From Panama to Paradise: The unending saga of shell companies and black money

Several governments are making efforts to reduce black stash and the NDA government’s demonetisation was a step in that direction.

Published: 12th November 2017 08:50 AM  |   Last Updated: 12th November 2017 09:34 AM   |  A+A-

For representational purposes

Express News Service

MUMBAI: In this world, nothing is certain, except death and taxes. That was Benjamin Franklin in 1817, who may have been compelled to use taxes in the same breath, as there was no Panama or ‘Paradise’ and shell companies were unheard of then. Much water has flown under the bridge since, and companies and individuals have devised ways and means to avoid taxes, and hoard black money, which is nothing but all income on which taxes aren’t paid.

Several governments are making efforts to reduce black stash and the NDA government’s demonetisation was a step in that direction. Sadly, it unearthed little and drove home the point that much of the shadow economy isn’t represented in cash, but in physical assets like real estate and gold, strengthening the argument that demo was a failure. But, wait. An Enforcement Directorate’s report, breaks this myth, confirming that half of the illicit cash in the country or 48 per cent of it is actually parked in shell firms. Agreed, real estate accounts for about 35 per cent as per the same ED report, but it’s worth noting that the money to mop up real estate is routed, again, through a maze of shell firms.

This, perhaps, underscores the genesis behind the recent crackdown on shell firms, the single-largest conduit for black money hoarder.Of the 15 lakh registered companies, less than half, ie., 6 lakh file annual returns. If in the past three decades, a mere 1,155 entities were detected as shell firms for over 22,000 beneficiaries and concealing Rs 13,300 crore, the war waged on black money through a blunt tool like demonetisation stirred it up to unbelievable proportions.  

According to the Ministry of Corporate Affairs, a staggering 2.24 lakh companies have been struck-down for being inactive for two years. Of this, it was found after demo, that nearly 35,000 companies deposited and withdrew Rs 17,000 crore between November, 2016 and March, 2017. In one case, a company with a negative opening balance on November 8, 2016, deposited and withdrew Rs 2,484 crore following demo. Another company was found to have as many as 2,134 bank accounts!

The ED report is based on a nation-wide search, started before demo, in 16 states, covering 110 locations in cities like Kolkata, Mumbai, etc. in respect of shell firms and related professionals. In Kolkata alone, officials busted a massive black money racket identifying 64,811 beneficiaries and shell companies involving bogus tax exemption of nearly Rs 38,000 crore through listed entities.

Estimates peg the country’s parallel economy to be roughly Rs 15 lakh crore and Rs 30 lakh crore, or 10-20 per cent of the GDP, which stood at Rs 150 lakh crore in FY17. Following demo, experts say, significant amount entered the banking system from the parallel economy, and with 99 per cent of the cash returning the banking system, the movement of cash from hereon will be easily tracked and traced.Much before, demo, the government also constituted a task Force on shell companies’ including revenue secretary and secretary, Ministry of Corporate Affairs in February, which has already met five times. 

As we speak, it is preparing a comprehensive digital database of shell firms and their associates, file prosecution complaints in criminal courts in respect of non-genuine transactions and efforts are on to sync Director Identification Number (DIN) with PAN and Aadhaar to check the role of directors.Following the striking off of defaulting companies, restrictions were imposed on their bank accounts, besides sale and transfer of moveable and immoveable properties.Shell firms are created merely to hide the assets of very rich, but barring such entities from securities market alone may not be a strong deterrent in itself and much more needs to be done.

Modus operandi

  • Promoters collude with broker who arrange purchase prices at nominal costs and sale at exorbitant prices, to get ‘capital gains,’ on which tax is zilch 
  • A company with poor financials raises capital alloting preferential shares to various entities and the scrip zooms instantly. It involves circular trading of shares among select companies often having common promoters/directors. The artificially inflated scrips are offloaded through companies, whose funding is provided by the same set of people who want to convert black money into white.
  • The primary method of black money generation remains suppression of receipts and inflation of expenditure. However, as income manipulation is not always possible by suppression of receipts, tax players inflate expenses obtaining bogus or inflated invoices.
  • Small entry operators provide accommodation entries accepting cash in lieu of cheque/demand draft given as loans/advances etc, and thereby launder large sum of money at miniscule commissions.
  • Use of shell companies to provide accommodation entries to launder black money is prevalent. For shell companies, shareholders or directors comprise drivers, cooks, or employees of main persons who intend to launder black money.
  • Trade-based money laundering through mispricing of imports/exports is anothe major means of taking money out of the country.
  • Cash donations to educational or religious institutions and betting on sport (cricket) are other ways of routing illicit cash.

What Should be Done?

  • Sebi should monitor unusual rise of stock prices and generate red flags based on trading volumes and other indicators like annual returns 
  • Information should be shared with CBDT and the Financial Intelligence Unit
  • ED should be informed to take action on violators under Prevention of Money Laundering Act.
  • A two-fold strategy including proactive detection of shell companies involving data mining and taking deterrent penal action against persons involved in shell firms

SIT Suggestions 

  • Limit cash holdings for private use and include provisions for confiscation of cash held beyond prescribed limits. A number of European countries bar any cash transactions above a particular limit.
  • Limit holding of cash/currency notes within reasonable thresholds to control holding of unaccounted money.
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