What are shell companies? All you need to know

What are shell 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.

Illegitimate purposes for registering a shell company include hiding particulars of ownership from the law enforcement, laundering unaccounted money and avoiding tax.

With the shell company as a front, all transactions are shown on paper as legitimate business transactions, thereby turning black money into white. In this process, the business person also avoids paying tax on the laundered money.

India, however, does not have a concrete definition of shell companies. Shell companies are not defined in any law or act. However, US has defined the shell companies under their Securities Act.

They have taken up the basic definition, hence making it the commonly used one.

The US Securities Act defines shell companies as -

"Securities Act Rule 405 and Exchange Act Rule 12b-2 define a Shell Company as a company, other than an asset-backed issuer, with no or nominal operations; and either:

>no or nominal assets
>assets consisting of cash and cash equivalents; or
>assets consisting of any amount of cash and cash equivalents and nominal other assets."

This means that a shell company will have minimum business activities. This could be a plausible definition as even theoretically, the business persons who own shell companies, will be more interested in the rise and fall of their main company.

However, not all shell companies are illegal. Some companies could have been started to promote start-ups by raising funds.

Why does it matter?

Firstly, for traders who invested in these companies, the tension of their stocks being stuck and the possibility of encountering losses will prevail. The companies that are probably not shell companies will have to face the brunt of restricting trading activities.