Explaining demonetisation: An open letter to Arvind Kejriwal from CA Mehul Shah

An open letter to Arvind Kejriwal by CA Mehul Shah explaining the probable logic behind issuing new Rs 2,000 note instead of Rs 1,000.

Mehul Shah November 14, 2016 13:11:45 IST
Explaining demonetisation: An open letter to Arvind Kejriwal from CA Mehul Shah


I am a practicing Chartered Accountant, aged 28, from Surat, and I was hoping that you would support the notification for demonetisation of currency and was very eager for your reaction. You entered politics supporting any small move to reduce black money and corruption, this, after all, was a very big and bold move.

But after going through the video released yesterday, my expectations from AAP as a common man were shattered once again. I believed that a person of your stature and designation would spread positivity without any ifs and buts to make this mega clean-up drive possible and help the common man in mitigating the problems rather than nagging them. Hence, I would like to bring to your knowledge the following points:

Point 1

Explaining demonetisation An open letter to Arvind Kejriwal from CA Mehul Shah

Representational image. PTI

As you have stated in your video that it took you two full days to understand the various aspects of the scheme. Even after consultation with various experts, you could not understand the logic of why Rs 2,000 notes were released instead of Rs 1,000. I would like to make an attempt to tender my best possible logic (please enlighten me if I am wrong somewhere) as follows:

Let us take 2 scenarios to understand the logic:

Scenario A: If as per your suggestion, Rs 2,000 notes are not issued, but only new Rs 1,000 notes are issued.

Lets say, for example X has Rs 1,00,000 black money in 100 old notes of Rs 1,000 each.

X divides Rs 1,00,000 into 10 equal bundles, each comprising of 10 old notes of Rs 1,000 each and puts each stack on a table.

On Day 1, in the morning, X would deposit the first bundle i.e. 10 old notes of Rs 1,000 valued at Rs 10,000 in the bank and in the evening, he would withdraw 10 new notes of Rs 1,000 again valued at Rs 10,000 and put it in the locker in his house.

Now the real game starts.

On Day 2, in the morning, X would deposit the second bundle of 10 old notes of Rs 1,000 valued at Rs 10,000. However, in his books of accounts submitted to the Income Tax Department, he will show that he has deposited the same 10 new notes which was withdrawn on Day 1 evening (which is actually still lying in the locker of his house)

On Day 2 evening, X would again withdraw 10 new notes of Rs 1,000 valued at Rs 10,000 and keep the same in the locker. So at the end of Day 2, X has Rs 80,000 on the table in old notes and Rs 20,000 in new notes in the locker.

Now, Day 3 will come in next week as limit of Rs 20,000 per week.

The same exercise will continue till Day 10 and by the end of Day 10, X will have no old notes and Rs 1,00,000 in 100 new Rs 1, 000 notes in the locker.

However, to the Income Tax Department, X has shown that he was having only Rs 10,000 as black money initially ( i.e. one bundle of 10 notes of Rs 1,000) and he has rotated the same Rs 10,000 by depositing it into the bank account in the morning and withdrawing it in the evening and again redepositing the same on next day and so on.

Thus, X has paid tax only on initial Rs 10,000 whereas he has managed to convert all his black money of Rs 1,00,000 into new notes.

This modus operandi is called Peak Theory i.e. the theory of rotation of the same money which is accepted by most of the high courts and tribunals. The Revenue Department is also sometimes helpless to catch X because the above scenario can also occur in genuine cases where you withdraw money from the bank to purchase something and then when you think that no good deal is available, you may again deposit the same money into your bank account and hence logically are not required to pay tax again.

Disclaimer: At time of writing this letter, it was known that the bank deposit slip did not have bifurcation between old and new notes and is based on the assumption that AIR information to AO will also contain information about total cash deposits.

Scenario B: Watch what happens when PM issues new Rs 2,000 notes instead of Rs 1,000

X deposits first bundle of 10 old notes lying on the table in the bank on Day 1 morning and then he withdraws five new notes Rs 2,000 in the evening and keeps it in the locker.

Now on Day 2 morning, when he goes to deposit second bundle of 10 old notes of Rs 1,000 each and wrongly shows the Income Tax Department based on cash book that he has redeposited the same money which was withdrawn on Day 1 evening – Bingo!

He is caught red-handed because if the Assessment Officer (AO) inquires, the bank slip on Day 2 submitted shows deposition of 10 notes of Rs 1,000 each whereas the government knows that X could never have withdrawn on Day 1 any note of Rs 1,000 because they were never printed.

The above examples are described to understand the concept of rotation of money and the fact that no tax is levied on redeposit.

