for maintaining price level at a certain level or
within a range.
 As per the Monetary Policy Framework Agreement, the RBI will be responsible for containing inflation
targets at 4%, with a band of (+/-) 2%, of Consumer Price Index (CPI).
 The RBI is also solely responsible for deciding Policy Rates to meet inflation target.
 If the RBI fails to achieve the target, it shall send out a report to the Central Government the reasons for
failure to meet targets, remedial measures proposed to be taken, & time bound achievement of target.
 The RBI will also be required to bring a document every 6 months to explain the sources of inflation and
forecast for inflation for next 6-18 months.
 The inflation target is set by the GoI, in consultation with the RBI, once in every 5 years.

1.3.4 THE MONETARY POLICY PROCESS Open and Transparent Monetary

 The amendment to the RBI Act, 1934 also provided for setting up Policy Making
of Monetary Policy Committee (MPC).  MPC is required to meet at least 4
 The MPC determines the policy interest rate required to achieve times in a year.
 Minimum quorum for meeting - 4
the inflation target.
members.
 It was setup in line with Urjit Patel committee recommendations.  Each member of the MPC has one
 The Central Government constituted the MPC, in 2016, through vote, and in the event of an
a notification in the Official Gazette. equality of votes, the Governor
 The MPC replaced the earlier system where the RBI governor had has a second or casting vote.
complete control over monetary policy decisions. The present Decision made by majority vote.
Committee-based approach adds value and transparency to  Resolution adopted by the MPC is
published after conclusion of
monetary policy decisions.
every meeting of the MPC.
 Composition of MPC (6 members)  On the 14th day, the minutes of
- RBI Governor (Chairperson) the proceedings of the MPC are
- RBI Deputy Governor in charge of monetary policy published.
- One official nominated by the RBI Board.  Once in every 6 months, RBI is
- 3 members - nominees, appointed by the Central required to publish a document
Government based on the recommendations of a search- called the Monetary Policy
Report.
cum-selection committee.

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Urjit Patel Committee Recommendations

 Inflation Targeting: RBI used to have “Multiple Indicator Approach” for monetary policy such as
employment, growth, foreign exchange rate, inflation etc. These were often conflicting, hence, the
committee recommended inflation targeting as primary objective of RBI.
 Use of CPI (combined) in place of WPI for deciding about monetary policy. Inflation target to be 4% (with
a standard deviation of 2%) of Consumer Price Index (CPI) (nominal anchor).
 Monetary Policy Committee should be created rather than the RBI governor solely deciding the Monetary
Policy. Members should be both from within and outside the RBI. RBI should give a public statement if it
fails to meet the inflation target.
 Repo rate should be more than inflation.
 Effective Coordination between Fiscal and Monetary policy must be maintained.
 Decrease SLR as per the Basel Norms and remove interest subvention scheme and Market Stabilisation
Scheme (MSS).
 Government obligations:
- The Central Government needs to reduce the fiscal deficit to 3% of GDP by 2016-17.
- Administered prices, wages and interest rates are impediments to transmission of monetary policy
and should be eliminated.
 Government debt management should be under a separate body like PDMA (Public Debt Management
Agency)

1.3.5 TYPES OF MONETARY POLICY

a) Contractionary Monetary Policy
 It seeks to decrease the money supply in the economy
 It usually checks the inflation
 It is also called “Dear money policy”
b) Expansionary Monetary Policy
 It seeks to increase the money supply in the economy
 It is pursued to check recession
 It is also called “Cheap money policy”

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 ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020
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UNIT 3: TAXATION & PUBLIC FINANCE

3.1 TAXATION

• Taxes are the compulsory payments to the government (local, regional or national), made by individuals
or corporations, without any quid-pro-quo.

3.2 CLASSIFICATION OF TAXES

3.2.1 ON THE BASIS OF TAX RATES
• Progressive tax - Marginal tax rate increases
with increase in Taxable Income. Eg. Personal
Income Tax.
• Proportional tax - Tax rate remains same
irrespective of taxable income Eg. Corporate
Income Tax.
• Regressive tax - Marginal tax rate decreases
with increase in taxable income.
• Degressive Tax - A type of progressive tax in
which the marginal tax rate increases with
increases in taxable income and then becomes
constant.

