APRIL 22, 2022

By L. Venkateswara Rao, Additional Commissioner (AR), CESTAT, Hyderabad

MONEY laundering is an age-old phenomenon. Earlier, Merchants of China used to conceal their profits accrued out of foreign trade, fearing theft at sea and forfeiture of the same by the Kings. They concealed the same by converting the profits accrued into readily movable assets, like cash and moved the same to outside jurisdictions. Subsequently, they did trade at inflated price and repatriated these stashed funds.

1.1 Money laundering and organized crime are inter-related. When a criminal has abundant wealth, everyone suspects about its origin. This fear will compel the criminals to launder their ill-gotten wealth to make it appear untainted or legally earned money. They do so by laundering the said ill-gotten money. The most important aspect of money laundering is disguising the link between the money and its (illegal) source. Most criminal and terrorist organizations use various money laundering techniques to funnel funds into legitimate businesses through illegal business entities. We will analyse the different techniques used by the money launderers and the role of crypto currency in aiding money laundering.

2. THE CONCEPT OF MONEY LAUNDERING:

2.1 Money laundering refers to conversion of proceeds derived or obtained by commission of a scheduled offence and make it appear to have been originated from a legitimate source ¹ . The term money laundering is said to be have originated from mafia ownership of laundromats ² in the US. The criminals and the drug mafia in the US who were earning huge sums of money in cash by committing offences like extortion, prostitution, gambling and bootleg liquor needed to show these ill-gotten monies as acquired from legitimate sources.

2.2 The criminals conceived the idea, of mixing this ill-gotten money obtained out of commission of the mentioned unlawful activities with the monies in the legitimate business to make it appear that the origin of these ill-gotten monies is from legitimate sources. Accordingly, they purchased laundromats which deal in cash business only. By seeing this advantage, a criminal by name Al Capone purchased this laundromat ³ and converted the ill-gotten money as clean money. Thus, the illegal or dirty money is made to undergo a cycle of transactions to make it appear as legal money, thereby, the source of illegally acquired funds, through several transfers and deals, made to appear as if it is derived from legitimate sources ⁴.

The process of Money Laundering generally involves the following three stages:

(a) Placement: The Money Launderer, who is holding the money generated from criminal activities, introduces the illegal funds into the financial systems. This might be done by breaking up large amount of cash into less conspicuous smaller sums which are deposited directly into a Bank Account or by purchasing a series of instruments such as Cheques, Bank Drafts etc., which are then collected and deposited into one or more accounts at another location.

(b) Layering: The second stage of Money Laundering is layering. In this stage, the Money Launderer typically engages in a series of continuous conversions or movements of funds, within the financial or banking system by way of numerous accounts, so as to hide their true origin and to distance them from their criminal source. The Money Launderer may use various channels for movement of funds, like a series of Bank Accounts, sometimes spread across the globe, especially in those jurisdictions which do not cooperate in anti-Money Laundering investigations.

(c) Integration ⁵ : - Having successfully processed his criminal profits through the first two stages of Money Laundering, the Launderer then moves to this third stage in which the funds reach the legitimate economy, after getting inseparably mixed with the legitimate money earned through legal sources of income. The Money Launderer might then choose to invest the funds into real estate, business ventures & luxury assets, etc. so that he can enjoy the laundered money, without any fear of law enforcement agencies.

The above three steps may not always follow each other. At times, illegal money may be mixed with legitimate money, even prior to placement in the financial system. In certain cash rich businesses, like Casinos (Gambling) and Real Estate, the proceeds of crime may be invested without entering the mainstream financial system at all.

3. Various techniques are being used by the launderers to convert the 'proceeds' derived out of unlawful activities to appear legitimate and untainted. However, some of the important one's are discussed hereinbelow:

Modus Operandi: -

(i) Over invoicing of Exports: Over invoicing of Exports is one of the most common modus operandi noticed in the money laundering offences. Over invoicing of exports will not only facilitate repatriation of money stashed abroad into the Indian territory but also benefits the exporter or the launderer in the form of receiving drawback and other export benefits also at a much higher rate.

