Techniques of Investigation
The purpose of any investigation is to only UNRAVEL the TRUTH and nothing else. Why do we need to UNRAVEL the TRUTH? Because normally in an investigation NO ONE TELLS YOU THE TRUTH, so the investigators have to UNRAVEL the TRUTH THEMSELVES.
The techniques applied to investigation help us to see the TRUTH using a COMMON SENSE approach. Since COMMON SENSE is not common, these techniques have evolved. The techniques help in finding the NEEDLE in the proverbial HAYSTACK because an investigator is confronted with abundant information and has very little time to unravel the truth from it. Therefore, ideally, the investigator has to select a small portion of information from the giant whole, which should do the magic of recreating the actual state in the shortest possible time.
Knowing the Abnormal is the Key
Many investigators are not successful as they cannot detect the ABNORMAL and break the ABNORMAL. Only few investigators know that to detect the ABNORMAL it is very necessary to find what NORMAL is. As long as one has the humbleness to accept, as an eternal LEARNER, as a child, 99% of the cases can be solved. The FIRE of knowing the unknown is sufficient to unravel any deeper mystery connected with the case.
Let me cite an example. What is considered normal in a poultry business? My experience shows that many may draw a blank. Let us understand that in case of a Poultry business the normal chain can be as under:
1. Case A: Chicks are brought and grown to adult
2. Case: B: Eggs are brought, chicks are hatched, and then grown to adult
3. Case C: Parent birds are maintained, eggs are laid, chicks are hatched, and then grown to adult.
I will expand from CASE A, as for Case B and CASE C, information is already known in the market about the cost of hatch able EGG and hatched Chick. Therefore, for CASE B the cost can’t go beyond HATCHED CHICK and for CASE C the cost can’t go beyond HATCHABLE EGG.
Every chick takes 42 days to become an adult, approximately weighing 2 Kg a bird. It consumes its daily feed and medicine in a certain proportion which has been standardised. To know the exact cost of a bird one has to include the cost of an EGG/Chick + Feed + medicine + number of birds that died (mortality rate) in 42 days + the cost related to a poultry farmer.
From the above it is now clear that the actual cost can be easily ascertained and profits on actuals can be easily be arrived at. When we know the above fact, then unraveling the truth becomes easy in case there is a deviation.
Learning About the Business and the Businessman
Every investigator must know that BUSINESS is a JUNGLE. The WEAK cannot survive, because the weak are eaten overnight by the STRONG. If the investigator has the humbleness to learn, then a couple of decade’s knowledge that is available with the assessee, can be learnt in a couple of hours.
While learning , the investigator must be humble to the person from whom he is sharing the knowledge - businessman becomes the master and the investigator a disciple. Today, very few investigators have the courage to accept grey areas in the investigation and accept that they DON’T KNOW. To hide ones ignorance, investigators do the learning part through their INSPECTORS who tell only one side of a story. Here the investigators miss the real story in its pure form.
As an investigator we have to understand that every businessman either suppresses receipts or inflates expenditure to reduce the quantum of profit. Either way, monies go out of business and are lying outside. Monies lying outside business are useless as long as it does not travel back to business. This is why the money comes back into the business as share application money, FII’s investment, loan creditors, sundry creditors for purchases... Down the line we will go through a few businesses to see how suppression of receipts or inflation of expenditure takes place. To investigate all kinds of aberrations we have to know the techniques which are essential to any investigation for unraveling the truth in its applied form.
The techniques of Investigation lie in understanding the following:
1. What is fundamental to business from the angle of investigation?: Business is just ROTATION of stock. I repeat - BUSINESS IS JUST ROTATION OF STOCK. An investigator must GRASP that it is the root of all tax evasion. The Investigator’s eye, trained to understand what a business is, is totally different from what has been taught in academics through text books in various colleges and business management schools.
If a query is asked to any student, as to what the most important constituent of a business is, the general answer would be CAPITAL. But businesses can be done without capital. For example: ‘A’ orders a truck load of potatoes from Punjab on credit and sells in Hyderabad to ‘B’ and makes a profit. It defies the very logic of capital required for the business. This is the general thumb rule of many business practices in our country. Therefore, what is necessary to understand is that for business the most important constituent is only the STOCK of material.
