Shell corporation

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A shell corporation is a company or corporation with no significant assets or operations often formed to obtain financing before beginning business. Shell companies were primarily vehicles for lawfully hiding the identity of their beneficial owners, and this is still the defining feature of shell companies due to the loopholes in the global corporate transparency initiatives. [1] It may hold passive investments or be the registered owner of assets, such as intellectual property, or ships. Shell companies may be registered to the address of a company that provides a service setting up shell companies, and which may act as the agent for receipt of legal correspondence (such as an accountant or lawyer). The company may serve as a vehicle for business transactions without itself having any significant assets or operations.

Contents

Shell companies are used for legitimate purposes but can be used for tax evasion, tax avoidance, money laundering, or to achieve a specific goal such as anonymity. Anonymity, in the context of shell companies, relates to anonymity of beneficial owners of the company. [1] Anonymity may be sought to shield personal assets from others, such as a spouse when a marriage is breaking down, from creditors, or from government authorities.

Shell companies' legitimate business purposes are, for example, acting as trustee for a trust, and not engaging in any other activity on their own account. This structure creates limited liability for the trustee. A corporate shell can also be formed around a partnership to create limited liability for the partners, and other business ventures, or to immunize one part of a business from the risks of another part. Shell companies can be used to transfer assets from one company into a new one while leaving the liabilities in the former company. Shell companies are also used for privacy and security reasons by wealthy individuals and celebrities. [1] Accordingly, shell companies may be used to generate both pecuniary and non- pecuniary private benefits by their beneficial owners. [2]

SEC definition

The U.S. Securities and Exchange Commission defines a "shell" company as follows:

Shell company: The term shell company means a registrant, other than an asset-backed issuer as defined in Item 1101(b) of Regulation AB (§ 229.1101(b) of this chapter), that has:

(1) No or nominal operations; and

(2) Either:

(i) No or nominal assets;

(ii) Assets consisting solely of cash and cash equivalents; or

(iii) Assets consisting of any amount of cash and cash equivalents and nominal other assets.' [3] [4]

Background

Some shell companies may have previously had operations that shrank due to unfavorable market conditions or company mismanagement. A shell corporation may also arise when a company's operations have been wound up, for example following a takeover, but the "shell" of the original company continues to exist. [5] The term "shell corporation" does not describe the purpose of a corporate entity, but in general is more informative to classify an entity according to its role in a particular corporate structure; e.g. holding company, general partner, or a limited partner.

Shell companies are a main component of the underground economy, especially those based in tax havens. They may also be known as international business companies , personal investment companies , front companies , or "mailbox" companies. While these terms are generally used interchangeably in practice, their meanings are not the same and each term is generated to refer to a different theme of illegality. [1] Shell companies can also be used for tax avoidance. A classic tax avoidance operation may utilize favorable transfer pricing among multiple corporate entities to lower tax liability in a certain country; e.g. Double Irish arrangement.

A special purpose entity, used often in the context of a larger corporate structure, may be formed to achieve a specific goal, such as to create anonymity.

According to a 2013 experimental study where the researchers requested anonymous incorporation in violation of international law, one in four corporate service providers offered to provide services in violation of international law. [6]

Examples

Shell companies can be used to transfer assets of one company into a new company without having the liabilities of the former company. For example, when Sega Sammy Holdings purchased the bankrupt Index Corporation in June 2013, they formed a shell company in September 2013, called Sega Dream Corporation, into which were transferred valuable assets of the old company, including the Atlus brand and Index Corporation's intellectual property. [7] This meant that the liabilities of the old company were left in the old company, and Sega Dream had clean title to all the assets of the old company. The former Index Corporation was then dissolved. Sega Dream Corporation was renamed as Index Corporation in November 2013.

When Hilco purchased HMV Canada, they used a shell company by the name of Huk 10 Ltd. [8] in order to secure funds and minimize liability. HMV was then sued by Huk 10 Ltd., allowing Hilco to regain assets and dispose of HMV Canada.

