Overseas shell companies & a shadow economy- A threat t national interest

shell company


Smt Nirmala Sitharaman

Union Minister for Finance & Corporate Affairs,

Dear Smt Sitharaman,

In recent times, there has been a proliferation of overseas shell companies, which have literally come to represent a shadow economy, posing a threat to the stability of the financial system and a serious affront to national security.

Answering a Rajya Sabha Question on shell companies on 6-2-2018, the Corporate Affairs Minister had stated “The Companies Act, 2013 does not define the term Shell Company. However, the Organization for Economic Cooperation and Development (OECD) defines a Shell Company as a company which is formally registered or otherwise legally organized in an economy but which does not conduct any operation in that economy other than in a pass through capacity. Under the Companies Act, 2013, Section 248(1)(c) provides for removal of name of company from the register of companies if it is not carrying on any business or operation for a period of 2(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. Based on the above mentioned provision, 2.97 lakh companies were identified under this category as on 31.03.2017 and after following due process names of 2,26,166 companies were struck off from the register of companies as on 31.12.2017

From the above statement, it is clear that “shell” companies are not defined in the Companies Act. Though the statement referred to the OECD definition, no such definition has yet been incorporated in the Act till date, even after a lapse of five years. The statement of the Minister also shows that action, if any, is taken only in respect of domestic companies, not the overseas ones with which promoters of domestic companies, their directors or major shareholders may have a beneficial relationship. Further, the action initiated against the domestic shell companies appears to be highly ad hoc, not as a part of a formal, comprehensive compliance and monitoring system provided in the Act, but at the instance of the Ministry of Corporate Affairs or some other concerned investigation agency, in fits and starts.

As if to compound the problem further, the Dept of Economic Affairs (DEA) in your Ministry had issued a relaxation in overseas investment rules in August 2022 [GSR 646(E) dated 22-8-2022], which implies that an overseas investment in a foreign entity by a resident in India would be permissible, even if the foreign entity in question invests into India, either directly or indirectly, either through another subsidiary registered in the main overseas location or in a third country, irrespective of whether the investment implies tax avoidance or outright tax evasion. My letter dated 18-9-2022 addressed to the Secretary (DEA) refers (http://eassarma.in/sites/default/files/public/Letter-to-DEA-on-Overseas-investment-rules.pdf). It is all the more surprising that the above cited revision in the rules fails to qualify the nature of the destination country where the investee company is located, for example, whether it has attributes of a tax-haven country or a country where financial regulation is weak.

In contrast, SEBI has, vide its recent notification, SEBI/HO/AFD-1/PoD/CIR/P/2022/108 dated 17-8-2022 on Guidelines for overseas investment by Alternative Investment Funds (AIFs) / Venture Capital Funds (VCFs), has stipulated that the country where an investment is proposed to be made should not be a tax haven destination or a destination where financial regulation is inadequate. Apparently, the DEA had issued the notification without aligning it with the SEBI guidelines, for reasons best known to it.

At a time like this, when the Indian rupee is under pressure in the exchange market, for the DEA to issue such an open-ended relaxation for outflow of capital raises serious concerns. The DEA’s notification of August 2022, either deliberately or otherwise, seems to create opportunities for and regularising round-tripping and money-laundering and allow big businesses to park their earnings in overseas accounts, without any benefit accruing to India.

Many big business houses are known to amass wealth through such shell companies, which are no more than “letter-box” companies located in tax haven countries. Several Indian corporate groups are reported to have parked their ballooning wealth in “family offices” akin to shell companies. Investigations undertaken by overseas research agencies have occasionally revealed how corporate entities from India, with the help of their shell companies, have manipulated the Indian stock market, by exploiting loopholes that exist in the relevant laws/ regulations and hoodwinking the investigation and regulatory institutions in India. It is such overseas shell companies that played a central role in some of these corporate entities earning illicit profits through trade involving import of coal, power machinery etc. and export of iron ore, atomic minerals, by over-invoicing/ under-invoicing the same. Political patronage enjoyed by the concerned corporates and the consequent laxity in regulation have hindered investigations in several such cases.

Some corporate entities are also known to have indiscriminately extended their activities across multiple sectors in India, with concerns expressed about the sources from which they have raised resources, concerns about viability of their operations and the overall implications from the point of view of the stability of the financial system. My letter dated 20-8-2022 addressed to the Governor of RBI  (https://countercurrents.org/2022/08/reports-on-highly-leveraged-debt-based-operations-of-the-adani-group-calls-for-a-closer-look-from-the-psu-banks-point-of-view/) conveyed such apprehensions in some detail. While it is not clear whether the RBI had acted on my letter or not, recent developments, especially the revelations emerging from external research agencies about some corporate entities, seem to corroborate the fears I had expressed earlier. Those reports refer to multiple layers of overseas shell companies, forming part of a complex web of interconnected accounts, in which Indian corporate groups have direct beneficial interest. It is unfortunate that those corporate entities should manipulate the Indian stock market from outside, to syphon off the funds invested by thousands of small retail investors.

