Content uploaded by Sagar Chaturvedi
Author content
All content in this area was uploaded by Sagar Chaturvedi on Nov 14, 2022
Content may be subject to copyright.
ECONOMICS III
BBA LLB (Hons.) Semester III
Fraudulent Risks Posed to the Economic System by Shell
Companies
Name- Sagar Chaturvedi
SAP ID- 81022100100
Roll Number- 56
Submitted To- Dr Parinaaz Mehta
1. Abstract
The existence of shell corporations in a nation poses a danger to its economy and government since
these businesses are created to escape taxes, which has a direct impact on economic development, and
are used as conduits for black money. In spite of this, many developed and developing nations have a
significant challenge in attempting to combat black money. The Panama Papers data breach, the
largest to date, dealt the globe a significant blow, prompting governments to ban shell firms. This
study is descriptive in nature and seeks to comprehend the notion of shell businesses in relation to its
use for legal objectives. It also examines the effect of shell company exposure on the Indian
Economy. Shell companies work in financial interaction with other companies to commit several
crimes such as concealing resources of illicit origin (money laundering), tax fraud (tax evasion),
corruption, bribery, and drug trafficking, among others. There is a fine line between managing shell
companies for legitimate purposes while enjoying their benefits legally and using them for illegal
purposes while getting into trouble. Stock markets negative response was brought under control by
implementing certain guidelines for the trade to those securities under Graded Surveillance Measure
(GSM) stage IV, through which the corporates and genuine investors gained confidence in the
Financial System.
Key words: Shell Companies, Legitimate, Stock Market, Regulatory Measures, Money Laundering.
2. Introduction
The 2016 disclosure of the Panama Papers implicated more than 80 nations, 100 media organisations,
twelve key international leaders who are either current or former heads of state, the Indian express,
business leaders, Bollywood celebrities, and politicians. In its campaign against black money, the
National Democratic Alliance (NDA) government discovered a few years ago that during the financial
year 2018-19, more than 2,25,910 businesses were detected under section 248 of the Companies Act
2013. Following legal procedure, 1,001,150 businesses were suspended. Later, Securities &Exchange
Board of India (SEBI) suspected 331 listed businesses to be shell corporations, 162 of which were
actively traded on BSE and 48 on NSE. The remainder have been suspended by the exchanges
because to anomalies. The Securities and Exchange Board of India (SEBI) issued an order on August
8, 2017 directing bourses to take action against 331 alleged shell firms by suspending the availability
of their scrip for the current month and placing their securities under Graded Surveillance Measures
(GSM) stage IV. The ministry of corporate issued a list of 331 businesses that may face mandatory
delisting in response to SEBI's recommendation, which resulted in intraday declines of 1% for the
S&P BSE sensex and Nifty 50. A "Shell corporation" is only a "outer wrapper" or "protective sheet"
that does not exist with actual assets or activities, but is registered on paper only. Which are generally
set up and maintained by accounting firms or Corporate Service Providers (CSPs) on behalf of
individuals who wish to set up a shell company and conceal their identity, as well as those who
secretly maintain and have indirect control over a company engaged in illegal activities, such as
money laundering or money dirtying.
3. Research Objectives
1) To examine the use of shell companies for legitimate purposes.
2) To study about the threats shell companies pose to the economic system.
3) To identify the regulatory measures taken in India to curb Shell companies.
4. Review Of Literature
Devendra Kumar Luna, Manoj Apte (2018) Explored only bank transactions were used while
investigating shell corporations. Using the Business Transaction Simulator (BTS) to detect shell
businesses. They concentrated mostly on transactions in addition to the transactions of shell
corporations, by offering five distinct methods. David Jancsics (2018) analysed shell corporations by
providing a definition of the term and analysing their use. It was stressed that it is often formed and
managed by accounting firms or Corporate Service Providers (CSPs) belonging to the subcategory
known as "shelf firms." David Also covered were 'Offshore vs. onshore' and 'Empty vs. live shells' in
terms of operations. Using the theory of shell corporations, he attempted to address the question,
"Does international business include shell corporations?" Frederic Compin (2008) analysed the
technique for accounting knowledge abuse. To commit financial crime, it was necessary to study the
key concepts for improving the functioning of money. As a result of all the imbalances, the financial
market economy is suffering. Dharmvir Singh (2010) examined shell corporations by finding key
characteristics. tied to it with the aim of preventing corporate scams and ensuring the greatest
availability of The regulator makes investigational resources accessible. The aims of this research
were to identify and recognise the prevalent problem in the Indian economic and regulatory system
and provide a solution use distinct methods to overcome the system's flaws, resulting in a more
efficient system. This information would be valuable for a comprehensive examination of shell
company activities useful for filtering the database and focusing on a certain firm out of vast amounts
of incoming data. under certain discovered qualities. Jason Sharma (2012) explored the definition of
shell corporations and research according to the Stolen Asset Recovery Act (STAR), the vast majority
of big thefts are There are 150 shell businesses involved in corruption. Jason claimed that there are no
shell corporations established by corrupt officials themselves as opposed to being bought through a
professional intermediary Corporate Service Providers (CSPs) and how shell corporations are used to
move funds prosperity from emerging nations. He decided that the increase in the formation of shell
corporations was a positive development. Transparency may be achieved by improved licencing of
existing FATF and CSPs subject to a legal obligation for data collection should be subject to audits
and fines. Jason Sharma (2013) studied the notion of shell corporations by focusing on Corporate
Service Providers (CSPs) that have a part in facilitating corruption, along with a few others, should be
held accountable. essential components for the proper administration of CSPs Jason stressed the
efficacy of implementation of the Financial Action Task Force (FATF) and the conclusion that
development will continue Agencies must formulate solid policies at home by bolstering the
regulations of CSPs and even by looking elsewhere. After laws and implementation in tiny tax havens
with limited resources, there are substantial capacity control. Quintana-Adriano (2015) found that
the clients of a financial institution can be classified into two large groups: natural persons and legal
persons. Natural persons are individuals with the capacity to assume obligations and exercise rights.
