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A Guide to Shell Companies

 
Jan 16, 2023 Red Flag Alert
A Guide to Shell Companies

 

Shell companies came under the spotlight following the 2016 Panama Papers publication. The extent of their use for illegal or immoral purposes, largely for money laundering or tax avoidance, caused public outrage and a ripple of legislative changes around the world.

But what is a Shell company? How do they operate and when are they used?

This article will explore both of these questions.

What is a Shell Company?

A Shell company is one that primarily or solely exits on paper only. This means that there will be no assets linked to the shell company and it will deliver no goods, services or other business functions to generate revenue for itself.

It will have no functional physical office and if it has a registered address this will most likely be a mailbox or an address that is shared by up to hundreds of other shell companies.

Primarily shell companies are used to move or hold assets in a manor where it is not immediately obvious who the ultimate beneficiary is. Shell companies can be set up by a third party, often a lawyer or accountant, to further obscure this; and a shell company is able to have any number of subsidiary shell companies under it.

Shell companies can exist in any country but are very popular in those that are considered tax havens or have low regulatory standards; such as: The Cayman Islands, British Virgin Islands, Bermuda or The Channel Islands are examples of High Risk Countries.

Shell companies can be set up and used by legitimate businesses as well as criminal enterprises and can be used by individuals as well as organisations.

Why would a legitimate company use a Shell Company?

There are numerous reasons that legitimate companies would use a shell company and they very commonly do.

If a company wants to do business or invest in a foreign market, they may set up a shell company in that country so transactions take place within one regulatory space and are not complicated by going between borders and regulatory laws. In this case legitimate business would be done by individuals in the home country but it would be as if they operated out of the shell company in the second country.

Shell companies may be set up as a precursor to them becoming a fully operational business and may hold assets whilst they are being set up.

Companies operating in volatile economies can use shell companies to store money in more stable economies.

An extremely popular use for shell companies by legitimate enterprises is tax and regulatory avoidance.

A common example of shell companies being used for UK tax avoidance is companies using shell companies in Ireland, which has a lower corporate tax rate than the UK, and attributing their profits from UK operations to this shell company; thus paying less tax.

Should a company wish to avoid the costs and impediments of complying to high standards of regulations they in some cases they can set up a shell company in a country that has lower standards to avoid these. For example, a UK company performing activities abroad may be held to certain environmental standards by UK regulations, they can set up a shell company in a suitably poorly regulated country and attribute the activities to this shell company.

Shell Companies and Criminal Enterprise

Shell companies play a pivotal role in money laundering schemes, both in the washing of illicit funds and in obfuscating ownership of assets held in their name.

Money laundering has three distinct stages: placement, layering and integration.

  • Placement – illegally gained cash is placed into the banking system. Turning the physical notes into digital money in a bank account.

  • Layering – the money is then sent through a complex series of transactions, often crossing international borders, to hide the original source of the funds.

  • Integration – the money can no longer be easily attributed to illegal activity and is essentially clean. It can then be used as if it were legitimate funds

Shell companies are integral to the layering stage of money laundering. The aim is to create a chain of as many transactions as possible, essentially to make it as confusing as possible for investigating authorities to trace the source or destination of funds. These chains may contain dozens or even hundreds of shell companies across multiple countries.

The advantage of money laundering schemes crossing international borders is that an authority investigating a money laundering scheme will only have jurisdiction in its own country and cross border collaboration between police forces slows or even halts investigations.

Also, the countries that are popular for laundered money to be routed through tend to have low or no financial regulations which would mean their authorities would not aid in the investigation as no crime had been committed on their soil.

Many such countries also have a vested interest in allowing these schemes to prosper as they collect tax on these funds whilst not having to provide anything in return, save their lack of regulations.

To add further complexity, shell companies will not be set up in the name of the ultimate owner of the illicit funds and frequently will be listed under a false name. Even in the UK it takes a matter of minutes to create a shell company attributed to a fake identity, which can be used for illegal transactions and then abandoned with little chance of ever being traced to who initially created it.

Shell companies are also used in the placement stage of money laundering schemes. Once the washed funds have made their way back to the destination economy, they can be stored anonymously in the accounts of shell companies or used to purchase assets, such as property, which are then held under said shell companies name.

Can business be done with Shell Companies?

 As Shell companies are not illegal in and of themselves and do have legitimate uses business can be done with them in certain instances.

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 makes it a legal requirement for companies in the regulated sector to adopt a risk-based approach for all business dealings. This includes confirming who the ultimate beneficiary is for any given transaction.

Considering Shell companies do not conduct business activities for themselves there will always be an ultimate beneficiary to identify. This not being freely given is a recognised sign of illicit activity, as is a party seeking undue secrecy.

Should a shell company be easily linked to a legitimate company or individual, and all other anti-money laundering requirements be met, then it may be appropriate to do business with them.

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Why Should I Be Concerned about Shell Companies?

Shell companies in and of themselves are legal and in many cases they are used for legitimate reasons. However, shell corporations are also commonly used as vessels for committing financial crimes, such as:

Money laundering

Money laundering is a form of financial crime that allows criminals to hide the profits of crime, or disguise the illicit sources of their wealth. Criminals do this by distributing money in such a way as to make it difficult to trace.

Shell corporations are useful tools for money launderers because they are easy to set up and their ownership can be difficult to determine. 

Illegal Business

Shell companies can also be used by people who want to engage in illegal business without revealing their identity.

For example, a company or individual can use a shell company to fund terrorist activities without this funding being traced back to them.

Shell corporations can also be used to conceal one’s identity when doing business with an unpopular client—for example, if a company wants to profit from a region or industry while giving the outward appearance of boycotting it to please the public. Although this is not illegal, this kind of activity is misleading and likely to garner negative media attention if discovered.

Concealing assets

Shell companies are commonly used to conceal assets during divorces, court cases, mergers, or acquisitions.

People do this to avoid having to share their assets when they divorce, having their assets seized during litigation, or having them taken over during a corporate merger or acquisition.

Deliberately hiding assets in this way is a form of fraud, and is illegal.

Tax Evasion

Shell corporations are also frequently used by companies or high-earning individuals to avoid or evade tax.

Tax avoidance involves avoiding paying while obeying the letter of the law, while tax evasion is unlawful avoidance of tax. Shell companies are frequently used for both.

Shell corporations are frequently used to evade tax because they are relatively easy to set up and difficult to trace. One of the main ways people use shell companies for tax evasion is by hiding taxable income and assets in a shell corporation in a different country.

Certain countries are such popular locations for tax avoidance and evasion through shell companies that they are commonly referred to as tax havens, because they have low tax rates and little tax regulation.

The world’s five most popular tax havens—measured by the amount of money they hold versus how much they should hold based on their local economies—are the British Virgin Islands, Taiwan, Jersey, Bermuda, and the Cayman Islands.

How to protect yourself from illegal Shell Companies.

Red Flag Alert can protect you against the adverse legal, professional, and reputational damage from being found to have facilitated illegal activity via doing business with an illicit shell company.

Search every UK company and their financial details with Red Flag Alert company search and reports.

Red Flag Alert AML check software offers:

  • Unbeatable match rates
  • Enhanced due diligence
  • A full suite of risk checks
  • Real time PEPs and sanctions checks
  • Director Search capability 
  • Time and cost saving automation
  • Ongoing support for users
  • Monitoring alerts
  • ID verification
  • KYB Checks

Find out more about how Red Flag Alert’s KYC AML platform could improve your AML compliance programme and safeguard your business from financial crimes and reduce AML risk, Try Red Flag Alert today. 

 

 

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Published by Red Flag Alert January 16, 2023

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