Every year, as companies close their books on 31st March, a silent timer begins ticking — one that could turn a minor delay into a major compliance miss. 30th April isn’t just another date on the calendar; it’s a hard stop for companies to take action regarding their unspent CSR (Corporate Social Responsibility) obligations.
Why 30th April? What must you do? What if you don’t? Let’s walk through it — step by step.
Why 30th April?
In terms of Section 135(6) of the Companies Act, 2013:
“Any amount remaining unspent under sub-section (5), pursuant to any ongoing project, fulfilling such conditions as may be prescribed, undertaken by a company in pursuance of its Corporate Social Responsibility Policy, shall be transferred by the company within a period of thirty days from the end of the financial year to a special account in any scheduled bank called the ‘Unspent Corporate Social Responsibility Account.'”
Thus, by 30th April, companies must transfer unspent CSR amounts related to ongoing projects into a special CSR account.
What Must Be Done by 30th April?
Open a dedicated bank account titled “Unspent Corporate Social Responsibility Account FY [Year].”
Transfer the unspent CSR amount related to ongoing projects into this account.
Update the Board Report appropriately (explained below).
What If You Don’t Do It?
If the company:
Fails to transfer the amount by 30th April — it’s a default under Section 135(6).
Fails to spend the amount altogether — Section 135(5) steps in: “If the company fails to spend such amount, the Board shall, in its report made under clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount and, unless the unspent amount relates to any ongoing project referred to in sub-section (6), transfer such unspent amount to a Fund specified in Schedule VII, within six months of the expiry of the financial year.”
In short: 1. Unspent on non-ongoing projects? → Transfer to a Schedule VII Fund within 6 months of FY end (i.e., by 30th September). 2. Unspent on ongoing projects? → Transfer to Unspent CSR Account by 30th April, then spend it within 3 years, failing which again transfer to a Fund.
What is an Ongoing Project?
Rule 2(1)(i) of Amendment Rules defines the term ‘ongoing project’ as:
a multi-year project, stretching over more than one financial year;
having timeline not exceeding three years excluding the year of commencement
includes such project that was initially not approved as a multi-year project but whose duration has been extended beyond one year by the Board based on reasonable justification.
The same should have commenced within the financial year to call it ‘ongoing’. This includes a project that was initially not approved as a multi-year project. The intent is to include a project which has an identifiable commencement and completion. The expenses which are recurring in nature should not be included in the ongoing project.
For example, if a company contributes to the annual running expense of a cancer hospital, the spending for the next year cannot be regarded as an “ongoing project”. However, if installation of a new facility at the same hospital is already undertaken during the year, such expense should be regarded as an “ongoing project”.
Board’s and Auditor’s Responsibility
Board’s Responsibility: In the Board’s Report (Section 134(3)(o)), specify reasons for any unspent CSR amount.
Auditor’s Responsibility under Rule 3 of CARO, 2020:
The auditor must specifically report:
(xx)(a) whether, in respect of other than ongoing projects, the company has transferred unspent amount to a Fund specified in Schedule VII within 6 months of expiry of the financial year, in compliance with the second proviso to Section 135(5);
(xx)(b) whether any amount remaining unspent pursuant to any ongoing project has been transferred to the Unspent CSR Account within 30 days from the end of the financial year, as required under Section 135(6).
Thus, both the Board and Auditor are responsible for ensuring, documenting, and reporting CSR compliance – and failure can attract regulatory scrutiny and penal consequences.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-04-28 19:23:492025-04-28 21:11:39Ongoing Projects, Unspent Funds, and the April 30 Countdown
– SEBI brings ratification provisions for RPTs skipping prior AC approval
– Jigisha Aggarwal, Executive and Sourish Kundu, Executive
The laws governing related party transactions (RPTs) in India mandate seeking prior approvals for RPTs. The law has also provided for a rescue in the name of ‘ratification’ where prior approval could not be taken or taking prior approval was not feasible for various reasons. This article explains the meaning of ratification, consequences of failure to ratify either due to lapse of the time limit or exhaustion of the monetary limit, and reinforces the need for companies to tighten their process of RPT approvals. In particular, this article becomes pertinent in view of the recent amendments in Reg. 23 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”) inserting express provisions for ratification of RPTs by Audit Committee (“AC”).
The ratification provision serves as a remedial measure, offering companies a chance to address regulatory lapses. This naturally raises several critical questions:
Does ratification effectively rectify non-compliance arising from the failure to obtain prior approval?
What happens if the required conditions for ratification by the AC are not fulfilled?
Can material RPTs be ratified by shareholders or does the violation remain unresolved?
These questions and other related concerns are analyzed, explored and discussed in detail in this article.
Meaning of Ratification
In simple terms, ratification means giving formal consent to an act, deed, contract, or agreement that initially lacked the required approval, thereby making it valid. It involves granting consent to an action that has already taken place.
The Latin maxim “Omnis ratihabitio retrorahitur et mandato priori aequiparatur” translates to “every ratification is retroactively placed on equal footing with an act performed with prior authority.” This applies when someone acts on behalf of another without prior consent—if the concerned person later ratifies it, the act is treated as if it had been authorized from the start.
Ratification can be seen as a counterpoint to Admiral Grace Hopper’s well-known saying, “It is better to ask forgiveness than permission.” While this principle supports fast decision-making in large organizations, ratification should remain an exception rather than the norm for post-facto approvals.
The Supreme Court, in the matter of National Institute Of Technology & Anr v. Pannalal Choudhury & Anr [AIR 2015 SC 2846], traced back the meaning of the term “ratification” to a succinctly made definition by the English Court in the matter of Hartman v Hornsby [142 Mo 368 : 44 SW 242 at p. 244 (1897)] as follows:
“Ratification’ is the approval by act, word, or conduct, of that which was attempted (of accomplishment), but which was improperly or unauthorisedly performed in the first instance.”
