India: New SBO Rules – Implementation Challenges

Last Updated: 8 November 2019
Article by Bharat Vasani and Cyril Shroff

India is yet to hit its stride in dealing with Significant Beneficial Owner (SBO) rules introduced by the Companies (Amendment) Act, 2017. The SBO rules have its origin in the recommendations made by the Financial Action Task Force (FATF) to its member countries, to make suitable changes in the national legislation to find out individuals, who ultimately own significant beneficial shareholding in the reporting company. There remains a large degree of uncertainty and confusion around the new norms, and their practical impact, as explored below.

Sections 89(10) and 90 of the Companies Act, 2013 (Act) were introduced on the recommendations of the Company Law Committee (CLC) in its Report dated February 1, 2016. The CLC noted that complex structures and chains of corporate vehicles are used to hide the real owners behind the transactions made using those structures.

Impact of Section 90 and Related Provisions

Section 90 of the Act read with the Companies (Significant Beneficial Owners) Rules, 2018 (SBO Rules) prescribe twin tests to find an individual who would qualify as SBO of the reporting company:

  1. Objective test of 10% shareholding at the reporting company level and majority holding through the ownership chain.
  2. Subjective test of SBO having the right to exercise or actually exercising "significant influence" or "control" in any manner other than through direct holding alone.

The expressions control and significant influence are defined in Section 2(27) of the Act and in Rule 2(1)(i) of the SBO Rules respectively. It is a factual analysis in every case to determine whether this subjective test is satisfied in the given factual matrix.

Section 90 has already been amended extensively by the Companies (Amendment) Act, 2019 even before the provisions became operational. Section 90 contemplates a statutory piercing of the corporate veil, to find out which individuals are SBOs of the reporting company. Section 90 has an extra-territorial operation and would apply to foreign registered trusts and persons, who are residents outside India. Hence, its remit is very broad and affects a number of stakeholders.

Section 89(10) had for the first time introduced the definition of beneficial interest for the purposes of Section 89 and 90. It is a very broad and inclusive definition to cover beneficial interest in shares held directly or indirectly, through any contract, arrangement, or otherwise, the rights or entitlements of a person alone or together to:

  • Exercise or cause to be exercised any or all of the rights attached to such share.
  • Receive or participate in any dividend or other distribution in respect of such share.

The Ministry of Corporate Affairs (MCA) had originally notified the SBO Rules in 2018, but the same were not implemented due to interpretative challenges. The MCA has, since then, significantly amended the SBO Rules, and the amended rules have come into effect from February 8, 2019. The last date for filing BEN-2 declarations (form prescribed by the MCA for declarations of SBO to be filed by the reporting company) has since been extended multiple times and the revised last date is December 31, 2019.

Unfortunately, despite extensive redrafting of the SBO Rules published earlier, the determination of an SBO in a reporting company is extremely difficult, due to several interpretative challenges in the SBO Rules. Whilst the new SBO Rules are a marked improvement over the previous ones, there still exists a considerable amount of ambiguity with regard to determination of the SBO in certain situations.

Practical Challenges in Determining SBOs

Some of these challenges are as follows:

1) 10% or 25% Threshold?

Section 90 stipulates that the threshold for triggering SBO reporting requirements is no less than 25% of shareholding in the reporting company, or "such other percentage as may be prescribed". The SBO Rules have lowered this threshold to 10% of the shareholding in the reporting company. The legal validity of this lower threshold prescribed in the SBO Rules is doubtful, and may be set aside by a Court, if challenged. The SBO Rules appear to be clearly ultra-vires Section 90, which goes against the cardinal principles of law, in which delegated legislation cannot go beyond the Act passed by Parliament.

2) Equity & Preference or Only Equity Shares

Given the definition of beneficial interest in Section 89(10) and Section 90, there are two views on whether both equity & preference shares should be considered for SBO determination, or only equity shares and convertible instruments. One view is that both equity and preference shareholding need to be considered in determining the shareholding threshold for identification of the SBO. The other view is that equity shares, Global Depository Receipts, Cumulative Convertible Preference Shares and Cumulative Convertible Debentures should only be used for computation of the 10% threshold as per explanation VI of the SBO Rules.

The counter-argument, however, is that if the individual has the right to receive or participate in more than one-half of the distributable dividend inclusive of any dividend from Redeemable Preference Shares (RPS), then the holding of such RPS will have to be considered on the basis of the definition of beneficial interest u/s 89(10) read with the definition of majority stake in Rule 2(1)(d)(iii) of the SBO Rules. The expression used in Sections 89 & 90 of the Act is 'shares'. The Supreme Court has held that Rules made under a parent legislation are a legitimate aid to construction of the parent statute (Telco v. Gram Panchayat, Pimpri1).

