Roundtripping ill-gotten wealth – Part 3

How ill-gotten wealth achieves a multiplier effect with Roundtripping

How ill-gotten wealth achieves a multiplier effect with Roundtripping
How ill-gotten wealth achieves a multiplier effect with Roundtripping

Part 1 of this series deals with How Tax Havens are used by HNIs. Part 2 explains why High Net worth individuals open shell companies in tax havens. This is Part 3.

…even though there are multitudes of entities in the structure, at the end of the day it is really just a single fund which is really managed by the real members of the ultimate GPs, who all are really based in India, and taking and executing all the decisions in India.

To truly achieve multiplication of the effect of wealth, many Politically Exposed Persons indulge in Roundtripping. For those who did not read Parts 1 and 2, Figure 1 explains the set of Shell companies opened to channel a block of money. It is not impossible for an individual to have several such sets of companies!

Roundtripping

These structures can also be used for what is known as roundtripping. Once the black money is routed out of India through hawala or other mechanisms, then the same money can find its way back to India via Cayman (secrecy) and Mauritius (DTAA). Thus the black money becomes white and the proceeds generated out of it will also be tax-free.
Figure 1. Shell company layering
The same structures can also be used to pay bribes either in offshore jurisdictions (e.g. bribes can be paid via the Cayman entities without coming under the scanner of the authorities) or in India. The Vasan Eye Care case that was investigated in 2016 by the ED is an example of such a mechanism[1]. Sequoia India and Westbridge Capital, two premium venture capital firms focusing on the Indian market had made an investment in Vasan Eye Care by buying its shares at a huge premium from a company connected to Karti Chidambaram which was a shareholder in Vasan Eye Care. The ED raided the offices of these venture capital firms and interrogated a few principals of these firms. What is the status of that investigation? We don’t know and would like to.

The news story on the Vasan Eye Care investigation also mentioned a partner in Westbridge Capital – KP Balaraj, who was earlier a partner in Sequoia India and is rumored to be close to Karti Chidambaram. The same news story quoted an ED official stating that they had found a suspicious Personal Holding Company (PHC) of KP Balaraj in Cayman Islands which was closed and all the assets were transferred to a PHC in Mauritius. We will cover this episode later on in the series.

Artificial avoidance of Permanent establishment

With the complex structures such as the one shown above, one can show an entity (individual or a corporate entity) to be a resident of Mauritius and a non-resident of India, avail the benefits of the DTAA, and thus not get taxed in India. However, even in this scenario the concept of Permanent Establishment can kick in and make the entity ineligible for the benefits of DTAA. This happens, for example, if the entity has a fixed place of business (i.e. office) in India, has employees (agents) in India who can conclude contracts, and are taking decisions in India. The subject of Permanent Establishment is a fairly involved one and we shall not go into the details. It is pertinent to mention here that in the normal course of operation, a fund as the one with the structure above will have a permanent establishment in India, and thus its income arising in India will be taxable in India. However, there is a bag of tricks that is provided by the army of accountants and lawyers of the offshore tax evasion industry that enable such entities to pretend not having a permanent establishment in India and escape paying any tax. Some examples of these tricks are enumerated below:

  1. The Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should not own or lease any office or place of business in India.
  2. The Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should not have any employee in India.
  3. The Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should not have an agent or any other person located in India who has an authority to conclude contracts in the name of the Fund/ Mauritius Subsidiary/ General Partner/ Ultimate General Partner in India.
  4. The Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should not have any person located in India who has authority to make investment, divestment or management decisions for the Fund/ Mauritius Subsidiary/ General Partner/ Ultimate General Partner. All such decisions of the Mauritius Subsidiaries should be made by its board of directors and/ or investment committee, upon the direction of the Fund. All such decisions of the Fund should be made by the General Partner. All such decisions of the General Partner should be made by the Ultimate General Partner. All such decisions of the Ultimate General Partner should be made by its board of directors and/ or investment committee.
  5. Each board of directors and investment committee of the Mauritius Subsidiaries/ Ultimate General Partner should be constituted such that a majority of the members of such board or committee are not residents of India (excluding for purposes of calculating such majority, the Mauritius resident administrator directors of the  Mauritius Subsidiaries).
  6. Each board of directors and investment committee of the Mauritius Subsidiary/  Ultimate General Partner should not hold a meeting at which a majority of the members of such board or committee are located in India.
  7. The Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should keep the primary copies of its company records including the original copies of minutes of meetings of its board of directors and investment committee, as applicable, outside India.
  8. All agreements/ documents that are executed by the Fund/ Mauritius Subsidiaries/ General Partner/ Ultimate General Partner should be executed by its directors or authorized signatories outside India.

Form over substance

Remember that even though there are multitudes of entities in the structure, at the end of the day it is really just a single fund which is really managed by the real members of the ultimate GPs, who all are really based in India, and taking and executing all the decisions in India. However, the drama recommended above is enacted to ensure that on paper the permanent establishment of the firm is not created in India, and thus the fund escapes paying taxes in India. Such optics enables the form to take over the substance. There are a few more such tricks including carefully wording all press releases, designing business cards of the real partners where they are shown as advisers, and showing all their recommendation as non-binding with a few of such non-binding recommendations deliberately rejected by the board of directors and investment committees which anyways comprise of phony members. As mentioned above the topic of permanent establishment (and its avoidance) is too vast to cover here, but hopefully, the above discussion gives a flavor.

Continued…

References:

[1] More trouble for Karti Chidambaram: ED questions ‘aide’ BalarajApr 28, 2016, CatchNews.com

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An inventor and out-of-the-box thinker, Sree Iyer has 37 patents in the areas of Hardware, Software, Encryption and Systems.

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9 COMMENTS

    • The Indian judiciary has stalled attempts at piercing the corporate veil – and the justification in such judgements are all bogus. I think it is high time that strong laws are enacted so that judicial discretion doesn’t come in the way of cleaning up the system.

    • Remember the azadi bachao andolan case where the SC upheld the circular 789 and over turned the Delhi HC order allowing the piercing of the corporate veil of Mauritius shell cos. That SC ruling was on the appeal filed against the order given by the HC while hearing the PIL filed by Mr Shiva Kanta Jha. Similarly the Vodaphone verdict.

  1. Why Dont Government Stop this Mauritius route and ban P Notes. If the Investors truly believe in Indian growth story they will come otherwise don’t. Why govt is encouraging these demean ways of Investors and claiming about FDI numbers.
    I think if India needs more Respect in International community we should make policies to get Clean money and no scope for illegal means.
    Finance ministry should understand why these round tripping is happening and encourage the Investors with Tax incentives. I am sure money going out through Hawala or any means attracts at least 25% charges/agents fee. If Finance ministry comes with some kinds of Carrot and stick method it would clean up the process.

  2. Super information! This concept should be simplified and taught at all colleges.

    I fear that all Indian StartUps are vulnerable to these frauds. The reasons are:

    1) StartUps work in an adhoc mode in the early years with little or no policies around HR and Financial checks – Forget strict policies and checks
    2) Absence of HR policies coupled with need for people to work with risk and low salary makes the company vulnerable to dubious employees coming on board
    3) Although Chartered Accountants look at financials – they cannot be entirely trusted. Here a Big ‘investor’ may come in and appear to be a saviour while he has his own agenda of laundering money.

    In fact there should be a campaign by Narendra Modi as part of StartUp India initiatives to educate youngsters and their families about such frauds.

    • First PayTM issue and now Flipkart. Watch every successful Indian start up brought shamefully down one by one. Its a well planned operation to bring India down and keep her down.

      NaMo should rescue StartUp India initiative. Things getting bad to worse.

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