Business Law & Compliance

What Is A Shell Company?

Luisa Ddakis | 20 September 2022 | 2 years ago

what is a shell company

A shell company is a business or individual that uses a company structure without having any significant assets or operations. Shell companies are popular for two reasons: first, they can be used to avoid taxes and domestic regulations; and second, they can be used to disguise illegal activity, such as money laundering. While there are legitimate reasons for setting up a shell company, there are also many criminal activities that involve these businesses. In this article, we will explore the world of shell companies in detail to explain everything you need to know about these often misunderstood business entities.

What are Shell Companies?

Shell companies by definition are businesses which exist on paper only and do not have a physical presence. This means that they don’t usually have a head office, employees, or any other type of physical infrastructure. In some cases, shell companies may have a small amount of staff to manage the company’s affairs, but this is usually not the case.

Shell companies can be either public or private. Public shell companies are listed on stock exchanges and are used by businesses to go public without going through the traditional initial public offering (IPO) process. Private shell companies, on the other hand, are not listed on any exchange and are often used for more nefarious purposes.

The term “shell” refers to the fact that these companies are often “empty” in the sense that they don’t have any significant assets or operations. This makes them different from holding companies, which exist for the purpose of owning and operating other businesses. Shell companies may or may not have actual physical operations, but if they do, those operations are usually very small scale. Shell companies are also known as “phantom firms”, “letterbox companies”, and “shell corporations”.

Shell companies can be registered in any jurisdiction, but they are often registered in tax havens due to the fact that they can be used for tax avoidance purposes. The most popular jurisdictions for shell companies are the British Virgin Islands, the Cayman Islands and Delaware in the United States.

Who uses Shell Companies?

Shell companies are used by both individuals and businesses. The idea is that by using a shell company, businesses and individuals do not have to consider or abide by the taxes and regulations of their home country.

Many multinational corporations use shell companies in order to minimize their taxes. For example, Apple Inc. is estimated to have saved billions of dollars in taxes by using shell companies registered in Ireland. Ireland is an attractive country because it has a low corporate tax rate.

Other well-known companies that have been accused of using shell companies for tax avoidance purposes include Google, Starbucks, Amazon, and Facebook. All of these companies have denied any wrongdoing.

Individuals also use shell companies for tax avoidance purposes. In some cases, individuals may use shell companies to hide their wealth from their home country’s government. For example, Russian billionaire Roman Abramovich was accused of using shell companies to hide his assets from the Russian government in tax havens such as the British Virgin Islands. Many British politicians and public figures were also exposed in the Panama Papers scandal for allegedly using shell companies to hide their assets in offshore accounts, including ex-prime minister David Cameron.

tax avoidance

Why do Businesses and Individuals Use Shell Companies?

The most common reasons for setting up a shell company are to avoid taxes, get around domestic regulations, increase profits and launder money.

Tax avoidance

For businesses, the use of shell companies can result in a significant reduction in taxes. This is because businesses can often structure their affairs in such a way that profits are attributed to the shell company instead of the business itself. This option is particularly useful for companies where their home country has high corporate tax.

For example, if a company is based in the UK, which has a corporate tax rate of 19%, but operates through a shell company in the Cayman Islands, which has no corporate tax, the company would be able to avoid paying any taxes. A high-profile case that has been in the news recently is the Paradise Papers scandal, where it was revealed that many multinational companies have been using shell companies in Bermuda to avoid paying taxes.

Avoiding domestic regulations

Avoiding domestic regulations is also a common reason for businesses to use shell companies. These may be regulations relating to environmental protections, labour laws, or financial reporting requirements. By operating where these regulations don’t exist, companies do not need to worry about the compliance costs associated with them.

An example of this is the case of ExxonMobil, which was accused of using shell companies to avoid regulations relating to its oil exploration activities in Indonesia. It was alleged that ExxonMobil had set up a series of shell companies in Bermuda, which allowed it to avoid paying taxes on its profits and also avoid complying with Indonesian laws.

Increasing profits

Another reason businesses use shell companies is to increase their profits. This can be done by using a shell company to invoice other businesses within the same group for goods and services that may not have been provided. This is commonly known as “transfer pricing”. For example, if a company has operations in both the UK and India, it could use a shell company based in a tax haven to invoice the Indian subsidiary for goods and services at an artificially high price. The Indian subsidiary would then be able to deduct the cost of these goods and services from its taxable profits, resulting in a lower tax bill.

Money Laundering

Shell companies can also be used for money laundering because they can be set up to hide the true beneficial owner of a company. For example, a criminal could set up a shell company in the British Virgin Islands and use it to buy assets such as property or shares in another company. The criminal could then transfer these assets to another person without anyone knowing that they were the true owner. The money used for these purchases would appear to come from the shell company but in actual fact, have come from the criminal’s illegal activities. Once invested in legitimate assets, this dirty money becomes “clean” which makes it more difficult for the authorities to track or seize.

tax havens

What are the Incentives for the Tax Havens Themselves?

