Shell Companies

CA SRIPRIYA KUMAR Overview

SHELL COMPANIES – IMPACT ON AUDITOR WHAT ARE THEY. ECONOMY SAFEGUARDS

CA Sripriya Kumar SHELL COMPANY What is a Shell Company

A shell corporation is a company or corporation that exists only on paper and has no office and no employees, but may have a bank account or may hold passive investments or be the registered owner of assets – Wikipedia

In the initial analysis, it has been found that 'Shell Companies' are characterised by nominal paid-up capital, high reserves and surplus on account of receipt of high share premium, investment in unlisted companies, no dividend income, high cash in hand, private companies as majority shareholders, low turnover and operating income, nominal expenses, nominal statutory payments and stock in trade, minimum fixed asset- https://www.business-standard.com/article/news- ani/analysis-of-shell-companies-reveal-extent-of-financial-irregularity-in-india- 117021001200_1.html

CA Sripriya Kumar What is a Shell Company

One of the key challenges has also been the lack of a definition of a Shell Company. The OECD definition is as under

”OECD defines ‘shell companies’ as a firm that is formally registered, incorporated, or otherwise legally organised in an economy but which does not conduct any operations in that economy other than in a pass-through capacity”

CA Sripriya Kumar What is a Shell Company

i.entities with insignificant business or assets; ii.entities set up to mainly facilitate cross-border currency and asset transfers along with transfer of large sums to related entities; iii.firms having no economic rationale in their banking transactions; iv.multiple companies having the same address; v.no physical existence at the given address; vi.high ticket transactions inconsistent with the business of the company; and vii.rotational transactions with no apparent legitimate business group

https://economictimes.indiatimes.com/news/economy/policy/govt-regulators-mull- challenge-proof-definition-for-shell-companies/articleshow/64145993.cms?from=mdr

CA Sripriya Kumar Low Share Capital Low or Nil Business and High Fixed Assets Operations and low P & L Share Activity Premium

High Loans and More or Less Assets and High Advances Liabilities in the Balance Borrowings or Sheet Investments

CA Sripriya Kumar No P & L activity, no interest received or paid, dividends Financial Statements received or paid

Share Capital and possibly a huge premium

Loans and Advances

Trade Payables

Fixed Assets

Investments

Loans and Advances

CA Sripriya Kumar (S)HELL COMPANY

CA Sripriya Kumar Entity to hold another entity’s Convenient to hold bribes as money and transactions with Current Liabilities / loans and No employees / products or pass them as investments or services loans and advances

Placement , layering and final Tax Saving devices – Huge integration of funds excess share premiums untaxed until amendment to Directors are usually Sec 56 “namesake” persons with no knowledge or connection to the business Unaccounted money, Tax Loss and Money Laundering CA Sripriya Kumar The Story of Raktabhija

The focus has always been on large corporate failures and monitoring large corporates, but even 50 to 100 of these Shell Companies have greater potential to damage the fabric of a clean economy that we all seek to achieve

ED SFIO MCA IT SEBI Auditors GOVERNMENT INITIATIVES Taskforce on Shell Companies’ was instituted under the Ministry of Corporate Affairs (MCA) in Feb 2017 . This taskforce has attempted to address the need to define and identity shell companies

ED SFIO MCA IT SEBI

CA Sripriya Kumar • The Ministry of Corporate Affairs (MCA) has struck off 6.07 lakh, about a third of the total 18.28 lakh registered companies, defunct companies from the official records, as of November 30 as a part of the plan to crack down on shell or paper companies. ( Jan 2019 ) https://www.moneycontrol.com/news/business/economy/one- in-three-companies-in-india-found-defunct-struck-off-official- records-3366571.html

• Preliminary lists of Shell companies – 80000+, 16000 stated to have been shared by SFIO / ED / CBDT for further actions . One such list is also circulating in the Public Domain

ED SFIO MCA IT SEBI Auditors

CA Sripriya Kumar • Reducing the layers of Investment Companies to 2 layers in the Government Companies Act 2013 • Director disqualification for non filing of MCA returns for 3 Initiatives consecutive years

• Taxation of Excess share premium in closely held private companies by an amendment to Sec 56(2)(viib) by an amendment to Finance Act 2012

