Demystifying The “Fraud Of Money Laundering” By Shell Companies
Author: LawSphereX
Category: Banking & Finance
Published:
Updated:
DEMYSTIFYING THE “FRAUD OF MONEY LAUNDERING”
BY SHELL COMPANIES
Medha Joshi, Dharmashastra National Law University, Jabalpur
ABSTRACT
Corporates are the foundational pillars of growth in an economy. Any deviance by the corporates encourages the notion of parallel economy. Creation of Shell Companies is one such operation through which the corporate houses in order to avoid taxes launder money to tax haven nations, where the tax norms are favourable to them. Controlling the operation of Shell Companies is sine qua non for the immobilization of laundering of unaccountable money. Parallel economy by way of Shell Companies manifests itself towards movement of unaccounted/ black money in an economy as against a legitimised system. Identification of Shell Companies is a difficult mechanism, where the beneficial owner is hidden in the mask of Corporate Veil.
The paper elucidates for the fraud committed by the Shell Companies in due diligence of their business and acts as an intermediary to launder black money into legitimate money by means of fake and fictitious receipts and transactions. Keywords: Shell Companies, Money Laundering, Tax haven nations, Parallel economy, Corporate Veil.
INTRODUCTION
Companies or corporations are instrumental in the developmental and economical pursuit of a nation. Companies usually have the tendency to commit economic crimes in the nature of money laundering, tax avoidance, illegal acts or evasion of taxes, etc. Money is a necessary evil, and as a consequence of which there are economic crimes which are inclusive of money laundering, tax evasion etc. The commission of criminal activity using money as a median by the incorporations has increased significantly in coherence to money laundering. Money laundering is a broad term which is inclusive of many other crimes as well which are in the nature of economic crimes and those which deals with legitimising the unauthorised money.
White collar crimes, as can be inferred from the definition of Sutherland, are those which are committed by the person of respectability and high social status during the course of their occupations. Money Laundering is specie of white collar crime wherein, the persons engaged in the corporation takes advantage, during the course of their occupation, for conversion of the illegal money into legitimate money. Money Laundering has crept in the society with its tentacles disturbing the fundamental disposition of the companies along with the social fabric. Money laundering being a category of economic crimes specifically, and in general being a socio-economic crime, not only posit financial or economic loss to the State but also disturbs the social conditioning.
The growing canvas of Shell Companies have created a havoc in the society, as the operators of these companies creates a fake proposition to enjoy hidden benefits along with them plundering the money to tax haven countries in order to evade taxes, or fostering their other financial pursuits, or by engaging in organised crimes. Money laundering by way of formation of Shell Companies, by and large, is a threat that caters towards organised crimes, such as terrorism financing, or other illegal or illicit activities. Shell Corporations, thereby, acts as a catalyst to convert illegal money into money accrued from a legitimate source.
When the illegal money is being cloaked by the corporates into legally gained transaction, it entails the conception and notion of corporate veil, which is a fictitious barrier that demarcates between those who run it from the corporation; thereby aiding the owners or creators of Shell Companies to remain hidden from the public watch The operations of the Shell Companies are organically entrenched with the idea of money laundering, tax evasion, illegal activities, though they being legally registered corporations. The fraudulent acts so committed in due course by these corporations entails legal responsibility on them, attracting the Prevention of Money Laundering Act, 2002 [PMLA, henceforth].
The offence of money laundering per se is not an independent offence but is based upon various acts that denote the acts wherein the black money or illegally obtained money is unveiled in such a washed / modified manner so as to display it being obtained from legal setup. In order to put a system of checks and to ensure social and economic interests of a nation, various authorities like the Directorate of Enforcement [ED] and Securities and Exchange Board of India [SEBI], Financial Intelligence Unit, etc. , play a crucial role in monitoring of money laundering activities. With legislations being around as claimed to be efficient and with authorities claimed to be efficient, there is an increase in the Shell Corporations meant to launder money.
The gravity of such laundering activities not only provides a shock to the nervous centre of the nation but also to the society as a whole, one most prominent one being that of Panama Paper Leak that led the world astonished to find the voluminous Shell Companies being the intermediary of money laundering.
RESEARCH
OBJECTIVES
The objectives/aim of the present study are-
1. To decipher the conjecture of Shell Companies and their direct co-relation with money
laundering.
2. To determine the ramifications of money laundering by Shell Companies in increasing
the arena of parallel economy.
3. To acknowledge whether the current legislations are sufficient to deal with money
laundering by Shell Companies.