3.2.2 ON THE BASIS OF POSSIBILITY OF SHIFTING OF TAX BURDEN

• Direct Tax
- It is usually imposed on the income and wealth of individuals and Tax incidence – on whom
firms. the tax is imposed.
- The burden of the tax and the incidence of tax fall on the same person. Tax burden – one who
- The tax burden can’t be shifted. actually pays tax.
- Generally progressive in nature.
- Eg. Personal Income Tax, Corporate Income Tax, Wealth Tax, Securities transaction tax, Property
tax, Capital Gains tax etc.

Minimum Alternate Tax (MAT)

• MAT is a tax introduced in India by the Finance Act of 1987, to facilitate the taxation of ‘zero tax companies’
i.e., those profit making companies which show zero or negligible income to avoid tax, by taking advantage of
the various deductions & exemptions allowed under the Act.
• Under MAT, such companies are made liable to pay to the government, by deeming a certain percentage of
their book profit as taxable income.
• In India MAT is levied under Section 115JB of the Income Tax Act, 1961.
• It is levied at the rate (recently revised) of 15% of the book profits (normal corporate tax rate applicable to an
Indian company is about 25%)
• It is applicable to all corporate entities, whether public or private, Indian or foreign, including companies in
Special Economic Zone (SEZ).

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Alternate Minimum Tax (AMT)

• The corresponding tax similar to MAT, but imposed on individuals or non-corporate entities, who claim certain
deductions under the IT Act, is known as Alternate Minimum Tax (AMT).
• The rate of AMT is also at 18.5%.

• Indirect Tax
- It is usually imposed on production and distribution of goods and services.
- The impact and incidence of tax is usually on different persons.
- The tax burden can be partially or fully shifted on others.
- They are regressive in nature.
- Eg. Excise, Customs, Service tax, VAT, GST

3.2.3 ON THE BASIS OF IMPOSITION

• Ad Valorem Tax
- Ad valorem means – according to value. It is imposed on the basis of value of output or value
added of a good or an asset. For eg. property taxes.
- It is expressed in terms of a percentage (%).
- As the value of the good/asset increases, the tax amount increases. Thus, it is likely to be more
progressive than a specific tax.

• Specific Tax
- It is imposed on the basis of specific criteria like weight, length etc. of commodity sold, regardless
of its price. Thus, it is called ‘per unit tax’.
- For example, a fixed tax of Rs. 100 on per litre of petrol.

3.3 OTHER TERMS RELATED TO TAXATION

• Tax Terrorism
- It refers to the adversarial or the overly aggressive approach adopted by the tax authorities
- It has adverse consequences esp. for honest taxpayers and creates ambivalence in the overall
investment climate
- It was used in the context of retrospective taxation in Vodafone-Hutch case
• Tax Expenditure
- Tax expenditure is also termed as ‘revenue forgone’. It refers to the sum total of the amount of
exemptions given to the tax payers.
- It measures the difference between the actual tax collected and the tax that would have been
collected if there were no such exemptions.
- But it does not necessarily imply that this quantum of revenue has been waived by the government.
It should be interpreted as targeted incentives for the promotion of certain sectors that may not,
in the absence of such incentives, have come up.
- High tax expenditure or exemptions can make the tax system unduly complex. Thus, Government
is taking deliberate steps to phase it out.

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3.4 TAX EVASION, TAX AVOIDANCE, & TAX PLANNING

3.4.1 TAX EVASION, TAX AVOIDANCE, & TAX PLANNING

Sno. Tax Evasion Tax Avoidance Tax Planning

1 Where the payment of tax is Where the payment of tax is Where the payment of tax is
avoided through illegal avoided by complying with the avoided by making use of
means or fraud provisions of law but defeating legitimate deductions &
the intention of the law exemptions provided explicitly
by government.
2 It is legally wrong It is morally wrong, as main It is morally & legally correct.
intention is to avoid paying taxes

3 It is carried out after the tax carried out before the tax carried out before the tax
obligation has arisen obligation has arisen obligation has arisen

4 Methods - Concealment of Methods - Round tripping, Methods - Availing Sec 80C by

income, manipulating Transfer pricing, Treaty shopping investing in tax saving
accounts, making false etc. instruments like PPF, Mutual
statements etc. Fund, Insurance etc.

