THE US CORPORATE TRANSPARENCY ACT: LESSONS FOR INDIA AND BEYOND
This guest post is authored by Mr. Animesh Anand Bordoloi, an Assistant Lecturer at the O.P. Jindal Global University, and Mr. Hitoishi Sarkar, a member of the GNLU Centre for Corporate and Insolvency Law.
The United States Congress recently passed the Corporate Transparency Act (“CTA”) which applies to foreign-owned shell companies. The CTA mandates a “reporting company” to provide the Financial Crimes Enforcement Network (FinCEN) a report containing the following information for each beneficial owner(s) to be updated annually so as to reflect any changes: (1) full legal name, (2) date of birth, (3) current residential or business street address, and (4) unique identifying number from an acceptable identification document or FinCEN identifier.
The CTA resurrects the need for an identical statute in India which has struggled to deal with the menace of shell companies which is evidenced by the fact that there are 15 lakh registered companies in India, and only 6 lakh out of these companies file their annual returns. This can be largely attributed to the fact that neither the Companies Act, 2013 (“CA, 2013") nor the Companies Act, 1956 attempted to define shell companies in India. Such ambiguity clouds the Indian enforcement agencies' understanding of shell companies, and thereby presents an ideal regulatory framework for corporate entities seeking to engage in illegitimate transactions through these shell companies.
This post seeks to highlight the need to curb the menace of shell companies in India, and the past attempts by Indian regulatory authorities in that regard. The latter part of this post will seek to declutter the Indian judiciary’s understanding of shell companies, while also comparing the same to the CTA’s and Organization for Economic Co-operation and Development’s ("OECD") definition of shell companies. The concluding part will seek to draw lessons from similarly placed jurisdictions.
In India, shell companies have for long been used for hiding the identity of their beneficial owners between layers and to carry out illicit financial activities with an intent to process reverse acquisition, tax evasion, siphoning of black money, shifting of corporate profit or income to jurisdictions that are regarded as tax havens, thereby, causing huge losses in tax revenues, creating imbalances in the economy, financing terror and crimes like money laundering.
Indian courts have also fallen prey to such definitional ambiguities as in its absence, the courts are restricted to lifting the corporate veil to identify the intent of an inactive company. Given that neither the procedure of establishing a company nor investing in it is per se illegal, courts have often relied on an evidentiary approach to identify the intent of companies in such cases. Moreover, such regulatory gaps have been used to advantage in instances like the YES Bank crisis and the Punjab National Bank crisis where several shell companies were used for laundering money.
Another corresponding demand for a regulatory framework also arises from the subsequent legal and financial implications that arise if any company is wrongly deemed to be a shell company by regulatory authorities. While recognizing this, the court in Assam Company India Ltd. and Anr. v Union of India denounced ‘a finding first and thereafter initiating a proceeding to justify the finding like a post-decisional hearing’ approach by the regulatory authorities. It is pertinent to note that such errors might also be committed at the proceeding stages by adjudicating authorities as it is complicated to identify the ‘purpose’ for the inactivity of any company.
3. PREVIOUS REGULATORY ATTEMPTS
The most significant regulatory effort so far has been the establishment of the Task Force on Shell Companies. The Task Force was established by the Prime Minister's Office (PMO), endowed with a mandate to check systematically, through a coordinated multi-agency approach. This has played a substantial role in the identification and removal of shell companies from the Register of Companies under Section 248 of the CA, 2013.
Echoing similar objectives, the Income Tax department had decided to share tax information with MCA. This was a positive measure considering that it would have helped identify shell companies that engage in money laundering and tax evasion. Likewise, the Government had requested the Reserve Bank of India ("RBI") to direct the banks to freeze the accounts of defaulting companies that have failed to file annual returns and financial statements. However, the request could not materialize into a tangible policy measure as the RBI argued that such regulatory actions are beyond its competence.
