Shell corporation

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A shell corporation is a company or corporation that exists only on paper and has no office and no employees, but may have a bank account or may hold passive investments or be the registered owner of assets, such as intellectual property, or ships. Shell companies may be registered to the address of a company that provides a service setting up shell companies, and which may act as the agent for receipt of legal correspondence (such as an accountant or lawyer). The company may serve as a vehicle for business transactions without itself having any significant assets or operations. Sometimes, shell companies are used for tax evasion, tax avoidance, and money laundering, or to achieve a specific goal such as anonymity. Anonymity may be sought to shield personal assets from others, such as a spouse when a marriage is breaking down, from creditors, from government authorities, besides others.

Shell companies do have legitimate business purposes. They may, for example, act as trustee for a trust, and not engage in any other activity on its own account. This structure creates limited liability for the trustee. A corporate shell can also be formed around a partnership to create limited liability for the partners, and other business ventures, or to immunize one part of a business from the risks of another part. Shell companies can be used to transfer assets from one company into a new one, while leaving the liabilities in the former company.

SEC definition[edit]

The U.S. Securities and Exchange Commission defines a "shell" company as follows:

'Shell company: The term shell company means a registrant, other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB ( § 229.1101(b) of this chapter), that has:

(1) No or nominal operations; and

(2) Either:

(i) No or nominal assets;

(ii) Assets consisting solely of cash and cash equivalents; or

(iii) Assets consisting of any amount of cash and cash equivalents and nominal other assets.'[1][2]

Background[edit]

Some companies may have had operations, but those may have shrunk due to unfavorable market conditions or company mismanagement. A shell corporation may also arise when a company's operations have been wound up, for example following a takeover, but the "shell" of the original company continues to exist.[3] It's important to understand that the term "shell corporation" does not describe the purpose of a corporate entity. In general, it's more informative to classify an entity according to its role in a particular corporate structure; e.g. holding company, general partner, or a limited partner.

Shell companies are a main component of the underground economy, especially those based in tax havens. They may also be known as international business companies, personal investment companies, front companies, or "mailbox" companies. Shell companies can also be used for tax avoidance. A classic tax avoidance operation may utilize favorable transfer pricing among multiple corporate entities to lower tax liability in a certain country; e.g. Double Irish arrangement.

A special purpose entity, used often in the context of a larger corporate structure, may be formed to achieve a specific goal, such as create anonymity.

Examples[edit]

Shell companies can be used to transfer assets of one company into a new company without having the liabilities of the former company. For example, when Sega Sammy Holdings purchased the bankrupt Index Corporation in June 2013, they formed a shell company in September 2013, called Sega Dream Corporation, into which were transferred valuables assets of the old company, including the Atlus brand and Index Corporation's intellectual properties.[4] This meant that the liabilities of the old company were left in the old company, and Sega Dream had clean title to all the assets of the old company. The former Index Corporation was then dissolved. Sega Dream Corporation was renamed as Index Corporation in November 2013.

As another example, the use of a shell company in a tax haven makes it possible to move profits to that shell company, in a strategy called tax evasion. Say, a United States company wants to buy products from overseas. If it brings the products directly to the United States, it will have to pay US tax on the profits. To avoid this, it may buy the products through a non-resident shell company based in a tax haven, where it is described as an offshore company. The shell company would purchase the products in its name, mark up the products and sell them on to the US company, thereby transferring the profit to the tax haven. (The products may never actually physically pass through that tax haven, and be shipped directly to the US company.) As the shell company is not based in the United States, its profit is not subject to US income tax, and as it is an offshore company in the tax haven jurisdiction, it is not taxed there either. Under the tax haven law, the profits are deemed not to have been made in the jurisdiction, with the sale deemed to have taken place in the United States. As US personal income tax is significantly less important than corporate income tax, US company executives would claim a salary (or fees, consulting fees, etc.) from the company's profits.

Countries of Domicile[edit]

Typical countries of domicile of shell companies are offshore financial centers like Ireland, Liechtenstein, Luxemburg, Switzerland, Guernsey, Isle of Man, Jersey, and the Channel Islands in Europe, Bahamas, Barbados, Bermuda, Cayman Islands, and Virgin Islands in the Caribbean, Panama in Central America, and Hong Kong and Singapore in Asia. But also in the USA some states like Nevada and Wyoming host many shell companies.[5]

Shell companies are usually offered by law firms based in thoses countries. Prices for setting up a shell company can be as low as just $1000 for a basic version. Additional services like guaranteed anonymity or a whole net of shell companies cost more.[6] The process of establishing a shell company is often quite easy and can sometimes be done very quickly online.[7]

Abuse[edit]

Shell companies have been used to commit fraud, by repeatedly creating an empty shell company with a name similar to existing real companies, then running up the price of the empty shell and suddenly selling it (pump and dump).[citation needed]

