The demonetisation of high denomination currency notes (to be deposited in banks by December 30, 2016) is an unprecedented move as these notes represent 86% of the cash in circulation in India. The objectives are to eliminate the circulation of fake currency notes being used for subversive and illegal activities and to counter the storage of unaccounted wealth in notes of these denominations. Apart from this, the government is now aggressively promoting the use of traceable digital transactions instead of cash. The challenges and frustrations of the public in getting access to currency have been widely reported and discussed.

Following up on demonetisation, the government introduced its fiscal measures through the Taxation (2nd Amendment) Bill 2016 in the Lok Sabha which has now been passed by Parliament. There are two stated objectives of these amendments. The first is to strengthen existing provisions of the Income-tax Act to plug loopholes for concealing unaccounted (black) money. The second is to introduce a temporary scheme to allow people to legally convert their black money held as currency into legitimate income by taxing it at a higher rate with a monetary penalty instead of their attempting to reconvert this unaccounted currency through other means.

The first set of amendments to the Income-tax Act enhance the tax rate and prescribe a separate penalty on income from unexplained sources in the form of investments, moneys, valuable articles, credits, expenditure and loans etc. These provisions allow for a taxpayer to ‘self-declare’ such income from unexplained sources in his return of income and pay taxes at a higher rate (of 75% plus applicable cess) to be paid before the end of the relevant financial year. The amendments empower income-tax authorities to levy penalty (of 10% of the tax payable) if they make an addition to the taxpayer’s income on account of such unexplained income instead of the taxpayer ‘self-declaring’ the income. The earlier provisions did not explicitly allow such ‘self-declaration’ by the taxpayer while the tax rate on additions made by income tax authorities was 30% plus applicable surcharge and cess. The primary aim of these changes is to raise the cost of reporting previously undisclosed income through the Income-tax Act by showing it as unsubstantiated business income or as income from unexplained assets and paying tax at the rate of 30 per cent without any penal consequences.

The second set of amendments is to provide a window for disclosure of unaccounted income held as cash or deposited into bank accounts. This has been done by amending the Finance Act 2016 to introduce a ‘taxation and investment regime’ which provides for a higher rate of tax, surcharge and penalty (of 50% of the deposit) for unaccounted currency deposited in a bank or post office account; 25% of the deposit is also to be invested in interest free government bonds for a period of four years.

The amendments bringing in a ‘tax and investment regime’ can be seen as a pragmatic after-thought to mop up unaccounted currency as tax receipts through an immunity scheme (which will be in effect till the March 2017) instead of ‘losing’ it to ingenious conversion mechanisms. While the immunity scheme is only up till the end of the financial year, the amendments to toughen the taxation of unexplained income in the Act are for the long term. That the government did not wait for the budget (which was to come two months later) to make these amendments shows its concern in countering wide spread attempts by those holding unaccounted high denomination currency notes to illegally convert them into legal tender which would deprive the exchequer of tax receipts.

It is therefore surprising that one avenue of receiving and spending cash has been left totally untouched, i.e. cash donations received by political parties.

The tax provisions for making cash donations to charitable institutions and to political parties have been gradually tightened in case of the donor. In the case of charitable institutions, the Income-tax Act was amended in 2012 to mandate that any donation in excess of Rs 10,000 to a charitable institution has to be in a non-cash mode for the donor to obtain a tax deduction. In 2013, any contribution in cash to a political party was made ineligible for a tax deduction in the hands of the donor.

However, there is a glaring disparity in the way ‘anonymous donations’ (i.e. where the identity of the donor is unknown) received by charitable institutions and political parties are taxed in their hands. Amendments to the Income-tax Act have made charitable institutions (which are otherwise exempt from tax) subject to tax at a rate of 30% for any ‘anonymous donation’ received in excess of certain thresholds, the upper limit being R1 lakh. This has effectively plugged attempts to circulate unaccounted cash through charitable institutions.

On the other hand, political parties (who, like charitable institutions, are also exempt from tax) have not been subjected to a tax on ‘anonymous donations’ received by them. They are only required to maintain the name and address of the donor for donations above R20,000 to maintain their exempt status under the Income-tax Act. Thus any donation below R20,000 can be received in cash without any verification of its source. The amount was earlier R10,000 but was raised to the current threshold by amending the Income-tax Act through the Election and other Laws Amendment Act in 2003 (which also made amendments to the Representation of the People Act, 1951 and the Companies Act, 1956). There is now a public debate about reducing this threshold by amending the Representation of the People Act (and consequently the Income-tax Act) for which consensus is sought among all political parties.

In order to block avenues for receiving and spending unaccounted cash, the current amendments to the Income-tax Act, should, along with raising the tax rate on unaccounted cash deposits in the hands of citizens, also have enabled cash donations to be taxed in the hands of political parties as ‘anonymous donations’ as in the case of charitable institutions. This is a taxing provision which is a prerogative of the government. If demonetisation and the fiscal measures taken thereafter by the government is movement towards a new normal, then political parties should be a part of it and the government needs to make such an amendment in the forthcoming budget.

The author is Of Counsel, BMR & Associates LLP, and formerly, joint secretary, ministry of finance, government of India