Shutting Down India’s Shell Companies – Government Continues Anti-Corruption Drive

October 4, 2017 Posted by India Briefing Reading Time: 5 minutes

By Ramya Boddupalli

Over the past two years, Prime Minister Modi’s government has introduced a slew of measures to prevent money laundering, counterfeiting, hoarding, and tax evasion – all popular modes of operating in the black economy. Ending these practices was, at least partly, responsible for two of the government’s flagship initiatives – GST and demonetization.

Relatedly, making the Aadhaar biometric identification number mandatory for banking transactions and filing returns, also aims to bring transparency in the Indian economy.

As part of this crusade, the government is now actively targeting shell companies.

What are shell companies?

There is no clear legal definition of a shell company in India. The Indian government usually defines it as companies with no operations for over a year.

In countries such as the U.S., shell companies are seen as legitimate corporate entities even if they have nominal or no operations or assets. They could have never started operations, owing to economic reasons, or may have been created for layering purposes. For instance, a firm may create an affiliate company to engage solely research and development (R&D); such companies operate like any other firm within legal limits.

Meanwhile, in India, the government notified new limits for companies establishing subsidiary firms on September 20; companies operating in India will now only be allowed to establish two layers of subsidiaries under law. This is probably because the government views shell companies primarily as vehicles of illegal financial maneuvering – established for the sake of diversion of funds and money laundering to evade taxes.

Data from the finance ministry shows that there are nearly 1.5 million registered companies in India, but only 600,000 companies file annual tax returns. The government suspects that many of the remaining companies are shell companies used for illegal financial transactions and tax evasion.

As part of its crackdown on India’s black economy, the government is syncing several databases, including data from the tax department, Registrar of Companies, and banks to detect unusual financial transactions and their benefactors. The vast amount of banking data generated during the demonetization exercise has also facilitated the government in assessing the full extent of misuse of shell companies for hiding cash and assets.

Recent crackdown on shell companies

The Prime Minister’s Office (referred to as the PMO locally) recently formed a team of top law enforcement officials to pursue action against shell companies. These authorities are now responding with stringent actions against identified offenders.

In July, finance minister Arun Jaitely told parliament that the government had ordered nearly 200,000 shell companies to shut down. This action was immediately followed up by the Security Exchanges Board of India (SEBI) directing stock exchanges in India to suspend the trading activities of suspected shell companies. Further, banks were directed to restrict the operation of bank accounts of firms suspected to be shell companies. Banks were also directed to scan the accounts of directors of shell companies to uncover illicit transactions.

In September, the Ministry of Corporate Affairs (MCA) disqualified over 300,000 directors and publicly named 55,000 directors in an attempt to shame them. These directors will not be eligible to become a member of any corporate board for a period of five years.

Additionally, the MCA and the Central Board of Direct Taxes (CBDT) have reached an agreement to facilitate data exchange on an automatic and regular basis. The two federal bodies will share information on PAN, TAN, and income tax returns (ITRs) for various businesses operating in the country through this mechanism.

The government is also scrutinizing the role of finance sector professionals – auditors, chartered accountants, and stock brokers – in abetting the activities of shell companies.

Improving transparency in the Indian economy

The clampdown on shell companies is part of a larger campaign to counter tax evasion and curb use of black money in India. The country’s black economy is estimated to be the size of over 20 percent of its GDP. In addition, practices such as tax evasion adversely affect the fiscal balance of the government. India’s current tax-to-GDP ratio is 16.6 percent, far behind the OECD average of 34.3 percent. This is not reflective of the profile of its workforce.

With the sustained clampdown on illegal financing and strengthening of federal and state monitoring agencies – the Modi government hopes to make India a more attractive business destination, and boost investor confidence that their funds are secure in the country.

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