[This post has been contributed by Stephanie Nazareth, a fifth-year student at ILS Law College.]
A detailed post on registration of beneficial ownership by foreign companies could be found here. However, the aim of this article is to analyse the threshold requirement under the recently notified Companies (Significant Beneficial Ownership) Rules, 2018 (SBO Rules). Is it too harsh? It is too wide? Is it in line with the international practice? The article will discuss the background of the SBO Rules along with a short comparative analysis of the threshold requirement in other jurisdictions and the concluding opinion of the author.
Sections 89 and 90 of the Companies Act, 2013 deal with the beneficial ownership in any shares of a company and the declaration thereof. Based on the Companies Law Committee Report of 2016, the Companies (Amendment) Act 2017 (Amendment Act) was passed in December 2017. Later, in June 2018, the Ministry of Corporate Affairs notified the SBO Rules. Both the Amendment Act 2017 and the SBO Rules 2018 have made substantial changes to the declaration of beneficial ownership provisions.
Prior to the Amendment Act 2017, there was no specific mention of what constituted ‘beneficial ownership’ and the threshold to determine who will fall under the category of ‘significant beneficial owner.’ The Amendment Act subsequently introduced the 25% threshold to determine a significant beneficial owner. However, the SBO Rules came in as a shock when this threshold was reduced to 10% or more shareholding/ownership in a company. The SBO Rules can be said to override the Amendment Act because of the clear but loosely added words in Section 90, which uses the expression “25 percent or such other percentage as may be prescribed.” The SBO Rules have, therefore, extensively slashed the threshold to as low as 10% from 25%. Although the intent of the Rules is justified as it aims to bring about more transparency and detect cases of money laundering and tax evasion easily, the reduced threshold is questionable.
The Amendment Act and the SBO Rules were introduced pursuant to the Financial Action Task Force's (FATF) ‘Guidance on Transparency and Beneficial Owners’ guidelines of 2014. The FATF is an inter - governmental body that was set up in 1989 by its member jurisdictions to set standards and measures to combat money laundering and terrorist financing, among other things. This is done through a series of recommendations that are recognised as the international standards for combating money laundering and other related threats. To stand in par with the FATF Recommendations, India complied with recommendations 24 and 25 issued by the FATF, which recommendations specifically deal with transparency and beneficial ownership. According to the guidelines, countries were expected to clearly define and demarcate what constitutes ‘significant beneficial ownership’. There were two approaches which were suggested for the same: 1) the threshold approach and 2) the majority interest approach. It is important to note that the FATF Recommendations do not specify as to what threshold may be considered appropriate. However, it clearly states that a threshold must be adopted that is appropriate, clear, practicable, workable and enforceable depending on country accepted norms. Therefore, in this regard, there is a need to analyse whether the 10% threshold is truly workable and appropriate in India.
First, let us see the general norms that exist currently under the Companies Act and definitions under other laws. The SBO Rules state that any person having significant influence or control or is holding 10% or more of the shareholding will fall under the ambit of the Rules. But the usage of the term ‘significant control’ on the one hand and the 10% limit on the other seems unusual. There is confusion regarding the meaning of the term ‘significant influence/control.’ Although the term ‘influence’ has not been defined, the term ‘control’ has been defined in the Companies Act, 2013. According to Section 2 (27), the term ‘control’ means “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 shareholder agreements or voting agreements or any other manner.” Therefore, the onus to prove control is quite high. The above-mentioned definition is also applicable to the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code). Under the Takeover Code, public offers are mandated when there is an acquisition of 25% or more of the voting rights in the target company. Thus, the SBO Rules implementing a 10% threshold seems out of place.
India has been following a certain type of corporate structure since years. The design of the corporate structure is such that 10% shareholding is considered significant only in a suit for oppression and mismanagement. Moreover, only a person having a shareholding of more than 25% is able to block special resolutions. This 25% mark, therefore, is an accepted threshold norm in the Indian corporate ecosystem. Most companies have a heavy promoter group concentration which gives them more control over the management and affairs of the company. Ultimately, a 10% shareholding is a minority stake with little or almost no influence on the working and management of a company.
The global yardstick to measure ‘significant beneficial owner’ stands at the 25% threshold. The 4th European Union Anti - Money Laundering Directive (ALMD 4) defines a ‘beneficial owner’ to mean any person who has a shareholding or ownership of 25% or more shares. There were discussions to decrease this threshold to 10% for certain passive non - financial entities and to tighten the norms for declaration of beneficial ownership. However, this proposal was not acceptable to corporate stakeholders and the final 5th European Union Anti - Money Laundering Directive (ALMD 5) was passed in July 2018 without any reduction of threshold. Therefore, the 10% mark was not put into practice.
Similarly, the Singapore Parliament passed the Companies (Amendment) Act 2017 (CAA) in March 2017 to improve transparency in companies. Here too, the CAA defined ‘significant interest’ as a natural person having any beneficial interest in more than 25% of the shares.
The United States FinCEN issued its final rules on Customer Due Diligence Requirements for Financial Institutions in May 2016. The Rules lay down the threshold for beneficial ownership and state that a ‘beneficial owner’ means: “Each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer.”
Therefore, the SBO Rules in India are not in line with the globally accepted norms in other developed jurisdictions on ‘significant beneficial ownership’.
The intent of the Government is noble and for a justified cause. There is indeed a need to increase transparency in companies and to avoid money laundering and other evasive tactics used by shareholders. A robust regime for the same was required pursuant to the FATF guidelines and quick steps were taken by many jurisdictions around the world, including India. However, the threshold limit for declaration of ‘beneficial owner’ pursuant to the SBO Rules is quite questionable. Not only is it against the generally accepted norms in the Indian corporate system and in other jurisdictions around the world, but it can also lead to unnecessary harassment and increased burden on companies. It can discourage genuine investments as well.
Stakeholders will find it difficult to enforce compliance because of the hardships caused in identifying individuals falling under the threshold, compared to the individuals falling under the 25% mark. This is because there will be a larger number of individuals who will have to be registered as a significant beneficial owner, thus increasing declarations manifold. To add to that, the stringent timelines required by the SBO Rules is causing panic among companies.
Moreover, in November 2018, the Ministry of Corporate Affairs issued a notice seeking suggestions and comments regarding other amendments of ‘urgent’ nature that need to be addressed. The notice seeks to place an obligation on companies to identify individuals who fall under the category of ‘significant beneficial owner’ and make them comply with the provisions. This is quite onerous for companies and results in an unnecessary burden. The SBO Rules read along with the Act is beyond the scope of the recommendations made by the FATF. This has attracted wide criticism as it oversteps the guidelines of making it workable, enforceable and appropriate especially in the Indian context. Instead, efforts must be made to study the complex structure and different layers in corporate entities in order to demarcate between high risk sectors and low risk sectors where chances of money-laundering and tax evasion are relatively low.