Cracking the shells of Kolkata's 'paper firms'

With enforcement agencies hot on trail of shell cos, city is no longer the Mecca of parallel banking

For the past three years, some of the young officers at the investigation wing in charge of shell companies in Kolkata had a hectic schedule. Beyond working hours, much of their time was spent conducting raids in remote locations and rummaging through layers of financial transactions.

In one instance, the department chased a money trail which ran up to 200 layers of companies. The investigations came with an element of thrill, too. Something like a Stasi-era Soviet vigil, with even the indescribable tea seller being watched for being a suspected messenger to the culprits. In another instance, the puppet director of fake companies had to be chased down in a remote slum.

The income-tax (I-T) department has almost completed its investigations, unearthing 20,000-odd paper companies. The tax liability of these entities is said to be about Rs 40,000 crore.

The business of forming shell or paper companies in Kolkata, like many other industries in West Bengal, is now a dead trade. According to government data, the number of new companies registered in Kolkata fell from about 16,000 in 2012-13 to less than 3,000 in 2013-14.

The fragile façade houses close to 600 offices, with about 125 being occupied by accounting professionals. Photo: Subrata Majumder

Earlier, a large number of companies were being created with the sole purpose of evading taxes. The method was like this. If one needed to convert Rs 1 crore of capital from unaccounted to accounted, the original owner of the money would give Rs 1 lakh to an “entry operator”, who’d divide the sum into 10,000 shares of Rs 10 each. Each share would then be sold at an exorbitant premium of around Rs 1,000 to directors of shell companies. This would instantly increase the value of the company from Rs 1 lakh to Rs 1 crore. Through a network of fake companies, the money then moves to the original owner. The entry operator charges a fee. Often, the ‘directors’ of these companies are daily-wage earners like tea sellers or peons.

While welcoming the crackdown, the chartered accountant (CA) community here is somewhat uneasy over a blanket ban on such entities. V K Goyal, a CA for nearly 40 years and president of the tenants’ association at Mercantile Buildings here, says he’s strictly opposed to the infamy attached with the term ‘shell companies’.

Mercantile Buildings is one of the many spots in Kolkata where hundreds of paper companies have their registration address. The fragile façade houses close to 600 offices, with about 125 being occupied by accounting professionals. Curiously, none of the offices have a number assigned, making it a challenging task to spot an office based on the address, an advantage in forming a paper company.

Amid the maze of dimly-lit alleys and mesh of electric wires erratically hanging on corners, the interiors of Goyal’s office don the look of a modern office space. “‘Shell company’ is not a word used in either the Companies Act or the I-T Act. It has been coined by politicians and bureaucrats. So-called shell companies are just inactive companies or defunct investment companies, no longer in business. If they go for liquidation, that’s a long-drawn and expensive process,” he says.

V K Goyal, President, tenants’ association at Mercantile Buildings in Kolkata. photo: Subrata Majumder

However, Goyal agrees Kolkata was once the ‘Mecca of parallel banking’ - or informal trade financing - the numbers of paper companies in several thousand. However, after 2012, forming a shell company has become a difficult task, mainly on account of the new Section 56(2)(viib) in the Companies Act, he said. If a company now issues shares at a premium - more than the book value - the premium has to be treated as income, making it taxable, not the case earlier. Hence, after 2012, hardly any new paper companies were born out of Kolkata, he says.

Why are there so many paper companies in Kolkata alone and that, too, in the old central business district? According to Goyal, one reason also lies in the Urban Land Ceiling Act, which does not allow a single entity to hold more than 7.5 kottahs (a kottah is an eighth of an acre) of land. Hence, several times, real estate developers formed hundreds of companies to own big real estate complexes. Proximity to key government offices, especially to the I-T office and high court made it easier for accountants to settle cases. Being within a two kilometre radius of the court, all cases would be expedited.

Kolkata, once the financial hub of Colonial India, has seen several trades die a silent death. The demise of shell companies’ trade comes with much furore.