ISSUE OF SHELL FIRMS

THE CONTEXT: On Independence Day last year, Prime Minister Modi mentioned India's battle against black money and said that more than 1.75 lakh shell companies have been de-registered so far. Also, in recent past, the Government has been very active in ensuring illegal shell firms are weeded out of the system.

This article discusses about shell companies and various initiatives taken the Government in the recent past to prevent their flourishing.

SHELL COMPANIESAND THEIR PURPOSE OF CREATION

What are shell companies?

Shell companies are companies without active business operations or significant assets.
They can be set up by business people for both legitimate and illegitimate purposes.

Why are they created?

This purpose is to divert money for tax evasion; route money generated from illegal activities to formal financial institutions; and transfer assets from one company to new company without the transfer of liabilities of the former company, to save tax.

Shell company vs Dormant company

What is a dormant company?

As per Section 455 of the Companies Act, 2013, a company that does not have significant financial activity or has been inactive can apply to the RoC and declare itself a dormant company.

How is a shell company different from dormant company?

A dormant company gets its title in two ways: it has chosen to get a ‘dormant’ status from the RoC by way of an application and is in compliance of the requirements of Section 455.
Further, in case a company has not filed financial statements or annual returns for two financial years consecutively, the RoC shall issue notice and include it in the register of ‘dormant’ companies.
But a shell company is one which is typically suspected of illegal activities.

MECHANISM OF WORKING OF SHELL COMPANIES

ISSUES WITH SHELL COMPANIES IN INDIA

Lack of legal definition of “Shell Company”: The Companies Act, 2013 has not defined what a ‘shell company’ is and as to what kind of activities would lead to a company being termed a ‘shell’.
Complex corporate structure in India: It is difficult to collect information on transactions of shell companies as transactions from multiple accounts makes it difficult to track them and also it is difficult to differentiate between a genuine and an illegal shell company.

No specific law dealing with Shell companies:
In India, there is no specific law relating to “shell companies.”
However, some laws help, to an extent, in curbing illegal activities such as money laundering and can indirectly be used to target shell companies — Benami Transaction (Prohibition) Amendment Act 2016; The Prevention of Money Laundering Act 2002 and The Companies Act, 2013
Companies as transactions from multiple accounts makes it difficult to track them and also it is difficult to differentiate between a genuine and an illegal shell company.
No specific law dealing with Shell companies:
In India, there is no specific law relating to “shell companies.”
However, some laws help, to an extent, in curbing illegal activities such as money laundering and can indirectly be used to target shell companies — Benami Transaction (Prohibition) Amendment Act 2016; The Prevention of Money Laundering Act 2002 and The Companies Act, 2013

ACTIONS TAKEN BY GOVERNMENT IN RECENT PAST

Centre has initiated action against more than 2.25 lakh shell companies as part of Operation Clean Money.
Serious Fraud Investigation Organisation has created a database of Shell companies where it categories companies into 3 types- Confirmed List, Derived List and Suspect List. The Confirmed List has a total of 16,537 confirmed shell companies The Derived List has 16,739 companies . The Suspect List has 80,670 suspected shell companies and has been drawn up by SFIO using certain Red Flag Indicators.
A ‘Task Force on Shell Companies’ under the Joint Chairmanship of Revenue Secretary and Secretary, Ministry of Corporate Affairs was constituted in February 2017.
Memorandum of understanding (MOU) was signed between Ministry of Corporate Affairs (MCA) and Central Board of Direct Taxes (CBDT) for automatic and regular exchange of tax information.
Appropriate powers given to RBI wrt freezing of accounts of defaulting companies and to SEBI for delisting companies if they suspect company’s fundamanentals.
Actions taken by Ministry of Corporate Affairs to ensure compliance:
1. In September 2017, Ministry of Corporate Affairs had introduced new Know Your Customer (KYC) norms affecting about 33 lakh directors of companies. Under it, directors were required to e-file forms providing details such as personal mobile number, e-mail address, Permanent Account Number (PAN) and Aadhaar number
2. The Ministry of Corporate Affairs has notified the Companies (Incorporation) Amendment Rules, 2019, under which all companies registered before December 31, 2017, are required to file eForm ACTIVE (Active Company Tagging Identities and Verification)-INC22A on or before April 25, 2019. Failure to file e-Form ACTIVE will lead to a penalty of Rs 10,000 with companies in default being declared ACTIVE non-compliant.

RECOMMENDATIONS OF TASK FORCE

Recommendation	Possible Impact
Re-introduction of the provision, whereby a company needs to declare commencement of business.	This would help in early detection and striking off of inactive companies.
Non-maintenance of a registered office as one of the grounds for striking off the name of a company from the Registrar of Companies, under Section 248 of the Companies Act.	It will ensure that companies maintain a registered office to prevent the existence of paper companies.
Disqualification of directors, who are holding directorship beyond the maximum limit prescribed under the act.	Ensure better Corporate Governance practices

WHAT MORE SHOULD BE DONE?

Having a separate law dealing with Shell companies	The Government can establish a law that caters explicitly to dealing with Shell companies. This law can provide a precise definition of shell companies based on parameters such as revenues, assets, employee strength apart from the requirement of filing returns, etc.
Amendments in Companies law 2013	There should be Exproriation powers given to financé ministry to seize assets and property if the shell company is dissolved. The proceeds from the assets seized should go to the Consolidated Fund of India.
Double tax avoidance agreements	The Government should look for signing of double tax avoidance agreements with tax havens and imposing minimum operational expense criteria on shell companies.
Using technology	There is a need to simplify corporate structure and make use of Big Data to track tax evaders.

CONCLUSION: Although, shell companies are not harming investors but the government by the illegal by doing hawala transactions converting black money into white and by not paying the tax. So, there is a need to bring the transparency in taxation & laws along with its implementation and widen the tax base.

SOURCES

https://www.businessinsider.in/the-indian-government-is-continuing-its-crackdown-on-shell-firms/amp_articleshow/65751194.cms

https://www.google.com/amp/s/www.moneycontrol.com/news/business/what-are-shell-companies-all-you-need-to-know-2361177.html/amp

https://www.google.com/amp/s/m.economictimes.com/news/economy/policy/ministry-of-corporate-affairs-deregisters-50000-shell-companies-in-a-week/amp_articleshow/65361314.cms

http://pib.nic.in/newsite/PrintRelease.aspx?relid=186743
https://www.google.com/amp/s/www.livemint.com/Money/gFqqUTa6pYGWVkjyHh58QO/What-are-shell-companies.html?facet=amp
https://m.businesstoday.in/lite/story/more-rules-likely-to-flush-out-shell-companies/1/282111.html

https://www.google.com/amp/s/www.bloombergquint.com/law-and-policy/company-law-government-proposes-changes-to-expropriate-property-of-shell-firms.amp

https://economictimes.indiatimes.com/news/company/corporate-trends/how-shell-companies-turn-black-money-of-india-inc-politicians-into-white-and-vice-versa/articleshow/20947474.cms

Mains Questions

1) What do you mean by Shell companies? Describing their mechanism, explain why India faces issues in dealing with them?

2) Shell company is an important way for corporates in India to evade taxes. In this context, discuss various Government initiatives to tackle the menace of Shell companies.

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