[IMGCAP(1)][IMGCAP(2)]With the unauthorized publication of the “Panama Papers,” many clients and even some professionals question why companies with no active trade or business even exist.

Aren’t companies supposed to make widgets or sell services and not exist on paper simply to own shares of stock or a bank account? Aren’t they only for money launderers and tax cheats?

“Shell company” is a term of art that has been used by politicians and pundits as being associated with structures created for illegal purposes. The more substantive term for such companies would be “single-purpose entity,” as the reasons for their creation vary and depend on each company’s and person’s goals.

In reality, single-purpose entities have been around for centuries, dating back to the East India Trading Company in Great Britain and earlier. They provide valuable vehicles for commerce, legitimate minimization of taxation, and privacy for those who have done nothing wrong. Those seeking to fashion remedies for abuse should always keep the many proper uses in mind.

Historical View
In the early 1900s, the single-purpose entity was utilized during the expansion of the growing and robust utilities industry in America. In capitalizing on the expansion of the utilities industry, equipment manufacturers would employ these structures to attract investors to their enterprises while shielding the investor from personal liability. An early example of this was the Electric Bond and Share Company, created by General Electric in 1905. The use of these companies helped develop the current finance industry and today’s world economy.

More recently, the Bacardi story of exile from Cuba illustrates the valuable use of shell companies. Fearful of the dictator Batista, company executives and lawyers organized a single-purpose entity in the Bahamas to own Bacardi’s intellectual property and license it to the manufacturing company in Santiago de Cuba. When the Communist confiscation occurred years later, the Bacardi family was able to convince the world that they owned their trademark outside of Cuba and not the Cuban company. It made all the difference in what happened to the shareholders in the ensuing decades and created the successful worldwide spirits company we all know today.

Living in an unstable world, the desire to hedge financial bets has always found a vehicle in companies created for a single purpose with no trade or business of their own.

Uses of Shell Companies
There are a wide variety of perfectly legitimate uses for “shell” companies. To catalog some of them:

Probate: The creation of the single-purpose entity has often been utilized by estate planners to legally and efficiently structure succession plans for individuals wishing to avoid the costly process of opening an ancillary probate proceeding in multiple jurisdictions. The single-purpose entity has also been used for the purpose of avoiding outdated “forced heirship” foreign jurisdictions, which require the decedent to devise property to their children, regardless of his or her wishes.

Joint ventures: Single-purpose entities are sometimes used in joint venture situations in order to provide a vehicle to serve as the “face” of the project. For example, a company is created, owned equally by two joint venturers. The actual assets and employees can be owned by the shareholders with only the invoicing run through the joint venture. The joint venture project can therefore be segregated from other businesses owned by the parties.

Start-up companies: While every entrepreneur dreams of starting a conglomerate or at least selling their business to one, many new businesses start as a company on paper and nothing else. State laws do not generally require any minimum capital to begin or any active business dealings. Silicon Valley technology companies often begin life owning nothing more than intellectual property.

Liability: While the public may think of a Fortune 500 company as a single investment, accountants and lawyers know they comprise many different entities. Single-purpose entities are used by these companies to isolate operations and therefore liability. Sometimes they are stacked such that one activity is far removed from other activities and assets.

Coming to America and taxes: Many single-purpose entities are created by foreigners to invest in the United States in order to circumvent many unfavorable tax consequences that would result had they owned such investments outright. For example, if a foreigner were to die owning U.S. real estate in his or her own name, the estate would be subject to the U.S. estate tax and a credit of $60,000. Legally utilizing these structures ensures investors are successfully maximizing their investment by minimizing costs. Other times these structures may be put in place abroad to plan for a foreigner’s business activities before applying for U.S. citizenship.

On the ocean: Corporations are often used in the ownership of sailing vessels. They can isolate liability for the beneficial owners from other vessels or assets or even personal liability. Many merchantmen are registered as single-purpose companies under flags of convenience in countries such as Panama and Liberia for regulatory and cost-saving reasons.

Privacy: Although gossip columns in which celebrities announce the price and location of their homes suggest otherwise, many people prefer to hold their assets in single-purpose entities to shield them from the public eye. Single-purpose entities with outside directors can serve this purpose well. Clients who are domiciled in countries with a high amount of violent crime such as kidnapping usually hold assets in companies, trusts and other vehicles and often request the same treatment for their assets here. Some clients even prefer the use of entities so their own children cannot track down the value of the family’s wealth!

Foreign asset ownership rules: Some countries have rules as to the amount of foreign ownership that can be vested in a single foreign entity. For example, at one time a multinational company we know sought to purchase its sole national distributor abroad and was met with the objection that no more than 25 percent could be owned by a single foreign company. Fortunately, in that civil law jurisdiction, regulators accepted the concept that four separate single-purpose entity subsidiaries each owning 25 percent of the distributor would satisfy the letter of the law.

Investors: Both those seeking to invest in a company and those already owning it sometimes have reasons to limit the participation of new members. For example, shareholders may create a single-purpose entity to own the company’s intellectual property, just as Bacardi did years ago. If the new investor were not to be involved in this company, IP decisions as well as any royalty stream would not concern him or her.

Professional Responsibilities
In many situations, professionals have a duty to review the use of single-purpose entities with clients, even despite the unfavorable publicity generated by news stories such as those surrounding the Panama Papers. We find that such review often leads to greater efficiency. While clients are free to reject the advice, not offering it may have consequences.

Today’s newspapers are filled with abuse allegations involving single-purpose entities, some of which even have involved foreign heads of state. We carry no brief for those abusers who will no doubt have their day in court. But given the rich and varied legitimate uses of such entities, any talk of remedies must be sensitive to the legitimacy of so-called shell companies and the rights of the honest to employ them.

Steven Naclerio is counsel at the law firm Richman Greer and focuses his practice on corporate transactions and consulting with high net worth individuals as well as general business matters. He may be reached at snaclerio@richmangreer.com. George L. Metcalfe, Jr., is an associate with Richman Greer, where he focuses his practice on taxation, international and domestic estate planning, corporate law, and probate law. He may be reached at gmetcalfe@richmangreer.com.

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