By Dibisha Mishra (email@example.com) (firstname.lastname@example.org)
There has been a series of changes brought in by the Ministry of Corporate Affairs (“MCA”) in recent years to bring in better transparency, easier compliance and weed out hurdles in the way of Ease of doing Business. In furtherance of the same, MCA vide notification dated 29th March, 2019, notified Companies (Incorporation) Third Amendment Rules, 2019 (hereinafter referred to as “Amended Rules”)[i] which has upgraded the existing SPICe form with a view to bring in a single window system for making application under GST, Employees Provident Fund Organization (‘EFPO’) and Employees State Insurance Corporation (‘ESIC’).
These additional services are being catered via e-form INC-35 named as ‘AGILE’ which shall be linked with SPICe (e-form INC-32) during filing with MCA. It is to be noted that though linking of the form is mandatory, option of availing the aforementioned services is left to the applicant. The company can very well choose the services which it wishes to avail.
The main features along with the technicalities of the incorporation process prior to the Amended Rules have been covered in our earlier article[ii]. This write up covers the highlights of AGILE along with a brief discussion on some practical aspects. Read more
By Falak Dutta, (email@example.com)
Since the Sarada scam in 2015, the Reserve Bank of India (RBI) had been on high alert and had been subsequently tightening regulations for NBFCs, micro-finance firms and such other companies which provide informal banking services. As of December 2015, over 56 NBFC licenses were cancelled. However, recently in light of the uncertain credit environment (recall DHFL and IF&LS) among other reasons, RBI has cancelled around 400 licenses in 2018 primarily due to a shortfall in Net Owned Funds (NOF) among other reasons. The joint entry of the Central Govt. regulators and RBI to calm the volatility in the markets on September 21st, 2018 after an intra-day fall of over 1000 points amid default concerns of DHFL warrants concern. Had it been two isolated incidents the regulators and Union government would have been unlikely to step in. The RBI & SEBI issued a joint statement on September saying they were prepared to step in if market volatility warrants such a situation. This suggests a situation which is more than what meets the eye.
Coming back to NBFCs, over half of the cancelled NBFC licenses in 2018 could be attributed to shortfall in NOFs. NOF is described in Section 45 IA of the RBI Act, 1934. It defines NOF as:
1) “Net owned fund” means–
(a) The aggregate of the paid-up equity capital and free reserves as disclosed in the latest
Balance sheet of the company after deducting therefrom–
(i) Accumulated balance of loss;
(ii) Deferred revenue expenditure; and
(iii) Other intangible assets; and
(b) Further reduced by the amounts representing–
(1) Investments of such company in shares of–
(i) Its subsidiaries;
(ii) Companies in the same group;
(iii) All other non-banking financial companies; and
(2) The book value of debentures, bonds, outstanding loans and advances
(including hire-purchase and lease finance) made to, and deposits with,–
(i) Subsidiaries of such company; and
(ii) Companies in the same group, to the extent such amount exceeds ten per cent of (a) above.
At present, the threshold amount that has to be maintained is stipulated at 2 crore, from the previous minimum of 25 lakhs. Previously, to meet this requirement of Rs. 25 lakh a time period of three years was given. During this tenure, NBFCs were allowed to carry on business irrespective of them not meeting business conditions. Moreover, this period could be extended by a further 3 years, which should not exceed 6 years in aggregate. However, this can only be done after stating the reason in writing and this extension is in complete discretion of the RBI. The failure to maintain this threshold amount within the stipulated time had led to this spurge of license cancellations in 2018.
However, the Madras High Court judgement dated 29-1-2019 came as a big relief to over 2000 NBFCs whose license had been cancelled due a delay in fulfilling the shortfall.
On 27-3-2015 the RBI by notification No. DNBR.007/CGM(CDS)-2015 specified two hundred lakhs rupees as the NOF required for an NBFC to commence or carry on the business. It further stated that an NBFC holding a CoR and having less than two hundred lakh rupees may continue to carry on the business, if such a company achieves the NOF of one hundred lakh rupees before 1-04-2016 and two hundred lakhs of rupees before 1-04-2017.
