A shell corporation often has no active business operations or hold any productive assets. Structured as an efficient financial vehicle, a shell corporation can serve as a convenient mechanism to raise funds, to complete a hostile acquisition or to take a company public. Nevertheless, these corporate structures can also be used for nefarious purposes some of which include disguising ownership from law enforcement or the public, or to evade taxes.

For instance, the “Panama Papers” leaks revealed that banks, political leaders and wealthy individuals had allegedly hidden billions of dollars in shell companies through a Panama law firm. The scheme allowed clients to evade taxes. Reportedly 214,000 shell companies were created to facilitate illegal activities.

Shell Games

Not all shell companies are creating to siphon off funds or to evade taxes. There can be merits to creating a shell company.

  • Fortunes
  1. A startup can use a shell corporation to safeguard its assets before officially launching its business.
  2. A company preparing for a merger or an acquisition can hold its assets in a shell company for legal reasons and keep those assets separately from the acquiring entity.
  3. Foreign companies can create shell companies in tax havens like Panama (Swiss private banking, Hong Kong, Belize are some of the other dubious and prominent tax havens) and lower their taxes at home. How so one may ask? Most tax haven countries do not mandate tax information for the funds being funneled into the tax haven countries via shell companies. Further, some tax havens do not report the existence of these shell companies to the government of the owners operating the shell companies thereby creating a “black hole.”
  • Misfortunes
  1. Shell companies are often set up to mask the identity of the individual owning assets in the company or to evade taxes.
  2. Occasionally, companies take advantage of the secretive nature of shell companies and engage illegal activities like money laundering.

Limited Games in the Land of the Free 

In the U.S., we are fortunate to have monitoring agents like the Securities and Exchange Commission, the Justice Department, and the Public Company Accounting Oversight Board (PCAOB) guarding the corridors of capital markets to ensure that public companies are not actively engaged in “shell games” to defraud minority shareholders.

In sharp contrast, and most inappropriately, in emerging markets and particularly in the BRICS countries, minority shareholders may not be as fortunate where the use of shell companies to hide business ownership or to evade taxes is rampant.

What is the auditors’ role in policing dubious shell companies which are actively created by publicly listed companies to siphon off funds and to dupe minority shareholders? 

Let the Games Begin in BRICS Countries

The Securities and Exchange Board of India (the counterpart of US SEC) is scrutinizing the functioning of auditors in various public companies in India, especially if the auditor has had a long-standing relationship with the client. Under the Companies Act of 2013, auditors, have greater responsibilities to ensure that financial statements of an Indian company are not materially misstated and that auditors red flag “dubious” transactions.

The Finance Ministry in collaboration with SEBI is taking actions against 331 listed suspected shell companies. More than 100,000 directors (holy cow!) may be disqualified for their association with shell companies. Investigations are in progress to identify professionals, chartered accountants, company secretaries and cost accountants associated with the defaulting companies.

The auditors are not exempt from these inspections. Authorities are looking at the possibility of having stricter scrutiny of global auditing firms (e.g., the Big 4 audit firms) and to make them more accountable when their auditors certify companies with a clean opinion even when clients are actively engaged in corporate misconduct.

Commentary on BRICS

Similar to the initiatives in India, China, where the problems of shell games are even more pervasive, under President Xi Jinping, has been actively confronting these problems. While these are modest steps, India and China can do more to bring the unaccountable or black money back into the mainstream economy for the betterment of their citizens.  

While India and China are at least attempting to tackle this social ailment, sadly not much can be said about the other 3 countries within the BRICS which include Brazil, Russia and South Africa where their top leaders appear to be the cause and not the solution to this social ailment.

http://timesofindia.indiatimes.com/business/india-business/auditors-come-under-lens-amid-crackdown-on-shell-companies/articleshow/60496210.cms

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