Shell Corporation

What is a Shell Corporation?

A shell corporation is a dummy company that only exists on paper and does not have any actual operations or significant assets. 

These businesses normally do not have any employees or a physical presence, but they do have bank accounts, ownership of some passive investments or assets, and certain intellectual properties (IP). 

Often, such a business is used for illegal purposes like evading taxes, laundering money, or contraband sales. They may, however, sometimes be used legitimately to raise funds, for hostile takeovers, to hold certain specific assets or IP, etc. 

It exists on paper and has no actual operations. It has no employees or assets and is hence termed as a ‘shell’ of an organization as it has nothing on the inside. 

Shell companies may be used for any purposes, be it legitimate, from raising financing to tax avoidance and money laundering. They help to maintain the anonymity of the person behind such a business, which can thus help in protecting one’s personal assets. 

Even though these firms often cause suspicion, such businesses are completely legal in most countries as long as they are used for legitimate purposes. These legitimate transactions can involve the sale of real estate or IP. 

It can also be used as a part of a process called a reverse merger which allows a firm to go private without an initial public offering (IPO). 

This involves a private company buying a majority stake in a public shell company. Then the private company swaps its shares for the public company and ends up being a subsidiary of the public company. 

This process is completely legal and is allowed by the Securities and Exchange Commission (SEC) in the United States.

However, most such companies are associated with illegally reducing tax liabilities by creating these corporations in foreign countries like the Cayman Islands, Switzerland, Bermuda, etc.

How to Set Up a Shell Corporation

Let's understand how these corporations are set up:

• Shell companies should always be formally registered in the registrar of the country it is to be set up. In the US, shell corporations register with the US Securities and Exchanges Commission (SEC). 

• The shell companies are normally registered in places with tax benefits. It can be countries like the Cayman Islands, the British Virgin Islands, or Switzerland.

• These companies must have registered agents who file all the necessary paperwork, pay the required taxes and fees, etc.

• Shell companies should reveal a beneficial owner and, thus, are required to name a director. A beneficial owner is someone who exercises substantial control over the company, even though he/she may not have any power, considering the company only exists on paper.  

• To hide the owner’s identity, shell corporations are often registered as a subsidiary of another shell corporation. This means that the business is owned by another shell corporation, and further layers can be added. This creates a high level of secrecy.

• Such a tactic is often used when these corporations are being used for illegal activities like money laundering, as it makes it difficult for law enforcement to employ anti-money laundering tactics against these firms due to the high level of secrecy.

Reasons to Legitimately Set Up a Shell Corporation

Shell companies can be used for legitimate purposes like real estate, investing in foreign markets, holding intellectual property, etc., and illegal activities like money laundering and fraud. 

The most common aim of setting up such companies, however, is to reduce tax liabilities.

These companies are often set up in tax havens which are countries that offer such businesses minimal or no tax liability. To avoid taxes, a business may establish a shell corporation in a tax haven such as the Cayman Islands, Switzerland, or the British Virgin Islands, among others.

Normally, when a company is purchasing goods from a foreign firm, buying real estate, or investing in foreign markets, it may incur a large tax liability. 

To avoid paying this significant tax duty, goods may be brought under these firms domiciled in a tax haven, allowing the business to avoid paying a hefty tax.

Similarly, high-earning individuals, due to progressive taxation, often have to pay a high tax. 

As a result, such persons frequently establish themselves as shell corporations in these tax havens. They then funnel their income through shell companies to avoid the high taxes. This is known as tax evasion.

Legitimate uses

Some of the legitimate uses are:

1. Real Estate: Shell corporations in the form of Limited Liability Corporations (LLCs) are often used to purchase a single piece of real estate as it helps in limiting the liability and dividing the profits. It helps in reducing taxation too. 
2. Holding intellectual property: Shell businesses are used by production companies to possess intellectual property and protect it from litigation or other forms of seizure.
3. Hostile takeovers: A group of investors attempting a hostile takeover of a publicly-traded firm may form it to acquire control of the company if the hostile takeover is successful.
4. Reverse mergers: Some private companies use it to go public using a technique called a reverse merger, which is swifter and less expensive than a typical IPO. It involves a private company buying a majority stake in a public shell company. Then the private company swaps its shares for the public company and ends up being a subsidiary of the public company.
5. Investing in foreign markets: Forming such organizations in different countries allows companies to invest in the capital markets of those countries. Thus financial institutions can invest outside their domestic borders and reduce their tax liability too.
6. Financing for startups: Before starting a new business, it can be used to gather and store funds, thus helping with funding for startups.

Ways That People Abuse Shell Companies

Despite the legal uses of Shell companies, most of such corporations are used for personal gain and to bypass the legal system. 

In May 2012 alone, the SEC had to suspend the trading of 379 such inactive companies as they were vulnerable to being used for fraudulent activities. 

Shell companies help in maintaining the anonymity of their owners. Due to the lack of transparency, these companies can mask their true ownership and are often used in conjunction with illicit activities.

Some ways that people often abuse the firms for illegal activities are as follows:

1. Money Laundering: Money laundering is a process that allows criminals to hide illegal wealth and profits from crimes. Shell corporations are typically ideal for this because they are simple to register and conceal their true ownership. As a result, it is frequently utilized to hold this type of black money and pass it off as genuine business activities.
2. Tax Evasion: The most common use of such corporations is to use them to avoid taxes. Wealthy individuals and businesses may hide their incomes and assets in shell corporations in a different country where the tax rates are lower. In this way, they reduce the tax they have to pay.
3. Hiding Assets: During mergers and acquisitions for businesses and divorces or court cases for individuals, these companies may be used to conceal the actual net worth of these individuals by hiding assets. This is done to avoid losing the assets in litigation or having to share them after a divorce.
4. Conducting illegal business: Due to the anonymous nature of such businesses, illegal businesses may use them to hide the identities of their actual owners. Such firms have historically been employed in criminal activities such as trafficking and terrorist activity since they cannot be traced back to their owners.

Pros and Cons of Shell Corporations

Some of the pros and cons are:

shell corporations Examples

An example of companies using shell corporations for legitimate reasons can be seen in the case of Sega Sammy Holdings. In June 2013, when Sega Sammy Holdings purchased the bankrupt Index Corporation, a shell corporation called Sega Dream Corporation was formed. 

This corporation was used to transfer the valuable assets of the old firm, including the IP. Thus the liabilities of the old firm were left behind, and only the valuable assets of the firm were in possession of Sega. 

Similarly, when Hilco purchased HMV Canada, a shell company by the name of Huk 10 was used to secure funds and minimize liabilities. Later on, HMV was sued by Huk 10 to get rid of liabilities and only be left with valuable assets.

Panama Paper Leaks

A Panamanian law firm, Mossak Fonseca, saw a lot of clients leak back in 2016. Over 11.5 million of its clients and a list of 214,488 offshore entities that were created to evade taxes were leaked. 

Titled 'Panama Paper,' the data was released by the German newspaper 'Süddeutsche Zeitung' under the title of 'Panama Papers on April 3rd, 2016, in which celebrities, businessmen, and famous personalities from dozens of countries were named. 

The firm of Mossak Fonseca owned a network of over 214,000 tax havens. Even though such tax havens and shell establishments are legal, these entities were being used for illegal purposes like tax evasion, fraud, and the avoidance of international sanctions. 

In 2018, the firm eventually had to terminate operations. But this was not before the names of high-profile individuals were associated with the scandal. 

Researched and authored by Soumil De | LinkedIn

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