“The High Court was right when it held that an act by a legally incompetent authority is invalid. But it was entirely wrong in holding that such an invalid act cannot be subsequently ‘rectified’ by ratification of the competent authority. Ratification by definition means the making valid of an act already done. The principle is derived from the Latin maxim ‘Ratihabitio priori mandato aequiparatur’ namely ‘ a subsequent ratification of an act is equivalent to a prior authority to perform such act’. Therefore ratification assumes an invalid act which is retrospectively validated.”
firstly, the person whose act is ratified must have acted on behalf of another person;
secondly, the other person on whose behalf the act was performed must be legally competent to perform the act the question and must continue to be legally competent even at the time of ratification; and
thirdly, the person ratifying the act does so with full knowledge of the act in question.
As is understood from the jurisprudence around, the following are the broad principles of ratification –
An act which is ultra-vires the company cannot be ratified.[2]
An act which is intra-vires the company but outside the scope of an authority in the company may be ratified by the company in proper form.[3]
There can be no ratification without an intention to ratify.[5]
The person ratifying the act must have complete knowledge of the act.
Ratification relates back to the date of the act ratified i.e., has retrospective effect.[6]
Ratification cannot be presumed, i.e., overt steps should have taken for the act of ratification.[7]
Global framework on ratification of RPTs
Ratification of RPTs is not a unique affair prevalent only in the Indian context. Even in the global parlance, regulatory references exist around the same, however, there is no concrete evidence of conditionalities around the same:
The newly notified UK Listing Regulations UKLR-8 (notified w.e.f. 29th July, 2024) requires the companies to take prior approval of the board before entering into an RPT, however, does not elaborate on the manner of seeking ratification if prior approval has not been taken. Further, pursuant to UKLR-8, the shareholders’ approval requirements for RPTs under LR-11 has been substituted with a notification requirement.
Article L225-42 of the French Commercial Code deals with the cancellation of transactions referred to in Article L225-38 (understood to be equivalent to related party transactions) without prior authorisation of the board of directors, if such transactions have prejudicial consequences for the company. However, such transactions, entered into without prior authorisation of the board, can still be ratified by shareholders through a vote in a general meeting, based on the special report obtained from the auditors on setting out the circumstances due to which the required approval process was not followed. No interested party can vote on such a matter.
Chapter 2E of the Corporations Act, 2001 of Australia deals with RPTs that require prior shareholders’ approval. Where such approval is not obtained, penal provisions may attract on the persons involved in such violation, although the same does not impact the validity of such contract or transaction except by way of an injunction granted by a court to prevent the company from giving benefit to the related party.
Circumstances that may result in requiring ratification
Practically, there may be genuine cases where the transaction could be blessed with prior approval and therefore be at the mercy of ratification, few cases:
Subsequent identification of a related party: Companies maintain a related party list to identify RPTs and ensure necessary controls, including prior approvals. However, an entity/person may sometimes be overlooked / become a related party subsequently, leading to transactions occurring without prior approval.
Increase in contract value due to market changes: Market fluctuations can cause price revisions, potentially breaching the ceiling limit of an existing omnibus approval. Until the AC approves an enhancement in the omnibus approval value, any transactions exceeding the OA limit would require ratification.
Oversight of transactions: Manual RPT controls are prone to oversight, where a business team may enter into a related party transaction without verifying whether prior approval has been obtained.
Exigency of business: In rare cases, an unanticipated but necessary transaction may arise in the company’s interest. Following the legal approval process beforehand might result in lost opportunities or financial losses.
While strong internal controls, automation, and strict monitoring can mitigate most of these issues, obtaining prior AC approval in every case may not always be feasible—especially for large listed entities with numerous RPTs. In such instances, ratification serves as a remedial mechanism.
Ratification of RPTs by Audit Committee
Section 177(4) of the Companies Act, 2013 explicitly allows ratification of RPTs undertaken without prior AC approval for all companies [third proviso to clause (iv) of Section 177(4)]. However, before the LODR (Third Amendment) Regulations, 2024 (effective from December 13, 2024), no such provision existed for listed entities under the Listing Regulations.
With the recent amendment, Reg. 23(2)(f) now extends ratification provisions to listed entities. However, this is not unconditional, as specific criteria must be met, which are discussed in detail later.
The following section examines the differences between ratification provisions under the Listing Regulations and the Companies Act..
Ratification of RPTs by the Audit Committee – Listing Regulations vis-a-vis Companies Act, 2013
Basis
Listing Regulations
Companies Act, 2013
Governing Provision
Reg. 23(2)(f)
Section 177(4)
Authority to ratify
Independent directors forming part of the AC
All members of the AC
Permitted value
Rs 1 crore, aggregated with all ratifiable transactions during a FY
Rs 1 crore per transaction
Prescribed timelines
Earlier of: – 3 months from date of transaction – Next AC meeting
Within 3 months from the date of transaction
What if the value / timeline is exceeded
Transaction shall be voidable at the option of the AC
Disclosure requirements
Details of ratifications to be disclosed along with the half-yearly disclosures of RPTs under Reg. 23(9)
No additional disclosures prescribed
Ratification of material RPTs
AC does not have the authorisation to ratify material RPTs
NA
Consequences of not getting AC approval for RPT
The concerned director(s) shall indemnify the company against any loss incurred by the company concerned, if: i. The transaction is with the related party to any director, or ii. The transaction is authorised by any director
Conditions for ratification of RPTs under Listing Regulations
The trail of AC ratifying an RPT is represented below:
Each condition is discussed in detail below:
Authority to ratify
Only those members of the AC who are IDs, can ratify RPTs.
Rationale: This is to ensure that the authority to ratify is in sync with the authority to approve. In terms of Reg. 23(2), only those members of AC who are IDs are authorised to approve RPTs, and hence, the power of ratification also vests with them only.
Given their role and responsibilities, Independent Directors (IDs) are least likely to have a “conflict of interest”, which is the primary concern behind RPT regulations.
SEBI’s penalty order in the LEEL Electricals case underscores the importance of IDs, as penalties were imposed on them for failing to fulfill their AC duties in overseeing RPTs. The company was penalized for fund diversion involving certain related parties.
Timeline
Earlier of:
3 months from the date of the transaction, or the next meeting of the AC.
Rationale: This is intended to aid in timely decision-making and minimizing the chances for undue delay in scheduling AC meetings. While recommendations were made to keep the provision as later of the two, in view of the probable misuse of such provision by causing deliberate delay in conducting AC meetings, the timeline has been kept at earlier of the two [refer SEBI BM Agenda].
