Ever since the notification of the Companies (Amendment) Act, 2017 (“2017 Amendment”), the identification and declaration of Significant Beneficial Owners (“SBO”) has been a vexed issue for India Inc.
The SBO regime, under Section 90 of the Companies Act, 2013 (“Act”), and the Companies (Significant Beneficial Owners) Rules, 2018 (“SBO Rules”), has its genesis in Recommendations 24 and 25 of the Financial Action Task Force (“FATF”) report, which state that member countries should ensure that there is adequate and timely information on ‘beneficial ownership’ and ‘control’ of legal persons. Keeping in mind the FATF recommendations, the Company Law Committee, 2016, had suggested that suitable amendments should be made to the Act, to obligate companies to obtain information relating to beneficial ownership.
Although it has now been three years since the notification of the SBO regime, companies continue to face difficulties in identifying the ‘SBO’ in certain specific situations, and various interpretative challenges surrounding Section 90 and the SBO Rules continue to bother India Inc. Unfortunately, the Ministry of Corporate Affairs (“MCA”) has not issued any clarification on any of those contentious issues.
Section 90 of the Act provides both quantitative and qualitative tests for identification of an SBO. Section 90(1) of the Act provides that every individual, who acting alone or together, or through one or more persons or trust, including a trust and persons resident outside India, holds beneficial interests, of not less than 25% or such other percentage as may be prescribed, in shares of a company or the right to exercise, or the actual exercising of significant influence or control [as defined in Section 2(27)], over the company, shall make a declaration to the company, specifying the nature of his interest and other particulars, in such manner and within such period of acquisition of the beneficial interest or rights and any change thereof, as may be prescribed.
Section 90(1) of the Act must be read conjointly with Rule 2(1)(h) of the SBO Rules, which provides twin tests for identifying the individual who would qualify as an ‘SBO’ of the reporting company:
- Objective test – An individual who indirectly (or together with direct holdings) holds 10% or more of the shares of the company, or 10% or more of the voting or dividend rights;
- Subjective test – An individual who has the right to exercise, or actually exercises significant influence or control in any manner, other than through direct holdings only.
It is pertinent to note that while Section 90 prescribes a threshold of 25% beneficial interest, the SBO Rules notified by the MCA have reduced this threshold to 10%, leading to considerable anxiety in the corporate world.
Is the reduction of the 25% threshold valid?
As Section 90(1) of the Act uses the expression “of not less than 25% or such other percentage as may be prescribed”, at a prima facie level, the express wording of Section 90(1) itself suggests that the Rules framed by the MCA [pursuant to the powers conferred by Section 469 of the Act] cannot reduce the beneficial interest threshold to below 25%, and can only prescribe a threshold that is higher than 25%. However, given that Section 90(1) also uses the words “other percentage as may be prescribed”, the MCA could argue that a conjoint reading of Sections 90(1) and 469 confers it with the authority to reduce the threshold to 10%.
While both interpretations seem feasible, it is instructive to interpret Section 90(1) with reference to the principles relating to ‘delegation of legislative power’, that have been enshrined by the Supreme Court (“SC”). In its celebrated decision in Re: The Delhi Laws Act, 1912, the SC held that:
“…legislature must retain in its own hands the essential legislative functions which consist in declaring the legislative policy and laying down the standard which is to be enacted into a rule of law”.
The ratio of this decision was subsequently clarified by the SC in Rajnarain Singh v. Chairman, Patna Administration Committee (“Rajnarain Singh”), where the SC held that:
“In our opinion, the majority view was that an executive authority can be authorised to modify either existing or future laws but not in any essential feature. Exactly what constitutes an essential feature cannot be enunciated in general terms, and there was some divergence of view about this in the former case, but this much is clear from the opinions set out above: it cannot include a change of policy”.
Pursuant to the SC decisions in Re: The Delhi Laws Act, 1912, and Rajnarain Singh, it is well-established that the formulation and declaration of the legislative policy is an ‘essential legislative function’ that is the prerogative of the legislature, and cannot be delegated to the executive.
Given that Section 90(1) expressly stipulates the Parliament’s policy of having a beneficial interest threshold of “not less than” 25%, it could be argued that the power to reduce the threshold to below 25% can only be exercised by the Parliament, and such an ‘essential legislative function’ cannot be delegated to the MCA.
Hence, it could be argued that the 10% threshold prescribed in the SBO Rules is ultra vires Section 90 of the Act, and may be struck down by the courts. To provide greater certainty to the SBO regime, and to avoid potential legal challenges, it would be advisable for the MCA to either:
- Propose an amendment to Section 90(1) of the Act, to reduce the threshold to 10%; or
- Amend the SBO Rules, and increase the threshold to 25%, which is easier as there is no need to approach the Parliament.