What is Black Money?

• While there is no legal definition of black money, it is most commonly understood as money which is generated
through illegitimate means or by bypassing taxation system (ie. Tax evasion)
• A 2015 FICCI report estimated black money in India to be as high as 75 per cent of the GDP.

3.4.2 WHAT ARE VARIOUS METHODS OF TAX AVOIDANCE?

• Round Tripping
- A process where Black Money leaves the country throu gh various channels – Payments to shell
companies, inflated invoices, hawala route – and returns to same country as investment (FDI,
participatory notes etc,), through offshore jurisdictions, to avoid taxes.
- This investment route is layered with multiple entities and companies (shell companies) to conceal
real identity of investors, who in many cases invest in their own companies.

• Base Erosion & Profit Shifting –

- BEPS refers to tax planning strategies used by multinational enterprises that exploit gaps and
mismatches in tax rules to avoid paying tax.
- It involves artificially shifting profits to low or no-tax locations, where there is little or no economic
activity, and shifting losses and high expenditures to high tax jurisdictions, resulting in little or no
overall corporate tax being paid.
- Sources of BEPS
✓ Abuse of tax treaties - Taking advantage of loopholes in bilateral tax treaty to escape taxation
in both countries ie. “Double Non Taxation”.

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✓ Problems in deciding Place IMPACT OF BEPS

of Effective Management
(PoEM) or Permanent
Establishment (PE) Status to
arrive at tax liability.
✓ Rise of digital economy and
problem in its taxation.
✓ Abuse of Transfer pricing
rules and tax avoidance
arrangements with
Subsidiaries.
- Not all BEPS strategies are
illegal as they just take
advantage of current rules
governments have put in place.
• Loss of Tax Revenues - As per OECD estimates, BEPS practices
cost countries USD 100-240 billion in lost revenue annually.
• Distorts competition - businesses that operate cross-border
may profit from BEPS opportunities, giving them a competitive
advantage over domestic enterprises.
• Impact on Developing countries - Developing countries’ higher
reliance on corporate income tax (esp. from MNCs) means they
suffer from BEPS disproportionately.
• Lead to inefficient allocation of resources by distorting
investment decisions towards activities that have lower pre-
tax rates of return, but higher after-tax returns.
• Issue of fairness - when taxpayers (including ordinary
individuals) see multinational corporations legally avoiding
income tax, it undermines voluntary compliance by all
taxpayers.

• Double Taxation Avoidance Agreement (DTAA)

- A DTAA is a tax treaty signed between two or more countries. It applies in cases where a tax-payer
resides in one country and earns income in another.
- Its key objective is that tax-payers in these countries can avoid being taxed twice for the same
income.
- For eg. India’s DTAA with Singapore, Mauritius and Cyprus used to give full exemption on capital
gains to investors as there was no cap gains in contracting countries. These agreements were
misused for round tripping black money.
- India has now revised treaties with these countries to curb revenue loss and check the menace of
black money.

• Transfer pricing - Lowering or increasing the prices of goods and services between parent and subsidiary
companies to take advantage of different tax rates charged in different jurisdictions to minimise the
groups’ tax liabilities. Thus using transfer pricing practices to shift profit from high-tax jurisdictions to
low-tax jurisdictions.

• Treaty Shopping - For eg. A resident of a third country (for eg. UK) invests by taking advantage of a fiscal
treaty (DTAA) between India and another contracting state (eg. Mauritius). (Vodafone-Hutch case).

• Off Shore Shell companies Tax Havens - The term is applied

- An offshore company is a company or corporation that is to countries and territories that
incorporated in a foreign territory. offer favourable tax regimes for
- A shell corporation is a corporation without active business foreign Investors, such as:
operations or significant assets. - Low or zero corporate tax
- These types of corporations are not necessarily illegal, but are rates.
sometimes used illegitimately, such as to disguise business - Low or zero withholding tax
ownership from law enforcement or the public. rates on foreign investors.
- Bank secrecy laws

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- Companies can create shell companies in offshore tax havens like Panama, Cayman islands etc.,
siphon off their earnings to tax haven, and lower their tax bills at home.

