UNCOVERING HIDDEN MONEY

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UNCOVERING HIDDEN MONEY

The government is asking the private sector and investors to invest in certain priority sectors with a promise that it would not seek the source of income for two years. While the government wants to leverage the hidden cash for the country's development during the crisis caused by the pandemic, there are also worries that such a move would be a setback for Nepal’s progress in combating money laundering and the flow of dirty money. However, providing such a nondisclosure facility could help the government in freeing up huge amounts of money that investors are otherwise reluctant to show sometimes on valid grounds. The government must strike a delicate balance between utilising such money to stimulate the economy during the crisis after Covid-19 and combating money laundering and terrorist financing under its international commitments.

Two separate events that unfolded last month sparked a debate in the country on how to deal with the money or wealth that rich people have shielded from the state.

First, the government, through the budget for the current fiscal year, made an announcement to allow investments in certain priority sectors without requiring investors to disclose their source of income. For its implementation, the government amended the Income Tax Act 2058 and assured legally that it would not seek the source of income for the investment in projects and industries in certain areas that it considers are of national importance. But that investment should be made by mid-April 2024. This relaxation means that the government would turn a blind eye on how the money that is invested was earned or made.

The provision was immediately welcomed by the private sector which has long been asking the government to allow them a chance for voluntary disclosure of their assets or properties. But there was also fierce criticism of the government's plan. The criticisms have both positive and political motives. Some critics are afraid that the government’s plan could lead the country into isolation from the financial world if it felt that the country was reneging on its promise to tighten the flow of illicit financing. Also, the provision drew ire from the main opposition CPN (UML) which itself had introduced—and later withdrawn—a similar facility three years ago. In that sense, the CPN (UML)’s opposition to the provision can be interpreted as a political attempt to stir anti-government sentiment.

A few weeks after the government introduced the provision that gives protection to investors from divulging the source of income, another event that could probably reinforce the government’s claim that the new provision would facilitate turning the idle and secret financial resources of the private sector into investments of the country occured.

International Consortium of Investigative Journalists (ICIJ)’s global investigation, branded as the Pandora Papers, exposed how the world's rich and powerful are using secret offshore companies to hide their wealth. The investigative report also revealed that at least 16 Nepali citizens have made investments abroad through offshore or shell companies. Characterising all such investments as ‘illegal’ or an attempt at ‘money laundering’ like some news reports or analysis did after the leak would be naive.

However, this leak has laid bare the restrictive environment in the country for investment.

Due to the hassles that investors face in the country including the disclosure of source of income along with evidence, some Nepalis find it convenient to make investments abroad or stash their cash abroad even when Nepal’s archaic law—Act Restricting Investment Abroad, 1964—bars it.

The 2020 report of Swiss National Bank, the Swiss central bank, showed that funds deposited by Nepali individuals and firms in Swiss banks more than doubled to 360.82 million Swiss Francs (over Rs 46.8 billion) in 2020, making Nepal the fourth largest depositor of cash in Switzerland among South Asian countries. The deposits made by Nepalis in Swiss banks represent a jump of 105 percent from 2019 when the total deposit of Nepali was 175.9 million Swiss Francs (CHF).

While some of these investors may have a global ambition to go abroad and do business overseas, there are many who still want to tap the potential of the domestic market.

Corporate leaders that New Business Age talked to say that most of those reaching abroad secretly for investment as well as many other potential investors within the country are reluctant to bring their funds in the country out of fear of retribution. But, that has not been an issue for them abroad. In fact, many have been doing that already even by circumventing the laws of the land. Despite restrictions, they have found loopholes in the existing laws to routs out their capital.

‘Black Money’! But, How?
Now, the question one may ask is, why are they hiding or shielding their wealth if they have earned it legally? The structure or the nature of our economy partly explains why some investors in Nepal are not willing to be transparent when it comes to disclosing their source of income. Nepal’s economy has largely remained informal for a long time. The parallel economy is estimated to represent half of the country’s GDP. Not only small or medium enterprises, even big businesses or corporate houses do not have a long experience of bookkeeping.

Investors in the real estate sector may help to understand this difficult conundrum that many investors in Nepal have faced. For example, a developer purchased 10 ropanis of land at the cost of Rs 10 million in 2009. As with all cases of land transactions, the valuation of the land is under-reported at Rs 8 million in Thaili (price stated in paper as per the government rate). The land price rises three times within a year. The developer finds selling the land a more profitable idea than building apartments there which could take some time and involve costs. He sells the land at Rs 30 million. This time the rate in Thaili puts the valuation of the land at Rs 18 million. Now, he may find it difficult establishing the source of income of Rs 12 million if he wants to pour that income somewhere else as an investor. That’s what has been happening not only in loosely regulated real estate but also in various sectors in the economy. Be it transportation or trade, businesses in Nepal have gained a foothold or flourished largely under the informal economy. It would be difficult for a third-generation trader to establish the source of capital that his grandfather mobilised from supplying goods when the invoicing of goods imported to the country was not as scientific as it is now or ask to show the evidence of income tax filing when the Income Tax was not even introduced.

