GST council throws cold water on financial lease transactions

By Abhirup Ghosh(abhirup@vinodkothari.com) & Anita Baid(anita@vinodkothari.com)

Introduction

The basic nature of levy under the GST laws (Goods and Service Tax) in India is that it is pervasive. Section 9 of the CGST Act, 2017, is the charging section which imposes tax on any “supply”. Here, exclusions are items like non-taxable supplies, exempt supplies and supplies which are zero-rated. Further, section 7(1) of the CGST Act, defines the ambit of the word “supply”, which consists of all forms of supply of goods and services:

“supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.”

However, activities as specified Schedule III of the said Act are not be considered as “supply”. Since the scope is fundamentally related to the words “goods” and “services”, hence it is necessary to examine the meaning of these terms:

“Goods” are defined in section 2(52) as

“(52) “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;”

“Services” are defined in section 2(102), as –

““services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”

Leases under GST

As per Schedule II, any transfer of right in goods amounts to supply of services. In case of both, operating leases and financial leases, there is a transfer of right to use to the goods from the Lessor to the Lessee. Therefore, under the GST law, both will be treated in similar way, unless otherwise provided in future.

However, here it is important to understand that the nature of a financial lease is admittedly a financial assistance and is akin to loan transactions. There have been several judicial pronouncements where it has been substantiated that financial leases are akin to loan. In the case of Association of Leasing and Financial Services Company v. Union of India, paragraphs 20 and 21 of the judgment clearly brings out the fact that financial leasing and hire purchase transactions are a mode of long term funding. In case of Asea Brown Boveri Ltd v. Industrial Finance Corporation of India[1], the judgment brings fore the fact that financial lease is nothing but loans in disguise.[2]

The banking and financial services in common parlance have always included activities like lending, depositing, issuing of pay order, demand draft, cheque, letter of credit and bill of exchange, financial leasing services including equipment leasing and hire-purchase, etc. under its ambit. The reason being financial leasing and hire purchase transactions in substance partakes the character of loans and advances as these involve grant of assets to lessors / hire purchasers on credit terms and at predetermined rentals. While in case of leasing transactions, lessor transfers the right to use the assets to the lessee for fixed periodic rentals. The lease rentals can be construed as interest inclusive instalment for the leased assets. Therefore, the leasing transactions assumes the character of loan and interest payments.

Currently, loan transactions, being for money transactions, are outside the purview of taxable supply (since neither “goods” nor “services” include money). By that argument, since a financial lease is admittedly a monetary transaction, it stands to logic that the interest inherent in financial lease should be exempt. However, currently, the reality is far from the idealistic situation and financial leases are being taxed as supply of services or supply of goods based on the actual terms of the transaction.

Further, there is apparently no difference between financial lease and operating leases under the GST regime.

Here it is important to note that some cases of financial leases involve transfer of title of the asset at the end of the tenure; such cases will be treated as supply of goods, because Schedule II of the CGST Act states any transfer of title in goods under an agreement which stipulates that property in goods shall pass at a future date upon payment of full consideration as agreed, is a supply of goods.

Clarification from Department

In order to address the ambiguities in various segments of the economy, the GST Council framed sector specific FAQs to resolve the issues. One set of such FAQs are meant for financial services sector and it is these FAQs that has opened up whole lot of complexities.

Question 47 of the FAQs state the following:

  1. Whether interest on a finance lease transaction is taxable under GST?

A finance lease is a method of borrowing against the asset. The interest represents the time value of the money expended by the Bank in financing the asset. Services by way of extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services) is exempt. But, in a financial lease the ownership of the asset is with the bank. In essence, it is a ‘purchase the asset and lend it further’ transaction for bank. Therefore, neither the services are purely in the nature of extending loans nor the consideration for a financial lease is purely in the nature of interest. Thus, interest on finance lease transactions will be taxable under GST.

Whether financial lease is at par with loan transactions?

First of all, while the whole country was waiting for a clarification in favour of financial leases, the GST Council has re-iterated the old position saying financial lease, though a method of borrowing against asset, is not in the nature of extending loans or advances, as the ownership is retained by the lessor. The nature of the transaction has been called as “purchase the asset and lend it further”.

However, the Council has disregarded one of the most important feature of financial lease transactions in India. The financial lease transactions in India are mostly full payout leases and the legal title of the asset is retained as a security against the payment obligations. Therefore, the financial lessor’s interest in a leased asset is more of a security interest than an ownership interest. In fact, both the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 and the Insolvency and Bankruptcy Code, 2016 recognise interest of a financial lessor in the leased asset as security interest rather than ownership interest. All these have not been sufficient to convince the Council members to treat financial leases at par with loan transactions.

