What are shell companies?

What are shell companies?
Jakub Chajdas

Jakub Chajdas

Partner / Attorney-at-law

Did you know that seemingly legal companies may hide illegal connections? Beyond their facade, there might be a network of shell companies. Such entities enable hiding the true owners and allow conducting business. In this article, we will explain what shell companies are. Find out how they operate and what are the consequences of establishing such a company.

Shell companies – what are they and how do they work?

Shell companies are formally legally operating entities that do not conduct real business activities or engage in so-called minimal activity. Their purpose is often:

  • hiding the identity of the real owners or
  • tax avoidance

What are the characteristics of a shell company?

Shell companies are often characterized by the following features:

  • No physical registered office. A shell company has no office, address or other physical assets.
  • Lack of qualified staff. A shell company does not hire skilled employees.
  • Low added value. A shell company does not generate significant added value and does not conduct real business activity.
  • Transactions with related entities. A shell company mainly deals with related parties.
  • Management from abroad. Management decisions are made outside the company’s home country.
shell companies

The European Union’s position on shell companies

In December 2021, the European Commission proposed a directive to prevent tax abuse by shell companies. This is the so-called unshell directive or ATAD 3 directive. Its goal is to prevent the use of shell companies to avoid paying taxes.

The assumptions of the Unshell Directive and the activities of shell companies

The unshell directive aims to fight the use of shell companies for tax avoidance. It outlines criteria for evaluating such entities. These criteria include:

  • having adequate human and material resources to conduct the declared activity,
  • conducting real economic activity in a given Member State;
  • incurring the actual costs and risks associated with the conducted activity.

Entities that do not meet these criteria will be considered shell companies. They will be obliged to fulfil obligations such as:

  • disclose their beneficial owners and beneficiaries,
  • keeping reliable accounting,
  • submit to tax audits.

Shell companies and the scope of the ATAD 3 directive

The ATAD 3 directive covers a wide range of entities that:

  • engage in economic activity,
  • may have various legal forms,
  • reside for tax purposes in one of the Member States.

The following entities remain outside the scope of the directive:

Holding structures in the same countryThe exemption applies to holding structures where the beneficial owner and the operating subsidiaries are residents of the same Member State. This means no cross-border element.
EU financial institutionsThe exemption applies to financial institutions regulated by EU law. For example: banks, insurance companies, and investment funds.
Companies listed on EU stock exchangesthe exemption covers companies listed on regulated financial markets in the EU
Entities with at least 5 employeesThe exclusion applies to entities employing at least 5 people full-time, who perform only tasks generating the so-called significant income
Entities outside the scope of the ATAD 3 directive

The essence of qualified revenue in the unshell directive

In the unshell directive, qualified revenue is fundamental to understanding its mechanism. It denotes passive revenue for assessing the entity’s minimum economic requirements.

Qualified revenue includes, among others:

passive income from various sourcesInterest or other income from monetary assets (including cryptocurrencies), license fees and other income from intellectual and industrial property and permits
Dividends and capital gainse.g. from the sale of shares, stocks, securities
Revenue from financial leasinge.g. interest on lease installments
Revenue from real estatee.g. rent, sales revenues
Revenue from movable property worth over 1 million eurosExcluding cash, shares and securities
Revenue from insurance, banking and other financial servicese.g. insurance premium, renewal fee
Revenue from services outsourced to foreign affiliatesServices performed in Poland. The services are closely related to the enterprise or place of business in Poland
Examples of qualified revenue
shell companies

The importance of qualified revenue for shell companies

Qualified revenue is crucial in assessing the risk of an entity being deemed a shell company. Entities with a high level of qualified revenues must meet stricter requirements to prove their economic substance. This refers to entities with over 75% qualified revenue in the past two tax years.

Entities not exempt from the ATAD 3 Directive must carry out self-control. Its purpose is to assess whether a given entity meets the criteria of a high-risk entity.

Conditions for recognising an entity as a shell company according to the Unshell Directive

The ATAD 3 Directive introduces new criteria for identifying shell companies. The qualification is based on two tests:

  1. Substance test.
  2. Management test.

Meeting one of these two tests is enough to consider a company as a shell company.