(ii) Under Valuation of Imports: Another modus operandi is that the importers try to undervalue the imported goods which attract higher rates of import duties under the Customs Tariff. The difference between the actual cost and the invoiced cost of the imported goods will be paid to the supplier with the foreign currency stashed abroad through hawala route.

(iii) Over Valuation of Imports: This modus operandi is rare but still not uncommon. Generally, imports with very low import duties like 'project imports' and machinery imported for 'initial setting up' of a mega power plants which attract either zero duty or 5% duty will be used as a channel to send more foreign currency abroad by the importers with a malafide intention to stash the excess foreign currency outside the country. It is pertinent to note that in all the cases of over invoicing of the imports, the importers will procure goods from a middleman (supplier), who will purchase the goods from the manufacturer and re-invoice the goods. After receiving the foreign currency, from the importer, the supplier will pay to the manufacturer and stash the remaining amount with him against receipt of commission and repatriate the remaining foreign currency either to the importer or stash the same on behalf of the importer as per the instructions received. This stashed foreign currency can be used for purchasing assets in foreign countries on behalf of the importers. In all such cases, the supplier and the importer will have some kind of relation with each other.

(iv) Money Laundering Through Shell Companies: Shell Companies are nothing but front companies which are formed and used as vehicles to raise funds. These are often misused for illegal purposes. Panama papers exposed the extent to which these shell companies are being used to launder money across the globe. Several shell companies have been set up across the globe particularly in Cayman Islands and British Virgin Islands and estimates would suggest that the misuse of shell companies costs the US around US 70 billion per year. For long, the banking industry developed innovative methods of cash payments. One of these is "Cyber Payments". Cyber payments would involve payment components, viz., cyber-cheques, cyber-credit and cyber debit. However, the government and law enforcement agencies are not able to track the card's sections as these cards, unlike the Visa and MasterCard, has no registration of the transaction. The inability of the Banks and Law Enforcement Authority to trace such funds has provided an opportunity for the movement of illicit funds. These companies are used in both the placement and layering stages of the laundering process. Shell Companies having no business are incorporated to conceal the true ownership of accounts and assets owned by the criminal organization.

Restaurants, hotels, casinos, bars, nightclubs, dry cleaners, retail outlets, video rental companies, vending machine companies, parking lots of construction companies are cash intensive concerns. Money launderers use them as front companies where illegal profits can be mixed with revenues obtained from legitimate undertakings.

(v) Private Investment Techniques: The repatriation of the funds parked in offshore shell companies is done by "loan back" method by the launderers. The launderer holding a foreign account who intends to make an investment secures down payment of legitimate funds. The balance payment can be arranged by him by taking two loans - one legitimate and second, from his illicit funds stashed in the foreign bank account. He repays the loan along with interest. He also repays the loan of his illicit funds making them available for borrowing again.

(vi) Acquisition of sick companies: The launderer may acquire ownership control of a sick company and make it as a front company. When the money market is tight, the money launderer will assume the role of a moneylender at higher rates of interest.

(vii) Retail business: In these types fake sales are recorded in books of accounts. The degree of money laundering in all these cases is directly proportional to the degree or volume of fake/fabricated sales. These fake sales are being shown as legitimate sales proceeds of trade. Fast-food restaurants, fashion designer's outlets, jewellers shops, travel agencies, would fall under this category and are suitable for money laundering.

(viii) Wholesale trade: The wholesale trade would more or less follow the fake/fabricated sales in books of accounts to launder money.

(ix) Manufacturing units: A shell-manufacturing unit may have a building and name board representing a plant. The units are used for projecting sales and using the unit for money laundering. Manufacturing units can also be used to launder money, with inflated invoices. The rate of inflation invoices will be directly proportional to the extent of money laundering.