The reason why that might have been thought of the GST council is the legacy of service tax. In the case of Association of leasing and financial services company v/s Union of India[3], paragraph 20 and 21 of the judgment clearly brings out the fact that financial leasing and hire purchase transactions are a mode of long term funding. The honorable Supreme Court said that financial lease has both elements- The bailment which underlies finance leasing is only a device to provide the finance company with a security interest. GST Council is perhaps seized of the service element in financial lease and not the loan element.

Is Interest taxable?

Secondly, the question talks about the chargeability of GST on the interest component of a financial lease transaction. While currently, GST is charged on the entire lease rentals, however, the Council has dealt with only the interest component of the finance lease receivables. They might therefore be seriously meaning to say it is only interest which is taxable.

This gives us a very intriguing thought. Even under the earlier regime, sales tax was charged on the entire lease receivable, in addition to it, service tax was charged on 10% of the interest component. However, there is no similar abatement available on the finance lease transactions under CGST.

If one were to assume that the GST will be charged on the interest component of the lease rentals, let us understand the impact of the same with the help of an example –

Cost of asset  ₹     100.00
GST 18%  ₹       18.00
Total Cost  ₹     118.00
Lease tenure 3 years  
IRR 12%
RV 0% [Assuming full payout transaction]
Rental ₹ 41.63 [paid annually]
                   
Where GST is charged on the entire rental   Where GST is charged on the interest component only
Cashflow GST ITC c/f Cashflow Interest GST ITC c/f
0  ₹ -100.00  ₹  -18.00 0  ₹ -100.00  ₹  -18.00
1 ₹ 41.63 ₹ 7.49  ₹     10.51 1  ₹     41.63  ₹   12.00  ₹      2.16  ₹  15.84
2 ₹ 41.63 ₹ 7.49  ₹        3.01 2  ₹     41.63  ₹   8.44  ₹      1.52  ₹  14.32
3 ₹ 41.63 ₹ 7.49  ₹         – 4.48 3  ₹     41.63  ₹   4.46  ₹      0.80  ₹  13.52

 

In this case, we have taken an example of full payout transaction where GST is paid on the cost of the asset at 18% and GST is charged on the output at the same rate. We have considered two cases, first, where GST in charged on the entire lease rentals and second, where GST is charged only on the interest component of the lease rentals.

If interest is taxable, what about the ITC?

Input GST is paid on the entire principal component so the available amount of ITC is Rs. 18. In the first case, output GST is charged on the entire rentals, that is, even on the principal component of the transaction, the entire amount of ITC is being used up and total amount of GST payable to the government is on the value addition on the transaction, that is, on the interest component.

On the other hand, in the second case, GST is charged only on the interest component of the lease rentals. The total recovery of GST from the transaction is much less than the available amount of ITC. Therefore, in the second option, substantial amount of input tax would remain unutilized.

The first option leads to accelerated utilization of the input tax credit, whereas, the second one leads to under-utilization of the input tax credit. Further, it has to be noted that under the current GST law, the lessor will not be able to claim refund of the excess of ITC[4]. Therefore, there will be an unnecessary blockage of funds in the second case leading to loss of interest, which is economically not a viable option.

Though the FAQs have opened up new questions on the base of taxation in case of financial lease transactions, but economically the second one does not make any sense.

Conclusion

In the past several industry bodies have represented to the government for treating financial lease transactions at par with loan transactions for the purpose of the indirect taxation purposes[5], however, the FAQs has thrown water on all the hopes of the industry. Moreover, it has unsettled the otherwise settled view on the base of taxation of financial leases. Sure enough we will see a lot of questions being raised and a lot of representations being made to the Council to settle this issue.


[1] https://indiankanoon.org/doc/1163314/

[2] According to Lease Financing & Hire Purchase by Vinod Kothari (2nd Edn., 1986 at pp. 6 & 7), a finance lease, also called a capital lease, is nothing but a loan in disguise. It is only an exchange of money and does not result in creation of economic services other than that of intermediation.

[3] https://indiankanoon.org/doc/1531013/

[4] Refund is available only where the goods or services are exported out of India or where there is an accumulation of ITC due to the rate of GST on outputs being lower than the rate of GST on inputs.