The tax havens themselves also have an incentive to attract shell companies. This is because these businesses bring in a lot of money without requiring the jurisdiction to provide any services in return. This money is often used to fund the tax haven’s economy and infrastructure.

The British Virgin Islands, for example, does not have any corporate income tax, capital gains tax, or estate tax. It is a small island with a population of fewer than 30,000 people and yet it is home to more than 400,000 registered companies. The Cayman Islands, another popular jurisdiction for shell companies, has a population of fewer than 60,000 people but is home to more than 18,000 registered companies. The Cayman Islands has no personal income tax, corporate income tax, or capital gains tax.

The lack of taxes and regulations in these jurisdictions makes them very attractive to businesses and individuals who want to minimise their taxes. Visas for these countries are also very easy to obtain both for individuals and businesses so the process of setting up a shell company can be very straightforward.

Are there any Legitimate Reasons for Shell Companies?

There are some legitimate reasons for businesses to set up companies in another country but these are known as holding companies. They are similar to shell companies in that they are used to hold assets such as shares in other companies or property but they differ in that they are usually set up for a specific purpose.

For example, a company may want to establish a presence in a country where it doesn’t have any operations yet but expects to in the future. By setting up a holding company, the business can create a legal entity that can then be used to open a bank account, sign contracts, and carry out other activities in preparation for when the company starts operating in that country.

Another legitimate reason for businesses to set up holding companies is to protect their intellectual property. This can be done by setting up a holding company in a jurisdiction where the laws relating to intellectual property are more favourable. The holding company can then own the intellectual property and license it to the main company. This can help to reduce the risk of intellectual property being seized or stolen.

Individuals may also set up holding companies for legitimate reasons such as to protect their assets from creditors or to manage their wealth in a more tax-efficient way.

global laws on shell companies

Global Response to the Issue of Shell Companies

There are a number of international treaties and conventions that touch on the issue of money laundering and tax evasion which can have an impact on shell companies.

The most relevant treaty is the Organisation for Economic Cooperation and Development’s (OECD) Model Tax Convention. This treaty provides guidance on how countries should treat income from cross-border transactions and sets out rules to prevent tax evasion. It also requires countries to exchange information about taxpayers with each other.

The OECD also updated the Model Tax Convention to include new rules specifically relating to shell companies. These rules are designed to make it harder for businesses and individuals to use shell companies to avoid taxes. They require countries to exchange information about the beneficial owners of companies and also place restrictions on the use of bearer shares (a type of share that can be owned by whoever holds the physical certificate) and nominee directors (individuals who are appointed to act on behalf of the real owner of a company).

In addition, a number of countries have signed up to the Common Reporting Standard (CRS) which requires financial institutions to share information about their customers with the tax authorities. This makes it much harder for individuals to hide assets and income in offshore accounts.

The Financial Action Task Force (FATF) is an intergovernmental body that sets standards and promotes measures to combat money laundering and terrorist financing. It has published a number of recommendations relating to shell companies, including that countries should require companies to obtain a license or permit before they can be set up, and that companies should be required to maintain records of their beneficial owners.

The United Nations Convention against Corruption (UNCAC) is another international treaty that contains provisions relating to shell companies. It requires countries to take measures to prevent the formation of shell companies and to require beneficial ownership information to be recorded and available to the authorities.

There are also a number of regional initiatives aimed at tackling the issue of shell companies. For example, the European Union has introduced a number of measures, including the requirement for companies to maintain a register of their beneficial owners and to have their accounts audited by an independent body.

In 2016, the G20 countries committed to taking action to improve global tax transparency and prevent the use of shell companies for tax avoidance and evasion. As part of this commitment, they agreed to exchange information on the beneficial owners of companies on an automatic and reciprocal basis.

The Panama Papers leak in 2016 also led to a number of countries taking action to crack down on the use of shell companies. For example, the UK introduced a new requirement for companies to disclose their beneficial owners when they are set up, and the US introduced new rules requiring banks to obtain information about the beneficial owners of their customers.

stop corruption

Final Thoughts

As you can see, the answer as to what a shell company is can be more complex than at first sight. The important thing to understand is that while there are some legitimate uses, such as raising capital or holding assets, shell companies are often used for illegal activities, such as money laundering, tax evasion and avoidance, and hiding assets from creditors. If you are even engaged in any business dealing with shell companies, be careful because you never know who you are actually dealing with.

Related Topics

Who is Responsible for Ensuring Compliance with GDPR?
8 June 2023

Who is Responsible for Ensuring Compliance with GDPR?

Read More →
How to Register a Small Business
30 March 2023

How to Register a Small Business

Read More →
What Is A Company Registration Number?
17 October 2022

What Is A Company Registration Number?

Read More →
Advantages And Disadvantages Of Running An LLP
11 October 2022

Advantages And Disadvantages Of Running An LLP

Read More →
How To Change A Company Name
3 October 2022

How To Change A Company Name

Read More →
Guide To Dissolving A Company
29 September 2022

Guide To Dissolving A Company

Read More →

If you enjoy reading our articles,
why not sign up for our newsletter?

We commit to just delivering high-quality material that is specially crafted for our audience.

Join Our Newsletter