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Shell, Dormant & Defunct Companies




SHELL COMPANIES

What are shell companies?
The Companies Act, 2013 has not defined what a ‘shell company’ is and as to what kind of activities would lead to a company being termed a ‘shell’. Shell companies are typically corporate entities which do not have any active business operations or significant assets in their possession. The government views them with suspicion as some of them could be used for money laundering, tax evasion and other illegal activities.

Is there a law governing shell companies?
In India, there is no specific law relating to “shell companies.” However, some laws help, to an extent, in curbing illegal activities such as money laundering and can indirectly be used to target shell companies — Benami Transaction (Prohibition) Amendment Act 2016; The Prevention of Money Laundering Act 2002 and The Companies Act, 2013.

Is it easy to strike off a shell company from the records?
Companies can be removed from the rolls of the Ministry of Corporate Affairs by two means: strike off by Registrar of Companies (RoC) — (Section 248 (1) of the Companies Act, 2013) and voluntary strike off — (Section 248 (2) of the Companies Act, 2013). Voluntary closure can be done with the approval of the board and shareholders and the firm should have nil liabilities.

What scenarios can lead to a company’s name being struck off by the RoC?
The strike off happens in case of companies which have failed to commence business within a year of incorporation.

Also, in case of companies that are not carrying on any business or operation for a period of two immediately preceding financial years and have not made any application within such period for obtaining the status of a ‘dormant company’ under Section 455 of the Companies Act can be struck off by the RoC unless cause is shown to the contrary.

The RoC issues a show-cause notice to such companies and their directors seeking their response within 30 days. If the response is not satisfactory, the company’s name would be removed from the register.

Recent Updates:
In August, 2017 the Securities and Exchange Board of India directed stock exchanges to initiate action against 331 suspected shell companies and bar them from trading. Further, MCA cancelled the registration of around 2,09,032 defaulting companies and the Ministry of Finance directed banks to restrict operations of bank accounts of such companies by the directors of such companies or their authorized representatives.

Following this, MCA has identified 1,06,578 directors for disqualification under Section 164(2)(a) of the Companies Act, 2013, as on 12 September 2017. There is no clear definition of what shell company is in the Companies Act, or any other Act.  On Independence Day, Prime Minister Narendra Modi mentioned India's battle against black money and said that more than 1.75 lakh shell companies have been de-registered so far. Theoretically, shell companies are companies without active business operations or significant assets.

They can be set up by business people for both legitimate and illegitimate purposes. Illegitimate purposes for registering a shell company include hiding particulars of ownership from the law enforcement, laundering unaccounted money and avoiding tax. With the shell company as a front, all transactions are shown on paper as legitimate business transactions, thereby turning black money into white. In this process, the business person also avoids paying tax on the laundered money. India, however, does not have a concrete definition of shell companies.

Shell companies are not defined in any law or act. However, US has defined the shell companies under their Securities Act. They have taken up the basic definition, hence making it the commonly used one. The US Securities Act defines shell companies as: "Securities Act Rule 405 and Exchange Act Rule 12b-2 define a Shell Company as a company, other than an asset-backed issuer, with no or nominal operations; and either: no or nominal assets; assets consisting of cash and cash equivalents; or assets consisting of any amount of cash and cash equivalents and nominal other assets."

This means that a shell company will have minimum business activities. This could be a plausible definition as even theoretically, the business persons who own shell companies, will be more interested in the rise and fall of their main company. However, not all shell companies are illegal. Some companies could have been started to promote start-ups by raising funds.

DORMANT COMPANIES

What is Dormant Company?
The concept of Dormant Company has introduced under the Companies Act, 2013. In a simple word, Dormant Company means inactive Company. Section 455 of the Companies Act 2013 deals with the provisions of Dormant Company. As per Companies act Dormant Company means a company which is formed or registered for the below objectives:
  • Incorporated for future project;
  • Hold an asset or intellectual property;
  • Has no significant transaction;
  • Is an inactive company.
Such Company can file an application to a registrar to obtain the status as Dormant Company.

In above situation Inactive Company means a company has not:
  • carried any business or operations
  • made any significant transaction during last two financial years
  • Filed financial statements and annual returns during last two financial years.

Significant Transaction means any transaction made by the company except below transaction:
  • Payment of fees to registrar
  • Payment made to fulfill the requirements of any Act
  • Allotment of shares to fulfill the requirements of any Act.
  • Payment made to maintain the records of its office.
Also, the registrar may issue notice the Company who has not filed the financial statements or annual returns for two consecutive financial years to enter its name into registrar maintained for a dormant company.

To maintain the status of a dormant company, a company shall have a minimum number of directors and pay such annual fees as may be prescribed by the Registrar.

