RPTs and related exemptions in the context of Government companies

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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:

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

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

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

IBC threshold raised in Coronatic Disruption: Analysis and Implications

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–Megha Mittal & Shreya Jain

(resolution@vinodkothari.com)

Frivolous initiation of insolvency process, merely for recovery of dues has been a persistent concern- catalyst being the seemingly low threshold of Rs.1,00,000/-.While murmurs about  raising the threshold limit for initiating insolvency process have long been in the picture, the notification comes in the wake of recent outbreak of the novel COVID – 19 – the minimum default requirement now stands increased hundred times; from Rs. 1,00,000/- to Rs. 1,00,00,000.

Applicable from 24.03.2020, the Government, in exercise of its powers under section 4 of the Insolvency and Bankruptcy Code, 2016 (“Code”)[1] has specified Rs. 1,00,00,000 (Rupees One Crore) as the minimum amount of default for the purposes of triggering insolvency. Note that Rs. 1 Crore is the maximum threshold which the Central Government can prescribe under section 4.

The step has been widely touted as a relief for MSMEs in this time of crisis, however, this might have multiple implications. The authors have made a humble attempt to analyse its implications from a broader perspective, and if at such increase would be welcomed in absence of the ongoing crisis.

Read more →

Relaxations by SEBI and MCA under disruption scenario: Some FAQs

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Further relief for corporates announced by the FM – amid Covid-19

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Vinod Kothari & Company

corplaw@vinodkothari.com

 

Companies under IBC-quarantine, get GST-rebirth

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-Vinod Kothari 

[vinod@vinodkothari.com]

Resolution is not a re-birth of an entity – it is simply like nursing a sick entity back to health. It is almost akin to putting the company under a quarantine – immune from onslaught of creditor actions, while the debtor and/or the creditors prepare a revival plan. The objective is that the entity revives – in which case, it is out of the isolation, and is back as a healthy entity once again.

This process is not unknown in insolvency laws world-over. However, in India, revival under insolvency framework has taken a completely unique trajectory. First was section 29A, cutting the company from its promoter-lineage for all time to come. The next was section 32A – redeeming the company from the past burden of civil as well as criminal wrongs, thereby giving it a new avatar, with a new management.

Now, the initiation of a CIRP proceeding will be akin to a new birth to the company, at least for GST purposes. Therefore, irrespective of whether the revival process succeeds or not, at least for GST purposes, the entity becomes clean-slate entity. This is the result of the new GST rule announced on 21st March, 2020. However, the new rules do not seem to have envisaged several eventualities, and we opine the intent of giving an immunity from past liabilities might have better been carried out by appropriate administrative instructions, rather than the new registration process.

Read more →

SEBI relaxes timelines at the time of disruption caused by COVID-19

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Vinod Kothari & Company

corplaw@vinodkothari.com

Below is a short snippet of the relaxed timelines issued by the securities market regulator in the wake of the disruption caused by COVID-19.

Is capital relief allowed for on-balance sheet securitisations?

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Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Non-Banking Financial Companies (NBFCs) have been actively involved in the securitisation market, being one of its major participants at the originating as well as investing front. One of the key motivation of a securitisation transaction is its ability to take the loans off the books of the originator, thereby extending capital relief.

Until the implementation of IFRS or Ind AS in the Indian financial sector, the de-recognition of financial assets from the books of financial institutions was pretty simple; however, with complex conditions for de-recognition under Ind AS 109, almost all securitisation transactions now fail to qualify for de-recognition.

This leads to the key question of whether capital relief will still be available, despite the transactions failing de-recognition test under Ind AS. Through this write-up we intend to explore and address this question.

Situation prior to Ind-AS

Prior to the implementation of Ind-AS, there was no accounting guidance with respect to de-recognition of the financial assets from the books of the financial institutions. However, it was a generally accepted accounting principle that if the transaction fulfilled the true sale condition, then the assets were eligible to go off the books.

