6 Black Market in Context of Tax Evasion and Its Consequences On

7/31/2019 6 Black Market in Context of Tax Evasion and Its Consequences On

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Hina Sarfraz

Author is student of LLB (III). She is member of study circle.

Tax Evasion in Context of Black Market

Black Market as the name suggests appears to be a matter of technical economics,finance and market phenomena. That it is. However, unlike the apparent connotation, this

seemingly academic and technical subject has a simple but strong base in the human

instinct to maximize financial self interest without regard to the constraints of ethics and

law. The basis of Black Market is thus, in hearts and minds of men.1

Statement of the Problem: Pakistan is the country rich in natural and strategic resources.

Yet, barring the present day scenario, it remained limping on the road to economicdevelopment. Many causes are ascribed to this scenario that range from issues of

governance to a number of historical and situational factors. In the recent decades one areaof focus in this context has been the role of Black market which is believed to be one of the

major challenges for the economy at large.From the onset it is essential to define Black Market in clear terms.

Sloman2stipulates it to be ( a market) where people ignore the governments price and

quality controls and sell illegally at whatever price equates illegal demand and supply.The noteworthy content of the definition is the illegal aspect. How exactly does the

illegality arise, is the next issue that requires attention. Perhaps the best exposition of the

illegality is that the underground economy, Black Economy, or Black Market consist ofall commerce on which applicable taxes are being evaded. The market include not only

legally-prohibited commerce( for example: drugs, prostitution, and gambling activities

that are illegal in some countries), but also trade in legal goods and services because someincome is not reported and consequently taxation is evaded, e.g., through moneylaundering, payment in cash (which can almost never be traced), or other means .3

Thus, whether the economic activities in goods, services or production are in legal

or illegal commerce the determining an differentiating factor towards identifying BlackMarket is primarily the tax-factor.

Main Causes of increase in Black Market: The growth of the Black Market is associated

with various factors, such as.-

Anomalies in Laws: The problem area pertaining to wealth statements is assets

held in the name of some other person. The exact inception of the practice of

benamiis not known but it is agreed that it has been in vogue from times immemorial

and practically in all the countries of the world though under different labels. The practiceis not confine to acquiring or holding of property in names other than those of the real

owners but also extends to carrying on business in that fashion. Many causes such as fear,

avoidance of taxation, fraud etc. account for the adoption of such a course and yet all of

1 Richard Lipsey, and colins, First Principles of Economics, Second Edition (NY: Oxford University Press,

1994 ), 102.2 Jhon Sloman, Economics, second Edition (NY. Prentice Hall, 2001) 983 Underground Economy Available from http://en.wikipedia.org/wiki/


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these may not be illegal and immoral. The practice ofbenami is, therefore, recognized

and protected in our system provided it does not offend the provisions of any law. The base

of benami, in our system of law, lies in the Trusts Act,1882. There are two types ofbenami transactions 1- there is a real transaction as, for example, when A sells property to

B but the sale deed mentions X as the purchaser. Here the sale itself is genuine, but the real

purchaser is B, X being his benamidar who in legal terms is known as the ostensibleowner. The other type is a sort of sham transaction, as, for example, when A purports to

sell his property to B without intending that his own title should cease or pass to B. The

fundamental difference between the two types of transactions is that whereas in the formerthere is an operative transfer resulting in the vesting of title in the transferee, in the latter

there is no genuine transfer, there being no passing of consideration. The former type is

covered by Section 82 and the latter by section 81 of the Trusts Act4. Our system of law,

therefore, duly recognizes the benami transactions subject to the following mainexceptions:

i. Bonafide transfer for value from the ostensible owner without notice of

the real title of the real\beneficial owner is protected under Section3 of

the Transfer of property Act,ii. Purchaser of property from the ostensible owner at court sale under

section 66 of the Code of Civil procedure is protected,iii. When the transaction of benami is a fraud upon the creditors of the real

owner, and

iv. If the transaction is against public policy i.e., the purchaser is illegal orin other words prohibited y law or contravenes the provision of any law.

There transactions can be enforced under the law by the real owner under Section

42 of Specific Relief Act by obtaining a declaration from a court of law. Of course in such

a case the plaintiff i.e. the real owner has to prove the benami nature of the transaction andeven the provisions of the Evidence Act\Ordinance do not stand in his way to give proof of

his title as against the ostensible owner\benamidar. The real owner cannot be deprived of hi

property in a benami transaction.The tax authorities, at present can utilize the information regarding benami

transactions for taxation purposes but they have to prove against the real owner\beneficiary

that the property held in the name of somebody else {benamidar) is really his.5

Analysis Of Tax Evasion: There are numerous causes which have contributed to birth an

spread of evasion. Historically, the areas comprising Pakistan do not have a tradition of

voluntary payment of taxes as the successive conquerors imposed taxes on the people

and the question of acceptance of these levies by the tillers of the soil or the traders whocontributed to the treasuries of the rulers was not even raised.