• Non-profit organizations - Taxation laws which allow certain privileges and incentives for promotion of
charitable activities are being misused and manipulated to park funds of corrupt politicians and
businessmen.

3.4.3 IMPACT OF TAX EVASION & TAX AVOIDANCE ON INDIA

• Financial & Economic impact –

- Rise of parallel economy leading to underestimation of GDP.
- Tax evasion ➔ reduced tax collections ➔ reduced fiscal capacity of government ➔ impact on
developmental & welfare expenditures ➔ reduced economic growth + increased poverty.
- Diversion of productive resources to sterile investments such as real estate, gold, jewellery. Thus,
distorting saving and investment pattern.
- Increase in conspicuous consumption ➔ Increase in inflation ➔ increase in interest rate ➔ high
cost of borrowing ➔ lower investment ➔ decreased economic growth.
- Threatens financial stability of legitimate businesses who cannot compete with firms with higher
profits due to aggressive tax planning. Thus, undermines free enterprise.
- Combating tax evasion requires expenditure on tax administration, audit, prosecution, putting a
pressure on already limited government revenues .
• Social effects - Tax evasion leads to redistribution of income from the honest to dishonest leading to
breach of horizontal and vertical equity between members of the society
• Political consequences –
- Tax evasion ➔ Non- achievement of the state’s fiscal target ➔ voter’s dissatisfaction ➔ political
instability
• Corruption – bribery becomes rampant at all levels eg. politicians, bureaucrats, accountants, financial
institution, corporates ➔ crony capitalism + money power in election ➔ impacts democratic fabric.
• Threat to National Security - due to undisclosed money flow in economy which may be used to finance
criminal activities.
• Decrease in country’s reputation - Black money has resulted in transfer of funds from India to foreign
countries through clandestine channels which decrease country’s reputation globally.

3.4.4 STEPS TAKEN BY GOVERNMENT TO CURB TAX EVASION

• By Individuals
- Enactment of the Benami Transactions (Prohibition) Amendment Act, 2016 to amend the Benami
Transactions (Prohibition) Act, 1988 and enable confiscation of Benami property and prosecution
of benamidar and the beneficial owner.
- Income Declaration Scheme - a window to violators to come clean by paying taxes, cess, and
penalty amounting to 45% of total undisclosed income
- Black Money and Imposition of Tax (Undisclosed Foreign Income and Assets) Act, 2015 to
specifically deal with black money stashed away abroad.
• By Corporates & MNCs
- GAAR (General Anti-avoidance rule) – to check aggressive tax planning/treaty abuse
- DTAA amendments – with Singapore, South Korea, Cyprus, Mauritius
✓ To enable levy of taxes in the country where income is generated rather than the country of
residence of the company.

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 ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020
Under the Guidance of M K YADAV

✓ Included ‘Limitation of Benefit’ clause – Deters treaty abuse and limits benefits to residents of
two countries only.
- Advance Pricing Agreements (APA) - Agreement between tax payer and tax authority on an
appropriate transfer pricing methodology over a fixed period.
- Base Erosion and Profit shifting – Union Cabinet recently approved the ratification of the
Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and
Profit Shifting ("Multilateral Instrument" or "MLI") (an outcome of the OECD / G20 Project).
- Place of Effective management (PoEM) - Income Tax Act was modified to provide that if ‘Place of
effective management” of a company is in India, it will be considered ‘resident of India’ and taxed
accordingly.
- 6% equalization levy (EL), imposed by the Finance Act, 2016, in lieu of specified digital services
(online advertising services) provided to residents in India by non resident companies.
- ‘Significant Economic Presence’ (SEP) concept, introduced by Finance Act, 2018, whereby
government can tax digital companies (like Facebook, Google etc,) even if they have a virtual
presence (ie. don’t have a permanent establishment (PE)) in India.