[5] http://www.assetfinanceindia.com/wp-content/uploads/2017/04/Representation-Financial-Leases-to-be-treated-as-Loan.pdf

Transitory liberalisation of asset classification norms for MSMEs

by Yutika Lohia and Anita Baid (finserv@vinodkothari.com)

With the advent of GST in the Indian economy, all three sectors i.e. Agriculture, Industry and Service, have been facing several challenges. Majority of small entities in the country have been impacted in some way or the other, irrespective of whether they required registration under GST or not. MSMEs requiring registration faced difficulties due to disruption of their business for ensuring compliance with the new regime. Even unregistered MSMEs faced complications as they were dealing with businesses which were directly disrupted due to GST implementation eventually effecting their cash flows to honour financial obligations. In response to the worries of small enterprise, the government has introduced several relaxation so as to enable them to adopt themselves with the revolutionary change of indirect taxation scheme being implemented in the country. Certainly the cash flows of the micro, small, medium enterprises (MSMEs) sector has been adversely affected with this new GST regime and such entities whether registered or not under GST, who have taken financial assistance are definitely facing problems to pay off their debts. Read more

Governmment NBFCs to stand on equal footing

 

Anita Baid, Senior Manager (anita@vinodkothari.com)
Rajeev Jhawar, Executive (finserv@vinodkothari.com)

 

Section 2(45) of the Companies Act, 2013 defines a Government Company as –

“any company in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company.”

A Government Company registered with the Reserve Bank of India (RBI) as a Non-Banking Finance Company (NBFC) is referred to as Government-owned NBFC or Government NBFC. As on March 2017, the count of Government NBFCs-NDSI was around 15 with an asset size of Rs.6280 billions and there were 2 deposit accepting NBFCs with an asset size of Rs.273 billion[1]. These Government NBFCs were earlier exempted from various regulatory and statutory provisions issued by the RBI for NBFCs.

In view of a regulatory regime for the financial sector, it has been a long drawn proposal of RBI to bring all deposit taking and systemically important government owned companies under the provisions of the same guidelines. Considering the same the RBI has eliminated regulatory exemptions for government-owned NBFCs vide its notification no. DNBR (PD) CC.No.092/03.10.001/2017-18 dated May 31, 2018[2]. The RBI has specified a roadmap, extending till 2021-22, for the Government NBFCs to meet the norms on capital adequacy, provisioning and corporate governance at par with the other NBFCs. The NBFC regulations shall be applicable to Government NBFCs as per the timeline indicated in the notification.

Previously, Government NBFCs were advised vide DNBS.PD/CC.No. 86/03.02.089/2006-07 dated December 12, 2006 to submit to the Reserve Bank [Department of Non-Banking Supervision – (DNBS)] a road map for compliance with the various elements of the NBFC regulations, in consultation with the Government. Hence, the current notification provides that Government NBFCs that are already complying with the prudential regulation as per the road map submitted by them shall continue to follow the same.

We have tried to list down the major provisions and the applicability on Government NBFCs post the withdrawal of exemption:

Relevant provision With exemption Without exemption
Reserve Bank of India Act, 1934
Sections 45-IB

Maintenance of percentage of assets – 15% of the outstanding deposits

Not required Government NBFCs will be required to maintain a percentage of asset as investment in unencumbered approved securities as per the following timeline:

 

March 31, 2019 – 5% of outstanding deposits

March 31, 2020 – 10% of outstanding deposits

March 31, 2021 – 12% of outstanding deposits

March 31, 2022 – 15% of outstanding deposits

 

Section 45-IC

Every non-banking financial company shall create a reserve fund and transfer therein a sum not less than twenty per cent of its net profit every year as disclosed in the profit and loss account and before any dividend is declared.

Not required By March 31, 2019, the Government NBFCs shall be required to transfer at least 20% of its net profit to the statutory reserve fund
Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-SI and deposit taking, will be required to recognize income in accordance with accounting principles for FY ending March 31, 2019.
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 90 days or more shall be classified as NPA.

Not Required Government NBFC-SI and deposit taking shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       120 days or more for the financial year ending March 31, 2019

2.       90 days or more for the financial year ending March 31, 2020 and thereafter.

 

Provisioning Requirement

Every applicable NBFC shall make provisions for

·         standard assets at 0.40 per cent by the end of March 2018 and thereafter of the outstanding, which shall not be reckoned for arriving at net NPAs.

·         loss asset: the entire asset shall be written off.

·         sub-standard assets: A general provision of 10 percent of total outstanding shall be made.

