The Government has been undertaking drastic attempts to corner black money and tax evaders. In wake of demonetisation, the Government observed frantic monetary transactions conducted through ‘shell companies’. In February 2017, it constituted a special task force to identify such ‘shell companies’ and take corrective action.  

In nexus with this pursuit, the Registrar of Companies (RoC) issued show cause notices under section 248, Companies Act 2013 to companies that had either failed to commence or were not undertaking any business activity in preceding two years. Inability to demonstrate sufficient cause rendered such companies liable to be struck-off from the register of companies. So far, RoC has struck-off names of almost 2.09 lakh companies and has disqualified directors of such companies under relevant provisions of Companies Act, 2013.

At this point, it is relevant to examine how the actions of RoC measure upto Government’s objectives to corner black money and tax evaders. The concept of ‘shell company’ is understood and applied under tax laws; and it usually denotes a company primarily formed to carry out financial transactions to either evade taxes or conceal the identity of its real owners. However, the Companies Act does not prescribe any definitional attributes of a ‘shell company’. It rather deals with concept of defunct/dormant company, i.e., a company that is inoperative or has no substance or any assets/liabilities. Therefore, conflating the concept of ‘shell company’ with defunct/dormant company may not necessarily result in successfully stemming the tide of black money.

Before examining the effects of striking off under the Income Tax Act, 1961 it is necessary to understand its implications under the Companies Act, 2013. Chapter XVII of the Companies Act, 2013 read with corresponding rules deals with concept of strike-off. Section 248 of the Companies Act, 2013 gives suo motu power to the jurisdictional RoC to remove a companys’ name from the register. The usual indicators on which RoC relies to determine that company is not in operation or carrying on business are non-filing of annual returns, income-tax returns etc. As per section 248, RoC has to first issue notice to the directors, the company and also a public notice and give opportunity (maximum 30 days) to the company to explain reasons for their inactivity. The RoC can then proceed to strike off the name, by issuing notice in the public gazette, if the company fails to reply or RoC is not satisfied with the reasons given by company for the inactivity. However, by way of an appeal before the NCLT, any person aggrieved by striking off can pray for revival.

Section 248 read with section 250 of the Companies Act, 2013 highlights the consequences that will arise on removal of the name of company from the Register—(a) the company will be dissolved with effect from publication of public notice meaning that it shall cease to operate and its Certificate of Incorporation shall stand cancelled, and (b) the director, manger or any officer exercising power of management before the striking off shall continue to be liable after striking off. Section 248 does not enhance the liability but merely continues the liability which existed prior to dissolution. If interpreted in this manner then section 248(6) just seeks to make it explicit what otherwise would have been implied. Another consequence under Companies Act, 2013 is the disqualification of the directors of company that has been struck off due to non-filing of annual returns and failure to observe other statutory requirements.

It is necessary to point out that despite being dissolved under section 248, the company is not wound up. In other words, striking off under section 248 only ends the life of the company and it can no longer operate or do business but does not result in appropriation of undisposed property towards the liabilities of the company. However, winding up is a process by which the assets of the company are realised and its liabilities are paid in accordance with the provisions of the Companies Act. The legislature being mindful of this distinction specifically inserted provision 248(8) that recognises the power of the Tribunal to wind up a company that has been struck off.

Besides the consequences under the Companies Act itself, some grave consequences can arise under the Income Tax Act, 1961 not only for the struck off company and its shareholders but also for those entities using such companies as part of their corporate structure. The tax liability of the shareholders of the struck off company will arise when they receive the capital contribution on final settlement of accounts. While this is not a direct consequence of striking off, but the same will arise on winding up of such struck off company. Further, if there was any pending tax liability of a private company that is struck off then the same may be recovered from the director of such company as per section 179 of the Income Tax Act, 1961.

In other instance, if an assessee has received any sum, which has been recorded, in the nature of investment (loan, subscribing to shares, etc.) from the struck off company then the same may be treated to be an income of the assessee as per section 68 of the Income Tax Act, 1961. This will happen if the assessee fails to provide satisfactory explanation for investment by an inactive company that is now struck off. In case, if the investment from struck off company is not recorded in the books of the assessee even then the same may be treated as income by virtue of section 69A of the Income Tax Act, 1961. Liability under these provisions deals with unexplained investments and the same will be attracted till the time struck off company is wound up.

However, after the struck off company gets wound up then the moneys payable by the assessee to the company against the investments made by latter will take colour of unexplained expenditure and may be deemed to be assessee’s income under section 69C of the Income Tax Act, 1961. This then might lead to taxing the same income twice in separate years under different provisions. Further, if there is interest payment by the assessee to the struck off company then the same can be deemed to be unexplained expenditure and disallowed under section 69C of the Income Tax Act, 1961.

Besides, the newly introduced GAAR provisions in chapter X-A of the Income Tax Act, 1961 may also get attracted as the CBDT has clarified that GAAR can be applied simultaneously with specific anti-avoidance provisions. These will be applicable if it is found that the struck off companies formed part of a corporate structure and their presence lead to any tax benefit to the assessee because the whole arrangement will then be one that lacks commercial substance. However, the GAAR provisions will be invoked only if the collective tax benefit, as defined in chapter X-A, is more than three crores.

The exercise of striking off a company was initiated to weed out all the shell companies because it is assumed that they are fronts for tax evasion. While so far, the ROC has struck off the companies and SEBI has begun their investigation into shell companies and banned 330 of them from trading, there is no record of proceedings or recovery of tax from these companies. As per official records, the Tax Department has detected 1,155 shell companies that were used as conduits by over 22,000 beneficiaries in the last three years, from 2013 to 2016. The amount involved in non-genuine transactions of such beneficiaries was more than Rs 13,300 crores. From the action of the Government in striking off company many ripples have been created under the Companies Act and trading on securities exchanges. However, the fate of these struck off companies and other companies that might have had dealings with them so far as Income Tax Act, 1961 is concerned is still awaited. Further, the claim that these companies are nothing but shell companies and conduit to evade tax may be mere presumption which can create a doubt on the success of government to unearth black money through this exercise.