3) How to Determine Acting Together?

The expression acting together has been clarified in Explanation V to include individuals acting through any person or trust, with a common intent or purpose of exercising any right or entitlement or exercising control or significant influence over a reporting company pursuant to an agreement or understanding, formal or informal. One position is that the "acting together" test needs to be applied only at the reporting company level and not throughout the ownership chain going right up to the top. However, given the objective of this enactment, it would be safer to take a view that this test needs to be applied at every layer of the ownership chain.

4) Private Discretionary Trust with a Corporate Trustee

In case the shares held by a private irrevocable discretionary trust, and the trustee of such trust is a corporate trustee, the SBO Rules are unclear as to who should be declared as an SBO in such a situation. The problem is further compounded by the fact that the SBO Rules use the expression "where the member of the reporting company is a trust (through trustee) and the individual is a trustee in case of a discretionary trust". A number of large Indian promoter families have started migrating their share ownership in their corporate empires to a discretionary trust, where sometimes the trustee is a corporate vehicle or family office. If one goes strictly by the literal interpretation of the Rules, it is possible to argue that in such a situation there exists no SBO.

5) Pooled Investment Vehicles

Another confusion is with regard to determination of the SBO where the member of the reporting company is a pooled investment vehicle or an entity controlled by the pooled investment vehicle, based in a jurisdiction that is not a member of the FATF or, if it's a regulator of the securities market, is not a member of the International Organisation of Securities Commissions. In such ownership situations, the SBO Rules are unclear as to how to determine SBO. The limited partner would surely not like to come forward to declare itself as SBO.

6) Dematerialised Shares Held by Pledge Offer Invocation of Pledge

SBO Rules are silent on who should be filing the declaration when the lender has invoked the pledge of shares held in a dematerialised form and is holding the shares in its own account as an investment. This is because of the conflict between the provisions of the Depositories Act, 1996 and more particularly Regulation 58 of the SEBI (Depositories and participants) Regulations, 1996 and Section 176 of the Indian Contract Act, 1872. The Supreme Court in the case of Balkrishna Gupta v. Swadeshi Polytex Limited2 has held that the pledgee does not become the beneficial owner of shares upon invocation of the pledge. In such a situation, there may be confusion as to who should be filing the SBO declaration.

7) Shares of a Deceased SBO Where the Transmission of Shares has not been Completed Due to Disputes

In some situations where the beneficial owner is not yet established, it is unclear who should be filing the SBO declaration. This would include when the SBO has died and the shares held by him are not legally and beneficially transmitted to his or her legal heirs, due to a dispute with regard to the validity of the will in case of a testamentary succession. It could also apply in cases of intestate succession, where the court has not issued succession certificates or letters of administration, or in some occasions, where courts may appoint an administrator pendete lite, under Section 247 of the Indian Succession Act, 1925, and such administrator pendent lite acts as an officer of the court, and holds the shares for a temporary period until the dispute regarding the validity of the will are resolved.

8) Interplay With Other Legislation

As of now, there are unclear ramifications as to how filing SBO declarations  interplays with other laws and regulations like the Income Tax Act, 1961, the Prohibition of Benami Transactions Act, 1988 and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, Black Money Act, 2015, and Insolvency law etc. There is also concern that if the shares are held through trust, the bankruptcy remoteness of such holding could get compromised by filing SBO declarations.

Consequences of Non-declaration / Mis-declaration

As per Rule 2A of the SBO Rules, the reporting company is required to take necessary steps to find out if there is any individual who is an SBO and, if so, identify him and cause such individual to make a declaration in Form No. BEN – 1. The reporting company is under an obligation to issue a notice in Form No. BEN – 4 in every case where its member (other than an individual) holds not less than 10% of its shares or voting rights, or has the right to receive or participate in the dividend, or any other distribution. The consequences of mis-declaration or non-declaration of SBO could result in the National Company Law Tribunal (NCLT) passing an order restricting the transfer of shares in question, suspension of all rights attached to such shares, etc. If the SBO fails to get such order vacated within a period of one year, the entire shareholding in question could get transferred to an Investor Education and Protection Fund.

Some Concluding Thoughts

Given the financial stakes involved for the SBO and the potential ramifications under other laws and rules, there is a very high-level of anxiety in the corporate world with regard to filing of an SBO declaration.

It is very important for the Government to now clarify any ambiguity in this regard or risk a negative impact on the investment climate in the country. Fear of the unknown is forcing companies to resort to legal opinions to support the positions taken by them. SBO Rules may prove to be a fertile ground for protracted civil and criminal litigation.

Footnotes

1 AIR 1976 SC 2463

2 (1985) 2 SCC 167

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions