New FATF guidelines: Shell companies and beneficial ownership

Shell companies are considered the safest means to stash wealth created through criminal activities. Incorporation of shell companies is not illegal but they are normally formed in tax havens where secrecy laws do not permit disclosure of ownership therefore, corrupt politicians, civil and military bureaucrats, members of judiciary and businessmen including large corporations involved in tax evasion or criminal activities feel secure in shifting their ill-gotten wealth to such jurisdictions to avoid legal proceedings.

Government authorities feel helpless in tracing their wealth due to vague information available with them. Moreover, shell companies have normally no presence in the public domain and to legitimize wealth, transactions between shell companies take place with no visible business activities.

The United Kingdom and some other European countries such as Luxembourg, Austria, Denmark, Sweden, Switzerland, the Netherlands, Jersey, Ireland and Germany are considered ideal for shell companies due to their secrecy laws offering incentives to foreigners to attract investments.

For example, Germany exempts from tax foreign income of non-resident corporations. Similarly, Ireland offers multinational establishments low tax rates on investments.

The Netherlands and Switzerland are world-famous tax havens. They just refuse to share information where they consider that the request does not conform to their procedure which, for seeking information from banks is quite complex.

For these reasons, wealthy families hide their wealth in these locations by creating anonymous, letterbox and special purpose shell companies with no physical existence, where they can conceal actual ownership, escape labor laws and social contributions with assurance of control over the resources and the company itself.

Therefore, despite extensive reporting from different platforms and active measures by various watchdogs as well as law enforcement agencies of a variety of jurisdictions, the share of illicit flow of funds in the global GDP is not diminishing and as per United Nation Office on Drug and Crime (UNODC) it is close to 2.5% or US$800 billion to US$2 trillion.

The global community through its consensus and efforts has prioritized this issue and the Financial Action Task Force (FATF) is continuously asking its member states to implement beneficial ownership guidelines to ensure knowledge of Ultimate Beneficial Ownership.

For this purpose FATF issued comprehensive guidelines on ‘Beneficial Ownership of Legal Persons’ on March 10, 2023. FATF members agreed in March 2022 to introduce strict guidelines related to beneficial ownership by amending FATF recommendation 24 to make sure that competent authorities have access to, and up to date information on true ownership of companies in the hope that this step would help prevent organized criminal gangs, corrupt and sanction evaders from using anonymous shell companies to store their dirty money and camouflage illicit activities.

The FATF’s guidelines will enable countries to identify, design and implement appropriate measures as per the revised Recommendation 24 that requires all jurisdictions to ensure access to beneficial ownership information by reserving it with a public authority, beneficial ownership registry or its like. This step would help in identifying real owners of shell companies and tracing illegally obtained assets.

The guidance explains types and sources of relevant information, and mechanism and sources to obtain such information. This includes the multi-pronged approach, which consists of combining information from, among others, companies themselves, public authorities in a registry, or alternative mechanism if it ensures rapid and efficient access to beneficial ownership information.

FATF’s mutual evaluations demonstrated that countries using a multi-pronged approach were more effective in preventing the misuse of legal persons for criminal purposes and ensuring transparency of beneficial ownership than countries using a single approach.

The revised recommendation demands that all jurisdictions including the corporate sector financial and Designated Non-Financial Businesses and Professions (DNFBPs) should adopt risk-based approach to mitigate the potential money laundering and terrorist financing risks.

The guidelines also require that each member state should devise a mechanism to a) identify and describe the different types, forms and basic features of legal persons in the country; b) identify and describe the processes for: (i) creating those legal persons; and (ii) obtaining and recording basic and beneficial ownership information on those legal persons; c) make the above information publicly available, and d) assess the ML/TF risks associated with the different types of legal persons, and to manage and mitigate risks that are so identified.

Similarly, the guidelines also require from the member jurisdictions to identify and assess the risk pertaining to foreign legal persons having sufficient links to the country.

In addition, the countries should take appropriate steps to manage and mitigate the risks they identify and determine what constitutes a sufficient link for a legal person not created in the country based on risk, but indicatively such a sufficient link could, for instance, be said to exist when the legal person: (a) Has a permanent establishment or branch or agency in the country; (b) Has significant business activity—defined either in terms of a monetary threshold, or by such other parameters as may be suitable to a country’s situation—in the country; (c) Has significant (in relation to the size of the relevant market and/or the impact of the business activity in the relevant market or the areas/sectors in which a legal person operates) ongoing business relations with financial institutions or DNFBPs subject to AML/CFT regulations in the country; (d) Has significant (determined with reference to the average price of the real estate/corresponding asset market in the country, or the quantity of real estate held) real estate or other investment in the country, including any asset subject to registration, such as ownership of high value commercial or residential real estate, securities market investment or other assets and (e) Employs staff, or is a tax resident (e.g., by reason of having its place of effective management or administration there) in the country.

In the light of above comprehensive guidelines, Pakistan should also streamline its affairs, improve its mutual legal assistance mechanism and strengthen cooperation with foreign jurisdictions.

The Federal Board of Revenue (FBR) has not considered all the above guidelines in the draft rules notified vide SRO 229(l)/2023 on February 28, 2023 for the purpose of section 181E of the Income Tax Ordinance, 2001 requiring every particulars of its beneficial owners in such form and manner as may be prescribed and also update the particulars of its beneficial owners as and when there is a change in the particulars of the beneficial owners.

Various leaks have exposed names of wealthy Pakistani individuals, including politicians, retired army officers, members of judiciary and bureaucrats owning shell companies to hide their assets.

The main hurdle in the past was obtaining beneficial ownership information due to which not even a single investigation could be completed.

However, as per amendment of Recommendation 24, each state will become responsible to make beneficial ownership information public.

Taking advantage of these initiatives, Pakistan being a responsible state should work closely with the global community synchronizing its Anti-Money Laundering and Terrorist Financing (AML/TF) regime in line with global practices.

The Anti-Money Laundering Act, 2010 despite 2020 amendments, still needs improvements as some of its provisions are incoherent with international best practices. Similarly, regulations issued by the FBR or Securities and Exchange Commission of Pakistan (SECP) are in dire need of improvement.

It is about time we address the anomalies in our system so that in 2024, when every country would be adhering to FATF requirements, Pakistan would be ahead in claiming to have information about those who plundered the country’s resources parking the loot in offshore havens.

Pakistan’s active role in improving its AML-CFT regime will not only have positive influence over our rating on Corruption Perception Index, but would also help us trace illegally generated assets by the powerful elites, corporations and private individuals as well as their abettors and collaborators.

(Huzaima Bukhari & Dr. Ikram Haq, lawyers, and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at the Lahore University of Management Sciences (LUMS), members of the Advisory Board and Visiting Senior Fellows of the Pakistan Institute of Development Economics (PIDE) and Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’)

Copyright Business Recorder, 2023