Black Money Scenario in Startup World: A Detailed Analysis

🔍Insights

Yash Gupta

Jul 16, 2021 — 9 min read

India is the birthplace of cultural, grassroots, and frugal innovation. The population of over one billion people makes this an exciting geography for startups to build repeatable and scalable business models. The beauty of startups is that they provide their employees freedom, the opportunity to innovate and explore rather than just to engage in unproductive work. There exists black money within this rising economy of startups.

Introduction to Black Money in Startups
Current Scenario and Analysis of Black Money in Startup World
How Whitewashing of Black Money is Done?
Impact of Whitewashing Black Money on the Economy
Black Money in Startups - Conclusion
Black Money in Startups - FAQs

Introduction to Black Money in Startups

"The Indian startup ecosystem is said to be the third largest in the world having added over 1,300 tech startups in 2019. Number of Indian unicorns could increase to 95-105 by 2025," says Nasscom president Debjani Ghosh.

Home of the largest e-commerce deal between Walmart and Flipkart, 31 unicorns and counting, and plenty of untapped opportunities — it shouldn’t come as a surprise that India has been home to some of the biggest startup success stories. Over the years, Indian startups have found success across sectors, with startups in enterprise tech, e-commerce and travel tech grabbing global attention. There has, however, been a grey cloud spanning the growing startup industry in recent years, something we are all familiar with – black money.

Canadian-Indian writer Rohinton Mistry says, “It is so much a part of our white economy, a tumour in the centre of the brain — try to remove it and you kill the patient. A 2015 FICCI report estimated black money in India to be as high as 75 per cent of the GDP."

In today's world, it is difficult to explain how a social anomaly could appear in the world of budding talent, making the next generation soar to the highest levels of recognition and profit. This anomaly increases the need for black money in startups or businesses. The purpose of this case study is to analyze the entry of black money into the industry, the factors that influence it, and how it is being whitewashed, as well as the impact this has on our economy.

Current Scenario and Analysis of Black Money in Startup World

Let’s look upon the case where a reputed startup lawyer (let's name him ‘A’) in the capital has worked with startups including two well-known hotel room aggregators, a funded media startup and few e-commerce firms. He is also involved in deals with a well-known real estate group in the country that is trying to dabble into tech startups. He gives a shocking revelation: “Some expatriate businessmen are using startup investing as a way to move black money into India.”

Here’s the underside, suppose you have $10 million cash parked in Mauritius. You look for tech startups where you can take a majority control or create an entity that can furnish a website, an app and a small team in place. You incorporate the company as a private limited entity and also register an overseas subsidiary. Once a legal structure is in place, you start routing the overseas money into that technology company.

The routing can happen on the seed stage - A funding round. Now to embezzle the funds, from that startup money you can buy a luxury car and other assets, pay yourself, your kin huge sums as directors. You run that company for a period of two years or more till you’ve routed all the money into India. Once done, you can simply close that startup, declaring the company bankrupt and paying off creditors and share-holders which might be your own companies. Even if they have not routed the money overseas, dabbling in startups by opening up mentorship firms has become easy and a glam route to use that money legally.

“Am not saying all such firms are using startups as a means to turn black money into white but this glamorous route has started to be misused in India,” says A, a managing partner of the law firm, requesting anonymity.

How Whitewashing of Black Money is Done?

Another lawyer (let's name him lawyer B) who is brokering deals for a Gurgaon-based fashion app and another small hotel rooms aggregator ratifies it. His firm which specializes in transaction advisory for tech startups says that there are many ways dishonest businessmen launder.

An unsavory investor makes his family members the board members of that startup.
Other companies of the same group act as vendors to that startup and quote ridiculous prices for that service or product.
These investors ask for too much equity and control of the startup (often over 70%). They wish to keep their kin on board.
They park the money in a trust-friendly jurisdiction, such as Switzerland, before it is moved to a tax-efficient country such as Cyprus, where the taxation levels are very low or have no taxes. It is then routed to a tax-friendly country like Mauritius, before reaching the final destination in India. India has a Double Taxation Avoidance Treaty (DTAA) with Mauritius.
Trade mispricing is a tool used to siphon off money, plays an important role in bringing money back into India. Instead of inflating invoices, a business can under-invoice and export machinery or software. One can open a company to sell bags or a restaurant. The business may not take off, but the owner can still show cash sales of Rs 1 lakh to Rs 2 lakh a day. Slowly, but surely, all money would be legitimate one day!