·         doubtful asset: 100% provision to the extent to which the advance is not covered by the realizable value of the security to which the applicable NBFC has a valid recourse shall be made. The realizable value is to be estimated on a realistic basis and also

Period for which the asset has been considered as doubtful
Up to one year 20%
One to three years 30%
More than three years 50%

 

 

Not Required Government NBFC-SI and deposit taking, will be required to comply with the prescribed requirement in totality for the financial year ending March 31, 2019 and thereafter.
Capital Adequacy

The NBFC shall maintain CRAR of 15 percent (with a minimum Tier I capital of 10 percent)

Not Required Government NBFC-SI and deposit taking will have to comply with capital adequacy ratio as mentioned in the table below:

CRAR of 10% (min Tier I – 7%;  March 31, 2019
CRAR of 12% (min Tier I – 8%) March 31, 2020
CRAR of 13% (min Tier I – 9%) March 31, 2021
CRAR of 15% (min Tier I – 10%) March 31, 2022

 

 

Concentration of Credit Investment

No applicable NBFC shall,

(i) lend to

(a) any single borrower exceeding fifteen per cent of its owned fund; and

(b) any single group of borrowers exceeding twenty-five per cent of its owned fund;

(ii) invest in

(a) the shares of another company exceeding fifteen per cent of its owned fund; and

(b) the shares of a single group of companies exceeding twenty-five per cent of its owned fund; (iii) lend and invest

(loans/investments taken together) exceeding (a) twenty five per cent of its owned fund to a single party; and (b) forty per cent of its owned fund to a single group of parties.

 Not Required Government NBFCs, set up to serve specific sectors may approach the RBI for exemptions, if any.

 

For other NBFC-SI and deposit taking, the timeline for ensuring the compliance is FY March 31, 2022

Corporate Governance

All applicable NBFCs shall adhere to following requirements in order to ensure good corporate governance

·         Formation of various committees

·         Fit and proper criteria for directors

·         Disclosure and Transparency

·         Rotation of partners of the Statutory Auditors Audit Firm

·         Framing of Internal Guidelines

Not required Government NBFC-SI and deposit taking, are required to adhere to corporate governance guidelines for the financial year March 31, 2019 and thereafter.
Conduct of Business Regulations (Fair Practices Code) Not required Government NBFC-SI and deposit taking, are required to adhere to fair practices code for the financial year March 31, 2019 and thereafter.
Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016
Income Recognition

The income recognition shall be based on recognized accounting principles. Income including interest/ discount/ hire charges/ lease rentals or any other charges on NPA shall be recognized only when it is actually realized. Any such income recognized before the asset became non-performing and remaining unrealized shall be reversed.

Not Required Government NBFC-NSI will be required to recognize income in accordance with accounting principles dated March 31,2019
Asset Classification

An asset, in respect of which, interest has remained overdue for a period of 180 days or more shall be classified as NPA.

Not Required Government NBFC-NSI shall classify an asset as a NPA if the interest has remained overdue for a period of

1.       180 days or more for the financial year ending March 31, 2019 and thereafter.

 

Leverage Ratio

The leverage ratio of an applicable NBFC shall not be more than 7 at any point of time, with effect from March 31, 2015.

Not Required A roadmap for adherence by March 31, 2022 to be prepared by the Government NBFC-NSI.
Master Direction – Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016
Minimum Credit Rating

To get rated by approved Credit Rating Agencies

Not Required Government NBFC-D shall obtain Investment Grade Credit rating for acceptance of public deposits- March 31, 2019.

 

A Government NBFC-D having investment grade credit rating can accept deposits only up to 1.5 times of its NOF. Government NBFCs holding deposits in excess of the limit shall not access fresh deposits or renew existing ones till they conform to the limit, the existing deposits will be allowed to run off till maturity.

Other Deposit Directions Not required All other directions shall apply from Balance Sheet dated March 31, 2019.

 

The removal of exemption benefits for Government NBFCs shall ensure that both types of NBFCs stand at par in terms of compliance with specific RBI regulations. This would also result in intensifying the competition between the two types of ownership structures.


[1] RBI Annual Publication- Trend and Progress of Banking in India

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11283&Mode=0

FDI in financial services sector: restrictions brought back but for unregulated entities

RBI’s First Monetary Policy for FY 2018-19

Anita Baid

finserv@vinodkothari.com

 

The Reserve Bank of India (RBI) released its first monetary policy statement for FY 2018-19 on April 05, 2018[1] (‘Policy Statement’). The aforesaid statement sets out various developmental and regulatory policy measures for the financial sector. It aims at strengthening regulation and supervision; broadening and deepening financial markets; improving currency management; promoting financial inclusion and literacy; and, facilitating data management. Some of the major issues from the Policy Statement have been discussed herein below: Read more

Comprehending Other Comprehensive Income (OCI) from NBFC’s Perspective

Torrid time for NBFCs as FIU-IND lays down ‘High Risk’ classification

– By Saloni Mathur (finserv@vinodkothari.com)

Introduction

Just when the NBFCs were grappling with the outburst of RBI’s Ombudsman Scheme which was proposed to come into effect from 23rd February, 2018, FIU-IND released the list of ‘High risk NBFCs’[1] (‘List’) on account of non-compliance with the Prevention of Money Laundering Act, 2002 (‘PMLA Act’)[2] and the Prevention of Money Laundering (Maintenance of Records) Rules, 2005[3] (‘PMLA Rules’).

