Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Startups

Jama-Kharchi and the Conversion of Black to White

For the uninitiated among us (and I am one) it seems there’s this concept called “Jama Kharchi”, which is about converting black money to white. Jama-kharchi , of “accomodating entry” companies which basically make two kind of entities meet:

  • One that wants to reduce its profits (and thus, taxes) by showing purchase entries
  • Two, that that wants to shore up sales because they will get higher credit

The Jama-kharchi companies will “accomodate” accounting entries that help both these companies and charge a 2% to 4% commission to be the go-betweeen.

Let’s say a company A wants to reduce profits but still wants to have the cash. It buys something from a Jama Kharchi company B, and that company (through conduits into other companies or directly) gives an unsecured loan, or buys shares of Company A. That way the company still has the money and managed to reduce its sales.

Technically, Company B has profits now (since it supposedly sold stuff to Company A), but it goes and purchases goods or services from Company C, which wants to show higher sales. The higher sales figure can be used to get credit from banks (or raise funds from institutions) The sale is a fake, and the money doesn’t actually move to them, but this process is cleverly hidden inside the accounting books.

Earlier, it used to be a thriving business in the stock markets, where promoters would also work hand-in-hand with the Jama Kharchi companies. The Calcutta Stock Exchange was supposedly full of such companies.

It’s such companies that have resulted in strange laws that the rest of us do not understand.

  • The Startup Tax, where income tax authorities can decide that a company’s share capital investment was income, if they can’t prove that the valuation was proper. (See More)
  • The new Companies Act changes that disallow companies from taking loans from people who are not their directors, or to disallow easy access to convertible debt.
  • Regulations that require debt financing to happen through regulated entities (financial service companies) rather than through private placement to investors.

The problem though is that for the sake of a few companies, the rest of us get hurt. Instead of creating rules that nearly everyone will violate, we are being told that look this is not meant for you, and we won’t enforce this against you, but we will against some other really terrible companies.

There has got to be a better way to operate than this, but the authorities tend to live in silos. The rumour is the Income Tax department in Kolkata is overstaffed due to exodus of industry, so they focus on fighting these Jama Kharchi entries (that seem to be concentrated in Kolkata) and therefore are able to influence rules that are built to help nail the rascals. The Startup Tax is an incredibly stupid rule, but when you see how the concept of Jama-Kharchi operates, you find that because the tax department couldn’t actually deny anyone the right to buy shares (at inflated valuations) they decided to demand that the valuation be justified to them instead. From one rent seeking arrangement to a much larger one that implicates all companies across the ecosystem.

Jama Kharchi is sadly, not actually money laundering, which is a term reserved for criminally tainted money only (such as drugs, terrorism and all that). I didn’t know this and only heard recently. So the effort to nail such people does not come from within the banking system who don’t really care about the tax fraudsters, only about money launderers; but it must, because when you’re laundering cash on which tax is not paid, it is really money tainted by crime.

Jama Kharchi might sound like something happening in Kolkata but such things eventually affect us – through rules like the Startup Tax. But will it get investigated, when the beneficiaries of such schemes are, supposedly, big politicians?