How shell companies are used to channel black money

The classic image, as portrayed in Indian films, of corporate corruption is one of a suited businessman handing over a suitcase stuffed with cash to a khadiclad neta.

Indeed, if there is a single physical object in India that often does symbolise corruption, payoffs and black money, it is a closed suitcase. In the appropriate context, it evokes all sorts of associations about what could be in it, and who it is for, and the motives of those involved.

This mental image is now laughably out of date. In purely physical terms, the amount of cash that can be stashed away in a suitcase (or several) is now too small given the ambitions of both the businessman and the politician or bureaucrat in question.

The sheer quantum of money involved in some of the biggest scandals such as 2G or coal — several thousand crores — makes it completely impractical, and dangerous, to keep that money lying around in physical form, unless absolutely necessary.

The more appropriate image these days is far more abstract and difficult to portray in films, but it is far more suited to the task of handling large volumes of money — the corporation.

Indeed, in retrospect it is obvious that a corporation is an ideal entity for the task since it was specifically designed, from the outset, as a legal entity to raise, allocate, handle and move large volumes of money.

At the same time, it has an existence that is legally completely separate from the persons who set it up.

But there is no reason, at the outset, why something that can be used for perfectly legal and above-board businesses should not also be used to handle black money or tainted money as well.

Paper Craft

While we are aware of how a company domiciled in a tax haven like the Cayman Islands can be used to funnel money into India (or become a repository of it overseas), India has its own fair share of ‘dummy’, ‘shell’, or ‘paper’ companies, which play a critical part in the process of moving black money from one person to another.

One of the many transactions that characterized the 2G case was the alleged movement of around Rs 200 crore from companies related to DB Realty (a group company which was allotted a spectrum licence) to Kalaignar TV, linked to the DMK, then ruling in Tamil Nadu.

The money allegedly moved through a set of companies and investigative agencies claim that this investment was, effectively, illegal gratification.

Later, that same money was ‘repaid’, with ‘interest’, something the ED claims was a sham transaction disguised as a legitimate deal. Counsel for telecom minister A Raja and DMK MP Kanimozhi claims that they were in no way connected with the flow of money.

The DB group has claimed that there was nothing untoward in the transaction which was done to purchase a stake in the channel, a deal which fell through.

In the coal scam too, sets of dummy companies, many of them Kolkatabased, were used as conduits to move money back and forth, often in seemingly bewildering patterns. Part of this is just to create more work for law enforcement. If company A needs to transfer funds to company Z, it is unlikely to do so directly. Instead it will transfer the funds to B, which will transfer it to C, and so on, into Z. Untangling this web of transactions is time consuming and difficult, even for investigators with the force of the law behind them.

But layering offers plausible deniability. A politician can claim that while he is accountable for money invested into his own company (company Z), he can hardly be held accountable for his investors’ source of funds (companies Y, X, W and so on). If the owner of company A is a powerful industrialist who just happens to have benefitted from government contracts controlled by the politician in question, well, that is just sheer coincidence.

Indeed, corporations are so efficient a means of transferring unaccounted-for money that a whole organized business involving lawyers and accountants has evolved, to manage and sell dummy companies offering just these services for a commission. The hub of this business started in Kolkata in the 1980s, but it has now moved into other large metros.

Attempts to crack down on specific forms of investment into such companies have been only partially successful simply because when the law closes one loophole, accountants and lawyers find another.

Corporations have other benefits. One of the most commonly known is with respect to real estate deals. If one person sells a house to another, the stamp duty can be a hefty chunk of the final price.

In addition, the seller has to pay capital gains tax. If instead, the seller transfers ownership of the house to a dummy company and sells the shares in that company to the buyer, the net effect is the same, but the duties and taxes paid fall sharply. There is no need to register the sale of the property since the property was never sold in the first place — only the company owning the property was. Ownership in high value properties such as those in Lutyens Delhi or South Mumbai, now often resides in the name of companies rather than individuals.

The Solution

It seems on the face of it that it should be easier to regulate, and go after, a company registered in India than one in the Cayman Islands, and this is largely true. An investigator would any day prefer to track down a dummy company and its investors based in Delhi, rather than say Switzerland or the British Virgin Islands. But because corporations exist for perfectly legitimate reasons, any attempt to change the environment in which such companies operate will also affect the shell companies’ business.

Making it easier to register a company, for instance, is good for entrepreneurs with an idea for the next breakthrough product and who need to raise funding from venture capitalists, but it is also good for an accountant looking to facilitate flow of money between an industrialist and a politician.

Conversely, closing off legal loopholes which allow dummy companies to flourish can end up hurting actual businesses. It’s a fine balance that the government must tread.

 

Source: http://articles.economictimes.indiatimes.com/2014-11-02/news/55682470_1_black-money-suitcase-cayman-islands/2