To curb illicit finance, it is crucial to understand the tools, vehicles and arrangements that facilitate it. Illicit finance is generated through tax abuse (avoidance, dodging and evasion) by multinational companies and elites, crime, corruption, trade manipulation and abusive transfer pricing methods. Its cross-border flow is known as illicit financial flows. The word ‘illicit’ indicates its systemic and abusive impact on the realisation of human rights and the development agenda, especially of developing countries. It is thus, necessary for state institutions to take appropriate actions against the enablers of illicit finance. Shell companies are vehicles that facilitate activities like tax abuse, hiding illicitly gained assets or money laundering by disguising true ownership. Infamous fugitive Nirav Modi was found to have used 17 shell companies to launder Rs 5,921 crore in the year 2017 alone.

Multiple disqualification and deregistration drives were undertaken by state authorities to target shell companies since last year. Companies that failed to provide financial returns consecutively for a period of three years came under the axe first. Consequent delisting also included limited liability partnerships. One of the biggest gaps in this exercise has been the failure to distinguish dormant companies from shell companies and holding true owners accountable. Many directors who were disqualified as a result moved court and were able to secure relief. Companies that were incorrectly classified as shell companies were later declassified. Moreover, disqualifying directors on the basis of the above criteria alone proved to be a cumbersome and largely opaque process.

Realising the counter-productive nature of this exercise, the ‘Taskforce on Shell Companies’ was instituted under the Ministry of Corporate Affairs (MCA). This taskforce has attempted to address the need to define and identify shell companies with 18 parameters, some of which are yet to be disclosed. Primarily, shell companies have obscure ownership, no particular business activity, low paid-up capital, few or no employees and assets comprising of cash or cash-based equivalents. The database on shell companies compiled by the Serious Fraud Investigation Office, one of the members of the taskforce, are divided into three categories – confirmed list, derived list and suspect list.

More than anything, there is a need to understand who benefits from this exercise and establish accountability to discourage any misuse. International institutions, financial intelligence units and state authorities in this effort have drawn distinctions between a legal owner, nominee and a ‘beneficial’ owner of an entity. A beneficial owner, is the natural person, who derives economic benefits, has voting rights or exercises control either directly or indirectly over a legal entity. In this regard, a beneficial owner is the true owner of an entity.

Who are the true owners?

Last month, the MCA issued a circular updating the transparency clause on ‘significant beneficial ownership’ (SBO) under the Companies (Amendment) Act, 2017. While reducing the threshold of identifying beneficial ownership from 25% to 10% is a welcome move, there is however, need for legal clarity in this clause. Presently, this clause has to be read with sub-section 10 of section 89 of the Companies (Amendment) Act, 2017. This implies that anyone with a shareholding interest of 10%, who was previously not registered with the Registrar of Companies (RoC), would now be identified as a natural person who has significant beneficial interest in that entity. The clause should mention that this new disclosure of natural persons includes the beneficial owners previously known to RoC to strengthen its reading. Further, SBO rules do not extend to companies, real estate investment trusts and other entities regulated by the Securities and Exchange Board of India (SEBI), who has mandated a threshold of 25% for ownership disclosure on foreign portfolio investments and 15% threshold for partnership firms. Jurisdictions that have been deemed high-risk by SEBI, likely to be offshore financial centers or tax havens, have disclosure requirements set at 10%.

The point about identifying the ultimate beneficial owner of an entity is to hold a natural person liable that is otherwise hidden behind layers of secrecy. This transparency reform takes a severe hit where the government of India has reserved the right to abstain any certain class or classes of persons from disclosing their beneficial ownership information. Additionally, if overseas arrangements are used to conceal ownership information, the SBO clause must apply to foreign and domestic beneficial owners alike. The acting authority must ensure appropriate probe is carried out especially in the case of listed companies.

The SBO clause must be furthered by mandating public registries of ultimate beneficial owners for all legal entities including trusts, foundations, companies, limited liability partnerships, associations and co-operative societies, open to both public and state scrutiny. Countries like Afghanistan, Slovakia, the UK, Kenya, Jamaica and others have either committed to or already have public beneficial ownership registers on companies in place. An investigation into nearly 4 million companies registered in the UK public register on beneficial owners of companies revealed firms with suspicious activity, circular ownership structures and potential avenues of abuse. The open nature of the register allowed for an in-depth analysis into its current weaknesses.

The next steps for the taskforce could possibly include isolating disqualified directors who are also significant beneficial owners of a company. Provisions and processes of internal co-operation have been put in place between the various members of the taskforce.