As a leading Nepali industrialist points out, high taxes, compliance costs and tighter regulations are major driving forces for the informal economy.

Labelling all income or wealth that does not have valid sources as ‘black money’ does not bode well for the country and the economy that desperately needs financial resources for investment, says the industrialist on the condition of anonymity.

“Those who do not understand the characteristics of Nepal’s economy or how businesses have thrived in Nepal are interpreting the unaccounted-for money as earnings through illicit means. The government is now left with two choices: facilitate in freeing up such funds and utilise it for the country’s development or allow it to remain underground for some time until the investor finds a way out to route it abroad,” said the industrialist.

“The government’s recent announcement to not seek the source of income on investments in certain priority sectors is a right step towards mobilising the hidden resources on priority sectors that have potential to transform our economy. But, I think the government should not limit the exemption of income source disclosure to certain sectors. It should come up with a policy to welcome such funds in all sectors,” he adds.

Representatives of private sector organisations say that even strict restrictions that the government has been imposing for the last few years has not stemmed the flow of so-called black money into the country. They cite the data of foreign direct investment in the last few years in Nepal which show the world’s most secretive offshore havens are the top countries or jurisdictions from where investments have been poured into.

According to the Nepal Rastra Bank (NRB)’s recent survey report on foreign direct investment in Nepal, Saint Kitts and Nevis is in third position in the list of country-wise FDI stock in Nepal with a total of Rs 15.26 billion in foreign investment after India (Rs 62.45 billion) and China (Rs 30.97 billion). Saint Kitts and Nevis is a tiny Caribbean island which allows individuals and firms to incorporate their companies without any intention of doing business there, but with a plan to invest in another country. Another such country (jurisdiction) in the NRB’s survey list is the British Virgin Islands which is in 13th position with FDI of Rs 3.72 billion. Other countries and jurisdictions that are considered tax havens for individuals and investors around the world are Bermuda, Cayman Islands, Samoa and Cyprus, also featured as major countries which have investments in Nepal.

Such individuals or companies can avoid tax as these offshore jurisdictions provide tax exemptions or levy a very low rate for foreign businesses.

Another reason these tax havens are attracting wealthy and rich investors is due to the high-level of secrecy they offer. Individuals or businesses hold money within shell companies and anonymous entities and can invest it from such companies or entities in another part of the world. This is mostly how investments from these jurisdictions also come to Nepal.

As Nepal has already been receiving investments from such tax havens where investors enjoy full confidentiality and anonymity, there is no reason the door should be shut for those who want to do it directly.

“On the one hand, the government is happy with investments from all tax havens which have been providing complete anonymity to investors. On the other hand, it asks us to become highly transparent and show the source of a single rupee. Isn’t it a double standard?” the industrialist asks.

An answer to resource shortage for development
Realising the need to tap such hidden or unaccounted money to accelerate the economic growth, the government decided to pursue a lenient approach when it comes to seeking the source of income for the investment in ten priority areas or sectors for the next two years.

The timing for introducing such a facility is also important to note here. When the global economy is battered by the Covid-19 and subsequent containment measures, there are worries that the sources of investment could dry up at least in the short to medium term.

Countries like Nepal could find themselves struggling to find necessary financial resources to steer the economy towards a path of growth from a Covid-19-induced slump, boost production and create employment opportunities.

There are also concerns that the foreign assistance for Nepal could fall when many countries are dealing with recessions and development partners are overwhelmed with financial requests. Private sector may not be tempted towards making new investments as they pursue a wait and watch policy until the pandemic subsides. The government’s revenue receipt may also witness a decline when economic activity slows down. The pandemic is already exacerbating the pressure on resources.

Most of the economic indicators including growth and the external sector position of the country have already turned negative. Policymakers agree that economic revival should be at the centre of the government’s agenda.

“We have to massively increase investment at any cost. Some certain sectors that we think of as being priorities need immediate and further investment. The government alone cannot do that. So, the government introduced a policy that would encourage the private sector to come up with investments that the country desperately needs at this moment,” says Dr Surendra Uprety, Senior Economic Adviser of Minister for Finance Janardan Sharma.

For that, the government listed out hydropower projects of national importance, international airport, tunnel and roads, railway, cement industry, steel industry, agro-based industry, tourism industry, manufacturing industry that provide jobs to at least 300 people and industries that utilise at least 50 percent domestic raw materials as the sectors where investments can be made until 2024 without income source disclosure requirements. However, investment in alcohol and tobacco industries will not be entitled for such anonymity.

“Some businessmen are not comfortable showing their money or the source of their income. Investment is itself shy in nature. It is sensitive to various factors like laws and regulations, interest rates and possibility of returns,” says Dr Uprety while explaining the reason behind the new relaxation. “There are even news reports about the flight of capital from Nepal. If we have such resources, we should not shy away from utilising it during the crisis,” he says.