In our history, tax evasion before independence was regarded as virtue- a contribution to

the struggle for independence. After independence, the same attitude has continues. In fact,the rich people regard the government as an adversary and the taxes as an instrument of

extortion. Even people who are deeply religious and righteous do not regard tax evasion as

a vice, much less a crime or sin.

Commercially, every person engaged in production or distribution of goods is a part of

one big machine. His activities are inextricably linked with others and he cannot work or

4 Trust Act 1872, Gazette of Pakistan amended adapted 1972.5 Central Board of Revenue, National Taxation commission Report, December 1986, Islamabad, 112.


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operate in isolation. In an economy where tax evasion has become a norm, it is almost

impossible even for the honest ones to pay taxes correctly because they are forced to

conceal those transactions which their suppliers or buyers do not want to put on record.

Further, in society where the majority of those liable to taxation are evading taxes, those

who are not doing so are also regarded as dishonest simply because it is not possible for the

tax department to identify the honest tax payer. Thus an honest taxpayer reporting hisincome correctly is also subjected to similar treatment neted out to the dishonest. He, thus,

ends up paying far more than he should have paid which discourages him for being honest

and straight forward.In an economy based primarily on cash transactions, tax evasion is easy and its detection

by the authorities difficult as cash transactions leave no trace behind. Since assessments are

made long after the transactions take place, the authorities are unable to detect those not

recorded.The Tax laws provide extensive Tax exempt Sectors. Income from agriculture though

under tax net yet escapes major tax burden. In addition, the tax statutes grant exemption to

a large number of other sectors like poultry farming, cattle farming, fishing and fish

processing etc, apart from tax holidays to a host of industrial undertakings set up in thebackward areas. Major parts, of Baluchistan, considerable parts of NWFP and the entire

Northern Areas are beyond the scope of Tax laws. Sectoral tax exemptions enable thebusinessmen to show their taxable income as derived from tax-exempt sources. Also,

exempt sectors and areas allow black money to appear as loans from those enjoying income

from such sectors or areas. Loans from agriculturists and tribal people have become acommon feature in the explanation of assets created with black money.

The Tax policies as such need to be reviewed in this perspective, e.g., until the agriculture

tax was not strictly enforce industrialists and traders were prompted, owing to lopsided tax

policies, to show their income having been generated from agriculture and were exemptedfrom taxation. Even now tax on agriculture sector is significantly lower and this practice of

tax evasion still persists. In the public sector government employees are not allowed to

work anywhere besides their main office. However, there are many persons who work atmore than one place6 and do not report their income from the second job, which remains

out of tax net.

Repeated amnesties discourage an honest taxpayer who honestly pays taxes every year atthe prescribed high rate while those who do not pay honestly pay taxes every year at the

prescribed high rates while those who do not pay honestly, earn further income on the

evaded tax. Over a period of time, the evaders are far richer than the honest taxpayer and

be a worse disincentive for honest taxpayers.In short, the prevailing conditions not only encourage tax-evasion but also positively

discourage honest tax-reporting.

Forms of Black money: it essentially comprises two forms, firstly, those funds used,employed and generate for and by activities that are outright illegal such as narcotics,

prostitution etc. This form of Black Market and its activities escape not only the state

taxation network but also transcend all borders of regulatory control.7 The other form,which we are mainly concerned here, is the market which evades the taxation network is

6 Central Board of Revenue, Natinal Tax Reforms Commission Report, Islamabad, 113.7 For details see black Markets at www.wikepedia.com.


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otherwise legal activities i.e. through deliberate tax evasion. Since tax evasion is birth point

of Black Market. We need to delve into its meaning, forms and consequences.

Broadly speaking, tax evasion means evading payment of tax legally payable onones genuine taxable income. It is done either by not showing ones income atall( non-

reporting) or showing less income than avoidance which means taking advantage of the

loopholes in the law or stretching the rules and regulations without actually breaking them.8

Forms of Tax Evasion: Although it is Notpossible to provide comprehensive details of

the various methods of tax evasion, an outline of the basic techniques and methods of tax

evasion include inter alia,A. Total Non-Reporting: This is the crudest but most prevalent form of evasion.

Persons earning taxable income just do not file their returns, some out of

ignorance, but mostly it is deliberate. This category includes not only

businessmen but persons owning property, shares and other investments andeven those drawing salary. Small shopkeepers, vendors, brokers, all belong to

this class. Now a large number of daily wage earners like masons,

carpenters( even the dock side labour) earn taxable income but file no return.

