Shell corporations are employed by major well-known public firms, sleazy business dealers and private individuals alike. They can serve as tax evasion vehicles for genuine enterprises. On the other hand, shell companies, as they are also called, can be used illegally for criminal activities. Here, we’ll understand how a shell corporation or company works, its purpose, as well as the risks involved in setting up one
What Is a Shell Corporation?
A shell corporation is one that does not have any active business operations or significant assets. These corporations are not always unlawful, but they are occasionally used illegally, such as to conceal business ownership from law enforcement or the general public. Legitimate reasons for forming a shell corporation include a startup using the corporate entity to raise funding, undertake a hostile takeover, or go public.
How Does A Shell Corporation Work?
Shell corporations are typically formed to conceal the identity of their business owners or the nature of the business with which they are involved. They do, however, have their address and identity as required by law. For instance, in the United States, the Securities Exchange Commission (SEC) requires every shell company to be registered with SEC to be at least in existence on documents, if not physically.
These businesses are largely based in tax haven regions and countries. Business owners or individuals set up such firms to avoid spending on big tax payments that can obscure the source of unlawful revenue and access the global markets at the same time.
Shell companies can engage in the following activities:
- Opening bank accounts and transferring payments as well.
- Handling financial transactions.
- Purchase and sales of real estate.
- They might even own the copyrights and collect royalties.
Shell Corporation Examples
To evade tax requirements, business owners establish shell corporations in tax havens, such as Panama, to decrease their tax responsibility to the greatest extent possible. Aside from Panama, other tax havens where multinationals set up offshore accounts include Switzerland, Hong Kong, the Cayman Islands, and Belize.
The following are some examples of when shell corporations are used:
Index Corporation, which had gone bankrupt, was purchased by Sega Sammy Holdings in June 2013. In September 2013, Sega Sammy Holdings established the shell firm ‘Sega Dream Corporation’ to transfer the assets of Index Corporation.
When Hilco purchased HMV Canada, Hilco established a shell business called ‘HuK 10 Ltd’ to raise the necessary capital while minimizing liability. Later, HuK 10 sued HMV Canada, causing Hilco to confiscate the assets and sell HMV Canada.
What Is The Purpose of A Shell Company?
To avoid paying taxes: The main purpose of setting up a shell company is to avoid paying taxes to the government of the particular country.
To safeguard assets: The original entity can simply transfer assets from a low-profitable place or region with the assistance of a shell company.
Special Purpose Vehicle: Because many assets are moved to an SPV to circumvent regulatory reporting requirements or for a variety of other reasons, they are utilized as a special purpose vehicle.
To gain access to global markets: They facilitate their original counterparts’ access to the international foreign exchange market and make available attractive commercial prospects.
Reasons to Form a Legal Shell Corporation
The primary rationale for a domestic corporation to establish a shell company is to benefit from a tax shelter elsewhere. Large firms, such as Apple, have decided to relocate employees and earnings offshore to take advantage of lower tax rates. This is the process of “offshoring” or “outsourcing” work that was formerly done in-house.
To stay within international legal boundaries, American enterprises will establish shell companies in foreign nations where they are outsourcing jobs. This is permissible in the United States, and some argue that the US tax code is forcing local enterprises to establish shell corporations abroad.
Another way that shell corporations deal with taxes is when financial organizations need to execute financial transactions in international marketplaces. This enables people to invest in capital markets outside of their home country and perhaps save money on taxes.
Benefits Of A Shell Corporation
There have been various cases where active business owners and individuals set up shell corporations for tax purposes. For example, a new business or company may obtain funds and place them in a shell company before launching its products and services to customers. Furthermore, a company that is undergoing a merger or acquisition could move its assets and property to a shell corporation to avoid having its assets transferred to the buyer.
These firms are likewise being formed to take advantage of tax breaks. Some governments and localities, for example, provide tax breaks in the form of lower or no taxes.
Shell corporations are sometimes used by businesses for security concerns. For example, such companies could be employed as a shield by a corporation linked with or doing business with a company with a bad reputation or in a less profitable region. It is also advantageous for anyone going through a financial crisis or divorce not to be required to pay for this diverted revenue.
How to Start a Shell Corporation
A shell corporation is not illegal in and of itself. When it is utilized for money laundering or other illicit activities, it becomes a criminal organization. Despite its reputation for assisting the wealthy and famous in evading taxes, a shell corporation is extremely simple to start.
Here’s how to start a shell corporation:
- Find a shell corporation
- Once the entity has been chosen, choose a company name and a tax haven to start up the company. The British Virgin Islands is the least expensive jurisdiction to establish a shell corporation, with costs ranging between $1,500 and $2,000.
- Because it is intended to conceal the owner’s identity, a director must be identified. He or she will have no actual power, but his or her name must appear on corporate documents.
- The individual must provide proof of identification, such as a passport copy.
How Are Shell Companies Used Illegally?
The following are the primary reasons that shell companies are used illegally. They are frequently linked to one another.
#1. Tax evasion
Shell companies are formed by firms in offshore countries, frequently referred to as tax havens, where taxes are lower, to park assets in order to avoid paying excessive taxes in their home nation.
