You’ve likely seen the term ‘shell corporation’ in news coverage of political corruption and financial crime, and in the wake of the 2016 Panama Papers data leak.
But what is a shell corporation, and why do people use them?
A shell corporation or shell company is a registered corporation that has no active business operations, so named because it is merely the ‘shell’ of a company with nothing ‘inside’ it. People and organisations use shell companies for a variety of purposes, some of which are legitimate while others involve committing financial crimes.
In this article, we explain what a shell company is and what purposes it can serve. We also discuss some of the reasons shell corporations can be cause for concern—including tax evasion.
What Is a Shell Company?
Shell companies have no employees and are not publicly traded, and they don’t deliver any goods or services to earn revenue. They’re generally created solely to hold and move assets on behalf of individuals or other businesses.
Shell companies may open bank accounts and engage in financial transactions, buy real estate, and own copyrights and royalties.
Furthermore, a shell company can be set up and owned from a different country. Certain countries, known as tax havens, are particularly popular destinations for shell companies because of their lax business or tax regulations.
Popular shell company locations include the Bahamas, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, Luxembourg, and Switzerland.
A shell corporation can be set up by a law firm in its host country, effectively masking its true owner. For example, the Panama Papers was a leak from Panamanian law firm Mossack Fonseca. The leak revealed the different ways that rich and influential people use offshore tax regimes to hide their wealth.
A shell company owner can also hire a nominee director to register the corporation under their name.
For further anonymity, it is possible to create shell company subsidiaries within a shell company. This process can be repeated multiple times to create Russian-doll-style layers. This makes the true ownership of assets difficult to trace—especially if each layer is registered in a different country.
However, this anonymity is not guaranteed or absolute, as is shown by high-profile financial investigations and data leaks such as the Panama Papers.
Why Do People Use Shell Corporations?
Shell companies are used for a variety of reasons by large public companies and private individuals alike.
Some of these reasons are legitimate, others exist in legal grey areas, and some are directly related to financial crime.
Below are some of the more legitimate reasons people use shell corporations. We will discuss the role of shell companies in financial crime in the next section.
- Sometimes, a shell corporation is simply the remnants of a business that has gone defunct or had all its assets bought out by another company during a merger or acquisition.
- A shell company can also be used by someone to gather and store funds they need to start a new business before the new company is registered.
- Some people use shell companies to make investments in foreign markets. Owning a company in a foreign country makes it easier to make investments or buy real estate in that country.
- Some companies use shell corporations to establish business operations in other countries. They might hire someone in another country to register and manage the shell company, which can act on behalf of the primary organisation without that business having to register a branch in a different country.
- Many businesses store assets in offshore shell companies to protect these assets from economic disaster. For example, someone who owns a business in a country with a volatile economy might decide to store their company’s assets in an offshore shell company. This way, if the country suffers an economic collapse the company's assets won’t be devalued and it can continue trading without going bankrupt.
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 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.
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.
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.
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.
Doing Business with a Shell Corporation
Doing business with shell companies is not illegal, but it is something you should approach with caution due to their heightened financial crime risk.
UK law enforcement holds businesses to a high standard of accountability with regard to vetting clients for potential financial crime. If your organisation is found to be involved in a money laundering scheme through a shell company, it could suffer serious reputational damage, fines, or even the criminal prosecution of staff.
To help firms vet potentially risky clients like shell corporations and maintain their anti-money laundering (AML) compliance, Red Flag Alert has created an intuitive AML service. Working in collaboration with Begbies Traynor plc and GB Group plc, we have developed a solution that is both effective and affordable. Whether you need to create a brand new compliance programme or are looking to complement your existing regime, our AML service offers:
- A full range of risk level checking
- Unbeatable match rates
- ID verification
- Enhanced due diligence
- Sanctions and PEPs real-time screening
- Monitoring alerts
- A user-friendly interface
- A secure audit trail
Find out more about how Red Flag Alert’s KYC AML platform could improve your AML compliance programme and safeguard your business from the risk of money laundering by getting in touch with the team or call on 0344 412 6699 to find out more.