In practice, this does not impose an additional compliance burden, as Reg. 18(2) of the Listing Regulations mandates at least four AC meetings per financial year. Given the AC’s quarterly responsibilities, meetings are typically held within a three-month gap. Thus, a ratifiable RPT is unlikely to fail due to delayed placement, except in cases where weak internal controls cause a significant delay in identifying the lapse in prior approval.
Maximum value permitted for ratification
An aggregate threshold of Rs. 1 crore has been laid down, for ratified transaction(s) with a related party, whether entered into individually or taken together, during a financial year.
Rationale: A low threshold has been specified to prevent misuse of the provision [refer SEBI BM Agenda].
The provision refers to (a) all ratified transactions, (b) in a financial year, (c) with a related party. Hence, all instances of ratification are to be aggregated for the complete financial year, on a per related party basis, and the same should not exceed the value of Rs. 1 crore.
Anonymous omnibus approval vis-a-vis ratification of RPTs
Reg. 23(3)(c) of the Listing Regulations allows the AC to grant anonymous omnibus approval for unforeseen RPTs, with a maximum limit of ₹1 crore per transaction. This approval does not require details like the related party’s name, transaction amount, period, or nature and remains valid for up to one year.
This creates an implied exemption for RPTs up to ₹1 crore per transaction, as they can proceed under the omnibus framework without fresh AC approval. However, unlike this per-transaction limit, ratification limits apply on an aggregated basis for all transactions with a related party in a financial year.
This raises a key question: Does the anonymous omnibus approval provision make ratification redundant?
The aforesaid question can be discussed in two contexts –
for unforeseen RPTs covered by the limit of Rs. 1 crore per transaction, and
for foreseen RPTs for which an OA limit is approved by the AC
The relevance of ratification in each case can be understood with the help of specific examples.
i. Ratification for unforeseen RPTs
If an anonymous omnibus approval (OA) allows up to Rs. 1 crore per transaction, an unforeseen RPT of Rs. 80 lakhs falls within this limit and does not require ratification, as the OA serves as prior approval for such cases.
However, if an unforeseen RPT of Rs. 1.9 crores occurs, only Rs. 1 crore is covered under the OA, and the excess Rs. 90 lakhs requires ratification.
In a case where the transaction is Rs. 2.5 crores and the OA is Rs. 1 crore, the excess amount (1.5 cr) exceeds ratification limits and therefore is voidable at the option of the AC.
Another example, where the foreseen RPT is for 1 cr – can this be included under the unforeseen RPTs? The answer should be No. Where the details of the RPT were available, irrespective of the value, they require prior approval of the AC after placing the requisite information before the AC.
ii. Ratification of foreseen RPTs
If the AC grants an omnibus approval for Rs. 100 crores for a specific transaction type with a particular RP, and the company undertakes an RPT of Rs. 101 crores, the excess Rs. 1 crore can be ratified by the AC, provided all specified conditions are met.
However, if a transaction of Rs. 105 crores is undertaken under the same approval, the excess increases to Rs. 5 crores, making ratification unavailable. This falls under “Failure to seek ratification,” discussed in detail below.
Transaction should not be material
Reg. 23(1) sets the materiality thresholds for RPTs as the lower of Rs. 1,000 crores or 10% of the listed entity’s annual consolidated turnover. Transactions crossing this limit require prior shareholder approval.
Rationale: Ratification authority lies with the approving authority. Since AC cannot approve material RPTs, it also cannot ratify them. The authority to ratify remains with shareholders, who must approve such transactions in advance.
Listing Regulations do not explicitly allow shareholder ratification if materiality thresholds are breached. Failure to obtain prior approval leads to penalties, as seen inPremier Polyfilm Limited, where a fine was imposed despite later ratification.
If prior approval is missed, shareholders’ ratification may still be sought. While it does not remove the breach’s consequences, delayed compliance is better than non-compliance.
Rationale to be placed before the AC
Ratification applies only when prior approval was not obtained, serving as a remedy for exceptional cases. It is crucial to present a proper rationale before the Audit Committee, explaining the inability to seek prior approval.
A key principle of ratification is the intent to ratify, as established in Sudhansu Kanta v. Manindra Nath [AIR 1965 PAT 144]. In Premila Devi v. The Peoples Bank of Northern India Ltd [(1939) 41 BOMLR 147], it was held that ratification requires both intent and awareness of illegality. The ratifying authority must have full knowledge of the breach, its reasons, and a justified basis for approval.
Disclosure
The details of ratification shall be disclosed along with the half-yearly disclosures of RPTs under Reg. 23(9) of the Listing Regulations.
Pursuant to SEBI Implementation Circular dated 31st December, 2024 the format for half-yearly disclosures of RPTs has been revised to include a column: “Value of the related party transaction ratified by the audit committee” to effectuate the disclosure of ratified RPTs.
Rationale: This is to promote maintenance of adequate transparency of substantial information, with the investors and shareholders.
Failure to Seek Ratification: Meaning & Consequences
A proviso to the newly inserted Reg 23(2)(f) specifies the consequences of a “failure to seek ratification”. The failure to seek ratification refers to a situation where the post-facto approval of AC could not be sought in accordance with the conditions laid down for ratification.
The failure to seek ratification may occur on account of one or more of the following:
(a) lapse of timelines for seeking ratification, or
(b) value of ratifiable transactions exceeding the limit of Rs. 1 crore in a FY, or both.
Here, it is important to note that in such an event, the AC may render such RPT voidable, and not necessarily void. Further, if it considers appropriate, it may seek indemnification from the concerned director(s), if any, for any loss incurred by the Company as a result of entering into such a transaction.
Differentiating between ‘voidable’ or ‘void’
Voidable means something that can bemade invalid or nullified, and void means something that is invalid or null.
