Rentals on finance leases: To deduct it all or just the interest slice? 

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Tax accounting standard ICDS IX raises an unanswered question

– Chirag Agarwal | Assistant Manager (finserv@vinodkothari.com)

While leasing in India has developed much lesser as compared to other countries12, there is an interesting and growing line of business in India – CTC leasing, that is, lease of assets offered to employees of large companies with the rentals forming part of the employee’s CTC. The key to the tax neutrality of a CTC lease to the employer is the full deductibility of the lease rentals, as the rentals replace what would otherwise have been the employment benefit expense. But if the lease is intrinsically a financial lease, is it that the employer will still be able to expense the rentals, particularly after tax accounting standard ICDS IX, providing that the interest component of a financial lease will be treated as a cost of borrowing? CTC leasing practices in the past may have depended on some tax rulings, which pertain to the period before the applicability of the ICDS  – hence, the question is still an open one.

CTC leasing of passenger cars alone is nearly Rs 6000 crores annual volume business in India, constituting roughly 1% of passenger vehicles sold in the country.

In this article, we explore:

  • What is a financial lease? Is there a concept of financial lease, from the lessee perspective, now that accounting standards have eliminated the distinction from the lessee perspective?
  • Why is a financial lease equivalent to a borrowing transaction?
  • Why is the tax neutrality of a CTC lease to an employer important? 
  • Past rulings that may or may not hold the answer?
  • So, is ICDS IX decisive?
  • So, if ICDS IX does not apply, does ICDS I (substance over form) apply?

What is a Financial Lease and its accounting from the perspective of a lessee?

Finance Lease is an alternative to taking a loan. In this type of lease, all major risks and benefits of owning the asset are passed from the lessor to the lessee. The lessor only provides finance and keeps the legal ownership. At the end of the lease, the ownership of the equipment usually gets transferred to the lessee.

In Asea Brown Boveri vs IFCI, the Supreme Court quoted the following para from Vinod Kothari’s book Lease Financing and Hire Purchase, with approval specifying the features of a financial lease: 

“1. The asset is use-specific and is selected for the lessee specifically. Usually, the lessee is allowed to select it himself.

2. The risks and rewards incident to ownership are passed on to the lessee. The lessor only remains the legal owner of the asset.

3. Therefore, the lessee bears the risk of obsolescence.

4. The lessor is interested in his rentals and not in the asset. He must get his principal back along with interest. Therefore, the lease is non- cancellable by either party.

5. The lease period usually coincides with the economic life of the asset and may be broken into primary and secondary period.

6. The lessor enters into the transaction only as a financier. He does not bear the costs of repairs, maintenance or operation.

7. The lessor is typically a financial institution and cannot render specialized service in connection with the asset.

8. The lease is usually full-pay-out, that is, the single lease repays the cost of the asset together with the interest.”

As per AS 19, in a financial lease, the rent paid is divided into two parts, i.e., finance charges and capital recovery. 

With Ind AS 116, this changed. Under Ind AS 116, the lessee will need to show all leases as a “right of use asset” (ROU Asset) along with a liability to pay rent over time.

In this case, only the lessor needs to classify leases as financial or operating. For the lessee, there is no such difference and the asset will simply be recorded as a ROU asset. This position is supported by Para 61 of Ind AS 116 which states “A lessor shall classify each of its leases as either an operating lease or a finance lease.”. Further, Paras 22 to 60A, which deal specifically with lessee accounting, do not mention any requirement for classifying leases into finance or operating categories.

Why is a financial lease equivalent to a borrowing transaction?

A financial lease is considered similar to a borrowing transaction because, in substance, it functions like a loan. The lessor recovers the full cost of the asset along with a financing return through lease rentals, while the lessee gains the right to use the asset and repays the cost over time. The lessor’s primary risk relates to the lessee’s repayment capacity rather than the asset’s residual value, making it economically similar to a borrowing arrangement rather than a traditional lease.

Why is the tax neutrality of a CTC lease to an employer important? 

The entire CTC leasing model is based on the taxation benefit, where the employer claims the entire lease rental as a deduction while computing income under “Profits and Gains from Business or Profession.” This also benefits the employee since the taxable value under perquisites is comparatively lower than if the same amount were paid as direct salary. 

