Shell corporation

In business and finance, a shell corporation (or shell company) is a business that exists primarily or exclusively on paper, with few, if any, employees and limited or no physical offices or operations. Shell corporations are used by a variety of entities, including large multinational corporations and other legitimate businesses, as well as illegitimate enterprises and very wealthy individuals. Due in significant part to their portrayal in entertainment and popular culture, shell corporations are widely associated with illegal activities such as tax evasion and money laundering. However, they have many legitimate uses, and most shell corporations are used legally for tax reasons, securities trading, and as vehicles for soliciting and holding venture capital and other forms of startup funding.

Shell corporations can be legally established either anonymously or by identifiable entities. In free-market economies, setting up a shell corporation is a straightforward and inexpensive process that practically anyone can undertake. However, an individual or a business requires significant assets to benefit from the functionalities a shell corporation can provide.

Background

Shell corporations are private, non-traded companies that are not listed on financial markets and are inaccessible to retail investors, even if they are owned by businesses whose shares trade on one or more stock markets. A large majority of shell companies exist solely on paper and lack any kind of physical offices or operations. In the United States, they must be registered with the Securities and Exchange Commission (SEC) and have a mailing address. However, in many cases, these mailing addresses belong to professional services corporations that specialize in establishing shell companies on behalf of their clients, either domestically or in offshore locations.

Structurally, shell corporations are usually configured as limited liability corporations (LLCs) or trusts. LLCs are business entities that establish legal separation between themselves and their owners for the purposes of tracking assets, debts, and credit-rating considerations. Trusts do not establish this same type of legal separation, as they remain associated with their owners and operators, who function as trustees and are individually responsible for any debts and liabilities the trust may incur. However, trusts have no tax liability under US law and can distribute income and assets to their trustees.

A similar type of business instrument known as a special purpose entity (SPE) or special purpose vehicle (SPV) functions similarly to a shell corporation, and the two are often confused even though they differ in important ways. SPEs/SPVs act solely as a means of isolating business assets or converting liquid assets into securities. They function as subsidiaries of the parent company and are only used to finance or acquire other asset classes as part of sophisticated risk reduction strategies. By contrast, shell corporations are not subsidiaries of a parent company and instead exist as standalone entities that can engage in a much wider range of financial transactions.

Overview

The ways in which shell corporations are used can be broadly categorized into legitimate and illegitimate functions. Businesses often establish shell corporations as a means of moving assets to jurisdictions where they are subject to relaxed taxation policies relative to the jurisdictions in which income or profits were initially earned. Thus, they provide financial benefits by legally relieving the business of tax liabilities. While such strategies remain controversial to many people, they are technically legal under US and international law.

Shell companies also allow multinational corporations and large financial institutions, like banks and brokerages, to invest and operate in capital markets beyond the country in which they are based. Many countries have laws that limit the types of financial activities that foreign businesses are legally able to engage in, and shell corporations allow their operators to establish domestic operations in foreign markets to circumvent such restrictions.

Another legitimate use of shell corporations involves the pooling of investment capital supplied by multiple international sources. Since different countries frequently have dissimilar or incompatible business and taxation laws, shell companies provide a way for international investors to park their funds in a single jurisdiction. This creates a stable base for allocating and distributing capital to fund its intended uses.

Additionally, shell corporations can be used to conduct “gray market” trading. Gray markets are unofficial, parallel, and legal markets where securities like stocks can be traded while they are suspended from official markets or have not yet been formally listed. Rarer applications see shell corporations function as a method of concealing assets from corrupt governments that would otherwise seize them from their rightful owners. Shell corporations can similarly be used to hide individual or corporate wealth from criminal actors such as extortionists, kidnappers, and thieves. They also provide companies with a means of obscuring legitimate business dealings with individuals or entities that do not have a positive public profile.

Illegitimate applications typically see shell companies used to conceal the true origin, nature, or ownership of funds or other assets. They are used in this way by fraudsters, money launderers, and organized criminal enterprises to hide profits earned through illegal activities and circumvent laws preventing their distribution. Jurisdictions where shell corporations are commonly based typically have laws that allow their ownership and operations to remain confidential and unavailable to domestic or international authorities. Thus, they provide ideal vehicles for criminals to untraceably funnel their earnings and profits. Terrorist networks also use shell corporations to avoid detection when accumulating funds from donors or sending funds to cells or individual members. Unscrupulous politicians can also use shell corporations to hide monies received for the purposes of bribery.

Like large businesses, wealthy individuals can also use shell corporations to reduce their tax liabilities. People who earn large sums of money can set up one or more shell companies in jurisdictions with favorable tax laws and then channel their income through shell entities, so it technically avoids being considered taxable income. The Panama Papers scandal of 2016 represents a high-profile example of how individuals with ultra-high net worth use shell corporations to protect their assets from taxation. Similarly, in 2018, Denmark's largest bank, Danske Bank, was involved in a money laundering scheme that used shell companies. In 2021, the International Consortium of Investigative Journalists leaked around 12 million documents indicating the pervasive nature of the use of shell corporations in money laundering among the world’s wealthiest individuals. This scandal was later termed the Pandora Papers. American and international taxation authorities are aware of these applications, which function as loopholes and exist in a legal gray area.

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