The Petitioner’s claim
The petition was filed by 4 NBFCs namely Nahar Finance & Leasing Ltd., Lodha Finance India Ltd., Valluvar Development Finance Pvt. Ltd. and Senthil Finance Pvt. Ltd. for the cancellation of CoR against the RBI. The petitioners claim that they had been complying with all the statutory regulations and regularly filing various returns and furnishing the required information to the Registrar of Companies. These petitions were in response to the RBI issued Show Cause Notices to the petitioners proposing to cancel the CoR and initiate penal action. The said SCNs were responded to by the petitioners contending that they had NOF of Rs.104.50 lakhs, Rs.34.19 lakhs, Rs.79.50 lakhs and Rs.135 lakhs respectively, as on 31.03.2017.
Valluvar Development Finance also sent a reply stating that they had achieved the required NOF on 23-10-2017, attaching a certificate from the Statutory Auditor to support its claim. The other petitioners however submitted that due to significant change in the economy including the policies of the Govt. of India during the fiscal years 2016-17 and 2017-18 like de-monetization and implementation of Goods & Services Tax, the entire working of the finance sector was impaired and as such sought extension of time till 31-03-2019 to comply with the requirements.
Now despite seeking extension of time, having given explanations to the SCNs, the CoRs were cancelled without an opportunity for the NBFCs to be heard.
It was argued that there is a remedy provided against the cancellation of the CoRs, the petitioners had chosen to invoke Article 226 contending violation of the principles of justice. The proviso to Section 45-IA(6) relates to the contentions in regards to cancellation of the CoRs.
“45-IA. Requirement of registration and net owned fund –
(3) Notwithstanding anything contained in sub-section (1), a non-banking financial company in existence on the commencement of the Reserve Bank of India (Amendment) Act, 1997 and having a net owned fund of less than twenty five lakhs rupees may, for the purpose of enabling such company to fulfill the requirement of the net owned fund, continue to carry on the business of a non-banking financial institution–
(i) for a period of three years from such commencement; or
(ii) for such further period as the Bank may, after recording the reasons in writing for so doing, extend,
subject to the condition that such company shall, within three months of fulfilling the requirement of the net owned fund, inform the Bank about such fulfillment:
Provided further that before making any order of cancellation of certificate of registration, such company shall be given a reasonable opportunity of being heard.
(7) A company aggrieved by the order of rejection of application for registration or cancellation of certificate of registration may prefer an appeal, within a period of thirty days from the date on which such order of rejection or cancellation is communicated to it, to the Central Government and the decision of the Central Government where an appeal has been preferred to it, or of the Bank where no appeal has been preferred, shall be final:
Provided that before making any order of rejection of appeal, such company shall be given a reasonable opportunity of being heard.
The decision was taken on two grounds. First, the statute specifically provides for an opportunity of personal hearing besides calling for an explanation. The amended provision is very particular that opportunity of being personally heard is mandatory, as the very amendment relates to finance companies, which are already carrying on business also. Not affording this opportunity would cripple the business of the petitioners.
Second, the amended section provides NBFCs sufficient time to enhance their NOF by carrying on business and comply with the notifications. For the aforesaid reasons, the orders by the RBI requires interference. Resultantly, the respondents (RBI authorities) are directed to restore the CoR of the petitioners and also extend the time given to the petitioners.
This was a landmark hearing in the case of NBFCs as they had been under increasing pressure as of recent times. Many NBFCs can now apply for restoration of their licenses and might already have. The case doesn’t just stand the case for NOF conflicts but will also ring in the minds of regulators in the future, compelling greater caution and concern. The last statement of the judgement stands apt here. The brief sentence read,” Consequently connected miscellaneous petitions are closed.”
 Certificate of Registration
-By Vinod Kothari
The recent rulings of appellate judicial and quasi-judicial authorities in India permitting the pursuit of schemes of arrangement even after initiation of liquidation proceedings may have sounded surprising to many. However, the history of schemes of compromise and arrangement is indeed replete with examples of such arrangements seeking to bail out an entity that is otherwise doomed to be liquidated. Since India stands out in the world, having enacted section 29A of the Insolvency and Bankruptcy Code, 2016, which disqualifies a promoter from submitting resolution plans or acquiring the assets of the entity in liquidation, the issue causing a lot of debate is – how does the possibility of a scheme of arrangement co-exist with this principle of promoter disqualification? Or, if the promoters, disqualified from either heading a resolution exercise or acquiring assets in liquidation, can find a surrogate route in schemes of arrangement, is there a potential of negating the very objective of insertion of section 29A?
