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This article is written by Prerana Das, pursuing a 6-Month Growth Camp: Preparation for LLM Abroad from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

Introduction

Shell firms are businesses founded for illegal objectives such as money laundering, tax evasion, Ponzi schemes, and insider trading. The businesses do not operate, do not have a registered office, and do not have any significant assets. The government has recently taken measures to rein down India’s growing number of shell companies. As a result, a significant number of shell firms have been shut down. As a result, the current concerns and challenges confronting shell enterprises are highlighted in this study report. In the first part of the article, the author will introduce the concept of shell companies as an offence The latter half of the article discusses the legal uses of shell companies.

The phrase ‘Shell Company’ is not defined anywhere, but it can be interpreted to denote firms that are formed solely to create a separate legal entity that does not conduct any activity. These firms may be formed primarily for the purpose of doing business in the future, but more often than not, the promoters have no intention of doing business through them. Most shell companies don’t produce or sell anything, and they don’t provide any services. A «shell company, » which is a corporation that simply exists on paper and has no office or staff, is one of the most crucial tools in corporate restructuring. It is frequently registered to the address of a company that specializes in forming shell businesses in tax havens. The majority of the time, shell companies are used to conducting financial transactions. In most cases, these businesses merely have assets on paper and not in reality. Almost no economic activity is carried out by these businesses.

Shell corporations are used for a variety of valid purposes:

  • To save money in order to start a business,
  • As a cover for product development that a well-established corporation might want to keep secret until it’s ready,
  • Facilitate financial institutions’ ability to conduct financial transactions in overseas markets,
  • To raise funding and keep control over the conglomerate company,
  • Create a “tax haven” in another country.

Shell corporations are legal entities. When they are employed for criminal purposes, they become illegal. Setting up a shell corporation doesn’t require much identification, and buyers are assured that their identities will remain hidden. As a result, they are more likely to be involved in illegal activities such as money laundering, tax evasion, corruption, terrorism, and drug trafficking.

Shell companies do not necessarily pose a risk because of their nature, but when used in conjunction with other instruments such as international tax treaties or lax transparency requirements, they can increase and facilitate asset origin concealment, beneficial owner concealment, and fraud workers’ rights. 

Why are shell companies formed?

Shell companies are usually associated with the following activities:

  • Money laundering and the conversion of black money into white money: When demonetization took place in 2016, a slew of shell firms were identified. This was due to their involvement in the use of black money. Instead of making deposits, many people and businesses use shell firms to store their excess cash.
  • Making money from Ponzi Schemes: Individuals or businesses can set up shell firms to mislead others by presenting false schemes and profiting from them. They save money by using these firms because it is  difficult to uncover the real persons behind the plan when fraud is discovered, and the only entity  that can be blamed is the corporation.
  • Tax evasion: Corporations frequently establish shell firms in offshore jurisdictions where taxes are levied at a lower rate. These areas are referred to as ‘Tax Havens.’ Panama and Switzerland are two examples of these places. These corporations use shell companies to hide their assets and avoid paying taxes on them.
  • Hiding the true owners’ identities: Finding the genuine owner of a shell corporation can be difficult because the owners of these companies frequently succeed in concealing their identities. They can’t be found since the company’s or directors’ registered office is frequently at a different location from the address given to the registrar.

Legal uses of the shell companies

While shell companies are frequently used for illicit purposes, big corporations and individuals use them legally. Some of the uses  are:

  • A Special-Purpose Acquisition Company (SPAC) is utilised to finance an existing private firm by raising funds through a public stock offering. SPACs are referred to as shell companies because they may not have any company operations or employees.
  • To stage a hostile takeover, a shell company could be established. This occurs when a company buys another company without the consent of the target company’s management. 
  • If a company wants to keep its dealings with another disreputable company, it can set up a shell company specifically for that purpose.
  • When the main firm/owner of the shell company plans to launch a new company, the money is temporarily held or stored.
  • People may construct shell corporations to hide money in order to avoid becoming a target for  criminals and thieves, if a company is working in a risky country like Afghanistan, where terrorist activities are common.
  • Shell corporations can also be established in order to get access to international markets.
  • To safeguard assets from lawsuits.

What laws are violated by the shell companies?

The following laws are broken as a result of the shell company’s:

  • Benami Transactions Prohibition (Amendment) Act, 2016: This Act grants the government the authority to seize benami assets, which are assets held in the name of another person or fictional person in order to dodge taxation or hide unaccounted money.
  • Prevention of Money Laundering Act (PMLA): When money that has not been taxed, i.e. unaccounted or black money, is passed via a shell corporation to appear as untainted money, it is considered money laundering under Section 3 of the PMLA and is punishable by 3 to 7 years in prison and a fine.
  • Indian Penal Code: When shell corporations are used for Ponzi schemes, a crime under Section 420 of the Indian Penal Code relating to defrauding is committed, which is punishable by imprisonment or a term of up to 7 years in prison, as well as a fine.

What steps is the government taking to combat unlawful shell companies?

The regulators started by waging a two-pronged attack against shell corporations. In February 2017, a task group on shell corporations was established under the joint chairmanship of the Revenue Secretary and the Secretary of the Ministry of Corporate Affairs. An investigation by the income tax department led to the identification of shell companies that were being used as conduits and criminal prosecution was launched by the income tax department against the beneficiaries of non-genuine transactions.

Shell companies were targeted for license revocation by the ministry of corporate affairs. The corporations that had not filed their financial statements were the first target. Section 248 of the Companies Act 2013 empowers the Registrar of Companies to strike a company off the register of companies if it fails to commence business within one year of its incorporation or if it fails to carry on business for two financial years and has not applied for dormant company status.

Over two lakh firms were struck off in 2017 as a result of this section, and the MCA published a list of these entities by ROC on its website. In addition, MCA has published a list of directors linked with these businesses. For a period of five years, the companies’ directors were barred from acting as directors of any other entities. These companies’ banking operations were likewise prohibited and the directors were barred from using their bank accounts.

Following demonetisation, the Ministry of Corporate Affairs (MCA) has made significant progress in its inquiry into the use of shell firms to deposit enormous quantities of cash in banks. Four Maharashtra-based companies revealed to authorities that they were only being used as a front face to carry out money laundering actions,” according to a report. These four businesses mostly dealt with things for which no tax was due.

Given that the government is focused on boosting the ease of doing business, which is directly related to the reduction of corruption and the parallel economy, it is reasonable to expect that the existence and operation of shell firms will become more difficult. However, in response to widespread resistance to the directors’ disqualification, the MCA has issued the Condonation of Delay plan, 2018, via General Circular dated December 29, 2017, which provides relief to such disqualified directors.

Conclusion

Shell firms that engage in illicit dealings, as they usually do, can be a big hurdle for the economy by engaging in tax evasion, money laundering, and other criminal activities. There is a major problem in India when it comes to working with these companies. This is due to the fact that there is no special rule of law that deals with Shell corporations. Furthermore, there is no legal definition or criteria for recognition.

The need for a well-structured approach to dealing with shell businesses is evident. In addition, such a framework must ensure that such regulation does not construct additional barriers for legal entities that appear to be shell companies.

A thorough, balanced definition of shell companies is needed, one that is broad enough to meet all criteria for identifying illegal shell companies while being restrictive enough to exclude all lawful shell companies.

References 


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