As another example, the use of a shell company in a tax haven makes it possible to move profits to that shell company, in a strategy of tax evasion. A United States company buying products from overseas would have to pay US taxes on the profits, but to avoid this, it may buy the products through a non-resident shell company based in a tax haven, where it is described as an offshore company. The shell company would purchase the products in its name, mark up the products and sell them on to the US company, thereby transferring the profit to the tax haven. (The products may never actually physically pass through that tax haven, and be shipped directly to the US company.) As the shell company is not based in the United States, its profit is not subject to US income tax, and as it is an offshore company in the tax haven jurisdiction, it is not taxed there either. Under the tax haven law, the profits are deemed not to have been made in the jurisdiction, with the sale deemed to have taken place in the United States. As US personal income tax is significantly less important than corporate income tax, US company executives would claim a salary (or fees, consulting fees, etc.) from the company's profits.

In addition, there are several shell companies that are used by broadcasting groups to circumvent FCC limits on television station ownership. For example, Sinclair Broadcasting Group forms local marketing agreements with stations owned by Cunningham Broadcasting and Deerfield Media; nearly all of the stock of Cunningham Broadcasting is controlled by trusts in the name of the owner's children. [9] Other examples include Nexstar Media Group controlling television stations owned by Mission Broadcasting and Vaughan Media.

Countries of domicile

Typical countries of domicile of shell companies are offshore financial centres like Ireland, Liechtenstein, Luxembourg, Switzerland, Isle of Man, and the Channel Islands including Guernsey and Jersey in Europe, Bahamas, Barbados, Bermuda, Cayman Islands, and Virgin Islands in the Caribbean, Panama in Central America, and Hong Kong and Singapore in Asia. Shell companies are usually offered by law firms based in those countries. [10] The process of establishing a shell company can sometimes be done very quickly online. [11]

In 2021 anonymous corporations were made illegal in the United States with the passage of the Corporate Transparency Act as part of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021. Exemptions were included which are meant to limit its scope to the entities most likely to be used for illicit purposes. Companies which are exempt from the act include foreign companies that do not formally register to do business and companies that fall into one of 24 enumerated categories, which include companies that employ more than 20 people, have revenues above $5 million, and a physical presence in the United States, as well as churches, charities, non-profits, trusts and partnerships. Companies that are banks, broker-dealers, public issuers, and insurance companies are also exempt. [12] [13] [14] [15]

Due to federalism in the United States, shell companies are often set up in states such as Delaware, Nevada, and Wyoming due to advantageous tax regimes. [16] [17]

Abuse

Shell companies have been used to commit fraud, by creating an empty shell company with a name similar to existing real companies, then running up the price of the empty shell and suddenly selling it (pump and dump).

There are also shell companies that were created for the purpose of owning assets (including tangibles, such as a real estate for property development, and intangibles, such as royalties or copyrights) and receiving income. The reasons behind creating such a shell company may include protection against litigation and/or tax benefits (some expenses that would not be deductible for an individual may be deductible for a corporation). Sometimes, shell companies are used for tax evasion or tax avoidance. [18]

Offshore Leaks

In 2013 the International Consortium of Investigative Journalists published a report called "Offshore Leaks" with information about the use and owners of 130,000 shell companies. Many of the shell companies belonged to politicians and celebrities from around the world and were being used for tax evasion and hiding financial assets. [19]

Panama Papers

In 2016 a leak of 11.5 million documents to the German newspaper Süddeutsche Zeitung revealed information about owners of more than 214,000 shell companies administered by the law firm Mossack Fonseca in Panama. The shell companies were used by politicians, businessmen, autocrats, and terrorists from around the world for tax evasion and other illegal activities. [10]

India

After India's decision to demonetise ₹500 and ₹1000 rupee notes on 8 November 2016, [20] [21] [22] various authorities noticed a surge in shell companies depositing cash in banks, possibly in an attempt to hide the real owner of the wealth. In response, in July 2017, the authorities ordered nearly 2,000 shell companies to be shut down while Securities and Exchange Board of India (SEBI) imposed trading restrictions on 162 listed entities as shell companies. A high-level task force found that hundreds of shell companies were registered in a few buildings in Kolkata. Many of those were found to be locked, with their padlocks coated in dust and many others which had office space the size of cubicles. [23]

Regulation

Since shell companies are very often abused for various illegal purposes, regulation of shell companies is becoming more important to prevent such illegal activities.