Another major question is: unlike the erstwhile Companies Act, 1956 regime where both schemes of arrangement and winding up were to occur under the same law and before the same forum, schemes of arrangement are now under the Companies Act, and liquidation under the Code. Therefore, if a scheme of arrangement has been suggested, should liquidation proceedings in the meantime stand stayed, as otherwise the very existence of a chance of revival through the scheme route will get nullified if liquidation achieves some milestones? Further, is it alright for the jurisprudence relating to the apparent overlap and, to an extent, conflict between arrangement and liquidation to develop on its own, or should the lawmakers interfere and write the law, instead of waiting for long winding route of litigation to reach a finality? This post seeks to address these issues, and seek answers for the various questions.
Schemes of arrangement for companies in winding up
Not only is it possible for schemes of compromise or arrangement to be presented for companies in liquidation, it may be interesting to note that the entire concept was originally intended, both in UK and India (and other countries drawing inspiration from the UK law), to be a bail-out device for companies otherwise headed for winding up. In fact, as far back as in the Indian Companies Act, 1913, section 153 pertaining to compromise or arrangement defines the word “company”, relevant to this section, as a company “liable to be wound up under this Act”. The definition continued in section 390 (a) of the Companies Act, 1956.
To a lay person, a “company liable to be wound up” meant a company that was either on the brink of bankruptcy, or was already into liquidation (since section 391 explicitly permitted a scheme to be presented by the liquidator, if the company was in winding up). It was only due to judicial interpretation of the expression “company liable to be wound up” that the expression includes every company which may be wound up under the Act following the procedure laid for winding up; healthy companies could also be covered under the chapter pertaining to schemes of compromise or arrangement. The ruling of the Bombay High Court in Khandelwal Udyog and Acme Manufacturing Co Ltd., (1977) 47 Com Cases 503, marked a departure from the principle earlier held by the same court in Seksaria Cotton Mills Ltd. v. A.E. Naik, (1967) 37 Com Cases 656, that the provision was meant only for a company on the brink of bankruptcy.
There have been numerous instances in India, and many in UK, where companies which have been in liquidation for years altogether have been ordered to be revived based on schemes of arrangement. Meghal Homes P. Ltd. v. Shree Niwas Girni K.K. Samiti, (2007) 139 Com Cases 418, is a case where the company was ordered to be wound up in 1984 and the scheme of arrangement was proposed in 1994.
Key differences between schemes of arrangement and resolution under Code
There are several significant differences between schemes of arrangement under corporate laws and resolution procedures under the Code. First, resolution schemes have practically no shareholders’ involvement. The structure of the Code seems to be exclude shareholders’ participation in resolution schemes, on the understanding that commencement of insolvency passes control from shareholders to the creditors. Indian law has gone to the extent of explicitly disabling the promoters (mostly majority shareholders) from proposing any resolution plan [section 29A(c) of the Code], or acquiring any assets of the company under liquidation [proviso to section 35(1)(f) of the Code]. On the contrary, schemes of arrangement under section 230(1) of the Companies Act, 2013 explicitly mandates meetings of creditors (and every class of creditors) and shareholders to be called separately, and an approval of the scheme by a supermajority vote in each of them. It may be noted that the need for approval by both shareholders and creditors depends on whether the arrangement involves the interests of shareholders as well as creditors (note the words in section 230 “as the case may be”). Most revival schemes of a company under liquidation will involve shareholders’ interest as well – hence, approval by both shareholders and creditors will be mandatory in case of a revival scheme.
Second, the supermajority approval requirement under section 230(6) has both a head count requirement as well a super-majority vote by value. The specific majority requirement, which was there in the 1956 Act as well, ensures that the supermajority in value does not completely cram-down the minority. Therefore, creditors of small value and small shareholders also wield the power to hold back the consent of larger creditors and shareholders. (See, however, an article by my colleague arguing that the head-count test was consciously dropped based on recommendations of JJ Irani Committee).
