The Shelling of Shell Companies

Inactive corporations without significant operations or assets may commonly be used to disguise business ownership from government authorities and the public at large. This is a tactic which may often be used for purposes that are spurious—including the evasion of taxes and the illegal siphoning off of money.

The Companies Act, 2013 (“Act“) classifies any company that has not, in the past 2 years: (i) been carrying on any business/operations; (ii) made any significant accounting transaction; or (iii) filed financial statements and annual returns, as “inactive”1. The Act further elucidates that any transaction which does not include the: (i) payment of fees by a company to the Registrar of Companies (“Registrar“); (ii) payments made by it to fulfil the requirements of the applicable laws; (iii) allotments of shares to fulfil the requirements of the Act; and (iv) payments made for the maintenance of its office and records; would be considered a “significant accounting transaction”2.

The Registrar, pursuant to Section 12(9) of the Act, has the power to physically verify the registered office of a company in the event the Registrar has reasonable cause to believe that the company is not carrying on any business or operations. Further, the aforesaid Section provides that the Registrar may initiate action for the removal of the name of the company from the register of companies under Chapter XVIII of the Act if the Registrar finds that the company does not have a registered office capable of receiving and acknowledging all communications and notices as may be addressed to it.

Recently, vide the Companies (Incorporation) Third Amendment Rules, 20223 dated August 18, 2022, the Companies (Incorporation) Rules, 2014 were amended and Rule 25B was inserted thereto. The aforesaid rule now provides that the Registrar may, pursuant to the information/documents made available to it on MCA 21, physical verify the registered office of any company for the purposes of Section 12(9) above. Such a physical verification would need to take place in the presence of 2 (two) independent witnesses belonging to the locality in which the aforesaid registered office is situated. The Registrar may also seek the assistance of the local police for such verification.

The Registrar is required to carry the documents filed on MCA 21 in support of the address of the company’s registered office of the company for the purposes of the physical verification and to check the authenticity of the same by cross verifying those documents with the copies of supporting documents of such address collected during the said physical verification, authenticated from the occupant of the property in which the registered office is situated.

Additionally, the Registrar is required to take a photograph of the registered office of the company during the course of the aforesaid verification and prepare a report of the same, in the format provided in Rule 25B(4). This report would detail the following: (i) name and CIN of the company; (ii) latest address of the registered office of the company (as per the MCA 21 record); (iii) date of authorization letter issued by the Registrar; (iv) name of the Registrar; (v) date and time of visit for the aforesaid physical verification; (vi) location details along with landmark; (vii) name, father’s name, residential address and relationship with the company of the person available (if any) at the time of the aforesaid visit; and (vii) remarks (if any).

The following documents would also be attached to the aforesaid report: (i) copy of the agreement/ownership/rent agreement/no objection certificate of the registered office of the company from owner/tenant/lessor; (ii) a photograph of the registered office; (iii) self-attested ID card of the person available; and (iv) any other necessary documents.

If, after conducting such physical verification of the premises in which the registered office of the company is situated, the Registrar finds that the company is incapable of receiving and acknowledging all communication and notices, the Registrar is duty bound to notify the company and all its directors of his intention to remove the name of the company from the register of companies and requesting their representations (along with accompanying documentation), if any, within 30 (thirty) days from the date of the notice. Thereafter, the Registrar may exercise his power to remove the name of the company from the register of companies, pursuant to Section 248 of the Act.

In the wake of several noteworthy instances of shell companies/inactive companies being used to layer the proceeds of crime, and to shirk compliance and disclosure related obligations, this amendment to the Companies (Incorporation) Rules, 2014 marks a welcome step towards curbing the malicious utilization of inactive companies by larger companies and merchants. Without excessively broadening the scope of the Registrar’s powers, the amendment establishes a streamlined process which aids the Registrar to succinctly gather the information necessary to ensure compliance with the Act.

1 Section 455(1)(i) of the Act.

2 Section 455(1)(ii) of the Act.

3 Ministry of Corporate Affairs Notification No. G. S. R. 643 (E), https://www.mca.gov.in/bin/dms/getdocument?mds=9Y5OnM%252BynyaO2gmwIgo30A%253D%253D&type=open