CriterionSubstance TestManagement Test
DefinitionA company lacks economic substance if it exists solely for tax benefits. This means that it does not engage in genuine business activities.A company is not properly managed if decisions are made outside its EU Member State of registration.
PurposeIdentifying companies solely used for tax optimisation, without genuine business activity.Identifying companies managed outside their home country, which may hinder tax audits.
Indicators– Lack of physical presence of the company (e.g. office, address) – Lack of qualified staff – Low added value generated by the company, – Low level of business expenses – Transactions made mainly with related entities – Use of the services of other related entities (e.g. management, accounting)– Decisions regarding the management of the company made by persons from outside Poland  – The company’s files and accounting documentation are located outside Poland – The company does not have actual management in Poland – The company uses management services provided by related entities outside Poland
Consequences of not meeting the test– Additional tax liabilities for entities related to the shell company – Limited possibility of using tax reliefs – Tax penalties – Civil liability– Additional tax liabilities for entities related to the shell company – Limited possibility of using tax reliefs – Tax penalties – Civil liability
Criteria for classifying a shell company

Consequences of recognising an entity as a shell company

Recognising an entity as a shell company under the ATAD 3 directive can have serious tax consequences. Here are some of them:

Tax transparency
(look-through entity)
This means that income and losses go directly to its beneficial owners, not the entity itself. As a result, beneficial owners may face higher tax burdens. They will pay taxes on the shell company’s income in their countries of residence.
Refusal to issue a tax residence certificateTax authorities may refuse to issue a tax residency certificate to the entity. They can also issue a certificate with a note that it is impossible to use the withholding tax exemption. A tax residency certificate is often required to benefit from double taxation treaties and other tax reliefs.
Loss of tax benefitsThe shell company will be deprived of the possibility of using tax benefits under the EU parent-subsidiary regime. This concerns for example exemption from withholding tax for dividends, interest, license fees. This may also apply to the benefits of double taxation treaties.
Additional costsFor example, related to appealing against tax authorities’ decisions or restructuring the business.
Consequences of recognising an entity as a shell company
shell companies

What are shell companies? Summary

Shell companies are a serious problem that many countries are struggling with. Their existence can lead to losses in the state budget, as well as to unfair competition. That is why it is so important to identify them and know the mechanisms of these companies.

Do you need more information about shell companies? Feel free to contact our experts! They will answer all your questions.

What is a shell company?

A shell company is an entity that does not conduct real business activity. Its only purpose is to achieve tax benefits. These benefits include avoiding or reducing tax liabilities, concealing income or money laundering.

What are the criteria for classifying a company as a shell company?

There are two main criteria for recognizing a company as a shell company:
Substance test. A company lacks economic substance if it exists solely for tax benefits. This means that it does not engage in genuine business activities.
Management test. A company is not properly managed if decisions are made outside its EU Member State of registration.

What are the consequences of running a business by a shell company?

The consequences of using a shell company can be severe for both the company and its owners. They include, among others:
Additional tax liabilities – tax authorities may impose extra taxes on the company and its owners.
Tax penalties – the company and its owners may be fined for conducting business by a shell company.
Civil liability – the owners of a shell company may be liable for damage caused to other entities.
Criminal liability – operating a shell company may sometimes be a criminal offence.

How to protect yourself from shell companies?

Entrepreneurs can protect themselves from shell companies by following the basic rules:
Thoroughly Verify the Contractor. Before entering into cooperation with a new contractor, they should be thoroughly verified. Check their address, registration data, staff, and the type of business activity conducted.
Avoid transactions with entities with low transparency. You should avoid transactions with entities that are not transparent in their activities. This applies e.g. to companies registered in tax havens.
Use the services of a tax advisor. If you have any doubts about a contractor or transaction, it is worth consulting a tax advisor.

Where can I get more information about shell companies?

More information on shell companies can be found on the websites of:
the Ministry of Finance
the National Tax Administration
the European Union.

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