4. To create an analogy of the relation of different authorities and money laundering by
Shell Corporations.
5. To emphasise upon the urgency to cure the problem of money laundering by the Shell
Companies.
6. To ascertain whether money laundering is an embedded evil or a curable disease.
7. To determine whether corporate veil is an enchanted cloak or a harsh opposing reality
to the creation of Shell /Ghost Corporations.
8. To assess the response mechanism for identification of Shell Corporations indulging in
the act of money laundering.
9. To find methods to prevent commission of money laundering by Shell Companies.
RESEARCH PROBLEM
Shell Corporations provide a platform by way of depicting fictitious transactions and thereby portraying the receipts of the illegally obtained money, wherein, the aim is to show legitimised records of the illegal money so obtained. Although, there is existence of legislation to deal with money laundering by the Shell Companies, but the acts of money laundering by the Shell Companies is becoming a trend thereby. The crucial challenge is that, sufficiency of legislations might be there, but is the enforcement of the legislations timely and is there efficiency in the identification mechanism of the Shell Corporations. Even if the legislations are apt but there are procedural delays many a times, due to complexities in a statue, which render time for the criminal to get an upper hand many times.
Furthermore, the identification of Shell Companies is not easy as it is difficult to ascertain who the true hidden beneficial owner is. HYPOTHESIS The research / project focuses on the co-relation between money laundering and Shell Companies, along with an analysis of role of different authorities like ED, SEBI, etc. The main orientation is to ascertaining the sufficiency of legislations and their enforcement measures. Since, the Shell Companies are generally in complementarity with money laundering, finding a base in a tax heaven nation. The Shell Corporations involved in money laundering seek to indulge in certain organised criminal activities, like terrorist financing, etc. The nature of these corporations is such that they being registered [legal corporations] but is used just to justify the legitimacy of unaccounted money.
The modus operandi of the Shell Corporation also entails the concept of corporate veil to disguise their transaction i. e. the transactions of an entity which is not being listed on the stock exchange despite being registered. The threat that are being posed by the Shell Corporations is not only national but global as well i. e. possessing a transnational aspect, as it is not only restricted to the nation but expands its horizon to the offshore other illegal acts. This posits the question that – “Are current legislations sufficient enough to prevent Shell Corporations from indulging in Money Laundering? ” Although, Companies Act of 2013 and PMLA of 2002 are the main legislations that ought to deal with these Shell Companies, but these statues merely under the umbrella of fraudulent conduct/ fraud encompasses the punishing aspect. There are certain authorities like ED, SEBI, etc.
, that are involved in identifying and aiding the courts in proceeding with the crime of money laundering by the Shell Companies. But the crime of money laundering has not reduced despite efforts and is yet being committed. RESEARCH QUESTION The research posits the following questions-
1. Whether the current legislations are sufficient to deal with the crime of money
laundering by Shell Companies?
2. How authorities like ED and SEBI play a crucial role in identifying Shell Companies?
3. Whether all Shell Companies incline towards money laundering?
4. Is there need to adopt more effective laws and procedure for determining Shell
Companies involved in money laundering?
5. What are the possible dimensions that could be incorporated to decrease the crime of
money laundering by the Shell Companies?
RESEARCH
METHODOLOGY
The research is primarily a doctrinal research. It emphasises on analysing possible explanations and outcomes from various texts, articles and findings, so as to demystify the problems that seem prevalent. The research further entrenches itself into the legislations and further encompasses itself on subject matter literature. The research adopts Bluebook 20th Edition as citation format. MONEY LAUNDERING VIS-À-VIS SHELL COMPANIES Money is the focal point of greed and drives persons towards it for fulfilling materialist tendencies. Money Laundering is an act of masking illegally acquired money as legal. It is a category of white collar crime, i. e. those crimes which are committed by the people of upper social status and respectability in the course of their occupation as defined by Sutherland. The impact of money laundering is not only an economic offence but also a social offence.
Shell companies exist in the manifestation of running parallel economy. Parallel economy envisages the notion of an economy that does not fall within the purview of official business of a nation. Industrialisation induced greed in the minds of people for expanding their business prospects. Greek Scholars like Plato also believed that human ‘greed’ was the potential cause of crime1, which was also emphasised by Rousseau, Bentham etc. NCRB Report of “Crime in India-2022” provides that total 1, 93,385 economic offences were committed in the year 2022, out of which the cases under fraud, forgery and cheating were 1, 70, 901 in number. The channelization of the money is done usually by way of corporates which are depicted having no or minimal assets and are usually dormant in their functioning and operations merely 1 Dr N. V.
