Setting Up To Fail: The Amended Significant Beneficial Ownership Rules

[Ayush Kashyap is a IV year law student at Hidayatullah National Law University, Raipur]

The Companies (Significant Beneficial Owners) Amendment Rules, 2019 suffer from a problem relating to the computation of significant beneficial ownership and disclosure requirements thereon. With the compliance deadline for these rules already lapsed, a look at the problem is in order. However, before that, a look at the history behind this significant piece of legislation is pertinent.

The Need for Regulation

Hiving off subsidiaries to restructure a business is a tenet of corporate law. However, it has also been abused relentlessly to cloak the real owners of companies. It has become a tool for tax evasion, money laundering and even terror-financing. To prevent this, the legislature inserted a proviso in the definition of a subsidiary company under section 2(87) of the Companies Act, 2013. It states that certain classes of holding companies cannot have more than a prescribed number of layers of subsidiaries.

This was a departure from the suggestion of the JJ Irani Committee (2005) which had noted that placing a restriction on the number of subsidiaries will disadvantage Indian companies. It also noted that a blanket restriction will not stop siphoning off from other routes. The Parliamentary Standing Committee on the Companies Bill (2012) did not share this concern. The proviso was inserted. Subsequently the Companies Law Committee (2016) recommended that the proviso be omitted. However in 2017, the Central Government notified the proviso.

To address the underlying concern, the Companies Law Committee (2016) had recommended the introduction of a register of significant beneficial owners to reveal the persons behind complex corporate structures. The Central Government heeded this suggestion to introduce the SBO Rules. This came at the back of a similar amendment in 2015 in the United Kingdom where certain companies were required to maintain a ‘persons with significant control’ register and file the information with Companies House. The push for such legislation was the recommendation by the Financial Action Task Force (FATF) – an inter-governmental, independent body whose recommendations are recognised as the global standards against money laundering and terror financing.

Effective Shareholding under the 2018 SBO Rules

In India, the Companies (Significant Beneficial Owners) Rules, 2018 (the “SBO Rules”) were introduced by the Ministry of Corporate Affairs in exercise of powers delegated to it under section 90 of the Companies Act, 2013 (the “Act”). The Act had set a threshold of 25 per cent shareholding held indirectly to qualify as a significant beneficial owner (“SBO”). The objective of the law was to shine a light on the convoluted holding structures being used to mask the real owners of companies. In other words, the law focused on natural persons taking advantage of the assets of a legal person.

The SBO Rules lowered the threshold to 10 per cent to qualify as a SBO.  These rules state that if X Ltd is a member of Y Ltd, then any natural person holding 10 per cent shares indirectly in X Ltd in any manner conceivable is a SBO. Here, Y is the reporting company while X is a member company. Under these rules, any shareholding pattern between X Ltd, Y Ltd and a natural person that adds up to 10 per cent of Y Ltd is covered. For instance, if X Ltd holds 40 per cent shares in Y Ltd, an individual holding 30 per cent in the former will qualify as a SBO of the latter because her actual shareholding in Y Ltd is 40 per cent of 30 per cent which comes to 12 per cent. This was in tune with the objective of the SBO Rules which was to uncloak the real beneficiaries.

The Amended SBO Rules

The amendment puts a spanner in the works. According to the amended rules, an ‘individual’ will be considered a SBO only if she holds a majority stake in X Ltd (member of the reporting company Y Ltd) or in the ultimate holding company of X. This has been given a considerable breather to potential SBOs.

Analysing the same illustration under the amended rules, an individual can hold up to 49 per cent (i.e., less than a majority stake) in X Ltd without qualifying as a SBO. Thus, her actual shareholding in Y Ltd will be 49 per cent of 30 per cent which comes to slightly less than 15 per cent. This is clearly more than the 10 per cent threshold in the rules but the amended rules do not see this as such. Extrapolating this example further, X Ltd can hold 49 per cent of shares of Y and as long as a natural person holds less than 49 per cent in X Ltd, she won’t qualify as a SBO of Y Ltd. Effectively, the new rules allow a natural person to hold up to 24 per cent (49 per cent of 49 per cent) shares in a reporting company and remain anonymous by layering just one company between herself and the reporting company.

This is in contrast to approach the amended rules take if an individual has a majority stake in the member company. In that case, the entire shareholding of the member company in the reporting company is attributable to the individual who automatically qualifies as a SBO. Thus if X Ltd holds 10 per cent in Y Ltd, then an individual holding 51 per cent in X Ltd will be considered as holding 10 per cent in Y Ltd (and not, 51 per cent of 10 per cent, i.e., 5.1 per cent). The amendment has definitely taken a step forward in this respect. However, the change described in the preceding paragraphs can only be described as taking two steps backwards.

Towards a Harmonised Approach

The concerns raised here have not been flagged by the Company Law Committee (2019) in its report. Its suggestions on the SBO framework have been limited to changing criminal offences to civil penalties. Both approaches – under the original and amended rules –  can be integrated to strengthen the regime. For individuals holding a majority stake in a member company, the latter’s entire shareholding in the reporting company can be attributed to the former, making them SBOs. And for individuals holding less than a majority stake, their effective shareholding in the reporting company should be considered. Doing otherwise, as the amendment has ventured to do, creates an anomaly and leaves room for abuse of the rules.

  Ayush Kashyap