UNDERSTANDING SHELL COMPANIES
The advent of professionals and education of such has brought about miraculous developments in every field and business has flourished. However, while these advancements in business and finance has created opportunities for a number of people, this has also been put to malicious use by professionals intending to earn money under the table. Money Laundering is a term that has become a common sight in every newspaper. One innovative method of laundering money are shell companies.
Mostly incorporated as a One Person Company (OPC), shell companies are companies incorporated on paper, with no business in reality. Although these companies are not illegal, they are however mostly used for illegal activities by people with malicious intents. They have neither assets nor liabilities and can be used for both legal as well as illegal activities. They neither generate revenues, nor create employment and are mostly used to park funds for both legal and illegal activities.
POSITIVES OF A SHELL COMPANY
- Parking funds for a startup: Shell companies can be used to park funds in the initial stages of a startup. Is that legal? How do the do it? Why would a startup need these companies? These are some questions one might have when one is introduced to this idea. Before a startup is incorporated, the founders of the company would want their finances in order, to allow operations to run with minimal hindrance. But they may not be able to raise all the money they need from under one roof or even if they do manage to do so, they would not want the funds gathered to remain idle before their company is incorporated. So, they may incorporate a shell company to park their funds and invest the money so raised in either equity or debt markets. This not only ensures an interest income over and above the money so raised, but also keeps the funds parked. Once incorporated, these funds can then be transferred to the company and the shell company be wound up.
- Safeguard of assets from a hostile takeover: A hostile takeover is when one company acquires another without the approval of the management. In this situation, the aggrieved company can protect their assets by incorporating a shell company and transferring the assets to the shell company. Since companies are a separate legal entity, the acquiring company have no right to takeover the assets of the shell company, owing to different legal entities. Further, since these assets are removed from the balance sheet of the company, it becomes less lucrative to the acquirer. This method is also used by companies to protect their assets from a lawsuit.
- Hide dealings between two companies: This is more of an unusual use of a shell company. Suppose A and B want to enter into a business transaction. However, the market reputation of B is extremely poor and A fears it might lose it’s goodwill if it does enter into a transaction. In this case, A can incorporate a shell company and route the business transaction through the shell company so incorporated. This ensures the goodwill of A is maintained viz-a-viz carrying out the transaction.
UNDERSTANDING MONEY LAUNDERING
Money Laundering, in simple terms, is the conversion of illegally earned money into legitimate money without paying taxes to the government. This is an illegal activity and there are laws such as Prevention of Money Laundering Act, 2002 which have been enforced to keep in check money laundering. The people who do this are called Money Launderers and this is done in a manner such that it is next to impossible for the investigating agencies to trace the source of a transaction. So, black money invested into the capital markets comes back to the holders in the form of legitimate money.
There are three steps with which a money laundering operation is carried out. These steps are:
- Placement: The first step in the process of money laundering is to invest money earned illegally into the financial system. The launderer does so through agents or banks in the form of cash through an informal agreement.
- Layering: This is the second step in the process where the launderer hides his real income and invests his illegal money into equity or bond market or in their bank accounts abroad. This is usually done in those countries whose legal framework does not permit the banks to disclose details of their depositors, thus maintaining secrecy of the source of funds.
- Integration: This is the final stage where the laundered money is re-introduced into the legitimate economy, integrating it with the economy as legal money.
SHELL COMPANIES AS A CATALYST OF MONEY LAUNDERING
Shell companies play the lead role in facilitation of laundering money. There is a complex set of process involved, in laundering money and integrating it with the economy so as to conceal it’s original source. Questions have been asked on why such shell companies have not been declared illegal. While this may seem to be a relatively simple solution to stop money laundering or at least reduce it, a legal restriction on incorporation may not be as feasible as it appears for the legitimate reasons it has, not considering the need of the governments to keep the business lobby happy to retain their fundings. These companies are mostly incorporated in tax heavens and places or countries which require minimal documentation so as to maintain their anonymity.
With anonymity, the corporates or individuals looking to launder money enjoy the benefit of non-traceability. The most lucrative places for money launderers are Panama, Caveman Islands and the British Virgin Islands. The company is usually incorporated in the name of a person who is not the brain behind the act. The beneficial owner of the company is usually someone else, who controls the operations of the company. The entire process of how the shell companies are used in laundering money is explained.
Suppose there is a billionaire named A looking to launder money. He sets up a company in say, British Virgin Islands. The company is incorporated in the name of another person called B, who is lured into the position by a handsome reward. The identity of A is concealed. While on paper B is the owner, in reality, A is the owner, also called Beneficial Owner. The company so incorporated is called 1 which in turn is the holding company of another shell corporation called 2. The company 2 further has investments in company 3 and this continue till company 50. Now, A gives out cash, obtained from illegal sources, to Company 1. Company 1 makes payments to company to 2 which are incorporated in various countries across the world, making it all the more difficult for officials to trace the source of these fund flows. The receipts of Company 2 are shown in the form of receipts for certain services rendered. Company 2 further invests these funds or shows them in the form of payments to Company 3. This process goes on till Company 50, which makes a payment to the original company of A, converting it into legal money, integrating it with the economy and also avoiding taxes that would have otherwise been payable.
If and when they come under the scanner of tax departments, an investigation into the source of these funds can take years to yield results and the traces might also be lost owing to the money and muscle power these corporates have and the nexus with the governments, making shell companies a perfect choice to launder money.
ARE THERE CHECKS IN PLACE?
Various legislations have been brought in over the years to keep a check on money laundering. While these legislations have not been able to completely abolish the practice of money laundering, they have been able to curb the practice.
One such legislation is Section 186(1) of the Companies Act, which specifically state that a company shall not be allowed to make investments in more than two layers. This has been brought into force to keep a check on the layers of investments these companies have, so as to enable easy traceability of the sources of funds and their point of origin. Further the introduction of Prevention of Money Laundering Act, 2002 is another such historic legislation which had been brought about by the GOI.
Despite repeated efforts of the government to stop the laundering of money, it has always been outsmarted. This can get worse with the advancement of technology or even come to a complete halt, depending upon how we as a society perceive to use these technologies.
