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On November 22nd 2016, the NDA government signed an agreement with Switzerland for exchange of financial information, which will provide India details of the financial assets held by its citizens in that country. In the backdrop of black money dominating the media headlines and popular discourse in the country, this development was termed as a game-changer in the fight against black money by a number of commentators. In the celebratory noise, however, some of the subtle elements of the agreement were ignored, which on detailed examination reveal serious weaknesses of the current framework that could potentially undermine the success of this initiative.

Background of the agreement

There are two components of black money – domestic and international, also known as illicit financial flows (IFFs). Unlike domestic black money that can be dealt solely by the prerogative of national governments, international black money, which moves across countries, creates the problem of information inaccessibility and legal jurisdiction for national authorities, which are the biggest hurdles in detection and control of illicit financial flows. One way to deal with these hurdles is sharing financial information among countries; for example - Switzerland sharing the information of assets owned by Indian citizens in Switzerland. This seemingly simple solution is rather hard to implement because many countries (loosely termed as tax havens) benefit from such financial flows; hence are against any such initiative. The issue becomes more complex due to differences in the regulatory framework among jurisdictions, the sensitive nature and the legal implications of information sharing.

To overcome these difficulties, jurisdictions sign agreements making it legally binding for them to share the information in the pre-agreed format. Such bilateral agreements have been part of international cooperation for long, either as a clause of Double Tax (Avoidance) Agreements (DTAs) or more recently as Tax Information Exchange Agreements (TIEAs). India signed its first such agreement with Egypt in 1965 and since then, more than 100 such agreements have been signed with various countries.

After the financial crisis of 2008 and subsequent revelations about the misuse/ abuse of international Financial and Tax Architecture, there was a global outcry against illicit financial flows, and Exchange of Financial Information was accepted by world leaders as a major tool to fight IFFs. Consequently, it led to the creation of the Global Forum on Transparency and Exchange of Information for Taxation purposes by OECD, backed by the G-20. With more than 130 member countries, the Global Forum is currently the biggest intergovernmental organisation working on the issue of a multilateral framework for exchange of information. It has created Common Reporting Standard (CRS) as a model for Automatic Exchange of Information (AEOI), which has been accepted by 101 countries and they are expected to start exchange of information automatically from either 2017 or 2018. The agreement signed between India and Switzerland, which is based on the CRS, is part of that process in which around 40 countries have agreed to share information with India.

Improvement over previous arrangement

There are two major ways of information exchange – upon request and automatic. Under exchange of information on request (EOIR), country A has to make a request to country B for information about a particular entity that is a resident of country A. The limitation of this method is ‘fishing expedition’ and hence the request made has to contain very specific details such as name of person, bank name, branch name, account number, etc. Because of such limitations of EOIR, there are instances when requests made by countries like India and Argentina were turned down by countries like Switzerland.

This limitation of EOIR is expected to be addressed with automatic exchange of information (AEOI). Under AEOI, designated financial institutions within each participating country will collect and report the financial information of foreign entities to the government authorities, which will then share the information with the respective foreign governments. Since, information for all the foreign financial accounts of citizens will be available to government authorities, AEOI is expected to help in detection and deterrence for black money compare to EOIR, which works just as a confirmation tool for already suspected fund flow.

Drawbacks in the current framework

Notwithstanding the improvement over the previous framework, the current method of AEOI under CRS still has many loopholes, which may significantly reduce the expected benefits. A select few of them are listed below:

1) Exempting the pre-existing accounts: Only the information of accounts opened after 2016-17 will be shared and in some cases, like the recent Indo-Swiss agreement, this exchange will apply on accounts opened on or after 2018. Also, in some cases the new account opened by an existing customer can be considered an ‘old account’ – this essentially means all the wrong-doers of past might get an easy and convenient escape route.

2) Exclusion of many financial instruments and non-financial assets: Trusts, foundations, real estate, bullion, art work, individual broker, credit card issuer and such instruments, many of which are known to be among the big instrumentalities of IFFs are excluded from reporting requirements.

3) Possible exemption of the accounts with balance less than $2,50,000 (around Rs 1.6 crore), where balance is to be checked on a particular date instead of setting as minimum balance during a period. An account holder can reduce the balance for a few days during collection of data thus escaping the reporting requirement.

4) Fake certificate of residence: If a resident of India opens an account by using a fake certificate of residence from a tax haven then information will be shared with that tax haven instead of being shared with India rendering the entire exercise rather ineffective. The current framework does little to check this abuse.

5) Beneficial Ownership (BO): It refers to the individual who owns and ultimately benefits from a legal entity. The unavailability of BO information, which is rather easy to conceal, is another obstacle in identification and curbing of IFFs, especially if the owner (either individual or legal entity) is resident of a foreign country.

6) Non-participation of the US: The US has not committed to the CRS and instead is continuing with Foreign Account Tax Compliance Act (FATCA), its own agreement for information exchange. Unfortunately, FATCA has only limited reciprocity. In other words, while the US will get information about US residents from abroad, it will provide limited information to countries like India and others. Given its economic significance and the fact that a number of regions in the US, like Nevada and Delaware, are considered tax havens, the non-participation of the US can seriously undermine the success of the entire process.

7) Some tax havens not yet committed to sharing information: Out of 101 countries committed to CRS, only 40 have indicated that they will share information with India. The notable ones missing from the above list of 40 countries are Cyprus, Hong Kong, Macao, Mauritius, Panama, Singapore and Bahamas among others. A 2014 study by Gabriel Zucman, an economist working on the issues of international tax avoidance, found that signing of agreement with a tax haven results only in the shifting of funds to other non-signatory tax havens highlighting the need to bring all such potential destinations of IFFs under AEOI agreements.

By a coincidental turn of events, both globally and domestically, the fight against black money has gathered significant political momentum. Time has never been more appropriate to push for these changes. Allowing these loopholes to continue runs the serious risk of these initiatives being just another exercise in futility with the scourge of black money persisting.