“The word ‘void’ in its strictest sense, means that which has no force and effect, is without legal efficacy, is incapable of being enforced by law, or has no legal or binding force, but frequently the word is used and construed as having the more liberal meaning of ‘voidable. The word ‘void’ is used in statutes in the sense of utterly void so as to be incapable of ratification, and also in the sense of voidable and resort must be had to the rules of construction in many cases to determine in which sense the Legislature intended to use it. An act or contract neither wrong in itself nor against public policy, which has been declared void by statute for the protection or benefit of a certain party, or class of parties, is voidable only.”
If a company fails to seek ratification, the transaction does not automatically become void unless explicitly declared so by the approving authority, usually the AC. The AC has the discretion to either:
Adopt the transaction with or without modifications, or
Cancel the transaction entirely, rendering it void.
Indemnification by director(s):
If the transaction is deemed invalid, indemnification may be sought from the concerned directors if:
The transaction involves a related party of any director, or
A director authorized the transaction without obtaining the necessary approval.
Conclusion
With the introduction of ratification provisions in the Listing Regulations, the AC’s responsibility for RPT ratification has increased. This underscores the need for stronger internal control mechanisms to ensure efficiency and proactiveness. Automation of RPT controls should also be considered to reduce human errors and streamline compliance for better detection of RPTs. While ratification serves as a fallback in case of lapses, it should never be seen as a substitute for obtaining prior approvals.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-04-18 13:39:002025-04-19 01:44:16Ratification of RPTs: a rescue ship or an alternative to compliance?
Notifies amendment as COREX timeline set to expire
– Team Corplaw | corplaw@vinodkothari.com
March 28, 2025 | Team Vinod Kothari & Company
Just before the expiry of the ‘Comply or Explain’ timeline of March 31, 2025 for HVDLEs, SEBI notified SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2025 inserting a separate chapter viz. Chapter VA: Corporate Governance Norms for a Listed Entity which has listed its Non-Convertible Debt Securities effective from March 27, 2025. The proposal for amendments were made in the Consultation Papers of October 31, 2024 and February 8, 2023, and was approved by SEBI in the board meeting held on December 18, 2024. A summary of the changes notified, comparison of the new compliance requirements vis-à-vis the earlier norms have been captured in this write-up.
HVDLEs: Meaning, Applicability, Sunset Clause
The only criteria for being categorized as an HVDLE is the amount of outstanding value of listed non-convertible debt securities, which has now been revised from Rs. 500 crores or more to Rs. 1,000 crores or more. This upward revision is aligned with the criteria for being identified as a Large Corporate, i.e. outstanding long-term borrowing amounting to Rs. 1,000 crores or more, and has been introduced with the dual objective of tightening the regulatory regimes for debt listed entities while simultaneously promoting ease of doing business in the corporate bond market.
The provisions of the Chapter VA, a chapter exclusive to entities having listed only their non-convertible debt securities, the outstanding value of which is exceeding Rs. 1,000 crores, and not specified securities, shall apply with effect from April 1, 2025. Explanation(1) appended to Regulation 62C clarifies that HVDLEs shall be determined on basis of value of principal outstanding of listed debt securities as on March 31, 2025, irrespective of the date of notification of this amendment.
A doubt may arise arise with regards the applicability of this chapter to an entity whose outstanding value of NCDs exceeds the threshold during the year, i.e. after March 31, 2025 – the Explanation(2) to the same regulation makes it clear that such entity shall ensure compliance with the provisions of Chapter VA within six months from the date of such trigger and the disclosures of such compliance may be made in corporate governance compliance report on and from third quarter, following the date of the trigger.
However, the earlier conception of “Once an HVDLE, always an HVDLE” has now been removed with the introduction of a sunset clause, in Regulation 62C(2), which specifies that the provisions of this chapter shall cease to be applicable, after three consecutive years of the value of outstanding NCDs being below the Rs. 1,000 crores threshold, as determined on March 31 of any given year.
Related Party Transactions by HVDLEs
While the scope of RP and RPTs continue to be the same as defined in regulation 2(1) (zb) and (zc) respectively, the present amendment introduces a revised RPT approval regime for HVDLEs particularly for Material RPTs. The restriction for related parties to not vote to approve the material RPT, provided under regulation 23, resulted in impossibility of compliance for HVDLEs as most HVDLEs were closely held companies. Accordingly, SEBI introduced a two step approval process for material RPTs with first obtaining NOC from the debenture holders (of listed debt securities issued on or after April 01, 2025) not related to the issuer and holding at least more than 50% of the debentures in value, on the basis of voting including e-voting, followed with approval of shareholders through ordinary resolution. The provisions of Reg. 62K is applicable to RPTs entered into on or after April 1, 2025. Refer to our FAQs to understand the implications and manner of seeking approval.
While the other requirements are similar to corresponding requirements under regulation 23 for equity listed entities (for e.g., framing of policy, prior approval of audit committee, half yearly disclosures etc.), recent amendments made in December, 2024 in relation to ratification of RPTs and exemption from approval requirements of audit committee and shareholders have not been inserted in reg. 62K.
Prior to this amendment, so long the debt was continued to be serviced and the terms and conditions of borrowing was met, the debenture holders were not required to intervene in the regular operations of the company. If there was a covenant to that effect in the debenture subscription agreement or Debenture Trust Deed or terms of issue, in that case, irrespective of whether the RPT is material or immaterial, the borrowing entity was required to comply. With this amendment, the debenture holders will also have a say in corporate governance, especially in case of material RPTs pursuant to a provision of law. Other lenders extending term loan and other facilities, and who have a larger exposure on such companies, will not have this opportunity.
Differing requirements under CG norms for an HVDLE vis-a-vis an equity listed entity
The provisions of Reg. 16 to 27 of Chapter IV have been suitably modified and inserted in the context of HVDLEs in Chapter VA. While largely the flow of the provisions and requirements are aligned, there exists certain gaps in certain provisions. The tabular comparison below highlights the same (excluding those differences that are linked with market capitalization related requirements/ outstanding SR equity shares related requirements that only apply to equity listed entities):
Particulars
Reqt. under Chapter IV for equity listed entities
Reqt. under Chapter VA for HVDLEs
Remarks
Meaning of IDs
Defined under Reg. 16(1)(b)
Reg. 62B (1) (b) refers to definition in Chapter IV and additionally provides for considering the NEDs other than nominee directors, in following listed entities: A body corporate mandated to constitute its board as per the law under which it is constituted; or Set up under public private partnership [PPP] model
In the case of the PPP model, the composition of the board is pre-decided or mutually decided between the public authority and private entity, hence the exemption. Further, for HVDLEs that are private limited companies, having IDs as per the criteria given under Chapter IV, becomes explicit.
