QA on how the shell companies exposed in the Panama Papers work

Leaked documents from a Panama-based law firm have revealed how politicians, celebrities and other famous people use banks, law firms and offshore shell companies to hide their assets.

Here’s a look at shell companies and how they are used:

Q What is a shell company?

A A shell company, or holding company, is a corporation without any active business or operations, or one that passively owns the shares of another company. It may have had operations in the past that have become dormant or been wound down.

Q How do you set up a shell company?

A Incorporation of a company in most jurisdictions is simple and inexpensive, according to Christopher Steeves, leader of the tax practice group at law firm Fasken Martineau DuMoulin LLP in Toronto. He says establishing a shell or holding company is generally no different than setting up any other type of company.

Q  Can a shell company be used for legitimate purposes?

A Yes. There are legitimate uses for shell companies, such as helping startups gain cheaper and easier public listings on a stock exchange. In addition, an individual may prefer to own investments through a holding company for administrative ease, estate planning, creditor protection, income splitting with family members, or deferral of income taxes, says Steeves.

Q Can shell companies be used for illegitimate purposes?

A Yes. What recent events are revealing is that people may be using offshore holding companies to disguise the ownership of assets, says Steeves. In contrast to the rules in Canada, some offshore jurisdictions do not require that companies disclose the identity of officers and directors and there is no requirement for locally resident directors. “This makes it possible for a person to control a offshore holding company as the sole director without any disclosure of this control,” Steeves says. “If a person was trying to control the ownership of assets without being personally identified with such ownership, they could easily transfer the assets to the offshore holding company.”

Q Are such transfers always indicative of a problem?

A No. There is nothing, in and of itself, that is illegitimate or illegal about such transfers and trying to preserve one’s privacy. But laws may be violated if the person does not disclose their ownership of the offshore holding company as required by law in the country where they reside or are a citizen, Steeves says. For example, under Canadian tax laws, a Canadian resident that owns an offshore holding company may be required to report such ownership on his or her annual tax return. If they fail to report such ownership, the person is subject to significant penalties.

Q Once a shell company is created, is it difficult to detect whether it is being used for a legitimate purpose or an illegal one?

A  Yes, the creation of a company is a commonplace activity. Determining if a company is being used for an illegal purpose can likely only be determined by a regulator, who is auditing whether its constituents are complying with regulations, says Steeves.

Q Do shell companies only exist in so-called tax havens?

A  No. Shell companies or holder companies exist in every jurisdiction that allows for incorporations. “It is doubtful that they are more common in tax-haven jurisdictions,” Steeves says. - Financial Post