B. Under Reporting: Most of the existing taxpayers resort to this type of evasion.They do file returns and pay taxes but declare only a part of their income. This

under=reporting can take the following forms:i. Suppression of transactions: Importers, wholesalers, retailers etc. omit

a substantial part of their transactions altogether. They neither record

such purchases nor sales correctly. Similarly, manufacturers do notrecord a part of their production, thereby evading excise duty and sales

tax where leviable. The prevalence of this form of evasion became

evident when entering the latest amnesty scheme, many parties

demanded amnesty against proceedings for evasion of custom duty,excise duty and sales tax. Their main argument was that bulk of the

black money represents, evasion of these duties.

ii. Under statement of sales: When an importer, producer, wholesaler or aretailer cannot conceal his sales quantitatively, he resorts to understating

his sales price. They charge more than the amount for which they issue

the receipts. Professionals, doctors, lawyers, architects etc. resort to thismethod. Many film stars receive a substantial part of their fees in cash

as on-money.

iii. Inflation of purchases: Where for any reason, the sale price is

verifiable as in the case of contractors, suppliers etc., the methodemployed is over-statement of purchases.

iv. Inflation of expenses: Like inflation of purchases, overstating the

expenses is employed to reduce profits. Some times such expenses aredebited although having not been incurred at all and some-times such

expenses are debited although having not been incurred at all and some-

times the amount claimed is shown substantially higher than the oneactually expended.

v. Under invoicing of exports: At times exporters understate the value of

exports and receive the difference abroad from the foreign importers.

8 Central Board of Revenue, National Taxation Reform commission Report, Islamabad 106.


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Large export houses usually export to their own concerns abroad thus

facilitating the process but commission for obtaining export orders is

paid to dummy agents in foreign countries.vi. Over invoicing of imports: where import duty is not charged ad

valorem, importers overstate their import price and obtain the difference

abroad. Similarly, importers usually receive rebate or discount on theirimports abroad. People, who receive commission (usually for

indenting) from abroad, keep a part of it outside Pakistan.

vii. Miscellaneous methods:a) Good debts are shown as bad debts.

b) Capital expenditure is shown as a deductible expense in the

revenue account.

c) Stocks are under-stated and under-valued in order to concealprofits.

C. Diversion of income: This takes many shapes but the more common methods

are as follows:

i. Acquiring income-yielding assets in the name of dependents orbenamidars e.g. acquiring property or shares in the name of wife or

children or dependents or even non-existent persons.ii. Making dependents and benamidar partners in various firms.

iii. Creating firms consisting of dependent, relatives or employees. There

are very few registered firms all of whose partners are genuine.iv. Contractors showing bogus sub-contracts in the form of

relatives/dependents.

v. Large firms and private companies create agencies owned by dependents

for sale/ purchase of goods dealt in by them or paying large amounts assalary/commission\ rent\ to dependent\ relatives of directors and

shareholders.

vi. Owners of cinemas, factories, etc. make fictitious leases to firmsconsisting of their dependents, relatives or give ownership rights to

fictitious persons.

The income on which tax has been totally or partly evaded is commonly calledblack money. Part of this money is utilized for consumption and part for hoarding or

investment. The black money not consumed is utilized in one or more of the following

ways:

a) Utilized in business recorded in books which may be in the formof:

i. Undeclared stocks

ii. Undeclared capital investmentiii. Unrecorded trade receivables

iv. Fictitious loans/payables

b) kept in cash in homes safes or bank safe deposits.c) Converted into gold, diamonds or other valuables.

d) Deposited in banks in form of fixed deposit receipts in fictitious

names.


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e) Converted into bearer bonds, Prize Bonds, Saving certificates

etc.

f) Invested in stocks\shares.g) Invested in real estate.

h) Used for private lending.

i) Used in furnishing bungalows, purchasing cars and other luxuryitems.

Conclusion and recommendations: Illegal activities such as smuggling, corruption,Black-marketing, narcotics, informal legal jobs etc. constitute the underground economy.

These activities are not in the tax net and have significant negative impact on social welfare

of the country. Almost all the transactions made in the underground economy are through

cash, e.g., payments to the contractual workers, transactions in illegal sales, transactionsinvolved in smuggling and drug trafficking, cash payments to the shopkeepers who do not

provide valid cash memos etc. in general, self employed persons are involved in tax

evasion and underground economic activities because there is no formal system of

documentation of self-employed persons and their activities.

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In attempting to address the challenges posed to the economy by the Black Market,

the best referent is available in the form of the factors that promote Black Market activities;thus, the obvious beginning point is the regulatory milieu and in this context the tax

system.

