All About Shell Companies

Contents  hide 

1 WHAT IS A SHELL COMPANY?

2 IDENTIFYING A SHELL COMPANY

2.1 Including some entities

2.2 Their roles and the threats they pose.

3 WHY ARE SHELL COMPANIES CREATED?

4 ARE SHELL COMPANIES ALWAYS CREATED FOR ILLEGAL PURPOSES?

4.1 CHALLENGES FACED TO STOP ILLEGAL SHELL COMPANIES IN INDIA

4.2 CONCLUSION

4.3 Related

WHAT IS A SHELL COMPANY?

Presently, none of the pivotal Indian Statutes including the Companies Act of 1956[1] and the Companies of 2013 give a definition for a ‘Shell company’. Even when there have been evident and longstanding efforts made by the Indian parliamentary panel to the Ministry of Corporate Affairs to define such a ‘Shell Company’.[2]

Through precedents and conventions, a shell company can be understood to be a company that exists only on paper. Neither does it have actual active business operations nor any significant assets. These companies do not engage in any economic activities but have a corporate legal personality.

In common parlance these non operational companies are used as a vehicle for financial maneuvers or even kept dormant for future use. Such a company arrangement is not illegal per se but has conventionally acted as a den for illegal acts including manipulation of share prices, evading taxes or even financial fraud.[3]

IDENTIFYING A SHELL COMPANY

Even though is no statutory provision regarding adjudication of such companies, The Securities and Exchange Board of India has identified certain parameters for the classification of shell companies. Namely,

• Not having significant operational activities;
• Not having significant operational assets;
• General capacity limited to a pass-through one.

Besides SEBI, there are many agencies and individuals who have attempted in identifying the parameters of such companies.

Including some entities

• Entities that have insignificant business activities.
• Entities that have an insignificant amount of assets.
• It might have been set up primarily to facilitate cross border currency and asset transfer.
• Entities that do not have any physical existence at the registered address.
• Multiple companies at times that may be under the same registered address. 
• Companies that have no economic rationale of any kind behind their banking transactions.
• Companies that carry out rotational transactions of money without any apparent legitimate business.
• High-value transactions which may be inconsistent with the operations of that particular business. ( Irregular booms accompanies by long standing periods of stagnancy )

Multiple shades of shell companies exist,

Contrary to the absentee nature of shell companies in India, the US has a longstanding definition shell companies.

According to its Securities and Exchange Commission (SEC),

“The term shell company means a registrant, other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB (229.1101(b) of this chapter), that has: (1) No or nominal operations; and (2) Either: (i) No or nominal assets; (ii) Assets consisting solely of cash and cash equivalents; or (iii) Assets consisting of any amount of cash and cash equivalents and nominal other assets.”[4]

Additionally, a 2018 study by the European Parliamentary Research Service (EPRS) further recognizes that the menace of shell companies is prevalent and the European Parliament had even sought a study to improve its understanding of the operation of these entities in the European Union.

Further, it categorizes shell companies into three sub categories,

Their roles and the threats they pose.

• Anonymous shell companies provide anonymity while guaranteeing control over the shell and its resources. The ultimate beneficiary (UBO) of such a company remains hidden behind this or behind a chain of interconnecting , often in several jurisdictions. Such companies are often connect to tax evasion, corruption, money laundering, and terrorist financing.
• Special purpose entities (SPEs) are the ones whose core business consists of group financing or holding activities. They have no or few employees with little or no physical presence in the host economy and their assets and liabilities represent investments in or from other countries. These firms are usually mention with regard to use in aggressive tax planning or tax avoidance.
• Letterbox or mailbox shell companies are the ones that are registered in one member state while their substantive economic activity takes place in another member state, it can even be used to circumvent labor laws and social contributions in the member state where substantive economic activity is taking place.

WHY ARE SHELL COMPANIES CREATED?

In this day and age shell companies are usually associate with one of the following activities:

1. For the purpose of evading tax. As a practice corporations set up shell companies at offshore venues where the taxes impose are extremely less. These places are also known as ‘Tax Havens’. Examples of these places are Panama and Switzerland. These corporations park their assets in such shell companies and conveniently escape paying taxes for these assets.