The true sale condition came from the RBI Guidelines on Securitisation[1]. The off-balance sheet treatment of the assets led to capital relief for the financial institutions. However, the Guidelines requires knock off, to the extent of credit enhancement provided, from the capital (Tier 1 and Tier 2) of the financial institution.

Post Ind-AS scenario

One of the key highlights of the IFRS 9 or Ind AS 109 is the introduction of the de-recognition criteria for financial instruments. Under Ind AS, a financial asset can be put off the books, only when there is a transfer of substantially all risks and rewards arising out of the assets. This, however, is difficult to prove for the transactions that take place in India because most of the structures practiced in India have high level of first loss credit support from the originators, therefore, evidencing high level of risk retention in the hands of the originator.

As a result, the transactions fail to satisfy the de-recognition test and the financial assets do not go off the books of the financial institutions.

This raises another concern with respect to maintenance of regulatory capital, since the assets are not de-recognized as per accounting standards, although backed by a legal true sale opinion. The apprehension here is whether capital relief would still be available in case the assets are retained on the books as per accounting norms. Capital relief would mean not having to assign any risk weight to or maintain capital for these assets.

RBI guidance on implementation

In the absence of any clarity on the question of capital relief to be availed by NBFCs, the whole idea for securitization was getting frustrated. However, RBI has on March 13, 2020 issued guidance for NBFCs and Asset Reconstruction Companies for implementation of Ind-AS[2].

It has now been clarified by RBI that securitised assets not qualifying for de-recognition under Ind-AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. This implies that the originating NBFC will not be required to maintain any capital against the securitised portfolio of assets. However, the originator shall still be required to make 50% deduction from Tier 1 and 50% from Tier 2 capital.

The relevant extract of RBI notification states as follows-

vii) Securitised assets not qualifying for de-recognition under Ind AS due to credit enhancement given by the originating NBFC on such assets shall be risk weighted at zero percent. However, the NBFC shall reduce 50 per cent of the amount of credit enhancement given from Tier I capital and the balance from Tier II capital.

Accordingly, the fact that a transaction does not qualify for off-balance sheet treatment shall not be relevant for capital adequacy computation. As long as a securitisation transaction satisfies the conditions laid down in the relevant Securitsation Guidelines the fact that whether it has been de-recognised or not for accounting purposes will not make a difference.

Read our related write ups here –

Securitisation accounting under Ind-AS

Securitisation accounting: disconnects between RBI Guidelines and Ind-AS

Accounting for DA under Ind-AS

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=2723

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11818&Mode=0#AN1

CSR funds may be used for COVID-19 relief, clarifies MCA

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Team Vinod Kothari & Company | corplaw@vinodkothari.com

Updated on 29th March, 2020

Like all other public agencies, MCA has been taking a series of steps in the wake of the rapidly spreading COVID-19 and issued clarification[1] on spending of CSR funds for COVID 19 stating that the amount spent on COVID-19 by companies will count towards CSR spending. The activities falling under item nos. (i) & (xii) of Schedule VII of Companies Act, 2013 undertaken due to COVID 19 shall qualify as CSR activity which covers the following:

  • Eradicating hunger, poverty and malnutrition, promoting health care including preventive health care and sanitation including contribution to the Swach Bharat Kosh set-up by the Central Government for the promotion of sanitation and making available safe drinking water.
  • Disaster management, including relief, rehabilitation and reconstruction activities.

Subsequently, the Ministry on 28th March, 2020 has also clarified by way of an office memorandum, that companies contributing towards recently formed Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund (‘PM CARES Fund’) shall also qualify as CSR expenditure under item (viii) of Schedule VII of Companies Act, 2013.

Hence, this is the right occasion, and unarguably, one of the noblest causes, to use CSR funds in whatever way, one may think of for the welfare of society.

Notably, substantial CSR money remains unspent, very often for want of appropriate CSR projects. Many companies have to explain the same by finding some reason or the other. Currently the country is passing through an epidemic that has affected the whole world. Hence, companies may come forward and spend their unspent CSR budgets. Indeed companies are also welcome to over-spend this year’s budget pursuant to a proposal in the Companies Amendment Bill which permits carry forward of excess spending as well.

Questions are often being asked – can the company include the expenditure incurred for COVID-19 preparedness for its own employees and workmen – say, giving of masks, sanitizers, or similar expense, as a part of its CSR spending?

Our answer to this question is the same as what we have continuously answered as a part of our FAQs[2] on CSR that CSR is spending on a social cause. An employer spending for the well being, safety or welfare of employees is performing the employer’s legal or moral obligation. That cannot be regarded as CSR. However, if the company spends on COVID-19 preparedness, either by itself or through implementing agencies, for a wider section of public, and its employees or their families are also the beneficiaries of such an exercise, there is no denial as to eligibility of the same as CSR spending.

Our detailed write ups on CSR may be viewed here:

Proposed changes in CSR Rules

Draft CSR Rules Make CSR More Prescriptive

CAB, 2020: Bunch of Proposals for revamping CSR Framework

[1]http://www.mca.gov.in/Ministry/pdf/Covid_23032020.pdf

[2]https://vinodkothari.com/2019/11/faqs-on-corporate-social-responsibility/

Reckoning banks’ loans to NBFCs for on-lending to priority sectors for PSL targets

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-Financial Services Division (finserv@vinodkothari.com)

 

The Master Direction – Priority Sector Lending – Targets and Classification[1] issued by the Reserve Bank of India (RBI) mandates Scheduled Commercial Banks (SCBs) to lend a specified percentage of their Adjusted Net Bank Credit (ANBC) to the specified ‘needy’ sectors called the Priority Sectors. Further, in order to assist the banks in meeting their Priority Sector Lending targets (PSL Targets) and to extend the reach of credit to these sectors, the RBI has allowed various modes of collaboration between banks and NBFCs. One such mode is lending by banks to NBFCs and HFCs for on-lending to priority sector.

Additionally, through a notification[2] issued in 2019 the RBI provided that the loans extended by the banks to NBFCs on or before March 31, 2020 and which are on-lent to priority sector, shall be eligible to be classified as priority sector lending by the bank. However, notification imposed a cap on the ticket size of the loans originated by NBFCs and they are:

Sector Maximum ticket size of loans
Agriculture ₹ 10 lakh per borrower
Micro & Small enterprises ₹ 20 lakh per borrower
Housing (for on-lending by HFCs) ₹ 20 lakh per borrower

The maximum PSL Target that can be fulfilled by a bank using this mode is 5% of banks’ total PSL. For this purpose, on-lending done by NBFC (except MFIs) and HFCs shall be reckoned.

Considering the credit demand by these sectors classified as ‘priority’ and the outreach of NBFCs, the RBI has issued another notification dated March 23, 2020[3], extending the above mentioned time limit to cover originations during FY 2020-21. Accordingly, the loans originated by banks on or before March 31, 2021 and extended to NBFCs for on-lending to Priority Sectors shall be eligible to be classified under Priority Sector Lending of such bank.

It is noteworthy that since lending to HFCs and NBFC-MFIs by banks for on-lending was already covered under the Master Directions on Priority Sector Lending and there was no time limit provided for such loans under the Master Directions, the provisions of the aforesaid notification relating to the time limit of eligibility shall not be applicable on such bank credit. The time limit applies only for on-lending to agriculture sector and micro & small enterprises.

 

[1] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=10497&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11659&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11828&Mode=0

 

Our related write-ups:

https://vinodkothari.com/2016/02/priority-sector-lending-certificates-permitting-trades-between-haves-and-have-nots

https://vinodkothari.com/wp-content/uploads/2019/09/Modes-of-Collaboration-between-Banks-NBFCs.pdf

GST on Priority Sector Lending Certificates