This article is written by Dev Agarwal, 3rd year student of Heritage Law College, Calcutta University
The term “shell company” has never been defined in any Company legislation of India, be it the Companies Act 2013 or even Companies Act 1956, the same was observed in Assam Co. India Ltd. v. Union of India (AIR 2019). It was ruled that there is no statutory definition of shell company, whether fiscal or penal statutes. The High Court, however, attempted to define the same, it held that shell companies are those companies in which they have a nominal existence. It held that a shell company is not a company which should be viewed negatively. It is only when these companies are used for the sake of maneuvering profits or for tax evasion which results in the attraction of relevant sections of Companies Act, 2013, Income Tax Act, 1961, Prevention of Money Laundering Act, 2002 or Prohibition of Benami Transactions Act, 2016.
DEFINITION AND CHARACTERSTICS
The Securities and Exchange Board of India (SEBI) has suggested that any entity, having no significant operational assets or business activity of its own but acting in a pass-through capacity as a channel may be called a shell company. The following other characteristics have been put forth by various other agencies:
- entities with insignificant business or assets;
- entities set up to mainly facilitate cross-border currency and asset transfers along with transfer of large sums to related entities;
- firms having no economic rationale in their banking transactions;
- multiple companies having the same address;
- no physical existence at the given address;
- high ticket transactions inconsistent with the main business
- rotational transactions with no legitimate business group
COMPANIES ACT AND RULES
A Task Force on Shell Companies was set up by the Prime Minister’s Office, under the joint chairmanship of the Revenue Secretary and Secretary, Ministry of Corporate Affairs in February 2017, with the intention to check in a systematic way, through a co-ordinated multi-agency approach, the menace of companies indulging in illegal activities including facilitation of tax evasion and commonly referred to as shell companies. The net result of this Task Force was that about 2 lakh shell companies were identified and same were shut as per Section 248 of the Companies Act, 2013. The Companies (Amendment) Act, 2019 was brought in the Parliament to enlarge the provisions of Section 248 and delegate more power to ROC.
Some of the measures contained in the Companies (Amendment) Act, 2019 are:
- A new Section 10A has been inserted which stipulates that a declaration is to be filed by a director within a period of a 180 days from the date of incorporation of company in the manner prescribed, affirming that every subscriber to the Memorandum has paid the value of shares agreed to be paid by him on the date of making such declaration.
- Where no declaration has been filed in accordance with Section 10A, and the Registrar has reasonable cause to believe that the company is not carrying on any business or operations, the registrar can take action for removal of name of the company from the ROC.
- The Amendment Act has also inserted sub-section (9) in the Section 12 of the Act, which empowers the Registrar to cause a physical verification of the registered office of the company on reasonable cause.
- The Amendment has also widened the ambit of powers assigned to the Serious Fraud Investigation Office to ensure speedy and more effective enforcement.
The second crackdown on the shell companies happened when the Ministry of Corporate Affairs notified the Companies (Restrictions on Number of Layers) Rules, 2017. The Rules provided that a company could no longer have more than two layers of subsidiaries. Under the Companies Act, a subsidiary of a company (holding company) has been defined as a company in which the holding company, on its own or with its other subsidiaries:
- can appoint or remove the majority of directors
- exercises, controls or owns more than half of the share capital.
Further, any company, whose board composition or share capital is controlled by a subsidiary of a holding company, is also considered to be a subsidiary of the holding company. The definition of subsidiaries under the Act is with respect to the concept of ‘control’ under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
However, the exception of these rules were four types of companies which include –
- a banking company;
- a non-banking financial company, which is considered to be systematically important;
- an insurance company; and
- a government company
It was often seen that many companies used to make layers after layers of companies as the subsidiaries of its subsidiaries, resulting in penetration of such companies so deep, that it would be difficult for the Income Tax authorities to find the real mind behind such nexus of companies. This would help an individual to convert his black money to white or to reduce the liability of the tax to be paid.
India today, is focusing the most on Ease of Doing Business but it is to be ensured that Ease of Doing Business does not get a meaning of Ease of Doing Fraud, and to ensure this, the crackdown on various shell companies was necessary. It not only promotes in Nation’s economy in a negative way by the way of evasion of taxes and individuals not disclosing their profits and helping others to convert the black money to an earning by giving it a legal background through the channels of bank transfers. A healthy competition is always welcome while unlawful practices to maximize profit and evade taxes will always be bad for any nation.
- RAJIB DAS, A Critical Anaysis of Shell Companies – Part- 1, TaxGuru https://taxguru.in/company-law/critical-analysis-shell-company.html
- Ashima Obhan, Nishtha Jaisingh, Shell Companies in India, MONDAQ, https://www.mondaq.com/india/corporate-and-company-law/841132/shell-companies-in-india
- Kartik Ganapathy, Kriti Bhatia, Sanjana Ramkumar, Restriction on the Number of Layers of Subsidaries, MONDAQ, https://www.mondaq.com/india/corporate-and-company-law/649154/restriction-on-the-number-of-layers-of-subsidiaries
- Assam Company India Ltd. And Anr v. The Union Of India And 2 Ors on 7 March, 2019