Both in press and legal literature there are often references to letterbox companies.

Sometimes different names are used, such as mailbox companies, brass-plate companies, shell companies or pro forma-companies. None of these terms has an explicit meaning, but all seem broadly to refer to the same phenomenon: a company which has no or very little activity at the place where it is registered.  These companies are often associated with activities that are, if not criminal, then at least dubious. If letterbox companies are used to either avoid paying taxes in the EU member state where they are due, or if they are used to avoid legislation in a member state, they may undermine the functioning of the internal market.

Until recently, EU law has been very tolerant toward letterbox companies and may even be said to facilitate their use. However, in recent years there have been several examples where the EU, through secondary legislation, has addressed letterbox companies with the aim of restricting their use.

 

Letterbox companies and free movement in the internal market

According to Article 49 TFEU, establishing a subsidiary is covered by the freedom of establishment. Therefore, it would seem that setting up a letterbox company would be protected by that provision. That, however, is only the case if the setting up of a company qualifies as an establishment. If the company is formed without any activities or without the intention of having any activities, then there is no establishment and consequently the formation would fall outside the protection of Article 49.  Consequently, EU member states are free to deny the incorporation of the company. Also, the court has accepted that companies are creatures of national law, and therefore member states may impose some requirements of a link to the state of incorporation to be fulfilled when the company is formed and later.  For instance, a member state may require that the company has its management in the state of incorporation. EU member states applying the real seat theory in international private law would require that the real seat of the company is in that member state. However, not every member state requires that companies should have a substantial link to the state of incorporation, and therefore setting up letterbox companies will be possible in many EU Member States.

Companies benefit from the internal market as they are guaranteed the freedom of movement according to both the right of establishment and the freedom to provide services, cf. Articles 54 and 62 TFEU. Article 54 provides a very broad definition of the companies that can claim the two rights, and this definition does not seem to exclude letterbox companies.

However, the member states were very early aware that letterbox companies which were easy to establish in some member states could make it very easy to get access to enjoy the right of freedom of movement. It was particularly feared that companies from third countries would be able to use the internal market by establishing a letterbox company in the Netherlands. Therefore, a requirement was imposed that companies that only have their seat situated within the EU can only exercise the right of establishment and the freedom to provide services if “… their activity shows a real and continuous link with the economy of a Member State.”  The implication is that letterbox companies formed without any activities in the Union cannot rely on the right of establishment and nor the freedom to provide services.

The court has subsequently accepted that companies without any activities in the EU cannot rely on the free movement rights.

Even though there should be some activities within the EU, this does not mean that the activity should be in the member state of incorporation. In Case C-212/97, Centros, the court held that there was an establishment even in the situation where a company was set up in one member state for the sole purpose of establishing a branch in a second member state, and even if the entire commercial activity of the company was in the member state where the branch was situated.  Accordingly, as long as a company satisfies the connecting factors required by national law in the state of incorporation, it is entitled to exercise free movement. As mentioned above, many member states do not require a company to have commercial activities or their “real seat” in the State of incorporation, and therefore this judgment has the important consequence of allowing letterbox companies formed in the EU to operate within the EU.

In conclusion, the free movement rights generally protect the use of letterbox companies and have done more to promote their use than to limit it. This is mainly due to the seminal judgement in Centros.

 

Sector specific regulation of letterbox companies

Since the EU had done very little to prevent the use of letterbox companies, it was left for the member states to cope with these. It has, however, proven to be difficult for the member states to do this because it often involved cross-border situations where investigations and enforcement are difficult, and because it is not crystal clear how far the free movement rights protect letterbox companies, see above. In recent years the EU has tried to help the member states by introducing legislation which aims to make it easier for member states to prevent letterbox companies from undermining the internal market in sectors where problems have been identified. In the following, two examples of such legislation will be given.

 

Posting of workers

Regarding posted workers, there have been increasing problems with employers using letterbox companies. The problem seems to be that the companies claim to be established in other member states and are thus apparently complying with the legislation there.

