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Artful evasion of tax?
April, 21st 2007

When finance minister P Chidambaram shared brush with Anjolie Ela Menon to canvas for a good cause last year, little did investors in works of art sense what was in store for them.

Many were stumped when the FM proposed a capital gains tax on profits made by investors from the sale of art work that they own. The reason: The booming business in the art market. The budget proposal is yet to be passed by Parliament, but the government has surely started tightening the noose on players in this market.

On Tuesday, the income-tax department went ahead with searches on a couple of auction houses and art galleries in Delhi and Mumbai for alleged tax evasion. This is the information that the tax department has so far gathered: One, payments are being made in cash to several art dealers. Simply put, art trading is being used to launder money. Two, art galleries are transacting amongst themselves to push up prices. Three, many high networth individuals are investing in art-funds. The department wants to check out the source of funds going into these investments.

But there is a small catch here. Unlike, say, mutual funds which provide a list of their investors to the tax department, there is really no mechanism in place to collate such information from art-funds. Besides, these funds are not regulated by any agency.

Mutual funds, for instance, are obliged to furnish a list of their clients who buy units valued at over Rs 2 lakhs a year under the income-tax laws. They do this by filing what is known as an annual information return (AIR). Each transaction in the return is accompanied with the permanent account number (PAN) of the investor.

The data given by the mutual fund is matched with an individuals tax return to check if his investments or assets are proportionate to his

known sources of income. If they are not, he could be evading taxes.

The AIR captures most of the high value investments made by individuals be it in equities, mutual funds, real estate or bank deposits. Credit card payment valued at over Rs 2 lakhs is the only transaction on expenditure that is covered under the AIR.

Big ticket expenses met through cash payments are not covered as of now, leaving room for money-laundering. Purchase of high value watches, jewellery, furniture, spends on luxury cruises and so on feature in this list. It is simply not possible to bring such transactions under the AIR. The reason: an organised authority, known as third party in tax parlance, has to be in place furnish such information.

Every jeweller in the country, for instance, cannot be asked to provide a list of customers to the tax department. Simply put, there is a limitation on the nature of transactions that can be covered under the AIR.

One way out is to make quoting of a PAN compulsory for all types of transactions. The government has already made PAN the sole identification number for all participants in the securities market. In due course, PAN quoting can be made mandatory even on nonfinancial investments or purchases. But this requires political will.

In a couple of years, India will join the league of other developed economies where every economic activity will be captured elecronically. Once this is in place, transactions from multiple sources can be correlated with the tax returns of the individual.

Till such time, perhaps, tax authorities will continue to take recourse to searches and surveys to detect tax evasion. But there are no two views that searches are blunt instruments and need to be used only in rare circumstances like it is done in countries like Singapore. This surely calls for accelerating the pace of full computerisation of the income tax department.

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