RPTs and related exemptions in the context of Government companies

Munmi Phukon and Tanvi Rastogi

corplaw@vinodkothari.com

Introduction

Ministry vide its Notification[1] dated 5th June, 2015 issued certain modifications/ exemptions/ exceptions for Government Companies on certain provisions of the Companies Act, 2013. One such exemption was with respect to the provisions pertaining to related party transactions (RPTs). Vide the said Notification, Government Companies were provided relaxation from obtaining the prior shareholders’ approval as required under the first proviso to section 188(1) and consequently, from the restriction on the affirmative voting by the related parties for (a) contracts/ arrangements with other Government Company(ies) and (b) where the Government Company is not a listed company, contracts/ arrangements with related parties other Government companies as mentioned above, if prior approval of the Ministry/ Department of the Central Government (CG) or State Government (SG) administrative in charge of the Company is obtained.

The aforesaid Notification has been revisited by the Ministry by issuing a further Notification[2] dated 2nd March, 2020 (2020 Notification) whereby the said exemptions have been extended to the contracts/ arrangements by the Government Companies with CG/ SG/ any combination thereof.

Before analysing the relevance of the 2020 Notification, one has to understand the related parties from a Government Company’s perspective. This article analyses the provisions of the Companies Act, 2013 (Act) only, considering the Notification has been brought in by the Ministry of Corporate Affairs.

Related parties for a Government Company

As per clause (76) of section 2 of the Act following shall be a related party with reference to a company:

  1. a director or his relative;
  2. a key managerial personnel or his relative;
  3. a firm, in which a director, manager or his relative is a partner;
  4. a private company in which a director or manager or his relative is a member or director;
  5. a public company in which a director or manager is a director and holds along with his relatives, more than two per cent of its paid-up share capital;
  6. any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
  7. any person on whose advice, directions or instructions a director or manager is accustomed to act:                                                            Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
  8. any body corporate which is—
    • a holding, subsidiary or an associate company of such company;
    • a subsidiary of a holding company to which it is also a subsidiary; or
    • an investing company or the venturer of the company
  9. a director other than an independent director or key managerial personnel of the holding company or his relative as prescribed under Rules

Accordingly, to consider someone as related party, he/ she/ it shall have to strictly fall under any of the aforesaid sub-clauses. Seemingly, the Government of India or any State Government having controlling stake in the company does not get fit in any of the said clauses as the CG/ SG is neither considered as a person nor an entity/ body corporate. Accordingly, CG/ SG is not a related party to a Government Company as per the aforesaid definition.

Similarly, to consider another Government Company as a related party for a Government Company, the former shall also be required to fall under the definition. Accordingly, one will have to determine whether the former Government Company is a related party or not, based on its structure i.e. private company, public company, body corporate, and also based on its relationship with the subject Government company i.e. holding company, subsidiary company, associate company etc.

Position before and after 2020 Notification

 Transaction between Government companies and CG / SG

 The position with respect to transactions between the Government Company and the CG/ SG before and after the 2020 Notification remains same as CG/ SG, as discussed above, does not get covered under the purview of the definition of related party provided under the Act. Therefore, until and unless there is a related party on the other side, any transactions with any other party cannot be considered as RPT. Accordingly, where the transaction itself is not an RPT, exemption from the provisions pertaining to RPTs does not arise.

Transaction between two Government Companies

As discussed above, for considering another Government Company as related party one has to consider the status of such company. Accordingly, for a Government Company, the following Government Companies may be considered as related party:

  1. A Government Company which is a private company in which a director, manager or relative thereof of the first mentioned Government Company is a member or director;
  2. A Government Company which is a public company in which a director or manager of the first mentioned Government Company is a director and holds along with his relatives, more than two per cent. of its paid-up share capital;
  3. A Government Company which is either the holding company or subsidiary or associate company of the first mentioned Government Company;
  4. A Government Company which is a fellow subsidiary of the first mentioned Government Company;
  5. A Government Company to which first mentioned Government Company is an associate company

Considering the structure of the Government Companies, it is very unlikely to have related parties covered under point (a) and (b) above. Coming to the position before or after the 2020 Notification, there is no change, as the 2015 Notification already covered transactions between two Government Companies.

