For several years, ever since the Narendra Modi regime came to power for the first time, the Government has initiated efforts to curb the expansion of what it calls shell companies. Over the past three year, it claims, more than 1,00,000 such firms were forcefully shut down. Shell companies are usually firms with just an address, minimal assets (maybe a chair and table, along with a computer), non-existent employees (probably a guard), and no transactions or operations (except for some paper entries). Experts feel that they are largely used for tax evasion, tax avoidance, money laundering, and siphoning off funds from listed or larger companies.
Now, the Government hopes to enhance its crackdown on such firms. The laws define dormant companies in a positive manner. They are registered firms that stayed inactive for the past two financial years, and showed no significant accounting transactions. There are other criteria under Section 455 of the Companies Act. Any company can legally apply for this status. This is because dormant companies may seem to be empty ones, but they are formed with specific objectives. The latter may include holding specific assets, intellectual property rights, or initial investments for a future project.
But the authorities are more worried about dormant firms, which have not applied for the status, and behave similarly, without business operations or any major assets. This is what they feel forms the kernels of shell companies. So, there is a case to legally define shell firms, and make them distinct from genuine dormant ones. Also, there is a need to differentiate between shell firms and shelf ones. The latter are usually companies that can be purchased off the shelf. In many cases, businesses need to form a company in a hurry to pursue a new plan, partnership, investment or marketing deal.
To save time required to form and register a new company, they just buy already-established firms off the shelf. There are chartered accountants, who set up these firms, and wait for buyers. This is especially true when businesses need to genuinely go through tax havens, where they need a company within hours and days. Not all companies in tax havens are bogus or those that pursue illegal or semi-legal activities. Not all are aimed to save taxes. There are benefits to investing via tax havens in some cases. For example, in case of large takeovers, especially the cross-border ones, secrecy is paramount. Doing business via tax havens ensures this.
Hence, a clear-cut legal definition of shell companies is crucial to distinguish between genuine and dishonest businesses. It is also important to save businesses from authorities who, in their zeal, tend to go overboard on pinpointing shell companies, which may not be so. In the case of global revelations, like the Panama Papers, there were hundreds of cases, where businesses had opened companies or accounts in tax havens to honestly pursue business deals. In many instances, these companies or accounts were not closed due to laxity or lack of time. But in the haste to deem them as shell companies, experts and journalists were unable to figure out right from wrong.
Another proposal that the Government hopes to implement relates to setting up of a central registry for shell companies, along with measures to address supervision gaps between the different regulators. Obviously, the trick will be to pinpoint the bad apples, and leave the good ones alone. There will be a need to continuously update the registry, as criminals are invariably a few steps ahead of the policy-makers, regulators and investigators. More importantly, the Government will need analysts, who can spot patterns within the registry, and inform the relevant authorities. The data needs to be used in the right manner. Just having it is not enough.
One of the suggestions in a recent meeting between the stakeholders was to use the information in the Central Know Your Customer Registry, which is maintained and operated by the Central Registry of Securitisation Asset Reconstruction and Security Interest of India. Officials revealed that the Government is trying to figure out if this large database can be shared with the banks and financial institutions to help the latter to detect shell companies earlier. In such an environment, the menace can be nipped in the bud, and mitigating accompanying risks will be easier and faster.
Elisa de Anda Madrazo, the president of global financial crime watchdog, Financial Action Task Force (FATF), recently asked nations to curb the use of shell companies, which were like “getaway cars” for the global criminals and underworld syndicates. She added that ways to counter this problem is a key part of a new round of national assessment. Such assessments allow FATF to put nations in negative grey or black lists. Being in the grey list can invite increased global monitoring, and damage the nation’s appeal among foreign investors and lenders. The grey list includes Monaco and the British Virgin Islands. Being in the black list is like a cross around the nations’ necks. These include North Korea, Iran and Myanmar.
“We will be looking heavily into the effectiveness of those systems (to close shell firms). Countries need to make sure that the information is updated, complete, accurate and readily-available for law enforcement authorities. We do see countries that are implementing the standard, and moving in that direction,” she recently said. However, nations can get smart. In 2022, Cambodia escaped the grey list by staging “fake crackdowns” on so-called corrupt officials. Today, there are allegations that a Cambodian company has emerged as the “largest online criminal marketplace in history.” It allegedly has ties with the ruling family, and uses hundreds of shell companies.
A recent study by Moody’s of more than 470 million registered companies across the globe found that nearly 20 million had at least one trait that hinted of them being shell firms. Ironically, a developed nation, the UK, had the highest number of red flags. For several decades, experts and investigators have maintained that Britain has become the safest haven for criminals to hide their money. Things are not so smooth in the US and Switzerland. Recently, the US stopped requiring local firms to provide data related to beneficial ownership. Switzerland excluded fo undations and associations from a planned national transparency register of beneficial owners.