The versatile shell companies serve not just as vehicles for corporate tax dodging but have also been used by the rich to get around paying hefty alimony payments. The existence of shell companies is not recent and its rather innocuous beginnings can be traced back to 1960s when Walt Disney & co. set out to acquire land in Florida to construct the Disney World Resort. Disney feared that its purchase of land may stoke interest in the real estate which it sought to acquire and would push up property prices. To keep the matter under wraps, it set up a few shell companies that acquired these tracts of land. While lack of compunction for use of the shell companies by Disney is contestable, the intent was not to avoid taxes. Nearly half a century later, shell companies have donned a more menacing role. The 2016 panama papers exposed the use of shell company named Maxima Middle East Trading, incorporated by Mossack Fonseca in Seychelles in 2012, for smuggling of gasoline and helping fund the Assad government. A startling revelation made by International Consortium of Investigative Journalists was the existence of 215,000 shell companies associated with Mossack Fonseca. The ramifications of existence of shell companies are therefore colossal.
A shell company is a legal entity that is incorporated for the purpose of avoiding taxes or laundering proceeds from illegal activities. The company is registered in the name of individual(s) distantly associated with the actual or beneficial owners, i.e., the identity of the beneficial owner can be kept secret through the use of “nominee” shareholders and appointment of board members who could be a professional such as a lawyer appointed by the beneficial owner. Shell companies can be located within the economy or in tax havens. As is well known, shell companies are the outcome of lax rules of incorporation that exist not just in small developing countries but are also the feature of countries such as the United States. In Delaware for example a company can be incorporated without furnishing the information on the owner. On the other hand, a Washington D.C. based think tank, Citizens for Tax Justice put out a dataset on large US corporations and found that “367 companies, or 73 percent of the Fortune 500, operate one or more subsidiaries in tax haven countries”.
India is also well known to host such companies, the income tax department’s crack down following demonetisation revealed their preponderance. Nearly 200 shell companies were found to be operating in different states that were facilitating the conversion of illegal money to legal. Shell companies are used for the purposes of making foreign exchange transfers or to bribe officials or to avail duty drawback. For instance, shell companies located abroad are known to be used by technology companies that develop patents in India but once developed the patents are registered in the name of shell companies incorporated in tax havens. While demonetisation exposed the widespread misuse of shell companies, the SITs had already flagged the issue in its 3rd report put out in July 2015 and recommended the proactive detection of shell companies through data mining of MCA21 data. Further it mentioned that the specific sections of the Companies Act (section 89(1), 89(2) and 89(4)) pertaining to beneficial ownership could facilitate the identification of fraud carried out through shell companies.
Based on the documented characteristics of shell companies I identified red flags, which are zero profits over the years with no income from sale of goods and services which imply predominantly income from other sources as well as reported registered office that is also used by at least 20 other companies. Using these red flags in my study (Tandon, 2016) I was able to narrow down 12 companies that belonged to the construction, real estate or infrastructure sectors. Some of the firms belong to a business group flagged in the past.
Shell companies are therefore commonplace and have gathered enough concern from organisations such as the OECD as well as FATF, an inter-governmental body developing and promoting policies to combat money laundering and terrorist financing. International efforts are now being directed at trying to curtail the misuse of such agencies. The OECD in its report on “Misuse of Corporate Vehicles for Illicit Purposes” flagged the misuse of the separate legal entity to cloak illicit incomes. In fact, the report points out that even in many countries where banking secrecy laws are in place, the individuals prefer to deposit money in bank accounts that are associated with a company. In this regard, the FATF and the Global Forum on Transparency and Exchange of Information for Tax Purposes have contributed significantly by undertaking peer reviews to ensure that the international standards on transparency are met. Further, the automatic exchange of information, Preventing of Granting of Treaty Benefits in Inappropriate Circumstances (Action 6 - 2015 OECD Final Report) and mandatory disclosure rules (Action 12 - 2015 OECD Final Report) in the BEPS action plan seek to address this concern. In addition, the EU will implement in June 2017 beneficial ownership rules in the EU’s latest (4th) directive on Anti Money Laundering (AML). As per the new law the information on company structures must be made accessible to banks, law firms and “any person or organisation that can demonstrate a legitimate interest”. In this regard an important concept that can prove useful for tracking shell companies is that of beneficial ownership.
In June 2013, the G8 leaders met and agreed on the principles of beneficial ownership. Following this the UK began the process of establishing a central register, in the same year. In 2014, the European parliament approved the provisions requiring the formation of public register as a part of its draft 4th Anti Money Laundering(AML) directive. FATF followed up such efforts by putting out standards (in recommendations 24&25) in a document that was to guide jurisdictions in identifying, designing and implementing measures to prevent the misuse of corporate vehicles. Later in 2014, a meeting of G-20 finance ministers and central bank governors was called where the high level principles of beneficial ownership were discussed. In that year India joined the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes. So far the UK government’s move to create a public register of beneficial interests has been exemplary.
