Introduction

India has, for many years, dealt with the peril of paper companies, also known as shell companies. The shell companies primarily only exist on paper; they have no real operations or real people employed in the company. These companies are also known as ghost companies. The main aim behind formulating shell companies is for money laundering, tax evasion, corruption, etc.  

What are shell companies?

There is no legal definition of shell companies. Organisation for Economic Co-operation and Development (OECD) defines shell companies as a company which is formally registered, or is legally recognised in the economy, or incorporated, but does not conduct any operations other than acting as a middleman. These companies are only established to hold or move the money around. 

The operation of the shell companies may be illegal or legal in nature. There are many companies in India which, despite being shell companies, operate fully within the legal limits. For instance, there are many companies that establish a different company for just HR-related activities. They are not directly involved in any economic activities, yet they are legal. 

However, the use of shell companies is done more for illegal purposes. Shell companies are established for illegal purposes like dodging regulations, tax evasions, corruption, money laundering etc. 

Legal uses of shell companies

Shell companies are established for the following legal reasons:

• Facilitating transactions
• Asset holding
• Protecting intellectual property
• Tax planning
• Protecting assets
• Raising capital
• Facilitating mergers and acquisitions
• Protecting trade secrets
• Access to international markets

Legal framework regulating shell companies in India

There are other legislation which also regulate shell companies in India like:

• Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015
• Indian Penal Code, 1860
• The Income Tax Act, 1961

Legal challenges in regulating shell companies in India

The legal challenges found in regulating the shell companies in India are:

1. One of the biggest legal challenges in regulation shell companies in India is having no legal definition. There is no formal definition of shell companies. This makes the regulation and identification of the shell companies a little bit complex. In order to have effective legal regulation it is important to have a definition. 
2. The Ministry of Corporate Affairs, under the guidance of SEBI had issued a set of guidelines which would help recognise the shell companies. However, these guidelines were not clear and lacked efficiency.Under these guidelines, determining whether a company is a shell company is time consuming.
3. There is an absence of a streamlined process to identify whether a company is a shell company.
4. Despite having quite strong taxation rules, India  has failed to tackle problems like money laundering and tax evasion. This also leads to failing in effectively regulating the shell companies in the country.
5. Rather than having one single legislation specifically for regulation of shell companies there are various acts which together oversee the regulation of shell companies. Laws like Income Tax Act, 1961, Companies Act, 2013, Benami Transactions Act, 1988, PMLA 2002 etc. 
6. A task force agency was also established by the government but its impact was very limited in nature. There was a Prime Minister’s Office involvement too to tackle the problem. The agency investigated the companies which were engaged in unlawful activities. Despite these repetitive efforts,the government could not curb the misuse of the shell companies.
7. A lack of proper legislation regarding the shell companies led to scams like the Vivo India case where the money was laundered using fake Indian companies. 

Conclusion

The rise of shell companies in the country is not surprising at all. Due to the absence of specific legislation for shell companies, identifying them becomes a little hard. However SEBI and the Government are taking vigorous steps to tackle the misuse of shell companies for illegal activities. Despite many key challenges, the steps are being taken in the right direction to curb the problem. Authorities can in the future define and introduce shell companies and its related provisions. 

Frequently Asked Questions (FAQs)

What are the risks of having shell companies?

The shell companies are used to hide tax evasion activities, money laundering, conceal the offences of criminals, evasion of sanctions etc. All these activities pose a threat to the economy of the country.

What are the red flags indicators of shell companies?

The red flag indicators of a shell company are:

• These companies do not have physical presence.
• Absent of any kind of operational activities.
• The corporate structure is very unusual.
• The presence of employees is very less.
• There is no transparency and non disclosure of other important details.

References 

• https://www.primedatabase.com/article/2019/Article–Rajiv%20Luthra%20&%20Sahil%20Arora.pdf
• https://www.whiteblacklegal.co.in/details/an-effective-regulatory-framework-to-combat-illicit-activities-of-shell-companies-in-india-by—shashwati-chowdhury-ayush-khare