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Will India let digital tax swindlers have a free run under digi-dhan?

APRIL 13, 2017

By Naresh Minocha, Consulting Editor

IS a tax evasion scam building under the benign canopy of digi-dhan/cashless economy? Is the Government legally and technically equipped to prevent growth of digital black money?

With due apologies to experts who have pitched digital payments as means to reducing tax evasion, we have to address such emerging issues for two reasons. First, India can't shut its ears to alarm bells ringing abroad over digital tax frauds.

Authoritative studies show that several developed and emerging economies are losing billions of dollars of revenue every year due to digital tax evasion. This is notwithstanding tightening of regulatory framework for usage of point of sale (POS) terminals, a major driver of both digital economy and black money.

As put by Capgemini Consulting, "digital technologies are a double-edged sword. These smart technologies are also giving rise to new types of digital tax fraud".

In a recent paper captioned 'Taming Tax Fraud's New Digital Frontier: What Can Tax Authorities Do to Take on Fraudsters and Win', Capgemini says it has modeled the evolution of tax fraud, taking into account new incidences of fraud enabled by digital technologies.

It adds: "Our findings are sobering for tax authorities. In a scenario where tax authorities continue to fight new tax fraud with conventional tools, we estimate digital tax fraud in the US will rise from billion (in 2015) to billion by 2020. Similarly, in the EU, we estimate it will surge from billion to billion."

Second, neither the Centre nor the States have notified regulations for preventing and detecting tax evasion via POS and other digital payment channels. The risk of digital tax frauds in India would grow manifold with introduction of GST later this year.

GST portal will, of course, employ data mining, etc to detect fishy transactions and thus catch tax evaders. This strategy provides for detecting tax frauds after they have happened and not for preventing them through fiscal devices, etc.

Available information in the public domain shows that the Union Government has only specified technical specifications for POS terminals from the standpoint of safety of users. Certain official reports have voiced concerned about digital payment frauds from the standpoint of protecting consumers and not tax authorities.

Neither the Centre nor the States have notified regulations to safeguard tax receipts. Moreover, the sale or installation of POS terminals at retail outlets is managed by banks. This is not overseen by tax authorities or other entities empowered by them to inspect & audit POS machines on their behalf.

This regulatory laxity can be grasped better by looking at reports/studies and comparing India's regulations with that of other countries. Take first the Organisation for Economic Co-operation and Development's (OECD's) report on 'Technology Tools to Tackle Tax Evasion and Tax Fraud' released on 31st March 2017.

It says: "Many tax authorities around the world are seeing particular types of tax evasion: underreporting of income through electronic sales suppression (ESS) and over-reporting of deductions through false invoicing. Tax evasion and fraud can be further facilitated by the cash economy and the sharing (or online) economy".

This report draws on the experience of 21 countries in this area and their successes in using these technology tools against tax-evasion technologies.

According to Revenue Tax Director Louisiana Department of Revenue Darlene A. Allen, the three ESS techniques that facilitate tax evasion are: 1) zappers (external hardware/software that skims cash by deleting some cash transactions recorded by POS terminals), 2) Phantomware, a secret software that is embedded in these machines and 3) cloud computing that offers ESS service from remote location-based vendors.

In a presentation delivered in June 2016, Allen pointed out that third technique enables automatic rewriting of sales records and maintenance of two set of account books.

OECD report explains: "Both phantomware and zappers allow the user to delete individual sales records altogether and also to substitute the sales amounts to a lower figure and thereby reducing the overall sales. Because of their concealed nature, the cash register appears to users to operate normally and poses a challenge to tax auditors to detect."

It adds: " New sales suppression techniques have emerged. Referred to as 'sales suppression as a service', this tool allows a taxpayer to achieve sales suppression through a foreign zapper which operates over the internet. The service provides deletion, alteration and replacement of sales data or remote crashing of the hard drive. This can be very difficult for the tax authority to detect as it otherwise appears authentic, or appears not to be attributable to any actions of the taxpayer. Often the service provider is in a foreign jurisdiction, making it difficult for domestic authorities to take enforcement action ".