• Amendment to Sec 248 of the Companies Act 2013 on Beneficial Ownership of Shares

• Restrictions on deposits – trade advances > 365 days

• IT return forms for Directors and shareholders of listed companies to curb dummy directors / investors

• Schedule III disclosures on Investments made by Companies

CA Sripriya Kumar Government • Enhanced CARO reporting on all Loans and Advances Initiatives obtained by Companies • CARO - transactions not recorded in the books of account have been surrendered or disclosed as income during the year in the tax assessments under the Income Tax Act, 1961

• CARO requirement on Internal Audit , no material uncertainty exists as on the date of the audit report that company is capable of meeting its liabilities existing at the date of balance sheet as and when they fall due within a period of one year from the balance sheet date

• Schedule III disclosures on Investments made by Companies

CA Sripriya Kumar AUDITOR SAFEGUARDS Are Auditors taking this seriously ?

143(1) (a) whether loans and advances made by the company on the basis of Inquiries security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its under members; Companies (b) whether transactions of the company which are represented merely by Act 2013 book entries are prejudicial to the interests of the company; (c) where the company not being an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company; (d) whether loans and advances made by the company have been shown as deposits; (e) whether personal expenses have been charged to revenue account; (f) where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading: CA Sripriya Kumar Auditors Safeguards THE CLIENT Basic • Is the Client still Active as per the MCA records. If the client is struck Safeguards off , then how will the audit be carried out. The Company has to be restored first ?

• Are the directors NOT qualified as per MCA records for non filing of financial information for consecutive years although they certify that they are indeed not disqualified

THE DIRECTORS

• Who are the Directors of the Company. Are they real. Do they exist. Are they aware that they are directors. Insist on meeting the Directors

• Exercise caution in obtaining the certificate under Sec 164(2) of the Companies Act 2013. Insist on the certificate to be provided in

writing and counter check the certificate with referenceCA to Sripriya MCA Kumar records Auditors Safeguards

Basic TRANSACTIONS Safeguards • Understand and appreciate the aging of all balances including Share Capital

• Confirmation of all financial Balances as well as contingent liabilities is a must.

• Repeat qualifications on inability to obtain confirmation of balances may not be acceptable and should give rise to Professional Skepticism

CA Sripriya Kumar SOURCES OF FUNDS Auditors Safeguards

Share • Obtain a copy of the Share Purchase agreement Capital • Check once again , although it is an earlier period whether bank funds and were actually received for the Shares allotted Premium • The Share valuation should have been done and a certificate would have been issued. Obtain a copy of such certificate although it may have been an earlier period. Are the projections in line with the actual financial information

• Obtain confirmation that the shares are continued to be held by the Share holder for both the share holder being a Corporate or non corporate

• If the share holder is a corporate, down load all the MCA data and check if the share holder company is still active or has been struck off by MCA. See if the financial statements have been filed promptly CA Sripriya Kumar Auditors Safeguards

Share • The share investment in your client should have been disclosed in Capital the Investments schedule in the financial statements and • Review all Income tax assessment orders of the client Premium • Check is any dividends have been declared. Enquire as to why some one would invest large funds without any expectation of return

• Report as appropriate

CA Sripriya Kumar Auditors Safeguards • Obtain a schedule of all loans and check if funds were received by the Financial Company in the first place or if the same was only book entries. Loans and • Get the aging of the loan. Advances • Get a copy of the loan agreement. If no such agreement exists, then it would raise a Red flag as to why the lender would advance funds without documentation necessary for future legal recourse

• Perform all CARO procedures in relation to loans received with regard to principal and interest charged. If no interest is charged, obtain reasons therefor especially in case loan funds have been received by your client from a Corporate and such loans would have been prejudicial to the interest of the lender of such funds

• Is there any violation of the Acceptance of Deposit rules – Is Sec 73 to Sec 76 of Companies Act 2013 complied. Have Sec 185 and 186 Compliances been met CA Sripriya Kumar Auditors Safeguards

• Check records to ensure if the party still exists – MCA records and Financial other information. The person who has given the loan should not Loans and be fictitious or a paper entity Advances • Insist on confirmation of balances from such parties from whom loans have been received by your client

• A crucial question would be as to why the party who has lent money does not want the funds back especially when the loans are of high aging

