India is yet to hit its stride in dealing with Significant Beneficial Owner (SBO) rules introduced by the Companies (Amendment) Act, 2017. The SBO rules have its origin in the recommendations made by the Financial Action Task Force (FATF) to its member countries, to make suitable changes in the national legislation to find out individuals, who ultimately own significant beneficial shareholding in the reporting company. There remains a large degree of uncertainty and confusion around the new norms, and their practical impact, as explored below.
Sections 89(10) and 90 of the Companies Act, 2013 (Act) were introduced on the recommendations of the Company Law Committee (CLC) in its Report dated February 1, 2016. The CLC noted that complex structures and chains of corporate vehicles are used to hide the real owners behind the transactions made using those structures.
Impact of Section 90 and Related Provisions
Section 90 of the Act read with the Companies (Significant Beneficial Owners) Rules, 2018 (SBO Rules) prescribe twin tests to find an individual who would qualify as SBO of the reporting company:
- Objective test of 10% shareholding at the reporting company level and majority holding through the ownership chain.
- Subjective test of SBO having the right to exercise or actually exercising “significant influence” or “control” in any manner other than through direct holding alone.
The expressions control and significant influence are defined in Section 2(27) of the Act and in Rule 2(1)(i) of the SBO Rules respectively. It is a factual analysis in every case to determine whether this subjective test is satisfied in the given factual matrix.
Section 90 has already been amended extensively by the Companies (Amendment) Act, 2019 even before the provisions became operational. Section 90 contemplates a statutory piercing of the corporate veil, to find out which individuals are SBOs of the reporting company. Section 90 has an extra-territorial operation and would apply to foreign registered trusts and persons, who are residents outside India. Hence, its remit is very broad and affects a number of stakeholders.
Section 89(10) had for the first time introduced the definition of beneficial interest for the purposes of Section 89 and 90. It is a very broad and inclusive definition to cover beneficial interest in shares held directly or indirectly, through any contract, arrangement, or otherwise, the rights or entitlements of a person alone or together to:
- Exercise or cause to be exercised any or all of the rights attached to such share.
- Receive or participate in any dividend or other distribution in respect of such share.
The Ministry of Corporate Affairs (MCA) had originally notified the SBO Rules in 2018, but the same were not implemented due to interpretative challenges. The MCA has, since then, significantly amended the SBO Rules, and the amended rules have come into effect from February 8, 2019. The last date for filing BEN-2 declarations (form prescribed by the MCA for declarations of SBO to be filed by the reporting company) has since been extended multiple times and the revised last date is December 31, 2019.
Unfortunately, despite extensive redrafting of the SBO Rules published earlier, the determination of an SBO in a reporting company is extremely difficult, due to several interpretative challenges in the SBO Rules. Whilst the new SBO Rules are a marked improvement over the previous ones, there still exists a considerable amount of ambiguity with regard to determination of the SBO in certain situations.
Practical Challenges in Determining SBOs
Some of these challenges are as follows:
1) 10% or 25% Threshold?
Section 90 stipulates that the threshold for triggering SBO reporting requirements is no less than 25% of shareholding in the reporting company, or “such other percentage as may be prescribed”. The SBO Rules have lowered this threshold to 10% of the shareholding in the reporting company. The legal validity of this lower threshold prescribed in the SBO Rules is doubtful, and may be set aside by a Court, if challenged. The SBO Rules appear to be clearly ultra-vires Section 90, which goes against the cardinal principles of law, in which delegated legislation cannot go beyond the Act passed by Parliament.
2) Equity & Preference or Only Equity Shares
Given the definition of beneficial interest in Section 89(10) and Section 90, there are two views on whether both equity & preference shares should be considered for SBO determination, or only equity shares and convertible instruments. One view is that both equity and preference shareholding need to be considered in determining the shareholding threshold for identification of the SBO. The other view is that equity shares, Global Depository Receipts, Cumulative Convertible Preference Shares and Cumulative Convertible Debentures should only be used for computation of the 10% threshold as per explanation VI of the SBO Rules.
The counter-argument, however, is that if the individual has the right to receive or participate in more than one-half of the distributable dividend inclusive of any dividend from Redeemable Preference Shares (RPS), then the holding of such RPS will have to be considered on the basis of the definition of beneficial interest u/s 89(10) read with the definition of majority stake in Rule 2(1)(d)(iii) of the SBO Rules. The expression used in Sections 89 & 90 of the Act is ‘shares’. The Supreme Court has held that Rules made under a parent legislation are a legitimate aid to construction of the parent statute (Telco v. Gram Panchayat, Pimpri).
3) How to Determine Acting Together?