Although it is not that in Scenario A, X can “never” be caught, however, the probability of getting caught is quite low because the audited cash book submitted to him shows rotation of the same cash and the process of inquiry with banks and their internal MIS would be way too tedious for any I-T Officer in scrutiny because withdrawals and deposits are natural processes for anyone. Mooreover, the common man would not like to be always looked upon with suspicion and even if I-T officer inquires about the denominations of deposit in Scenario A, he would not be able to have any adverse view on initial inquiry as the bank slip for deposit may not contain any differentiation of old and new notes, but simply contain 10 * 1000.

Even if the above explanation is hypothetical, it shows that such on-paper rotations may be attempted or many other jugaad are also possible using the same theory, so we should rather rely on and respect the PM of our country who is elected through clear democratic majority and have confidence that he would have taken this decision in the best interest of the country.

Making any other alternative like having bank slip show the bifurcation of notes into old and new as you might argue would make the process more cumbersome and lengthy and bank queue will increase further. Someone may also argue that serial number on notes may be tracked, but you know that I-T officials have many other things to investigate than sit back and tally the serial numbers of notes deposited and when majority of the taxpayers are honest citizens and hence you would not like to harass all taxpayers to prove whether rotation in their bank statement is genuine or not. But the best way is to go for a strategic decision to discourage the rotation of money by keeping lower withdrawal limits and at the same time deferring the printing of Rs 1,000 note as taken by our prime minister.

If we disregard the above theory of discouragement of rotation of money, another strategy may be to call back all Rs 2,000 notes after two-three years once the new Rs 1,000 notes are in circulation. This will further keep a check on corruption which many have already questioned. This is because the businessman who have managed bogus accomodation entries to make money white in this period are likely to reverse the entries and get them converted into Rs 2,000 notes in 17 January.

Also with inflation, the value of Rs 1,000 notes had gone down so induction of a new higher denomination had become necessary. The US has $100 note whereas UK has €50 both valued around Rs 6,000

Another simple logic is to save the printing and transportation cost compared to it face value because much cost has gone into securing that fake notes of Rs. 2000 are not easily printed. ATM cash be stuffed with more cash which is the need of the hour.

Further, the fact that when someone is holding the new Rs 2,000 note, he is psychologically getting a sense that the country is in the growth phase. Messages are also being circulated not to write anything on new notes. Imagine if the government would have never issued new higher denominations notes with inflation and growth we would still be dealing with annas and pavlis.

Sir, the above example also gives you an explanation as to why the withdrawal limit is kept so low and you should educate people who are standing in long queues and nagging about low withdrawal limits and explain how higher withdrawal limit may lead to more rotations and tax evasions. Though the above modus operandi can still be done with Rs 500 note, however, as mentioned the incentive would be less because X cannot withdraw more than Rs 10,000 in a day and even if he withdraws Rs 10,000, there is every possibility that banks will give X, Rs 2,000 note.

And believe me Sir, each and every condition in the notification takes care of the problems that are likely to be faced by citizens and at the same time makes sure that such sophisticated theories are not resorted to by black money hoarders, but questioning everything in the name of freedom of expression may create panic or bring out loopholes in notifications and hamper the success of reforms.

Point 2

Sir, you have again criticised and stated in the video that printing Rs 2,000 note will help to increase corruption because stacking those Rs 2,000 notes would require lesser space as compared to stacking Rs 1,000 notes.

In this regard, I would like to ask, have you come across any case where the “babus” have not taken any bribe and have worked honestly because they had a small bag which could not be fitted with Rs 1,000 notes?

Or have you come across any businessman who has declared unaccounted money solely because there was no space to keep those Rs 1,000 notes.

Point 3

As you have stated in the video, it is true that in spite of PM's efforts, there will be dubious commission agents and unaccounted investment in gold through jewellers, but as far as I remember when the jewellers were on strike for 45 days, when our PM levied excise duty on gold in April 2016, it was you who supported their strike. It shows that whenever some changes are suggested to regulate a particular market, AAP opposes them and now you nag that the gold market is unregulated.

In fact, I believe that the PM had a full blue print for the development of our country right from Day 1 of his getting elected, if I recall my last three years as a professional.

Firstly, they asked for all the bank account numbers in your Return of Income

Then they linked your PAN with Aadhaar

They linked all the subsidies, pension and other benefits directly to your bank account through Direct Benefit Transfer Scheme.

Then they gave opportunity to the common man to open a bank account through Jan Dhan Yojna

They entered into revised treaty with most of the countries in which unaccounted money goes through Hawala e.g. Mauritius and thus the route of black money coming from Mauritius which everyone knew is stopped.

