What are shell companies? Govt to lay down guidelines by Jan-end

The government will come up with a proper definition of what a shell company is by the end of this month.

According to sources, the Prime Minister’s Office (PMO) had in February last year constituted a special task force to tackle malpractices by shell companies. The task force will lay down specific guidelines to validate the clampdown on shell companies. The definition of shell firms is expected to be inserted in the Companies Act, securities laws, and also in the Income-Tax (I-T) Act, wherever applicable.

The Centre is working on recommendations from multiple enforcement agencies and regulatory bodies, sources said. “We have received a lot of suggestions in this regard as there is no law that defines the subject and related parameters,” said an official privy to the development.

According to the official, the special task force had directed all enforcement agencies concerned, including the Central Board of Direct Taxes, Enforcement Directorate and Ministry of Corporate Affairs (MCA), to provide inputs on the functioning of shell companies. “The government is of the view that a fair number of shell companies exists for legitimate purposes, and wants to distinguish such a company from those that are being created for the purpose of tax evasion, siphoning of public money, dubious transfer pricing, manipulation of share prices or money laundering,” said the official. Another source said the task force had observed that there were instances where dummy firms or penny stocks were often being misunderstood as shell companies. “Such lack of clarity has halted investigations in various actionable cases,” the source said.

“According to the concept adopted, shell companies are inactive. They do not have an operating income. They are incorporated to hold shares and investments, hence, are static in terms of valuation. However, the definition needs clarity so that one can justify while classifying them into shell firms,” said Sandeep Parekh, founder, Finsec Law Advisors.

Experts also believe that any action on these firms should be based on facts. “A proper definition and concept having backing in law is needed to crack down on such companies, as it will be codified as a concept. Even if the definition is provided in law, it should be an inclusive definition depending on the facts and circumstances,” said Lalit Kumar, partner, J Sagar Associates.

Defining shell firms

* PMO constitutes special task force on shell company early in 2017

* Task force comprises officials of MCA, Finance Ministry, SFIO, CBDT, ED

* Govt asks task force to come up with a proper definition of shell firms

* All shell companies are not necessarily "front" created for manipulation

* Absence of definition and guidelines refrain probe agency from taking action against wrongdoers

* Move after action against MCA-331 list of suspected shell firms criticised widely

* Shell companies often misunderstood with penny stocks and dummy firms

* Govt to come out with specific guidelines by January-end 

* May insert definition in Companies Act, Securities Act, I-T Act

The move follows the government’s inability to clamp down on shell firms even after the ministry of corporate affairs (MCA) disqualified directors and put out a list of 55,000 companies as “defaulters”.

Some of these companies were not shell companies according to the previous concept. Moreover, 224,000 companies were struck off for remaining inactive for two years or more.

Market regulator Securities and Exchange Board of India had also suspended trading in 331-suspected shell firms, a list of which was issued by the MCA on August 7.

However, these actions did not go down well with those affected, and some firms approached various courts and judicial bodies like the Securities Appellate Tribunal. They obtained stays on the directives in the absence of strict parameters classifying them as shell firms.

The judicial bodies observed that the orders against the companies had been passed without proper investigations, and that they were not given enough opportunity to be heard.