Why Large Corporations Using Shell Companies Can Be Criminal

Shell companies have a bad rap. These organizations have earned a popular reputation as tools for tax evasion and criminal activity. But is that really true? In fact, shell companies can be used for criminal purposes, but you might be surprised to find there are also plenty of legal reasons to use a shell corporation.

Shell corporations, or shell companies, are corporations without any active business operations, employees, or revenue, according to ComplyAdvantage. Because they don't require physical locations or employees, shell companies can be created very quickly. Additionally, they are registered anonymously, so that they can hide the identities of their owners, according to UpCounsel. Shell companies can hold and spend money, so they're primarily used as a way to hold assets or carry out transactions when a person or company does not want those transactions to be done under their own name. Shell corporations can also buy real estate and file copyrights.

How are shell companies created?

Shell corporations are established by registered agents in the country where they are hoping to set up shop, according to SoFi. That means, in practice, that if a U.S.-based organization wants to set up a shell company in Ireland, for instance, they must work with an Irish registered agent. It's a relatively simple process to register: All that's required is the name of the registered agent and the name of the owner of the shell corporation, according to UpCounsel.

The cost for setting up a shell company is also low, as little as a few hundred dollars. Since the whole process can be done remotely, shell companies can be created quickly and easily, and from almost anywhere in the world. However, most shell companies tend to be created in countries with favorable tax laws, including the Cayman Islands, Switzerland, Bermuda, and even the United States, with a particular concentration in the states of Nevada, Wyoming, and Delaware, according to UpCounsel.

Legitimate reasons to set up a shell company

Though shell companies are often seen as suspicious enterprises, there are many legal reasons that an organization might want to set up a shell company. The most common reason is to take advantage of a tax haven abroad, according to Investopedia. A tax haven is a country which offers low tax rates to foreigners storing assets abroad, allowing large or wealthy companies to direct their income into the shell corporation. In doing so, they can avoid their own home country's higher tax rates, according to Northeastern University. While this may sound like tax evasion, it isn't necessarily: tax evasion is specifically the illegal avoidance of taxes, so using a legally set-up shell company is not considered evasion (via Cornell Law School). According to U.S. tax law, so long as companies operate these shell companies legitimately, this is a legal way for organizations to reduce their amount owed on taxes in the U.S.

There are other legal uses for shell companies as well. For instance, shell companies are sometimes used by early-stage startups to store funds as a company expands, according to UpCounsel.

Criminal uses for shell companies

However, while there are legal ways to use shell companies, many shell companies are also used for criminal purposes. One of the most common ways shell companies are misused is by rich individuals seeking to avoid high taxes, according to Investopedia. Though not technically illegal, it is considered legally questionable for an individual to use a shell corporation to reduce their taxes owed. In the United States, as in many other countries, taxes are apportioned by a bracket system in which those who make a higher income pay a higher share of that income to taxes. Using a shell company, these individuals can reduce the amount of income they appear to make, and thus reduce their taxes.

On the corporate side, shell companies can be used for money laundering, according to Investopedia. By funneling money through a shell corporation, someone can hide where money came from, including if it came from illegal sources. Similarly, shell corporations can be used in fraud schemes. Since the owners of a shell corporation are anonymous, it can be harder to bring owners of such a company to justice for any type of fraud, and so those who perpetrate fraud may choose to do so through a shell corporation.

Famous examples of shell companies

Despite the anonymous nature of shell companies, there are many famous examples of shell corporations being used for a host of different, potentially nefarious purposes. For instance, a leak of data in 2021 revealed dozens of celebrities and billionaires who held shell companies which they used to hold assets like money and yachts, according to The Guardian. While these shell corporations were not strictly illegal, the leaking of these so-called "Panama Papers" in 2016 still provided a unique insight into the frequency of shell companies among the rich and elite.

Other shell corporations who have made it to the news include a host of shell companies owned by the Chinese government, according to CNBC. These shell companies have been used to pay officials abroad, including through bribes, as well as hiding money that the Chinese Communist Party and its affiliated higher-ups have obtained through suspicious circumstances. Over 40,000 shell companies identified in the Panama Papers were tied to Chinese government officials or their friends or relatives.

Other ways people commit tax fraud and tax evasion

Of course, shell corporations, even when they are used for nefarious purposes, are far from the only way people commit tax fraud. In fact, if you hear someone did commit tax fraud, it's probably not through an enterprise as sophisticated as setting up a dummy corporation overseas. Most people who commit tax fraud do so through relatively small ways, sometimes inadvertently, according to WKM Law. One way to commit tax fraud is to not report or to under report your income, which is how billionaires might use shell companies. But skipping adding a 1099 to your tax return is also considered under reporting of income and fraudulent.

Other ways to commit tax fraud include lying about your deductions, especially your charitable deductions. If you give a too-high estimate of your donations, you'll be getting an unfairly high tax refund. Similarly, if you're self-employed and overreport business expenses, i.e. by including your entire monthly rent as a business deduction, that would also be considered tax evasion.