They passed few strict laws to overcome the evil of black money such as Benami Transaction Act and Foreign Black Money Act

They levied excise duty on gold.

They also made TCS compulsory for cash transactions above 2 lakhs.

They withdrew lakhs of pending income tax and service tax litigation where the common man had won at appeal level and department had gone further.

They also entered into information exchange agreement with such countries.

Then they gave last opportunity to all black money hoarders through Income Declaration Scheme, 2016

Now, they have a Scheme for Dispute Resolution Panel again to reduce litigation till December 2016.

Now the masterstroke, they have banned Rs 500 and Rs 1,000 denominations.

Not only the destination of this whole process is commendable but even the journey or the chronology of these events is interesting which explains the ultimate destination and who knows, may be the journey is still not over and the ultimate destination may still be the Swiss account holders.

Point 4

Further, you have stated in your video that penalty would be levied at the rate of 200 percent. The said statement has created panic and people have stated discounting their hard-earned cash.

Being in Income Tax Department in the past, you ought to know that as per the present Income Tax Act, 1961 penalty is never levied on cash deposits but on “concealed income”. Hence, when the common man is depositing cash in hand which is duly accounted or out of his past savings and even out of unaccounted current years income whose return is yet to be filed, there will not be any penalty if there is no mismatch between returned income and assessed income. Even the government officials in their statement used the words “under-reporting” or “mismatch”. To understand the definition of “under-reporting”, Sir please refer Section 270A of the Income Tax Act or go through the following article:

Instead, you could have encouraged the citizens to pay appropriate tax.

Point 5

Nowhere in the video have you stated anything relating to fake currency or counterfeit notes because you know that the issue of existing fake currency is solved foolproof.

Which situation would be better?

Scenario A: A labourer standing in queue to exchange notes from bank just for a few days.

Scenario B: A labourer working hard to get a fake note at the end of the day.

The issue of terrorist funding is also tackled but you chose to remain silent on the same.

You have stated that Modiji should have infused Rs 100 note from before and it would have been you only to have said in this video that “Arre ATM se do din pehle se hi sirf Rs 100 ki note bahar aa rahi thi toh sab ko pata tha, yek koi secret nahi tha.

Just a food for thought, what if new notes are printed with an expiry period of 10 years, 20 years and 30 years and so on and hence the same has to be deposited in banks before the expiry date. People are asking how do you reduce corruption after January 2017? This step will reduce corruption and reduce chaos at every deadlines as while I have few notes expiring now I shall also have few notes which are due expiry in the next 10 years and hence do not have to stand in long queue for withdrawals.


Now Sir, if I am to believe that you really don’t understand these simple concepts even after consulting with experts for two days, I am deeply saddened because the common man believes that you are an IITian and have spent considerable amount of time in the Income Tax Department.

On the contrary, if I am to believe that you already know the benefits of demonetisation which I first learnt in Standard 8 when the subject of economics was introduced to me and the concept of Peak Theory which is described by me above and which I learnt with my very limited experience while pursuing my profession of Chartered Accountancy, then I am more saddened and see the AAP party as more dangerous because I believe that above any religion, politics or reservations in any caste or creed, it will always be education which shall uplift the common man and it is the common man who have elevated you to a position where you are looked by millions as their idol and it is your duty to educate them and spread knowledge and not keep them in ignorance to preserve your vote bank.

I am grateful to all my teachers who have selflessly shared their knowledge and some fellow members of CA fraternity who are playing an active role in creating awareness and educating the common man about the positive consequences of demonetisation true to the jewel crowned to the profession as “Partner in Nation Building” and I would, therefore, like to advise the citizens not to sell the notes at discounted prices or deposit the cash into bank accounts of other benami persons in fear of penalty. Further, do not claim any bogus expenses or bogus loss to gain more trouble. Do not manipulate accounts by creating bogus cash on hand. Be a sport and pay tax honestly to buy peace of building capital.

Jai Hind.


CA Mehul Shah



PS: Sir, please share the same explanation to Rahul Gandhiji too as lately you both share the same thoughts and statements and have the same queries.

Having said this, I also agree that at ground level, everyone has to act responsibly especially the government to make sure there is smooth implementation and no casualties. But the thrust of this letter is to encourage citizens to pay taxes and come free.

Wait for a miraculous amount of tax collection this year.

I have mainly written this letter for my love for writing and my love for questioning and understanding the concepts and in view of the freedom of speech and expression my country offers and hope that no one is offended.

(This letter was originally published on blog.taxorigin.com)

Updated Date:

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