4. ADDRESSING DEFINITIONAL AMBIGUITIES
Indian courts have often adopted asymmetrical approaches to define shell companies. The most favoured definition so far has been that of the ‘OECD Benchmark Definition of Foreign Direct Investment’ which defines shell companies as ‘companies that are formally registered, incorporated, or otherwise legally organized in an economy but which do not conduct any operations in that economy other than in a pass-through capacity.’ The Indian Supreme Court has on multiple occasions relied upon the OECD definition, particularly its ruling in Union of India v. Azadi Bachao Andolan. The Supreme Court’s approach seems to be the better alternative in the absence of a statutory definition as it aligns the Indian position with those of other major jurisdictions.
However, unfettered discretion to courts in defining shell companies has provided multiple contradictory judicial rulings, thereby allowing shell companies to escape regulatory actions. For instance, the Gauhati High Court in Assam Company India Ltd. v Union of India had ruled that ‘a company is classified as a shell company if it is a non-trading company that has been floated with the intention of financial maneuvering.’ This ruling muddied the waters on two counts. Firstly, it added an element of mens rea to the definition of shell companies by holding that ‘it is no offence to be a shell company per se’. Secondly, it marked a departure from the reliance on the OECD definition which had previously been the approach of the apex court. The availability of a statutory definition would help in curbing these judicial asymmetries to a large extent and aid in better regulation.
Interestingly, the MCA has so far resisted the need to amend the CA, 2013 to provide for the definition of shell companies by arguing that the present regulatory powers bestowed under section 248 of the CA, 2013 are adequate. However, this approach is erroneous on two counts. Firstly, Section 248 does not include the element of ‘fraudulent’ intent and consequently does not make a distinction between companies that are guilty of fraud and those irregular with filings. Secondly, the availability of a statutory definition would go a long way in avoiding any legal ambiguity and preempt avoidable litigation. Similar sentiments have been echoed by the Parliamentary Standing Committee on Finance which recommended that the state should expeditiously define shell companies under the CA, 2013.
5. LESSONS FROM OTHER JURISDICTIONS
Interestingly, the CTA happens to be one among many similar statutes enacted in other jurisdictions to deal with the menace of shell companies. The European Union’s ("EU") regulatory efforts in this regard are substantial and worth a detailed discussion. The Fourth Anti-Money Laundering Directive for the first time required EU member states to ensure that legal entities incorporated in their territory obtain and hold accurate and current information on beneficial ownership. Similarly, the Fifth Directive which came into force in January 2020 mandated public access to data on the beneficial owners of most legal entities, with the exception of trusts, through the use of a central register. The EU Parliament is likely to further tighten the screws on shell companies with the Sixth Anti-Money Laundering Directive which is likely to be implemented by June 2021.
The Monetary Authority of Singapore ("MAS") has also been exploring regulatory options to deal with the menace of shell companies. Notably, in 2015, the MAS set out a guidance paper on effective practices to detect and mitigate the risk from misuse of legal persons. Internationally, Article 12(2)(c) of the United Nations Convention against Corruption is of relevance as it calls on states to promote transparency among private entities and take measures, where appropriate, to identify ‘legal and natural persons involved in the establishment and management of corporate entities’.
The CTA marks an important milestone in the history of corporate regulation. However, the success of this statute will have to be measured at the anvil of implementation and not on the basis of the noble objectives it seeks to achieve. The authors are primarily of the view that the CTA shouldn’t face any hurdles in that regard as it makes sufficient exemptions to simplify implementation. The US approach should serve as a lesson for Indian regulators who have in the past endorsed a “one size fits all” approach while enacting similar statutes such as the GST Act. As most developed jurisdictions prepare themselves to curb illicit financial activities, India's efforts seem to be suffering at the root with definitional ambiguities which have been further complicated by multiple court rulings. While Indian regulatory authorities and legislators have previously been proactive in bringing regulations to check corporate fraud and similar illegal activities, it is now the time to not only bring in definitional changes, but also the procedural regulations in line with the CTA that allow authorities to keep a check.
(Note from the authors: We would like to thank Ms. Sanya Memon, a 4th-year student of Jindal Global Law School for her research assistance. All errors, however, remain solely ours. Please feel free to provide us with feedback at email@example.com or firstname.lastname@example.org)
A shorter version of this post earlier appeared at the Oxford Business Law Blog and can be accessed here.