Consequently, they claim that they cannot in full be subject to the legislation in the member states where they post workers in order to supply services. Given that the service provider has no real activities in the member state that the company claims to be established in, there does not seem to be any reason for not applying the legislation in full in the member state where the workers are posted. The problem with letterbox companies seems to have spread to several member states. A report on the revitalization of the internal market prepared by the previous European Commissioner Mario Monti stated the importance of fighting letterbox companies: “In this context, it is also of key importance that the fight against ‘letterbox companies’ is intensified and that posted workers’ access to legal remedies against abuses of their rights suffered in the host country is strengthened.”

In 2014 the EU adopted a directive to improve the enforcement of the Posted Workers Directive (Directive 96/71/EC).  The directive includes several interesting initiatives to counter letterbox companies. First of all, the directive specifies the definitions of when there is a genuine establishment and a genuine posting. In relation to the fight against letterbox companies, the former is particularly interesting as it is intended to ensure that the company posting employees is not just a letterbox company. The introduction of article 4 of the directive determines that the assessment of whether it is a genuine establishment is based on a comprehensive assessment of a number of factual elements listed in the directive. Cf. Article 4(2), these elements are:

“a)     the place where the undertaking has its registered office and administration, uses office space, pays taxes and social security contributions and, where applicable, in accordance with national law has a professional licence or is  registered with the chambers of commerce or professional bodies
b)     the place where posted workers are recruited and from which they are posted
c)     the law applicable to the contracts concluded by the undertaking with its workers, on the one hand, and with its clients, on the other
d)     the place where the undertaking performs its substantial business activity and where it employs administrative staff
e)     the number of contracts performed and/or the size of the turnover realised in the Member State of establishment, taking into account the specific situation of, inter alia, newly established undertakings and SMEs.”

The elements stated are not exhaustive. The elements have in common that they seek to identify where the activities that are central to most service companies actually are exercised. If all or most of these activities are performed elsewhere than in the member state of establishment, the company in the member state of establishment will solely exercise what is characterised as “purely internal management and/or administrative activities” and it will not be a genuine establishment. Consequently, it is not necessary to accept that it is a foreign company exercising the freedom to provide services.

Moreover, the member states are urged to try to identify who is behind these letterbox companies. Para 42 of the preamble states that in cases where a service provider is not really established in the member state in which the company is formed, member states should not conclude the procedure, but should investigate the matter to further establish the identity of the natural person or legal person who is responsible for the posting. In addition, the new directive suggests a strengthened enforcement of the sanctions across borders.

 

Certain types of crime

In a report from 2001, OECD pointed out that companies can be used for different types of crime. This includes, i.a., money laundering, bribery and corruption, hiding assets from creditors, different types of illegal fiscal practices, illegal self-dealing and evasion of the rules which prohibit insider dealing.  This type of crime is often performed by letterbox companies as the companies have no real business activity in the country in which they are established.

The report reviews the various types of companies which are engaged in such criminal activities, and the report concludes that within the EU mainly private limited companies are used, whereas internationally other types of companies are also , including international business corporations (IBC), exempt companies, trusts and funds. It is a common feature that the preferred types of companies ensure the anonymity of the owners. Anonymity can be ensured by 1) issuing of bearer shares, 2) allowing “nominee shareholders,” i.e. permitting others – for example dealers – to be registered as owner of the shares, 3) allowing a “nominee director,” who is a person who lets him/herself register as director but leaves the tasks associated with being a director to another, or 4) allowing a company to be registered as director.

Already in the report from 2001, OECD suggested meeting this type of misuse of corporate vehicles by providing and sharing information about who is a “beneficial owner.”

Subsequently, the Financial Action Task Force (FATF) under OECD formulated recommendations for beneficial ownership. Most recently, the government leaders at the G20 meeting in Russia in September 2013 recommended more exchange of information in order to counter tax evasion, and thereby they referred to FATF’s recommendations on beneficial ownership. At a meeting in June 2013 in Northern Ireland, the G8 agreed on the action plan: “Principles to prevent the misuse of companies and legal arrangements.” The plan also includes an invitation to introduce rules which ensure insight into who the beneficial owners of the company are.