The Financial Intelligence Unit in the List laid down 9500 high risk NBFC’s that are coming under the ambit of the non-compliance with the PMLA Act and the PMLA Rules in respect of non-registration of the Principal Officer(PO) as on 31.01.2018.

Rationale

The intent of the Financial Intelligence Unit seems quite rational. Post demonetization in 2016 it has been strongly witnessed that several NBFCs were taking advantage of their business models by allegedly converting banned currency notes and accepting cash as deposits, and subsequently violating the provisions of the PMLA Act and the PMLA Rules. In order to curb this malpractice, the FIU has issued a warning to the NBFCs by categorizing them as ‘high risk NBFCs’ on the basis of non-compliance with the PMLA Act and the PMLA Rules with regard to non-appointment of the Principal Officer and the kind of repercussions that these may encounter in the case of any further non-compliance.

Legality emanating the ‘High Risk Classification’

The legality that governs the above high-risk classification of the NBFCs has its roots from the PMLA Act, PMLA Rules and the RBI directions titled, ‘The Reserve Bank of India (Know Your Customer (KYC)) Directions, 2016’ applicable to all the Regulated Entities (RE’s) as defined in 3(b)(xiii) of the said directions[4].

Clause wa of Chapter 1 of the PMLA Act, 2002 defines Reporting entity:

Reporting entity” means a banking company, financial institution, intermediary or a person    carrying on a designated business or profession.”

Clause f of the PMLA (Maintenance of Records) Rules, 2005 defines Principal Officer:

Principal Officer” means an officer designated by a Reporting Entity.”

Rule 3 of the PMLA( Maintenance of Records) Rules 2005 deal with the maintenance of the records and the transactions of following nature and value:

  • “All cash transactions of the value of more than 10 lakhs or its equivalent in the foreign currency
  • All series of cash transactions integrally connected to each other which have been individually valued below rupees ten lakh or its equivalent in foreign currency where such series of transactions have taken place within a month and the monthly aggregate exceeds an amount of ten lakh rupees or its equivalent in foreign currency.”
  • All transactions involving receipts by non-profit organizations of value more than rupees ten lakh, or its equivalent in foreign currency.
  • All cash transactions where forged or counterfeit currency notes or bank notes have been used as genuine or where any forgery of a valuable security or a document has taken place facilitating the transactions;
  • All suspicious transactions whether or not made in cash and by way of-
  • deposits and credits, withdrawals into or from any accounts in whatsoever name they are referred to in any currency maintained by way of-
  • cheques including third party cheques, pay orders, demand drafts, cashier cheques, or any other instrument of payment of money including electronic receipts or credits and electronic payments or debits, or
  • travellers cheques, or
  • transfer from one account within the same banking company, financial institution and intermediary, as the case maybe including from or to nostro and Vostro accounts, or
  • any other mode in whatsoever name it is referred to;
  • all cross border wire transfers of the value of more than five lakh rupees or its equivalent in foreign currency where either the origin or destination of fund is in India.
  • All purchase and sale by any person of immovable property valued at fifty lakh rupees or more that is registered by the reporting entity, as the case maybe.”

Following table represents various compliances by the reporting entity and their respective principal officers in respect to the above functions under various legal regulations:

 

S.no Act/Rule/Legislation Governing Regulation/Section Requirement
1. The Prevention of Money Laundering(Maintenance of Records) Rules, 2005 Reg.7 Every reporting entity shall communicate to the director the name, designation, and address of the designated director and the Principal Officer.
2. The Prevention of Money Laundering(Maintenance of Records) Rules, 2005 Reg.8 The principal officer shall submit all the information pertaining to the transactions to the director as defined in rule 3 above.
3. The PMLA Act, 2002 Section 12 (a) and (b) a)Every reporting entity shall maintain records of all transactions

b)furnish to the director any such information within such time as may be prescribed.

