Capital markets and commodities regulator Securities and Exchange Board of India has given its inputs to the Ministry of Corporate Affairs (MCA) for defining ‘shell companies’.

Over the last year, the government has been cracking down on these so-called ‘shell companies’, many of which exist only on paper and are used as a conduit for tax evasion and money laundering.

So far, 2.26 lakh companies have been struck off the list of Registrar of Companies (RoC) by the MCA on the grounds that they did not carry out any business operations and were being used to help firms and wealthy individuals launder their money and evade taxes.

However, investigative agencies like the Enforcement Directorate and Serious Fraud Investigation Office have been hampered by the lack of a proper definition of ‘shell companies’, and the MCA is looking to plug this breach by defining such firms. The MCA had sought inputs from SEBI in this regard a few weeks back.

SEBI has based a part of its inputs from its investigation into penny stocks, and also from the existing definition of shell companies by the US Securities and Exchange Commission.

The Securities Act defines a shell firm as one that has no or nominal operations and assets. “The assets must consist mainly of cash and cash equivalents with very little other assets. In other words, a shell company should not have active business operations or assets”, the Act says.

Defining a shell company is crucial to taking action against companies that have been depriving the government of thousands of crores in tax revenues over the last few years. At present, investigative agencies have been using the provisions of Section 248 of the Companies Act to remove the name of company from the RoC.
The name can be struck off if the Registrar has “reasonable cause to believe that—
(a) a company has failed to commence its business within one year of its
incorporation;
(b) the subscribers to the memorandum have not paid the subscription which
they had undertaken to pay within a period of one hundred and eighty days from the
date of incorporation of a company and a declaration under sub-section (1) of section 11
to this effect has not been filed within one hundred and eighty days of its incorporation;
or
(c) a company is not carrying on any business or operation for a period of two
immediately preceding financial years and has not made any application within such
period for obtaining the status of a dormant company under section 455.”
Defining shell companies would give agencies such as the CBI, ED, Income Tax and SFIO more teeth to go after such companies.

Theoretically, shell companies are companies without active business operations or significant assets. They can be set up by business people for both legitimate and illegitimate purposes such as hiding particulars of ownership from the law enforcement, laundering unaccounted money and avoiding tax.

Since November 2016, when the Modi government announced demonetization, the urgency to define shell companies so as to crack down on illicit trades and bring culprits to the book increased manifold.

Soon after the currency overhaul exercise, MCA had disqualified the directors of 2.26 lakh companies. Thereafter, the ministry had passed an order to strike the names of the companies under Section 248 of the Companies Act, 2013. The ministry, however, had recommended SEBI to treat only 331 firms as shell companies. SEBI suspended the firms. The regulator has also asked the exchanges to conduct an independent audit of these companies, and if necessary, a forensic audit to be conducted as well.On August 15, 2017, Prime Minister Narendra Modi mentioned India’s battle against black money and said that more than 1.75 lakh shell companies have been de-registered so far.