Shell corporations or Shell companies are entities that do not have active business operations but are set up to achieve specific business objectives such as reducing tax liabilities, shielding an entity from legal risks, raising capital, and oftentimes, for illegal purposes such as laundering money, hiding beneficial ownership from law enforcement or circumventing sanctions.

While shell companies are often regarded negatively, they are also used legally by large corporations and individuals. For example, a SPAC is used to raise capital through the public issue of shares to acquire an existing private company. SPAC by themselves may not have any business operations or workforce and therefore are referred to as Shell Companies.

The Panama Papers leak of early 2016 made public the financial and ownership details of over 200,000 offshore shell companies and other entities set up by a law firm for their clients, many of which were set up for wealthy individuals, politically exposed persons and sanctioned parties.

Shell entities are often set up with complex ownership structures in jurisdictions that may be considered to have relaxed tax laws alongside financial institutions that offer opacity as a value proposition. Though legal in these jurisdictions, these entities have been used by the beneficial owners to launder undeclared monies (monies originating from bribery/corruption), circumvent sanctions, finance illegitimate and illegal business concerns, impersonate legit businesses, and much more. Mosaic Fonseca, the law firm whose data leak is referred to as the ‘Panama Papers Leak’, is known to have facilitated at-least 30 odd individuals sanctioned at the time by OFAC, to conduct business through shell companies.

Another commonly heard term, ‘Front companies’ is quite different from ‘Shell companies’ in the fact that Front entities usually have ongoing business operations but the true nature of the business is masked. Both Shell Companies and Front Companies are used for money laundering purposes.

Shell companies in the Indian context

There is no specific definition of shell companies mentioned in the Companies Act, 1956, the Companies Act, 2013, or any other Indian law. However, judicial decisions (ex: Assam Company India Ltd. and Anr. Vs Union of India), definitions in foreign statutes, or literature are used to understand this term in the Indian context.

The Organisation for Economic Co-operation and Economic Development (OECD) defines a shell company as ‘a firm incorporated or organized or registered in the economy but does not take part in the economic operations (other than pass-through capacity)’. In layman’s terms, it can be construed that shell companies are entities that only exist on paper without having any assets, liabilities, or employees. Thus, they are structured like a company without any actual business activities.

SEBI is widely quoted in the media as having suggested that any entity having no significant operational assets or business activity of its own but acting in a pass-through capacity as a conduit may be called a shell company.

Shell companies are increasingly used to commit GST fraud in India. Though the Indian Corporate registry offers good visibility into the ownership of registered entities, shell corporations are floated using PAN cards and IDs of unaware employees (like domestic help) to raise invoices and claim input credits against those invoices without delivery of any goods or services. These frauds run into thousands of crores of rupees and have caused significant losses for the tax authorities. Regulators such as the Income Tax Department, GST department, SEBI, and law enforcement agencies such as CBI, FIU, and SFIO have been tasked by the Govt. to identify and scrutinize these pass-through entities with no legit business interests.

Identify shell companies using SignalX Risk Intelligence Platform
SignalX being used to analyze the ownership history of a target.

SEBI flagged over 331 shell entities from the listed markets, 169 of which were being actively traded. Shell entities on stock exchanges are often used as a medium to transfer laundered money in and out of the country without much regulatory scrutiny.

Conducting business with shell companies with unknown beneficiaries could result in steep penalties from regulators, prohibition, and the associated loss of reputation. Understanding the ultimate beneficiary of a given entity is crucial in ensuring sanctions and regulator compliance. Such was the case with Essentra FZE, a UAE based entity penalized by the OFAC late last year for conducting business with a Chinese shell company whose ultimate beneficial owners happened to be from North Korea, an OFAC sanctioned country at the time.

How to check for shell companies and dubious entities?

There are some key steps you can take to ensure that you’re not putting yourself at risk by conducting business with shell companies. At SignalX, we execute a combination of the following checks to flag the target as a potential shell entity. Any robust due diligence platform can help you run these checks on the target in an instant.

Common checks that will help you identify shell companies include -

  1. Probe for ultimate beneficiaries. (read about ‘Significant Influence’)
  2. Check if the company owns insignificant assets given its financial position
  3. Check historic P&L statements for nil or marginal operations
  4. Check if there are frequent changes in management
  5. Check if the email id used to register the business is valid
  6. Check if the target is a ‘Struck off’ company
  7. Check if the target is flagged as a Defaulting company
  8. Check if the target is flagged as a Vanishing Company
  9. Check if the directors are flagged as Defaulters
  10. Check if the directors are flagged as Proclaimed Offenders
  11. Check if the target is flagged by SFIO
  12. Check if SEBI has debarred any of the promoters
  13. Check if SEBI has debarred the company previously
  14. Check if the entity has been flagged as a Shell Company by SEBI if a listed entity
  15. Check if the beneficial owners are associated with companies flagged by the SEBI as shell entities
  16. Check if the entity has been prosecuted for GST fraud
  17. Check the number of employees through their EPFO registration
  18. Check if the entity has PEPs in the management
  19. Check if the entity of beneficial owners are sanctioned by OFAC, UN, or EU
  20. Check if the entity has parent firms or subsidiaries in tax havens

Once done, these checks should help you identify whether any potential business engagement might see you associated with a shell company. With the fast changing landscape of financial dealings in Indian businesses, more companies are opting for unconventional corporate structures to optimise how they use government offered benefits. As the network of inter-related companies grows larger and more dense, the time seems ripe for independent companies to set up a thorough process to investigate just who they are getting in bed with.

If you liked this article, we recommend you go through:

Anti-Money Laundering- A Guide to Enhanced Due Diligence

FinCEN Files: Financial Crime Compliance & The Need for an Anti-Money-Laundering Whistleblower Program

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