The Shell Companies Fiasco

One of the least talked about, but a very controversial and onerous measure of the Modi regime, has been the arbitrary closure of lakhs of small entities, alleging them to be shell companies, and assuming them to be involved in illegal activities of hawala, money laundering and tax evasion. Unfortunately such heavy handed punitive action against what are called shell companies, is being taken at a time when there is no specific definition of what is a shell company, under the law. It is entirely a matter of an adhoc and fanciful interpretation by the babus manning the ministries, such that even companies with regular business and assets like in the case of the Assam Company Ltd., have been wrongly classified and closed, alleging them to be a shell entity. Since a shell company has not been defined, any company that has not filed its returns with the ROC for a consecutive period of three years, is classified as a shell company and is automatically struck off and closed, even if it is a running company with a regular business and such non filing of annual returns could be due to genuine reasons, such as a dispute among the promoters.

A shell company as per popular notion is one which has a huge capital, little turnover and miniscule profits. It is considered to be a sham entity, since it is often used as a platform to give entries of bogus capital, bogus turnover and profits to others, in order to help them to manipulate their books of account, show a rosy picture, evade taxes etc. But by that definition ILFS and many other leading NBFCs would be categorised as shell companies. Interestingly, though such entities have not been truly defined, yet for mere non filing of ROC returns, about 3.50 lac companies have been closed down by the government till date, alleging them to be shell companies. Such an across the board closure of companies is an arbitrary and heavy handed action, which has caused immense loss and damage to the Indian SME sector in particular, due to the sudden closure of running companies.

It all started with the investigations conducted by the Income Tax Department, Kolkata, revealing a web of dubious companies engaged in money laundering, bogus capital, bogus turnover and hawala activities. There were a few hundred such entities or perhaps a couple of thousand at the maximum and the most stringent action was rightly taken against them by way of penalty and prosecution under the income tax as well as money laundering laws. The tax department instead of containing its action against such entities only, expanded it to many others, which were actually not engaged in such activities. That is when the government also took up this matter in a generalised manner, on a pan India basis. Any company not filing its ROC returns was deemed to be a shell company by the government and was closed down under this reckless action that was initiated, without bothering to look into the actual operations and state of affairs of these entities. This action coincided with demonetisation and heavy handed tax laws and thus received little resistance from the aggrieved parties already reeling under it.

But such simplicities and adhoc closure of entities was a blunder in many cases, since those closed entities were bonafide ones with regular business and had no activities of money laundering, tax evasion etc. which the government equates a shell company to. In fact many of them owed money to banks, to the public and also owed taxes etc., which could not be recovered upon the closure of the company. Ironically, it is the CBDT and banks that are now approaching the NCLT, fervently seeking to revive and restore these entities in order to recover their dues. The unfortunate part is that tormented by such an arbitrary closure of their entity and unable to bear the heavy litigation cost of revival, many of these small entities preferred to close down, resulting in loss of employment and livelihood to the small sector, already reeling under an economic slowdown. And now comes the news that as per the FM, the government has closed down 6.8 lakh fake companies, even while admitting that what is a fake company is not even defined in the Companies Act. That itself is proof of the government’s action being arbitrary high handed and illegal.