Crackdown on Shell Companies

Context:

• The Ministry of Corporate Affairs (MoCA) has identified 1.06 lakh directors of ‘shell companies’ for disqualification under the relevant provisions of the Companies Act, 2013.

Why is it done?

• To break the network of ‘shell companies’ and the fight against black money/money laundering activities.
• The move is pursuant to the MoCA’s action of cancellation of registration of around 2.10 lakh defaulting companies.
• It is done to restrict operations of bank accounts of such companies by the directors of such companies or their authorized representatives.

Who all are getting monitored?

• Professionals including Chartered Accountants, Company Secretaries and Cost Accountants associated with such defaulting firms and involved in illegal activities have been identified in certain cases.
• The action by professional institutes such as ICAI, ICSI and ICoAI is being monitored.

What are shell companies?

• Shell companies are companies without active business operations or significant assets.
• Shell companies can be set up by business people for both legitimate and illegitimate purposes.
• Illegitimate purposes include hiding particulars of ownership from the law enforcement, laundering unaccounted money and avoiding tax.
• With the shell company as a front, all transactions are shown on paper as legitimate business transactions, thereby turning black money into white. In this process, the business person also avoids paying tax on the laundered money.
• Indian law does not contain any specific definition of shell companies, However, US has defined the shell companies under their Securities Act.
• All shell companies are not illegal. Some companies could have been started to promote start-ups by raising funds.

As per the Ministry of Finance definition shell companies are characterized by the following features:

• Nominal paid-up capital;
• High reserves and surplus on account of receipt of high share premium;
• Investment in unlisted companies;
• No dividend income;
• High cash in hand;
• Private companies as majority shareholders;
• Low turnover and operating income;
• Nominal expenses;
• Nominal statutory payments and stock in trade;
• Minimum fixed asset.

What are the problems associated with shell companies?

• Shell companies were used to deposit large amount of cash during the period of demonetization
• Kolkata is a hub of such companies and about 145 entities under the securities market scanner are registered there.
• Shell companies were being used to hid assets and money.
• The shell companies support much of the fraud and embezzlement in India.
• The owners of shell companies create elaborate smokescreens, including naming personal servants, and chauffeurs as board directors, route money to evade tax, commit fraud or manipulated tenders.

What can be possible solutions?

The crackdown on shell companies is necessary process to contain the menace of black money. The following steps need to be taken in order to tackle problems arising from shell companies:

• The government should be careful in taking action against listed companies as it can affect investor confidence
• The government needs to use information technology more effectively to track such transactions
• The government need to target individuals who are suspected to be avoiding taxes instead of taking action against companies in the listed space as it could affect other stakeholders also. Last month, the authorities ordered nearly 200,000shell companies to be shut dow
• The systematic crackdown on shell companies, which have no active business operations, is one of the outcomes of demonetization.
• The crackdown of shell companies will hit tax evasion and move India towards cashless, digital transactions that leave a paper trail.
• Need of Investigation and enforcement mechanism to check misuse of stock market platform for generating “bogus” long-term capital gains to curb black money.
• The Serious Fraud Investigation Office is creating a database of shell companies, and has so far identified 114,269 as front firms.
• The database contains details of those involved in the shell company ‘eco-system’

What are the Government initiatives?

The government has taken number of initiatives to check tax evasion through shell companies.

• Last month, the authorities ordered nearly 200,000 shell companies to be shut down.
• In 2012, government amended the law to tax share premium in excess of fair market value.
• In 2017, the government amended the law to account for other than a quoted share sold at less than fair market value.
• These amendments have made tax avoidance difficult through the sale and purchase of shares in unlisted companies.
• The government has identified 300,000 shell companies, out of which the registration of 175,000 companies has been cancelled.
• The government also plans to use Big Data for tracking tax evaders.

• Recently, SEBI named 331 listed companies as suspected “shell companies” that exist for the purpose of financial manoeuvring.
• The SEBI, in its upcoming meeting on September 18, is likely to have a detailed discussion on the developments related to suspected shell companies listed on the bourses.

• As many as 141 of these companies were registered in West Bengal, followed by 53 in Maharashtra and 35 in Delhi.

Conclusion:

Reducing the curse of black money will result in higher tax revenue which will further help the government to enhance public spending and will also lower the tax burden on honest taxpayers.