[Niharika Sharma is a IV Year, B.A. LL.B. (Hons.) student at the National Law School of India University, Bangalore]
In June 2018, the Ministry of Corporate Affairs (‘MCA’) issued the Companies (Significant Beneficial Owners) Rules, 2018 (‘SBO Rules’) and notified section 90 of the Companies Act, 2013 (‘2013 Act’). This was to curb the illicit activities (such as money laundering) being carried out using the corporate structure and to bring about transparency and accountability. On 8 February 2019, the MCA introduced the Companies (Significant Beneficial Owners) Amendment Rules, 2019 (‘Amendment Rules’). Several criticisms were raised regarding the SBO Rules and one needs to consider whether the Amendment Rules address these lacunae. The first part of this post highlights the key changes brought in by the Amendment Rules, and the second part analyses these changes by discussing factors such as clarity in the definition of significant beneficial owner (‘SBO’), significant influence, requirement of indirect holding and companies’ power to apply to the Tribunal.
Amendment Rules: Key Changes
The main changes brought in by the Amendment Rules have been through addition and modification of some definitions, which bring in greater clarity to the SBO Rules. One such definition is that of ‘majority stake’, which has been defined using three parameters: (a) holding more than one-half of the equity share capital in the body corporate; (b) holding more than one-half of the voting rights in the body corporate; and (c) having the right to receive or participate in more than one-half of the distributable dividend or any other distribution by the body corporate. They also provide definitions of ‘control’ and ‘partnership entity’, which were missing in the SBO Rules. Similarly, ‘reporting company’ has now been defined to mean a company defined in section 2(20) of the 2013 Act, which is required to comply with the requirements of section 90 of the 2013 Act.
One noteworthy change has been in the definition of an SBO. Under the SBO Rules, read with section 90 of the 2013 Act, SBO meant an individual referred to in section 90(1) holding ultimate beneficial interest of not less than 10% shares of the company or holding the right to exercise or actually exercising significant influence or control (as defined under section 2(27) of the 2013 Act) over the company, and whose name was not entered in the company’s register of members as the shareholder. Compared to this, the amended definition is much more detailed. It covers an individual who may be acting alone or together, or through one or more persons or trust, and possesses one or more of the four specified rights or entitlements in the reporting company: (a) holding indirectly, or together with any direct holdings, not less than 10% of shares; (b) holding indirectly, or together with any direct holdings, not less than 10% of the voting rights in the shares; (c) right to receive or participate in not less than 10% of the total distributable dividend or any other distribution in a financial year, through indirect holdings alone or together with any direct holdings; and (d) right to exercise, or actually exercising, significant influence or control, in any manner other than through direct holdings alone.
One must note here that Explanation I to this definition clarifies that, for the first three rights or entitlements, indirect holding of the concerned right or entitlement is a necessary element to qualify as an SBO. To provide further clarification, the Amendment Rules also define ‘direct holding’ by listing two conditions: (a) the reporting company’s shares representing such right or entitlement are held in the name of the individual; or (b) the individual holds or acquires a beneficial interest in the reporting company’s share under section 89(2) of the 2013 Act and has made a declaration in this regard to the reporting company. Thus, according to the Amendment Rules, persons with only direct holdings would not qualify as SBOs.
Further, Explanation III to this definition covers the scenarios where the individual holds some right or entitlement in a member of the reporting company and such member is a body corporate (including those incorporated or registered outside India), Hindu Undivided Family (‘HUF’), partnership entity, trust, a pooled investment vehicle or an entity controlled by the pooled investment vehicle. The Amendment Rules clarify the levels that need to be checked in order to identify whether an individual is an SBO.
Another significant change is that the Amendment Rules clarify what ‘acting together’ means, something which the SBO Rules lacked. It has been defined to mean an individual or individuals through any person or trust: (a) acting with a common intent or purpose; (b) when such intent or purpose is for exercising any rights or entitlements, or exercising significant influence or control over the reporting company; (c) in pursuance of an agreement or undertaking, which may be formal or informal. ‘Significant influence’ has also been defined now as the power to participate, directly or indirectly, in the financial and operating policy decisions of the reporting company, but it is not control or joint control of those policies.
Moreover, the Amendment Rules have inserted rule 2A which casts clear duties on the reporting company regarding identification of SBOs, causing them to make declarations, and giving of notice to certain members (other than individuals) of the reporting company to seek information from them. These duties were not specified in the SBO Rules. Rule 7 has also been amended to provide two conditions (similar to those under section 90(7) of the 2013 Act) where the company is required to apply to the Tribunal to get an order for restrictions on shares. This rule now uses the word ‘shall’ instead of ‘may’. Further, the list of exemptions in rule 8 has been expanded and clarified, and the Forms have been amended to bring them in line with the changes brought in.
Comments on the Amendment Rules
While the SBO Rules were recognised as a positive move in the direction of transparency and accountability, they were not free from lacuna (as highlighted here, here and here). Several ambiguities affected their implementation and practical usage. Now, with the Amendment Rules, some ambiguities have been cleared and, thus, there should be greater ease in the implementation of these rules.
