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This article has been written by Oishika Banerji, an undergraduate student at Amity Law School, Kolkata. This is in an exhaustive article that deals with the comparison between shelf companies and shell companies.

Introduction  

A company is a type of organization, specifically a legal entity that represents an association of people that can either be natural or legal or at times a mixture of both which has been formed with a specific object. All members of the company work towards the goal to successfully achieve it. A company can take the shape of various structures such as voluntary associations, educational organizations, business entities, financial entities like banks, etc. Within the broad heading of companies comes shelf and shell companies. A shell company is a type of company that is inactive by nature. These companies are kept for future use or for financial exercises. On the contrary, shelf companies are those companies that are majorly in use by law firms and have been legally registered to be used currently or in future. 

There exists a clear line of difference between both these types of companies. It is necessary to discuss them for the reason that they play a modest role in influencing the market, other types of companies, and the people. There exists a lot of myths related to these companies that need to be busted and a lot of truths that need to be looked for. These companies are misused at times to achieve an illegal object. Further, at times an entity can be used for carrying out fraudulent activities as well which can have a detrimental impact on the nation it is operating and therefore the government should be acknowledged with the movements of these entities. There are no statutory provisions governing these types of companies. The Companies Act, 1956 and the Companies Act, 2013 does not consist of any provision that deals with shell companies and shelf companies. This creates a problem in dealing with these kinds of companies. The executive should be able to properly use the legislation in order to bring suspicious companies under control in order to avoid a major loss. 

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Shelf companies 

Before going to a detailed study regarding shelf companies, it is necessary to understand its meaning from close quarters in order to form an idea about its traits. A shelf company can be defined as any company that has been registered initially but has no records of conducting business and therefore does not have any assets and liabilities attached to it. The very name of the company reveals that a ready-made company is waiting on the shelf to be purchased by someone. Shelf companies are also familiar with the names of ready-made companies, aged companies, and blank check companies. Buying or purchasing of a shelf company is an intelligent and a smart move because the company does not need to go through any kind of registration procedure that is often time-consuming for the company as shelf companies are ready from all spheres to carry out business. This type of company also helps a person cut down on paperwork involved in setting up companies. These companies are purchased mostly by law and accounting firms. These companies are often confused with another type of companies called the shell companies that are mostly formed with a motive to carry out fraudulent activities. Traditionally shelf companies were of much use as registration procedure would be long and expensive. This increased purchase of shelf companies among attorneys, accountants and some specialists companies. But as the world is fast-changing and things are becoming easier to handle, the registration procedure has also become easy and less time-consuming. It has also become cost-effective which has helped to purchase companies easily. It was the time factor that made many purchase shelf-company rather than setting a new company altogether. Some of the advantages of shelf companies have been listed below:

  • A business can be started immediately on the very day of purchasing a shelf company
  • Access to corporate debtor financings like banks and investors can be gained easily
  • Help in entering into a legal agreement with other companies or investors easily.

The aim of the shelf companies is to let it get old being on the shelf for a certain period of time and then purchasing the same to carry out business. By making the company active, the person who is purchasing the company is creating a history for that particular entity. But as many researchers have said the truth, technology has weakened the strength of shelf companies and therefore the companies that were once meanest for the purpose of making business practices easier, is now being used for illegal activities. This calls for controlling malpractices in business activities by using read-made companies. 

Identification of a shelf company

To proceed with shelf companies further, it is necessary to realise that a shelf company is like all other companies and therefore there are certain unique traits that distinguish the company from all other companies. The identification of a shelf company can, therefore, be carried out by the following characteristics that the company possesses which are provided hereunder:

  • A company that do not have any past transaction records
  • A company that does not have any record of holding assets and liabilities of its own
  • A company that has been registered with all legal procedures
  • A company which has all the necessary documents that any company should possess
  • A company that has been registered under the Companies Act, 2013 

The reason behind the creation of a shelf company

A registered company by nature, shelf companies is created for the following reasons: 

