(Photographer: Tomohiro Ohsumi/Bloomberg)

Will The Real (Beneficial) Owner Please Stand Up?

India’s over 1.7 million companies will soon need to disclose their beneficial owners. But after stakeholders pointed out the various challenges in reporting the beneficial owners of companies the deadline, of Sept. 12, was extended by the Ministry of Corporate Affairs.

This beneficial ownership disclosure is a result of an amendment to the Companies Act, 2013 that was introduced to prevent misuse of corporate vehicles for tax evasion and money laundering. The amendment was followed by rules that lay down the thresholds for beneficial ownership. Experts told BloombergQuint that its these thresholds that are giving rise to several unintended consequences and causing considerable confusion among companies.

Where Did It All Start?

In January this year, Section 90 of the Companies Act, 2013 was amended to say that every individual – acting alone or together- who is a significant beneficial owner must disclose this fact.

In June, the Ministry of Corporate Affairs (MCA) notified the rules that define significant beneficial owner as an individual who has an ultimate beneficial interest of 10 percent and more in a company. If the beneficial ownership rests with not an individual but a company, partnership firm or trust, the natural person who meets the threshold behind these intermediate vehicles must be disclosed.

The intent is to go to the real owner of shares in a company because if shareholding is held via complex structures, one really doesn’t know who the ultimate owner behind the shares is, Haigreve Khaitan managing partner at Khaitan & Co. told BloombergQuint. Before Section 90 was introduced, disclosure was required by both the legal owner of the shares and the person holding beneficial interest in the company. But what constituted beneficial interest was not defined, which made it difficult to identify the real owner, he explained.

Trigger For Disclosure

The trigger for significant beneficial ownership is a 10 percent threshold but when applied across structures, the test doesn’t always produce simple outcomes.

Illustration 1: If the significant beneficial owner is not an individual but a company…

In the case of corporate structures a ‘significant beneficial owner’ is one who, alone or together with others

  • owns 10 percent or more of a company, or
  • has control, or
  • has significant influence over it.

If such a person is not already a registered shareholder then he has to make disclosure regarding his significant beneficial ownership.

Two of these three tests pose interpretational issues.

What is significant influence?

While ‘control’ is defined in companies law, ‘significant influence’ is not.

For that one may need to turn to the Takeover Code, said Ashwath Rau, partner at law firm AZB, to BloombergQuint.

My sense is that the way ‘persons acting in concert’ has been used in the Insolvency Code but it’s not been defined; similarly, here too, you would look at the Takeover Code to understand the parameters that would amount to significant influence.
Ashwath Rau, Partner, AZB & Partners

The interpretation of significant influence has to be much more positive - for instance right to appoint members on a board, acting with other shareholders as a block. It can’t just be a negative influence, Khaitan explained.

Then, there’s the 10 percent calculation confusion?

How should the calculation of 10 percent be applied across a corporate structure.

For example, Company ‘A’ which needs to make a disclosure has Company ‘B’ as its 10 percent shareholder. And person ‘C’ holds 10 percent in Company ‘B’. The question is – will ‘C’ be the beneficial owner vis-à-vis Company ‘A’?

It would be a ludicrous outcome to basically say that C’s interest in Company A is 10 percent because it is actually 10 percent of 10 percent which is 1 percent, Rau said. According to him, in such a case person C would not be a significant beneficial owner of Company A and hence no disclosure would be required.

That should logically be the conclusion, and it is in line with the definition of significant beneficial owner rules as well as my reading of the relevant parts of the statute, where you ultimately are looking to calculate the beneficial interest in the reporting company and not the intermediate company.
Ashwath Rau, Partner, AZB & Partners

Khaitan disagreed. He said pro-rating nullified the intent of the new rules.

For instance, in this example, if Company ‘B’ would have to hold 100 percent in Company ‘A’ for C to ever make a disclosure vis-à-vis Company ‘A’ that would not meet the intent of the amendment and rules, he pointed out.

Let’s say there’s a special purpose vehicle that holds 51 percent in an Indian company. The parent of the SPV would never hit a disclosure if you pro-rate it. And if you’re going to do that, why did we need a definition of significant beneficial owner?
Haigreve Khaitan, Managing Partner, Khaitan & Co.

The same logic would apply if ‘C’ exercises significant influence or control over Company B, he added.

Illustration 2: If the significant beneficial owner is not an individual but a trust…

The 10 percent threshold applies here as well. So if the author of the trust, trustee, or beneficiaries hold 10 percent or more interest in the trust disclosure is triggered. If any individual exercises ultimate effective control over the trust then too disclosure is triggered.

While ultimate effective control is not defined in the rules most lawyers are interpreting it to mean control, as defined in the Companies Act, 2013.

The position of trusts is better than the position of intermediate companies, Rau pointed out.

For instance, in an indeterminate trust- where the interest of the beneficiaries is not determinant and is left to the discretion of the trustee to determine the benefit from time to time - there are two options, he explained. One is to name the trustees.

If you look at the construct of the beneficial owner, it combines control and beneficial ownership. So, if you are not able to identify the beneficial owner, you can name the trustees who have control over the trust.
Ashwath Rau, Partner, AZB & Partners

Option two requires more extensive disclosures. In most indeterminate trusts, the beneficiaries are members of the same family and so, rather than disclose which individuals in the family meet the disclosure threshold, the view is to disclose all the ultimate beneficiaries. Many clients are picking option two since they don’t want to take a chance, said Rau.

Is Anyone Exempt?

Yes, if the intermediate vehicle is a mutual fund, Alternative Investment Fund, Real estate Investment Trust and Infrastructure Investment Trust regulated by market regulator Securities and Exchange Board of India.

Foreign private equity funds aren’t exempt, and the rules will apply based on whether they are set up as a company or LLP or as a trust, Rau explained.

Where the thresholds are met on the pro-rata basis, disclosures will need to be made by General Partners of private equity funds but it doesn’t stop there, he added.

You may also need to go to the natural person behind the GP. So, you have to end up with an individual over there and/or a situation depending on the nature of control, the nature of beneficial interest and whether it is an individual who holds more than 10 percent as a limited partner on a pass-through basis- those disclosures may also be required.
Ashwath Rau, Partner, AZB & Partners

Is That It?

Besides these interpretational issues, stakeholders are nervous about the potential implications of these rules as well ie. how will this data be used?

The disclosure on significant beneficial owners can be one of the grounds for the tax department to deny benefits under tax treaties, a partner at a law firm told BloombergQuint on the condition of anonymity.

If the beneficial owner comes via a jurisdiction, for instance Mauritius, that gives treaty benefits to investments in India, there is a real fear that those benefits can be denied on grounds that the ultimate beneficial owner is elsewhere.

Also, the forms prescribed by the MCA require that instruments, documents that give an individual the beneficial interest must be provided. There are concerns around disclosing trust deeds or share purchase agreements. These documents will be available on the MCA website and will be public, which is a cause of concern, this lawyer, added.

In its notification of Monday, the MCA has stated that will issue a revised form.