4. The PMLA Act, 2002 Chapter IV Section 12A The director may call for any such information as may be required by him within such time and in such manner in which he may specify.
5. The PMLA Act, 2002 Chapter IV Section 13(2) The director may, either of his own motion or an application made by the authority, officer or person with regard to the obligations of the reporting entity.

 

Any failure to comply with the provisions of this chapter would result in laying down some standing instructions and monetary penalty.

6. The Reserve Bank of India (Know Your Customer (KYC)) Directions, 2016 Chapter II Reg.7(i) and (ii) Principal officer shall be responsible for ensuring compliance, monitoring transactions, and sharing and reporting information as required under the laws/regulations

 Impact of such release on NBFCs

The publication of names is primarily a step by the FIU to make the public aware that these NBFCs are not law compliant and they should refrain from indulging into transactions with them. Through this release NBFCs are being urged to comply with this ‘basic obligation’ of appointing a principal officer who would oversee the compliances under the PMLA Act and the PMLA rules.

The Financial Intelligence Unit has come out with this list with an intent to warn the NBFCs in case of non-compliance with the PMLA Act, 2002 and the PMLA Rules, 2005. Further failure to comply with the provisions of the PMLA Act, 2002 and the PMLA Rules, 2005 specifically non-registration of the Principal officer would require stringent penal proceedings against the NBFC as specified in Section 13(2) of the PMLA Act, 2002.

Section 13(2) of the PMLA Act, 2005 prescribes certain standing instructions and monetary penalty for all applicable entities. These are as follows:

Standing instructions that might be imposed by the FIU

  • Director may issue a warning in writing.
  • Direct such reporting entity or its designated director on the board or any of its employees, to comply with the specific instructions
  • Direct reporting entity to send reports at regular intervals as may be prescribed

Monetary Penalty that might be imposed by the FIU

  • Penalty shall not be less than ten thousand rupees but may exceed to one lakh rupees for each failure.

The intent of this circular does not seem so stringent in nature presently. NBFCs who have not appointed Principal officer as on date are required to appoint them in order to remove the name from this list. This warning is issued in the nature of a standing instruction, which soon has to be complied by all the NBFCs who are not complying with the provisions of the Act.

Quick Actionable by the NBFCs

  • Appoint Principal Officer
  • Ensure communication of name, designation and address of the Principal Officer to the director, FIU-IND
  • Ensure that the Principal Officer reports all transactions under rule 3 of the PMLA( Maintenance of Records) Rules, 2005 to the director, FIU-IND.

Conclusion

Generation of the above list can be viewed as a measure by the Financial Intelligence Unit a standing instruction to all the NBFC’s to comply with provisions of the PMLA Act, 2002 and the respective Rules regarding the appointment of the Principal Officer

This standing instruction may turn into severe stringent penalty in case of further non-compliance. Thus if the principal officer is failed to get appointed until now, NBFCs can ensure their appointment now in order to escape any further penalties that may arise in this regard.

[1] http://fiuindia.gov.in/pdfs/quicklinks/High%20Risk%20NBFCs%20as%20on%2031.01.2018.pdf

[2] http://lawmin.nic.in/ld/P-ACT/2003/The%20Prevention%20of%20Money-laudering%20Act,%202002.pdf

[3] http://www.enforcementdirectorate.gov.in/pmla_rules.pdf

[4] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/18MDKYCD8E68EB13629A4A82BE8E06E606C57E57.PDF

RBI’s Ombudsman storm- Tough road ahead for NBFCs

By Saloni Mathur & Mayank Agarwal (finserv@vinodkothari.com)

 

Introduction

In the wake of rising discrepancies and deficiencies witnessed in the implementation of NBFCs general services, the Reserve Bank of India(“RBI”) came up with The Ombudsman Scheme for Non-Banking Financial Companies, 2018 (hereinafter referred to as the “Scheme”)[1] to address and target any complaint by any party aggrieved by any discrepancy in the service obligation of the NBFC.

The intent behind this scheme is to alleviate any laxity in the service delivery mechanism of the NBFC such that any party aggrieved may turn to a system for Ombudsman for a quick and ready solution and seek for any redress regarding any issue concerned with it.

The Scheme shall come into effect and force from February 23, 2018.

Applicability of the Scheme

The Scheme lucidly lays down the applicability of the provisions to the following class of NBFCs:

NBFCs, as defined in Section 45-I(f) of the Reserve Bank of India Act, 1934 and registered with the RBI under Section 45-IA of the Reserve Bank of India Act, 1934 which:

  • are authorised to accept deposits; or
  • have customer interface, with assets size of one billion rupees or above, as on the date of the audited balance sheet of the previous financial year, or of any such asset size as the RBI may prescribe.