Hence, as investigators, we must all understand that business is nothing but just ‘rotation of stock.’ “It’s only when stock rotates that the expenditure in business is recovered and profits/loss are made.” If rotation of stock has led to recovering excess monies over expenditure (salaries, rent, electricity, depreciation, interest, taxes…), the business earns profits or suffers a loss. If one rotates its stock more number of times, one becomes a more efficient businessman than others.
Understanding Rotation of Stock
If one understands the movement of stock then one can quickly and easily grasp what is NORMAL and ABNORMAL in a business. A successful investigator is one who learns quickly through the stock ledger, how material was converted from raw material to finished goods, in case of manufacturer. In case of a trader it is much easier as one has to just understand the cycle time of the stock of material. If an investigator understands the cycle time of a stock in any given business then it is not at all difficult to know and reach the bottom of the truth during investigation.
Every businessman, in order to evade taxes, mainly manipulates the stock position in terms of ‘value’ or in terms of ‘quantity’ at the close of the year, besides inflating expenditure. At the end of year all ledger accounts are closed. It is only through stock manipulation that profits are engineered and structured which suit every businessman (inflating bogus vouchers on one hand and showing excess consumption of same item on the other).
Why is tax evasion through stock manipulation easier than inflating other expenditure at the end of the year? This is because generally every expenditure other than purchase comes within the purview of TDS deduction affecting immediately the cash flow. Hence, TDS deduction becomes an important tracker to get caught as it cannot be manipulated since prescribed percentage of monies have to be collected and remitted to government account within the stipulated date.. But bogus purchase bills can be created as sundry creditors without affecting the cash flow at any given point of time.
It is for this reason Chartered Accountants never certify the stock in the audit report. They conveniently wash off their hands by stating ‘STOCKS AS CERTIFIED BY THE MANAGEMENT’. Now it must make sense so as to why it is imperative for the investigator to understand the rotation of stock.
2. The age of business: The business can be classified in the nature of a tap root or a fibrous root
Tap Root Fibrous Root
0--------1--------2--------3--------4--------5--------6--------7-------8-------9-------10
The scale for a business is given from 0 (zero – new business) to 10 (ten – old business) which represents age of business from NEW to OLD.
If one is investigating a new business, then the new business will look like TAP ROOT. Cracking the promoter/promoters will be sufficient to unravel the mystery as the entire power centre is at one point. Investigations will reveal that only one person or a couple of persons are the key to unravel the truth in case of a new business.
When the business grows, the organization looks like FIBROUS ROOT. The investigation needed will be wider as the target becomes more seasoned by developing a network with vendors who give accommodative entries for avoidance of payment of taxes. Hence the entire chain needs to be broken to unravel the mystery.
Depending on the age of the organization, one can know where the information will be available and how the investigation root for the organization will look like.
3. The nature of business: Every trade has its own unique method to suppress facts. An investigator has to understand, given the nature of business, whether the business will suppress receipts or inflate expenditure, or both. When one understands the nature of the business it helps the investigator to leave out many facts which may not be needed at all. For example in case of a Government Contractor there is no need to probe much on the receipts as receipts are fixed. Similarly if one has a PETROL BUNK then purchases need not be probed much as entire supplies are from only one source. By applying this technique, half the load for investigation automatically gets reduced, and much of the haystack gets weeded out.
4. Fact of service: “Fact of Service” means that every expenditure/revenue originates due do the FACT that either a “SERVICE has been RENDERED to receive ‘REVENUE’ or a SERVICE has been AVAILED to become ‘EXPENDITURE’ in the books of accounts.” Let me cite an example: - ‘A’ has sold goods to ‘B’ and payment of Rs. 100/- has been made by ‘B’ to ‘A’. The ‘fact of service’ is that A has rendered service by selling goods to ‘B’ and received payment of Rs. 100/-. On the other hand ‘B’ has availed service by receiving goods from ‘A’ and has made payment of Rs. 100/-.
The fact of service may look very innocuous and one may wonder how this becomes a great technique of investigation? But every businessman plans in advance to create expenditure/revenue or postpone expenditure/revenue to evade taxes by altering this item so that it can create a loss or profit to avoid payment of taxes.