Timeline for obtaining shareholders’ approval for board appointments
Reg. 17 (1C) To be obtained within 3 months from appointment or ensuing general meeting, whichever is earlier. Carve outs: Time taken for obtaining approval of regulatory, government or statutory authorities, shall be excluded.Provisions not applicable to appointment or re-appointment of a person nominated by a financial sector regulator, Court or Tribunal to the board of the listed entity
Reg. 62D To be obtained within 3 months from appointment or ensuing general meeting, whichever is earlier. Both the carve outs are not available for HVDLE.
The corrections made to corresponding provision in Reg. 17 (1D) vide LODR Third Amendment Regulations, 2024 have not been made in Chapter VA. The carve out under Reg. 62D (4) pertains to that sub-regulation and not the entire Reg. 62D.
Continuation of director on the board subject to shareholders’ approval once in every five years
Carve outs provided in provisos to Reg. 17 (1D): To the director appointed pursuant to the order of a Court or a Tribunal or to a nominee director of the Government on the board of a listed entity, other than a public sector company, or to a nominee director of a financial sector regulator on the board of a listed entity.To a director nominated by a financial institution registered with or regulated by RBI under a lending arrangement in its normal course of business or nominated by a SEBI registered DT under a subscription agreement for the debentures issued by the listed entity.
Carve outs in Reg. 62D (4) are broadly similar. Reg. 62D (4) additionally exempts director appointed under the public private partnership model/structure.
As composition is pre-decided or is as per mutual terms between the public authority and private entity.
Nature of listed entities considered and limits for maximum no. of directorships
Reg. 17A- LEs shall be cumulative of those whose equity shares are listed on a stock exchange and HVDLEs. Director in not more than 7 LEsID in not more than 7 LEsIf WTD/ MD in any LE, ID in not more than 3 LEs Further, to give sufficient time to all the listed entities to ensure compliance with the provision, a period of 6 months or till the time AGM is held from the date of applicability of the provision to the entity, whichever is later, has been provided.
Reg 62E provides the same limits. LEs shall be cumulative of those whose equity shares are listed on a stock exchange and HVDLEs. Carve out for directorships in PSUs and entities set up in PPP arrangements are not to be included.
In order to ensure that directors devote adequate time to listed entities including HVDLEs and in the interest of investor protection.
Composition of NRC, SRC and RMC
Reg. 19, 20 & 21:Each of the committees viz. Nomination and Remuneration Committee, Stakeholders Relationship Committee and Risk Management Committee (top 1000 based on market cap) are required to be constituted.
Reg. 62G – The functions of NRC may either be discharged by the board or by NRC.Reg. 62H – The functions of SRC may either be discharged by the board or by SRC.Reg. 62I – The functions of RMC may either be discharged by the board or by audit committee or by RMC.
In order to avoid the constitution of multiple committees by HVDLEs.
Exemption from prior approval of AC of the holding LE, in case, provisions of Reg 23 is applicable to the subsidiary
Reg 23(2)(d): Prior approval of the audit committee of the listed entity shall not be required for a related party transaction to which the listed subsidiary is a party but the listed entity is not a party, if regulation 23 and sub-regulation (2) of regulation 15 of these regulations are applicable to such listed subsidiary.
Reg 62K: Identical provisions, however, position is not clear where the subsidiary is also an HVDLE.
The exemption should be available even in case of an HVDLE subsidiary, as such a subsidiary will be required to independently comply with Regulation 62K, similar to that provided in Reg. 62K(6).
Exemption from approval of AC w.r.t. remuneration and sitting fees paid to Director, KMP and SMP (non-promoter)
Reg 23(2)(e): remuneration and sitting fees paid by the listed entity or its subsidiary to its Director, KMP and SMP (non-promote, shall not require approval of the audit committee provided that the same is not material.
No such carve out in Reg. 62K (3)
The amendments made in Reg. 23 vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62K.
Ratification of RPT
Reg 23(2)(f): The members of the audit committee, who are independent directors, may ratify related party transactions subject to the certain conditions and timelines
No such provisions are included in Reg. 62K (3)
The amendments made in Reg. 23 vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62K.
Omnibus approval proposed to be undertaken by subsidiary companies
Reg 23(3): Audit committee may grant omnibus approval for related party transactions proposed to be entered into by the listed entity or its subsidiary subject to the certain conditions
Reg 62K: Identical provisions, However, subsidiary companies of HVDLE are not included in the ambit of omnibus approval provisions for HVDLE
The amendments made in Reg. 23 vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62K.
Approval regime for material related party transactions
Reg 23(4): All material related party transactions and subsequent material modifications shall require prior approval of unrelated members.
Reg 62K(5): All material related party transactions and subsequent material modifications shall require prior NOC from the DT and the DT shall in turn obtain No-Objection/approval from the unrelated DH who hold atleast > 50% of the debentures in value, on the basis of present and voting including e-voting. 62K(6): approval of shareholders shall be required after obtaining NOC from DT, however, no restriction has been placed on shareholders that are RPs from voting to approve the resolution.
Several HVDLEs are closely held companies, holding a negligible portion of the equity or none at all, in which case the entity was not able to transact such RPTs because of ‘impossibility of compliance’ with the provisions of LODR Regulations. Therefore, taking cue from Sec. 186 (5), SEBI tried to address this issue by mandating NOC from debenture holders.
Exemption from Material RPT approval in case of listed subsidiaries
Reg 23(4): Available if regulations 23 and 15 (2) are applicable to such listed subsidiaries.
Reg 62K(6): Prior approval of the shareholders and NOC by DT of a HVDLE, shall not be required for a RPT to which the listed subsidiary is a party but the listed entity is not a party, if regulation 62K of these regulations is applicable to such listed subsidiary, however, position is not clear i.r.t. Listed subsidiary, if reg 23 is applicable to such subsidiary.
