Do the Companies (Significant Beneficial Owners) Amendment Rules, 2019 Narrow the Scope of these Rules?

[Aditi Tomar is a 4^th Year B.A.LLB (Hons.) Student at NALSAR University of Law, Hyderabad]

The Companies (Significant Beneficial Owners) Rules, 2018 (“Rules”), which were notified on 14 June 2018, aimed to trace the ultimate individual or natural person who holds beneficial interest, i.e., exercises rights and entitlements in the company, by looking through the complex layers of the corporate structure. In my earlier post, I discussed some lacunae prevalent in the Rules, especially with respect to identifying who would be a Significant Beneficial Owner (“SBO”). In the Rules, the major ambiguity pertained to whether the materiality threshold, which is one of the criteria to identify SBO, be calculated only at the level of the intermediate member company or also at the level of the ultimate company. In this respect, the Companies (Significant Beneficial Owners) Amendment Rules, 2019 (“Amendment”), which came into force on 8 February 2019, has provided some clarity.

The Amendment has also defined various terms such as control, significant influence, which are the criteria for identifying SBO. It also inserted the terminology such as “reporting company”, which is defined as a company that is required to comply with the requirements under section 90 of Companies Act, 2013. In my earlier post, I had used the terminology “target company” to refer to the same.

Identification of SBO

The amended definition of SBO makes it amply clear that the 10% materiality threshold has to be calculated with reference to the ultimate company or the reporting company. Further, unlike the earlier definition where the materiality threshold of 10% was calculated only in relation to the share capital of the reporting company, now this threshold is also calculated with reference to the voting rights in the shares and dividend or other distribution rights.

Rule.2(h) “significant beneficial owner” in relation to a reporting company means an individual referred to in subsection (1) of section 90, who acting alone or together, or through one or more persons or trust, possesses one or more of the following rights or entitlements in such reporting company, namely: –

(i) holds indirectly, or together with any direct holdings, not less than ten per cent. of the shares;

(ii) holds indirectly, or together with any direct holdings, not less than ten per cent. of the voting rights in the shares;

(iii) has right to receive or participate in not less than ten per cent. of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings;

(iv) has right to exercise, or actually exercises, significant influence or control, in any manner other than through direct holdings alone:

The amended definition further elaborates on the meaning of “direct” and “indirect” holding in the reporting company by delineating certain situations which will definitely amount to direct and indirect holding respectively. Thus, an individual:

1. who holds shares in his or her name in the reporting company; or
2. who holds beneficial interest in the shares under section 89(2) of Companies Act, 2013 and has made a declaration in that behalf,

shall be considered to hold a right or entitlement directly in the reporting company. The statement and objects behind introducing section 89 was to collect information about benami transactions wherein a person who, even though is a registered member of the company but does not hold the beneficial interest, was required to disclose such details to the company. Explanation III under rule 2 of the Amendment, lays down the criteria to determine the “indirect” holding of an individual in the reporting company.

Indirect Holding

When the member of the reporting company is body corporate:

In this situation, to trace the natural person who is indirectly holding rights and entitlement in the reporting company, one need to analyse whether such individual holds “majority stake” in the member body corporate or holds “majority stake” in the ultimate holding company of that member.  Thus, according to this explanation, an individual who fulfils any of the two criteria by either calculating the majority stake at the intermediate company level or at the ultimate reporting company level, shall be considered to hold right or entitlement indirectly in the reporting company. “Majority Stake” has been defined as holding more than one – half (50% and above) of: (i) the equity share capital or (ii) the voting rights or (iii) distributable dividend or any other distribution, of the body corporate.

Thus, while determining SBO of the reporting company, when member of reporting company is a body corporate, the following two factors should be kept in mind:

1. first, identify whether the individual has majority stake to determine indirect holding; and
2. second, apply the 10% materiality threshold at the reporting company level.