Lets us know how it is done? Rajesh is awarded a tender for a construction contract of Rs. 1 Crore and has to pay a bribe of Rs. 10 lakhs to get the contract. The entire cost of project for Rajesh comes to 60 Lakhs. But he wishes to declare an income of only Rs. 10,00,000/-. To reduce tax liability on the balance Rs. 30,00,000/-, Rajesh plans a bogus sub-contract of certain works worth Rs. 30 Lakhs to Mahesh and deducts tax deducted at source at the rate of 1%. Mahesh actually doesn’t do any service except withdrawing the cash and giving back to Rajesh after taking commission of Rs. 1 Lakhs and also paying income tax by declaring income of Rs. 2,40,000/- (@ of 8% on Rs. 30,00,000/- under clause 44AD of Income-tax, Act relating to presumptive tax). The net tax which Mahesh pays is Rs. 9000/- (Rs. 2,40,000 – 1,50,000 * 30% ). Further Mahesh also gives a loan to Rajesh for Rs. 2,00,000/- earned out of this source. From the above arrangement the cost of bogus entry to Rajesh is Rs. 1,09,000/- (9000 + Rs. 100,000) and Rajesh gets back Rs. 28,01,000/- out of which the bribe money is also accommodated.
In this case it is clear that the businessman has siphoned off monies by creating bogus expenditure without ever taking any service from the vendor. On the other hand the alleged service provider has given the cash back to the businessman after deducting certain cost. So it can be opined that a major misadventure is done by a businessman by twisting the FACT of SERVICE to launder the monies in and out of business. When an investigator probes, it will unravel to their surprise, that monies were paid/received either by distorting the fact of service or without ever rendering/availing “services” which were verifiable facts. In order to bring more clarity I will dwell on a few examples to show how money gets laundered/siphoned off/introduced, defying the principle of “FACT OF SERVICE.” These are as under:-
a. In the 2G scam, a businessman (A) has paid Rs. 200 Crores in the form of expenditure for availing service without actually rendering any service from the books of accounts. Actually the transaction is a kickback to a leading listed company, which is run by few noted politicians. Let us see the magnitude. ‘A’ has made a payment of Rs. 200 Crores as expenditure which will reduce profits in its own book and thereby further reduce the profits to the shareholder. On the other hand the recipient of Rs. 200 Crores would take over an existing company with huge losses or create fictitious losses in the previous years and absorb the entire revenue without ever paying taxes. This way both escape from the tax net adopting dubious means.
b. A leading land developer and a builder purchase a piece of land for a cost Rs. 2.5 Crores a decade ago. The land was a business asset as it formed part of stock-in-trade. A deal of Rs. 400 Crores to sell the land was made on 01.09.2010. Since huge profits were getting accrued, the builder backdated an agreement of sale with a third party on 15.08.2010 for Rs. 150 Crores. Since the developer got a new deal at Rs. 400 Crores for the same land a peaceful settlement was made by paying compensation of Rs. 100 Crores to the third party on 31.08.2011. The third party had planned in advance to avoid payment of taxes by creating a fictitious loss of Rs. 100 Crores. By adopting this scheme the entire payment received by the developer got absorbed to the losses which were carried from the earlier years by adjusting it.. Furthermore, the developer also hoodwinked the Income-tax Department by dubiously reflecting the land as a capital asset which was indeed a business asset. By doing it so the profits will be calculated under the head “Capital Gains” and not under the head “Income from Business” which has not only lower percentage of taxes but also allows the asset to get indexed increasing the cost of the asset leading to lower computation of income for taxation purpose. Therefore, in this example the FACT OF SERVICES has been totally morphed and transformed for tax avoidance. (a little more clarity required in the transaction)
c. A manufacturer pays Rs. 3 Crores for laminating the wire to ‘X’ which was questioned by an investigator. Studying of business process revealed that the manufacturer was paying a sum of Rs. 12 Crores to ‘Y’ for making the wire which gets transformed through ‘metal to wire’ through 18 process in a single machine. What was alleged as a payment for lamination of wire was the 16th process inbuilt in machine itself. So it was not possible for a manufacturer to pay Rs. 3 Crores to ‘Y’ as it was a fact that laminating as a separate service was never done by ‘Y’ as it was done by the ‘X’ in the 16th process in machine itself.
Probing fact of service by an investigator is very essential and important to unravel truth.
5. Know your BOM/BOQ: Bills of material (BOM) or the Bills of Quantity (BOQ) show the actual material consumed in terms of quantity and value for any given product without the addition of any cost to it. For example take a pen, stove, mobile phone, a burger/pizza… in order to know the BOM one has to break the component into a number of constituent material in terms of quantity and cost. This needs to be compared with the sale price to know approximately the profit margin.
