Shell Company/Corporation

 Shell Companies/banks

Shell corporations or Shell companies are entities that do not have active business operations but are set up to achieve specific business goals such as lowering tax liabilities, shielding an entity from legal risks, raising capital, and, in some cases, for illegal purposes such as money laundering, hiding beneficial ownership from law enforcement, or circumventing sanctions. While shell companies are often viewed negatively, large corporations and individuals use them legally too

A Special Purpose Acquisition Company(SPAC), for example, is used to raise capital by issuing shares to the public to acquire an existing private company as SPAC may not have any business operations or employees on their own, so they are referred to as Shell Companies.

Shell companies are merely an 'outer cover,' or a 'protective layer,' that exist only on paper and have no real assets, liabilities, or operations. As a result, they don't generate any economic activity, but they do give the structure a distinct corporate legal personality. There haven various news publications and ministry circulars that highlight the efforts being made in India to prevent the emergence and regulation of shell corporations. Despite the government's proactive measures, significant issues remain in the operation, implementation and harmonization of the system.

The Organization for Economic Co-operation and Economic Development (OECD) defines a shell company as ‘a firm incorporated or organized or registered in the economy but does not take part in the economic operations (other than pass-through capacity)’. In layman’s terms, it can be construed that shell companies are entities that only exist on paper without having any assets, liabilities, or employees and they are structured like a company without any actual business activities.

 

The Securities and Exchange Board of India (SEBI) has also come up with certain parameters that could be taken into account while gauging the active status of the company, or lack thereof and hence according to reports, SEBI has suggested that any entity with no significant operational assets or business activity of its own but acts as a conduit in a pass-through capacity is referred to as a shell company.

 

A Task Force on Shell Companies in February 2017 was set up by the Prime Minister's Office, under the joint chairmanship of the Revenue Secretary and Secretary, Ministry of Corporate Affairs (MCA) with a "mandate to check systematically, through a coordinated multi-agency approach, the menace of companies indulging in illegal activities including facilitation of tax evasion which is commonly referred to as shell companies."

The Securities and Exchange Board of India (SEBI) has also come up with certain parameters that could be taken into account while gauging the active status of the company, or lack thereof and hence according to reports, SEBI has suggested that any entity with no significant operational assets or business activity of its own but acts as a conduit in a pass-through capacity is referred to as a shell company.

 

A Task Force on Shell Companies in February 2017 was set up by the Prime Minister's Office, under the joint chairmanship of the Revenue Secretary and Secretary, Ministry of Corporate Affairs (MCA) with a "mandate to check systematically, through a coordinated multi-agency approach, the menace of companies indulging in illegal activities including facilitation of tax evasion which is commonly referred to as shell companies."

The major achievement of the Task Force was the compilation of a list of companies under three lists such as the Confirmed list, Derivative list and the Suspect list. The basis of compilation when seen was that the confirmed list of 16,537 companies was information from various agencies regarding their indulgence in illegal activities. The derivative list of 16,739 companies was prepared based on a common directorship with the confirmed companies and the suspected list was prepared based on certain red flag factors.

 

Out of these lists of companies, the Securities and Exchange Board of India (SEBI) had released a list of 331 ‘shell companies’ back then in August 2017. On the release of the list, a host of actions were promptly initiated against these companies and instructions were given to various stock exchanges to restrict or suspend trading of their shares, which meant that their shares could be traded only once a month. A laundry list of notices was served upon them, pulling management’s time away from core business activities.

 

Some companies had been included because they had a connection with any of the confirmed companies could be even if such connection related to a time many years before preparation of the list or was of remote significance to the present operations of the company or even if there had already been a change of hands from such directors. In many cases, the current management seemed unaware of any association with such individuals and was mystified as to why their names were put on the list. There were companies on the list that was tremendously profitable, paid significant taxes, complied with the law regularly, and employed a huge number of people.

 

Recently, in a written response to a question in the Rajya Sabha, Minister of State for Corporate Affairs Rao Inderjit Singh said the government had discovered 2,38,223 shell businesses in the last three years (2018-2021). The databases that had been compiled, and had more than 2 lakh companies were identified and their names were struck off the Registrar of Companies (RoC) under Section 248 of the Companies Act, 2013

The major law if seen are:

 

1.      Benami Transactions Prohibition (Amendment) Act, 2016, which prohibits anyone from holding assets under a fake name to avoid taxation.

2.    The companies (restriction on the number of layers) Rules 2017, which restrict the number of layers of subsidiaries a company can have.

3.    Prevention of Money Laundering Act (PMLA): When black money is passed through a shell    company, it is presented as tainted money. This is punishable under Section 3 of PMLA.

4.      Indian Penal Code: In case the shell company is used for engaging in Ponzi Schemes, the owners and anyone involved can be punished under Section 420 of IPC which prohibits cheating.

5.      Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

6.      The Income Tax Act, 1961: PoEM Guidelines issued by the Central Board of Direct Tax.

Because the entire exercise is based on the assumption that these organisations are shell companies, it is critical to comprehend the concept of a shell company under the law as well and not merely with the literal meaning.

Happy reading