What Is a Shell Company?

Shell companies act as ghost companies. They manage and hold funds for another entity. However, shell corps engage in more intricate operations, as well. There are several reasons to create a shell corporation, but it is important to be wary of the legal aspects of establishing this type of business structure.

In 2016, the Panama Papers leak revealed financial details concerning the ownership of over 200,000 offshore shell companies. It brought worldwide attention to the business practice, and it led many people to ask, what is a shell company?

A shell company is a type of business that holds funds and manages the financial transactions of another entity. Shell companies don’t have employees, which can’t be said about traditional companies. Let’s dig deeper to know what other differences these companies feature. 

How a Shell Company Works

It’s easy to spot a shell company when you know how they work. Here is what to look for:

• A shell corporation isn’t involved in active business operations. It doesn’t have significant assets either. Shell corporations are also tabbed as ghost companies, international business companies, personal investment companies, front companies, mailbox companies, phantom firms, or letterbox corporations. 
• Businesses or individuals can set up such corporations anonymously. This way, they conceal ill-gained finances, stay away from tax payments, and sidestep anti-money laundering (AML) regulations.
• These corporations don’t create products, hire employees, or generate revenue. They don’t have an office. They’re non-traded corps, so you can’t find them on stock exchanges. 
• These companies have only a name and mailing address, only existing on paper as a registered financial entity. However, they can have a bank account, store money, conduct financial transactions, purchase real estate, hold copyrights, and collect royalties. 

Who Uses Shell Corporations?

These are big, well-known public companies, shady business dealers, and private individuals.

Based on some estimates, about 500 shell companies qualify as SPACs or special purpose acquisition companies. A SPAC is a company without commercial operations. It exclusively aims to raise capital via an initial public offering (IPO) to acquire or merge with an existing company. 

As a rule, investors avoid using shell businesses for their day-to-day trading activities. However, they might allocate part of their portfolios to a SPAC.

Is a Shell Company the Same as a Holding Company?

When seeking an answer to “what is a shell company?” you might also want to know what a holding company is. The latter is a company not involved in active business affairs and with no operations. However, it holds assets in one or more companies. A holding company is a parent company that owns shares from another business and keeps its policies and management under control. As a rule, holding companies can hire managers or directors and close contracts with them.

Shell Companies in the European Union

What is a shell company in the European Union? According to the European Parliamentary Research Service (EPRS), the term “shell company” is often interchangeable with the terms “letterbox company,” “mailbox company,” “special purpose entity,” and “special purpose vehicle.” However, these terms often have different connotations. 

Shell businesses include anonymous shell companies, letterbox companies, and special purpose entities:

• Anonymous shell companies focus on providing anonymity, meanwhile keeping their business and resources under control. 
• Letterbox companies are also called mailbox companies. They’re usually registered in one Member State, with their substantive economic activities in another Member State. 
• Special purpose entities or SPEs’ core business involves group financing or holding activities. 

Are Shell Companies Legal?

Often, these entities feature complex ownership structures in jurisdictions. However, most of them are legitimate. For example, when a shell company is created to store early startup funds, this is an example of a legitimate operation.

According to the Department of the Treasury Financial Crimes Enforcement Network (FinCEN), legitimate operations include:

• Owning stock or intangible assets of another company
• Facilitating domestic and cross-border currency and asset transfers, as well as corporate mergers. 

No company (shell or otherwise) is allowed to do the following:

• Money laundering: to hide finances acquired illegally. Money laundering represents a widespread abuse of the shell corporation model.
• Tax evasion: when wealthy people hide finances to avoid taxation. As of November 2020, the Cayman Islands represented the most extensive global tax abuse, according to Statista. 
• Doing illegal business: this may include trading arms or drugs. 
• Disguising business ownership from law enforcement bodies or the public.
• Keeping assets out of sight in a divorce: this is tabbed as fraud.

In 2021, the U.S. made anonymous corporations illegal. The decision is due to the passage of the Corporate Transparency Act as part of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021. Exemptions limit the scope to those companies that are most likely to operate illegally. 

Besides, in the U.S., banks must know their customers’ names to reveal them to law enforcement agencies upon request. The decision is according to the 2016 customer due diligence (CDD) rule.

Offshore Tax Havens

What about offshoring or moving some business operations to a tax haven to enjoy lower rates and less regulation? This practice is legal if the business owner earned the stored money in that country.

A tax haven is a foreign country that imposes little or no tax liability on non-residents in a politically and economically stable environment. When discussing tax havens, it’s essential to know what a tax shelter is. The latter is a vehicle that taxpayers use to reduce their taxable incomes. The result will be decreased tax liabilities.

Famous tax havens include the Bahamas, Barbados, Belize, Bermuda, the Cayman Islands, the Channel Islands, including Guernsey and Jersey in Europe, the British Virgin Islands, Hong Kong, Ireland, Isle of Man Bahamas, Liechtenstein, Luxembourg, Panama, Singapore, Switzerland, and the Virgin Islands. 

According to the Financial Secrecy Index (FSI), as of 2020, the Cayman Islands topped the list of the world’s biggest private tax havens. 

Reasons to Start a Shell Corp

When interested in “what is a shell company?” you might also look for the reasons to start this type of business. Here are some of the most popular reasons (some of which are illegal):

• To avoid taxes. Tax avoidance is among the most common reasons. 
• To hide assets, which is another common reason. 
• To defend wealth, e.g., to protect your assets from volatile national economies.
• For a hostile takeover. In this case, a company purchases another company without the approval of the latter’s management.
• To store finances temporarily, like when holding funds while preparing to launch a new business. 
• To become publicly traded through a reverse merger. The latter means allowing a private company to go public through a more straightforward process than an initial public offering (IPO). In this case, the shell corp serves as a vehicle to raise funds.
• To invest in foreign markets and enjoy new business opportunities.
• To conceal deals between two companies. E.g., when you don’t want to be associated with a business lacking a good reputation.  
• To keep your identity safe, e.g., in an unsafe country where your finances could attract criminals’ attention.

How to Start a Shell Company

As a rule, you’ll need to use a registered agent in the country where your shell business’ legal headquarters are. In the U.S., people register such companies with the Securities and Exchange Commission.

Most countries require the agents to register their names and an owner’s or a shareholder director’s name. The launch and registration costs vary from a few thousand dollars to hundreds of thousands of dollars.

When acquiring a company, you might need access to proper acquisition funding.

Reasons Not to Start a Shell Company

Now, let’s see why this type of company may not be the best choice for you: 

• Legal issues. Holding personal assets in this type of company exists in a legal grey area. Income that you earn in the U.S. is subject to U.S. taxes. If you conceal your earnings from the IRS, you could end up with civil or criminal penalties if revealed. In addition, the U.S. now requires foreign banks to provide information on U.S. citizens’ accounts. Therefore, you should pay attention to your small business taxes. 
• If you use this type of entity to hide your identity, you’re engaged in misleading activities, which may be illegal.
• If you open a shell corp to hide assets during divorces, court cases, mergers, or acquisitions, you are committing fraud. 
• Other individuals and businesses may approach your shell business with caution because of a higher level of financial crime risk.
• Poor publicity. If your customers discover something negative about your company, this could hurt your sales. 

Sum Up

Sometimes people open a shell company to hide illegal businesses. But, that’s not the only reason they exist. Legitimate businesses use shell companies to manage finances while concealing the identities of the assets’ owners. 

Take the time to study the specifics of a shell business to know if starting one is a prudent business decision.