Centre close to cracking shell firm puzzle; panel decides 18 parameters

The government’s task force has arrived at a formula to define a ‘shell company’, a move critical for enforcement agencies to crack down on dubious entities exploiting the regulatory framework.

According to sources, the task force has listed 18 key parameters, including beneficial ownership and the nature of business dealings, to determine if a company has been created to launder money or exploit regulatory arbitrage. 

A company that lacks beneficial ownership, is inconsistent in big-ticket transactions, or is one that does repetitive transactions with no apparent business purpose could be tagged a ‘shell company’.

Further, any company that transfers large sums to a related party, and makes disproportionate investments in shares of other companies or one with dubious directors could be termed shell entities. Companies whose shares quote a high premium to their face value despite having nominal share capital too could fall into the category. 

The panel, set up in July 2017, has extensively defined each attribute of a shell company, based on suggestions it had received from probe agencies and regulators, including the Enforcement Directorate, Securities and Exchange Board of India, Financial Intelligence Units, and the Central Board of Direct Taxes.

Sources say the task force has submitted its report to the Prime Minister’s Office, the Ministry of Finance, and the Ministry of Corporate Affairs (MCA) for feedback. 

“It is well understood that just defining a shell company is not enough to identify potential shell companies as there is a very 

thin line between legitimate businesses and illegitimate businesses, which depends on the merits and facts of each case.

All that can be done is to identify and collate the attributes of shell companies from the broader definition and identify them from the total population of registered companies,” the report says. Business Standard has reviewed the report sent to the ministries concerned. According to the task force, a typical shell firm is incorporated with a standard memorandum or articles of associations. It has inactive shareholders and directors, and is left dormant. It is created for the purpose of being palmed off later.

After the sale transaction, inactive shareholders usually transfer their shares to the buyer and the so-called directors resign or flee. The panel states that these firms are prone to abuse as they may be structured in a way to hide the identities of those controlling them. The task force was set up on the directive of Prime Minister Narendra Modi and comprises members of regulatory ministries and enforcement agencies under the co-chairmanship of the revenue secretary and the corporate affairs secretary. The panel is said to have been asked by the government to take into account the findings of probe agencies in various bank fraud investigations, which revealed the role of shell firms in routing and receiving funds.

The task force also highlighted that companies had been misused to channel unaccounted cash after demonetisation in November 2016. “There is a strong possibility that companies have been used to place illegitimate cash belonging to others,” it said, adding that the MCA must look into the filings of financial statements of such companies specifically.

It also raised the red flag on the abnormal increase or decrease in debts, or more than 10 per cent of bad debts written off, and the increase in investment in partnership firms by 100 per cent or more.