However, if we were to say that the employer, as the lessee, cannot claim full deduction for the lease rental, the employer would likely prefer paying the equivalent amount directly as salary. This is because salary expenses are fully deductible, making direct salary payments more tax-efficient in such a scenario for the employer.

There is yet another way the neutrality to the employer is impacted: the employer books an ROU assset and a related OTP liability; however, that may still be okay considering the employees’ interest. However, losing a tax benefit may be an added cost.

So, is ICDS IX decisive?

ICDS IX deals with borrowing costs, which defines the same as, 

are interest and other costs incurred by a person in connection with the borrowing of funds and include:

(iv) finance charges in respect of assets acquired under finance leases or under other similar arrangements.

Hence, as per ICDS IX, the interest component of a financial lease will be treated as a cost of borrowing, and the deduction can be claimed only for the interest portion which is relevant only for the lessee.

However, as discussed above, under Ind AS 116, there is no difference between FL/OL for the lessee.  Accordingly, ICDS IX should not apply here. 

So, if ICDS IX does not apply, does ICDS I (substance over form) apply?

It may be noted that the ICAI Technical Guide on ICDS warrants that substance should prevail over the form (ICDS I). 

Hence, if we say that ICDS IX does not apply whether ICDS I should also not apply in case of financial lease? In our view, the substance of the lease would definitely matter. Even if the accounting distinction does not matter, if the transaction of lease is so structured so as to be equivalent to a loan, the deductibility of entire lease rentals would not be allowed. 

Hence, to get the benefit of deductibility, the lease shall be a true lease. The following may be considered as essential features of a true lease:

Past rulings that may or may not hold the answer?

The Supreme Court in its decision in the case of ICDS Limited Vs CIT (350 ITR 527) held that in a leasing transaction, the lessor would be entitled to claim depreciation under section 32 of the IT Act on the leased assets. On the other hand, the lessee would be entitled to claim the entire lease rentals as a deduction while computing its total income.

Similarly, in the case of Wipro Ge Healthcare Private Limited vs Assistant Commissioner Of Income Tax, 2023, it was held that the assessee is entitled to claim a deduction on account of lease rentals paid as it is a revenue expenditure on the ground that the assessee is only a lessee and the lessor is the owner of the assets leased.

A similar judgment was passed in the case of Tesco Bangalore Private Limited vs Deputy Commissioner Of Income Tax, on 23 May, 2022.

However, the case laws relate to the assessment year before the introduction of ICDS IX and hence the same cannot be relied upon now.

Thus, tax treatment of leases for lessees is still a grey area. While Ind AS 116 has made accounting simple by removing the difference between operating and finance leases, the taxability of leases still remains a question because of ICDS IX. 

Therefore, there is a need for a clear guideline by the IT dept that finally settles this question. 

Footnotes:

  1. We have discussed the evolution of leasing in India in this publication: https://www.ifc.org/content/dam/ifc/doc/mgrt/evolution-of-leasing-in-india-aug-30-2019.pdf ↩︎
  2. See India chapter in WLY 2023 volume: https://www.world-leasing-yearbook.com/wp-content/uploads/2023/12/India_WLY.pdf ↩︎

Understanding “Undertaking” in the Context of Investment Demergers

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– Barsha Dikshit and Sourish Kundu | corplaw@vinodkothari.com

The meaning of “undertaking” has been one of the most debated issues under Indian company law and tax law, particularly when it comes to shares/investments to be treated as an “undertaking”. While the term intuitively refers to a business or division carried on as a going concern, its application becomes complex when the company’s business primarily consists of holding investments in shares of other entities. This complexity raises important questions about whether such passive investment portfolios can be considered independent undertakings capable of being demerged under Section 2(19AA) of the Income-tax Act, 1961 (now section 2(35) of the Income-tax Act, 2025). 

This article examines  the statutory framework, relevant judicial precedents, and the practical implications of treating investment division as “undertaking” for companies with diverse investment portfolios.