For instance, we need to find the SBO of X Ltd, which is the reporting company. Here, A, a natural person holds 51% of equity share capital of Y ltd, which is a registered member of X Ltd. Y Ltd holds 20% of equity share capital of X Ltd.

CASE -1:  X Ltd (reporting company) ← (20%) Y Ltd ← (51%) A (natural person)

Here, as A holds 51% of the equity share of the member company, i.e. Y Ltd, A is considered to be holding majority stake in Y Ltd and indirectly holding rights and entitlement in the reporting company i.e. X Ltd. After this, according to the definition of SBO under rule 2, an individual who indirectly holds not less than 10% of the shares of the reporting company is considered an SBO.

In the instant case, A is indirectly holding rights and entitlements in reporting company as she fulfilled the majority stake criteria but to qualify as SBO, she also needs to hold not less than 10% of the share of the reporting company. By computing on proportionate basis, A holds 10.2% (51% of 20%) in X Ltd which is the reporting company. Thus, A is the SBO of X Ltd.

Further, on a perusal of the format sought to report indirect holding in the BEN-1 Form, it appears that under clause 3(h), which seeks information regarding SBO where the member of the reporting company is a company or another body corporate, there are only two options i.e. whether the SBO has majority stake in the member or majority stake in the ultimate holding company of such member.

This implies that in situations where the member of the reporting company is a body corporate, then while adopting a look-through approach to trace the SBO, only those individuals would be considered who hold more than 50%: of (i) the equity share capital or (ii) the voting rights or (iii) distributable dividend or any other distribution, of the member of reporting company or the reporting company itself.  Elaborating further on the previous example, the declaration in BEN-1 does not contemplate a situation wherein A could be a SBO even though it holds say 40% (which is less than majority stake) of the equity share of Y Ltd but still ultimately holds more than 10% in X Ltd, the reporting company i.e. 40% of 30% = 12%.

CASE – 2: X Ltd (reporting company) ← (30 %) Y Ltd ← (40%) A (natural person)

In order to bring such a situation also within the ambit of SBO declaration, then probably there should be a third option in clause 3(h) of the BEN-1 form, which would be something on the lines of “neither of the above but fulfil 10% materiality threshold”. Further, according to the amended definition, the answer to the situation is discussed in my previous post.

CASE – 3: X Ltd (reporting company) ← (20%) Y Ltd ← (15%) A (natural person)

Here, the inquiry whether A would be SBO of X Ltd would stop at first level itself as A neither has majority stake in Y Ltd or in X Ltd.

Conclusion

On a perusal of the SBO definition and BEN-1 form as specified in the Amendment, it appears that, in the process of identifying SBO for a reporting company where the member of the reporting company is a body corporate or a company, the first step should be to identify all the individuals holding majority stake in the member which, in most situations, would be only one person as the threshold for majority stake is 51% and above or majority stake in the reporting company itself. If the individual satisfies the 51% criterion, then further enquiry has to be undertaken to determine whether she also holds more than 10% of the shares in the reporting company.

Even though this literal interpretation of the Rules is a bit narrow in its scope, nevertheless such an interpretation is within the bounds of section 90 of the Companies Act, 2013, which prescribes the materiality threshold to determine SBO as not less than 25% or such other percentage as may be prescribed, in the shares of the company. Another possible and wider interpretation could be that the situations mentioned in Explanation III are not exhaustive and it covers even those cases where the member of the reporting company is a body corporate and an individual who, even though does not have majority stake in the member company or reporting company, still satisfies the criteria of 10% materiality threshold with respect to the ultimate reporting company is an SBO (Case 2, discussed above).

However, it is a policy choice undertaken by the Ministry of Corporate Affairs, to incorporate the additional criteria of “majority stake” in identifying SBO where member of reporting company is a body corporate, thereby increasing the materiality threshold for qualifying as SBO above 10% (which extends to 50% or more). From the compliance perspective, indeed there has been more clarity with respect to identifying the SBO and the Amendment has surely brought some relief to the companies by relaxing otherwise onerous reporting requirements.

Aditi Tomar