Legal persons are entities with legal representatives commonly called “corporations”. Although
natural persons can relate to shell companies through financial transactions, they cannot be shell
companies them-selves. The possibility of being a shell company is present only in legal person.
Morselli and Petit (2007) proposed to take the legal persons of the financial institution as vertices of
the social network. Most social network applications establish vertices and edges that define
relationships in cross-sectional data. The relationships between many vertices (individuals,
companies, products, etc.) are defined without considering the social variations that may exist over
time. Sharma(2017) analysed the evolution of the drug importation network and observe how the
centralization of the network and node status change according to the law-enforcement targeting over
time. Morselli (2009) explains how the variation in different centrality measures can be incorporated
to better analyse important patterns in organized crime. The changing/dynamic aspect of criminal
networks is an intrinsic feature that cannot be ignored. Criminals are intelligent entities that adapt to
new laws and seek new methods of committing crimes. Their risk factors such as age, source of
income, and economic activity are constantly changing.
5. Findings
5.1 Shell Companies Defined
At present, neither the Companies Act 2013 nor the Companies Act 1956 nor any other act provides a
definitive definition of shell companies. However, the Organization for Economic Co-operation and
Development (OECD) has defined a shell company as "a firm that is formally registered,
incorporated, or otherwise legally organised in an economy but does not conduct operations in that
economy other than in a pass-through capacity." When we hear about shell companies the idea
conceived is generally optimistic but let us try to examine the use of shell companies which are used
for legitimate purposes as well.
5.2 Shell Companies for Legitimate Purpose
1. Stable Capital for New Businesses
Entrepreneurs from many countries join to pool their finances for future business investments with
diverse tax, unpredictable economies, and business rules. They seek to finance their start-ups in a
variety of methods, such as temporarily amassing cash in the form of capital.
2. To protect Goodwill
If a corporation participates in business activities with another company that has a poor image, it may
negatively impact its stakeholder relationships as well as its goodwill. In order to avoid these
situations, the former firm may build a shell solely for the purpose of collaborating with the latter. To
prevent harming a brand's reputation, shell firms may be created and may have entire control of its
new inexpensive brand.
3. Hostile Takeover
To arrange a hostile takeover, which is when a firm buys another company (Target Company) without
the approval of the target company's management, a shell company may be formed. Popular methods
for hostile takeovers include hostile bid, open market, and proxy battle.
4. Defending assets against legal action
In nations where there is no real legal protection for people and corporations, the assets of affluent
individuals may be taken if they are seen as a political danger. To prevent their assets from being
unlawfully confiscated by corrupt governments and targeted by criminals, entrepreneurs in these
countries conceal their money behind shell corporations.
5. Corporate Armour
If a corporation is operating in a risky area with an unfavourable business climate, such as one with
widespread terrorist activity, then shell companies are created to conceal money and avoid becoming
the target of criminals and thieves.
6. Access to International Markets
The formation of shell businesses facilitates access to overseas markets.
7. Reverse Merger
It refers to the acquisition of a publicly traded company that is already listed on the stock exchanges,
allowing the private company to bypass or avoid the lengthy and costly process of setting up an Initial
Public Offering (IPO) and resulting in significant cost and time savings for a company that wants to
go public. The shareholders of the private firm acquire all of the shares of the public shell company
and combine it with the private company, a procedure that may be accomplished in weeks as opposed
to the months required for a standard acquisition/IPO.