Third, it is important to note that section 230 requires consent of every “class of creditors”. As to what is meant by a class in this context and the difficulties in identifying a class has been discussed elaborately in State Bank of India and others v. Altstom Power Boilers, 116 Comp. Cas 1 (2003). (Palmer’s Company Law also discusses as to what constitutes a class for the purpose of compromises and arrangements. These were discussed in the landmark Supreme Court ruling in Miheer N Mafatlal v Mafatlal Industries Limited (1996)). Generally speaking, secured creditors, preferential creditors and unsecured creditors will form different classes. It may also be argued that one of the ways of recognising classes, in case of a company under bankruptcy, is their position in the waterfall under section 53 of the Code.
Fourth, the creditors’ or members’ meetings under section 230 cannot be reduced to a farce by only recognising the votes of only those members who are able to make it to the meeting – because the law explicitly recognises voting by proxies in such meetings. Additionally, requirements imposed by the Securities and Exchange Board of India (SEBI) in case of listed entities have put several additional safeguards, including mandatory facility of e-voting in such meetings, and a separate recognition of votes of “independent shareholders” (see Annex I Para I(A) point 9 of SEBI Circular dated 10 March 2017).
Can section 230 scheme be a surrogate route for ineligible promoters?
One of the most important questions concerning schemes of arrangement is – do the schemes permit the promoters to do what they are not able to do by virtue of section 29A – submit and approve schemes of revival whereby the promoters will perpetuate their stay in the company? The object of introducing section 29A in the Code, unusual in insolvency laws around the world, is to debar existing promoters of the company in default to perpetuate their stay in the company by submitting resolution plans. The sweep of the section is indeed very wide – it is not only limited to promoters of the company in question, but also any other defaulter company. Section 29A has blocked the submission of resolution plans in several high profile insolvency cases in the country, and it will be illogical to allow the submission of revival plans by promoters or controlling shareholders who cannot submit resolution plans by virtue of section 29A.
On the other hand, it may be argued that section 230 is a provision under the Companies Act, which has no equivalent of section 29A. In any case, the scheme of arrangement has the supermajority vote, not only of the shareholders, but also each of class of creditors. If the company in question is a listed entity, the shareholders’ consent must at least meet simple majority by disregarding the votes of promoter-shareholders. Thus, if the creditors and shareholders, in their separate meetings, have anyways reposed faith in the scheme as proposed, should the company not be allowed to come out of the Code and be revived under the Companies Act? After all, a section 230 compromise is not a resolution plan and in any case if the National Company Law Tribunal (NCLT), who would be sitting for approving such scheme, is able to see that the so-called scheme for a revival is an abuse of the process of law, the NCLT may always turn the scheme down. But there does not seem to be sufficient reason to have a generalised disqualification for promoters or shareholders in proposing the scheme.
At the same time, the NCLT also needs to be careful in ensuring that the scheme does not become a device to hold the process of liquidation in limbo and perpetuate the stalemate. Very often, the interest of promoter-shareholders lies in prolonging the uncertainty – when they see that the ultimate is their exit from the management, they try to prolong the stalemate. This is a real risk that NCLTs presiding over the schemes of arrangement will have to safeguard against.
Mechanics of schemes of arrangement during liquidation
How would a scheme of arrangement work during liquidation? The scheme may be proposed by shareholders, or creditors, or the liquidator himself. Typically, the initiation of an application before the NCLT under section 230 happens by the board of directors approving a scheme and making an application for convening a meeting of shareholders and members. During liquidation, since the directors relinquish their offices, there is no scope for the board submitting a scheme. Presumably, the mechanics may be for a substantial shareholder block proposing the liquidator to put a scheme before the NCLT. Creditors, of course, may propose the same directly to the NCLT. If the liquidator sees prima facie strength in the scheme, the liquidator may put forth the scheme before the NCLT.