Let’s investigate the profit margin for a medium sized Chicken Pizza selling at Rs. 150. An investigator has to know the BOM for making a chicken pizza which is as under;
Bills of Material: Chicken Pizza
|
Item
|
Qty in gms
|
Value in Rs.
|
Kneaded Flour
|
200
|
3.00
|
Chicken
|
50
|
10.00
|
Capsicum
|
20
|
0.40
|
Onion
|
50
|
0.50
|
Tomato
|
20
|
0.20
|
Mozarella Cheese
|
30
|
3.00
|
Origano
|
5
|
0.10
|
Olive
|
5
|
0.50
|
Tomato Sauce
|
20
|
0.50
|
Total
|
400.00
|
18.20
|
After knowing the BOM of Chicken Pizza which is 400 grams of material at a value of Rs. 18.20/-. The other costs need to be added to know the total cost with respect to cost of BOM. Generally all direct and indirect cost put together does not exceed 150% on BOM which means a sum of Rs. 27 can be further added to the BOM to know the actual cost. Which comes now to Rs. 47 rounded off to Rs. 50. This clearly highlights that the manufacturer is having approximately profit of 500% on BOM (Rs.18.20/- rounded off to Rs. 20/-) which comes to Rs.100/-.
KNOWING the BOM and the COST associated with it is necessary to know WHAT NORMAL is for a BUSINESS. If the investigator KNOWS the BOM then the investigator can easily know what is ABNORMAL during investigation. The Investigator can safely deduce that entire business circumvents in and around the BOM. The cost structure of every product whether it is a simple product like a PIN or a complex product like a LAPTOP is determined as under:
Cost of BOM/BOQ
| |
Add
|
Direct Expenses
|
| |
Add
|
Indirect Expenses
|
| |
Add
|
Depreciation
|
EBDIT
|
Earnings before Depreciation Interest and Taxes
|
Add
|
Interest
|
EBIT
|
Earnings before interest and Taxes
|
Add
|
Taxes
|
EBT/PBT
|
Earnings before Taxes/Profit before Taxes
|
Add
|
Profits
|
PAT
|
Profit after taxes
|
Cost of a Product
| |
When the investigator understands the making of a cost structure of a product, the same technique can be applied to any type of business for unraveling the truth. Once an investigator knows the BOM then it is a real BOMB for person who is targeted. So I just say to all investigators - know your BOM.
6. The trend of business: Perusing entire books of accounts during investigation may look like a herculean task given the length of time available for an investigator. An investigator has to evolve a technique to go through the entire books of accounts in couple of minutes and look into faulty zone.
Investigators must collect a soft copy of the details of annual returns for 5 to 7 years where items of financials are plotted in an excel sheet. For Manufacturing, Trading and Profit and loss Account all items must be arrived in percentage total vis-à-vis the gross receipts/sale. Similarly all items in Balance Sheet must be arrived in percentage vis-à-vis total sum of Balance Sheet. By doing so the percentage can be arrived at which can be compared with the earlier years percentage. The increase and decrease of percentage from the common average can indicate the direction in which an investigator has to focus to unravel the mystery.
7. Parallel Linkages: The broad rule which an investigator must remember is that “In case of manufacturer if one cheats on ELECTRICITY then one will necessarily cheat on Sales Tax, Central Excise and Income-tax. A businessman conceals income many a time not to avoid income-tax but to evade other taxes like Sales tax, Service tax, Central Excise, Stamp duty, etc. Investigators while probing into business must find the connect to which statutory Act/Acts hurts the business interest which leads to avoid payment of taxes.
REAL LIFE CASES DEVELOPED THROUGH INVESTIGATION
A few real life cases have been cited which were developed during the course of work by applying the above techniques of investigation relating to different trades. In these cases one can observe that a person has taken recourse to either inflation of expenditure, suppression of receipts or both, to deliberately reduce the quantum of tax to be paid.
Incident -1: Inflation of Expenditure
A leading stove manufacturers return of income was perused. While looking at manufacturing details, the weight of the stove was seen as 7.2 KG which was consistently reflected for many years. A stove piece was brought in complete knocked down (CKD) condition and when the stove was weighed the weight was found to be only 3.8 Kgs. This means the assessee while manufacturing is showing excess material consumption to the extent of Rs. 3.4 Kgs per stove.