Remove Loopholes in Laws: The controls in matters such as those falling in the domainof Benami transactions, Trust Act and other laws that provide grey areas to the tax evader

and Black Market operator, can be made more effective by providing in the law that

holding of a property liable to taxation in the name of another (benami) without showing it

in the wealth statement filed with the IncomeTax Department by real owner would be apenal offence. In that event, the transaction should also be made unenforceable by the real

owner as against the bemanidar. This would not offend the constitution. Provisions having

similar import also exist in the Indian Income-tax law.- It may be pointed out that in Pakistan, assets are also held by taxpayers not in the name of

any benamidar in the legal sense of the word but in the name of non-existent\ bogus

persons. This is quite common in respect of bank deposits and shares. This practice can bechecked by providing in the law that in cases where any assets are found to have been held

in the names of non-existent\bogus persons, the aets involved may be forfeited by the

Government.

Improvement in labour laws: requires introducing laws favourable to the labour andcompliable for the employers.

Improved Documentation: the best weapon against continuing unhindered growth of the

informal sector in laws enected to promote stringent documentation of as many economicactivities as it feasible. These laws then nee to be enforced strictly so that they become a

deterrent to migration to the informal sector. In Pakistan, uptill 2001 when the Income-Tax

Ordinance of 2001 superseded the Ordinance of 1979,only corporate & professionalentities like doctors\architects were required to maintain books of accounts and related

documentation. Thus all taxpayers other than companies, doctors & architect could claim

9 M. Ali Kemal, A Fresh Assesment of the Underground Economy and Tax Evasion in Pakistan: Causes,

Consequences, and linkages with the Formal Economy


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before the ITO they did not maintain any accounts\documentation whatsoever and the

income tax assessing officer then would have no option but to determine the assessees

total income in his best judgment. After the enactment of the Ordinance of 2001 howeverevery tax payer is required to maintain accounts and documentation as prescribed by FBR

for different categories of assessees.

Taxation Reforms:- Tax system should be simple and easy to understand becauseloopholes in the complex tax system tempt people to evade taxes which they might pay

otherwise.

- Reduce the rate of direct taxes-Broaden tax base to compensate for reduction in rates

-Integrate tax reforms with macro-economic reforms. Many an economic initiatives fails

due to lack of congruence between the two.

- Re-enact the Wealth Tax Act. It would also be very good idea to revive the wealth TaxAct originally enacted in 1963, albeit with very low rates of wealth tax. Such low rate

would force taxpayers to declare all assets formally, including immoveable property that

has become a heaven for funds that have suffered no tax and have been contrived illegally

through the informal sector.Efficient Enforcement: Firstly, through checking and containing corruption

-Effective monitoring by inter-alia integrating various departments such as excise, propertyregistrars, etc with the taxation system. NTN and NADRA records can be linked through

an information management system.

Economic and Financial Regulations: Pre-dominance of cash transactions in trade andcommerce is one of the main factors which assist under-reporting of income because such

transaction are by their nature difficult to trace. As the system of tax assessment is based on

a re-construction of past events, the scantier the surviving data or secondary evidence

regarding the past situation, the more difficult it is to make a sound assessment. Attemptshave been made in past by the income tax authorities to devise such mechanisms as may

assist them in enforcing recording of cash transactions. The introduction of mechanical and

electronic Cash Registers, and more so the mandatory maintenance of accounts envisagedin the latest CBR regulations, can serve the same purpose as these machines also permit

easy verification of the periodic sale-volume. It is, therefore, suggested that use of Cash

Registers may be made obligatory in certain types of businesses and the cost incurredcompensated by allowing it as revenue expenditure over a period of two years instead of

allowing it as depreciation allowance over a number of years as at present.

Another remedy for this problem would be to put some legal restraint on the

unlimited quantum of transactions which can be made in cash. This could be madeeffective by providing incentive to the buyer and seller in the form of tax rebates.

Bibliography:

-Trusts Act 1872-Wealth Tax Act

-Income Tax Ordinance

-Law of Benami Transactions 1952-NTRC (1986) Final Report of the National Taxation Reform Commission.

-Sloman, John., Economics, Second Edition, Prentice Hall, NY.

-Lipsey, Richard and Colins, First Principles of Economics, Oxford, 1994.

-Ghausi, Sabihudin., The Hidden National Wealth, Dawn September 25, 2006.


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-Kemal, M.A., Underground Economy and Tax evasion in Pakistan, PIDE R.R. No

183,2003.

-Kemal, M.A., Fresh Assessment of the Underground Economy and Tax Evasion inPakistan:Causes.

- Net Browsing

List of Abreviations:CBR Central Board of Revenue

ILO International Labour Organisation

ITO Income Tax Officer

NAB National Accountability Beareau

NADRA National Data Base Registration Authority

NTN National Tax Number

FBR Federal Board Of Revenue

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