Transactions between the Government Companies and other related parties including non- Government Companies

From the definition provided in the Act, the following persons/ entities may also be considered as related parties for a Government Company:

  1. Individuals who are director, key managerial personnel (KMP), relatives of director/ KMP (s), a director other than an independent director or KMP of the holding company or his relative;
  2. Firm in which a director or manager or relative thereof is a partner;
  3. Non- Government Companies such as:
    • Private companies in which a director or manager or relative thereof is member or director;
    • Public companies in which a director or manager is a director and holds > 2% of its paid-up share capital, singly or jointly with his relatives;
  4. Body corporate whose Board/ managing director/ manager accustomed to act in accordance with the advice, directions or instructions of a director or manager;
  5. Any person on whose advice, directions or instructions a director or manager is accustomed to act.

While the parties mentioned in point (d) and (e) above, cannot be determined without analysing the proper facts and considering these are purely circumstantial in nature, it is very unlikely to have such related parties. As regards the position before and after the 2020 Notification, the transactions between these related parties will still require the prior approval of the administrative Ministry in charge, if the company is not obtaining prior shareholders’ approval. Accordingly, there is no change in the position after 2020 Notification.

Conclusion

While the 2020 Notification is an extended version of the 2015 Notification, however, it seems that it does not carry any relevance at all. The reason for the same is that CG/ SG, as discussed above, does not get covered under the purview of the definition of related party provided under the Act. Therefore, until and unless there is a related party on the other side, any transactions with any other party cannot be considered as RPT. Accordingly, where the transaction itself is not an RPT, exemption from the provisions pertaining to RPTs does not arise.

[1]http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3XHmN4i4mFb+v2wWhMvQoFsXKgJTHtRr9VmNjj/XQUFc9vZ6tRKIi2gIhxfNI2SOK

[2]http://www.mca.gov.in/Ministry/pdf/Notification_02032020.pdf

 

Our other articles on related party transactions:

http://vinodkothari.com/2020/02/proposed-changes-in-rpts-ppt/

http://vinodkothari.com/2019/11/mca-revisits-the-existing-cap-of-materiality-of-related-party-transactions-u-s-188/

http://vinodkothari.com/2017/09/presentation-on-related-party-transactionrpts-an-overview/

FAQs on Corporate Social Responsibility

Analysis of Companies (Amendment) Act, 2019

Applicability of NFRA Rules on overseas subsidiaries and associates: Conflict between the Rules and FAQs

Pammy Jaiswal

Partner, Vinod Kothari and Company

 

Background

National Financial Reporting Authority (‘NFRA’) being a quasi-judicial authority has been empowered by the Central Government to independently regulate and monitor the accounting and auditing standards (‘A&AS’). The intent of NFRA is to oversee the quality of A&AS of large entities as mentioned under Rule 3 (1) of the NFRA Rules.

Evidently NFRA intends to oversee the A&AS of large entities in terms of being listed or the size of the company or being functionally different entities like electricity companies or insurance companies, etc. Such entities have the presence of its subsidiaries and associates all around the world which may be contributing materially in terms of Rule 3 (1) (e) of the NFRA Rules to the net worth and turnover of the Indian parent entity.

While the last date for filing one time return by bodies corporate is approaching fast i.e. 31st July, 2019, there seems to a lot of ambiguity in the applicability of the NFRA Rules.

This note has been prepared with the intent to showcase the conflict between the provisions of the Companies Act, 2013 (‘Act’) read with its allied Rules and the FAQs issued by NFRA.

Various Provisions of the Act applying to bodies corporate

  • Applicability section of the Act

The first section of the Act laying down the applicability of the Act clearly mentions the following under clause (f) of sub-section (4) – such body corporate, incorporated by any Act for the time being in force, as the Central Government may, by notification, specify in this behalf, subject to such exceptions, modifications or adaptation, as may be specified in the notification.”

This provision makes it very clear that the Ministry of Corporate Affairs (‘MCA’) has been vested with the powers of applying the provisions of the Act to any bodies corporate. Further, the provision is also quite clear that such body corporate may be either incorporated under the Act or any other Act. This implies that even for foreign companies, the MCA has the power to apply the provisions of the Act subject to the changes as may be notified.

