Governments struggle to combat money laundering, terrorism funding and threats to the integrity of global financial systems. Complex cross-border corporate vehicles are used to facilitate illegal activities, allowing the anonymous movement of illicit funds through the financial system.
Following a 2014 report by the Financial Action Task Force, an independent inter-governmental body intended to encourage governmental action on corporate transparency and disclosure of beneficial ownership, the Ministry of Corporate Affairs (MCA), proposed amendments to the Companies Act, 2013.
In June 2018, MCA notified an amendment to section 90 of the act and the introduction of the Companies (Significant Beneficial Owners) Rules, 2018. The concept of Significant Beneficial Owner (SBO) is wider than “beneficial interest” as defined in section 89(10) and not limited to “significant beneficial interest”. SBO includes not only an individual holding a beneficial interest up to the prescribed percentage in a company, but also those in a position to exercise significant influence over it. Among other requirements, the rules oblige companies to file a return of SBOs with the Registrar of Companies.
For this purpose, the company is required to issue a notice to the SBO directly or to any person believed to have knowledge about the SBO, seeking information, which is to be responded to within 30 days. Default by the company or an SBO attracts a monetary penalty. Those willfully furnishing false or incorrect information or suppressing material information face punishment.
The rules represent good intentions to improve corporate transparency and accountability, but gaps in section 90 and in the rules cause obstacles. Companies have many unanswered questions on the implementation of the framework, requiring them to seek guidance from MCA.
One problem is the ambit of an SBO; this is different in section 90(1) from that in the rules. The section defines an SBO to be either (1) an individual who (acting alone or together with other persons, including a trust and persons resident outside India) holds a beneficial interest in shares of the company; or (2) an individual who has the right to exercise significant influence or control over the company. The rules define an SBO as an individual referred to in section 90(1) holding ultimate beneficial interest of not less than 10%. An explanation accompanying the rules does not reconcile the differences.
The definition of “beneficial interest” in section 89(10) includes the right of a person, directly or indirectly, to exercise rights attached to such shares, or to receive or participate in any dividend or other distribution. It is difficult to confirm if the intent of the rules is to target individuals at all levels of holding companies including those controlling the ultimate parent. This would be so on a strict interpretation of SBO in the rules, which describe an SBO as a person holding the ultimate beneficial interest. However, this would not be the case if the explanation in the rules is correct. The explanation does not deal with foreign corporate entities; the rules do not define “company” and the act defines a company as one incorporated in India. The legislature has expanded the definition of company in other situations to cover those incorporated overseas. It should have done so if the rules were intended to require such corporations to be covered as SBOs.
Clarity would be required in cases when a chain of shell companies obscuring ultimate beneficial ownership includes an operative overseas company. Such operating companies could break the chain of beneficial interest. For instance, Indian company A is 100% owned by US operating company B which is held wholly by US company C. Company B is a registered shareholder and has discretion not to declare a dividend even if company A does so. It is unclear whether any officer of company C would be an SBO.
Besides the above, another ambiguity comes from the fact that the applicability of 10% threshold seems to be irrelevant to a scenario where an individual does not have beneficial interest in shares, but enjoys significant influence or control over the company. Such influence or control over the company could be exercised by virtue of a contract or an arrangement other than shareholding.
The SBO regime is a commendable attempt to restrict money laundering. India could match the standard of leading jurisdictions in the fight against the unlawful acquisition, movement and use of money and funds. However, MCA should clarify the scope of the reporting requirements.
Ritika Ganju is a partner and Tushar Thimmiah is an associate at the Delhi office of Phoenix Legal.
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