#2. Money laundering
Shell companies are frequently used to conceal the origin of black money or ill-gotten gains.
#3. Hiding funds from Ponzi schemes
Criminals may set up shell firms to redirect funds from Ponzi schemes. When the scam is discovered, the true perpetrators are not identified, and law enforcement agencies are left with only shell firms to blame.
#4. Hide the identities of the true owners
Most of the time, the true owner/owners of an offshore shell corporation cannot be found since the registered addresses of the directors varies significantly from the addresses supplied to the registrar. Shell companies are regarded as one of the most secure methods of concealing business ownership from law enforcement or the general public.
Below is an example on how shell companies are used illegally:
Company ABC Inc. is in the mining industry. It has a sister company, XYZ Inc., that is likewise in the same industry.
ABC is in the midst of a business crisis and is certain of its impending liquidation.
As a result, ABC transfers the vast bulk of its valuable assets to XYZ.
If ABC is forced to close owing to huge losses, its creditors will be unable to recover their losses because ABC has no major assets in its name.
ABC’s promoters may later use the assets given to XYZ as they see fit.
How To Prevent the Illegal Use Of Shell Companies
The Financial Action Task Force (FATF) was the first international organization to establish global rules for beneficial ownership reporting requirements in 2003. It required countries to ensure that their authorities had access to up-to-date and accurate information about the person or persons behind corporations, foundations, and other legal entities.
The FATF enhanced and clarified its beneficial ownership standards further in 2012, 2014, and 2019. The following are the best practices recommended by FATF in its October 2019 publication.
- Use of one or more mechanisms (the Registry Approach, the Company Approach, and the Existing Information Approach) to ensure that information on a company’s beneficial ownership is obtained and available at a specified location in their country; or can be determined in a timely manner by a competent authority.
- A multi-pronged strategy incorporating many sources of information is generally more effective in preventing the exploitation of legal persons for illegal purposes and implementing procedures that make the beneficial ownership of legal persons adequately visible.
- Increased sharing of pertinent information and transaction records will aid worldwide efforts to promote beneficial ownership transparency.
- Create an efficient system with crucial elements such as:
- Risk evaluation
- Information sufficiency, correctness, and timeliness in beneficial ownership
- Competent authorities can gain access.
- Bearer shares and nominee arrangements are prohibited or immobilized.
- Sanctions that are effective, reasonable, and dissuasive
What Are The Risks Of A Shell Company?
While the aforementioned ideas would assist government agencies in limiting the creation of shell corporations, implementing them would be a difficult undertaking for countries. According to the FATF, the following are the most typical problems in adopting beneficial ownership measures:
- Inadequate risk evaluation of potential legal person misuse
- Inadequate efforts to ensure information is correct and up to date
- Insufficient measures to ensure relevant authorities had timely access to information
- Inadequate means for monitoring the quality of other countries’ support
What is vital from the standpoint of financial institutions, with which shell firms open accounts and perform transactions, is to have a current system that can identify red flags related to shell companies and accurately inform personnel on the same. The following are some common red flags:
- Transactional velocity is unusually high.
- The sophistication of financial transactions
- Unusual trends in transactions (eg. transfer of financial assets to a new company that has no liabilities or wire transactions and activity history that do not match the company profile)
- Regimes that are either high-risk or sanctioned registration or operation country
- Negative media coverage of the shell business or its directors
- Any directors on the watchlists
- Participation with agents or other firms of a similar sort Contact with high-risk clientele
- Transactions involving companies that share the shell company’s address
- A wide range of recipients receive wire transfers.
Use of Contemporary Technology to Avoid Shell Company Abuse
Shell corporations cannot be identified manually in most cases. Financial institutions, on the other hand, may follow and monitor these organizations, conduct investigations, and report questionable activity to regulators by actively using contemporary technology and automation. Here are some methods financial institutions can employ to ensure compliance.
#1. Customer Risk Assessment
When onboarding new customers, financial institutions must consider a variety of risk criteria such as unfavorable jurisdictions, the same registered address with changing owners, and inclusion on watchlists. A system should be in place to provide a single comprehensive perspective of client risk, eliminating the need to reference various sources of information. Based on the initial assessment, each customer should be assigned a risk score. Significant risk profile changes must be dynamically captured throughout the client lifecycle.
#2. Transaction Monitoring
Using contemporary tools, the company’s transactions should be matched to consumer activity assessed during onboarding. Transaction analysis tools should generate notifications when actual transactions differ from expected client activity.
#3. Screening
Shell firms and their owners should be screened on a regular basis against PEP lists, sanctions lists, and negative publicity, among other things.
In Conclusion
Shell corporations are typically formed to conduct legal company operations. To conceal the true identities of the owners who provide the financial resources, business owners establish shell corporations to handle the assets of original entities. For example, for roughly $900, any individual can find an associate firm to form an offshore shell corporation for them. As a result of the Panama Papers revelations, the number of shell corporations that were used to shift the unlawful revenue of affluent business owners, including politicians, was revealed.
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