Though the scheme presently is applicable to all the deposit taking NBFCs, it is however proposed to operationalise the scheme for the remaining identified categories of the NBFCs in the later stage. Hence currently, the scheme does not reflect any obligation on the part of the non-deposit taking NBFCs with asset size of one billion rupees and above to comply with the requirements of various provisions of the scheme.

Non-Applicability of the Scheme

The Non-banking Financial Company – Infrastructure Finance Company (NBFC-IFC), Core Investment Company (CIC), Infrastructure Debt Fund – Non-banking Financial Company (NBFC-IDF) and an NBFC under liquidation, are excluded from the ambit of the Scheme.

Ombudsman

The RBI is of the view that one or more officers in the rank of not less than General Manager shall be called the Ombudsman to carry out the functions entrusted by or under this Scheme. The territorial jurisdictions of the Ombudsman cover four metro centres viz. Chennai, Kolkata, Mumbai and New Delhi for handling complaints from different zones.

Grounds for complaint

The Scheme specifies various grounds for complaints as per which the customer may approach the Ombudsman, they can be further classified and rearranged as follows:

  1. Financial deficiencies
    1. Non-presentation or excessive delay in submitting post-dated cheques provided by the customers;
    2. Failure to provide in writing, the terms and conditions relating to loans disbursed;
    3. Failure to provide the aforesaid written document, including any changes made to the terms, if any, in vernacular language or a language as requested by the customer;
    4. Failure or excessive delay in furnishing the securities documents to the borrower upon repayments of all dues;
    5. Non-compliance with RBI regulations in any regard;
  1. Operational deficiencies:
    1. Non-presentation or excessive delay in submitting post-dated cheques provided by the customers;
    2. Failure to provide in writing, the terms and conditions relating to loans disbursed;
    3. Failure to provide the aforesaid written document, including any changes made to the terms, if any, in vernacular language or a language as requested by the customer;
    4. Failure or excessive delay in furnishing the securities documents to the borrower upon repayments of all dues;
    5. Non-compliance with RBI regulations in any regard;
  1. Contractual deficiencies:
    1. Non-insertion of repossession clauses in loan agreement or contracts which are not legally enforceable;
    2. Unclear terms in contracts or loan agreements relating to the following:
      • Notice period before taking possession of security;
      • circumstances under which the notice period can be waived;
      • the procedure for taking possession of the security;
      • a provision regarding final chance to be given to the borrower for repayment of loan before the sale/ auction of the security;
      • the procedure for giving repossession to the borrower and
      • the procedure for sale/ auction of the security;

While the directions do specify at length the grounds for filing of compliant, they also specify certain conditions which must be satisfied before filing of a complaint. One of the most notable conditions is the fact that the complainant, before approaching the Ombudsman, must approach the NBFC. In case the NBFC is of no help to the complainant, only then can he/she seek remedy from the Ombudsman. A detailed flowchart covering the possible scenarios for the aforesaid case has been shown below.

 

This Scheme also specifies certain other conditions which must be satisfied before seeking redressal from the ombudsman and they are:

  1. Any compliant which has already been covered by the Ombudsman in previous proceedings or the proceeding for which an order has been passed or is ongoing in any court, tribunal or arbitrator or any other forum, cannot again be raised by a different complainant
  2. The complaint must be meaningful in nature
  3. the complainant has filed along with the complaint, copies of the documents, if any, which he intends to rely upon, and a declaration that the complaint is maintainable.
  4. the complaint is made before the expiry of the period of limitation prescribed under the Indian Limitation Act, 1963 for such claims.

Additionally, the Ombudsman may decide to reject a complaint, at the time of inception or during the process as well in the following cases:

  1. The complaint does not satisfy the grounds of complaint, as mentioned above;
  2. The complainant is seeking monetary compensation that is higher than what the Scheme limits;
  3. The complaint requires excessive deliberation and diligence on part of the Ombudsman and hence, is not appropriate for adjudication of such complaint;
  4. The complaint is not made with a sufficient cause;
  5. The complainant is callous while the case is ongoing;
  6. The Ombudsman adjudges that there is no loss, physical or financial, suffered by the complainant.

Process for filing Complaint under the Ombudsman Regime

 

Settlement of complaint

Consequent to receiving of a complaint, the primary road of action for the Ombudsman remains to arrive at an amicable solution, which means a Settlement.  A complaint will be adjudged to be settled when any of the following scenarios are satisfied:

  • Where the grievance raised by the complainant has been resolved by the NBFC with the intervention of the Ombudsman; or
  • The complainant is satisfied with the process and extent of resolution provided by the Ombudsman based on mediation and conciliation provided by the NBFC
  • When the Ombudsman adjudges that the NBFC has complied with the respective laws and the same has been informed to the complainant. In case the complainant fails to raise an objection to the same within the time frame provided, the same will be adjudged to be settled.