(x) Charity shows: Organizing charity/entertainment shows would fall under the money laundering techniques . False sales of tickets will be shown as if a person is buying a ticket. The buyer is not obligated to be present in the show. The extent to which fake tickets have been purportedly sold is the limit to which money can be laundered. However, this type of money laundering will be subjected to payment of entertainment tax.

(xi) Casinos : Casinos will throw an opportune way to launder money. Money launderers take their proceeds of crime to the casinos, buy a large number of chips and do little or practically no gambling. At the end of the day, the launderer purchases chips from the winner at a premium and will also encash the chips in his possession by passing them off as genuine winning.

(xii) Large numbers of bank accounts: The money launderers may operate a large number of accounts with small sums of money, in fictitious names, in bank branches located all over the country - is one of the techniques used for money laundering. These techniques will be used to avoid arousing of suspicion regarding the origins of illicit money.

(xiii) Securities market: The capital markets raise capital from the general public or financial institutions. The capitalized markets are also known as securities markets. In the stock market, capital is raised is in two ways (i) from equity capital, which denotes ownership in the form of company shares; and (ii) interest-bearing bond. These bonds are debt instruments issued to the general public / financial institutions. In the securities market, profits can easily be recorded on paper to launder the illegal proceeds. Losses on paper can also be recorded in the securities market to save on income tax. As only a few securities markets ask for tax deduction from customers, money launderers are able to get around that by having aliases or false identities.

(xiv) Agricultural sector in India: In India, the agricultural sector is exempt from income tax. The objective for such exemption is to give boost to agriculture and relief to farmers. Money launderers holding land would show highly inflated gains from agriculture, claiming usage of technology. Another advantage of laundering money through the agricultural sector is that one also saves on income tax. The other ancillary services in the agriculture sector, viz., dairy farming and poultry, which are also exempt from income tax, are also utilized to launder money.

(xv) Amnesty schemes : The Governments often announce amnesty schemes, giving opportunity mostly to people to declare their illegally acquired proceeds or black money to government on payment of a certain amount of tax. In all these schemes, no questions are asked about the source of the money and after payment of tax the remaining monies becomes legitimate money which can be used openly in the economy. These amnesty schemes reward the criminal elements at the expense of honest taxpayers.

(xvi) Use of gold/diamonds/precious gems ⁶ : Criminals can also buy gold, diamonds and precious gems and use them to launder money. In India, there is a high demand for gold since Indian women are fond of gold and gold is also seen as a safe investment in the society. As a result, there is heavy smuggling of gold and most of the gold and diamond purchases are made without a bill and in grey markets. This would throw a windfall of opportunity to smugglers to purchase gold and diamonds with the Proceeds of Crime and launder money. India is also the largest center in the world for the cutting and polishing of diamonds. With their illicit proceeds, the criminals buy gold and diamonds.

(xvii) Investments in real estate: In most of the Indian Cities, there is a huge gap between the registered values and active values of property. Thus, the launderers give huge amounts in cash and less amounts in cheques to buy such property from the seller ⁷.

(xviii) Gifts received from Non - Resident Indians: Gifts from relatives and friends staying abroad in foreign currency and in the form of cheques are accepted by Indian citizens against payment of equal amount in cash in India to the NRI's family members based on the prevailing exchange rate. This facilitates money laundering.

(xix) Money Laundering through NGO's: In India approximately 43,527 NGO's are registered under the Foreign Contribution (Regulation) Act. These organizations receive contributions in the range of 2-2.5 billion USD annually. Income tax benefits are available to NGO's in India, which are doing charitable work. Since NGO's have good reputation among public due to their work in imparting education, rendering medical reliefs; that their financial operations involve multiple donors including some anonymous donors donating in cash as well as kind, they can be used by the money launderer's at will for laundering the proceeds of crime.

