Sophisticated and high-net-worth business clients often hear about the conversation between the use of a shell company vs holding company for furthering their corporate interests. While they have similarities, in theory, their differences lie in their practical applications and surrounding connotations. Here, we unpack some of the use cases for these business entity structures and provide an informative comparison.
What Is the Difference Between a Holding Company and a Shell Company?
The main difference between shell and holding company is their function and purpose to the owner. You often see shell companies used for reasons that don’t necessarily involve the traditional operation of a business. In contrast, holding companies exist to extend liability protection and streamline the ownership and management structure.
What is a shell company? Although the term sometimes has a negative or nefarious connotation, shell companies can be legitimate vehicles for achieving various business and financial outcomes. However, users of shell companies can find themselves subject to investigation from law enforcement and liability when they use shell companies for illegal reasons such as tax avoidance, fraud, money laundering, etc. More legitimate reasons for a shell company may include uses in jurisdiction shopping, accessing tax benefits, corporate financing, and M&A dealings, amongst other functions.
When trying to distinguish a shell company from other business entity structures, the primary question to ask is whether the company serves an active business purpose? In other words, does the company actually have business transactions where it offers goods or services in exchange for compensation? If the answer is yes, then the entity is probably not a shell company.
In answering the question of what is a holding company, we recognize that it holds some similarities to shell companies in that they don’t necessarily operate as an active business. Rather, a holding company’s purpose is to control (i.e., hold) other companies or assets. The term usually has a broader acceptance of legitimate use of the corporate structure. You may hear about holding companies in the context of a parent company and subsidiary company relationship, businesses that manage real estate, etc.
Shell Company Vs Holding Company Comparison Chart
| Comparison | Shell company | Holding company |
|---|---|---|
| Setup | Likely use of a professional registered agent | Professional registered agents are common but not always necessary or preferred |
| Infrastructure | Exist mostly on paper (i.e., no physical presence) | May still have a physical presence through office space, employees, etc |
| Liability Protection | May struggle with defending liability shield when faced with a lawsuit depending on the circumstance | Possibly has greater support liability protection in separating key assets (e.g., real estate from a business operation) |
| Taxes | May offer different tax advantages and benefits when not used to abuse tax laws or commit tax evasion | Can offer streamlined tax reporting through consolidated returns |
| Protecting Anonymity and M&A | Legitimate use cases in seeking anonymity for beneficial owners through state law and in M&A dealmaking | May be useful for acquiring subsidiary companies |
Holding Company Vs Shell Company: A Closer Look
In many ways, the comparisons between a holding and shell company are purely semantical and their application, in reality, is indistinguishable. It’s not uncommon to see situations where you have layers of both company types established within a particular venture, especially with high-net-worth individuals. However, when discussing a shell company vs holding company, you may consider the following points for comparison.
Setting Up a Shell Company Vs Holding Company
The process for creating a shell company versus a holding company is not too different. Depending on the type of new company, you will need to file the appropriate articles of incorporation or organization with the state or country where the company will exist. You will also have to submit annual reports and other compliance items necessary to maintain the company’s active status.
However, a big difference with a shell corporation is that you will most likely use a professional registered agent service as the point of contact for filing and communication with the applicable Secretary of State. The reason for this is to maintain anonymity as most article filings are public record accessible via online databases. Use of a registered agent service may still be preferable with a holding company but will depend on if that privacy is important to the owners.
Shell Companies Often Only Exist on Paper
Another point of comparison is the fact that shell companies tend to exclusively exist on paper. In other words, they don’t have the infrastructure and business operations you might see with other companies. For example, shell companies don’t usually have:
- A physical presence such as an office space
- Employees
- Real or standard personal property (e.g., inventory, machinery, equipment, etc.)
Instead, shell corporations tend to hold paper assets only such as trusts, other businesses, contractual rights, intellectual property, etc. The shell may also hold large sums of cash through a bank account or investment accounts held through various financial institutions.
A holding company, in comparison, could still have some of the standard features you would see with an active business such as office space, employees, and other infrastructure.
Separate Your Potential Liability Between Different Assets
Regardless of intent or purpose, a core function of a business entity structure like a limited liability company or corporation is to separate the business from the people who own it. The effect of this separation is a shifting of personal liability that may arise from business operations or the underlying assets for those owners to the company.
Shell companies used for illegal activity or illegal purposes like tax evasion, however, won’t normally benefit from this liability protection as courts will generally enforce a claim for piercing the corporate veil to obtain justice against the owners by holding them personally liable. Even in legal use cases, shell companies may struggle as a liability shield when pressed in litigation because the business entity only exists for that purpose and does not maintain actual business operations.
Holding companies, by comparison, tend to have stronger reasoning behind their existence that may hold up better when defending limited liability status in a lawsuit. Situations where holding companies can be useful for liability protection are where you want to separate different parts of a business venture. For example, separating the real estate of a business from its operation like in the context of a restaurant or manufacturing facility. In cases where you have multiple locations for the same business, a holding company may be helpful to separate the liability amongst them. The effect is to limit the assets available to a potential creditor or claimant.
Streamlined Tax Reporting and Other Tax Considerations
You may consider a holding company to file consolidated tax returns if you own and operate several businesses or corporations. Instead of having to file individual tax returns for each business, you can streamline the process and reduce some of the administrative burdens.
Other tax considerations for shell companies often involve reducing tax liability by forum shopping the location of your business for more favorable tax treatment. Unfortunately, people do abuse the corporate structure through the creation of shell companies for the sole purpose of hiding or underreporting earned income and not paying owed income tax. You often hear of offshore shell companies in places like the Cayman Islands and other locations that serve as tax havens.
Protecting Anonymity for Financing or M&A Purposes
Shell companies are more common in high-stakes, risky investment and business dealings. Certain states are well known for their acceptance and welcoming of shell and holding companies because of their state laws that favorably skew toward the protection and anonymity of beneficial owners (e.g., Delaware and Wyoming).
Another legitimate use of shell companies, subject to regulation and oversight from the Securities and Exchange Commission, is the SPAC. A SPAC is a shell company that raises and stores funds through an IPO to then acquire a private company and take it public through a merger or acquisition.
Is a Holding Company or Shell Company Better for Your Business?
Choosing a holding company or a shell company is a nuanced decision that requires careful review of the business goals and compliance with applicable laws. Each has its own strengths and weaknesses for achieving different outcomes whether it is optimizing tax liability, managing corporate control, protecting anonymity, or other liability and risk prevention. Each instance of creating a shell or holding corporation will require the help and legal advice of an attorney.
The business lawyers at Cueto Law Group are available to help business clients understand and appreciate the risks of various corporate structures and to provide guidance along every step of their creation and maintenance.
Contact Cueto Law Group to schedule a consultation for your questions about a shell versus a holding company.