Impact of Whitewashing Black Money on the Economy

Along with the economic effects, black money also has social consequences. Some of them are mentioned below:-

Loss of revenue to the government and running of parallel economy in the country – It is the increase and spread of black money that poses a serious economic threat since it leads to a decrease in government revenues. If only some part of the black money that has been in circulation in the economy could have been paid as taxes to the government, it would have benefitted the Indian economy to a large extent.
Vicious circle as a result of black money and corruption – Black money has added to corruption by the illegal transactions made to hide the black money. Bribes are given by the people to bureaucrats, government officials, etc. This forms a vicious circle which is never going to end unless some serious step is taken by the government.
Effects on national income and real capita income– Black money is a result of revealing low income to the government while paying tax by people which results in low national income of the country. The national income of the country will take a big leap if the amount of black money in circulation is backed up to the national economy of the country. This will also increase the quality of life for the whole country.
Higher taxation and inflation – The main reason behind the taxation is to earn revenues for the expenditures done by the government to make a balanced budget. Therefore, it is obvious that if the amount of black money which the people are hiding from the government is revealed and included in the budget of the government then the tax rate will surely come down as the revenues which the government wants to earn from the people by imposing high taxes will already be with the government. Therefore the amount of goods and services which were there in the market according to the accounted money gets a hike in their prices which results in inflation.
Difficulty in the formation of monetary and fiscal policy – This is an obvious impact as the government while making these policies is not able to count the exact national income because of the hidden black money which makes such policies unrealistic.
Increased criminal activities in society– Black money usually gives rise to various illegal activities in society and corruption is one of them. The duration of the election is also the time when the illegal use of black money can be seen. Various terrorist activities have backup power of hoarders of black money which is even harmful to the whole country. The illegal weapons with various groups of unsocial elements are usually bought up by the use of black money.

Black Money in Startups - Conclusion

The problem of black money should be solved in a real sense and a very rational manner.

First of all the problem is to be dealt with morally. The morals of the people in the society must be raised.
The tax system should be realistic in nature.
The authority which is responsible for the collection of taxes should be honest, without any corruption.
Various incentives should be given so that people voluntarily agree to disclose their real income.
The Economic Intelligence unit must be maintained thoroughly and should be looked after.
The corruption in administration must be stopped at all levels.
Startups should be aware of individuals who ask for higher credit in the company.
Limited kin involvement should be allowed.
The accounts must be looked after by the team and not the angel investors.

The government alone cannot curb this issue completely from society. Making different policies, laws, acts and legislation will not work alone. For the implementation of these laws and policies, every citizen has to come forward. People should understand why it is important to pay tax and should stop evading their income and should not lead to the generation of black income. Every citizen should make some contribution to the development of the country in the form of paying taxes. By doing this, the economy will definitely decrease its black money, as well as startups will not need black money to operate.

Black Money in Startups - FAQs

Why do Startups have Black Money?

The social anomaly could appear in the world of budding talent, making the next generation soar to the highest levels of recognition and profit. This anomaly increases the need for black money in startups or businesses.

What is Black Money?

Black Money is the money that is earned through illegal activity and that money is not recorded for tax purposes.

Are Startups a way to convert black money into white?

Not always, because even startups fail. So if the startup fails, say in 2 years, then your money is gone. But it can be a way to convert black money into white. As the Startups have to pay taxes on raised money.

Can a person convert black money into white through the stock exchange?

No, even the money that is invested in the stock market is invested via banks. So if one breaches their bank limit, it automatically catches the eye of IT officials.

What are the best ways to convert illegal money to legal money?

There is no other way to convert black money into white besides paying taxes. If there would have been a way then no person has to leave their native country and roam like a fugitive.

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