What is the procedure to obtain the dormant company?
  • Call a Board Meeting to fix date and time of EGM.
  • Ask an Auditor/ Chartered Accountant to issue a certificate.
  • Hold Extra Ordinary General Meeting.
  • Pass Special Resolution to obtain a status of a dormant company.
  • The director shall be authorized to make application for Dormant with ROC.
  • File E-form MGT-14 with ROC for filing special resolution.
  • After filling of form MGT-14, File Form MCS-1 with the registrar along with the required attachments.
  • Registrar shall issue certificate through e-mail confirming the application
Conditions to be fulfilled by the Company before obtaining a dormant status:
  • The company shall not undergo any inspection, inquiry, or investigation or shall not initiate any prosecution against the company and pending under any court.
  • The company shall not have any public deposits or interest and outstanding for payment.
  • There should be an outstanding loan, secured or unsecured in Company. If there are unsecured loans then the consent of the lender should be obtained and enclosed along with the form.
  • Any dispute or difference between the management and promoters of the company shall not be there and a certificate was issued to give effect is enclosed.
  • The Company shall not have any outstanding tax dues.
  • There shall not be any default in payment of its workmen’s dues;
  • The Company should not be listed company.
Dormant Company Compliances requirement:
A dormant company shall have a director as below: if a Company is:
1.      Public company: minimum 3 director
2.      Private Company: 2 Director
3.      OPC: 1 Director
  • A dormant company shall file a “Return of Dormant Company” annually, duly audited by Chartered accountant n such form along with the fees prescribed under the act.
  • If a dormant company fails to file an annual return for consecutive two financial years Register may ask to change the status of dormant company
  • Dormant company tenure is 5 consecutive year. They cannot hold status as a dormant company more than 5 years.
What are the benefits and exemptions provided to a dormant company?
  • Dormant Company gets an advantage of fewer compliances cost as there are only minimal compliances applicable to the dormant company.
  • Dormant Company is not required to include the statement of cash flow in its financial statement.
  • Dormant Company shall hold only two board meeting in a year with a gap of 90 days in between the two company.
  • The auditors are not required to be rotated under the dormant company.

What is the difference between dormant and shell companies?
A dormant company gets its title in two ways: it has chosen to get a ‘dormant’ status from the RoC by way of an application and is in compliance of the requirements of Section 455.Further, in case a company has not filed financial statements or annual returns for two financial years consecutively, the RoC shall issue notice and include it in the register of ‘dormant’ companies. But a shell company is one which is typically suspected of illegal activities.

The Companies Act, 2013 has not defined what a ‘shell company’ is and as to what kind of activities would lead to a company being termed a ‘shell’. Shell companies are typically corporate entities which do not have any active business operations or significant assets in their possession. The government views them with suspicion as some of them could be used for money laundering, tax evasion and other illegal activities.

DEFUNCT COMPANIES

What is Defunct Company?
A defunct Company means a company who has:
  • Nil asset and nil liability, and
  • Failed to commence business within one year of incorporation
On 5th April 2017 vide circular the most awaited procedure Fast track Exit is activated. The Section 248 of Companies Act 2013 deals with fast-track exit procedure. Strike Off mode was introduced by the MCA to give the opportunity to the defunct companies to get their names struck off from the Register of Companies

Fast track exit can be done in below two ways:

Suo moto by Registrar:
The Registrar may by its own strike off the name of a company on its own if:
  • A company has failed to commence any business in a year of its incorporation;
  • The company is not carrying out any business or Activity for preceding 2 financial years and has not sought the status of Dormant Company under Section 455 of the Act.
The ROC shall send notice to the Company and all the directors of the Company stating his intention to remove the name seeks the representation of Company in 30 days.

Voluntary Removal of Name:

The Company by itself can file an application to Registrar of Companies for striking off the name. The ROC shall satisfy him that all the amount due by the Company is discharged. ROC can also issue a show cause notice in case of default in filing returns or other obligations. After satisfaction, ROC shall issue a public notice and strike off the name of Company.

Procedure:

  • A Company eligible to apply for striking off, needs to apply to Registrar of Companies in Form STK-2 filed electronically by making payment of Rs. 5000/- as the ROC fees;
  • Any pending litigations involving the company should be disclosed while applying under this Scheme;
  • The Registrar of Companies shall examine the same and if found in order, shall give a notice to the Company under section 248(2) of the Companies Act, 2013by e-mail on its e-mail address intimated in the Form, giving thirty days time, stating that unless cause is shown to the contrary, its name be struck off from the Register and the company will be dissolved;
  • The Registrar of companies shall put the name of applicant(s)and date of making the application(s) under Fast Track Exit mode, on the MCA portal www.mca.gov.in, giving thirty days time for raising objection, if any, by the stakeholders to the concerned Registrar;
  • The Registrar of Companies shall, simultaneously intimate the concerned regulatory authorities regulating the company, viz, the Income-tax authorities, central excise authorities and service-tax authorities having jurisdiction over the company.
  • The Registrar of Companies immediately after passing of time given in above sub-paras and on being satisfied that the case is otherwise in order, shall strike its name off the Register and shall send notice under Section 248(5) of the Companies Act, 2013 for publication in the Official Gazette and the applicant company under this Scheme shall stand dissolved from the date of publication of the notice in the Official Gazette.
Attachments:
  • An affidavit in Form STK -4 sworn by each of the existing director(s) of the company to the effect that and has not carried on any business since last one year.
  • An Indemnity Bond in Form STK -3, duly notarized, to be given by every director individually or collectively, to the effect that any losses, claim and liabilities on the company, will be met in full.
  • Statement of Account made upto a day, not more than thirty days preceding the date of filing of application in Form STK-2 duly certified by a statutory auditor or Chartered Accountant in whole time practice, as the case maybe.
  • Copy of Board resolution showing authorization for filing the application.
  • Copy of the special resolution duly certified by each of the directors of the company or copies of consent of seventy five per cent of the members of the company in terms of paid up share capital as on the date of application; And MGT-14 Will be filed within 30 days of special resolution.
  • a statement regarding pending litigations, if any, involving the company.

Following are the companies who cannot apply for fast-track exit:
  • Companies Registered Under Section 8
  • Listed companies
  • Companies that have been delisted due to non-compliance of listing regulations or listing agreement or any other statutory laws;
  • Vanishing companies;
  • Any inspection or investigation is ordered and being carried out against Company
  • Companies where notices have been issued by the Registrar or Inspector (under Section 234 of the Companies Act, 1956 (old Act) or section 206 or section 207 of the Act) and reply thereto is pending;
  • Any prosecution for an offense is pending in any court against the Company;
  • Companies whose application for compounding is pending;
  • Companies which have accepted public deposits which are either outstanding or the company is in default in repayment of the same;
  • Any charge satisfaction is pending against Company.

Difference between dormant and defunct company:
As per Section 455 of the Companies Act 2013 the name of the company is entered in the register of dormant companies when the company is inactive (not carrying on business or operation) during the last two financial years. In other hand, when the company has failed to commence its business within one year of its incorporation or company is not carrying on any business or operation since last two immediately financial years and has not made any application within such period for obtaining the status of a dormant company under section 455, then the company is treated as defunct company and shall be entitled to go for strike off.

It can be interpreted that, as per the provisions mentioned ROC has the power to issue a notice to change the status of the Company from Active to Dormant or strike off of Companies after the trigger of above-mentioned conditions.

Recent Updates: 
The tax office is reopening old records of many companies that have wound up and no longer exist in the books of the government — something the revenue department has rarely done in the past.

Former directors of such closely-held private companies, which have received tax notices along with the official liquidators, fear they could be suddenly saddled with unforeseen liabilities. While opening new private companies and shutting down old ones have often been a ploy to move unaccounted money, some of the companies set up to carry out bona fide businesses which subsequently failed have also come under the glare of the income tax department

Till now, the department has typically stayed away from companies to which it had issued non-objection certificate prior to the winding process. But, it's well within the law and powers of the tax office to review an old tax assessment if there is suspicion of tax fraud.

"In case of private limited companies, the liability of directors continues even after liquidation. Here, these ex directors have to prove that any non-recovery of tax is not due to any gross neglect, malfeasance, or breach of duty on their part in relation to the affairs of the company,"

"But such reopening in case of companies which have been liquidated or struck off from the RoC (Registrar of Companies) records should be done very selectively — may be only in situations of tax fraud and not situations of plain vanilla income having escaped assessment,"

The liquidator of a company going for 'voluntary liquidation' can approach the tax office to ascertain the outstanding tax liability, and set aside the amount before distributing the proceeds from asset sale to creditors and shareholders. 

But even in such cases the department can (though rarely done) reopen old assessments if it later suspects fraud or fund diversion. The no-objection certificate, according to a senior tax official, is simply based on the outstanding tax claim on that date. If the department has to look into serious irregularities, then no NoC can be issued. "The provisions do provide powers to assessing officers to re-open and issue such notices".

The taxman can go back up to six years in reopening of old assessments. However, in covering undisclosed foreign assets — overseas bank accounts, properties etc — the I-T department can rake up 16-year old transactions in probing tax evasion. There are no provisions for reopening unless a tax fraud has been identified.



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Note: Information placed here in above is only for general perception. This may not reflect the latest status on law and may have changed in recent time. Please seek our professional opinion before applying the provision. Thanks.

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This blog is Created by CA Anil Kumar Jain.