Paranjape, Criminology & Penology (including Victimology) 117, (Central Law Publications, 2019). showcasing fictitious transactions and sham invoices of the transactions, wherein, the mode is by the creation of Shell Companies. Shell Companies though are created through legal procedure but the creation is usually done in pursuance of money laundering as is evident from the case of Vijay Mallya, Panama Papers, Nirav Modi, etc. Since, money laundering is a trans-national crime; it can be committed outside India by various fictitious transactions of fake goods and services. Vijay Mallya, renowned for the Kingfisher Airlines, created Shell Companies to launder the loans taken by him from banks in India to foreign nations having favourable tax structure i. e. tax heaven nations.
The Shell Companies were showed to be run by Directors who were found to sham, and when the matter was brought into light Mallya flew to United Kingdom to avoid being prosecuted due. Nirav Modi also took loans from various banking institutions and channelized by layering them in complex financial processes by way of many Shell Companies. Similarly was the case with Panama Papers leak and Mehul Chouksey. The notion behind Shell Corporation is the corporate veil that is functional in aiding to hide the individual liability by the cover of corporate personality. The characteristics inherent of Shell Corporation are as-
1. Presence of hidden beneficial owner
2. Legally incorporated but having least transactions or fake transactions, thereby having
an essence of fraud involved in it.
3. Acts as an intermediary for conversion of illegal transactions as legal
4. They are usually created in tax heaven countries
5. Intangibility with respect to its incorporated location
6. Works on the basis of no employees along with little or no assets
Generally the motive behind creation of Shell Companies is to avoid taxes or else to involve in fraud and embezzlement activities, sometimes even such companies are involved in organised crime rackets as well. It is also premised on breach of trust or faith by the perpetrator who is dealing with unaccounted money.
Due to hidden character of the Shell Corporations, their operations of committing fraud with the public and their creditors/ shareholders remain dormant unless it is brought into light by enforcement agencies or by whistle-blower, etc. MECHANISM OF FRAUD OF MONEY LAUNDERING BY SHELL COMPANIES Shell Companies operate in the 3 layered intricate mechanisms in order to launder money-
1. Placement
2. Layering
3. Integration
LAYERING
After creating a legal financial mode, the money so legalised reach its destination where it is integrated and presented as wholly legalised money by way of a Shell Company. •Creation of a legal entity/comapny. •Inducing funds/ unaccounted money in a legal business showcasing fictitious receipts. •Creation of a bank account in the name of the company • Layering or covering the illegal money obtained into a financial process that is legitimised by a company that is legal. •Series of complex financial transactions are done, to mitigate the source of money.
PLACEMENT INTEGRATION succession. This gives persons involved in the companies an edge to dodge their existence and thereby to disentitle them from legal liability. The conceptualization of corporate veil aids the Shell Companies to aid the flow of black money in a smooth manner in the society. With the fast and smooth movement of the unaccounted money, the parallel economy becomes stronger in expanding their scope in the matters involving illicit activities. Corporate veil separates the acts done by the companies and organizations from the manoeuvres of its members. This notion of corporate veil gives an edge towards creation of Shell Companies, because it gives a mask to hide behind the corporate edifice. The piercing of the corporate veil is practiced when the Shell Companies/ companies in general commit a fraudulent act. In the case of Singer India Ltd.
2, the Supreme Court held that- “In the cases where the veil is lifted, the law either goes behind the corporate personality to the individual members, or ignores the separate personality of each company in favour of the economic entity or ignores the separate personality in favour of the economic entity constituted by a group of associated companies. The principal grounds where such a course of action can be adopted are to protect the interest of the Revenue and also where the corporate personality is being blatantly used as a cloak for fraud or improper conduct. ” The corporate veil may be lifted to ascertain the true character and economic realities behind the legal personality of the company. 3 In the case of Life Insurance Corporation of India V. Escorts Ltd.