In cases where it is deemed practical to do so, the Ombudsman shall intimate the concerned NBFC and forward all requisite documents with the view of reaching an understanding. The Ombudsman shall consider documents and declarations from both the concerned parties and in case a decision cannot be arrived at, a meeting may be arranged between the two. In case a settlement has been reached through such meeting, the proceedings of the meeting must be signed by both parties concluding the same.

Award by the Ombudsman

If the complaint is not settled by agreement, the Ombudsman shall pass an Award where it will either allow or reject a complaint. While doing so it shall take into account all the relevant evidence placed before him, the RBI circulars and Directions as prescribed from time to time, and shall state the reasons for passing such an award.

The Ombudsman shall prescribe certain conditions of specific performance on the part of the NBFCs if it allows the complaint and also direct the NBFCs for the payment of any compensation. The complainant shall also submit to the NBFC and the Ombudsman concerned within a period of 30 days, a letter of acceptance of the Award in full and final settlement of his claim.

The NBFC shall unless it has preferred an appeal within one month from the date of receipt by it of the acceptance in writing of the Award by the complainant comply with the Award and intimate compliance to the complainant and the Ombudsman.

Appeal before the Appellate Authority

Any person aggrieved by the award may within 30 days of the receipt of the communication of Award or rejection of the complaint, prefer an appeal before the Appellate Authority. An appeal by an NBFC may be filed within 30 days from the date on which the NBFC receives letter of acceptance of the Award from the complainant.

Appeal may be filed by the NBFC only with the previous sanction of the chairman or the Managing director/Chief Executive Officer or any other officer of equal rank.

Quick Actionable by NBFCs pursuant to the scheme

The Scheme though is currently applicable to only deposit taking NBFCs, however the intent is to gradually extend it to other NBFCs as well. Following is a set of actionable required on the part of the NBFCs:

Display salient features of the scheme for Public Knowledge

  • The purpose of the scheme and the contact details of the Ombudsman to whom the complaints are to be made by the aggrieved party to be displayed prominently in all the offices and branches.
  • The NBFCs covered by the Scheme shall ensure that a copy of the Scheme is available with the designated officer of the company for perusal in the office premises, if anyone desires to do so, and notice about the availability of the Scheme with such designated officer shall be displayed and shall place a copy of the Scheme on their websites.

Appointment of nodal officers

To appoint Nodal Officers at their Head/ Registered/ Regional/ Zonal Offices who shall be responsible for representing the company and furnishing information to the Ombudsman in respect of complaints filed against the NBFC.

Information to all offices of Ombudsman

Inform all the Offices of the Ombudsman about the appointment of nodal officers. Wherever more than one zone/ region of a NBFC is falling within the jurisdiction of an Ombudsman, one of the Nodal Officers shall be designated as the ‘Principal Nodal Officer’ for such zones or regions.

Obligations of the NBFCs pursuant to the Scheme

Providing information

Provide information to the Ombudsman when there is a call for any to decide upon any complaint filed, and furnish all certified copies and documents as required from time to time.

Specific performance

Where the Ombudsman decides to allow the compliant, it is required to do specific performance of its obligations in addition to or otherwise, the amount, if any to be paid by it to the complainant by way of compensation for any loss suffered by the complainant arising directly out of the act or the omission of the NBFC.

Implementation/Enforcement of Award

It shall be the obligation of the NBFC concerned to implement the settlement arrived with the complainant or the Award passed by the Ombudsman when it becomes final and send a report in this regard to the Reserve Bank of India within 15 days of the award becoming final.

Penalty

NBFC’s are required to pay an amount which is more than the actual loss suffered by the complainant as a direct consequence of the act, omission, or commission of the NBFC, or one million rupees whichever is lower.

Compensation for any harassment

NBFCs are  also required to pay compensation as a requirement of the Reward passed by the Ombudsman not exceeding one hundred thousand rupees to the complainant, taking into account the loss of time, expenses incurred, harassment and mental anguish suffered by the complainant.

Conclusion

In a nutshell, this will increase the responsibility of the NBFCs while dealing with the customers and other stakeholders and ensure that proper redressal is provided by them to the aggrieved party so as to avoid scrutiny of the Ombudsman.


[1] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/NBFC23022018.pdf