The meetings of shareholders and creditors for approving the scheme are called at the instructions of the NCLT. Unless the NCLT dismisses the application in the very first hearing, the issue is – while the meetings of creditors and shareholders are being called, will the process of liquidation be stayed? It seems that it will be logical that the winding up proceedings should be temporarily stayed, until the shareholders’ and creditors’ meetings are called to consider the scheme. The principles for stay of winding up proceedings were contained in section 466 of the Companies Act, 1956 – this provision, and several English and Indian authorities on this regard has been discussed at length in Forbes and Company and another v. Official Liquidator (2013). If the schemes have the approval of the shareholders and creditors, then the NCLT may go by the principles well enunciated in Miheer N Mafatlal and similar rulings and, if eventually the NCLT passes order approving the scheme, the initiation of liquidation will be liable to be reversed.
It appears that when the Code was being written, the overlap of section 230 was not clearly visible, even though section 230 as amended by the Code itself makes a reference to liquidator appointed under the Code. However, now that this possibility has been opened up by jurisprudence, it is appropriate that we have codified law, rather than the uncertainty of a judicial law-making. Revival is always preferable over death, unless the so-called revival is just another ploy to permit a promoter using limited liability to continue to do unfair trading.
By Vinod Kothari & Sikha Bansal
Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19th century ruling in Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too.
Insolvency laws have not been accommodative of “group concerns” – the insolvent entity is treated as a separate and focused subject matter altogether, and the group entities remain insulated, irrespective of the extent of intermingled structures and shared resources. The relevance of the enterprise approach may be seen from two perspectives – the objective of insolvency or liquidation proceedings, and the complex, inter-connected nature of legal entities in corporate groups of the present day. Given the primary objective of insolvency laws to rescue an entity, a mostly entity-focused approach may fail to do justice to the needs of an ailing enterprise, where resources, operations and assets may be scattered across entities. In liquidation too, where the intent is to liquidate assets, if the assets are entangled across entities and jurisdictions, no meaningful liquidation may be achieved. In any case, due to the entangled nature of the entities, whereby picking up one of the group entities and seeing the same in isolation may not be meaningful at all, the group approach becomes unarguable.
As Sir Goode laments,
Business, entity or group enterprise?
The subject of insolvency proceedings has always been, and continues to be, the particular corporate entity that has become insolvent, and this focus is accentuated by the reluctance of English law to pierce the corporate veil. What insolvency law here and overseas has so far singularly failed to accommodate is the management of enterprise groups where one or more, or possibly all, members of the group have become insolvent. Whereas the preparation and filing of group accounts has long been required, when it comes to insolvency the distinct legal personality of each individual company within the group is respected, with separate proceedings for each company, yet the insolvency of one member of a group may threaten the viability of previously solvent members and where the group activity is integrated a coordination of the management of the group as a whole may be highly desirable. This is particularly the case as regards multinational group of companies, where the complexity is exacerbated by the variety of corporate structures and the possibility of concurrent proceedings in different jurisdictions governed by different laws, . . .”
While India is pondering over developing a framework under the Insolvency and Bankruptcy Code for group-based insolvency, a lot of work has already been done across the globe – UNCITRAL had constituted a working group, Working Group V, to deal with insolvency law, and through its various sessions, the Working Group has been advancing its work on insolvency of enterprise groups. The UNCITRAL Legislative Guide to Insolvency Law has dedicated a complete part, viz., Part 3, dealing with insolvency of enterprise groups. The EU Insolvency Regulation also applies in cases where there are insolvency proceedings in two or more EU member states.
When it comes to approaches, a group-focused approach may involve looking in multiple directions – as in “looking up”, “looking down” and “looking laterally”. As it suggests, looking up would mean looking at the holding or controlling entities, looking down would mean looking at the subsidiary level, and looking laterally would require looking at fellow subsidiaries, or entities equally controlled by holding entities. The UNCITRAL work discusses several approaches – extension of liability and contribution orders, equitable subordination, avoidance applications, procedural consolidation, and substantive consolidation – last two being major and extensive ones.
Procedural consolidation is where the proceedings of insolvency of different entities are coordinated, even if before different judicial or adjudicating authorities. On the other hand, substantive consolidation disregards the separation of entities and pools the assets and liabilities of various entities into a common hotchpot. This extreme remedy is rarely used, even though UNCITRAL has been aggressively working on developing the principles for the same. Basically, substantive consolidation is ordered by courts where pooling of assets and liabilities is to the larger benefit of different creditors, and generally not prejudicial to any. Mostly, this is done under circumstances similar to those inviting “lifting or piercing the corporate veil”; even substantive consolidation is different from veil lifting or piercing. US courts have well developed jurisprudence around substantive consolidation, though the remedy has been considered to be one which should be “sparingly used”, particularly after the ruling in Owens Corning. Recourse to the remedy will depend upon several factors, majorly, interests of creditors of the entire group.
