Taking a deeper look at changes to SBO regime

The Companies Act, 2013 (act) was amended in 2018 to introduce a regime for significant beneficial owners (SBO) of shares or companies. The SBO regime aims to identify ultimate individual owners behind corporate structures in order to increase transparency, prevent tax evasion, money laundering, etc.

The central government introduced the Significant Beneficial Ownership Rules, 2018 (rules), under the act, for implementing the SBO regime. The application and interpretation of the rules has been widely discussed. A related question is whether the rules transgress the central government’s rule-making powers under the act.

The act earlier required persons having beneficial interest in a company to make a declaration but the term “beneficial interest” was not defined. The Companies Law Committee in 2015 suggested amending the act to define the term, requiring disclosures and record-keeping obligations. Section 89 was amended to define beneficial interest and section 90 introduced the definition of SBO.

Section 90 and rules: Section 90 compels individuals who qualify as SBOs to make a declaration to the company. Companies are required to proactively seek information about SBOs from shareholders, maintain registers and file returns.

As with other provisions of the act, section 90 empowers the government to legislate on certain issues through rules. The government accordingly framed the rules under section 90 of the act, read along with section 469(1), which empowers the government to make rules to carry out the provisions of the act. While the rules may be aimed at giving effect to section 90, they seem to narrow its scope, something which the government isn’t expected to do.

Under section 90, an individual is an SBO if they (alone or jointly with others) hold beneficial interests of not less than 25%, or “such other percentage as may be prescribed”, in shares, or exercise significant influence or control over a company. Beneficial interest is defined widely, under section 89, to include the right or entitlement of a person to
exercise any rights attached to shares.

The rules also define an SBO as an individual referred in section 90 who (alone or jointly with others) holds certain rights and entitlements specified in the rules. These rights and entitlements are (through direct and indirect holdings) – not less than 10% shareholding, not less than 10% voting rights, right to receive not less than 10% dividend and exercise of significant influence or control.

Validity: The definitions in section 90 and the rules differ on the types of interest that an individual should hold in a company for them to be an SBO. There are grounds to argue that the government has used the rules to effectively amend or replace the definition of SBO under section 90.

Section 90 contemplates not less than 25% holding of beneficial interests and although the government is empowered to prescribe another threshold, the rationale for reducing the one prescribed by the parliament is unclear. The rules could also be questioned on the basis that they amend the rights, entitlements, interests an individual is required to possess to be an SBO, which the government is not empowered to do.

Under section 90, an individual could potentially qualify as an SBO even if they have rights or entitlements other than those specified in the rules (shareholding, voting rights or dividend) and such a scenario cannot be ruled out.

From the government’s perspective, it is arguable that the rules are clarificatory and merely intended to carry out the provisions of section 90 in line with the government’s mandate under section 469(1). However, the rules do seem to overlap with section 90 and have arguably amended it. If the government’s intention was to clarify the scope of section 90, it could also have exercised its powers under section 470 of the act, which empowers the government to remove difficulties.

The importance of delegated legislation, especially in an increasingly complex and technical legal framework like ours, cannot be doubted. At the same time, it is imperative to avoid overreach to ensure that executive action does not extend beyond the powers conferred by the parliament.

The objectives behind the SBO regime are positive and the government can be credited with introducing reforms across the board to try and increase transparency and accountability. However, it is critical to ensure greater focus in ironing out the practical challenges that come with any new regime. Given the wide scope of the SBO regime and lack of clarity surrounding its application, the government has its task cut out.

Saket Shukla is a partner and Akshay Sachthey is a senior associate at Phoenix Legal.