What are Shell Companies – All you need to know? (In Detailed)

Shell Companies

What are Shell Companies ? : While addressing the CA fraternity on the occasion of Chartered Accountants day on 1st July, Prime Minister Narendra Modi has hinted that stringent action would be taken on shell companies which are defunct when it comes to real operations. Following this, there was a massive crack down by the Ministry of Corporate affairs on such companies which Prime Minister has reiterated in his Independence speech though the absolute number of companies whose registration was canceled is not clear. In this post we have come up with the information that we think can help you understand these shell companies to a primary extent.

What is a shell Company?

A shell company is a business entity that has no active business operations or significant assets. In simple terms, a shell Company is like an empty shell having nothing inside it. Often, we hear the term shell company when the cases of tax evasion, money laundering or such cases involving large amount money have come out. Thus, it has become one of the synonyms for illegitimate use of companies act to secure illegal gains. Shell companies are the deliberately created entities to avoid taxes which cannot be simply termed as illegal. However, ironically Companies act 2013 has not given an exhaustive meaning to shell companies.

The commonly referred definition of the shell companies is here under as defined by The US Securities Act:

“Securities Act Rule 405 and Exchange Act Rule 12b-2 define a Shell Company as a company, other than an asset-backed issuer, with no or nominal operations; and either: no or nominal assets; assets consisting of cash and cash equivalents; or assets consisting of any amount of cash and cash equivalents and nominal other assets”

Shell Companies

Are they same as Dormant company?

No, both are different from each other having a very thin line drawn between them.

A company is dormant company if it has chosen by making an application to get a ‘dormant’ status from the Registrar of companies in compliance with the requirements Section 455 of Companies Act 2013.

On the other hand, a shell company is the one having neither active business operation nor significant assets which are typically suspected of illegal activities mainly tax evasion and financing the illegal activities.

Are there shell companies trading in stock exchanges too?

Yes. In August 2017, the Securities and Exchange Board of India (SEBI) directed the stock exchanges to initiate action against 331 suspected shell companies and bar them from trading. To decide up on the genuineness of the companies with no/nominal operations backed by no significant assets, the law implementing authority has to go through many steps ranging from scrutinizing the initial operations to digging deep each transaction & finding the real owners benefited by them.

What makes it so  important to weed out the shell companies?

  1. Many shell companies are just intentionally constituted entities to launder the money, to park the illegitimately earned wealth and to avoid taxes in the veil if separate entity concept. There have been media reports that many shell companies were created to sponsor the terrorist activities by people having vested interests.
  2. Most of the shell companies are registered in the places that are popularly called as tax heavens. Tax heavens are those which offer least/no tax liability to the foreign individuals or business houses. Some of the tax heavens which have become very popular these days are Mauritius, Cayman Islands, Channel Islands, and Monaco etc. These places are the resting resorts of the money acquired through illegitimate ways by deliberately causing massive loss to a country’s exchequer.
  3. To protect the interests of investors who put their hard earned money in these companies, it is very much important to ensure that shell companies are identified and weeded out before they immerse the economic interest of the innocent investors in the ocean of losses.

Bottom line:

On the legitimate side, shell companies are created to promote the startups by raising funds etc. Cracking down on every company that is suspected to be a shell company is such a dangerous step that it would ruin the startup eco system and ease of doing business in our country. So, the government has been acting very conscious of such consequences while probing into the suspicious entities. So, before looking for a company to purchase equity, one has to conduct proper due diligence with all the available information.

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