India does not seem to have any trail of winding up case law on substantive consolidation, though “lifting of corporate veil” has been a well-known recourse in several judicial precedents. While, under the Insolvency and Bankruptcy Code, a subsidiary’s assets cannot form a part of an insolvent holding company, it is felt that the very idea of substantive consolidation is based on a substantive, equitable power of the adjudicating bodies. The remedy is applied in cases where the separation of legal entities is either artificial, or it is observed that dealing with the insolvency of one of the several entities, without disturbing the others, will be self-frustrating approach. Therefore, it is futile to search for legal provisions to permit approaches such as substantive consolidation. It is felt that insolvency laws have equity at their core: therefore, irrespective of the provisions explicitly providing for exclusion of the assets of a subsidiary from those of the holding entity, the National Company Law Tribunal has the equitable power to order substantive consolidation, wherever deemed appropriate and in the ends of justice.
In the Paper titled Entity versus Enterprise: Dealing with Insolvency of Corporate Groups, posted on SSRN the authors have delved deeper into the discussions and have made an effort to identify ways for making group insolvency work from global and Indian perspective.
The powers of a Court, specifically Bankruptcy Court w.r.t. “substantive consolidation”, lifting of corporate veil etc., in case of SPVs, has been discussed in the article titled “Consolidation” available at: http://vinodkothari.com/consolidation/
 Goode on Principles of Corporate Insolvency Law, Fifth Edition, by Kristin Van Zwieten, pg. 29-30.
By Abhirup Ghosh & Smriti Wadehra (firstname.lastname@example.org) (email@example.com)
Usage of common brand is a common practice that we notice among companies which are part of large conglomerates. Often the brands created by one single entity of a group are used by its related parties, however, these transactions are often structured with differential pricing terms i.e. either these transactions are not charged at all or are overpriced.
Therefore, in order to increase transparency and regulate to these transactions, a Committee on Corporate Governance constituted by the SEBI under the chairmanship of Uday Kotak has proposed disclosure requirements this kind of transactions.
In this article we will primarily discuss the proposal made by the Committee threadbare. Additionally, we will also discuss the impact of indirect taxes on such transactions.
Brand usage and Royalty as per Listing Regulations
The erstwhile provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) did not provide anything for royalties or brand usage paid to related parties. However, a SEBI constituted committee under the chairmanship of Mr. Uday Kotak on 2nd June, 2018 provided a report on corporate governance with certain recommendations for implementation. One of the recommendations was to insert provision pertaining to payments made for brand and royalty to related parties.
As noted above, often the transactions involving usage of brands and royalty payments are structured with differential pricing terms. The Committee has noted the importance of brand usage and it also brought the importance of disclosing the terms relating to payments against these brand usages, considering the role it plays in driving the sales or margin.
In this regard, the Committee suggested that where royalty payout levels are high and exceed 5% of consolidated revenues, the terms of conditions of such royalty must require shareholder approval and should be regarded as material related party transactions. The Listing Regulations currently prescribe a materiality limit at ten percent of annual consolidated turnover of the Company. Therefore, the Committee prescribed a stricter limit for brand usage and royalty i.e. 5% instead of the existing limit which is 5% of consolidated turnover.
SEBI applied its discretion to make the provision stricter and subsequently, made the following insertion in the Listing Regulations:
“23(IA) Notwithstanding the above, with effect from July 01, 2019 a transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.”
On reading the aforesaid provisions and basis our discussion, we understand that from 1st July, 2019 transactions involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.
It is pertinent to note that all transactions entered with related party for brand usage and royalty shall always be regarded as related party transactions. However, the trigger point of qualifying such transactions as material related party transaction is when the quantum of payout exceeds two percent of the annual consolidated turnover of the listed entity.
Whether provisions applicable for payments received for Brand usage and royalties?