What was done with excess consumption?
The assessee brought bogus bills of purchase of Stove from SADAR BAZAR, Old Delhi and opened a new concern in the name of an employee through which he sold all the stoves that were manufactured by over consuming the material.
Incident -2: Inflation of Expenditure
A leading sweet and savories business was searched. Only four days milk slip was available reflecting 400, 480, 440, 400 Litres. When books of accounts were observed it was found that assessee has debited 2000 litres on an average as expenditure. The Milk Vendor was cross verified, who confirmed the supply of milk as per assessee’s claim.
How excess consumption was detected?
Milk cans comes in the cans of 40 Litres. The delivery boy who delivered the milk was targeted and was nabbed after six hours without the knowledge of milk vendor. The delivery boy confirmed that he had delivered milk as per the slip of 400, 480, 440, 400 Litres in a small tempo van.
The details of sweet manufactured was observed. The principal item of milk was perused for consumption. The principle items in sweets are Paneer, Khova, Sugar and Ghee and it was checked with the cooks and the same was tabulated in a sheet to know the BOM’s of normal daily production. The cooks confirmed that the average consumption in lean season is around 400- 500 Lt and during festivals it goes up to 800 to 1000 Litres. When four days analysis of BOM’s was made it was found that not more than four hundred liters of milk were consumed.
In the mean time, the milk vendor’s transportation bills were perused which reconfirmed that transportation charges paid were only for a tempo which can carry 10-15 containers of milk and not for a mini truck which can carry 50-60 containers as claimed by milk vendor. The milk vendor confirmed the truth during investigation. The milk vendor further revealed that at end of the month he used to return excess cash back to assessee.
Incident -3: Inflation of Expenditure
A manufacturer of water solar heaters case was investigated. Material was consumed in books over and above the actual consumption. Excess consumption was shown by inflating purchases which was reflected as entries for sundry creditors which were vouch able and non-vouch able. The assessee surrendered when consumption was cross-checked as the businessman has inflated the expenditure in the form of purchases on one hand and also manipulated the consumption of same materials which were never utilized in the process of manufacturing.
Incident - 4: Suppression of Receipts
A Kalyana Mandapa was surveyed as it was reflecting meager income. On the date of survey, the premises were locked. The gatekeeper opened the premises and no books of accounts and documents were available to know the number of days the Kalyana Mandapa was occupied. Assessee surrendered to the facts that came up during the course of investigation by relying on corroborative evidence and paid taxes accordingly.
How the case was unravelled?
The electricity consumption for a day was taken when a premise was unoccupied and when it was occupied. BOM for occupancy of premises was ascertained easily on the basis of average unit of electricity consumed through corroborative evidence of electricity bill.
Incident - 5: Suppression of Receipts
A bullion trader was searched. During the search it was found that assessee has traded annually in bullion for more than Rs. 400 Crores. No major breakthrough was made as he apparently had not updated the books and the transactions were more or less explainable. The bullion trade was understood in detail as it pertained to a highly regulated trade.
The bullion needs to be purchased from banks and public sector undertakings. A bullion trader gives the annual requirement to bank or the public sector undertaking which in turn buys a couple of month’s stock on their behalf from overseas producers. The Bullion trader gives advance payment of a week and takes one week worth of BULLION. After selling the same, the trader gives the same sum in advance and gets its regular supplies for next week. The same method of trade exists in the business of petrol bunk. If the business was so regulated then how there was a flaw in the business was the question as an investigator? The assessee surrendered when the facts were brought to light.
How the case was cracked?
Assessee was asked to give the details of annual order of purchase placed on the bank for bullion. When details were obtained it was found that orders were for Rs. 120 Crores, whereas the assessee has been consistently doing business to the tune of Rs. 400 Crores. When it was investigated it was found that bank colluded with assessee - the stock of three months which was brought for assessee by the bank was also given to assessee without any advance payment. When the bank was covered under investigation it was found that bank did not have any stock of bullion in the locker/chest as mentioned in its stock register.
This method of bank collusion with traders is popularly called as TEEMING and LADING in accounting parlance. The bullion trader got interest free money to trade daily in bullion in parallel market and earned a couple of lakhs on daily basis. The bank manager and the staff were dismissed.