4. Crypto Currency and Money Laundering:

a) Crypto Mixing: Crypto mixing also known as tumblers -Mixing of cryptos of several users. A typical mixing service involves accepting and sending cryptos from a client, sent through series of various addresses and then recombines them, resulting in 'clean cryptos'.

b) Peer-to-Peer Crypto Networks: Criminals use these decentralized networks to transmit funds to a different crypto ATM's. These ATM's allow people to purchase Bitcoin via credit or debit cards. Some ATM's offer the facility to trade crypto currencies for cash as well. In many cases, KYCs are poorly enforced. These ATM's frequently change their locations and addresses to another country where there are crypto exchanges. These exchanges help individuals in converting crypto currency into flat currencies in order to purchase high-end item.

⁸In June, 2021, the Enforcement Directorate issued show cause notice to an exchange which failed to trace the real beneficiary who had laundered more than 2800 crores using crypto currency in two transactions. The agency found receipt of 880 crores and transfer of Rs. 1400 crores worth crypto currencies but none of the transactions had the details of beneficiary. In the above case, the criminals have converted the 'Proceedings of Crime' stashed in India in rupees into cryptocurrency 'Tether' and then transferred the same to 'Binance Wallets', a crypto wallet service registered in Cayman Islands where the illegal money was converted into dollars with ease for being laundered back into the legal banking system using Shell Company.

The Enforcement Directorate Sleuths claimed that this exchange had provided the conversion of Indian rupees into crypto currency and kept all these transactions in secrecy and none of these transactions are available on the block chain for any investigation. In a paper released on "crypto currencies", recently, the Financial Action Task Force (FATF) mentioned that many of these exchanges are so designed to avoid regulatory Law Enforcement scrutiny and help the criminals to distribute, store and launder the proceeds. In one such case mentioned by the FATF in its study, an entity 'Liberty Reserve', having its own crypto currency called Liberty Dollars, was busted by the US enforcement agencies. The money transferor in this case operated on a massive scale with over a million users worldwide and made 5.5 crore transactions which were later found to be illegal. In December last year, the Enforcement Directorate had arrested one person from Bhavnagar, Gujarat, who was found to be transferring a large amount of "Proceeds of Crime" from illegal online betting to Chinese Nationals out of the country converting Indian rupees into crypto currency.

5. Challenge to RBI Circular dt. 05.04.2018 by Internet and Mobile Association Vs. Reserve Bank of India

Issue Involved:

The RBI Circular dt. 05.04.2018 directing the entities regulated by the RBI not to deal with or provide services to any individual or business entities dealing with or settling virtual currencies and to exit relationship, if they already had one, with such individuals has been challenged in the Hon'ble Supreme court by the Internet and Mobile Association. The Hon'ble Supreme Court of India in their decision dated 4 March, 2020 in the case of Internet and Mobile Association vs. Reserve Bank of India adjudicated on the relevance of the abovementioned RBI Circular.

The RBI, in the counter affidavit filed, stressed on the following objections: -

i) The corporate bodies/entities who come up with the challenge are not citizens and hence not entitled to maintain a challenge under Article 19(1)(g) of the Constitution of India.

ii) That there is no fundamental right to purchase, sell, transact and/or invest Virtual Currencies and therefore, the petitioners cannot invoke Article 19(1)(g).

6. The Hon'ble Court on hearing the arguments advanced by both the parties felt that the measure taken by RBI should pass the test of proportionality, since the impugned Circular has almost wiped the virtual currency exchanges out of the industrial map of the country, thereby infringing Article 19(1)(g) and observed as follows:

a) "Despite best efforts made to educate customers, the inherent risks in Virtual Currencies (VC's) would still remain. It is reiterated that VCs transactions would remain anonymous and open to facilitating illegal activities. It is unlikely that the education of customers would change the intent of nefarious customers, who would continue to conduct illicit transactions through VCs. The anonymous nature of VCs cannot be disputed. The transactions in VCs are anonymous due to the pseudonymous address or user handle. For instance, the reportedly largest transfer of Bitcoins, worth nearly USD 1 billion,114 took place as recently as September 2019, was between anonymous accounts. Even if the exchanges try to mitigate the risks of cyber-attacks by subscribing to insurance products, the risks are likely to spread to sectors other than banking".