  • Definition of the term body corporate

Section 2 (11) defines the term ‘body corporate’ to include a company incorporated outside India. Here also, the intent of law is explicitly clear to cover the bodies corporate governed by foreign laws.

  • Chapter 22 of the Act

Section 379 (2) of the Act provides that a foreign company which is substantially owned and controlled by an Indian citizen or by an Indian company is required to comply with the provisions of the Act as mentioned thereunder.

Areas of conflict

While the consolidated financial statements of the Indian parent entities include the accounts of the subsidiaries and associates also, it cannot be argued that the quality of auditing and accounting is anywhere less relevant than the A&AS of the Indian parent. Therefore, it seems in fitness of things under clause (e) of Rule 3 (1) of the NFRA Rules to include foreign subsidiary and associates if they fulfil the condition of materiality under the said Rules (foreign subsidiaries and associates whose income or net worth exceeds 20% of the consolidated income and net worth of the Indian parent [‘material subsidiaries and associates]).

However, the FAQs[1] issued by NFRA have taken a different stand altogether with respect to the applicability of the NFRA Rules. It states that only those material subsidiaries and associates are covered under the scope which are having place of business in India.

While it sounds very surprising that if this wouldn’t have been the case, the condition of the foreign subsidiaries and associates which has an Indian parent, doing business back in India is very unlikely.

In any event, if merely by not having a business in India absolves the material subsidiaries and associates from the overview of the NFRA that would frustrate the whole intent and objective of the NFRA and allow such subsidiaries and associates to escape from the regulation of NFRA by virtue of the additional clause in the FAQs.

It seems that this condition of having business in India should have either be mixed with section 379 of the Act which talks about foreign companies having business in India or should may have actually been intended to be referred to the Indian parent’s business in India.

Further, if the question is one of jurisdiction as of how the Act extends its application to foreign bodies corporate not having business in India is concerned, it may be noted that section 1 (4) of the Act allows the Central Government to extend the provision of Act to bodies corporate, and it may therefore, it may be construed that in a manner of speaking is actually extended to foreign bodies corporate which have a business connection in India by virtue of having an Indian parentage.

Conclusion

One of the major questions in front of the stakeholders is the jurisdiction of NFRA which the FAQs have seemingly restricted to bodies corporate having place of business in India. However, considering the other provisions of the Act, it is quite clear that NFRA has been constituted not only to govern the auditors registered in India but also those in abroad as MCA has left number of provisions open under the Act which applies to bodies corporate.

If one interprets the applicability of NFRA on Indian bodies corporate, the whole intent and object of setting this regulatory body will get frustrated.

 

[1] https://nfra.gov.in/sites/default/files/FAQ.pdf

MCA set to deploy the eForm for reporting details of SBOs

Ambika Mehrotra

corplaw@vinodkothari.com

Background

Amendment to Section 89 and insertion of Section 90 are one of the key amendments brought in by the Companies (Amendment) Act, 2017 (‘Amendment Act’).  The said provisions were enforced w.e.f. June 14, 2018and Companies (Significant Beneficial Owners) Rules, 2018 were notified[1] (‘SBO Rules’). MCA, thereafter, issued General Circular No 7/ 2018[2]for extending the last date of filing eForm BEN-2 and 08/ 2018[3] to the effect that the format of declaration to be submitted by Significant Beneficial Owner (SBO) will undergo revision.

MCA on February 8, 2019[4] amended SBO Rules by amending the definition of significant beneficial owner. The due date for submission of declaration in Form BEN-1 was 90 days from the said amendment. However, eForm for filing the said declaration with MCA was not made available.

MCA, on July 1, 2019, issued Companies (Significant Beneficial Owners) Second Amendment Rules, 2019[5]thereby notifying eForm BEN-2 required to be submitted by companies.

Scope of Section 90

Section 90 focuses on the identification of a ‘significant beneficial owner’ through his ‘indirect holdings’ in an entity, which is to be considered only where the individual has majority interest in the vehicle holding stake in the “reporting company”, or in the ultimate holding entity of such holding vehicle. That is to say, simply direct holding or direct control, or direct significant influence (without any indirect holdings) were not required to be reported as significant beneficial interest under the Rules, irrespective of the magnitude of direct holding. Therefore, the direct holding of interest by an individual is relevant only if the direct holding may be clubbed with indirect holding.