Meaning of ‘Undertaking’

Section 180(1)(a) of the Companies Act, 2013 restricts the Board of a company from selling, leasing, or otherwise disposing of the whole or substantially the whole of an undertaking without shareholders’ approval by way of special resolution. While the provision does not offer a definitional explanation of what constitutes an “undertaking,” it does lay down quantitative thresholds: 

  • An undertaking is one where investment exceeds 20% of net worth or contributes 20% of total income in the preceding financial year.
  • Disposal of “substantially the whole” of such undertaking means disposal of 20% or more of its value.

This numerical test, merely sets quantitative thresholds to determine when shareholders’ approval is required for the disposal of such an asset. 

To understand what constitutes an “undertaking” and, in particular, whether a passive investment division, essentially a portfolio of shares, can independently qualify as an undertaking, reference can be drawn to the definition of “undertaking” provided under the Income-tax Act, 1961 as well as relevant judicial precedents. 

Under the Income-tax Act, 1961, Section 2(19AA) defines the term “demerger”, which requires the transfer of one or more undertakings from the demerged company to the resulting company, such that at least one undertaking remains with the demerged company. The meaning of “undertaking” for this purpose is explained in the Explanation to Section 2(19AA) (now renumbered as Section 2(35) under the Income-tax Act, 2025), as–

“Explanation-1: For the purposes of this clause, “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.”

This definition emphasizes the need for functional and operational coherence in what is considered an undertaking, ruling out passive asset transfers that lack an identifiable business character. 

The meaning of the term ‘undertaking’ has also been clarified in several judicial precedents. For instance, in the landmark decision of Rustom Cavasjee Cooper v. Union of India [[1970] AIR 564], Hon’ble Supreme Court explained that “‘undertaking’ clearly means a going concern with all its rights, liabilities and assets as distinct from the various rights and assets which compose it… is an amalgam of all ingredients of property and are not capable of being dismembered. That would destroy the essence and innate character of the undertaking. In reality the undertaking is a complete and complex weft and the various types of business and assets are threads which cannot be taken apart from the weft.” 

The Court thus highlighted the holistic nature of an undertaking that it is not a disjointed collection of parts, but a complete and functional enterprise. [See also, P.S. Offshore Inter Land Services Pvt. Ltd. v. Bombay Offshore Suppliers and Services Ltd. [[1992] 75 Comp Cas 583 (Bom)].

This brings us to a significant  question: Can a portfolio of shares, held in a company’s books, be regarded as a separate segment or ‘undertaking’? 

This question assumes particular relevance in the context of schemes of arrangement, particularly those involving demergers, where a portfolio of investments is proposed to be transferred to a resulting company. In such schemes, the tax neutrality of the transaction often hinges on whether the transferred segment qualifies as an “undertaking” under the applicable tax laws.

For a unit to be regarded as an undertaking, and for the demerger to be treated as tax-neutral, both the demerged and remaining undertaking must possess the characteristics of a going concern, i.e., each must be capable of independent and sustainable commercial operations with the objective of earning profits. [See: Yallamma Cotton, Woollen and Silk Mills Co. Ltd., In re [[1970] 40 Comp Cas 466]]

This criteria becomes particularly nuanced when the subject of demerger is a mere pool of passive investments, rather than an operational business unit. The key consideration is whether such a portfolio, in itself, demonstrates the organisational integrity, continuity of activity, and profit-making intent sufficient to satisfy the definition of an “undertaking”.

One of the most notable rulings on this issue is the decision of the Income Tax Appellate Tribunal (ITAT) in the case of Grasim Investments Ltd. v. ACIT, wherein the Tribunal was called upon to examine whether a division engaged primarily in holding and managing investments in shares could be treated as an undertaking for the purposes of a tax-neutral demerger under Section 2(19AA) of the Income-tax Act, 1961.

The ITAT held that a mere pool of passive investments does not, by itself, constitute an undertaking. To qualify as an undertaking, the investment division must be more than a collection of financial assets; it must constitute a distinct business activity carried on with a certain degree of autonomy. The Tribunal emphasized factors such as, presence of separate books of account, an identifiable organizational structure, and the existence of management and decision-making functions related specifically to the investment activity and the capability of generating independent business income, to consider a division as an ‘undertaking.

In one of the recent rulings in the matter of Reckitt Benckiser Healthcare India Private Limited v DCIT, 2025 171, dated 18th February, 2025, Ahmedabad ITAT reiterated the principles governing tax neutral merger. 