  • Consumption of time: As it takes 5 months to set up a company in India followed by the time period spent on registration of a company, shelf companies help in saving these time and therefore provides greater scope to the company to work towards its development and market competition.
  • Ageing of companies: The specialists who created shelf companies will all deliberation allow the company to get older as much as it can so that companies of all ages are available in the market to be used as and when wanted.
  • Smooth procedure: A shelf company helps the owner to avoid any kind of hesitations from previous trading and operations by being unused for years. This helps the owner to completely focus on his new project rather than wrack his brain with past transactions. 
  • Avoiding delays: A shelf company is always advantageous if the jurisdiction under which it is formed does not require public filings. The directors, register, secretaries can be informed about the company privately by the seller while the owner can take full authority over it and start his work immediately. 
  • Speedy process: Along with the consumption of time period, shelf companies promise speed. If any action regarding the setting of a company needs to take place then shelf companies can best assist in the process. No application procedure is in need. 
  • Certainty: If a person acting as an intermediary between a client and the company and performs the function of an offeror for the client convincing him to purchase a company then he can with certainty show a list of shelf companies for the client to purchase. He will also be certain on the fact that the client will easily purchase the same looking towards the benefits. 

Ways in which shelf companies affect a person 

Shelf companies have always proved to be beneficial for any person who is purchasing the same. This is because the company is ready to be carrying out business operations and transactions with no past differences making it simpler for the owner. A shelf company is used as a medium to merge the history of the owner of the business and the company so that the new shelf company can easily adapt to the environment of the company making it easier for the owner to carry out business operations. The company can be kept alive for many years and therefore promotes longevity. This also shows that the statutory needs have been met for several years making way for the seller to attend future statutory requirements as well. Very few companies are able to keep a long list of shelf companies. This is because availability decreases through the age whereas the price of the same increases. Shelf companies are available in a number of internet websites at a lower price making it feasible for the person to purchase.

India and shelf companies: the challenge 

Shelf companies in India can be created under the statute of Companies Act, 2013. The two purposes for which a shelf company is formed has been provided below:

  • Shelf companies are formed for the purpose of carrying out circumventing or 
  • Shelf companies are formed to enable an entrepreneur occult.

In the first case, shelf companies do not carry out any productive activity and consist of assets that do not produce any profits therefore it can evade any kind of fiscal assets. Whereas in the second case, a shelf company is set up because the entrepreneur does not want to appear directly in a company and therefore appears in a shelf company. Setting up shelf companies in India is a good challenge that India must take up in order to initiate the growth of companies in the nation to boost the economy. If shelf companies infringe any legal provision then it will be the Companies Act, 2013.

Shell companies 

A shell corporation or company is a company that has a theoretical existence only that is being restricted only to papers without any actual office or employees working for it. These companies may be registered with any other company that has a service of creating a framework of shell companies. The company with whom registration has taken place can as well act as an agent for legal correspondence for the shell company. By its very existence, a shell company does not become illegal but it is only through its usage can it have been declared as an unlawful company. By its very name, shell companies symbolise companies that are hidden and are not visible. These companies are often used to hide the existence of business ownership from any kind of legal enforcement or from the public at large. 

The organization for Economic co-operation and economic development defines a shell company as any entity that does not participate in the economy but like any other company is registered, incorporated, and legally sanctioned. Shell corporations are a way to avoid tax avoidance by a business entity that has a legitimate existence. These companies, therefore, play a great role in black market activities. This makes it natural for anyone to have suspicion over shell companies which calls for a detailed study of the shell companies. 

Identification of a shell company

In order to deal with shell companies, it is necessary to know as to what constitutes a shell company. It is the Security and the Exchange Board of India that has laid down certain parameters which can be applied to identify a shell company. Such parameters have been listed below:

  • If the company does not have a record of having significant business operational activities
  • If the company does not have a record of operational assets 
  • If the company is acting as a medium to carry out other purposes. 

These are the grounds which if are present in a company, then the company can be identified as a shell company. Beyond the Security and the Exchange Board of India, several other agencies have tried to locate certain traits that a company can possess to be identified as a shell company. Some of the other grounds are provided hereunder:

  • Companies having business activities that are mostly unrecognised
  • Companies having unrecognised business assets
  • These companies have been set up to facilitate cross border transfer of assets
  • These companies only have theoretical existence and no physical existence in the registered office where all companies are registered
  • There is no kind of economic rationale that is attached to these companies except them having a bank account kept for transaction purposes
  • There is no legitimate business that these companies carry out and therefore the transaction of money that takes place is rotational by nature with no fixed destination
  • These companies are also associated with high-value transactions which are not in consistency with the business operations. 

