Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.
Dr. JeFreda R. Brown is a financial consultant, Certified Financial Education Instructor, and researcher who has assisted thousands of clients over a more than two-decade career. She is the CEO of Xaris Financial Enterprises and a course facilitator for Cornell University.
What Is a Shell Corporation?
A shell corporation is a corporation without active business operations or significant assets. These types of corporations are not all necessarily illegal, but they are sometimes used illegitimately, such as to disguise business ownership from law enforcement or the public. Legitimate reasons for a shell corporation include such things as a startup using the business entity as a vehicle to raise, funds, conduct a hostile takeover or to go public.
Understanding Shell Corporation
Shell corporations are used by large well-known public companies, shady business dealers and private individuals alike. For example, in addition to the legal reasons above, shell corporations act as tax avoidance vehicles for legitimate businesses, as is the case with Apple’s corporate entities based in the United Kingdom. They are also used to obtain different forms of financing.
However, tax avoidance is sometimes seen as a loophole to tax evasion, as these corporations have been known to be used in black or gray market activities. It’s natural to be suspicious of a shell corporation and it’s important to understand the various scenarios in which they arise.
Reasons to Legitimately Set Up a Shell Corporation
The number one reason for a domestic company to set up a shell company is to realize a tax haven abroad. Large corporations, like in the Apple example, have decided to move jobs and profits offshore, taking advantage of looser tax codes. This is the process of "offshoring" or "outsourcing" work that was once conducted domestically.
To remain within legal bounds internationally, American corporations will set up shell companies in the foreign countries in which they are offshoring work. This is legally allowed by the United States and some say that it’s the U.S. tax code itself that’s forcing domestic companies to create shell corporations abroad.
Another way that shell companies help with taxes surrounds the need for financial institutions to conduct financial activity in foreign markets. This allows them to invest in capital markets outside of domestic borders and realize potential tax savings.
Ways That People Abuse Shell Companies
Even though there are legitimate reasons to set up a shell company, many wealthy individuals abuse shell companies for personal gain. Progressive taxation within the United States, that is, tax brackets, slowly caused people to seek personal tax havens. Significantly high earners set themselves up as shell companies in one or many locations, like the Cayman Islands. This is a gray area of tax evasion where people funnel earnings through shell companies in such a way that it isn’t counted toward personal income.