All the Readers are requested to read the following notes after reading earlier note on this topic which was published on 01.01.2020 in Taxguru. A Critical Analysis of “Shell Company”- Part 1

The term Shell companies generally refer to limited liability companies and other business entities with no significant assets or ongoing businesses activities. Shell companies typically have no physical presence other than mailing addresses, employs no one, and produces little to or no independent economic values. They are frequently used to shield identities and/or to hide unaccounted money. They exist for one big reason-to help its customers convert unaccounted money into white, or vice versa and are attractive vehicle for those customers.

The four basic steps in the processes of conversion of unaccounted money into unsecured loans

1.Placement –The process starts with the owner (beneficiary) of unaccounted money identifying the brokers/operators and deciding the mechanism for converting the said unaccounted money through some legitimate means. When the deal is struck at a certain agreed percentage of commission, the unaccounted income is hand over to the broker in lots .The broker in turn deposited into bank accounts he controls or with the help of another broker who deals in cash transaction. As banks are required to report high-value transactions, so usually the money will be deposited in small increments over a period of time. This is the riskiest stage of the process and most unorganized of the three stages. This is because the accounts are normally closed after certain amount of transaction and becomes inoperative after a short time span.

2. Layering – This includes wire transfers and bank-to-bank transfers to spread the money out among various financial institutions and various shell companies. While transferring the money in between the various bank accounts and various shell companies the basic idea is to change the form of it. The whole idea is to make the money as untraceable as possible; therefore, it’s considered the most complex step of the process. In case of unsecured loans , the money is rotated among various concerns operated by the operator or with the help of other brokers where the availability of funds can be manipulated in a legitimated ways either as share application money, proceeds of sales of investments, loan refund or bogus billing. This layering makes it difficult to trace the original source. They are frequently used to shield identities and/or to hide the source of unaccounted money

3.Integration – This step involves where the unaccounted money re-entering the mainstream economy in legitimate form of unsecured loans in the hands of beneficiary company. The procedure will often involve a simple borrowing by the beneficiary company often with or without interest. The money appears to come from a legal source as unsecured loans from these shell companies and therefore is usable by the beneficiary as unsecured loans. The unaccounted monies are laundered and brought into the company for conducting the legitimate business

4.Disposition -This is the final and last stage where the unsecured loans are shown as repayments to these shell companies by the borrower (the de facto real owner). The process ultimately culminated with the shell companies transferring these funds again to various concerns depending upon the requirement of real owner, legitimately showing such transfer as purchases, expenses, share capital etc by these shell companies.

Tax avoidance is an accepted principle. Any person is entitled to adjust its affairs in such manner as to minimize tax liability. However, the methodology and acts done in such cases of is not tax avoidance but of deliberate tax evasion. It is more in the nature of tax evasion by money laundering. These are cases of clear human ingenuity with the clear and contumacious intention to defraud the revenue.

When peruse a Financial Statement of a Shell company, it reveals that the company is consistently showing a negligible profit or making loss and is without any worthwhile commercial activities. These are typical symptoms of shell companies that produce little to or no independent economic values. The high value banking transaction could not be co-related with any actual or tangible business activity. They were found to be merely completing the paper formalities and using the banking channels to route the money which does not make these transaction ipso facto genuine. At best it qualifies them to be a paper/shell companies attempting to cloak the accommodation entries as genuine business transaction.

Action taken:

When Income Tax Department identifies a company is a Shell Company then they follow section 68 of Income Tax Act,1961- any unexplained cash credit added back to the total income of the assesse for the relating financial year and penalty Proceedings u/s.271AAC initiated separately for unexplained cash credit income/ unexplained expenditure of the assessee company. I.T. Department may refer the matter to S.F.I.O. to proceed under relevant sections of IPC for fraud. S.F.I.O. should also refer the matter to Enforcement Directorate (E.D.) for taking action under P.M.L.A. for all such cases of money laundering.

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January 2021