Thus these are some of the ways in which a shell company can be identified. It is necessary to identify a shell company to keep in track the working of any unlawful activity by these companies which can prove to be detrimental for the economy of the nation.

The reason behind the creation of a shell company

If a shell company is viewed from the perspective of other companies then the reason behind the creation of a shell company sounds vague and baseless this is because it does not abide by the essence of formation of any company. A company without any physical existence cannot be completely termed as a company be it whatever trait it possesses. But shell companies have a specific reason for its formation. It can carry out certain activities which no other mainstream company can. These activities have been listed below:

  • Evasion of taxes: When tax imposed upon a corporation is comparatively less, then the corporation forms a shell company majorly at offshore venues. Some of the notable offshore venuses are Panama, Switzerland etc. What the corporation on its part does is to store their assets in these shell companies which helped them escape from paying taxes that were charged on their assets. This in on way contributes to the black market activities. Several notable companies have done this in order to avoid paying taxes.
  • Hiding of real owners identities of the corporation: Shell companies by lacking in having physical existence helps in hiding the identities of the real owner of the corporation who have stored their assets in the form of shell companies. It becomes difficult to locate the owner also because the registered office of the corporation and its directors are located in different places altogether.
  • Money laundering: Shell companies help in the process of money laundering that is the conversion of black money into white to be used in mainstream business. Shell companies became a very familiar time during the time of demonetization in the year 2016. This was because a large number of shell companies were made to be used as surplus cash holders in order to avoid excessive cash deposits by the original holders. Recently, the world also has come across instances in which fake identities of few people were being used to create accounts in the banks without them having any idea about the same. This shows how shell companies can instigate money laundering.
  • Usage in Ponzi schemes: Shell companies are used by fraudulent businessmen to carry on with illegal activities and escape from any kind of trap when they are revealed. Ponzi scheme signifies an investment scheme that is meant for fraudulent purposes which promises a high rate of returns with only a few risks to the investors. These schemes are used to fool people to extract money from them.  Ponzi schemes can be used by these company owners to defraud people initially and subsequently run away with the money without getting caught by the law. 
  • Shifting of income to a neutralised jurisdiction: Shell companies are used to shift the income to a more neutralised jurisdiction in order to escape from tax payment. This happens in international cases where the company owner in order to get out of territorial jurisdiction of any nation shifts his income to a neutralised jurisdiction where no country can actually sue him for escaping taxes. In this way, the fraud owner can continue enjoying his illegal earnings while the government forces and the law holders will keep on searching him to get hold of him. If also they get hold of him, he cannot be charged as his income is shifted to a neutral jurisdiction.

These are the obvious reasons for the creation of shell companies. From the above reasons, it can very well be inferred that the reason for the creation of shell companies is for carrying out the illegal business activity without letting the world know about the same creating difficulties for the law holders to find the original owner of the company and sue him for the same. One company is used by another for fulfilling illegal satisfaction of the latter. 

But one thing to be notified is that it is not necessary that shell companies will be used to carry out unlawful activities only. There are certain legal activities that are carried out by shell companies also. If a company creates its own subsidiary that is meant to be looking after only the legal functions associated with that company but has not to use it to carry out any business activity and thereby has no assets or liabilities attached to it then that subsidiary can be known as a shell company which has been made for a legal purpose and not for am illegal one. As we have discussed illegal grounds for which a shell company can be created, it is necessary to check out the legal grounds for creating a shell company as well. Some of the legal grounds have been provided hereunder:

  • A shell company can be formed by the main company in order to use it as a temporary place to store money that will be used in bringing up a new company in future. 
  • In case a company is carrying out dealings with another company who does not have a goodwill in the market then to avoid such revelations, a company can create a shell company. 
  • Creation of a shell company can take place to create a platform for a hostile takeover which happens when a company has purchased another company without receiving the approval from the management.
  • At times, the company needs to safeguard its assets from coming under the purview of assets. In such situations, the company can resort to the formation of a shell company.
  • Shell companies can be created by the main company based on its location. If the country the company is operating in is terrorist influenced then in such cases the company may create a shell company to protect its assets and liabilities and the investments of the people also.
  • As it is the time of globalization, companies will try to reach out to the foreign market. In doing so, a company creates a shell company that can help in reaching out to the foreign markets easily.