Onus of making the declaration

The individual holding significant beneficial interest by virtue of holding shares or voting rights or right to distributable dividend or exercising significant influence was required to furnish the declaration in Form No. BEN-1 within 90 days of February 8, 2019 and thereafter in case of any change, to the reporting company. Herein, the onus lies on the individual to come forward and submit the declaration. The reporting companies on the other hand were required to give notice to members (other than individual) holding 10% or more of participating interest [either of shares, voting rights, or right to receive or participate in the dividend or any other distribution],  seeking information about the individual who is significant beneficial owner in the reporting company in Form BEN-4.

It is pertinent to note that the obligation of the individual to self-declare his significant beneficial holdings and the obligation of the company to send notice seeking information from members in terms of Rule 2Aare independent obligations.

Intimation to the ROC by the reporting entity

As per the SBO Rules as amended from time to time, the declaration of beneficial interest is required to be filed in e- Form BEN-2 with the Registrar in respect of such declaration, within a period of thirty days from the date of receipt of declaration by the company.

With the deployment of e-Form BEN -2 vide Companies (Significant Beneficial Owners) Second Amendment Rules, 2019, the Companies shall be required to intimate the same to the Registrar within 30 days of its deployment.

Companies are facing difficulty in identification of SBO in view of complex structures. Until receipt of declaration in Form BEN-1, companies will not be able to file eForm BEN-2.

Consequences of non-filing

Section 90(11) of the Act, 2013 provides for penal provisions for the failure of the part of the company and every officer in default in complying with the provisions of Section 90(4) i.e. filing of the above return  and changes therein with the Registrar with a fine:-

  • For company and every officer in default:- Rs. 10 Lakhs – Rs. 50 Lakhs
  • For Continuing default: – Upto Rs. 1000 for every day after first day of failure.

Analysis of e-Form BEN -2

  • Declaration of holding reporting company

 Pursuant to Rule 8 of the SBO Rules, which states that the rules are not applicable to the extent the shares of the reporting company is held by its holding reporting company. It is presumed that the SBO of the holding company is also the SBO of the subsidiary company for the shares held by the holding company.

First bullet of Field no. 3 requires the companies to report the details of such holding reporting company which shall be mapped through the CIN of such company.

  • Requirement to furnish copy of agreement

 In order to specify the manner in which significant beneficial interest is being held or exercised either indirectly or together with any direct holding or right, the form requires attachment of agreement in following cases:

  1. Exercise of control
  2. Exercise of significant influence

 This might be a serious constraint, as it may not be necessary that the companies might have in place a written and executed agreement specifying the control and/ or significant influence exercised by the members. However, at present the mode of mapping of control and/ or significant influence has only been done through the agreement to be attached in the form.

Conclusion

While, the eForm BEN-2 seems a derivative of the format of declaration Form BEN no. 1, companies will be able to report correctly subject to receipt of accurate declarations from the SBOs.

Other practical difficulties in reporting in the eForm can be ascertained once the eForm is deployed on MCA portal.

 

Other related articles on SBO can viewed here-

http://vinodkothari.com/2019/02/mca-revisits-sbo-rule/

http://vinodkothari.com/wp-content/uploads/2019/03/Final-FAQs-on-revised-SBO-Rules_17.03.2019-1.pdf

http://vinodkothari.com/wp-content/uploads/2019/03/Guide-to-identification-of-SBO-in-your-Company.pdf

http://vinodkothari.com/2019/02/new-sbo-rules-illustrations/

http://vinodkothari.com/wp-content/uploads/2019/02/Amended-SBO-Rules.pdf

 

[1]http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantBeneficial1306_14062018.pdf

[2]http://www.mca.gov.in/Ministry/pdf/GeneralCircularNo.7_06082018.pdf

[3]http://www.mca.gov.in/Ministry/pdf/GCCircularBen_10092018.pdf

[4]http://www.mca.gov.in/Ministry/pdf/CompaniesOwnersAmendmentRules_08020219.pdf

[5]http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantRules_01072019.pdf