India targets shell companies in black money crack down

Such entities are often used to hide and launder illegal wealth and avoid taxes, depriving the government of revenues

In this photograph taken on December 16, 2016, an Indian waiter makes his way past financially themed decorative panels at a function in Mumbai, following the government's shock move last month to withdraw high-denomination 500 and 1,000 rupee banknotes from circulation in a bid to tackle tax evasion.
Prime Minister Narendra Modi unleashed chaos with his bombshell move to pull the high-value notes, triggering long queues outside banks and ATMs which have been running dry as thousands throng to them. The sweeping abolition was meant to bring billions in so-called "black", or undeclared, money back into the formal system, the government says.

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India has stepped up its efforts to crack down on "shell companies" in the country as it strives to clean up its business environment.

“The government is not leaving anything to chance,” says Nishank Goyal, the chief executive of Masters India, a tax solutions company. “The government has seen the complete picture of 'black money' and they're trying to attack it from everywhere.”

Shell companies are a widespread problem in India, often used to hide and launder illegal wealth, or black money, on which taxes due have not been paid.

The Indian government has deregistered 200,000 shell companies, and last month it froze their bank accounts. About 300,000 directors of shell companies have been blacklisted by the authorities. There are understood to be many more such companies that have yet to be identified.

The government is also investigating suspicious deposits of more than US$1 billion made by 20,000 shell companies after the prime minister Narendra Modi moved to root out and halt black money flows in November last year by suddenly banning the two highest-value banknotes.

"Our purpose is to increase compliance so that investors' confidence increases in Indian companies,"  PP Chaudhary, India's junior minister for corporate affairs, told Bloomberg News. "This will also attract foreign investors who would be sure that the companies they are investing in are genuine. We will have to curb shell companies if we want to increase confidence of investors in India".

In August, India's markets regulator, the Securities and Exchange Board of India (Sebi) ordered stock exchanges to take action against 331 shell companies listed on Indian bourses.

Shell companies have played a role in hampering the growth of the Indian economy, with tax revenues to the government being diverted because of the existence of such vehicles.

Estimates of the amount of black money in the India economy range from 10 to 20 per cent of the country's GDP. The IMF puts the country's GDP at $2.26 trillion for last year.

The government has come under immense pressure of late to take steps to boost the economy. There are widespread concerns about flagging growth in the country. In the quarter between April and June, India's GDP growth slowed to a three-year low of 5.7 per cent, down from 7.9 per cent in the same months a year earlier. It is widely accepted it needs to achieve levels of above 8 per cent to support its population.

The move to close in on shell companies also comes as the government has faced questions over how effective demonetisation was, with figures from the Reserve Bank of India showing most of the banned notes were deposited in banks following the demonetisation announcement - suggesting that the black money has made its way into the formal economy.

This is only adding to the pressure on authorities to take action.


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Mr Modi's government “is cracking down on shell companies as part of its larger programme of cleaning up the economy”, says VK Vijayakumar, the chief investment strategist at Geojit Financial Services, headquartered in Kochi in Kerala.

The Panama Papers leak on tax havens last year has brought the matter of illegal money flows into focus globally.

Analysts say that there is a significant shift in India towards eradicating the problem with the measures that are being taken.

“I think this is a real fight toward curbing black money and it's not something we've seen before in the history of the Indian economy,” says Mr Goyal. “It's very refreshing.”

When businesses evade tax through shell companies, it means that a number of legitimate law-abiding firms are left at a competitive disadvantage because they are paying their taxes and are left with lower profits, he says. Therefore, it is important to make sure they are competing in a level playing field.

The efforts are continuing. It has emerged that India's central government is now urging the country's state authorities to try to identify and investigate properties owned by the shell companies that it has deregistered.

Meanwhile, Sebi is aiming to tighten regulations to prevent dubious companies from getting listing stock exchanges, the Indian business newspaper Mint reports.

The moves are largely being welcomed by corporate India, with the country's reputation having been tarnished by the fact that corrupt practices are so widespread.

“It is indeed a welcome step, which will boost the confidence of the investors as it will result in elimination of many shell companies and also act as a deterrent for any future misuse of corporate structure for fraudulent activities,” says Inder Mohan Singh, a partner at Shardul Amarchand Mangaldas, one of India's biggest law firms.

Mr Vijayakumar says the emergence of shell companies can be traced to high income taxes and corporate taxes in India.

“To evade these high taxes many businessmen resorted to over-invoicing of imports and under-invoicing of exports,” he says. “The difference became unaccounted money, which was sometimes stashed abroad. A part of this money later came back to the country through 'round tripping' via the stock markets. Shell companies were also used to derive the benefit of exemption of long-term capital gains from shares.”

But there are "many hurdles on the way", when it comes to cracking down on these entities, he adds.  "Since there is no definition of a shell company, the companies identified can move [to] the court and stall proceedings."
Mr Singh says the steps authorities are taking should be effective in eliminating the use of such companies for illegal purposes, but he goes on to explain that some legitimate firms have been caught in the crossfire.

“This has resulted in some of the companies incorporated for bonafide purposes and which were waiting to commence business to face flak of the government,” says Mr Singh. “In the recent past, India has witnessed a steady economic growth resulting in substantial growth in incorporation of companies. Many of these companies have been incorporated for lawful purposes, to promote start-up ventures, for example.”

There are some who remain more sceptical about the steps that are being taken.

Sangeeta Lakhi, a senior partner at Rajani Associates, a law firm based in Mumbai, says she expects the measures to ultimately be “unfortunately, not very effective”.

“Such measures do create a temporary dent in the activities and business but we Indians find new ways to carry on our activities,” Ms Lakhi says.

With large amounts of black money often going abroad, it becomes even more challenging for the Indian authorities to trace such activities.

But others remain confident that the problem can ultimately be eradicated.

“Certainly if the government continues to strive to solve the problem – as they are currently doing – then we'll be able to come out of this whole cloak of black money,” says Mr Goyal.