‘Know Your Investor’ is more important than KYC

S.MURLIDHARAN | Updated on March 12, 2018

Often times, if the funds come from abroad, especially a tax haven, the investigations grind to a screeching halt. — K. Gopinathan

Crooks take care to guard their citadel by not letting their minions be the investors in the ultimate company.

L’affaire BJP President Nitin Gadkari has not come as a surprise to the cognoscenti.

Multi-layering is old hat amongst ingenious company promoters, both for routing investments as well as siphoning away funds. The Chhabria brothers, who went on a takeover spree in the 1980s, are known to have created a complex web of subsidiaries of Shaw Wallace & Co, which they had acquired in a hostile takeover and from which they were alleged to have siphoned off funds.

And even before that, Reliance Industries came for scrutiny as to the exact sources of funds for its capital, with private investigations revealing a complex web of investment companies having names from the aquatic world, such as Crocodile Investments.

The Delhi High Court was appalled to find in one Sophia Investments Ltd’s case that its promoter had brought in illicit money, with a view to laundering it in the names of a whopping 35,000 applicants. All these applicants got their drafts made for the application and allotment from the same branch of a bank located in some rural backwaters, with the branch manager going along nonchalantly in an era when the Reserve Bank of India (RBI) had not yet woken up to the damaging potential of money-laundering. Clearly, the promoter here was trying to bring in his own black money under the garb of non-existent investors running into 35,000. And more recently, the Sahara Group had the mortification of being hauled up by the Supreme Court for not providing satisfactory explanation about its investors, many of whom were suspected to be fictitious or benamis.

Funds for shell cos

The RBI expects banks to examine all savings bank account applications with a fine-tooth comb under Know Your Customer (KYC) norms. Our corporate regulators, on the other hand, aren’t as finicky. They haven’t put in place any formal Know Your Investor (KYI) norms, so much so, men of straw, from drivers to servants, lend themselves conveniently to laundering the ill-gotten wealth of their masters.

In short, a so-called lowly servant, who faces a stiff resistance from a bank at the time of opening an account and every three years thereafter in the name of KYC, is not even asked to present himself by the Registrar of Companies (ROC) when he is supposed to have invested a mind-boggling sum, running into crores, into an investment company.

Should the ROC bestir from his ivory tower, he would find that the servant is only fronting for his master itching to bring his ill-gotten wealth into the mainstream. Crooks take care to guard their citadel by not letting their minions be the investors in the ultimate company. The minions, instead, invest in a first-layer investment company, preferably away from the ultimate company in terms of ROC jurisdiction, with the second or third or even the fourth layer investment company ultimately investing in the listed company or operating company.

These multi-layers of investment companies are obviously all shell companies. While they cannot be stopped from being floated, they can surely still come for a fine-tooth-comb examination, especially as to the source of their funding. Often times, if the original source of funds comes from abroad — especially a tax haven or a place having lax banking norms — the investigations grind to a screeching halt, as seems to have happened with the IPL cricket circus.

The reverse happens when it is time for siphoning off: The operating company, which often is a listed company, gives a loan to the fourth layer investment company and the money passes downward unhindered sometimes into an inconspicuous place or a clandestine destination with authorities having no clue as to the goings-on.

The point one is making is that the KYI is probably more important than KYC, which should be used more intelligently and not as a reflex action to discourage financial inclusion. There is no reason why banking software cannot be developed to highlight abnormal transactions often indulged in by crooks, instead of harassing poor wannabe account holders who are often illiterate.

Feeble legal efforts

Section 115O of the Income tax Act seeks to render multi-layering — often designed to hoodwink authorities and frustrate tracing of trail — unattractive, by insulating dividend received by a company from another company from dividend distribution tax (DDT) only if the investor company is the ultimate holding company.

Thus, in a multi-layering arrangement, the exemption from DDT on dividend received from a subsidiary would be available but once, and not to all the companies enacting the charade. But this might act as a disincentive only where dividend is passed on down the line. In most cases, though, crooks resort to multi-layering for a sinister purpose — to confer anonymity to the funds — and not with any eye on dividends or tax savings.

The original pristine version of the Companies Bill 2011 expressed the government’s resolve to restrict a subsidiary to just one. But somewhere down the line, this resolve seems to have wavered, perhaps with the Government wilting under pressure from vested interests.

No wonder, the now diluted version of the Bill says that the Government reserves the right to prescribe restrictions on multi layering in respect of such classes of holding companies as it might prescribe. This is clearly a comedown in the same manner in which the Government came down from its resolve expressed in the pristine version of the Direct Taxes Code, where it swore by the adage that income is income and no exception or favour shall be shown.

The diluted version, all set to be rolled in, leaves long-term capital gains from bourses alone and seeks to tax short-term gains with kid gloves.

(The author is a New Delhi-based chartered accountant.)

Published on October 29, 2012

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