This situation is inverse for obtaining audit committee approval in case of HVDLE. In the context of equity listed entities, the exemption is not available in case of Material RPTs undertaken by an HVDLE subsidiary.
Exemption from AC & S/h approval requirements for certain RPTs
Reg 23(5): Following transactions are exempt from the applicability of approval provisions: (a) transactions entered into between two public sector companies;(b) transactions entered into between a holding company and its WOS (c) transactions entered into between two WOS of the LE(d) transactions which are in the nature of payment of statutory dues, statutory fees or statutory charges entered into between an entity on one hand and the Central Government or any State Government or any combination thereof on the other hand. (e) transactions entered into between a public sector company on one hand and the Central Government or any State Government or any combination thereof on the other hand.
Reg 62K(7): The exemptions are not identical:(i) under point (a) exemption available for government companies and not public sector companies;(ii) point (b) and (c) are identical(iii) point (d) and (e) are excluded.
The amendments made in Reg. 23 vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62K.
CG requirements with respect to subsidiary
Requirements of Reg. 24 apply to unlisted subsidiaries.Reg 24 (1) – appointment of atleast 1 ID of the parent listed entity on the board of the unlisted material subsidiary (whoseturnover or net worth exceeds 20% of the consolidated turnover or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year) Reg 24(2): Review of financial statements of the unlisted subsidiary by the audit committee of the listed entity.Reg 24(3): Review of board minutes of the unlisted subsidiary by the board of the listed entity. Reg 24(4): Review by the board of significant transactions/arrangements entered into by the unlisted subsidiary.Reg 24 (5): Shareholders’ approval for disposal of shares of material subsidiary whoseturnover or net worth exceeds 10% of the consolidated turnover or net worth respectively, of the listed entity) resulting in reduction to less than or equal to 50% or cessation of control.Reg 24 (6): Shareholders’ approval for sale, disposal and leasing of assets of material subsidiary (whoseturnover or net worth exceeds 10% of the consolidated turnover or net worth respectively, of the listed entity)
Reg 62L: All requirements apply only to unlisted material subsidiary (whoseincome or net worth exceeds 20% of the consolidated income or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year)
CG requirement pertaining to subsidiary is relaxed for HVDLE in comparison to that of equity listed entity
Secretarial Audit and Secretarial Compliance (ASC) Report
Reg 24A: LE and its material unlisted Indian subsidiaries ((whoseturnover or net worth exceeds 10% of the consolidated turnover or net worth respectively, of the listed entity) to undertake Secretarial audit by Peer Reviewed Secretarial Auditor. Further, the regulations also deal with tenure of appointment, rotation of secretarial auditors, eligibility, qualifications and disqualifications for appointment of a secretarial auditor, and prohibited services prescribed w.r.t Secretarial Auditors of the listed entity. ASC report to be submitted within 60 days from the end of FY by the listed entity.
Reg 62M: HVDLEs and its Indian material unlisted subsidiary (no definition provided) to undertake secretarial audit and annex the report in annual report. Further, HVDLEs to submit ASC report within 60 days. The requirement of peer reviewed CS to conduct Sec audit or issue ASC, tenure of appointment, rotation of secretarial auditors, eligibility, qualifications and disqualifications for appointment of a secretarial auditor, and prohibited services prescribed w.r.t Secretarial Auditors etc not applicable.
The amendments made in Reg. 24A vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62M. Further, the scope of material subsidiary is not provided as the definition under Reg. 16 and Reg. 62L may not apply unless expressly indicated.
Agreement pertaining to profit sharing or in connection with dealings in securities of the company
Reg 26(6): Any agreement entered into by the employees, KMP/director/promoter for himself/herself or on behalf of any other person with regard to compensation or profit sharing in connection with dealings in the securities of listed entity, requires prior approval by the board and public shareholders by way of ordinary resolution. Interested persons involved in the transaction are required to abstain from voting.
Reg 62O(5): The regulation is similar to that provided in Reg. 26(6) with the exception that there is no restriction for voting by the interested persons.
The amendments made in Reg. 26(6) vide LODR Third Amendment Regulations, 2024 have not been made in Reg. 62O.
Other Amendments
Related Party Transactions by SME Listed entities
A listed entity which has listed its specified securities on the SME Exchange are not required to comply with the CG norms otherwise applicable to a Main Board listed entity which have either paid up capital exceeding Rs. 10 crore or net worth exceeding Rs. 25 crore). In order to plug the risk of siphoning of funds to related parties, as observed by SEBI in certain instances, the present amendment harmonizes and aligns the RPT norms applicability by extending it to SME listed entities other than those which have paid up capital not exceeding Rs. 10 crores and net worth not exceeding Rs. 25 crores. Further, considering the size of SMEs, the threshold limit for Material RPTs have been set to Lower of INR 50 Cr or 10% of annual consolidated turnover as per last audited financial statements. Where the provisions become applicable at a later date, SMEs will have 6 months time to ensure compliance. The provisions shall continue to apply till both the conditions w.r.t equity share capital and networth falls below the threshold and remains below the threshold for 3 consecutive FYs.
Business Responsibility and Sustainability Reporting
Regulation 34(2)(f) of the Listing Regulations so far required assurance of the BRSR Core Report, which has now been modified to term it as ‘assessment or assurance of the specified parameters’ to prevent unwarranted association with a particular profession (specifically audit profession). Assessment defined as third-party assessment undertaken as per standards notified by the Industry Standards Note on BRSR Core, developed in consultation with SEBI.
Similar modification has been reproduced for obtaining BRSR Core Report from Value Chain Partners of the Listen Entity, and a clause of voluntary disclosure of the same for HVDLEs has been added in Regulation 62Q(3).
The Ministry of Micro, Small, and Medium Enterprises (MSME), through its notification dated March 21, 2025, has revised the classification criteria for Micro, Small, and Medium Enterprises. While the proposed revision was mentioned in the Union Budget 2025, the formal notification confirms the upward revision of classification limits, effective April 1, 2025. This revision will permit several enterprises to qualify as MSMEs, as also allow existing MSMEs to expand, without losing their present classification.
