Control based SBO identification beyond the current legislation

Critical analysis of a recent RoC’s Order u/s 90 of the CA, 2013

– Neha Malu, Deputy Associate | corplaw@vinodkothari.com

Background

The requirement of identification of Significant Beneficial Owners (“SBOs”) for companies in India kicked in with effect from 13th June, 2018[1]. It marks its origination based on the recommendations issued by the Financial Action Task Force (“FATF”). However, since its inception, neither the regulator nor the regulatees have been able to take a sigh of relief when it comes to implementing the directive for identifying an SBO for their company. There were several rounds of amendments[2], followed by extending the requirement to identify such SBO for LLPs[3] and thereafter introducing the concept of ‘designated persons’[4] for sharing the information of beneficial owners. Not only that, but to ensure companies do not miss their identification spree, the RoC has been sending advisory to several companies since the last year being 2023 seeking clarification on why they have not or whether they have identified the company’s SBO.

In the present article, the Author discusses the legal framework governing SBOs in the Indian parlance with a specific focus on the identification of SBOs who have or is said to have control  without any shareholding or voting rights in the light of the Adjudication Order[5] issued by the Registrar of Companies, NCT of Delhi and Haryana (“ROC”), in the matter of LinkedIn Technology (“Order”) and also delves into the discussion under the FATF guidance in this respect.

Legal framework governing SBOs in India

The present definition of SBO as provided under section 90 of the Companies Act, 2013 (“Act”) read with the rule 2(h) of the Companies (Significant Beneficial Owners) Rules, 2018 (“Rules”) sets out two criteria to ascertain the SBO for the reporting company.

  • The first is the ownership threshold test that examines whether the individual holds shares indirectly through majority ownership in the ownership chain of the reporting company, either along with any direct holdings or with persons acting together with.
  • And the second is the control and influence test which assesses whether the individual exercises or has the right to exercise ‘significant influence’ or ‘control’ over the reporting company in any manner other than through direct-holdings alone.

Having said that, the present definition does not mandate the identification of an individual as an SBO if no individual meets any of the aforesaid tests.

Now, here it is important to note that when the provision w.r.t. identification of SBO was introduced in India, the erstwhile definition provided that where no natural person has been identified as an SBO as per the provisions of erstwhile rule 2(I)(e) of the Companies (Significant Beneficial Owners) Rules, 2018, in that case, the SBO shall be the relevant natural person who held the position of a senior managing official.

In this regard, the author intends to discuss the relevance of linking the second test through the concept of “absentee control” or in some form of leadership control and how does the current order of the RoC be seen in the light of the said manner.

Principles laid down in FATF Recommendations

As per Recommendation 24 of the FATF Recommendations[6], “Beneficial ownership information for legal persons is the information referred to in the interpretive note to Recommendation 10, paragraph 5(b)(i). Controlling shareholders as referred to in, paragraph 5(b)(i) of the interpretive note to Recommendation 10 may be based on a threshold, e.g. any persons owning more than a certain percentage of the company (determined based on the jurisdiction’s assessment of risk, with a maximum of 25%).”

Now, para 5(b) of Recommendation 10 provides as follows:

(b) Identify the beneficial owners of the customer and take reasonable measures to verify the identity of such persons, through the following information:

(i) For legal persons

(i.i) The identity of the natural persons (if any – as ownership interests can be so diversified that there are no natural persons (whether acting alone or together) exercising control of the legal person or arrangement through ownership) who ultimately have a controlling ownership interest in a legal person; and

(i.ii) to the extent that there is doubt under (i.i) as to whether the person(s) with the controlling ownership interest are the beneficial owner(s) or where no natural person exerts control through ownership interests, the identity of the natural persons (if any) exercising control of the legal person or arrangement through other means.

(i.iii) Where no natural person is identified under (i.i) or (i.ii) above, financial institutions should identify and take reasonable measures to verify the identity of the relevant natural person who holds the position of senior managing official.

To summarise the above, Recommendation 24 specifies that beneficial owners are those who hold a significant ownership interest, generally over a threshold of 25%. Recommendation 10 outlines a step-by-step process:

  • first, identify natural persons with a controlling ownership interest;
  • if none are found or there is uncertainty, identify individuals who control the entity through other means; and
  • if still no one is identified, identify the senior managing official.

Further, para 45 of the “Guidance on Beneficial Ownership of Legal Person”[7] issued by FATF provides that the application of an ownership threshold is not the only way that beneficial ownership should be determined under the FATF definition, which encompasses both concepts of ownership and control over a legal person.

One of the circumstances mentioned therein provides for control through positions held within a legal person. It suggests that natural persons who exercise substantial control over a legal person and are responsible for strategic decisions that fundamentally affect the business practices or general direction of the legal person may be considered a beneficial owner under some circumstances.

Now, if we discuss from the point of the law notified in the Indian jurisdiction, as discussed above, it provides a twin test for identification of SBOs i.e., the ownership threshold test and the control and influence test. If we look at the “control and influence test”, rule 2(I)(i) defines the term “significant influence” as the power to participate, directly or indirectly, in the financial and operating policy decisions of the reporting company but is not control or joint control of those policies. It is imperative to note that this test is inherently subjective, adaptable to specific circumstances. However, its application should always focus on assessing the genuine impact and active involvement of individuals in the company’s decision-making processes.

Tests applied by ROC for SBO identification in a recent case

For the purpose of identifying the SBO for the Company, the ROC undertook three tests namely, (i) beneficial ownership through a holding subsidiary relationship, (ii) beneficial ownership through the reporting channel test, and (iii) beneficial ownership through the test of financial control. Below we discuss each of the tests in detail:

  • Beneficial ownership through a holding subsidiary relationship:

The group structure of the indian resporting company (downstream entity of the multinational group) (hereinafter referred to as “Company”) is as follows[8]:

It is to be noted that LinkedIn Corporation, USA is not holding any stake in the Company. However, as per the annual filings of the Company, LinkedIn Corporation, USA has been consistently reported as the “holding company” of the Company.

Pursuant to the definition of “holding company” as provided in the Act[9], for the purpose of establishing a holding – subsidiary relationship, it is required to satisfy either of the below two relations:

  1. controls the composition of the Board of Directors; or
  2. exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies.

As reported in the present case, two of the directors of the Company are also holding the post of director in LinkedIn Corporation, USA. Therefore, it is not correct in saying that the directors were controlling themselves. Further, as mentioned above, LinkedIn Corporation, USA is not holding any stake in the Company. Therefore, none of the relations as mentioned above has been met.

  • Beneficial ownership through the reporting channel test:

Two of the directors of the Company are holding the directorship in 367 and 461 companies across the globe respectively. Further, most of the companies in which they are directors in the same multinational group.

On the part of ROC, the following set pattern was observed in the appointments made at group level:

  1. The directors do not take any remuneration from the subject company;
  2. Upon taking an exit from the parent company, they also resign from the subject company;
  3. The individuals are also associated with other group entities across several countries.

Based on observing the above mentioned pattern, ROC contended that the above referred directors are nominees on the board of the Company whose reporting channel would end up to the CEOs of the upstream group entities.

Now, as per the Adjudication Order, the website of one of the upstream group entities of the Company regards one of the aforesaid person who holds the position of CEO in the said upstream entity as its leader. It is also reported on its website that the first gentleman reports to the second one who obviously is a part of the senior leadership team of the ultimate parent company. Now, going by the fact that these two individuals belong to the senior management of the upstream group entity  (not in the reporting entity)have been held as SBO for the Company.

Having said that, while the RoC concluded on the reporting lines, the same looks to go beyond the premises of FATF which provides for one of the criteria to establish control through positions held within a legal person. In this case, the RoC has identified senior professionals holding leadership positions in the upstream entities and found them to have exercised control over the entities falling several levels below them.

  • Beneficial ownership through the test of financial control:

In this case, the Treasury maintains control over thousands of bank accounts across different entities. And the employees of the ultimate parent company who have been made signatories to the accounts take their own reasoned decisions and are not answerable to the Board of the Company.

Therefore, applying the test of financial control, ROC concluded that because the employees of the ultimate parent company, who manage the Company’s financial transactions, are supervised by its CEO, it gives him the “right to exercise control” over the Company. And hence, consequently, the said CEO is considered the SBO for the Company.

Conclusion

At this juncture, after having discussed the stance taken by ROC, it is extremely important to note while in the present case, the professional members of the senior leadership team have been identified as SBO by the ROC in its Adjudication Order. However, the provision requiring the reporting of senior managing officials as SBOs has been omitted from the current definition of SBO vide 2019 amendment. Therefore, the extent to which the current test’s conclusions are aligned with the framework of the provisions,  remains a significant and open question. Again, it is imperative to mention that group level hierarchy will always be designed in a manner to report to an assigned senior. further, such senior will have certain additional powers to manage and oversee the functions of the reportee, however, in such a scenario, considering the cross reporting to the senior management of the upstream entity as one of the test for identification of an SBO for the downstream entity raises anomaly on the omission of  the provision for considering the senior management of the reporting entity as an SBO. Further, while the goal of enhancing transparency is commendable, it is crucial to balance this with the practical aspects of compliance.

The ROC’s application of tests such as beneficial ownership through holding subsidiary relationships, reporting channel tests, and financial control reflects a thorough approach to identifying SBOs. However, the decision to identify global group counterparts as SBOs, based on their roles in the senior leadership of the upstream group entities, suggests an interpretation that may extend beyond the intended scope of the law. This may lead to disputes and legal challenges, further complicating compliance efforts for companies.


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

[2] our resource centre on SBOs can be accessed at: https://vinodkothari.com/article-corner-on-sbos/

[3] Read our article titled “SBOs behind LLPs all set to be surfaced” at https://vinodkothari.com/2023/11/sbos-behind-llps-all-set-to-be-surfaced/

[4] Read our article titled “Designated to reveal beneficiary identity: all companies mandated to name one” at: https://vinodkothari.com/2023/10/companies-to-disclose-designated-person-with-respect-to-beneficial-interest-in-shares/

[5] https://www.mca.gov.in/bin/dms/getdocument?mds=san%252BPg76sI9tkgd5lcHzZg%253D%253D&type=open

[6] https://www.fatf-gafi.org/content/dam/fatf-gafi/recommendations/FATF%20Recommendations%202012.pdf.coredownload.inline.pdf

[7] https://www.fatf-gafi.org/content/dam/fatf-gafi/guidance/Guidance-Beneficial-Ownership-Legal-Persons.pdf.coredownload.pdf

[8] Source: ROC Adjudication Order

[9] Section 2(46) of the Act read with the definition of “subsidiary” provided under section 2(87) of the Act

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