While the provision talks about royalty payments to be treated as material related party transactions, but what remains to be answered is whether royalty receipts would also be considered as material related party transactions.
Please note that provisions of the amendment clearly provides:
involving payments made to a related party with respect to brand usage or royalty
Therefore, the applicability of the provisions appears to apply only in case of payments made to related party for brand usage and royalty. However, this does not seems to be the intent of law. Every transaction has two parties, in the present case, the two parties are the receiver and the giver. It does not seem rationally correct to include one side of the coin within the ambit of the law while keeping the other side out. Therefore, ideally receipt of royalty must also be treated as material related party transaction for the purpose of Regulation 23(IA) of the Listing Regulations.
Meaning of “Royalty”
Despite insertion of a new regulation dealing with royalty payments, the Listing Regulations do not define the term royalty. The meaning of the term, however, can be borrowed from the Income Tax Act, 1961 which provides for an elaborate definition. Section 9(1) of Income Tax Act, 1961 reads as:
“royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.
Therefore, as per the aforesaid provisions, consideration for transfer of rights (including granting of a licence) in respect of a trade mark or similar property or for use of a trademark or transfer of rights (including granting of a licence) in respect of any copyright, literary, artistic or scientific work, falls under the definition of ‘Royalty’ under the IT Act. Accordingly, any transaction with the related party for the aforesaid activities shall be regarded as related party transaction for usage of royalty.
Similarly, the term ‘brand usage’ has not been defined under the Listing Regulations. In this regard, reference may be drawn from section 2(zb) of the Trade Marks Act, 1999 which identifies brand as a trade mark or label which is an intellectual property right. Accordingly, any transactions of brand usage by related party shall be regarded as related party transaction.
Impact of GST laws on brand usage transactions
After the introduction of regulation 23(1A) it is very clear the companies will have to structure the brand usage transactions properly and pricing policy of the same shall have be relooked at, however, one must not forget the potential impact GST laws can have on these transactions.
Rule 28 of Central Goods and Services Tax (CGST) Rules, 2017 states that all transactions between related persons must be carried out on arm’s length basis and should be priced at open market value. This applies to all transactions between related parties, needless to say even brand usage transactions will also be covered under this.
Therefore, if going forward the parties decide to execute the transactions without any consideration, in order to escape the provisions of regulation 23(1A), the same shall be subjected to rule 28 which provides for computation of notional value and GST will have to paid on the notional value.
However, rule 28 provides for an exception which states that if an invoice is raised by the supplier with GST on it and the recipient of the supply is eligible to claim input tax credit on the value of services, then the value quoted in the invoice shall be deemed to be the open market value of the goods or services.
Therefore, to ensure that notional value taxation does not apply, the parties must refrain from structuring transactions with nil consideration. However, if the same involves royalty payments of more than 2% of the consolidated turnover, it will have to comply with regulation 23(1A).Therefore, the companies must be mindful of both these provisions while structuring this kind of transactions henceforth.
While the Committee does not intend to stop brand usages in the country, all it wants to establish is a fair and transparent practise of charging royalty payments for the usage of brands. Accordingly, listed companies have to be more careful before charging for brand usages, as the same have come under the radar of materiality and have to be reported. Further, considering the tax implications, the structuring of such kind of transaction shall be important. To summarise, the Listing Regulations have introduced a new dimension to payments made for brand usages and royalties.
-Ruling of Bhavesh Pabari overrules Roofit Industries
By Smriti Wadehra (firstname.lastname@example.org)
A three member Bench of the SC recently overruled its earlier decision in Roofit Industries Ltd vs SEBI, and provided a controlled discretion to the Adjudicating Officer in fixing penalties for offences under the SEBI Act as well Securities Contract Regulation Act (SCRA) as a result of the ruling, the Adjudicating Officer shall not be constrained by the minimum extent of penalty laid in SEBI Act and may, where circumstances so warrant, either waive off the penalty completely or may assign a penalty less than the so called minimum. Thus, the adjudication of penalties may be expected to be more commensurate with the gravity of the offence, than was so far possible primarily due to the position arising out of Roofit ruling. Read more
By CS Megha Saraf
Nidhi as the Hindi word denotes “sampatti” is a type of public company which may be incorporated with an exclusive object of cultivating the habit of thrift and savings amongst its members, deposits from, and lending to, its members only, for their mutual benefit. The same is a type of company which may be incorporated under Section 406 of the Companies Act, 2013, read with the applicable rules, as a public company with a minimum paid-up equity share capital of Rs. 5 lakhs. Although the activities of a Nidhi company is similar to that of a non-banking financial company, as to accepting deposits and granting loans, however, they have been exempted from the purview of the RBI Act, 1934 by virtue of the RBI Master Direction- Exemptions from the provisions of RBI Act, 1934.