In this case, the assessee transferred only a portfolio of investments (constituting the so-called “Treasury Segment”) to the resulting company, while retaining the associated liabilities. The assessee attempted to justify this by arguing that the liabilities pertained to other business divisions and not to the Treasury Segment. However, the Tribunal rejected this explanation, holding that such selective transfer is contrary to the statutory mandate. The Tribunal emphasized that for a transaction to qualify as a tax-neutral demerger, it must strictly comply with the conditions prescribed under Section 2(19AA) of the Act. One of the key requirements of which is that all the assets and liabilities pertaining to the transferred undertaking must be transferred to the resulting company.

Treating block of investments as separate undertakings

The real difficulty lies in the case of investment companies, or companies holding multiple blocks of shares in different entities. Can each such block of investments be regarded as a separate undertaking for purposes of demerger?

Here it becomes important to differentiate between active investments and passive investments. For instance, holdings in group companies, such as subsidiaries or associates, may be classified as active investments, given the element of strategic control or influence. On the other hand, investments in mutual funds, debt instruments, or derivatives are typically treated as passive investments, lacking operational involvement.

While judicial decisions have considered active investments as a separate undertaking, investment in mutual funds, securities, or similar financial instruments, when held passively, are typically regarded as individual assets forming part of a company’s investment portfolio , majorly on the ground that they do not, by themselves, represent a business or functional unit capable of independent operation. 

In CIT v. UTV Software Communication Ltd. the Bombay High Court drew a sharp distinction between transfer of shares and transfer of an undertaking. The Court held that a mere transfer of shareholding, even to the extent of 49%, does not amount to a transfer of an “undertaking” under Section 2(42C) of the Income-tax Act, 1961 (now Section 2(103) of the 2025 Act). Relying on the Supreme Court’s rulings in Vodafone International Holdings and Bacha F. Guzdar, it concluded that passive shareholding does not confer ownership of the underlying business and cannot constitute an undertaking for tax or restructuring purposes.

However, the author humbly differs from the view expressed by the Bombay High Court. In the author’s opinion, such matters must be examined in light of the prevailing corporate structures wherein large business groups operate distinct business verticals through separate legal entities, including subsidiaries, joint ventures, and associates. In such cases, transfer of shares in a subsidiary or associate company may, in substance, result in divestment of an entire business segment.

Moreover, as discussed above, section 180(1)(a) of the Companies Act, 2013 provides a quantitative definition of ‘undertaking’ and mandates shareholders’ approval by special resolution for the sale, lease, or disposal of a company’s undertaking. In this context, treating the transfer of shareholding, as a mere transfer of shares and not an undertaking, may arguably be a  narrow interpretation, particularly when the transaction has the effect of transferring operational control and revenue-generating capabilities.

The author’s view also finds support in jurisprudence such as the Grasim Industries Ltd. ruling (Supra), where a financial services division, primarily holding investments in shares and securities, was accepted as a valid “undertaking” for the purposes of demerger under Section 2(19AA) of the Act. 

Conclusion

The concept of “undertaking” in Indian law is broader than a mere division of physical assets; it captures the idea of a self-sustaining business activity. In the context of investments, while passive shareholding may not qualify, an organised investment division with identifiable assets, liabilities, and management can constitute an undertaking capable of demerger. Thus, companies holding multiple investment portfolios may, subject to careful structuring, demerge them into resulting companies under sections 230-232 of the Companies Act and section 2(19AA) of the Income-tax Act.

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Decoding “Control” in Pooled Investment Funds: Manager, Investors, or no one?

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– Sikha Bansal, Senior Partner and Payal Agarwal, Partner  | corplaw@vinodkothari.com 

Corporate relationships and hierarchies are prone to misuse and hence, there are regulatory prescriptions to ascertain and address the areas of conflict. This is usually done through identification of control and/or significant influence, if any, existing between the parties. If there is an element of control /significant influence, the parties may be required to follow a host of protocols – including but not limited to being identified as a promoter, to put in place related party controls, to disclose their  transactions and even go for consolidation of accounts, etc.