b) "Further, the utilization of Corporate Social Responsibility (CSR) funds is not regulated or governed by the RBI. Therefore, implementation of this suggestion would require other authorities to formulate necessary rules or directions, which is beyond the RBI's control and would depend on the final law passed by the Parliament based on the currently pending draft Banning of Crypto currency and Regulation of official Digital Currency Bill, 2019.Though, at the time when the impugned Circular was issued, RBI has not obviously addressed many of the issues flagged by the writ petitioners, RBI did in fact consider the issues raised by the petitioners, pursuant to the order passed by this court on 21-08- 2019. RBI has also analyzed in Annexure B to the reply dated 18-09-2019 extracted above, the additional safeguards suggested by the petitioners, to see if the purpose of the impugned measure can be achieved through less intrusive measures. While exercising the power of judicial review we may not scan the response of RBI in greater detail to find out if the response to the additional safeguards suggested by the petitioners was just imaginary".

c) "But at the same time we cannot lose sight of three important aspects namely, (i) that RBI has not so far found, in the past 5 years or more, the activities of VC exchanges to have actually impacted adversely, the way the entities regulated by RBI function (ii) that the consistent stand taken by RBI up to and including in their reply dated 04-09-2019 is that RBI has not prohibited VCs in the country and (iii) that even the Inter-Ministerial Committee constituted on 02-11-2017, which initially recommended a specific legal framework including the introduction of a new law namely, Crypto-token Regulation Bill 2018, was of the opinion that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures".

Accordingly, the APEX Court allowed the writ petition and set-aside the impugned circular dated 05/04/2018 issued by RBI.

7. It is pertinent to note that the Finance Bill for the FY 2022-2023 budget, extended the definition of "property" so as to include virtual Digital assets. Subsequently, the Chairman, Central Board of Direct Taxes (CBDT) clarified that in the case of gift of virtual digital assets, with inadequate or without consideration, tax will be imposed at the recipients' end on the market value at the time of gifting. The Chairman, Central Board of Indirect Taxes & Customs (CBIC) has clarified that the commission paid to the operator or an exchange providing a platform for digital transactions in a digital currency, is 'service' provided to the users of that platform and, therefore, it is supply of service and is chargeable to Goods Service Tax (GST) ⁹ . It can be summed up that even though there are substantial changes noticed in the techniques/modus operandi adopted by the money launderers, the offence of money laundering still sustains. In fact, there is a substantial increase in the quantum of amounts of money being laundered. It is said that the amount of monies laundered would constitute nearly 2-5% of the world's GDP.

As long as there is a desire for mankind to amass wealth without any emphasis to the means, be it legal or illegal, the offence of money laundering will remain.

[The views expressed are strictly personal.]

¹Section 2(1) (p) of Prevention of Money Laundering Act, 2002 (hereinafter PMLA-02) defines Money- laundering" has the meaning assigned to it in Section 3. Section 3 provides for offence of money- laundering - whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of offence of money laundering.

² A service mark used for a commercial establishment equipped with washing machines and dryers, usually coin-operated and self-service. Excerpted from The American Heritage Dictionary of the English Language, Third Edition.

³Gururaj, B.N., Commentaries on FEMA, Money Laundering Act and COFEPOSA, Nagpur: Wadhwa, Ed. 2005, p.729

⁴ Alagiri, Dhandapani, Ed. Money Laundering: Issues and Perspectives , Hyderabad: ICFAI University Press, 2006, p.iii

⁵ Agarwal: J.D and Aman Agarwal "International Money Laundering in the Banking Sector"; www.fatf-gafi.org.

⁶Serg Sabourin "Drug Money Interpol International Criminal Police Review" (2.9.1991), P.1

⁷Subrahmanyan.K. Security in changing world (Delhi: B.R. Publishing.com, 1990)

⁸ https://timesofIndia.Indiatimes.com

⁹ BUSINESS LINE- THE HINDU, Hyderabad Edition dt. 03.02.2022.