Requirements for incorporating a Nidhi company
In order to incorporate a Nidhi company, it shall have:
- atleast 200 members;
- Net Owned Funds of Rs. 10 lakhs or more;
(Note: Net Owned Funds= aggregate of paid up equity share capital + free reserves – accumulated losses and intangible assets appearing in the last audited balance sheet)
- Unencumbered term deposits of atleast 10% of the outstanding deposits;
- Ratio of Net Owned Funds to deposits not more than 1:20;
- Issuance of shares of nominal value of atleast Rs. 10 each;
- To allot a minimum of 10 equity shares or shares equivalent to Rs. 100.
In order to clarify point no. 4, let us take an example; Company X has 20 equity shares of face value of Rs. 10 each. Mr. A, an individual shall be required to subscribe atleast 10 equity shares in order to deposit Rs. 2000 in the Company. Further, as evident, such subscription of equity shares shall not provide any interest to the deposit holder, but, shall form part of the shareholders’ funds of the company.
Requirements w.r.t deposits and loans
As mentioned above, the objective of a Nidhi company is to take deposits and provide loans to its members. The Ministry of Corporate Affairs (“MCA”) being the regulator of Nidhi companies has regulated the norms for taking deposits and providing loans which are as follows:
The Nidhi company shall be allowed to accept deposits with the following timelines:
- Fixed deposits- 6 to 60 months
- Recurring deposits- 12-60 months
- Recurring deposits relating to mortgage loans- Maximum period shall correspond to the repayment period of loans granted.
Interest rate on deposits
- Savings Account- Maximum 2% above the rate allowed by nationalized banks
- Fixed and Recurring deposits- At par with the RBI rate
A Nidhi company can provide loan to its members as per the following ceiling limits:
- Where total amount of deposits from its members is less than Rs. 2 Cr- Rs. 2 lakhs
- Where total amount of deposits from its members is more than Rs. 2 Cr but less than Rs. 20 Cr- Rs. 7.50 lakhs
- Where total amount of deposits from its members is more than 20 Cr but less than Rs. 50 Cr- Rs. 12 lakhs
- Where total amount of deposits from its members is more than Rs. 50 Cr- Rs. 15 lakhs
Interest rates of loans
The interest charged on any loan given by a Nidhi company shall not exceed 7.5% above the highest rate of interest offered on deposits by Nidhi and shall be calculated on reducing balance method.
General restrictions or prohibitions
Similar to a NBFC, there are certain restrictions or prohibitions on Nidhi companies as well.
Some of the major restrictions or prohibitions of a Nidhi company are that it shall not:
- carry on the business of chit fund, hire-purchase finance, leasing finance, insurance or acquisition of securities issued by any body corporate;
- open any current account with its members;
- accept deposits from or lend to any person, other than its members;
- carry on the business other than the business of borrowing or lending in its own name;
- take deposits or lend money to any body corporate;
- issue of advertisements in any form soliciting deposits;
- pay brokerage in order to mobilize deposits from members or for deployment of funds or for granting loans
Compliances to be made by Nidhi companies
Nidhi companies shall be required to do the following compliances:
- Filing of return of statutory compliances in e-Form NDH-1– Within 90 days of the close of first F.Y. and where applicable, the second F.Y.
- Filing of non-compliance with the conditions mentioned w.r.t incorporation of a Nidhi company such as minimum no. of members, Net Owned Funds etc. in e-Form NDH-2– Within 30 days of the close of first F.Y.
- Filing of half-yearly return in e-Form NDH-3– Within 30 days of the conclusion of each half year.
To read our other articles click here