Shell Company

Definition: Shell Company implies a fictitious company with no active business operations. These companies are formed with an aim of achieving specific business objectives which may or may not be legitimate. Such companies do not have a physical existence, as they exist only on paper. Meaning that it has no office, no staff, no assets, but just a bank account, to carry out financial transactions in the name of the company.

• They neither produce any product nor render any service.
• These are used to perform financial transactions.
• The assets exist only on paper.
• It has little to no independent economic value.

Such companies are not always illegal. These are formed to avoid taxes without attracting any legal consequences. And tax avoidance is not illegal but undesirable. However, many times shell companies are set up to park black money, to perform illegal or fraudulent activities, and to play the role of a facilitator of money laundering.

These companies are non-traded corporations, which are used as pass-through, that allow other firms to effortlessly transfer funds from one country to another.

Basically, a shell company is used as a means to perform different financial activities and it remains dormant for future use. In general, shell companies are opened in tax haven countries.

Now the question arises – what is a tax haven country?
Well, a tax haven country is a country with little to no tax provisions at the same time there are financial institutions that provide privacy as to financial transactions. Plus, the formation of a company in such a country is very easy.

Features of Shell Companies

1. Nominal paid-up capital
2. High reserves and surplus
3. Investment in unlisted companies
4. No dividend income
5. High cash income
6. Majority shareholders are private companies
7. Turnover and operating income is low
8. Nominal Expenses

Identification of Shell Company

One should take note that a shell company is not defined under the Companies Act, 2013. So, for the purpose of its identification, the Securities and Exchange Board of India has given a few guidelines which include:

• Absence of any operational activities
• Absence of operational Assets
• Existing in the capacity of Pass-through.

Apart from SEBI, there are some other bodies who have also provided a number of criteria to identify Shell Company are:

• Facilitating cross-country currency and asset transfer.
• No physical existence of the office at the address registered.
• Multiple companies registered with the same address.
• No economic rationale except the one related to banking transactions.
• High ticket transactions, that are not consistent with business operations.

Creation of Shell Company

For creating a shell company, the steps followed include:

1. Selection of a Tax Haven Country.
2. Once the country is selected, the next step is the creation of a corporation, which would be a Shell Company.
3. After incorporation, one nominee will be hired, who will look after the state of affairs of the Shell Company.
4. Thereafter a bank account will be opened in the concerned jurisdiction with an aim of performing financial transactions.
5. Once the account is active, the movement of money starts and the transfer of money is facilitated.

You might have a question in mind that – What do these tax haven countries get?

Well, as these are tax haven countries, they do not earn from taxes like property tax, corporation tax, VAT, dividend distribution tax, etc. Rather they make money from the registration fee from the incorporation of shell companies, as well as renewal of licenses year after year. Additionally, it helps in the development of banking infrastructure, which creates job opportunities for people who reside there.

Example

David India Limited a company based in India purchases goods from farmers worth ₹ 300 crores and sells them to David Haven Limited, which is situated in a Tax Haven Country @ ₹ 300 crores. As the company David India Limited does not make any profit on the sale of goods, no tax will be payable.

Further, David Haven Limited sells goods to David Paris Limited @ ₹ 600 crores. The company David Haven Limited earns a profit of ₹ 300 crores, still, it does not need to pay any taxes on the export as it is based in a tax haven country. Now, David Paris Limited will sell the goods to customers of Paris @ ₹ 600 crores. As the company does not earn any profit on the sale of goods. No tax will be payable.

Now, to bring back these funds to the home country, foreign direct investment is made by the shell company.

Illegitimate Purposes

Illegitimate purposes for which a shell company is formed are:

1. Money laundering
2. Tax Avoidance
3. Concealment of ownership of the real beneficial owner
4. Conversion of black money into white money
5. Making money off Ponzi schemes

A word from Business Jargons

Apart from the above-given purposes, a shell company can also be constituted to act as a vehicle to arrange money prior to the beginning of operations of an enterprise or to seek a takeover of another firm. Another name for shell company is Phantom Companies, Anonymous Companies, and Ghost Companies.