Incident - 6: Inflation of Expenditure
A metal mould products manufacturer’s case was investigated. The business process was that sand is hardened by mixing a chemical where a die is inserted. MS or SS Steel is liquefied with certain alloys and poured in the mould. In order to get the ‘X’ weight of the mould “2X” molten metal is poured. The mould is cooled and excess materials which are called as run and raisers (foundry returns) are cut. After cutting it is grinded and then it is sand blasted. After sandblasting/polishing/painting is done then the mould is tested.
How the excess consumption and negative consumption was detected?
The assessee was asked to give daily stores issue slip and store register for material withdrawal. Assessee stated both were not available. But the department could lay its hands on the stores register. While perusing the stores register, excess consumption and negative consumption was detected. Since stores issue slip was not available, parallel records were scrutinized and it was found that all materials drawn from store was consumed by the melting department which melts the material and which reflects in MATERIAL CHARGE SHEET. When the material consumed as per MATERIAL CHARGE SHEET was compared with the consumption reflected in stock book presented to the Income-tax Department, there was huge EXCESS CONSUMPTION and NEGATIVE CONSUMPTION of various items in stock of material. Excess consumption was disallowed from purchases whereas the NEGATIVE CONSUMPTION was added in preceding year as UNEXPLAINED INVESTMENT as this evidence proved beyond doubt that assessee had used the material which was deliberately suppressed in closing stock of the previous year. The assessee deliberately undervalued closing stock to bring down profits in the previous year.
Incident - 7: Inflation of Expenditure
A leading builder was searched, Rs. 172 Cores was found as excess expenditure booked and the same sums were siphoned through check discounting.
How the builders suppress the income?
Builders outsource their entire works to various vendors for CIVIL CONSTRUCTION, ELECTRICAL, PLUMBING, INTERIORS and so on. Builders generally have arrangements with vendors to overcharge work and return the cash. Investigation of various vendors brings out a clear picture.
A leading Software Company has given the entire turn-key contract to a leading builder. The Builders have a strong presence in Dubai and are popularly connected to a senior politician having business interests. The builders charged three times the cost of material by escalating the project expenditure and paying the promoters monies outside our country. How cash is siphoned out of business will be dealt in detail while dealing the topic of CHEQUE DISCOUNTING.
Incident - 8: Inflation of Expenditure
Every Government contractor has to get a contract after being the lowest bidder through tender process. We need to understand the cycle of transactions done in case of a government contractor. In every tender, specification of work is prescribed where work is measured and bills are released periodically. Since the work goes for a stipulated time period which may take couple of months to couple of years too, the payment is released in several cycles as work is done in umpteen cycles. Therefore, it is not one bill through which accounts are settled but a series of bills termed as RUNNING ACCOUNT BILL (RA BILL). For example RA BILL-19 means that 18 bills prior to that have been released. For release of each bill the work is certified based on MEASUREMENT BOOK (MB) at the end of each day or each week. When the work is certified as per MB only then can a RA-BILL can be processed for release of payment to a CONTRACTOR. Generally a contractor suppresses closing stock to reduce the incidence of tax.
How to find concealment?
If one is attempting to detect concealment in the A.Y 2009-10 then the investigating officer should see the value of closing stock. It has been my experience that the value of closing stock is suppressed, but to find the real value, the officer must call for TDS Receipts for A.Y 2010-11. The officer must look into the TDS receipts of APRIL/MAY 2009 as RA BILL for release of payment would have been applied in the month of MARCH 2009. Whatever was applied in the month of MARCH 2009 should DEFINITELY form part of the closing stock as on March 2009.
After detecting suppression of value of closing stock one can just reduce average of past three years gross profits from the RA BILL presented to the GOVERNMENT for arriving value of stock for taxation purpose.
Incident - 9: Suppression of Receipts
A popular financier was surveyed. Books of accounts were perused and were found to be normal. Market information was that financier gives net amount after charging interest of one month in advance. The financier charges 36% to 60% on principal as compound interest which is evaluated monthly. By this method the financier also earns interest on interest. Net revenue income by this method actually reaches 42% to 76% per annum. The Assessee who pleaded innocence and was very rude to Income-tax staff till evening was totally on back foot when the real picture came out.
How the evasion was detected?