Another OECD report on ESS released in February 2013 is equally relevant for India. It points out that tax administrations are losing billions of dollars/ euros through unreported sales and income hidden by the use of ESS techniques. A Canadian restaurant association estimates sales suppression in Canadian restaurants at some CAD 2.4 billion in one year.

Urging Tax administrations should develop an anti-ESS strategy, the Report recommends that the Governments should review its legal powers for e-audit and forensic examination of POS terminals. A legislation criminalizing the supply, possession and use of electronic sales suppression software can also be considered.

It is here pertinent to note that International Monetary Fund last month released three technical notes and manuals on 'Use of Technology in Tax Administrations'. These can prove handy for Revenue Department to acquire an edge in technology war with tax evaders.

An IMF working paper (WP) on 'Electronic Fiscal Devices (EFDs) - An Empirical Study of their Impact on Taxpayer Compliance and Administrative Efficiency' merits attention.

According to WP released in March 2015, Electronic Fiscal Devices (EFDs) such as electronic tax registers (ETRs) or electronic fiscal printers (EFPs) help revenue administrations monitor business transactions.

OECD report says that 135000 cash registers in Sweden are connected to a fiscal control unit since 2010. This includes all companies selling goods and services paid in cash. Increased VAT and income tax revenues has been estimated to around SEK 3 billion (EUR 300 million) per annum since the related legislation was implemented.

According to Fiscal Governance guru, Richard T. Ainsworth, tax and technology critically intersect in the retail marketplace. The outcome is not always for the best.

In a paper titled 'Zappers - Retail VAT Frauds' published by International VAT Monitor in mid-2010, Mr. Ainsworth stated: "Sales suppression is not the only marketplace where the intersection of tax and technology is problematical. On a far larger scale, MTIC (missing trader intra-Community) fraud is also a technology-driven theft of public revenue by criminals. These frauds include the well-known carousel fraud in cell phones and computer chips, MTIC fraud in CO2 permits, the yet to be fully investigated VoIP MTIC fraud, as well as MTIC fraud in the electricity and gas exchanges."

The Government's laxity with POS technology came to the fore in December-January 2017 when it relaxed norms for import of POS terminals to ease citizens' demonetization pain.

In a circular dated 16th January 2017, Central Board of Excise & Customs (CBEC) noted that marketing of POS terminals and their batteries are governed by Electronics and Information Technology Goods (Requirement for Compulsory Registration) Order, 2012 for mandatory BIS registration.

The Circular stated: "Import of non-labeled registered PoS devices shall be allowed subject to the condition that the importer shall put standard logo on each carton at the port instead of each separate PoS Terminal device along with the declaration to the Customs confirming that each terminal device would be labeled after clearance but before sale /distribution in the Indian market. Customs may release the consignments of PoS devices based on the declaration along with the details of model/ Serial nos. of the PoS terminal devices inside the cartons".

Compare this laxity & safety related registration of POS equipment with tax frauds prevention-related stipulations in other countries.

Take the case of Philippines' Bureau of Internal Revenue (BIR). In a memorandum dated 21st July 2014, BIR said it "reserves the right to inspect any machine/system registered at any time during store hours, to verify compliance with specifications of a valid machine/system, the data requirements of the machine generated invoice, the conditions for use of the machines as well as other regulations …."

Similarly, Australia has provided safeguards in its regulations against misuse of POS equipment. Its 12-page Pattern Approval Specifications for POS Systems stipulates: "Devices shall have no characteristics likely to facilitate fraudulent use."

It adds: "The non-legally relevant software must not be able to influence the legally relevant software in a manner that causes non-compliance with this document."

Modi Government should consider substituting euphoria over digital payments & GST into an initiative for proactive action against digital frauds that have either remained unnoticed or in the making.

As put by Capgemini, "Unless government authorities stay one step ahead on the digital curve, the fraudsters could win the digital tax war".