With the experience of demonetisation it is clear that these companies can give a tough fight to even the most radical of policy changes. While the Indian government has attempted to deal with shell companies, the efforts are far from complete. Indian government introduced the concept of Place of Effective Management (POEM) to the Income Tax Act which is expected to come into effect from 1st April 2017. As per this definitional change a company would be Indian if the control and management of its affairs is situated wholly in India. This was to restrain companies from holding board meetings abroad which allows companies the non-resident status. While such a change is in the direction of tackling the issue, it is important to gather information on beneficial ownership for both companies that are set up within the economy as well as registered abroad. India’s response was rather well timed since the Companies Act of 2013 introduced the section 89 which dealt specifically reporting of beneficial interest. Subsequently, the company law committee, set up to review the new act, in its report made recommendations with respect to changes necessary to specific sections. Section 89 was amended to incorporate the definition of beneficial ownership, which aligned with the EU’s definition of “not less than 25 per cent”. However, this amendment is still pending for approval by the parliament.
India has made swift advances in this regard but the amendment bill (2016) still awaits approval. Given that the SIT had already flagged the issue of shell companies being used for laundering money, the demonetisation made little sense without plugging of such loopholes. The introduction of the amendment and the section 89(4) that allows the central government to “make rules to provide for the manner of holding and disclosing beneficial interest and beneficial ownership under this section” can provide the necessary tools to fight shell companies. However, India’s slow response in taking forward such reforms could mar progress. Further, India may seek to receive information on shell companies located abroad through the exchange of information. To ensure such co-operation India must also maintain such records, as has been urged by some OECD countries.
The days of mickey mouse shell companies have come to pass. The means to nab these companies are in close reach and reforms that move in this direction must be braced swiftly.
1 “How billionaire husbands including Scot Young used mysterious Panama law firm to hide their fortunes from the wives they divorce”
2 Some of the companies listed in the leaks date back to 1970s (http://panamapapers.sueddeutsche.de/articles/56febff0a1bb8d3c3495adf4/)
4'Panama Papers' blockbusters make waves abroad, but secret money is a U.S. problem too” http://www.latimes.com/opinion/op-ed/la-oe-mcmanus-panama-papers-20160406-column.html
5 “Anonymous Companies”, http://www.gfintegrity.org/issue/anonymous-companies/
6 “Just as Common as Panamanian Ones”
7 “Forget Panama: it's easier to hide your money in the US than almost anywhere” https://www.theguardian.com/us-news/2016/apr/06/panama-papers-us-tax-havens-delaware
8 “Offshore Shell Games 2016” http://ctj.org/ctjreports/2016/10/offshore_shell_games_2016.php#.WJ1AL2997IU
9 “Shell companies' patents to come under domestic tax net on adoption of BEPS” http://economictimes.indiatimes.com/news/economy/policy/shell-companies-patents-to-come-under-domestic-tax-net-on-adoption-of-beps/articleshow/49499206.cms
10Recommendations of SIT on Black Money as Contained in the Third SIT Report http://pib.nic.in/newsite/PrintRelease.aspx?relid=123677
11 Suranjali Tandon. 2016. Survival and Death in the Indian Corporate Sector, in Miguel M. Torres , Virginia Cathro , Maria Alejandra Gonzalez-perez (ed.) Dead Firms: Causes and Effects of Cross-border Corporate Insolvency (Advanced Series in Management, Volume 15) Emerald Group Publishing Limited, pp.77 - 111
12 The newspaper articles named the business group. However since this study is indicative and provides a means of developing indicators to recognize shell companies no name has been provided.
13 Behind the Corporate Veil, USING CORPORATE ENTITIES FOR ILLICIT PURPOSES, OECD,2001 https://www.oecd.org/corporate/ca/43703185.pdf
14 To the extent that such information exists in collaborating jurisdictions.
15 Point (6), http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:JOL_2015_141_R_0003&from=ES
16 “Article: Beneficial Ownership Register Opens On 6 April 2016”, https://www.bdo.co.uk/en-gb/insights/business-edge/business-edge-2016/beneficial-ownership-register-opens-on-6-april-2016
17 This came into effect from April 2016
18 GAAR, POEM to come into effect from April 1: Government, http://indianexpress.com/article/business/economy/gaar-poem-to-come-into-effect-from-april-1-govt-4504696/
The author is Suranjali Tandon, Consultant at NIPFP, New Delhi.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.