HOW SHELL COMPANIES CONVERT BLACK MONEY IN INDIA

By Devm Blogs December 1, 2020

INTRODUCTION

Shell companies can be defined as companies existing only on paper without having a legitimate office and employees such corporations are used for tax evasions and money laundering i.e. channelizing proceeds of crime money in the economy. Globally shell companies are without significant assets or active business functions these companies can be legal or illegal according to the nation’s law. In India shell companies are not illegal; it has neither been defined in the Companies Act 1956, nor in Companies Act 2013. In Assam company Ltd Vs Union of India (Guwahati High Court) 2019, it stated there is no statutory definition of shell company however government agencies identified shell companies as corporations involved in serious economic offences, such as money laundering, tax evasions, conversion of black money, Benami transactions and Round-tripping. Shell companies have the potential for illegal activities and it threatens the basic economic foundation of a country. Shell company comes in radar ones they are caught violating any of these laws:

Benami Transaction (Prohibition) Amendment Act, 2016
The Prevention of Money Laundering Act, 2002
The Companies Act, 2013
Income-tax Act, 1961

Securities and Exchange Board of India (SEBI) has set-up certain guidelines to monitor the active status of the company. SEBI defines a shell company as an entity having no considerable active assets but acting in a pass-through magnitude.

Multiple corporations at the same address.
Firms with zero economic rationales in banking operation.
No physical presence at the mentioned address.
Corporations with negligible business or assets.
Corporations’ set-up to transfer cross-border currency and assets.
High-ticket transactions without any significant growth of the firm.
Rotational-transaction with no legitimate business entity.

WHY SHELL COMPANIES ARE FORMED?

Money laundering–It is a serious financial crime achieved by white-collar and street-level criminals in which large sums of money are generated by criminal activities. The ‘laundering’ is done to make it look clean. Cryptocurrencies and online banking transactions have made it easier to transfer funds without detection. In 2016, around 2.24 lakh companies were discovered as shell companies after demonetization happened. And around 3.09 lakh board of directors disqualified for not filing an annual financial report.
Tax evasion –An illegal activity that involves a person or corporation intentionally avoids paying tax-liability. The offenders are subjected to criminal charges and penalties. Globally corporations set up shell companies in a foreign country where taxes are generally low, such places are referred to as ‘Tax Havens’. Corporations allocate their assets to shell companies and escape from paying taxes. Some famous tax haven countries are Switzerland, Hong Kong, Panama, and the Bahamas. Many famous Indian businessmen and celebrities were involved in the Panama paper scandal 2016, which leaked 11.5 million confidential documents of more than 214, 488 offshore entities.
Hiding identities of the true owner -Locating the real owner of a shell company can be a complex task, as the registered office of the company or board of directors is at a completely different place. These illegal practices make it possible for owners to successfully hide their identities.
Ponzi schemes – It is an investment fraud that is used to pay funds to exist investors with funds collected from new investors. The organizers promise to invest money and generate high returns. Ponzi schemes require a continuous flow of money to survive. Many corporations defraud people by offering Ponzi schemes and earns money out of them. If they are caught it is very difficult to find actual people behind the scam.

THE FOUR STEPS INVOLVED IN CONVERSION OF UNACCOUNTED MONEY

Placement – The process starts with the owner of unaccounted money by identifying the operator/broker and choosing the mechanism for converting the unaccounted money by legitimate means. After the deal is confirmed certain amount of agreed commission is handed-over to the operator in lots. Generally, banks are required to notify high-value transactions, so the money is deposited in small lots by different brokers. This is the riskiest part in all 4 stages and the most unorganized one because generally accounts are closed after certain transactions and become inoperative.

Layering – This stage includes bank-to-bank transfers to roll-out money to various financial institutions and different shell companies. The basic idea behind this rotation is to change the form of money. This is considered the most ‘complex’ stage as it makes money untraceable as possible. The whole process of layering makes it difficult to trace it to original source. This step is frequently used to hide identities or hide sources of money.
Integration – This stage involves re-entering unaccounted money in the mainstream economy through unsecured loans by legitimate means. This simple step involves borrowing funds from the beneficiary company without or little interest. The seems to appear from a legitimate source i.e. by unsecured loans from shell companies. Now the black money is ‘laundered’ which will be used by corporations for conducting legitimate business.
Disposition – The final stage which includes unsecured loans is shown as repayment to shell companies by the borrower (Real owner). The process of transferring funds can be culminated with shell companies and again be used according to the requirement of real owner by legally showing transfer as share capital, purchase, expense, etc.

HOW INDIAN GOVERNMENT IS TAKING ACTION TO ERADICATE SHELL COMPANIES

There are more than 15 lakh registered companies in India, and only 6 lakhs of them apply for their annual return. During the past 3 decades, more than 1,155 shell companies have been used by 22,000 beneficiaries to hide around 13,300 crores. On April 1, 2017, Enforcement Directorate conducted country-wide raids at business centers, market places, and even houses, were put down allegedly and suspicious corporations which were the backbone of black money in India. The raids were conducted in 110 locations in major cities like Kolkata, Delhi, Panaji, Bengaluru, Lucknow, Patna, Ahmedabad, Chandigarh, Jalandhar, Hyderabad Indore, Haryana, Mumbai, Kochi, Jaipur, and Srinagar. In September 2017 government-directed authorities to freeze more than 2.09 lakh companies whose records have been struck off and invoke Benami Transaction Prohibition 2016, Act on such companies.

The Income-tax department carried out an internal investigation to identify shell companies and initiated criminal prosecution against owners of such corporations. And Section 28 of the Company’s Act, 2013, was implied by the Ministry of Corporate Affairs which targeted shell companies who were not registered by the registrar of companies, such companies were struck off and necessary action was taken.

VARIOUS CHALLENGES FACED BY INDIA

No specific law in India which directly deals with Shell companies.
Pre-existence of vast complex corporate composition, which makes it difficult to identify original source of the transaction from various accounts and legal and illegal companies?
No legal definition for Shell Company in Indian law.

SPECIAL TASK COMMITTEE

It was headed by the Ministry of Corporate Affairs, and various other members of the task force include RBI, Department of financial services, SEBI, ED, DG-GSTI, CBIFIU-IND, and DG-CEIB’S. The task committee has given the following recommendations which have immensely helped in curbing out shell companies:

Told Securities and Exchange Board of India (SEBI) To authorize auditing officers to verify Testimonials of suspected companies, incase testimonials do not match their stock was delisted.
Reserve Bank of India was requested to freeze all the accounts of fraud companies who have failed to file financial statements and returns as needed by The Companies Act, 2013.
Supervised all the members to send details of CA’s involved in any of these illegal acts, to the Institute of Chartered Accountants of India (ICAI).
Serious Fraud Investigation Office (SFIO) was requested to create a database of shell companies and share details with various concerned government agencies.
Also requested the central government to legally define ‘Shell company’ to enable superior implementation.

CONCLUSION

There is a need for a strong coherent structure to deal with shell companies in India, by engaging in illegal malpractices is posing a huge threat to the economy, India faces a big problem in tackling with dealings of such companies because till now there is no provision or law which straightforwardly deals with shell companies. A core structure is necessary to ensure that the regulation of such companies does not create a hindrance of legal bodies. It is worth considering that shell companies can be used for legal purposes which do not necessarily poses a risk because of what they are. However, when associated with treaty abuse, Tax evasion, tax avoidance, money laundering, and abuse of social rights these companies can impact the economy and society as a whole.

Author(s) Name: Rishabh Patil (United World School of Law, Karnavati University, Gandhinagar)

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