Need for revision:
During the 2025 Budget Speech, the Hon’ble Finance Minister emphasized the critical role played by MSMEs in India’s economy:
“Currently, over 1 crore registered MSMEs, employing 7.5 crore people, and generating 36 per cent of our manufacturing, have come together to position India as a global manufacturing hub. With their quality products, these MSMEs are responsible for 45 per cent of our exports. To help them achieve higher efficiencies of scale, technological upgradation, and better access to capital, the investment and turnover limits for classification of all MSMEs will be enhanced to 2.5 and 2 times, respectively. This will give them the confidence to grow and generate employment for our youth.”
Revised Classification Criteria:
Category
Investment in Plant and Machinery or Equipment (₹ crores)
Annual Turnover (₹ crores)
Current
Revised
Current
Revised
Micro
≤1
≤2.5
≤5
≤10
Small
≤10
≤25
≤50
≤100
Medium
≤50
≤125
≤250
≤500
It is important to note that MSME classification follows a composite criterion, meaning that if an enterprise exceeds either the investment or turnover limit, it will be reclassified into the next higher category.
Applicability of the revised classification criteria
With effect from FY 2025-26, a substantial rise in eligible enterprises is expected, leading to a new influx of registrations on the UDYAM portal. The notification dated June 26, 2020 (the principal circular) prescribes the process for UDYAM registration.
A pertinent question arises regarding enterprises currently classified as Medium or Small Enterprises: Will they be downgraded to Small or Micro Enterprises due to the reclassification? Clause 8(6) of the principal circular clarifies:
“In case of reverse graduation of an enterprise, whether as a result of re-classification or due to actual changes in investment in plant and machinery or equipment or turnover or both, and whether the enterprise is registered under the Act or not, the enterprise will continue in its present category till the closure of the financial year and it will be given the benefit of the changed status only with effect from 1st April of the financial year following the year in which such change took place.”
This means that enterprises eligible for reverse graduation will retain their existing status until March 31, 2025, with the revised classification taking effect from April 1, 2025.
Impact:
The reclassification is expected to have far-reaching consequences across various economic sectors. Some key implications include:
Tax Implications & Payment Compliance
One of the major benefits for Micro and Small Enterprises (MSEs) over Medium Enterprises is derived from Section 43B(h) of the Income Tax Act, 1961, which allows deductions for payments made to MSEs only on a cash basis (i.e., upon actual payment rather than accrual). This provision aligns with Section 15 of the MSMED Act, 2006, which mandates payment within 45 days.
With a larger number of enterprises falling under the MSE category, buyers availing goods and services from these entities will need to ensure timely payments. Delays beyond the prescribed timelines may lead to tax disallowances and potential compliance issues.
In addition to disallowance of deductions under the Income Tax Act, 1961, such debtors, also have to comply with the requirement of filing Form MSME-1 on a half yearly basis, as discussed below.
Enhanced Regulatory Compliance
The Ministry of MSME, via its notification dated March 25, 2025, has mandated that companies receiving goods or services from MSEs and failing to make payments within 45 days must file Form MSME-1 on a half-yearly basis, disclosing outstanding amounts and reasons for delay.
The form was revised by MCA’s order dated July 15, 2024; however, the revised classification criteria will not impact filings for the six months ending March 2025. Companies must ensure that subsequent filings accurately reflect payments owed to newly classified MSEs.
Enhanced Access to Credit
Furthermore, the Budget 2025 proposed enhancements in credit guarantee coverage:
For Micro and Small Enterprises: From ₹5 crore to ₹10 crore, facilitating an additional ₹1.5 lakh crore credit over five years.
For Startups: From ₹10 crore to ₹20 crore, with a 1% guarantee fee for loans in 27 identified focus sectors.
For Export-Oriented MSMEs: Term loans up to ₹20 crore.
These initiatives are expected to bolster MSME financing through schemes like the Emergency Credit Line Guarantee Scheme (ECLGS), Credit Guarantee Fund Schemes (CGS-I & CGS-II), Credit-Linked Capital Subsidy Scheme (CLCSS), and the Micro Finance Programme. A comprehensive overview of these schemes can be accessed here.
Increase in scope of Priority Sector Lending (‘PSL’)
The expansion of MSME eligibility is set to widen the scope of financing options available to these enterprises. Under RBI’s Master Directions on Priority Sector Lending, loans extended to MSMEs are considered part of banks’ priority sector obligations. The increase in eligible entities may result in higher loan disbursements across both manufacturing and service sectors.
As per the Master Direction – Priority Sector Lending (PSL) – Targets and Classification, domestic Scheduled Commercial Banks (SCBs) and foreign banks must allocate 40% of their Adjusted Net Bank Credit (ANBC) to priority sectors, including Micro, Small, and Medium Enterprises (MSMEs). Specifically, domestic SCBs and foreign banks with 20+ branches must lend at least 7.5% of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure (whichever is higher) to Micro enterprises.
Boost to Supply Chain Financing & Securitization
With a broader pool of eligible MSMEs, platforms such as TReDS (Trade Receivables Discounting System) and other supply chain financing mechanisms may witness an upsurge in receivables for securitization. This could lead to improved liquidity and lower financing costs for MSMEs. A detailed discussion on MSME receivables securitization is available here.
Other benefits to MSMEs by Central/State Government(s):
Apart from credit-related benefits, MSMEs receive various non-financial support from the government. Some of these are highlighted below:
The ZED Certification Scheme, launched by the Ministry of MSME, encourages small businesses to adopt quality manufacturing practices with a focus on energy efficiency and environmental sustainability. MSMEs registered under Udyam can apply, and eligible enterprises receive financial assistance covering up to 80% of certification costs for micro enterprises, 60% for small, and 50% for medium enterprises.
To foster MSME clusters, the Micro and Small Enterprises – Cluster Development Programme (MSE-CDP) provides financial assistance for infrastructure development, setting up common facility centers, and improving market access. Industry associations, state governments, and groups of MSMEs can avail of grants covering 70-90% of project costs, depending on the cluster’s location and nature.