A list of debtors was taken from assessee’s book and market enquiry was done. Market enquiries revealed that actual debtors were almost ten times the size of debtors as per books. Assessee conveniently ignored last zero of the digit of real debtor as reflected in books. For example if in books of accounts the debtor was Rs. 50,00,000/- (fifty Lakhs) then actual debtor in market enquiry was found to be Rs. 5,00,00,000/- (five crore).
Incident - 10: Inflation of Expenditure
A leading importer of Stents (medical equipment) used for heart blockage was surveyed. Assessee was importing stents from Germany. It was found that hospitals were charging Rs. 1,50,000/- to Rs. 2,50,000/- for the brand imported by the assessee. When cost was perused it was found that cost was not more than Rs. 15,000/- to Rs. 20,000/- per stent. Assessee inflated the cost by bogus purchases in the name of bogus processing. Amounts of bogus purchase and processing were taken out through CHEQUE DISCOUNTING. The portions of excess sums were used for payment of bribes to Doctors for using stents on patients.
Incident – 11 Inflation of Expenditure/ Suppression of Receipts
A leading kitchen equipment manufacturer earned a contract to supply kitchen equipment to a leading IT company. The Manufacturer supplied material worth Rs. 50,00,000/- to IT company and requested the company to make two separate cheques in the name of manufacturer for Rs. 20,00,000/- and Rs. 30,00,000/-. The Manufacturer recorded turnover in books for Rs. 20,00,000/- and discounted cheque in bank for Rs. 30,00,000/- and took out cash by suppressing receipts.
Investigators may be puzzled as to what could be wrongin something that has been stated so simply. But when the entire story gets unraveled then it will make total sense behind the wisdom of manufacturer.
Every manufacturer is covered as a small scale industry (SSI) as long as the turnover is below Rs. 1,50,00,000/-. Once the turnover increases beyond that limit, the manufacturer looses SSI status and comes within the ambit of Central Excise Tax. Once Central Excise is levied in tendering process, the manufacturer doesn’t become competitive. Therefore, the manufacturer hides turnover and enters into this scheme of evasion of several statutory taxes.
How the evasion is practiced?
Once goods are manufactured, the entire goods are transshipped by creating two sets of invoices – one which is original and the other an under-invoiced one. The under-invoiced invoice is used to record transactions in the books of accounts which get compared whenever goods are intercepted by sales tax or central excise authorities. Whereas the original one is given to IT Company to release payment by two cheques levying sales tax and Central Excise on entire sum. The cheque of Rs. 20,00,000/- is entered in books and cheque of Rs. 30,00,000/- goes outside the system. This way the manufacturer suppresses not only receipts but also the Sales Tax and Central Excise collected on Rs. 30,00,000/-.
In this case, the manufacturer has inflated the expense as a major portion of monies siphoned off has been booked as expenditure for purchase of material. Since the investigator is not aware of the actual cost of product, the manufacturer can manipulate value of the closing stock also.
Many restaurant businesses suppress receipts in similar manner. By doing so the businessman not only suppresses revenues but also tax monies which have been collected from public for remitting into government account as Sales Tax.
Why SUNDRY CREDITORS is the softest target for an investigator to know that an ABNORMALITY exists?
A manufacturer used to melt metal scrap to make metal castings. During the course of an investigation it was found that manufacturer had sundry creditors for metal scrap to the tune of Rs. 20 Core. Assessee was able to produce certain confirmation too. But as an investigator it struck me that something is grossly wrong.
I gathered information about the margin and the nature of trade in case of metal scrap. I found that metal scrap is a volatile product as prices of all the metal products were rising very sharply. In a year, metal rose to 100% in cost. Business of metal scrap was cash-and-carry business where profit margins were 2-3% only. I also found that the item was subject to 16% Central Excise and 10%VAT. All these facts made me to converge on to the assumption that Sundry Creditors were bogus. My analysis is as under:
METAL SCRAP BUSINESS
|
Item
|
%age
|
Bank Interest
|
18
|
Central Excise
|
16
|
VAT
|
10
|
Total
|
44
|
Profit
|
3
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It does not sound logical in a business that a scrap dealer will do business on credit by bearing 44% expenditure in the form of bank interest, Central Excise taxes, VAT to earn 3% profit on credit after a year. Furthermore, leaving the scrap material in control of a debtor who will enjoy appreciation of 100%. It is really absurd and the transaction is a sham. The metal casting manufacturer has increased bogus expenditure to reduce profits by introducing bogus creditors on one hand and showing entire amount as metal consumed by tinkering with the closing stock value.
