The US Corporate Transparency Act: Lessons for India and Beyond

The United States Congress recently enacted the Corporate Transparency Act (CTA) which applies to foreign-owned shell companies. It mandates a ‘reporting company’ to provide certain information of beneficial owner(s) to the Financial Crimes Enforcement Network. 

The CTA resurrects the need for an identical statute in India which has struggled to deal with the threat of misuse of shell companies. This can be largely attributed to the fact that neither the Companies Act, 2013 (CA, 2013) nor the erstwhile Companies Act, 1956  attempted to define shell companies in India. 

This post seeks to highlight past attempts by Indian regulatory authorities to curb the menace of shell companies. The latter part will seek to declutter the Indian judiciary’s understanding of shell companies while also attempting to address the definitional ambiguities. The concluding part will draw lessons from similarly placed jurisdictions.

Previous regulatory attempts

The most significant Indian regulatory effort has been the Task Force on shell companies established by the Prime Minister's Office to check on shell companies through a coordinated multi-agency approach. This has played a substantial role in the identification of shell companies under section 248 of the CA, 2013.

Echoing similar objectives, the income tax department had decided to share tax information with the Ministry of Corporate Affairs (MCA) in an effort to identify shell companies which engage in money laundering and tax evasion. Likewise, the Government had requested the Reserve Bank of India (RBI) to direct banks to freeze the accounts of defaulting companies which have failed to file annual returns and financial statements. However, the request could not materialize into a tangible policy measure as the RBI construed such regulatory actions as beyond its competence.

Addressing definitional ambiguities 

A large part of the legal hurdle in regulating shell companies in India stems from the absence of a legal definition of shell companies. This has clouded the regulatory agencies’ understanding of the concept of shell companies and consequently their ability to regulate the same. 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. 

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 marks 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 expeditiously define shell companies under the CA, 2013. 

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 is substantial and worth a detailed discussion. The Fourth Anti-Money Laundering (AML) 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 AML Directive 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 forthcoming Sixth AML Directive. 

The Monetary Authority of Singapore (MAS) has also been exploring regulatory options to deal with 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. 

Conclusion ​

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 should not 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 Central Goods and Services Tax 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, the time is ripe not only to bring in definitional changes but also procedural regulations, in line with the CTA, that allow authorities to keep a check on any negative effects of shell companies.

Animesh Bordoloi is Assistant Lecturer at Jindal Global University, India.

Hitoishi Sarkar is a Member of the GNLU Centre for Corporate and Insolvency Law, India.