Dr Uprety, however, quickly adds that the government would not provide exemption for the funds or income earned through financial crimes like money laundering, financing of terrorism and corruption.

It is not clear whether the new policy could really help in boosting the investment as expected by the government. Government officials and experts cannot estimate the volume of such a fund or possible investment the policy can help generate.

This is not the first time that the government has tried to woo investment by allowing investors exemption on disclosure of income source. Earlier in Fiscal Year 2018/19, the government led by KP Sharma Oli had also introduced similar provisions. But, then Finance Minister Yuba Raj Khatiwada did not implement the provision following criticisms from some sectors.

Voluntary Disclosure of Income was a scheme introduced by the then Finance Minister Dr Baburam Bhattarai through the budget speech of FY2008/09, allowing people to pay 10 percent tax on their assets and make them legal without worrying about any investigation. However, that announcement did not result in a high amount of declarations. The government collected nearly Rs 1.5 billion from the voluntary declaration of income of nearly Rs 15 billion at that time.

Former Finance Minister Bhattarai, who is also a former Prime Minister, also came to the current government’s defence. “It’s good to convert the black money into legal. The trend here is to keep the illegal money and keep it black,” says former Prime Minister Bhattarai. “Whether it's black or white money, it's right and appropriate to ask people to invest in the productive sector, create jobs and develop the economy,” says Dr Bhattarai.

Upbeat private sector
The government is optimistic that the new policy will spur investments in the country in the coming two years. So is the private sector.

Private sector umbrella organisations welcomed the government’s decision to not seek the income source on investment in certain sectors for two years. While the new provision has elated leaders of Confederation of Nepalese Industries (CNI) and Nepal Chamber of Commerce, the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) formally praised the government for introducing the new facility.

In its statement issued after the passage of the Financial Bill that amended the Income Tax Act to introduce the provision, the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) said that the relaxation would create an environment that would allow capital to flow from the informal to formal sector and boost economic output and employment opportunities.

Business leaders say that the new policy will benefit both the government and the private sector.

“If it is not ill-gotten money earned through arms or drug deals or other financial crimes, the government should roll out the red carpet for investment from all,” says Shiv Ratan Sharda, the chairman of industrial conglomerate Sharda Group.

“Let people bring the money to the country from abroad where they have either made investments or park in bank accounts with little or no interest. That’s what other big economies are doing. There is no need to be conservative or negative. The country and the economy will benefit from such investment,” he says.

Walking a tightrope
Leveraging the hidden or unaccounted money for economic development during a time of crisis, as the government wants, is no cakewalk. It also comes with risks. The government has decided to introduce the provision also at a time when Nepal is under the strict vigilance of global and regional global money laundering and terrorist financing watchdogs like Financial Action Task Force (FATF) and Asia/Pacific Group on Money Laundering.

Nepal is scheduled to undergo the APG mutual evaluation in the current fiscal year 2021/22. The peer review from the APG—the FATF-styled regional body—will assess the levels of compliance with the international anti money laundering and combating financing of terrorism (AML/CFT) standards. If the report determines there are strategic deficiencies in the country to counter money laundering, terrorist financing, and proliferation financing, Nepal could slip to a list of jurisdictions under increased monitoring, commonly referred to as the ‘greylist’.

Remaining in the ‘greylist’ would not only damage Nepal’s reputation in the international community, but also lead to isolation from the financial world as foreign organisations, countries and international banks will turn reluctant to carry out transactions with such countries, according to experts.

Does the new provision on income source disclosure waiver for investors risk Nepal being sent down that path? Experts and leaders are divided. Some analysts believe that the recent relaxation introduced by the government would be interpreted as an attempt to provide a sanctuary to dirty money that could tip Nepal onto the path of the ‘grey list’.

However, government officials say that such fears are overblown. Issuing a statement on September 20, Mahesh Acharya, the spokesperson at the Ministry of Finance, said that the government is fully committed to implementing national laws and regulations and international commitments on AML/CFT and the new provision would not allow an exemption on financial crimes like money laundering, terrorist financing, drug trafficking and corruption.

Former finance minister Dr Ram Sharan Mahat also says that there are money laundering prevention related laws and regulations as well as institutions like the Department of Money Laundering Investigation that will investigate if there are any suspicious transactions, making it difficult if not impossible for those committing financial crimes to get off the hook.

According to a senior official at the Nepal Rastra Bank (NRB), whether the new provision will have any consequence during the mutual evaluation largely depends upon the government. “If there is high level commitment that such a provision is not exploited for money laundering and terrorist financing and the government pushes through the laws and regulations as recommended in the earlier report, then it may not have any significant impact,” says the senior official. “If there are no other reforms as recommended by the APG, the government will have a hard time defending itself which could also put us in trouble.”

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