The expression acting together has been clarified in Explanation V to include individuals acting through any person or trust, with a common intent or purpose of exercising any right or entitlement or exercising control or significant influence over a reporting company pursuant to an agreement or understanding, formal or informal. One position is that the “acting together” test needs to be applied only at the reporting company level and not throughout the ownership chain going right up to the top. However, given the objective of this enactment, it would be safer to take a view that this test needs to be applied at every layer of the ownership chain.
4) Private Discretionary Trust with a Corporate Trustee
In case the shares held by a private irrevocable discretionary trust, and the trustee of such trust is a corporate trustee, the SBO Rules are unclear as to who should be declared as an SBO in such a situation. The problem is further compounded by the fact that the SBO Rules use the expression “where the member of the reporting company is a trust (through trustee) and the individual is a trustee in case of a discretionary trust”. A number of large Indian promoter families have started migrating their share ownership in their corporate empires to a discretionary trust, where sometimes the trustee is a corporate vehicle or family office. If one goes strictly by the literal interpretation of the Rules, it is possible to argue that in such a situation there exists no SBO.
5) Pooled Investment Vehicles
Another confusion is with regard to determination of the SBO where the member of the reporting company is a pooled investment vehicle or an entity controlled by the pooled investment vehicle, based in a jurisdiction that is not a member of the FATF or, if it’s a regulator of the securities market, is not a member of the International Organisation of Securities Commissions. In such ownership situations, the SBO Rules are unclear as to how to determine SBO. The limited partner would surely not like to come forward to declare itself as SBO.
6) Dematerialised Shares Held by Pledge Offer Invocation of Pledge
SBO Rules are silent on who should be filing the declaration when the lender has invoked the pledge of shares held in a dematerialised form and is holding the shares in its own account as an investment. This is because of the conflict between the provisions of the Depositories Act, 1996 and more particularly Regulation 58 of the SEBI (Depositories and participants) Regulations, 1996 and Section 176 of the Indian Contract Act, 1872. The Supreme Court in the case of Balkrishna Gupta v. Swadeshi Polytex Limited has held that the pledgee does not become the beneficial owner of shares upon invocation of the pledge. In such a situation, there may be confusion as to who should be filing the SBO declaration.
7) Shares of a Deceased SBO Where the Transmission of Shares has not been Completed Due to Disputes
In some situations where the beneficial owner is not yet established, it is unclear who should be filing the SBO declaration. This would include when the SBO has died and the shares held by him are not legally and beneficially transmitted to his or her legal heirs, due to a dispute with regard to the validity of the will in case of a testamentary succession. It could also apply in cases of intestate succession, where the court has not issued succession certificates or letters of administration, or in some occasions, where courts may appoint an administrator pendete lite, under Section 247 of the Indian Succession Act, 1925, and such administrator pendent lite acts as an officer of the court, and holds the shares for a temporary period until the dispute regarding the validity of the will are resolved.
8) Interplay With Other Legislation
As of now, there are unclear ramifications as to how filing SBO declarations interplays with other laws and regulations like the Income Tax Act, 1961, the Prohibition of Benami Transactions Act, 1988 and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, Black Money Act, 2015, and Insolvency law etc. There is also concern that if the shares are held through trust, the bankruptcy remoteness of such holding could get compromised by filing SBO declarations.
Consequences of Non-declaration / Mis-declaration
As per Rule 2A of the SBO Rules, the reporting company is required to take necessary steps to find out if there is any individual who is an SBO and, if so, identify him and cause such individual to make a declaration in Form No. BEN – 1. The reporting company is under an obligation to issue a notice in Form No. BEN – 4 in every case where its member (other than an individual) holds not less than 10% of its shares or voting rights, or has the right to receive or participate in the dividend, or any other distribution. The consequences of mis-declaration or non-declaration of SBO could result in the National Company Law Tribunal (NCLT) passing an order restricting the transfer of shares in question, suspension of all rights attached to such shares, etc. If the SBO fails to get such order vacated within a period of one year, the entire shareholding in question could get transferred to an Investor Education and Protection Fund.
Some Concluding Thoughts
Given the financial stakes involved for the SBO and the potential ramifications under other laws and rules, there is a very high-level of anxiety in the corporate world with regard to filing of an SBO declaration.
It is very important for the Government to now clarify any ambiguity in this regard or risk a negative impact on the investment climate in the country. Fear of the unknown is forcing companies to resort to legal opinions to support the positions taken by them. SBO Rules may prove to be a fertile ground for protracted civil and criminal litigation.
 AIR 1976 SC 2463
 (1985) 2 SCC 167