First, the definition of SBO is much clearer and detailed now. Importantly, the definition no longer uses the words “but whose name is not entered in the register of members of a company as the holder of such shares”. Earlier, these words were present only under the definition in the SBO Rules. Hence, on a plain reading, a natural person whose name was entered in the register would not be required to make such declarations. But, if the name entered in the register was of a legal entity, a natural person would still have to be identified and disclosures would have to be made accordingly. The reason behind this removal could be the fact that now an explanation to the definition of SBO anyway emphasises the requirement of indirect holding instead of mere direct holding, and it also defines direct holding.
Second, the requirement of indirect holding, and not merely direct holding, to qualify as an SBO is sound and reasonable. This is coupled with the clarity brought in by specifying what constitutes direct holding. This makes sense as the purpose behind these Rules is to identify the ‘ultimate’ beneficial owners and, thus, where the companies are anyway aware of the direct holders of such rights or entitlements, or where such holders are already disclosed, such further identification or declaration would not be required.
Third, there is clarity on what constitutes ‘significant influence’. This is important for the fourth type of right or entitlement specified in the definition of SBO. This term is present in section 90 of the 2013 Act and the original SBO Rules as well, but its meaning was not elucidated, which led to ambiguity in the identification of SBOs.
Fourth, there is clarity on what ‘acting together’ means. This was missing in the SBO Rules, leading to ambiguity and the possibility of varied interpretations.
Fifth, the Amendment Rules have expanded the ambit in cases where the member of the reporting company is a body corporate by including companies incorporated or registered outside India too. Such companies have also been included where they form the ultimate holding company of another body corporate in question. This would make the rules more effective. The SBO Rules did not define ‘company’ and the 2013 Act defines it to mean those companies which are incorporated under the 2013 Act.
Sixth, the Amendment Rules have clarified the scope of inquiry in cases where the individual holds rights or entitlements in a body corporate which is a member of the reporting company. In the SBO Rules, where the member was a company, the individual was qualified as an SBO where he held at least 10% share capital of the company or exercised significant influence or control in the company through other means. This did not provide clarity regarding a situation where the individual held shares in the holding company of this company. It was not clear how many levels would have to be considered in cases where a natural person was not identified as an SBO in the first step (and some other legal entity existed as a member of the company in the chain). This has now been covered by the Amendment Rules. For example, A is a body corporate which is a member of the reporting company B. X is an individual who holds 60% of the equity shares in A. X would qualify as an SBO of B. In the same example, say C is the ultimate holding company of A and X holds 60% equity shares of C instead of A. As C is the ultimate holding company (which may be incorporated or registered within India or abroad) of the member body corporate, A would still qualify as an SBO of B.
Similarly, such clarity regarding the levels to be checked for identifying SBO has also been introduced in the cases where the member of the reporting company is a partnership entity. The SBO Rules considered an individual as an SBO where he held at least 10% of capital or was entitled to at least 10% of the profits of the partnership. There was no mention of a scenario where the individual holds a stake in a company which is a partner of this partnership entity. Such scenarios have been covered by the Amendment Rules. For example, A is partnership entity which is a member of B, which is the reporting company. X is a partner in A. X is an SBO of B. In the same example, say X holds 60% of voting rights in a company C. This company is a partner in B. Even now, X is an SBO of B. Further, say X holds 60% of voting rights in company D, which is the ultimate holding company of this partner company C. Even now, X is an SBO of B.
In cases where the member in the reporting company was a trust, the language used in the SBO Rules was not clear as it also covered a person exercising ultimate effective control over the trust through a chain of control or ownership. In the Amendment Rules, this has been removed and the trustee, beneficiary, and author of the trust are recognised for different kinds of trusts. The Amendment Rules have also covered the situation where the member of the reporting company is an HUF and the individual is the karta of this HUF. This was not covered in the SBO Rules.
Seventh, the Amendment Rules have addressed the inconsistency between section 90(7) of the 2013 Act and rule 7 of the SBO Rules. The former made it mandatory for companies to apply to the Tribunal when either of the two specified conditions was met, whereas the latter made it discretionary. As this power’s application may lead to restrictions on shares (such as on their transferability, voting rights, etc.), some qualifications were necessary. Now, the word ‘shall’ has replaced the word ‘may’ in rule 7, bringing it in line with section 90(7). Thus, the discretionary nature of this power of the reporting companies has been curbed and the inconsistency has been resolved.
Eighth, the non-applicability rule has been expanded. Further, the Amendment Rules take into account the fact that some pooled investment vehicles may be members of the reporting companies and some individuals may be in positions such as investment manager, general partner, etc. in these vehicles. Thus, though the regulated or registered investment vehicles are exempt from the applicability of the Amendment Rules, situations falling in the above scenario have been taken into account so as to recognise the ultimate beneficial owners. The Amendment Rules have also covered both the scenarios, where the pooled investment vehicle or an entity controlled by it is based in a member State of the Financial Action Task Force on Money Laundering and the regulator of such State’s securities market is a member of the International Organisation of Securities Commissions, as well as where it is based in some other jurisdiction not falling in the above description.
Overall, the Amendment Rules have filled several gaps that were present in the SBO Rules and were hampering their successful and effective implementation. This amendment is a positive step which would ultimately work in the direction of curbing illicit activities and bringing about greater transparency and accountability in the corporate set-up in India.
– Niharika Sharma
 Beneficial interest was defined under section 89(10) of the 2013 Act.