Why billionaires set up shell companies in offshore tax havens

Hindenburg Research, the US-based short-seller, on August 10, alleged in a report that Madhabi Puri Buch, the chairof stock market regulator Securities and Exchange Board of India, and her husband had a stake in offshore entities connected to the Adani group.

Hindenburg Research also called on the SEBI chief to disclose the client list of all individuals or firms consulting with her on her offshore investments. In the report, Hindenburg used multiple market terms to describe its claims. Here is a list of such terms and their meanings.

Offshore entities

The report mentioned offshore entities. According to Hindenburg Research, whistleblowers' documents have revealed that the SEBI chair has a stake in offshore entities of Adani Group that have allegedly siphoned off money.

The term offshore means a place outside a company’s home country. Financial and banking regulations in such places are generally different from the home country.

Offshore locations are usually island nations, where firms set up corporations, investments, and deposits. Companies and high-networth individuals may prefer offshore locations for tax avoidance, relaxed regulations, or asset protection. Offshore companies are legal but could be used for illegal purposes.

Shell entities

The Hindenburg report refers to Mauritius-based shell entities that are used to transfer alleged billions of dollars as undisclosed related party transactions, undisclosed investments, and stock manipulation.

Shell entities are such companies that do not conduct any business operations but are formally registered in a country.

Such companies are not necessarily illegal, but they are sometimes used illegitimately to disguise business ownership from law enforcement agencies or the public domain. Shell companies may also act as a tax avoidance mechanism for legitimate businesses.

According to the Organisation for Economic Cooperation and Development (OECD), the term shell is used to refer to a company that is formally registered, incorporated, or otherwise legally organised in an economy but which does not conduct any operations in that economy other than in a pass-through capacity.

Stock manipulation

Stock manipulation or ‘pump and dump’ scheme is a method of artificially controlling the price of securities. A stock price may increase or decrease in such a situation. It mostly seeks to influence prices to mislead other investors. This practice is illegal in India.

Short position

According to the report, SEBI did not allege any factual error in the previous report but wanted the disclosure around Hindenburg’s short position.

A short position is when a trader sells a security to repurchase it later at a lower price. A trader may short a security when they expect that its price will decrease soon.

SEBI defines a short position in a futures transaction as when the short sells the commodity or security for future delivery, and in an options transaction when the short sells the call or put and is obligated to take a futures position if he or she is assigned for exercise.

Related party transactions

Hindenburg refers to undisclosed related party transactions multiple times in its report. Related party transactions are arrangements made between two parties who are joined by a pre-existing business relationship or common interest. Companies usually prefer business deals with parties with whom they are familiar or have a common interest. The Companies Act, 2013 has defined related parties and the regulations governing them.

Tax haven

According to the Hindenburg report, “in one complex structure, a Vinod Adani controlled company had invested in “Global Dynamic Opportunities Fund” (“GDOF”) in Bermuda, a British overseas territory and tax haven, which then invested in IPE Plus Fund 1, a fund registered in Mauritius, another tax haven”.

A tax haven country provides minimal or no tax liability to foreign businesses and individuals for their bank deposits in a stable environment. Tax haven countries have special tax rules that make it attractive for businesses and individuals to park their funds.

However, they are often used for illegal tax avoidance or money laundering. The tax structure in such countries may vary from each other but all offer a place where foreign entities can escape high taxes by putting their assets in that jurisdiction. The laws and administration of a tax haven are opaque and personal information is highly protected.

Stock parking entities

Stock parking is selling of shares illegally to another party with the intention that the original owner will buy them after a short duration. It aims to hide the real ownership of a stock and make it appear like complying with the regulations. The report says that the trading patterns of the funds suggest stock parking entities and the suspicious offshore entities may have artificially inflated the volume and/or price of some listed Adani companies.

Share transfer

Transfer of shares means voluntarily offering the rights and duties of a shareholder who does not wish to be a part of the company to a person who wants to be a part of the company. Shares are transferable like any other movable property if any articles of the company do not restrict such transfers. The report alleges that the SEBI chairperson transferred her stake in Agora Partners to her husband, Dhaval Buch, according to Singaporean share transfer details.

REITs

A Real Estate Investment Trust is a trust registered with SEBI to carry out the activity prescribed under SEBI (Real Estate Investment Trusts) Regulations, 2014. According to SEBI, a REIT raises funds by issuing units to investors and invests those funds primarily in assets in the real estate sector.

It is regulated by SEBI (Real Estate Investment Trusts) Regulations, 2014. Parties to a REIT include its trustee, sponsor, and manager.

According to the report, in August 2020, Mindspace REIT, which is backed by Blackstone, became India’s second REIT to go for IPO, after SEBI approval. Dhaval Buch joined Blackstone as an adviser in July 2019 when SEBI brought regulatory changes in REITs, the report said. Such regulatory changes in REITs have benefitted private equity firms such as Blackstone, the report alleges.

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