• Has the other party issued any legal notices for the recovery of the amount

• Review all Income tax assessment orders of the client

• Report as appropriate CA Sripriya Kumar Auditors Safeguards

• Obtain a schedule of all trade advances and current liabilities and check if funds were received by the Company in the first place or if the same Trade was only book entries. advances • Get the aging of the advance

• Is there any violation of the Acceptance of Deposit rules – Is Sec 73 to Sec 76 of Companies Act 2013 complied. Is the advance pending for more than 365 days

CA Sripriya Kumar Auditors Safeguards

• Check records to ensure if the party still exists – MCA records and other Trade information. The person who has given the loan should not be fictitious or a paper entity advances • Insist on confirmation of balances from such parties from whom loans have been received by your client

• Has the other party issued any legal notices for the recovery of the amount

• Review all Income tax assessment orders of the client

• A crucial question would be as to why the party who has provided a trade advance does not want the funds / goods or services back especially when the loans are of high aging

• Report as appropriate CA Sripriya Kumar APPLICATION OF FUNDS Auditors Safeguards

Fixed Assets • If funds received have been used to purchase Fixed assets, check the Share valuation and the estimate projections if this was the intended purpose for the investors to bring in the money

• Is the fixed asset in the name of the company. Is it under litigation. Who is occupying the said asset, if land and buildings . Is the asset generating revenue

• Review all Income tax orders and court cases if any on such properties

• Perform all CARO compliances in this regard

• Report as appropriate

CA Sripriya Kumar Auditors Safeguards

Investments • If the funds received have been invested in other entities as Share capital and Premium. Check the year of investment and obtain a copy of the Valuation Reports. Are the Share premiums justified with reference to actuals

• Are the investments properly disclosed as per Schedule III requirements in our client

• How old are the investments. Has the investment resulted in any return to your client

• Has the investee company been struck off in the MCA records

• Have any of the directors of such investee companies been disqualified

• Obtain a copy of the Share Purchase Agreements

CA Sripriya Kumar Auditors Safeguards

Investments • In case of investment in shares of other companies / LLP, down load the MCA data of the investee companies and check if the investment is still held in the books as per their Shareholding schedule

• In case of investment in capital of partnership firms etc, obtain a confirmation and a certificate from the authorised person of such partnership

• Are the end use of such invested funds monitored. That is, as a share holder who has invested funds, is your client obtaining any monthly reports, receiving notice of AGM, attending AGM etc

• Any litigation initiated by the client

• Obtain confirmation of share holding in the said entity. Can we be sure that the shares have not been transferred to some other entity

• Report as appropriate CA Sripriya Kumar Auditors Safeguards

Loans and • Obtain a schedule of all loans and advances along with name of party and Advances contact details • Obtain loan agreements. If no such agreements are available, enquire as to why, funds would be advanced without such documentation necessary for legal recourse

• Prepare an aging of such loans and advances. Why is the loan not repaid back to the client

• Ensure CARO reporting on such loans and advances

• Check if loans have been provided on an interest free basis and why this has been done

• In case loans and advances have been given to companies and LLP’s check if the entity is still active or struck off from MCA records CA Sripriya Kumar Auditors Safeguards

Loans and • In case loans and advances have been given to companies and LLP’s check if Advances directors are disqualified and enquire about the same • Has any litigation been initiated by the client to enable recovery of the loan

• Obtain confirmation of balances

• Report as appropriate

CA Sripriya Kumar APPRECIATION OF CONNECTED AND RELATED PARTIES Auditors Safeguards Connected Parties WHO HOW • Share holders • Common Directors

• Loans and advances received • Related directors

• Current liabilities in whose favour • Common addresses

• Asset purchases • Common mail ids

• Investee Companies

• Loans and advances given

Can there be a situation where loans and advances etc have been given to and / or received from connected entities but a qualification that confirmations could not be obtained. Is this feasible, especially if the auditor is common CA Sripriya Kumar THANK YOU

CA SRIPRIYA KUMAR [email protected] 9841026973 THE AUTHOR IS A PRACTIISING CHARTERED ACCOUNTANT AND A FORMER MEMBER OF THE CENTRAL COUNCIL OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA . VIEWS AND SUGGESTIONS ARE PERSONAL