United Kingdom

Currently British overseas territories and crown dependencies are only required to tell the true name of owners of shell companies upon request from official law enforcement agencies. However, since 2020 they are forced to publish these names in a public register in order to prevent anonymous use of shell companies. [24]

United States

The new customer due diligence (CDD) rule from 2016 requires that banks know the identities of beneficial owners of legal entity customers, enabling them to disclose this information to law enforcement agencies, thus aiding in the identification true business owners and their tax liabilities. Thereby, the rule aims to prevent the anonymous misuse of shell companies. The rule is administered by the Financial Crimes Enforcement Network (FinCEN). [25] In January 2021, anonymous shell companies were effectively banned via a provision in the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021. [26]

India

A "Task Force On Shell Corporations" was constituted in 2017 under the chairmanship of the Revenue Secretary to the Government Of India and Corporate Affairs Secretary to Govt. Of India, for effectively tackling malpractice by shell companies in a comprehensive manner. [27]

European Union

On 22 December 2021, the European Commission adopted a proposal for an EU Directive to tackle the misuse of shell companies for tax purposes. [28] Also known as the "Unshell" directive, the proposal requires the unanimous agreement of all 27 EU Member States' finance ministers before entering into force.

See also

Related Research Articles

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<span class="mw-page-title-main">Limited liability company</span> US form of a private limited company

A limited liability company (LLC) is the United States-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. An LLC is not a corporation under the laws of every state; it is a legal form of a company that provides limited liability to its owners in many jurisdictions. LLCs are well known for the flexibility that they provide to business owners; depending on the situation, an LLC may elect to use corporate tax rules instead of being treated as a partnership, and, under certain circumstances, LLCs may be organized as not-for-profit. In certain U.S. states, businesses that provide professional services requiring a state professional license, such as legal or medical services, may not be allowed to form an LLC but may be required to form a similar entity called a professional limited liability company (PLLC).

<span class="mw-page-title-main">Incorporation (business)</span> Legal process to create a new corporation

Incorporation is the formation of a new corporation. The corporation may be a business, a nonprofit organization, sports club, or a local government of a new city or town.

Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdictions that facilitate reduced taxes. Tax avoidance should not be confused with tax evasion, which is illegal. Both tax evasion and tax avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that intend to subvert a state's tax system.

<span class="mw-page-title-main">Offshore company</span> Company or corporate entity established in an offshore jurisdiction

The term "offshore company" or "offshore corporation" is used in at least two distinct and different ways. An offshore company may be a reference to:

Tax evasion or tax fraud is an illegal attempt to defeat the imposition of taxes by individuals, corporations, trusts, and others. Tax evasion often entails the deliberate misrepresentation of the taxpayer's affairs to the tax authorities to reduce the taxpayer's tax liability, and it includes dishonest tax reporting, declaring less income, profits or gains than the amounts actually earned, overstating deductions, bribing authorities and hiding money in secret locations.

Offshore investment is the keeping of money in a jurisdiction other than one's country of residence. Offshore jurisdictions are used to pay less tax in many countries by large and small-scale investors. Poorly regulated offshore domiciles have served historically as havens for tax evasion, money laundering, or to conceal or protect illegally acquired money from law enforcement in the investor's country. However, the modern, well-regulated offshore centres allow legitimate investors to take advantage of higher rates of return or lower rates of tax on that return offered by operating via such domiciles. The advantage to offshore investment is that such operations are both legal and less costly than those offered in the investor's country—or "onshore".

<span class="mw-page-title-main">Corporate tax in the United States</span>

Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Since January 1, 2018, the nominal federal corporate tax rate in the United States of America is a flat 21% following the passage of the Tax Cuts and Jobs Act of 2017. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. The corporate Alternative Minimum Tax was also eliminated by the 2017 reform, but some states have alternative taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return.

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<span class="mw-page-title-main">Offshore financial centre</span> Corporate-focused tax havens

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<span class="mw-page-title-main">Base erosion and profit shifting</span> Multinational tax avoidance tools

Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions or no-tax locations where there is little or no economic activity, thus "eroding" the "tax-base" of the higher-tax jurisdictions using deductible payments such as interest or royalties. For the government, the tax base is a company's income or profit. Tax is levied as a percentage on this income/profit. When that income / profit is transferred to a tax haven, the tax base is eroded and the company does not pay taxes to the country that is generating the income. As a result, tax revenues are reduced and the country is disadvantaged. The Organisation for Economic Co-operation and Development (OECD) define BEPS strategies as "exploiting gaps and mismatches in tax rules". While some of the tactics are illegal, the majority are not. Because businesses that operate across borders can utilize BEPS to obtain a competitive edge over domestic businesses, it affects the righteousness and integrity of tax systems. Furthermore, it lessens deliberate compliance, when taxpayers notice multinationals legally avoiding corporate income taxes. Because developing nations rely more heavily on corporate income tax, they are disproportionately affected by BEPS.

