Reserve-Bank.com - Banking Forum

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Many Indian businessmen have discovered that the neatest way to bring back money that’s stashed away abroad is to show it as foreign direct investment in a small unlisted firm that few would notice. This involves a string of transactions that not only escape the regulatory radar but also have a touch of legitimacy. But beware a small change in banking rules.

The laundering trail, honed by experts in tax and foreign currency laws, begins with a simple overseas investment, allowed by Reserve Bank of India under its liberalised remittance scheme. The investment, which can be up to $200,000, is made to float a shell company in Dubai’s Free Trade Zone. That’s the first step. Owning such a company is no big deal: no tax is paid, regulations are simple and hundreds of professionals are available to tell you how to go about doing it.

Once this is done, the undisclosed money lying with banks in tax havens in other parts of the world is brought into the Dubai company, which just holds it in a bank account. The next step is to bring the money back home.

To make this happen, the owner of the money now lying with a Dubai company, sets up a firm anywhere in India or uses an existing unlisted firm to get the money back. The way this happens is that the Dubai company buys the shares of the Indian firm at a hefty premium. A high premium allows you to bring in as much as money as possible, and also ensures that the firm’s capital post-transaction is within the authorized capital, so that no extra charge is paid to the local authorities.

The money that comes in is in the form of foreign direct investment, through the automatic route where the inflow is not scrutinized by any government agency or the foreign direct investment board. With this, the Dubai company becomes the predominant shareholder of the firm. The next and final step is buying out the Dubai company’s shareholding. This happens after a year to avoid suspicion.

However, when the Indian firm buys out the Dubai company — a transaction that restores control back to the local shareholders — it pays only a small fraction of the price it received a year ago. Indeed, such deals happen at a price of just one or two rupees a share. So, at the end of it all, big money flows in but only a tiny amount leaves the country.

What can complicate matters now is a recent change formalized by RBI. The regulator has asked all commercial banks (which act as the authorized dealers for foreign exchange transactions) to carry out a check on entities that are investing into the country.

This in all likelihood emanates from concerns that the majority of FDI deals are automatic in nature. These deals are not in the public domain, and are hardly tracked by any of the central authorities. Under the circumstances, if concerned banks which handle such transactions have to carry out a `know your customer’ check on organizations that invest, it could make such laundering a little riskier.

At present, neither banks nor authorities bother to find out who actually owns the Dubai company which is investing.

Such foreign companies have a separate board of directors who are largely Dubai nationals or Indians in Dubai. These are small, innocuous firms, and transactions happen at decent intervals.

Chances are, not much will change, since it would be difficult to establish the identities of account holders sending money to the Dubai company. Dubai authorities won’t bother, and Indian authorities and banks here will find it difficult to overcome the barriers of jurisdiction.

see: http://economictimes.indiatimes.com/Dark_money_trail_runs_into_RBI_firewall/articleshow/3091628.cms
http://in.reuters.com/article/domesticNews/idINBOM27742920080530
http://www.newsline365.com/20081219/stricter-derivatives-norms-for-the-indian-banks-new-rbi-guidelines/