8. To reduce tax obligations
As the tax rates in tax havens such as Panama and Switzerland are much lower than in other countries,
this is perhaps one of the most logical reasons for establishing shell businesses there. In addition to
avoiding the tax on the sale of assets, registration expenses may be avoided if shell corporations are
sold.
5.3 Threats Posed by Shell Companies to the Economic System
Money Laundering
Numerous procedures and strategies are used by criminals to disguise the origin and ownership of
illicitly acquired resources. Money is mostly brought into financial systems via a series of cash
deposits to shell corporations. The funds are then moved to related accounts during the stacking step.
These accounts may relate to shell corporations with common directors and shareholders. This
intricate network of businesses constructed by a money launderer is intended to conceal the identities
of the source and recipient. Short-lived resources are placed in the origin accounts during the stacking
process. Finally, the money is lawfully utilised for activities typical of money launderers, such as real
estate investments, charitable gifts, real estate leasing, investment in metals, jewellery, and watches,
and public resource allocation.
Tax Evasion
Using an invoice, a shell firm replicates the sale of an asset to another shell or formal corporation. The
latter pays the supplier through bank transfer for the transaction detailed on the invoice. Eventually,
the supplier shell business returns a sum of money equal to the invoice total less a discount %. This
discount % represents the profit generated by the shell business simulating activities. The formal
corporation deducts taxes from the fictitious invoice. In addition to deducting taxes, the receiving
shell corporation may also operate as a generator of fictitious invoices in order to create additional
profit. For formal businesses, the cycle concludes when they are able to deduct taxes on each
transaction. In the case of shell corporations, they may be connected via an infinite loop of purchasing
and selling fraudulent invoices.
Corruption & Bribery
The use of shell corporations in corruption and bribery is intimately connected to the government.
Politicians and governmental officials often utilise shell corporations to funnel public funds into
personal accounts. They negotiate a variety of contracts for public and social initiatives utilising a
complicated network of shell corporations to make them look legitimate. The subsequent diversion of
funds is carried out via bank transactions between the government entity and a network of shell
corporations that mask the identity of the main benefactor. A recent example of this occurred in the
United States with "Essential Consultants LLC," a shell business created by Administration Trump's
attorney Michael Cohen to take contributions in exchange for information about the incoming
president. These transactions involve Frequent financial transactions between governments and shell
corporations enable their surveillance and identification.
Financial Crimes
Some financial crimes, such as loan fraud and identity theft, are ideally committed through shell
corporations. The complex network that may be built with several legal representatives\sand the lack
of information of the identity of the major beneficiaries these crimes. When a legal entity applies for a
loan (such as a house loan or a business loan), the financial institution requests documentation to
show the entity's ability to pay and commitment to the contract. Typically, these papers consist of the
balance sheet, the income statement, and the company's formation records in order to validate the
company's existence and economic activities. When these requirements are not satisfied, legal
organisations often turn to forming shell corporations to meet credit requirements. Shortly before the
financial institution finds the manipulation of financial accounts, the shell business vanishes after
credit is issued. Identical to how financial accounts are misrepresented for a shell corporation, the
legal representative's identity may also be forged to conceal it.
5.4 Regulatory Measures taken by the government to curb shell companies in India
Since 2014, the NDA administration headed by Prime Minister Narendra Modi and the Ministry of
Corporate Affairs have taken a number of significant moves and launched a remarkable effort to
remove black money from the Indian economy, which indirectly aids in the suppression of shell
corporations. These measures include the establishment and enactment of the "Special Investigation
Team on Black Money," the "Black Money (Undisclosed Foreign Income and Assets) Imposition of
Tax Act 2015," the "Income Declaration Scheme 2016," the "Benami Transaction (Prohibition)
Amendment Act 2016," the "scheme of demonetization" in 2016, and the "Task Force on Shell
Companies."
It is an undeniable truth that the presence of black money produces economic variation, disrupts the
financial system of the nation, and allows the supply of funds for terrorism and money laundering,
which negatively affects the country's poor. The most common method of accumulating black money
is via the construction of shell corporations, which serve to conceal the origin of the money through
ongoing cycle transactions.
By announcing the demonetization of currency notes in 2016, the Indian government took the first
step in combating and preventing fraud via shell corporations. Along with the Indian government, the
Ministry of Corporate Affairs (MCA) has taken a number of substantial and audacious measures to
eliminate shell businesses.
1. Special Investigation Team (SIT) on Black Money was established ahead of the Supreme Court's
orders in 2014 through a government notification to suggest methods to curb black money in the
economy; it is headed by former Supreme Court judge, M B Shah, and is responsible for case
investigation of black money stored abroad in coordination with various members from the Reserve
Bank of India (RBI), the Intelligence Bureau (IB), the Enforcement Directorate (ED), and the Central
Bureau of Investigation (CBI) (DRI).