4, the Supreme Court held that- “Corporate veil may be lifted where a statute itself contemplates lifting the veil, or fraud or improper conduct is intended to be prevented, or a taxing statute or a beneficent statute is sought to be evaded or where associated companies are inextricably connected as to be, in reality, part of one concern. It is neither necessary nor desirable to enumerate the classes of cases where lifting the veil is permissible, since that must necessarily depend on the relevant statutory or other provisions, the object sought to be achieved, the impugned conduct, the involvement of the element of the public interest, the effect on parties who may be affected etc. ”
2 Singer India Ltd. v. Chander Mohan Chadha, (2004) 7 SCC 1.
3 Dr. N.V. Paranjape, Studies in Jurisprudence and Legal Theory 518 (Central Law Agency, 2019).
4 Life Insurance Corporation of India v. Escorts Ltd., (1986) 1 SCC 264.
The Panama paper leak where the firm ‘Mossack Fonseca’ which had many branches all over the world created many Shell companies in order to aid in hiding the beneficial owner from all over the world. In order to unmask the culpability of persons involved in an offence, lifting/piercing of corporate veil is used by the courts to make a person/persons liable for the acts done, thereby, piercing the veil of corporate personality. The corporate veil indisputably can be pierced when the corporate personality is found to be opposed to justice, convenience and interest of the revenue or workmen or against public interest. 5 Incidence of corporate personality piercing may vary case to case as, so as to ascertain the origin/genesis of those hiding behind veil. All the big corporate players like Vijay Mallya, Mehul Chouksey, Nirav Modi, and Vijay Madanlal Chaudhary etc.
create shell companies offshore, and by taking loans from various banking institutions in India were creating fictitious transactions and sending money offshore, and it would be continued if there were no intricacies that came into public domain questioning their unpaid credit balance. ANTI-MONEY LAUNDERING LAWS AND ROLE OF AUTHORITIES In order to prevent the commission of fraud by the Shell companies, anti-money laundering laws are created to put a check on the illegal and fictitious transactions. Prevention of Money Laundering Act [PMLA], 2002 is the prime legislation created to prevent offences of unaccounted money transactions and thereby deals with confiscation, attachment and adjudication of the same.
Section 3 of the PMLA defines Money Laundering as “Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering”. 6 The Act of 2002 lists “scheduled offences” that deals with offences primarily encompassing the provisions under various acts that attract the offence of money laundering, like in Companies Act of 2013- Section 447 that deals with the fraud committed by the companies. Section 2(1)(y)
5 Dr. S.C. Tripathi, New Company Law 19 (Central Law Publications, 2019).
6The Prevention of Money-Laundering Act, 2002, §3, No. -15, Acts of Parliament, 2003. of the PMLA, 2002 defines scheduled offences as those mentioned in Part A, Part B where the total value in such offence involved is 1 Crore rupees or more, and Part C. 7 Money laundering deals with proceeds of crime which is defined as “any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad. ”8 It is the proceeds of crime that attracts the PMLA, wherein apart from abovementioned definition, it also includes any property that is derived or obtained from any criminal activity.
This very conception gives the reasoning that the crime of money laundering is a crime dependent on any other criminal activity/ predicate offence, of which, money laundering is a process. PMLA, thus, is to be construed with other laws/acts, as in individual capacity it cannot be done. The crime of money laundering is a process but the actual commission is by way of other crimes i. e. the predicate offences- a conduct which when committed in other country will be an offence if so specified in the national laws of that country, i. e. the offences which fall under serious offences under the national law- as per the Financial Action Task Force (FATF) 40 Recommendations. Authorities that regulate the crime of money laundering by shell companies are as-
1. Directorate of Enforcement [ED]
It is an agency of the government, established under Ministry of Finance and is tasked at unearthing and reporting any economic offences. It is the agency through which various crimes are being reported and comes to public light. It is the intelligence agency of the government and plays a significant role in doing operations to decipher financial frauds as that of money laundering in due course. It is the agency that is also authorised to conduct investigations looking into the receipts and transactions. Many a times the ED during its investigation uncovers that to avoid taxes or to involve in malicious activities the intervention of Shell Companies is used to layer the financial transactions 7The Prevention of Money-Laundering Act, 2002, §2(1)(y), No.-15, Acts of Parliament, 2003. 8The Prevention of Money-Laundering Act, 2002, §2(1)(u), No.-15, Acts of Parliament, 2003.
/ fictitious receipts into interwoven complexities to make the source of unaccounted money foggy. ECIR, i.e. Enforcement Case Information Report is the complaint mechanism that the ED files under the PMLA before proceeding with its investigation for prosecuting. ECIR is not backed by statutory force rather it is an output of administrative convenience to initiate with investigation unlike FIR.
2. SEBI [Securities and Exchange Board of India]
It is a regulatory statutory body established by the SEBI Act of 1992. The character of SEBI is to regulate the securities and their exchange and in due course, it also regulates and checks upon the working of Companies to determine their dispositions. It realises the aim towards good corporate governance. It also scrutinizes the Corporations in pursuance of shelling.