In light of the recommendations issued by the FATF and the conclusions at the G8 and G20 meetings, the EU changed the Money Laundering Directive so that companies are obliged to be in possession of information on who their beneficial owners are. The information should also be stored in a central register in each member state, and it should be possible for the authorities (and the so-called “obliged entities”) to get access to this information.  The Parliament had suggested that the information should be made publicly available, but in the end it was decided to leave it to the member states to decide whether this should be the case.

Undoubtedly such a register will make it easier to prevent many types of crime. However, it must be assumed to be a challenge to ensure that the register contains updated information about the companies’ beneficial owners.

The directive – when implemented – will be limited to apply to companies established in the member states in the EU. Clearly an effective action against these types of companies requires an effort to make countries outside the EU introduce similar rules. Here it is interesting that the other G8 countries also are prepared to ensure greater access to information on beneficial owners. But the greatest challenge is to get other states, including the so-called tax havens, included in these efforts. In 2012 the Commission recommended how the EU, with the help of the member states, must implement measures to encourage third countries to apply minimum standards of good governance in tax matters.  This means, i.a., that these third countries must ensure that “… ownership and identity information for all relevant entities and arrangements is available to its competent authorities” and likewise there is an obligation to ensure that this information can be exchanged with the member states’ authorities.

 

Conclusions

As the examples show, the undesirable use of letterbox companies is not necessarily an issue which is connected to the internal market. The problems concerning misuse of companies for certain types of crime especially have no direct connection with the establishment of the internal market. However, there are certain problems with letterbox companies which are closely connected to the establishment of the internal market. This is illustrated by the problems with the posted workers.

Looking at how letterbox companies may be misused, the examined cases show that this can be done in different ways. In some cases – as illustrated by the posted workers case – it is a problem that letterbox companies are not really established in the EU member states in which they are registered, but on the contrary have placed their activities in another member state. The intention is to avoid the full impact of the legislation in the member states where they operate. The companies used for different types of crime also normally have limited activities, but what is problematic in these cases is the fact that the companies are used to hide from the authorities what is happening and who is behind the company.

The examples reviewed indicate that the problems with the letterbox companies are very different, and thus it has been difficult to make a general initiative to combat all these types of misuses. Instead, the EU has decided to solve the problems in the sectors where they appear, which seems to be an appropriate strategy.

The sector-specific strategy which is followed in combating undesirable use of letterbox companies seems to follow different tracks. Two are illustrated in the examples: either implementing a more specific definition of when a company is established and therefore not a letterbox company, or alternatively, collecting as much information as possible about the companies and those controlling them. These tracks, as well as the other tracks used by the EU, are examined more closely in the article I have published in Common Marked Law Review 2015 pp. 85-118.

 

ENDNOTES

  1. Shelf companies on the other hand refers to a less dubious occurrence where companies are formed without any specific activity in mind and are later sold to business entrepreneurs who need to incorporate quickly. The fact that it is often possible to incorporate quickly online today means that the use of shelf companies has declined in many jurisdictions.
  2. See Case C-196/04, Cadbury Schweppes.
  3. See Case 81/87, Daily Mail, paras 19-23.
  4. See General Programme for the abolition for restrictions on freedom of establishment OJ 1962 36/62.
  5. See Case C-208/00, Überseering, para. 75.
  6. See Case C-212/97, Centros, para. 17.
  7. Mario Monti: A new strategy for the Internal Market, May 2010, p. 70. The report is available on http://ec.europa.eu/bepa/pdf/monti_report_final_10_05_2010_en.pdf
  8. See Directive 2014/67/EC concerning the posting of workers in the framework of the provision of services and amending Regulation (EU) No 1024/2012 on administrative cooperation through the Internal Market Information System (‘the IMI Regulation’), OJ 2014 L 159/11.
  9. Cf. OECD: Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes, 2001, s. 33-37.
  10. See Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, OJ 2015 L 141/73, Article 30. In addition Article 31 includes a rule which shall apply to trusts.
  11. Cf. C(2012) 8805.