How demonetisation have helped dig out the menace of shell companies

On Independence day, Prime minister, Modi mentioned his achievements in unearthing black money and digging out the shadow channels of shell companies which helps this menace. He pointed out that more than 1.75 lakh shell companies have been de registered so far. Even capital market regulator, SEBI brought 320+ shell companies under its radar, restricting trading activities for these companies. IT department, ED, CBI and serious fraud Investigation office all are working day-night examining thousands of these.

So the basic question which comes to mind is, “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.

They are mostly used for hiding particulars of ownership of a company from law enforcement, laundering unaccounted money, avoiding tax etc. Shell companies are kept at business front which makes all transactions on paper as legitimate business transactions, helping corporates or individual avoid tax. However, not all shell companies are illegal. Some companies could have been started to promote start-ups by raising funds.

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Shell companies in India

There is an old practice in Kolkata, which dates back to the command economy of pre 1991 reform era, which says-“Paisa mat dikhao” (don’t show your wealth) to fly under the radar of tax authorities. Even in the transformed economy in which wealth creation is widely appreciated, this old thought keeps its position.

There are bogus transactions done, which can’t be easily detected as these transactions go through layers and layers of shell companies. Some times the layers are as much as 50-55. All these shell companies have some random directors. These are common people who sign as a director for a small amount of money. Sometimes a single person is named as a director of 200-300 shell companies.

Charter accountants who help launder money, keep a stock of 500-600 companies with them which can easily fulfil their 5-6 years requirements. They create different kinds of shell companies which can fulfil different set of requirements. For example if some “dairy products company” owner wants to launder his money, the charter accountant will already be having many “dairy shell companies” which can show bills selling milk/dairy products to the owner. In this way price of raw material and selling price everything can be manipulated and profits can be shown far lesser than real.

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demonetisation

In most cases, these directors are traceable. But even if the department gets to them, it doesn’t help because they know nothing-not even the operator who employs them from behind several layers of proxies. The whole game is played through proxies, with layers and layers of them acting as smoke screen. A number of operators have been identified, each controlling hundreds of firms. But because they leave no fingerprint, the department can’t do much to rout them from their trade.

The main purpose of this elaborate operation, described by a leading Kolkata-based lawyer as “parallel banking”, is “accommodation”. For a substantial section of the economy, it is the key to efficient working capital management and tax rationalisation.

For instance, a vast majority of real estate developers are known to buy “bogus invoices” to suppress profits. Often they end up holding a lot of cash in their hands. When the accumulated cash needs to be brought back into the books, they approach the operator. There are various ways to launder this cash and put it back into the books. One of the simplest and quickest ways which may not lead to laundering is to find a lender with legitimate funds on his books.

HeScribbleRhymes-Black-money-problem-e1482399516814 This person receives the cash from the builder, and in exchange makes an unsecured loan with proper documentation. The money is transferred through bank accounts and comes into the books of the builder as legitimate funds that can be deployed in business. The loan is repaid over time from legitimate business income, and the cash returned to the builder—his need for temporary accommodation thus fulfilled. And the man with legitimate funds has in the process made some handsome gains, though perhaps in cash.

There’s a lot of politicians’ money as well stashed in benami and shell companies.

Calcutta stock Exchange Case (source: Livemint)

Even after Calcutta stock exchange collapsed after the 2001 fraud case, some 150+ companies continued to be traded. These were shares of so-called jama-kharchi companies, a variant of shell companies, which were used by stockbrokers and traders to rationalize their tax liabilities. Because these were illiquid stocks in which no one was interested, a clutch of traders could easily manipulate their prices through collusive trades.

Brokers would “buy losses” from trading in these shares to set off their short-term capital gains against such losses another form of accommodation that CSE or the income tax department could not stamp out despite knowing that these were collusive trades aimed at reducing tax liabilities.

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For the exchange, there was a bigger dilemma: trading in jama-kharchi companies was its only source of revenue post 2001. Stamping it out, if at all possible, would mean driving into sunset.

The problem, as described by an income tax officer is

As the department is short-staffed, there are layers and layers of shell companies created. The whole idea is to make it humanly impossible to get to the bottom of most circuitous transactions. “Even our tools are dated,” regretted one officer. “For instance, we don’t have a tool that links every bank account with the same PAN.”

The result: even with real-time alerts, it is impossible for the department to keep pace with the movement of cash through intermediaries.

How demonetisation is helping Unearth these shell companies?

After banning the high denomination notes, government authorities noticed a surge in shell companies depositing cash in banks. This was an eye opener for government which had no idea how many shell companies were operating in the country.

Government has formed a team and last month authorities ordered more than 200000 shell companies to be shut down and hundreds of thousands more are examined. The crackdown on shell companies which had no active businesses is one of the major achievements of demonetisation. It will lead to substantial reduction in tax evasion and will lead to cashless digital transaction which leads to a paper trail.

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Lal Bazar street Kolkata case (source: Economic Times)

A high-level task force leading the investigation has found hundreds of shell companies are registered in a few buildings in Kolkata, according to the government note reviewed by Reuters.

More than 400 companies listed their address in a dimly lit colonial-era building at 9/12 Lalbazar Street.

In its warren of offices were firms offering services such as earth moving equipment, infrastructure financing, information technology consultants and many others which had office space the size of cubicles.

Many were locked, with their padlocks coated in dust. Others were grimy residential quarters with laundry hanging from the windows.

Data separately provided by Tofler, a company information database service, identified nearly 3,000 companies in two offices in the building. Some were named after flowers.

A tax inspector said the Kolkata firms were a virtual money laundering industry and drew a parallel to the Panama legal firm Mossack Fonseca that emerged from obscurity last year after the leak of millions of documents from its offices that illustrated how the wealthy use offshore corporations to avoid taxes.

“The Kolkata industry does the work of obfuscating money trails. Kolkata companies are a huge network that take your money from one end and bring it out the other,” said the inspector, who didn’t want to be identified as he’s not authorised to talk to the media.

This is why it seems Mamta Banerjee was so much afraid after demonetisation. 

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These shell companies are used to obscure the ultimate beneficiary, conceal political investments, route money to evade tax, commit fraud or manipulate tenders.

Hope demonetisation  helps in cleaning this mess and even brings transparency in electoral funding. If politicians and elections become clean then bureaucracy will also become clean. In my views, this will also have a trickle down effect and will make Indian economy more transparent.

I agree, demonetisation brought too much difficulty for us, but if the menace of black money and shell companies gets cleaned, it will be a god’s gift for our economy and country’s future.

Author : Gaurav Kumar

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