Every company comes into existence after getting incorporated under the Companies Act, 2013, to facilitate regular business operations.
A shell company however, instead of transacting into ordinary business transactions, is made with a view to enter into illegitimate transactions with a view to evade taxes or indulge into money laundering practices. Although when it is incorporated, it is registered as an ordinary regular company.
A shell company may or may not have authentic business transactions. It may not be into involved in any exchange of goods or services. But it may have fake financial transactions to validate its existence. And these fake transactions are of illegal nature.
One of such transactions done by Shell companies to evade taxes is when assets of one company are transferred to another company. The assets are transferred to a new company which has no liabilities so that when the old company is dissolved due to losses or poor performance and the dues of the creditors have to be paid, the assets of the old company are not in charge.
This kind of a transaction is an unlawful transaction.
Let’s take an example for better understanding,
A company named ABC Ltd. is a garments export company. It has a sister concern named PQR Ltd. which is also in the same business. ABC is running into losses and might soon be dissolved. So ABC transfers most of its valuable assets to its sister concern PQR Ltd.
After a few months, ABC Ltd. had to be shut down due to the heavy losses and the creditors were unable to recover their dues since the company did not have substantial assets. As these assets were transferred to the sister concern PQR Ltd.
This kind of an arrangement, where a company is formed to indulge in fraud, tax evasion, money laundering etc. is when a supposedly regularly company acquires the status of a Shell company.
What is the difference between a Shell company and a Dormant company?
A Dormant company is the one which does not have active running business operations. A company may start with active business but due to some reason cease to operate or does not have an active status.
Such companies can acquire the status of a dormant company by making an application to the registrar of companies. These companies are not involved in any fraudulent transactions unlike the shell companies.
A dormant company is simply a regular company with no active business operations whereas a shell company may or may not have active business operations but is involved in unlawful transactions.
A company named XYZ Ltd. started its operations in 2002 as garments export house. But due to heavy losses it ceased its operations in 2005. After being inoperative for two years, the directors of the company applied to the registrar of the company for the status of ‘dormant’.
Upon receipt of application, the registrar shall inspect the status of the company. Once satisfied then he will grant XYZ Ltd. the status of being ‘dormant’. And thus XYZ Ltd. will now become XYZ Ltd. (Dormant).
A shell company is not a dormant company. It is a company that is used as a vessel to facilitate unlawful transactions.
How are Shell companies identified?
Shell companies have not been defined by the Companies Act, 2013. However, due to the recent disqualification of various directors and companies, it caught the attention of people.
Since there is no specific definition of Shell companies, Ministry of Corporate Affairs have issued a public notice, explaining the grounds and the basis of such disqualification.
In the notice they have mentioned, that after the amendment of the Companies Act 1956, a new clause was added in the Companies Act, 2013, wherein it has been clearly mentioned that any director who fails the furnish the annual returns or the financial statements of a company for three years shall be liable for prosecution and disqualification.
Based on this ground the directors have been disqualified. And the companies, to which these directors were serving to, are suspected to be shell companies.
What are the consequences of forming a Shell company?
A Shell company is an entity that is indulged in unlawful activities. If a company is found guilty of operating as a shell company then such company and all its directors shall be liable to prosecution under the Companies Act, 2013, wherein the name of the company will be struck off from the register.
Also it shall be liable for prosecution under different acts such Money Laundering Act, Income Tax Act etc. based on the offence committed.