After the release of the Panama Papers in 2015, the terms “shell company” or “shelf company” became associated with tax evasion, fraud and other illegal acts. Shell and shelf companies have become ideal conduits to facilitate financial transactions around the world, thanks to innovative banking technology and access to the international markets. Although it is undeniable that some do use these companies for fraudulent activities, this does not mean that all shelf and shell companies are used for criminal purposes. In order to understand how these are used for illicit purposes, it is necessary to first distinguish each of these corporate vehicles.
Shell company is an “incorporated company with no independent operations, significant assets, ongoing business activities, or employees”. Such companies do pose a risk for money laundering and other financial crimes because of the ease and low cost of forming and operating a shell. Otherwise, such companies possess legitimate purposes such as holding intangible assets of other business entities and conducting cross-border transactions.
Shelf company is a registered company but it is “put on a shelf” where it is left dormant for a longer period even if a customer relationship has already been established. Despite the fact that the entity has been deactivated, it is crucial to remember that it has met all legal criteria, including registration and payment of state fees. An individual or other corporate entity that wants to skip the time-consuming procedure of forming a new company can buy a shelf company. Such companies are frequently formed in states with low taxes, low filing fees or low regulations.
Some of the most common states where shelf companies are formed:
Front company is a “fully functioning company with physical presence which serves to disguise and obscure illicit financial activity”. In case of a mishap, a front company is used to protect a parent company from negative publicity, as well as to conceal illegal activities that could not be facilitated if the true stakeholders/beneficiaries were made public. A front company may be more than a shell company because it can be a real company with physical presence that conducts legal businesses at other times. The primary differentiating feature of a front company is that it is designed to hide the true originator or end user of a prohibited good or set of transactions. For example, in the oil sector, Iran appears to be using legitimate companies as front companies to important dual-use nuclear materials.
Searching for signals
Considering all this, it is important to search for signals and mitigate the risk of fraudulent activities coming from a shell, shelf or front company. Therefore, differentiating each of these terms and understanding that they are not the same is pivotal. Searching for red flags e.g., suspicious addresses and adopting stricter measures on enhancing due diligence in an effort to combat illegal acts is crucial. As these types of businesses play an important role in criminal activity, institutions are at risk of being exploited by criminals who use these firms to launder money, disguise beneficial ownership, and escape sanctions due to the large number of businesses and ease with which they are established.