<span class="mw-page-title-main">Dutch Sandwich</span> Dutch withholding tax avoidance tool

Dutch Sandwich is a base erosion and profit shifting (BEPS) corporate tax tool, used mostly by U.S. multinationals to avoid incurring European Union withholding taxes on untaxed profits as they were being moved to non-EU tax havens. These untaxed profits could have originated from within the EU, or from outside the EU, but in most cases were routed to major EU corporate-focused tax havens, such as Ireland and Luxembourg, by the use of other BEPS tools. The Dutch Sandwich was often used with Irish BEPS tools such as the Double Irish, the Single Malt and the Capital Allowances for Intangible Assets ("CAIA") tools. In 2010, Ireland changed its tax-code to enable Irish BEPS tools to avoid such withholding taxes without needing a Dutch Sandwich.

<span class="mw-page-title-main">Bermuda Black Hole</span> Corporate tax avoidance strategy

Bermuda black hole refers to base erosion and profit shifting (BEPS) tax avoidance schemes in which untaxed global profits end up in Bermuda, which is considered a tax haven. The term was most associated with US technology multinationals such as Apple and Google who used Bermuda as the "terminus" for their Double Irish arrangement tax structure.

<span class="mw-page-title-main">Panama Papers</span> 2016 document leak scandal

The Panama Papers are 11.5 million leaked documents published beginning April 3, 2016. The papers detail financial and attorney–client information for more than 214,488 offshore entities. These documents, some dating back to the 1970s, were created by, and taken from, the former Panamanian offshore law firm and corporate service provider Mossack Fonseca, and compiled with similar leaks into a searchable database.

This article lists some of the reactions and responses from countries and other official bodies regarding the leak of legal documents related to offshore tax havens from the law firm Mossack Fonseca, called the Panama Papers.

In 2010, the United States implemented the Foreign Account Tax Compliance Act; the law required financial firms around the world to report accounts held by US citizens to the Internal Revenue Service. The US on the other hand refused the Common Reporting Standard set up by the Organisation for Economic Co-operation and Development, alongside Vanuatu and Bahrain.

<span class="mw-page-title-main">Brass plate company</span> Company of no physical substance

A brass plate company or brass plate trust is a legally constituted company lacking meaningful connection with the location of incorporation. The name is based on a company whose only tangible existence in its jurisdiction of incorporation is the nameplate attached to the wall outside its registered office. The registered office is often the same office and address of the local professional service firm(s) or corporate service provider(s) (CSPs), who act as local support to the company. Brass plate structures are associated with tax havens, corporate tax havens, and offshore financial centres.

<span class="mw-page-title-main">Loan-out corporation</span> Type of US business entity

A loan-out corporation, also known as a loan-out company, or personal service corporation, is a form of US business entity in which the creator is an 'employee' whose services are loaned out by the corporate body. The creator of the corporation is typically the sole shareholder, and thus the corporation is used as a means to reduce their personal liability, protect their assets and exploit taxation advantages. Loan-Out corporations are especially prominent in the entertainment and professional sports industries, as the creator's services are typically performed on individual contract basis, and receive large, irregular sums of income throughout the year.

