Shell company’ has neither been defined in the Companies Act, 1956 nor in the Companies Act, 2013.

In Assam Co. India Ltd. Vs. Union of India, the Gauhati High Court has noted that there is no statutory definition of shell company, whether fiscal statutes or penal statutes.

The High Court has attempted to define ‘shell companies’ as companies having only a nominal existence, i.e., it exists only on paper without having any office and employee. Such company is a corporate entity without having active business operations or significant assets. Such company may be used as a deliberate financial arrangement providing service as a tool or vehicle of others without itself having any significant assets or operations. Interestingly, the High Court also observed that shell companies are identified as companies which are used for tax evasion or money laundering, i.e., channelizing crime tainted money or proceeds of crime into the formal economy.

Also Read- A Critical Analysis of “Shell Company”- Part 2

The High Court made a very significant observation “it is no offence to be a shell company per se. The maximum Registrar of Companies can do is to strike off the name of such company from the register of companies. But the shell company is involved in money laundering or tax evasion or for other illegal purposes, then relevant provisions of laws under the Prevention of Money Laundering Act, 2002, Prohibition of Benami Transactions Act, 2016, Income-tax Act, 1961 and the Companies Act,2013 would be attracted.”

A company is classified as a shell company if it is a non-trading company that has been floated with the intention of financial maneuvering. To improve corporate governance and to check financial irregularities undergoing in these shell companies, various ROCs have recently removed the names of many companies from the register of companies exercising their powers under section 248 of the Companies Act, 2013 (‘Act’).

There has been a rise in the number of shell companies floated across the country in recent years. The fight against black money shall be incomplete without breaking the network of shell companies. There is a lot of possibility of using the shell companies for laundering of the black money.

The Government has decided to track down the beneficial owners of suspected shell companies and take penal action against those who divert funds from companies that are struck off the records of the Registrar of Companies (RoC).

The intent of the Government is to ensure that companies take their statutory obligations seriously and to deter firms from using a complex corporate structure to divert funds raised from financial institutions or to launder money. However, the recent massive clean-up operation, whereby RoCs started issuing public notices in April, 2017 to strike off the name of the companies from the register of companies and to dissolve them unless a cause is shown to the contrary, within thirty days from the date of the notice, has come to centre of focus. Thereafter, on September 5, 2017 the government confirmed that names of over 2.09 lakh companies have been struck off from the Register of Companies for failing to comply with regulatory requirements.

By virtue of a legal process, a company is born as a separate legal entity, so is its death process. In case of dissolution of a company pursuant to the company’s name being removed from the Register by the ROC in terms of Section 248 of the Act, the corporate status of an entity ceases to subsist, its functionality stops and for all practical purposes corporate activities come to an end.

The third interim report of the M.B. Shah-led special investigation team (SIT) on black money was submitted to the apex court has admitted these menace of money laundering through shell companies.

Shell Companies and beneficial ownership (Reference p. 73-76 of the Third SIT Report). The primary method of generation of black money remains suppression of receipts and inflation of expenditure. The suppression could be over a range of businesses and industrial activities which are covered by what may be called ‘primary’ enactments to regulate sale receipts, actual production, charging amount in excess of statutory amounts, etc.

However, as manipulation of income is not always possible by suppression of receipts, tax-payers may try to inflate expenses by obtaining bogus or inflated invoices from ‘bill masters’, who make bogus vouchers and charge nominal commission. As these persons are of very modest means, upon investigation, they tend to leave the business and migrate from the city where they operate. This is one of the reasons for a proportion of income tax arrears attributed to ‘assessee not traceable’.

Similarly, there are other categories of small ‘entry operators’, who provide accommodation entries by accepting cash in lieu of cheque/demand draft given as loans/advances/share capital, etc and thereby launder large sums of money at miniscule commissions. Due to frequent migration, such entry operators escape prosecution under the Income Tax Act. The appellate tax bodies also tend to tax their income at nominal rates. There is no effective deterrence, except for taxing commission on such bogus receipts and tax in the hands of beneficiaries. Providing fake bills and entries need to be dealt with strongly and as criminal offence under the tax laws.

Use of shell companies to provide accommodation entries to launder black money has been observed in a number of high profile cases investigated or under investigation in the recent past.

The strategy to curb this menace has to be twofold:

Proactive detection of creation of shell companies: This would involve intelligence gathering through regular data mining and dissemination of information gathered to various law enforcement agencies for active surveillance.

Deterrent penal action against persons involved in creation of shell companies and providing accommodation entries.

The following recommendations are made in this regard:

Proactive detection of creation of shell companies: Serious Frauds investigation office (SFIO) under Ministry of Company needs to actively and regularly mine the MCA 21 database for certain red flag indicators. These red flag indicators could be based on common DIN numbers in multiple companies, companies with same address, same contact numbers, use of only mobile numbers, sudden and unexpected change in turnover declared in returns etc. These indicators are illustrative in nature and the SFIO office can prepare a set of indicators based on its own experience and consultation with other law enforcement agencies like CBDT, ED and FIU.

Sharing of information on such high risk companies with law enforcement agencies : Once certain companies are identified through data mining above, the list of such high risk companies should be shared with CBDT and FIU for closer surveillance.

In case after investigation/assessment by CBDT, a case of creating accommodation entries is clearly established, the matter should be referred to SFIO to proceed under relevant sections of IPC for fraud. SFIO should also refer the matter to Enforcement Directorate for taking action under PMLA for all such cases of money laundering.

It has also been observed that in many cases of creation of shell companies the shareholders or directors of such Companies are persons of limited financial means like drivers, cooks or other employees of main persons who intend to launder black money. Section 89(1) and 89(2) of the Companies Act, 2013 provides for persons to declare if they have “beneficial interest” in the shares of the Company or not. Section 89(4) enjoins the Central Government to make rules to provide for the manner of holding and disclosing beneficial interest and beneficial ownership under this section. The Ministry of Company Affairs may frame such rules at the earliest.

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May 2021