3. FATF [Financial Action Task Force]
It is an intergovernmental body. It was created by Paris Summit in 1989. The main aim is to synchronize the illegal acts and thereby to ensure the proper implementation of the recommendations being provided by it.
4. FIU [Financial Intelligence Unit]
It is an agency as well as an intelligence unit that aids and scrutinises, analyses the information and disseminates it accordingly. It is works under the aegis of Ministry of Finance.
5. MCA [ Ministry of Corporate Affairs]
It signed a memorandum of understanding with the Central Board of Direct Taxes [CBDT] in 2020 in order to share data and information on a regular basis. The MCA is the administrative ministry that overlooks the Shell Companies if any and thereby removes their names from their database.
6. ROC [ Registrar of Companies]
The ROC plays an important role in the identification of shell/ghost companies by verifying their corporate activities and when the veracity is in question, it strikes down the company from its register.
7. Authorities under the PMLA
Section 48 of the PMLA prescribes for classes of authorities that should be therea. Director or Additional Director or Joint Director b. Deputy Director c. Assistant Director, and d. Such other classes of officers as may be appointed for the purpose of this Act. 9 The Director will have the power of Civil Court under the Civil Procedure Code, 1908, while trying a suit in relation to discovery and inspection, compelling the production of records, receiving evidence on affidavits, etc. 10 With respect to the legislations, there is legislation that deal with prevention, adjudication and punishment of the offenders in the commission of money laundering using shell companies as their cohort. There are sufficient laws to deal with the crime of money laundering by the shell companies.
SUGGESTIONS Although, sufficiency of legislation is there, yet the creation and incorporation has become a dominant concept to avoid taxes or in some cases there is involvement for illegal funding. Some suggestions that could be incorporated in the present legal order to cater justice in a judicious manner-
1. Eased and favourable tax structure should be adopted to reduce the creation of shell
companies merely to avoid taxes.
9 The Prevention of Money-Laundering Act, 2002, §48, No.-15, Acts of Parliament, 2003.
10 Prevention of Money Laundering Act, 2002, §50(1), No.-15, Acts of Parliament, 2003.
2. The companies should be mandated to show transparent transactions which are not
complex but are legible.
3. A multiple check authority should also be established that will scrutinize every cross
border transactions in coherence with FATF recommendations.
4. A systematised corporate governance edifice to be induced both at national and
international level.
5. Emphasis on making transactions through electronic means which will ensure greater
answerability on part of the Shell Companies.
6. Limiting the quantum of companies a person can incorporate to certain justifiable limit
based upon the profits accruing to the company.
7. Setting a minimal limit a company needs to have premised on the previous business
nature on a weighable manner.
8. Banks/ financial institutions while giving out loans should do a proper check while
lending and should complex the procedure of lending. Lending must be given only when the corporate credit score is good along with the good credit score of the investors/shareholders, owners and members.
CONCLUSION
In the globalised era, where businesses are constantly growing and expanding, the greed of humans to acquire more is also increasing; giving rise to tendencies inclined towards the socioeconomic offences significantly the offence of money laundering. Corporate houses have gained a prominent position in the society but they are also driven by greed for money and thus in order to avoid taxes, they take median method of creating shell corporations in tax haven nations and allowing investments that will exempt from taxes to avoid paying higher taxes. To curb the menace faced by the shell corporations, anti-money laundering laws are there to try such cases and thereby subsequently the authorities are there to keep a check, like ED, SEBI, FIU, and etc. The Panama Paper leak case has brought into light the Shell Companies concept in a broad vision that has to be closely dealt with.
The best remedy to combat money laundering by shell corporations is inducing more transparent checks on the transactions of the companies, even if offshore but operating in India. Ensuring a check on the Shell Corporations would also ensure a disruption of flow of money in the parallel economy. The notion behind their incorporation is not always full of malice but is genuine as well most of the times. The strict regulatory measures of SEBI which deals with veracity of business activities also put an eye to the working of the Companies which may or might be Shell entities.
On a contrasting basis, it can be concluded that money laundering cannot be curbed and cured fully from the shackles of society due to continuance of money as a mode towards a luxurious life, but its effect and spread can be controlled with appropriate actions and measures that the Government is adopting and implementing. India is strictly focusing on regulation of Shell Companies after the shocking shadow realities of giant corporate owners absconding from India, on pretext of taking huge loans from various banks and sending it offshore by Shell Companies as a medium. On a timely basis, the Registrar of Companies and the Ministry of Corporate Affairs release the list of Shell Companies to public domain so as to prevent any fraudulent conduct of these corporations.