The overseas shell companies in which domestic business groups have a beneficial interest are also used for misappropriating loans obtained from domestic banks, especially PSU banks, and round-tripping the same at an appropriate time, showing them as the corporate entities’ own resources. Instead of prosecuting them for misappropriating the bank loans, the regulatory agencies have often chosen to allow the affected banks to offer the culprits concessions such as debt restructuring, which, in the case of PSU banks, passes on the burden to the unwary Indian taxpayer. Overseas shell companies are also used by corporate entities for manipulating the Indian stock market whenever they choose to acquire control over targeted domestic companies. Both domestic companies and overseas firms are known to use their overseas shell accounts to deposit bribe amounts to be passed on in India in return for undue favours. Some such overseas shell companies are also reported to be used for routing funds from external sources to outfits in India, engaged in activities that hurt the national interest.

More recently, India has suffered setbacks in two important cases of international arbitration, one in the case of Vodafone and another in the case of Cairn, though there was apparently tax avoidance on transactions, entirely attributable to domestic activities. In the absence of adequate statutory safeguards, the Indian regulators were unable to enforce tax compliance.

Some recent moves made by the Centre have further reinforced the problem of shell companies, rather than resolving it.

For example, the Centre chose a few years ago to amend the Companies Act and the Foreign Contributions Regulation Act (FCRA). Those amendments allowed subsidiaries of foreign companies to fund elections, removed the cap on corporate donations to political parties under the Companies Act and introduced a highly non-transparent system of Electoral Bonds through which political parties can receive unlimited donations. As a result, there is no way to identify the source of funds received by political parties. This has opened up new avenues for foreign agencies, using their overseas shell companies, to influence India’s elections.

So far, the Central investigation agencies such as the CBI, the Enforcement Directorate, the Registrar of Companies, the Serious Fraud Investigation Organisation (SFIO), the Income Tax Department, RBI, SEBI and the NIA, as well as the State investigation agencies, have been dealing with individual cases of illicit overseas accounts in a somewhat uncoordinated manner, pursuing action, each from its own restricted point of view. As a result, the larger issue of overseas shell companies being misused to corrupt the electoral system, manipulate the stock markets and act in a manner that hurts the national interest, is lost sight of.

The first important legislative measure that is long overdue is to adopt an unambiguous definition of a “shell company”, perhaps on the lines of the OECD definition (or, the definition adopted in the US Security Exchange Commission Act), and insert an appropriate provision in the Companies Act, the SEBI Act, the Income Tax Act, the Prevention of Money Laundering Act, the Prohibition of Benami Property Transactions Act and other related legislations, so that there may be consistency and a coordinated approach on the part of the concerned enforcement agencies in dealing with such companies located in India and elsewhere.

As and when investigations are carried out by individual investigation agencies at the Centre and in the States, they come across overseas shell companies and gather information about them, which could be put together in an easily retrievable manner in a common database that is readily accessible to both Central and State agencies.

Any promoter, significant shareholder or a director of an Indian-registered company should be mandated under the relevant legislations to make a disclosure of the beneficial relationship, if any, he/she has in a domestic or an overseas company including a shell company and such a disclosure should be placed in the public domain. Any lapse in making such a disclosure or making a misleading disclosure should attract deterrent penalties, including blacklisting of the person obligated to make such a disclosure. The investigating agencies should be empowered to attach and confiscate the assets of those in non-compliance.

One needs to be cautious in conferring such coercive powers on investigating agencies without insulating them fully from the executive wing of the government, as they could come under pressure to divert attention from important cases of investigation to misuse their authority to harass opponents of the political executive.

If the government is earnest about rooting out corporate corruption and safeguarding the national interest, it should fully insulate the investigation agencies from executive influence altogether. All investigation agencies should be made accountable to the Parliament, so that they may function in an independent manner, not subject to extraneous pressures.

The website of the PMO boldly states, “Transparent and Corruption-Free Governance reap huge benefits for the nation”. True to the spirit underlying that statement, the government should do away with non-transparent modes, such as “Electoral Bonds” of funding elections, PM-CARE, as one cannot rule out overseas shell companies playing a role in manipulating elections through such opaque means of funding political parties.

Mushrooming of shell companies, set up or promoted by business houses, not subject to public disclosure, has created a shadow economy that poses a serious risk to the stability of the financial system and a threat to the national interest. The only way to address those threats is by taking the above suggested measures.

In view of its importance for national security, I feel that this subject should be placed before the Parliament for a more comprehensive discussion and further action.


Yours sincerely,

E A S Sarma
Former Secretary to Government of India



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