What are shell companies?
Most shell companies are authentic and legal entities which do not possess actual assets or run business operations. Their main purpose is to run transactions for a variety of firms and for an innumerable shady purposes. Generally, they are used to obtain financing, maintain control over a national/multinational companies to allow favorable tax treatment, which occasionally also facilitates money laundering as other illegal activities. Shell companies exist as non-trading corporations; they are not listed on any stock exchanges for buying and selling by investors. Most exist with only a name, and a mailing address, and on paper as a registered financial entity.
Legal Uses: Majority of shell companies serve legitimate purposes, such as to hold stock or intangible assets such as copyrights, patents, goodwill, trade names, trademarks, mail lists, etc. These assets are often reported at lower cost on the balance sheet after property, plant and equipment. Quite often the intangible assets are of another business entity to facilitate domestic and cross border currency and asset transfer in mergers and acquisitions carried on by a corporation, often they are used for hostile takeovers. Many small-cap companies fall under the category of shell corporations, as they have limited assets and often trade just to keep the company alive. Many Internet startups are shell companies which are kept by corporates to protect their trade secrets or safeguard directors from abductors or gossips. Shell corporations are used by large respectable public companies, as well as shady businessmen and private individuals. Shell corporations are used for avoiding tax and to obtain different forms of financing.
Why reputed companies legitimately set up a shell companies? The number one reason for a domestic company to set up a shell company is to realize a tax haven abroad. Large corporations, like Apple, use shell companies to move jobs and profits offshore, taking advantage of looser tax codes. This is the process of ‘offshoring’ or ‘outsourcing’ work that was once conducted domestically. Another example is to remain within legal bounds internationally, American corporations set up shell companies in the foreign countries in which they are offshoring work. This is legally allowed by the United States, and some say that it’s the U.S. tax code itself that’s forcing domestic companies to create shell corporations abroad. It is understood that shell companies need to conduct financial activity in foreign markets. This allows them to invest in capital markets outside of domestic borders and realize potential tax savings.
While some corporate use shell companies for legitimate reasons, many wealthy individuals abuse shell companies for personal gain. High bracket income people set up shell companies in one or many locations for tax evasion. Many rich people funnel earnings through shell companies in such a way that it isn’t counted toward personal income. Reputed journalists, lawyers, accountants, doctors, architects, educationists have set up their own shell companies domestically and abroad; this just goes out to illustrate how lax international financial regulations are. Setting up shell companies is quite easy.
An article in the Economist magazine has used useful legitimacy scale ranging from “perfectly legitimate” to “deeply dodgy” to rank the shell companies. It is a fact that nobody knows how many shell companies are used for a genuine purpose, and how many are used for doubtful purposes. The British Virgin Islands, where the majority of shell companies were exposed through the Panama papers story are registered which are over 450,000 companies. However, there is no reliable estimates of the total number of shell companies worldwide. This is quite scary for vulnerable small investors like us. In some of the authentic uses of shell companies, secrecy is kept unnecessary. For example, when an offshore shell company is being used to pool investments, or when a corporation owns a yacht or an airplane and they show it in one of their shell company just to avoid time-consuming bureaucracy, and not to evade tax. This obviously makes it difficult to think of a good reason why the ownership of that company is kept undisclosed. Again, for protection of trade mark, IPR, or patent which is for protecting trade secrets where justification can be given, why organizations become so secretive? Is using offshore shell companies the only way to achieve these goals?
Even if some secret shell companies are being used for legitimate purposes, the direct benefits of these uses go to private individuals and single corporations. However, the costs of the misuse of secret shell companies, in terms of large-scale tax evasion, corruption and crime, are borne by society as a whole and this mostly affect the growth of developing countries. This route is mostly used for laundering illicit money.
The Panama Papers, were the biggest seepage in history, which broke in early 2016; over a period of months, an unidentified man, referred to only as ‘John Doe’, released 2.6 terabytes of documents from the Panama based law firm, Mossack Fonseca. These documents involved everybody from the closest friends of Vladimir Putin, to Ian Cameron, the father of the former British Prime Minister, David Cameron. A random check from Indian database displays about 22 offshore entities, 1,046 officers or individual links, 42 intermediaries and as many as 828 addresses within the country. The leaked documents exemplify how wealthy individuals and public officials have been able to keep personal financial information private. The number of shell companies used by the rich and famous in world is too large. The Panama papers report 11.5 million documents that bring light to more than 200,000 shell companies used by the global elite.
According to some economists, not all shell companies are evil, but it is extremely hard to know who actually owns the assets or funds controlled by a firm. And in two decades of research conducted by Global Witness which is a nonprofit NGO firm established in 1993 that works to break the links between natural resource exploitation, conflict, poverty, corruption and human rights abuse has found that shell companies are the common thread between human rights abuses, environmental degradation, and political corruption, because they can maintain anonymity.