2. For the purpose of laundering money and converting black money into white money. People and corporations use shell companies to store their surplus cash, instead of making deposits. Many such shell companies were discover in 2016 (demonetization year) which were as a matter of fact involved in illegal methods of laundering money.

3. For the purpose of making money off of Ponzi Schemes, creation of such shell companies tend to defraud people by offering fraudulent schemes

4. For the purpose of hiding identities of real owners, tracking down the real owner of a shell company is a problematic task as more often than not the owners of these companies hide their identities. They cannot be located due to the incorrect or fraudulent details of the company, including the registered office of the company or directors being at a completely different place, than that submitted to the registrar.

ARE SHELL COMPANIES ALWAYS CREATED FOR ILLEGAL PURPOSES?

A shell company does not necessarily have to engage solely in illegal activities. Shell companies can work within a few legal parameters.[5]

In the case of Assam Co. India Ltd. vs. Union of India,[6] a company that owned a substantial number of tea estates, producing millions of kilograms of tea on an annual basis and feeding thousands of families was termed a ‘shell company’. The court held that merely the negative implications of being brand as a shell company cannot justify treating the company as a shell company.

The legal reasons for which a shell company can be create include,

• To store money temporarily when the main company or the owner of the shell company is planning to start a new company in the future.
• To aid a company if it wants to hide its dealings with another company, which has a maligned reputation; such transactions may create a shell company solely to engage with the other company.
• To stage a hostile takeover, essentially when a company buys another company, without the approval of the management of the target company.
• protect assets from lawsuits.
• To approach foreign markets.

Mere creation of shell companies is not an offense.

However, some issues arise with establishing a shell company including,

• Bad publicity when a company forms a shell company offshore about profits being share offshore.
• While not necessarily illegal, using a shell company to hold assets in it falls in a conventional legal grey area accompanied with multiple presumptions which may lead to multiple legal issues.

CHALLENGES FACED TO STOP ILLEGAL SHELL COMPANIES IN INDIA

The Indian government has made momentous efforts to restrict shell companies from engaging in illegal activities. But the rampant issues remain unsolved, these issues include:[7]

• Lack of a legal definition for the term ‘shell company’ under any Indian statute.
• Absence of a specific law to deal with shell companies primarily.
• Existence of a multifaceted corporate structure, which makes it complicated to track transactions from atypical accounts and differentiate between legal and illegal company .

CONCLUSION

The government has taken multiple steps to troubleshoot the multiple issues that accompany such transactions. The income tax department has carried out multiple investigations to find out all the companyy engaging in illegal activities and initiated criminal prosecution against the beneficiaries of many such companies. Ministry of Corporate Affairs has targeted for deregistration, even attacked the companies who did not file any required financial statements. Under Section 248 of the Companies Act, 2013[8], the Registrar of Companies has struck down many such companies from the register of companies. In February 2017, a joint force was set up.

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[1] The Companies Act, 1956, No. 1, Act of Parliament, 1956 ( India).

[2] Akshi Singal Analysing the aftermath of being brand as a “Shell Company”,  LAWSTREET INDIA (Jan. 9th, 2021, 13:00 pm), http://www.lawstreetindia.com/experts/column?sid=297.

[3] Mariya Paliwala,  All you need to know about shell companies, IBLOG PLEADERS (Jan. 9th, 2021, 13:00 pm), https://blog.ipleaders.in/shell-company/ .

[4] Prasanna Mohanty, Taxing the untaxed IX: Is India blissfully ignorant to the menace of shell companies?, BUISNESSTODAY INDIA  (Jan. 9th, 2021, 13:00 pm), https://www.businesstoday.in/current/economy-politics/taxing-the-untaxed-india-shell-companies-threat-global-economy-indian-economy-black-money/story/399411.html .

[5] Challenges to the Shell Companies in India,  SBS AND COMPANY LLP ( Jan. 9,  2021, 13:00 pm), https://www.sbsandco.com/blog/challenges-to-the-shell-companies-in-india ..

[6] Assam Co. India Ltd. vs. Union of India, (2019) 197 CTR Gau 659 (India).

[7] Narendra Kumar, Legal Implications of Shell Companies, ENTERSLICE ( Jan. 9, 2021, 13:00 pm), https://enterslice.com/learning/shell-companies/ .

[8] The Companies Act, 2013, No. 121-C, Act of Parliament, 2011 ( India).