In the case of Assam Co. India Ltd And Anr vs. The Union of India, a  company who owned several tea estates and was responsible for feeding several families was categorized as a shell company.  The court was with the observation that as shell company is always associated with a negative connotation, it will not be correct to categorize this concerned tea estate company as a shell company taking into consideration the noble work it was doing. This judgment made one thing very prominent and clear that is in India, shell companies have been used for illegal purposes compared to that of legal activities. This has created in the minds of the people that this kind of a company can never be provided with a positive thought and therefore very few companies have been considered to be a shell company carrying out a legal activity. But we cannot say that formation of a shell company is by itself an offence. This is because the legal usages of these companies are also existing along with the illegal ones. But as illegal sides of shell companies exist on a large scale, some issues arise when a shell company is to be established by the main company. The issues are pertaining to the following grounds:

  • If any shell company had been formed by the main company in offshore regions, the same can lead to bad publicity for the profits that are earned by the company are not flowing inside the country of origin but in the foreign countries. This is one way that is responsible for affecting the economy of the domestic nation.
  • Although the purpose with which a shell company is created to hold assets of the main company may not be illegal in nature, the concept of a shell company is not a law friendly term, therefore the creation of shell companies is not advisable by market experts. 

Statutes that a shell company may violate

It is true that shell companies are neither governed by any statute nor are they mentioned in statutes governing companies in India that is the Companies Act, 2013.  But there are certain laws that are violated when shell companies are used to carry out illegal activities as have been discussed above.  The laws that are violated have been provided below: 

Ways in which shell companies affect a person 

A person getting affected by shell companies depends on the fact whether the person is ready to invest his hard-earned money for an unlawful purpose. Although it is true that a person investing in a shell company is not aware of the fact that his money will be used for some illegal purpose. Therefore the most possible way in which shell companies can affect a person who is investing his money there is by fooling that person and fleeing with his money subsequently making him a trap of the corrupted world. Another way in which a person can be affected is by losing their money completely as the government is taking the initiative to formulate a scheme to seize and remove any kind of shell companies due to the rise in illegal activities associated with these types of companies. Individuals who are honest taxpayers will be exasperated by seeing that a company is escaping liability of tax on a continuous basis. Tax evasion on a repeated basis affects the economy of the nation to a large extent.

India and shell companies: the challenge

India has on a recent basis experienced several scams that have had a severe impact on the nation’s developing economy. The Indian government has been able to take certain measures to curb the extension of the shell companies. In the process, the government has experienced several issues some of the notable beings:

  • No specific statute governing shell companies 
  • No statute provides with an appropriate definition of shell companies which if would have been present would have been helpful in order to know the ambit of the company
  • India being a developing country has several complex corporate set up which makes it difficult for a government official to keep in track of different accounts and categories them as legal or illegal.

The Indian government has worked beyond these issues in order to provide protection to the economy and the people and companies who are the victims of illegal shell companies. The ways in which the Indian government has worked towards building a better future has been provided below:

  • An investigation was carried out by the income tax department in order to locate all shell companies which were involved in carrying out illegal activities and contributed to initiating criminal prosecution against beneficiaries of several companies.
  • Efforts were made by the Ministry of Corporate Affairs to carry on deregistration that interrogated the companies who had not filed for necessary financial statements. Section 248 of the Companies Act, 2013 helped the Register of Companies to strike down many companies who had not filed for financial statements. 
  • The Government of India in February 2017 had set up a force called the task force which was headed by the Secretary and Revenue Secretary belonging to the Ministry of Corporate Affairs that provided several solutions for the government and the Reserve Bank of India which in turn was helpful in curbing tax evasion in a large way. 

Conclusion 

To conclude the discussion regarding shelf companies and shell companies, it can be said that while the former is more of an opportunity to build companies to boost the economy, the latter is an opportunity to escape from payment of taxes thereby bringing in disadvantages for the companies and the economy as a whole. It is only through proper legal enforcement can these two forms of companies be utilized effectively and efficiently. 

References 

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