Identification of ‘SBO’ in the case of PIVs from non-compliant jurisdictions
While the SBO Rules expressly prescribes the ‘individual’ who should be declared as the SBO in situations where the PIV (or the entity controlled by a PIV) is based in an FATF-compliant jurisdiction, it does not specify the ‘individual’ who should be declared as the SBO if the PIV (or entity controlled by it) is located in a jurisdiction that is not FATF-compliant.
This has significant implications for those overseas PE funds that have invested in Indian companies, through PIVs based in jurisdictions that are not FATF-compliant. Such PE funds have been facing difficulties in identifying and declaring the ‘SBO’.
Shares held by a private discretionary trust with a corporate trustee
Another aspect where there is still lack of clarity is in situations where the shares are held by a private discretionary trust at the top of the ownership chain and, which has a corporate trustee.
In situations where there is lack of complete clarity, companies have been reluctant to make their SBO declarations, as the consequences of an ‘incorrect declaration’ can be severe.
There is also anxiety related to what other implications the SBO declarations could have under the Income Tax Act, 1961, the PMLA, 2002, the Insolvency law, the Prohibition of Benami Property Transactions Act, 1988, and many other legislations.
One such consequence of a supposedly ‘incorrect declaration’ may result from Section 90(7) of the Act.
Section 90(7) – Scope for abuse?
Section 90(5) of the Act provides that a company shall give notice to any person whom the company knows or has reasonable cause to believe:
- to be an SBO of the company;
- to have knowledge of the identity of a SBO or another person likely to have such knowledge; or
- to have been an SBO of the company at any time during the three years immediately preceding the date on which notice is issued,
and who is not registered as a significant beneficial owner with the company as required under this section.
Section 90(7) provides that the company shall:
- where that person fails to give the company the information required by the notice within the time specified therein; or
- where the information given is not satisfactory,
apply to the NCLT within a period of 15 days of the expiry of the period specified in the notice, for an order directing that the shares in question be subject to restrictions with regard to transfer of interest, suspension of all rights attached to the shares and such other matters as may be prescribed.
Further, Rule 7 of the SBO Rules provides that the company may apply to the NCLT in accordance with Section 90(7), for an order directing that the shares in question be subject to restrictions, including:
- restrictions on transfer of interest;
- suspension of dividend rights;
- suspension of voting rights;
- any other restriction on all/ any of the rights attached with the shares.
The provisions of Section 90(7) of the Act pose a grave danger of being misused, especially in situations where there are disputes between the majority shareholder and minority shareholders. In such situations, the majority shareholder may file a Section 90(7) petition before the NCLT, contending that no SBO declaration has been made by the minority shareholder, or the information provided is ‘not satisfactory’. If the NCLT comes to the same conclusion, then it may lead to severe consequences for the minority shareholders, as their rights relating to voting, dividend, etc., may be suspended by the NCLT.
Section 90(7) poses a danger to PE investors in India, who have acquired a significant minority stake in Indian companies. In case of disputes between the promoter and the PE investor, the promoter may approach the NCLT, contending that the SBO declarations made by the PE investor are inaccurate/ faulty, and the investors’ rights relating to voting/ dividend, etc., must be suspended, and their shares should be subsequently transferred to the Investor Education and Protection Fund (IEPF).
Along with the potential consequences of Section 90(7), it is also pertinent to note that Section 90(12) provides that if any person wilfully furnishes any false or incorrect information or suppresses any material information of which he is aware, in the SBO declaration, he shall be liable to action under Section 447. Treating an inaccurate SBO declaration as a ‘fraud’ under Section 447 has serious criminal consequences.
Given the adverse consequences of an ‘incorrect declaration’, companies have exercised extra caution before declaring an ‘SBO’. To make the SBO regime more robust, suitable amendments should be made to achieve consistency between the Act and the Rules, and the MCA should come out with clarifications on those issues. As the FATF has also proposed draft amendments to make its recommendations relating to beneficial ownership even more comprehensive, it will present an opportunity to India to make suitable changes in its SBO architecture, to make the regime free from interpretative challenges.
More safeguards need to be introduced on invoking Section 90(7), which in its current form, provides a majority shareholder/ promoter with an unbridled tool to make a ‘pre-emptive strike’ on a minority shareholder, in the event of a dispute, and could send negative signals to international investors in India.
 Recommendation 24, The FATF Recommendations, adopted by the FATF Plenary in February 2012, updated as on June 2021.
 Section 2(27) of the Act provides that – “”control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner;
 Rule 2(1)(i) of the SBO Rules provides that – ““significant influence” means the power to participate, directly or indirectly, in the financial and operating policy decisions of the reporting company but is not control or joint control of those policies”.
 AIR 1951 SC 332
 AIR 1954 SC 569
 Financial Action Task Force, Revisions to Recommendation 24 and the Interpretative Note, Public Consultation Paper, available at https://www.fatf-gafi.org/publications/fatfrecommendations/documents/public-consultation-r24.html.