While in simple structures, it is still possible to objectively conclude the existence of control/significant influence (or the absence of it); in certain complex structures, particularly where unincorporated entities are involved, the determination can be quite subjective and dependent on multiple factors. For instance, in the case of pooled investment schemes (called “funds” henceforth) like mutual funds, AIFs, ReITs, InVITs, etc., the entity would often be formed as a trust which would hold the common hotchpot of funds contributed by investors. Besides investors, there would be multiple parties involved, viz., the fund sponsor, fund manager, and the trustee. Mostly, the fund may not be a legal entity[1]; however, it is segregated from the funds of either the manager or trustees. If there is any element of control or even significant influence on the funds, by any of these investors/parties, it would necessitate treatment of such funds in accordance with regulatory protocols as discussed above. Further, at the next level, if there is any element of control by such funds on other entities, then there would be concerns around indirect control of investors/parties on such other entities as well, percolating through the fund. Therefore, whether the fund is being controlled or significantly influenced by any person, becomes a pertinent question. 

In this article, we attempt to analyze the same and try to frame some guiding principles for ascertaining circumstances in which a fund would be said to be controlled or significantly influenced. 

Meaning of control

Depending on the specific nature and characteristics, pooled investment funds in India are governed by distinct SEBI regulations, such as, SEBI (Alternative Investment Funds) Regulations 2012, SEBI (Infrastructure Investment Trusts) Regulations 2014, SEBI (Mutual Funds) Regulations 1996, etc. These regulations define the terms “control” or “change in control” in the context of either the sponsor or the manager or both, but not in the context of the fund. Hence, one will have to look towards accounting standards – namely IFRS 10 which sets out guidelines for the assessment of control in the hands of a fund manager. In India, Ind AS 110 replicates the guidance provided under IFRS 10. Detailed discussion on the principles discussed under IndAS 110 is as below.

Components of control

Ind AS 110 refers to three cumulative components of control, viz.,

  1. Power over the investee,
  2. Exposure or rights to variable returns from its involvement with the investee, and 
  3. The ability to use its power over the investee to affect the amount of the investor’s returns.

As evident, the Standard assumes a relationship of investor and investee. In case of funds, while there would be investors; however, the asset manager too, may be required to hold a certain percentage in the fund as skin-in-the-game, pursuant to applicable regulations. Therefore, in the case of funds, the asset manager is also in the position of an investor, besides being in the position of a manager.

Here, it is significant to note that the “existence of power” or “exposure to returns” individually does not indicate an existence of control, unless there is a link between power and returns, that is, the power can be used to direct the relevant activities, which would affect the returns of the investee.

Component of controlTest for existence
Existence of power over the fund Ability to direct the relevant activities, i.e., activities that significantly affect the investee’s returns.
Exposure to or rights over variable returnsPotential to vary investor’s returns through its involvement as a result of investee’s performance
Link between power and returns

Ability to use its powers (of directing relevant activities) to affect the investor’s returns from its involvement with the investee, i.e., the investor shall hold decision-making rights as a principal.  

Also, note that what matters is “ability”, whether there is actual use of such power or not, becomes irrelevant.

As power arises from rights, the investor must have existing rights that give the investor the current ability to direct the relevant activities [para B14]. Such rights have been briefly discussed in the later part of this write-up.

Power to direct relevant activities of the Fund

In the context of a fund, the relevant activity would be the management of the asset portfolio of the fund. The said function is primarily performed by the fund manager, albeit, the same may be in the capacity of an agent to the unitholders. Hence, Para 18 of Ind AS 110 requires a decision-maker to determine whether it is a principal or an agent for the fund, since a delegated power cannot signify control.

Fund manager – a principal or an agent

IndAS requires that an investor with decision-making rights (called as “decision maker”), when assessing whether it controls the investee, shall determine whether it is a principal or an agent. An investor shall also determine whether another entity with decision-making rights is acting as an agent for the investor [para B58]. The investor shall treat the decision-making rights delegated to its agent as held by the investor directly [para B59].

Thus, in cases where the fund manager is acting as a mere agent of the investor (that is, the fund manager is under the control of the investor), the decision-making rights of the fund manager are treated as that of the investor itself, and control is assessed accordingly. Therefore, to say that an investor has control over the fund, it is important to establish that the investor has control over the fund manager, who in turn, is acting as an agent of the investor. Here, whether the fund manager itself is able to control the fund or not also becomes a pertinent point for determination.

Para B60 of Ind AS 110 specifies the factors that need to be considered in order to determine whether the fund manager in its capacity of a decision maker, is merely an agent to the principal (other investors) or exercises its decision-making rights in the capacity of a principal to the fund.

The primary factor, holding the highest weightage, in making such determination – is the kick-out rights available with other investors. However, where the same does not conclude fund manager as an agent, various other factors require consideration.

Determination of fund manager as a principal v/s agent

Determining ‘control’ of the investor

Various tests are relevant for determining the control of the investor over the Fund. A summary view of the same is given below:

The table below shows a detailed analysis of each relevant test for assessing the existence of control:

Sl. No.Test of controlAssessment Remarks
Power to direct relevant activities
1. Nature of rights The nature of rights shall be substantive, i.e., providing an ability to direct relevant activities and not merely protective. Protective rights apply only to protect an investor from fundamental changes in the funds’ activities or in exceptional circumstances and do not imply power over the fund.
2. Majority voting rights

An investor holding more than 50% of voting rights in the fund would generally be considered to have power over the fund, unless such voting rights do not signify substantive decision-making rights.   

Mention is also made of the SEBI Circular dated 8th October, 2024 that requires conducting due diligence for every scheme of AIFs where an investor, or investors belonging to the same group, contribute(s) 50% or more to the corpus of the scheme.

3. Ability to influence other investors into collective decision-makingWhere a right is required to be exercised by more than one party, whether the investor has the practical ability to influence other rights holders into collective decision-making is relevant in assessment of control of the said investor over the fund.
4. Contractual arrangements with other investorsVoting rights as well as other decision-making rights may arise out of contractual arrangements giving an investor sufficient rights to have power over the fund.
5. Size of an investor’s holding relative to size of holding of other parties
  • Significantly high voting rights held by one investor, and
  • Small fragmented holdings by other parties, and
  • Large number of parties required to outvote one investor 

An investor holding substantially higher stake, where other investors are holding fragmented holdings, such that a large number of parties are required to outvote the investor, will give the first investor power over the other investors, even in the absence of majority voting rights.

6. Exercise of voting rights by other investors
  • Absolute size of one investor’s holding is higher than the relative holdings of other investors, and
  • Other investors are passive and do not actively participate in decision-making

Where the stake held by an investor is relatively higher from other investors but not significantly higher to indicate existence of power, however, the other investors do not actively participate in the meetings – the same indicates the unilateral ability of the first investor to direct the relevant activities.

Exposure to, or right over variable returns
7. Dividend and distributable profits proportionate to holdingsThis is directly proportional to the holding of an investor in a fund. Where the holdings of an investor does not comprise a sizable portion of the fund, the same does not indicate a significant exposure to variable returns earned by the fund.
8. Remuneration for servicing the assets and liabilities of the fund

In the context of a fund, the fund manager provides services w.r.t. the management of its assets and liabilities. The remuneration may contain a fixed as well as a variable component, generally, a percentage based fees based on performance of the fund.   However, the same does not indicate an existence of control, if the following elements are present:

  • Remuneration is commensurate with services provided, and
  • Terms and conditions are on arm’s length as per customary arrangements for similar services
9. Returns in other formsIn addition, there might be returns available in other forms providing a right over variable returns of the Fund.

Analysis of examples contained in Ind AS 110

Below, we discuss the examples explained under Ind AS 110 in the context of funds: 

IllustrationFactsAnalysis
13
  • Defined parameters for investment decisions within which fund manager has discretion to invest
  • Fund manager’s stake in Fund – 10%
  • Market based fee for services – 1% of NAV of Fund
  • Assumption that fees are commensurate to services provided
  • No obligation to fund losses
  • No independent board in the fund
  • No substantive rights held by other investors
  • Current ability to direct relevant activities rest with fund manager since no other investor has substantive rights to affect the fund manager’s decision-making authority
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal  

Fund manager is an agent, so question of holding control does not arise

14
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal  

Fund manager is an agent, so question of holding control does not arise

14A
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 2%
  • No obligation to fund losses
  • Removal of fund manager – through simple majority vote of investors, but only for breach of contract
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal
  • Removal rights with other investors are in the nature of protective rights, hence, not substantive  

Fund manager is an agent, so question of holding control does not arise

14B
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 20%
  • No obligation to fund losses
  • Removal of fund manager – through simple majority vote of investors, but only for breach of contract
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
  • Removal rights with other investors are in the nature of protective rights, hence, not substantive  

Decision-making rights are exercised by the fund manager in the capacity of principal. Variability of returns appears significant to conclude an existence of control. 

14C
  • Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 20%
  • No obligation to fund losses Independent board in fund
  • Appointment of fund manager – annually through the independent board 
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
  • Removal rights with other investors are substantive, since fund manager’s appointment is subject to annual approval of independent board, and can be terminated without cause  

While variability of returns appears significant to indicate control with the fund manager, more weightage is given on substantive removal rights held by other investors. Hence, the fund manager is considered as an agent, and does not control the fund. 

15
  • Investments in fund through both debt and equity instruments
  • First loss protection to debt investors
  • Residual returns to equity investors
  • Assets funded through equity instrument – 10% of the value of the assets purchased
  • Fund manager decision-making within parameters set out in prospectus
  • Market based fee for services – 1% of NAV of Fund
  • Profit sharing upon achieving a specified level of profit – 10% of the Fund’s profits
  • Assumption that fees are commensurate to services provided
  • Fund manager’s stake in Fund – 35% of equity
  • Other investors for remaining equity and debt – large no. of widely dispersed unrelated investors
  • Removal of fund manager – without cause, by simple majority
  • Current ability to direct relevant activities rest with fund manager
  • Variability of returns pursuant to fees and investment, as well as significant exposure to losses on account of equity investments being subordinate to debt investments are substantial for the fund manager to consider personal economic interests in making decisions for the Fund.
  • Removal rights with other investors are without cause, still, not considered substantive, on account of the large number of investors required to exercise such rights.  

Considering the significant level of exposure to variability of returns, the fund manager is considered principal and controls the fund.

16
  • Sponsor establishes a multi-seller conduit
    • Establishes terms of conduit Manages conduit for market based fees (commensurate with services provided)
    • Approves the sellers/ transferors and the assets to be purchased and makes decisions (in best interest of investors)
    • Entitled to residual return
    • Provides credit enhancement (upto 5% of all conduit’s assets, after risk absorption by transferors)
    • Liquidity facilities provided (except against defaulted assets)
  • Transferors sell high quality medium term assets to the conduit
    • Manages receivables on market based service fees
    • Provides first loss protection through over-collateralisation
  • Conduit
    • Issues short term debt instruments to unrelated investors by a conduit
    • Marketed as highly rated medium term asset with minimum exposure to credit risk
  • Investors
    • Do not hold substantive decision-making rights
  • Current ability to direct relevant activities of the conduit
  • Exposure to variability of returns through right to residual returns of the conduit and provision of credit enhancement and liquidity facilities 

Considering the significant level of exposure to variability of returns, the sponsor is considered principal and controls the fund. The obligation to act in the best interests of the investors is not significant.

The “trust” angle

Funds are usually constituted in the form of a trust, where there is an independent trustee. Further, the investment manager is under an obligation to act in a fiduciary capacity towards the investors of AIF, in the best interest of all investors and manage all potential conflicts of interest [Reg 20(1) of AIF Regulations r/w the Fourth Schedule]. In such a scenario, can it be argued that there can be no element of control over a fund, irrespective of who the contributor is?

In SREI Infrastructure Finance Limited vs Shri Ashish Chhawchharia, the NCLAT, in view of the specific facts and circumstances of the case, held the existence of control of the contributor of the AIF over the investee company of the AIF through the AIF. The matter pertained to identification of the appellant as a related party of the corporate debtor in the context of IBC. The surrounding facts and circumstances are briefly put forth as under:

Therefore, in a given set of facts and circumstances, it might be possible to contend that the fund is being controlled by an investor/group of investors.