2.The Black Money (Undisclosed Foreign Income and Assets) Imposition of Tax Act 2015 - Act of
the Parliament of India that went into effect on April 1, 2016 applies to the whole country of India. Its
primary purpose is to restrict black money, or unreported foreign assets and income, such as assets
held by an assessee either in his own name or where he is the beneficial owner with no sufficient
explanation regarding the source of information, and levies tax and penalty on such income.
3.Income Declaration Scheme 2016 - It is established as part of the 2016 Union budget to find black
money and return it to the system. The programme gave tax and wealth tax evaders the opportunity to
avoid litigation and become compliant by disclosing their assets, paying the tax on them from 1 June
to 30 September, and a 45% penalty afterwards. It also promised protection from prosecution under
the Income Tax Act, the Wealth Tax Act of 1957, and the Benami Transactions (Prohibition) Act of
1988, and assured that disclosures made under these laws would not be subject to scrutiny or
investigation.
4.The Benami Transaction (Prohibition) Amendment Act of 2016 mandated a seven-year jail sentence
and the seizure of Benami properties for individuals who dealt in illicit funds in the real estate
industry.
5. Demonetization Scheme 2016 - To stymie terrorist funding and aid discover black money in order
to enhance the government's budgetary flexibility.
6. Conclusion
The situations listed under the title shell corporations for valid reasons are lawful, however this does
not imply that shell firms are solely employed for good purposes. There is a delicate line between
operating shell corporations for legal reasons while enjoying their perks and utilising them for
criminal objectives while getting into problems.
After suspecting 331 shell companies, SEBI ordered indices to restrict trading on found listed
securities and directed them to add those securities directly to stage IV of GSM in order to protect the
investment interests of the general public and to ensure that the found securities did not negatively
impact the market by implementing certain trading guidelines for those securities under GSM stage
IV.
After the banning of shell businesses on August 8, 2017, the nifty and sensex plunged to their lowest
levels on August 11, 2017.
The Corporate Affairs Ministry has removed the identities of almost 2.09 lakh firms from its records
because they have been inactive for an extended period of time. Their bank accounts have been
frozen, and directors of shell companies who manipulate money face up to ten years in jail.
Since 2015, the Government of India, in collaboration with the Ministry of Corporate Affairs and
Securities Exchange Board of India, has taken stringent regulatory measures to eliminate black money
connected to shell companies from the Indian Financial System, thereby boosting the confidence of
both corporations and genuine investors.
To stimulate the economy during these epidemic times, more initiatives of this kind are required.
7. References
1. Aggarwal, V., & Dharni, K. (2020). Deshelling the shell companies using benford’s law:
2. An emerging market study. The Journal for Decision Makers, 45(3), 160–169
3. Devendra Kumar Luna, Manoj Apte Finding Shell Company Accounts using Anomaly
Detection, CoDS-COMAD, January, pp 1- 8.
4. David Jancsics (2018), Offshoring at Home? Domestic Use of Shell Companies for
Corruption, Routledge Taylor & Franc’s Group, pp 4-21.
5. Frederic Compin (2008), The Role of Accounting in Money Laundering and Money Dirtying,
Elsevier, January, pp 591-602.
6. Dharmvir Singh (2010), A Study of Various Differentiating Attributes of Shell Companies in
India, Emerald, pp 459-484.
7. Jason Sharma (2012), Tackling shell companies: Limiting the Opportunities to Hide Proceeds
of Corruption, U4 Brief, December, pp 1-4.
8. Jason Sharma (2013), Preventing the Misuse of Shell Companies by Regulating Corporate
Service Providers, U4 Brief, October, pp 1-4.
9. Morselli, C., & Petit, P. (2007). Law-enforcement disruption of a drug importation network.
Global Crime, 8(2), 109–130
10. Morselli, C. (2009). Inside criminal networks (1st ed.). Springe
11. Quintana-Adriano, E.A. (2015). Natural persons, juridical persons, and legal personhood.
Mexican Law Review, 8(1), 101-118.
12. Singh, D. (2010). Incorporating with fraudulent intentions. A study of various differentiating
attributes of shell companies in India. Journal of Financial Crime, 17 (4), 459–484
13. Singh, K., & Best, P. (2019). Anti-money laundering: Using data visualization to identify
suspicious activity. International Journal of Accounting Information Systems, 34 (100418)
14. Tiwari, M., Gepp, A., & Kumar, K. (2020). A review of money laundering literature: The
state of research in key areas. Pacific Accounting Review, 32(2), 271–303
15. Force. (2018). Concealment of beneficial ownership. Financial Action Task Force.