Let us examine what has actually happened? Why did the metal casting manufacturer take this route for inflation of expenses?
The principal books which are the bank book and cash book gets closed at the end of year. Real profit appears to be large which a manufacturer does not want to pay huge taxes. Inflation of expenditure through bogus purchase bills is the easiest as it will not attract deduction of TDS. All other expenditure other than purchase is more or less within the ambit of TDS which puts the responsibility on businessman to deduct the prescribed percentage sum and remit into government account within the stipulated time. Therefore a businessman takes a safe route to debit expenditure bills as bank and cash book cannot be tinkered at the yearend closure. The expenditure is raised on one hand by inflating purchase and on the other entire material is also shown as consumed by tampering stock register thereby brings down the quantum of profits because the expenditure gets increased and the material does not become part of the closing stock By this method a businessman is able to evade payment of taxes.
How to crack such cases?
In every such case an investigator must not call for the credit confirmation from sundry creditors from the manufacturer but verify the money trail as to how subsequently the payment was made to creditors for purchase. Bogus creditors never like to spoil their bank book to withdraw cash and give back to the manufacturer through bogus entry. Rather the bogus creditor will use the cheque discounting route to give back the cash to manufacturer.
Therefore, an investigator must go through the entire cycle of money trail for payment made for purchase of material on credit till the last transaction.
CONCEPT OF CHEQUE-DISCOUNTING
Though I may sound naïve, my experience shows that more than 99% of investigators do not know the difference between Account Payee Cheque and Payee’s Account Cheque. The Account Payee Cheque is the biggest bane to the business for siphoning out the monies. Only by this mode is the BLACK MONEY generated by a businessman where cash does not leave a trail.
Let us understand different type of Cheques issued in a banking process. These are:-
1. Bearer Cheque:
a. In the name of self: Cheque issued in the name of self where money can be withdrawn across the bank counters.
b. In the name of others: Cheque issued in the name of others where money can be withdrawn across the bank counters.
2. Crossed Cheque:
a. Account Payee Cheque: The monies have to be withdrawn by routing through individual account or through an account of a DISCOUNTER of a Bank.
b. Payees Account Cheque: The monies have to be necessarily withdrawn by routing through individual account whose name is mentioned in the cheque.
The rationale of bringing cheque discounting in banking system?
Every banker has a nominated cheque discounter who holds an account with bank. The cheque discounter discounts cheques in the name of various people by certifying the identity of a person to bank. This facility was provided as many people did not have bank account. In every such case the discounter will facilitate the identity to bank and assist in withdrawing monies to a person who does not possess the bank account.
How the cheque discounting method has been abused and misused?
The system of cheque discounting was brought in so that a discounter will do all the due diligence in making payments using a bank account for those who do not have any bank account, especially for people who live in remote villages. But the Discounter of a bank has become greedy to earn more discounting commission. And this greed has made them a conduit in withdrawing cash for even those persons who already have bank account. Without doing the due diligence, cash is withdrawn, results in generation of black money.
For example “A” issues a cheque in the name of “B” as if some purchases are made on credit for which subsequent payment is made by ‘account payee’ cheque. ‘A’ goes to discounter of a bank with ‘B’s cheque and discounts it and receives cash. This way ‘A’ is able to book bogus expenditure and reduce profits and later withdraw cash and get it back in ‘A’s control.
Now it can be seen, how this system is being chiefly utilized by businessmen who already have bank accounts to withdraw cash by writing as if payment is made in so many pseudo names. The system of cheque discounting is majorly routing unaccounted transactions which get generated through inflation of receipts through bogus sundry creditors or through suppression of receipts by under-invoicing. Now an investigator can easily understand how through this process all the monies are laundered for generating ill gotten money in businesses.
If you link the above example of builders and others then you would realize that a builder receives back cash from their vendor only through the route of cheque discounting. It is not an understatement to state that 99% of black money in form cash generation is only from cheque discounting in the Indian Economy.
WHEN IT COMES TO MONEY EVERYBODY BELONGS TO THE SAME RELIGION
Article written jointly by
Hari Rao and Muralimohan (1999 Batch of IRS)
05.03.2012
