Is it possible to solve the problem of shell companies?

A year ago, an investigation was conducted on the territory of Slovenia due to suspicion of abuse of position and money laundering. The investigation related to companies that issued fictitious invoices for allegedly performing construction works. Among them was a company from Bosnia and Herzegovina that issued fictitious invoices to companies in Slovenia and returned the money paid.

 

58 house searches were carried out on suspicion of money laundering and abuse of position, 36 persons were suspected, and 36 legal and 42 natural persons were included in the investigation. The total illegal property benefit amounts to more than five million euros.

 

 

 

What is a shell company?

 

Shell companies are legally permitted business entities, which do not own real assets or conduct business operations. Their very existence is legitimate, but the problem is in the illegitimate use of such companies. Most of these companies exist only by name, address and proof of registration as a financial entity.

 

Worrisome data from Moody’s Analytics

 

The mentioned case in Slovenia is not isolated and recent data from Moody’s Analytics show that there are almost 5 million suspicious companies in Great Britain alone. The total figure in the EU is estimated at around 4 million, with Cyprus and France taking the lead. There are potentially millions of fictitious, shell companies used to avoid taxes or sanctions.

 

The criteria used in the analysis include the lack of operations, connections with high-risk destinations, and the like. An analysis of the age of responsible persons was also conducted, and as they state, thousands of company directors are listed as younger than five years old. Also, a Belgian company is managed by a 900-year-old person.

 

Great Britain is at the very top of the Moody’s table, followed by Panama, Switzerland and Cyprus. Datta points out that in addition to the indicators, one should “look at the people behind the fake company … to see if there are other signs of nefarious activity.”

 

 

 

 

Who is behind the fake companies?

 

Ted Datta, Moody’s Analytics Financial Crimes Compliance team leader, says the findings are, among other things, an indication of a system that isn’t as systematic as it could be. He pointed to the lack of information in the official registers, which is worrying in itself, because the analysis of the financial system is based on them.

 

Part of the blame can be placed on the lawyers and middlemen who help individuals hide their wealth behind complex corporate structures. This is possible with few regulations and few checks.

The situation may soon change with new EU anti-money laundering rules requiring the institution providing the registration service to verify the identity of customers, just as banks do.

The U.K. tax authority HMRC has begun to fine some brokers for gross negligence, Datta noted, and expressed confusion as to why some shell company records are so obviously false. Namely, there are more than 22,000 companies that are registered at the address of the “Great Pyramid” in Egypt.

 

 

 

 

Directive of the European Commission on shell companies

 

On 22nd December 2022, the European Commission published a draft Directive aimed at controlling the use of various business entities in order to obtain tax benefits within the EU. For the most part, the Directive tries to deal with the prevention of attempts to avoid paying taxes by shell companies established by entities outside the EU member states. The Directive applies to companies based in the EU, associations and other entities without official legal personality.

Market participants who meet the criteria set by the Directive will have to submit an annual report regarding the operations of the shell company, and it is possible that they will be considered “shell companies”.

 

In order to determine whether a company will be considered “shell company”, the key indicators from the annual reports should be considered, as follows:

• The first level of indicators looks at the activities of the subjects based on the income they generate. The threshold is defined as 75% of total income in the last two years.
• To meet the second threshold, a cross-border element is required. If the company generates most of its income in transactions related to other jurisdictions or if it redirects the income to a company based abroad, then the company also meets the second threshold.
• The third threshold focuses on whether corporate governance and administration services are performed internally or externally.

The company will be considered a “shell company” if one of the set indicators is violated. The shell company will not be able to access the tax benefits and benefits of the member state’s tax treaty network.

An entity that meets all three thresholds is required to report information related to tax refunds.

 

 

 

 

Will the new EU rules be able to change anything?

 

Paul Tang, chairman of the tax committee of the European Parliament points out: I don’t see a strong enough reason why you should have shell companies” stating their problematic impact on tax collection and sanctions towards Russia.

Tang is pushing for new EU laws proposed by the Commission that would potentially deprive companies with dubious activities of the tax incentives they previously received based on revenue, cross-border activity and management.

– We need to increase revenues by solving tax evasion, and shell companies are at the centre of that. The Unshell directive, as it is known, is a “very targeted instrument”, which affects only a small part of companies. But in order to pass the Law, the proposal needs the unanimous support of all 27 EU member states, including Luxembourg.

Luxembourg is a major financial centre that the commission has already accused of facilitating “aggressive tax behaviour.” Belgian Finance Minister Vincent Van Peteghem said he wanted further analysis before supporting further procedure, citing “concerns about administrative burdens”.

 

With Belgium, as the country holding the presidency of the EU council, rushing to finalize a raft of legislation ahead of June’s European elections, Tang expressed hope that Van Peteghem would reconsider his position.

 

 

 

How to check shell companies?

 

Even with the new Laws, the question remains how you can practically check the company regarding the performance of suspicious activities. Defining the criteria too vague, broad or narrow will create a lot of bureaucracy and legal uncertainty. Datta calls this an “endless game” between those who enforce anti-money laundering rules and those who try to evade or break them. In all this, it is only possible to increase the cost of concealing wealth.