References

  1. 1 2 3 4 Murat Can, Pehlivanoğlu (2023). Paravan Şirket (Shell Company). Istanbul: On İki Levha Yayıncılık. ISBN   978-625-432-623-3.
  2. ↑ Pehlivanoğlu, Murat Can (2024). Non-Pecuniary Private Benefits in Publicly Traded Corporations How Involuntary Dissolution Statute May Be the Solution. Leiden: Brill Nijhoff. ISBN   978-90-04-68651-9.
  3. ↑ See Rule 12b-2 of the Securities and Exchange Act of 1934
  4. ↑ Cornell Law School Legal Information Institute 17 CFR 240.12b-2 - Definitions.
  5. ↑ "Webster's New World Finance and Investment Dictionary". 2010. Archived from the original on 8 April 2016. Retrieved 1 November 2015.
  6. ↑ Findley, Michael G.; Nielson, Daniel L.; Sharman, J.C. (2013). "Using Field Experiments in International Relations: A Randomized Study of Anonymous Incorporation 1". International Organization. 67 (4): 657–693. doi:10.1017/S0020818313000271. hdl: 10072/56156 . ISSN   0020-8183. S2CID   153353492.
  7. ↑ "Notice of Conclusion regarding Business Transfer Agreement of Index Corporation" (PDF). Sega Sammy Holdings Inc. 18 September 2013. Archived from the original (PDF) on 3 May 2022. Retrieved 18 September 2013.
  8. ↑ "HUK 10 LIMITED - Overview (free company information from Companies House)". beta.companieshouse.gov.uk.
  9. ↑ "Family's TV Clout in Bush's Corner, Howard Kurtz and Frank Ahrens, Washington Post, October 12, 2004, Page A1". Washingtonpost.com. 12 October 2004. Retrieved 4 January 2014.
  10. 1 2 "About the Panama Papers". Sueddeutsche Zeitung. Süddeutsche Zeitung. Retrieved 10 June 2018.
  11. ↑ "Setting up your own tax haven shell company takes 10 minutes". triple j. abc.net.au. 4 April 2016. Retrieved 9 June 2018.
  12. ↑ Appleton, Robert (4 February 2021). "The End of the Anonymous Shell Company in the United States". The Harvard Law School Forum on Corporate Governance. Retrieved 31 May 2021.
  13. ↑ "'Long Overdue' Anonymous Shell Company Reforms Move Forward". Thomson Reuters Tax & Accounting News. 16 December 2020. Retrieved 31 May 2021.
  14. ↑ Kirby, Jen (21 December 2020). "The US has made its biggest anti-money-laundering changes in years". Vox. Retrieved 31 May 2021.
  15. ↑ "US passes 'historic' anti-corruption law that effectively bans anonymous shell companies". The Independent . 2 January 2021. Retrieved 31 May 2021.
  16. ↑ Sharman, J. C. (Fall 2010). "Shopping for Anonymous Shell Companies: An Audit Study of Anonymity and Crime in the International Financial System". Journal of Economic Perspectives. 24 (4): 127–140. doi: 10.1257/jep.24.4.127 . hdl: 10072/36463 .
  17. ↑ Jana Kasperkevic (6 April 2016). "Forget Panama: it's easier to hide your money in the US than almost anywhere". The Guardian.
  18. ↑ Nicholas Shaxson, Treasure Islands: Tax Havens and the Men who Stole the World, Random House, January 2011
  19. ↑ "ICIJ Offshore Leaks Database". offshoreleaks.icij.org. International Consortium of Investigative Journalists (ICIJ). Retrieved 10 June 2018.
  20. ↑ "India scraps 500 and 1,000 rupee bank notes overnight". BBC News. 8 November 2016. Retrieved 8 November 2016.
  21. ↑ "In an attempt to curb black money, PM Narendra Modi declares Rs 500, 1000 notes to be invalid". news. The Economic Times. 9 November 2016. Retrieved 9 November 2016.
  22. ↑ "Here is what PM Modi said about the new Rs 500, Rs 2000 notes and black money". India Today . 8 November 2016. Retrieved 9 November 2016.
  23. ↑ "Cracking down on black money, scrutiny of shell firms stepped up". Archived from the original on 17 August 2017. Retrieved 16 August 2017.
  24. ↑ "UK moves to trace tax-avoiding overseas shell firm owners | DW | 01.05.2018". DW.COM. Deutsche Welle. Retrieved 10 June 2018.
  25. ↑ "Customer Due Diligence Requirements for Financial Institutions". Federal Register. Financial Crimes Enforcement Network (FinCEN). 11 May 2016. Retrieved 10 June 2018.
  26. ↑ Kirby, Jen (21 December 2020). "The US has made its biggest anti-money-laundering changes in years". Vox. Retrieved 6 January 2021.
  27. ↑ "'Task Force on Shell Companies' for effectively tackling the malpractices" . Retrieved 8 July 2018.
  28. ↑ European Commission. "Questions and Answers on the Commission's proposal to end the misuse of shell entities".
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