PoEM (Place of Effective Management)

• Taxation authorities need information on residential status of foreign companies for the purpose of assessing
tax liability. PoEM rules helps arriving at this.
• "Place of effective management" is defined in the Income Tax Act, 1961 (as amended by Finance Act, 2015)
to mean a place where key management and commercial decisions that are necessary for the conduct of the
business of an entity as a whole are, in substance, made.
• While the non-resident foreign company is generally taxed only on its Indian sourced income; a resident
foreign company is taxed for its global income ➔ more tax revenues.
• Concept of PoEM is recognised by OECD and in various international treaties for determination of residence
of a company as a tie-breaker rule for avoidance of double taxation.

• Other measures
- Constitution of SIT on Black Money
- Tightening KYC norms on Participatory Notes by SEBI
- Prevention of Money laundering act, 2002 and various amendments to strengthen it.
- Constitution of Multi-Agency Group (MAG) consisting of officers of Central Board of Direct Taxes
(CBDT), Reserve Bank of India (RBI), Enforcement Directorate (ED) and Financial Intelligence Unit
(FIU) to probe Panama papers leak.
- Special Combating Financing of Terrorism (CFT) Cell created in the Ministry of Home Affairs in
2011, to coordinate with the Central Intelligence/Enforcement Agencies & State Law Enforcement
Agencies.
- Demonetisation - It was the biggest blow to black money hoarders across the country.
- Linking bank accounts with Aadhaar & PAN: huge success in getting hold of fake or Ghost accounts
and tracking big and suspicious transactions.
- ‘Project Insight’- ICT based initiative for strengthening non-intrusive, information driven approach
for improving tax compliance.
- Operation Clean Money’ - using information on cash transactions & data analytics tools for e-
verification of suspect cases. Portal launched.
- Rationalisation of taxes - expansion of tax base and lowering of tax rates.

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 ECONOMIC & SOCIAL DEVELOPMENT: TARGET 2020
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• International Cooperation
- Financial Acton Task Force (FATF) - India has complied with all FATF requirements and Action Plan
items.
- G -20 – India played major role in developing international consensus for taking action against tax
havens
- Multilateral convention of Mutual Administrative Assistance in tax Matters.
- Proactive sharing of Financial Information known as Automatic Exchange of Information (AEOI) to
enable India to receive financial account information of Indian residents in other countries.
- Tax information Exchange Agreement (TIEA).
- Information sharing agreement with the USA under the Foreign Account Tax Compliance Act
(FATCA) of USA.
- Section 94A inserted in Income Tax Act to black list country as non-cooperating if there is lack of
effective exchange of information. E.g.: Cyprus was black listed in 2013.
- Setting up Income Tax Overseas units to unearth black money in Mauritius, Singapore etc.
• Institutions
- Economic Intelligence Council (EIC)
✓ Apex forum, chaired by Union Minister of Finance, responsible for oversight on government
agencies responsible for economic intelligence and combating economic offences in India.
- Financial Intelligence Unit (FIU) [under Department of Revenue, Ministry of Finance]
✓ FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC)
headed by the Finance Minister.
✓ Responsible for analyzing and disseminating information relating to suspect financial
transactions. It is not a regulatory body and only gathers and shares financial intelligence.
✓ Coordinates efforts of national and international intelligence, investigation and enforcement
agencies against money laundering and terrorist financing.
- Enforcement Directorate (ED) [under Department of Revenue, Ministry of Finance]
✓ Responsible for enforcement of 2 key acts: Foreign Exchange Management Act 1999 (FEMA)
and some provision of the Prevention of Money Laundering Act 2002 (PMLA)
- Directorate of Revenue Intelligence (DRI) [under Central Board of Indirect Taxes and Customs,
Department of Revenue, Ministry of Finance]
✓ It is an apex anti-smuggling agency of India. It enforces the prohibition of the smuggling of
items (drugs, gold, diamonds, electronics, foreign currency, and counterfeit Indian currency)
- National Investigation Agency (NIA)
✓ Statutory body formed in 2008 under the NIA Act to combat terror in India.
✓ Terror Funding and Fake Currency Cell set up in the National Investigation Agency to
investigate Terror Funding cases.
- Serious Fraud Investigation Office (SFIO) [under Ministry of Corporate Affairs (MCA)]
✓ Probes corporate frauds (including shell companies) in coordination with IT Dept. / CBI

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