Abhijit Bhatlekar/Mint
Abhijit Bhatlekar/Mint

What are shell companies?

Shell companies include multiple layers of companies that have been created for the purpose of diverting money or for money laundering

On 14 September, the Ministry of Corporate Affairs (MCA) and Central Board of Direct Taxes (CBDT) signed a Memorandum of Understanding (MoU) to facilitate the sharing of data and information with each other on an automatic and regular basis. According to a press release by MCA, “The move is targeted to curb the menace of shell companies, money laundering and black money in the country and prevent misuse of corporate structure by shell companies for various illegal purposes."

Earlier in August, the Securities and Exchange Board of India (Sebi) directed stock exchanges to initiate action against 331 suspected shell companies and bar them from trading. Further, MCA cancelled the registration of around 2,09,032 defaulting companies and the Ministry of Finance directed banks to restrict operations of bank accounts of such companies by the directors of such companies or their authorized representatives. Following this, MCA has identified 1,06,578 directors for disqualification under Section 164(2)(a) of the Companies Act, 2013, as on 12 September 2017.

There is no clear definition of what shell company is in the Companies Act, or any other Act. But typically shell companies include multiple layers of companies that have been created for the purpose of diverting money or for money laundering. Most shell companies do not manufacture any product or deal in any product or render any service. They are mostly used to make financial transactions. Generally, these companies hold assets only on paper and not in reality. These companies conduct almost no economic activity. 

Under Section 248 of the Companies Act: “Registrar of Companies has powers to remove name of a company from register of companies where a company fails to commence its business within one year of its incorporation or the subscribers to the memorandum have failed to pay their subscription within a period of 180 days or where a company is not carrying on any business or operation for a period of two years." 

According to data provided by the finance ministry, there are about 1.5 million registered companies in India, while only 600,000 companies file their annual return. “This means that a large number of these companies may be indulging in financial irregularities," the ministry states.

In future, we may see more companies being categorised as shell companies. According to a recent report, the government has prepared a list of 16,794 shell companies after inputs from investigative agencies.

However, not all shell companies may be money laundering vehicles. There are many shell companies that work within legal limits and do not have financial irregularities. For example, a company may separate its HR function into another company altogether. The second one is a legal entity, which operates like any other company. 

If you are an equity investor, it is better to stay away from investing in shell companies that have financial irregularities. Conduct proper due diligence of companies that you have invested in, and try to research their operations, businesses and financials.