Conclusion

In questions involving conflict of interest, control, and relationships, Courts have often adopted purposive interpretation in such cases rather than literal interpretation. As held in Phoenix Arc Private Limited v. Spade Financial Services Limited, AIRONLINE 2021 SC 36, albeit in the context of section 21(2) of IBC would still be relevant. Referring to an authoritative commentary by Justice G.P. Singh which states that the terms may not be interpreted in their literal context, if the same leads to absurdity of law, the Supreme Court held: “The true test for determining whether the exclusion in the first proviso to Section 21(2) applies must be formulated in a manner which would advance the object and purpose of the statute and not lead to its provisions being defeated by disingenuous strategies.” Therefore, whether the fund is being controlled by any person/entity is to be seen in the light of all facts and circumstances, and there can be no straight-jacket formula to arrive at a conclusion.

Other resources on AIFs: 

[1] For example, it may be a trust. However, it is possible to envisage funds held in LLP or company format, in which case the fund becomes a separate entity. This article does not envisage a fund formed as a body corporate.

Budget, Bazaars and Bank Rate: Understanding inflation, GDP, Repo Rate etc.

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Access the Youtube video at https://www.youtube.com/watch?v=EXH6Nt1fXdg

Bugdet, Bazaars and Bank Rates – Simrat SinghDownload

See our other resources on this topic:

  1. https://vinodkothari.com/2025/02/union-budget-2025/
  2. https://vinodkothari.com/2022/08/hike-in-repo-rate-how-to-modify-loan-instalments/
  3. https://vinodkothari.com/2023/08/rbi-streamlines-floating-rate-reset-for-emi-based-personal-loans/

Virtual Session on Supply Chain Financing

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Register here: https://forms.gle/HHn6SqmfgHmgCJw2A
Workshop on Supply chain financing .pptx (1)Download

See our resources on the same:

  1. Unlocking Working Capital: An Overview of Supply Chain Finance
  2. Omnibus use vs know-its-use: Is Supply Chain Financing a revolving line of credit?
  3. From Trade Payables to Financial Liabilities: Ind AS Disclosure Reforms for Supply Chain Finance arrangements


Online money gaming: Financial Institutions to stay away

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– Saloni Khant | finserv@vinodkothari.com

The Promotion and Regulation of Online Gaming Bill, 2025, passed by the Parliament, received the assent of the President on Friday, 22nd August, 2025. The law will come into force on its publication in the Official Gazette. As soon as it becomes effective, the immediate implication of the Bill will be to prohibit online money gaming services.

Online money game is defined as “an online game, irrespective of whether such game is based on skill, chance, or both, played by a user by paying fees, depositing money or other stakes in expectation of winning which entails monetary and other enrichment in return of money or other stakes”. In other words, an online game, irrespective of whether it involves skill or chance or combination, where money (or other stake) is paid to play, with the expectation of winning (which may either be money or other enrichment), will be barred. 

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From Trade Payables to Financial Liabilities: Ind AS Disclosure Reforms for Supply Chain Finance arrangements

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Dayita Kanodia | finserv@vinodkothari.com

The amendments in Ind AS 7 emanate from similar amendments in IAS 7 by the IASB, made in May 2023, which itself is the culmination of a project that was initiated in 2020.

The amendments related to Supply Chain Financing (SCF) or reverse factoring arrangements. Globally, the SCF volumes increased by 8% to USD 2,462bn by the end of 2024.

Read our article explaining the Supply Chain Finance here.

The key features of a supply chain finance arrangement to require specific disclosure under the revised Standard are:

  • The trade payables of the entity are paid by a financial institution; the entity then pays to the financial institution.
  • The entity either gets extended payment terms, or the suppliers get earlier payment terms, than the terms as contained in the relevant supply invoices/agreements.
    • Examples: X Ltd acquires goods/services from vendors with a 90 days’ credit. It organises a supply chain financing arrangement where Bank A discounts the receivables and pays off the vendor within 30 days, whereas the Bank will collect payment from X on 90 days of the invoice. The arrangement is covered.
    • Same facts as above; but X is required to pay to the Bank in 180 days, whereas the Vendor is paid in 90 days. The arrangement is covered.
    • If the due date of payment to the Bank is the same as the due date of payment to the vendor, the arrangement has no economic value, and does not impact either party’s cashflows – hence, does not require any specific disclosures.
  • Note that the amendments do not affect asset side financing arrangements, that is to say, receivables financing or forward factoring.
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