Black Money - Shell Company game

Since demonetization, everyone wanted to know how the black money will be uncovered. The uncovering of black money is like a game of chess. It is boring to watch but very interesting if you follow it. The government, it seems, has made another move. Shell Companies are under the scanner in the next step against Black Money. Mint first broke the news in this article titled "Govt. plans crackdown on shell companies". The mainstream media is not focussed much on this development. Economic Times put it up recently titled Centre may shut down 7 lakh shell companies in war on black cash. Yet, it represents a significant move.

There are, by one estimate about 600,000 to 700,000 shell companies in India. It was not easy to identify these. Here is what Mint reported:

After monitoring a small sample of these shell companies, it has been found that Rs1,238 crore has been deposited in the accounts of such entities in the November-December period. 

Further, 49 shell companies and other proprietorship concerns have been identified wherein it was found that 559 beneficiaries laundered money amounting to Rs3,900 crore with the help of 54 professionals including chartered accountants. 

The Serious Fraud Investigation Office (SFIO) has filed for criminal prosecution of these entities and initiated the process for winding them up.

Indian shell companies fall into a few categories below (not exhaustive):

1. Companies held by Benami-owners (example owned by driver/servants of politicians)
2. Dormant shell companies  (companies that have not filed any returns, primarily because they do not have any business activity either by design or by lapse of time)
3. Aged shell companies (these are marginal companies not filing returns regularly but having some assets and liabilities)
4. Foreign registered shell companies

Few ways Money is laundered using shell companies

1. Government Contracts are given to Companies held by Benami-owners. [Municipal Corporations tend to like this mechanism]
2. Backdating the Infusion of cash and transactions in dormant shell companies. [Individual money launderers, developers, construction industry participants prefer this]
3. Hiding a high-value asset in aged shell company which has otherwise minimal net worth. [Always a chartered accountant is involved in such deals]
4. Purchase of aged shell company with accumulated losses in combination with point no. 3 above. It delivers double advantage - tax savings and subsequent long-term capital gains (tax-free). [This is also a chartered accountant money laundering technique]
5. Globally registered shell companies do business with India using the P-note route.  [This is sophisticated routes the big fish are here]
6. Alternatively, they interact with legitimate businesses owned by relatives of politically-connected persons at a discount or loss. [Central and State bureaucrats use this modus operandi]

And there are more.

In this context three essential elements need to be tackled. First, the ownership of these companies should be made clearer. Second, the banking channels should be tightened. Finally, P-note route should be closed.

Further Reading - The Global Shell company problem

The shell companies are also on the radar across the world. 

To understand one aspect of the shell company game you can see this post How shell companies launder dirty money? This is the American description of the problem. 

These companies are fronts for money laundering, illegal trade and smuggling. Jo Becker, back in 2010, detailed the mechanism of using shell companies by Iranian arms smugglers in his New York Times article. It is worth a read. 

Huffington post has a great compilation of different aspects of shell companies.

Reuters' investigation Shell Games is a must read.  Read this line from the report:

At a single address in this sleepy city of 60,000 people, more than 2,000 companies are registered. The building, 2710 Thomes Avenue, isn't a shimmering skyscraper filled with A-list corporations. It's a 1,700-square-foot brick house with a manicured lawn, a few blocks from the State Capitol.

Global Witness has taken up a campaign to end anonymity of the shell companies. More on Global Witness' war on anonymous companies is here.

World Bank has released a report on links between corrupt and shell companies in its report titled "The Puppet Masters: How the Corrupt Use Legal Structures to Hide Stolen Assets and What to Do About It". Needless to say it is a fascinating read.

This problem affects Indians through the p-note route.

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