There are also shell companies that were created for the purpose of owning assets (including tangibles, such as a real estate for property development, and intangibles, such as royalties or copyrights) and receiving income. The reasons behind creating such a shell company may include protection against litigation and/or tax benefits (some expenses that would not be deductible for an individual may be deductible for a corporation). Sometimes, shell companies are used for tax evasion or tax avoidance.[8]

Offshore Leaks[edit]

In 2013 the International Consortium of Investigative Journalists published a report called offshore leaks with information about use and owner of 130,000 shell companies. Many of the shell companies belong to politicians and celebreties from around the world and were used for tax evasion and hiding financial assets.[9]

Panama Papers[edit]

In 2016 a leak of 11.5 million documents to the German newspaper Süddeutsche Zeitung revealed information about owners of more than 214,000 shell companies administered by the law firm Mossack Fonseca in Panama. The shell companies were used by politicians, business men, autocrats, and terrorists from around the world for tax evasion and other illegal activities.[6]

India[edit]

After India's decision to demonetise ₹500 and ₹1000 rupee notes on 8 November 2016,[10][11][12] various authorities noticed a surge in shell companies depositing cash in banks, possibly in an attempt to hide the real owner of the wealth. In response, in July 2017, the authorities ordered nearly 2,000 shell companies to be shut down while Securities and Exchange Board of India (SEBI) imposed trading restrictions on 162 listed entities as shell companies. A high-level task force found that hundreds of shell companies were registered in a few buildings in Kolkata. Many of those were found to be locked, with their padlocks coated in dust and many others which had office space the size of cubicles.[13]

Regulation[edit]

Since shell companies are very often abused for various illegal purposes, regulation of shell companies is becoming more important to prevent such illegal activities.

United Kingdom[edit]

Currently British overseas territories and crown dependencies are only required to tell the true name of owners of shell companies upon request from official law enforcement agencies. However, by 2020 they will be forced to publish these names in a public register in order to prevent anonymous use of shell companies.[14]

United States[edit]

The new customer due dilligence (CDD) rule from 2016 forces banks to know the names of their customers in order to reveal them to law enforcement agencies upon request. Thereby, anonymous misuse of shell companies shall be prevented. The rule is administered by the Financial Crimes Enforcement Network (FinCEN).[15]

India[edit]

A "Task Force On Shell Corporations" was constituted in 2017 under the chairmanship of the Revenue Secretary to the Government Of India and Corporate Affairs Secretary to Govt. Of India, for effectively tackling malpractice by shell companies in a comprehensive manner.[16]

See also[edit]

References[edit]

  1. ^ See Rule 12b-2 of the Securities and Exchange Act of 1934
  2. ^ Cornell Law School Legal Information Institute 17 CFR 240.12b-2 - Definitions.
  3. ^ "Webster's New World Finance and Investment Dictionary". 2010. 
  4. ^ "Notice of Conclusion regarding Business Transfer Agreement of Index Corporation" (PDF). Sega Sammy Holdings Inc. 18 September 2013. Retrieved 18 September 2013. 
  5. ^ Sharman, J. C. (Fall 2010). "Shopping for Anonymous Shell Companies: An Audit Study of Anonymity and Crime in the International Financial System". Journal of Economic Perspectives. 24 (4): 127–140. 
  6. ^ a b "About the Panama Papers". Sueddeutsche Zeitung. Süddeutsche Zeitung. Retrieved 2018-06-10. 
  7. ^ "Setting up your own tax haven shell company takes 10 minutes". triple j. abc.net.au. 2016-04-04. Retrieved 2018-06-09. 
  8. ^ Nicholas Shaxson, Treasure Islands: Tax Havens and the Men who Stole the World, Random House, January 2011
  9. ^ "ICIJ Offshore Leaks Database". offshoreleaks.icij.org. International Consortium of Investigative Journalists (ICIJ). Retrieved 2018-06-10. 
  10. ^ "India scraps 500 and 1,000 rupee bank notes overnight". 8 November 2016. Retrieved 8 November 2016. 
  11. ^ "In an attempt to curb black money, PM Narendra Modi declares Rs 500, 1000 notes to be invalid". news. The Economic Times. 9 November 2016. Retrieved 9 November 2016. 
  12. ^ "Here is what PM Modi said about the new Rs 500, Rs 2000 notes and black money". India Today. 8 November 2016. Retrieved 9 November 2016. 
  13. ^ "Cracking down on black money, scrutiny of shell firms stepped up". Archived from the original on 17 August 2017. Retrieved 16 August 2017. 
  14. ^ "UK moves to trace tax-avoiding overseas shell firm owners | DW | 01.05.2018". DW.COM. Deutsche Welle. Retrieved 2018-06-10. 
  15. ^ "Customer Due Diligence Requirements for Financial Institutions". Federal Register. Financial Crimes Enforcement Network (FinCEN). 2016-05-11. Retrieved 2018-06-10. 
  16. ^ "'Task Force on Shell Companies' for effectively tackling the malpractices". Retrieved 2018-07-08.