Under the Public Procurement Policy for MSEs, all central government ministries, departments, and CPSEs must procure at least 25% of their requirements from MSEs, with sub-targets for SC/ST and women entrepreneurs.
The Lean Manufacturing Competitiveness Scheme (LMCS), MSMEs assists in reducing their manufacturing costs, through proper personnel management, better space utilization, scientific inventory management, improved processed flows, reduced engineering time and so on.
These targeted initiatives collectively strengthen MSME growth, market access, and technological advancement.
Conclusion
While the upward revision of MSME classification limits may appear to be a simple adjustment, its implications are widespread. The surge in registrations will not only affect enterprises seeking MSME benefits but also influence businesses procuring goods/services from them and financial institutions extending credit. Companies and financial stakeholders must revisit internal policies to adapt to the evolving MSME landscape and ensure smooth compliance with the revised framework.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-03-27 16:43:282025-03-27 22:44:19Broadening the MSME landscape: Impact of revised limits
Regulations often attempt to curb opacity in corporate structures, transactions and arrangements. Opacity may quite often be the breeding ground for ulterior designs. Opaque corporate structures may be used for hiding the identity of real owners, or to shift corporate funds from entities. Section 186(1) of the Companies Act (‘Act’) is one such provision which restricts companies to make investments through more than two layers of investment companies. While the objective of removing opacity through several layers of entities becomes clear through this provision, however it also creates a tricky situation for several corporate houses which have a long vertical stretch of investments in entities. This restriction in itself raises several questions, such as:
What is covered under the ambit of ‘investments’?
What is meant by ‘investment through’?
Does this section relate to investment subsidiaries or investment companies in general? and so on.
Before we delve into the intent and implication of interpreting this section, it will be interesting to note that a similar provision exists under section 2(87) of the Act which only talks about putting a limit on the number of subsidiaries a company may have. Our detailed write up and FAQs on the same can be referred to.
Rationale behind 186(1)
When companies invest through multiple entities, the primary challenge for a lawmaker is the inherent lack of transparency that such structures can create. The topmost entity may try to route its investments through several layers to invest in a business in which investing directly may not be possible or even legal. This issue is succinctly captured by the Latin maxim “quando aliquid prohibetur ex directo, prohibetur et per obliquum” meaning “what you cannot do directly, you cannot do indirectly.” The concern here is that by using a series of interconnected entities, investors may circumvent regulatory intent, thus undermining the transparency and oversight that the law seeks to ensure. To address this, legislators have generally focused on two main mechanisms: enhancing disclosure requirements and limiting the number of entities through which investments can be made. Section 186(1) adopts the latter approach and restricts a company from making investments through more than 2 investment companies.
The JJ Irani Committee, [Pg 17, Para 8.1 to 8.6] in its deliberations, recommended against prescribing rigid group structures or limiting the number of subsidiaries, arguing that such restrictions could place Indian companies at a disadvantage relative to their global counterparts. Instead, the Committee advocated for a focus on transparency and governance, emphasizing robust disclosure requirements and greater supervision of subsidiaries through clear and accountable board processes.
However, the Joint Parliamentary Committee[Pg. 21, Para 4.10 (1)], which investigated the Stock Market Scam of 2008, had its reservations regarding use of a multi-layered approach for investment as this can make it difficult to trace the origin of the fund. The Department of Corporate Affairs also considered putting a cap on the number of investment companies that can be set up by an individual. In line with this, the Ministry of Corporate Affairs (MCA) at one point considered restricting investments to a single investment company [Pg. 254 para 11.8 (a)]. This suggestion, however, was not accepted, as it could stifle legitimate business structures and limit operational flexibility.
In 2016, the Companies Law Committee Report[Pg 60, Para 12.16] further explored this issue and proposed dispensing with certain restrictions under Section 186(1) of the Act. The Committee acknowledged that a multi-layered investment structure could be justified for legitimate business purposes. Despite this, the recommendation was not incorporated into the final amendment bill. As a result, the restriction limiting investments through no more than two investment companies remains in effect.
Similar restrictions were made applicable by the RBI on Core Investment Companies (‘CICs’) by way of para 7 of Master Directions on CICs wherein the number of layers of CICs within a Group (including the parent CIC) shall be restricted to two, irrespective of the extent of direct or indirect holding/ control exercised by a CIC in the other CIC. Further, if a CIC makes any direct/ indirect equity investment in another CIC, it will be deemed as a layer for the investing CIC.
Deciphering the language of section 186(1)
The provisions of the said sub-section reads as under –
“Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed, make investment through not more than two layers of investmentcompanies:
Provided that the provisions of this sub-section shall not affect,—
(i) a company from acquiring any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as per the laws of such country;
(ii) a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force.”
On the basis of the language used above, let us understand few terms and its implications in the instant context
What is an ‘investment company’ ?
As per the explanation to Section 186, an “investment company” for the purpose of this section means a company whose main business is investing in shares, debentures or other securities. A company is considered to be primarily engaged in this business if:
at least 50% of its total assets consist of investments in shares, debentures, or other securities, or
at least 50% of its total income comes from such investments.
Note that unlike the 50-50 test for determining an NBFC, an investment company has to fulfil either of the above conditions and not both at the same time.
What is an ‘investment’?
It is important to understand what ‘investment’ is, since 186(1) restricts investments being made by a company through another company(ies). Common examples of investment include subscription or purchase of shares, warrants, debentures or similar securities. However, purchase of trade receivables, extending credit facilities or making of loans would not count as investment.
‘Not more than two investment companies’?
What is prohibited is routing of investments through more than 2 investment companies. Note that Section 2(87) of the Act read with the Companies (Restriction on Number of Layer) Rules, 2017 restricts creation of more than 2 layers of subsidiaries. On a combined reading of the above, let’s examine whether the following structures are feasible or not.
In the above example, A is investing through 1 investment company (B Ltd.) into another company (D Ltd.) and therefore this structure is permissible.
A is investing through 2 investing companies (B and C Ltd.) into D and therefore the structure is permissible.
In the above example A is investing in E through more than 2 investment companies i.e. through B, C and D. Therefore, the above structure is not permissible as per law
When can it be established that a company has made investment ‘through’ another company?
The primary intent of 186(1) is to capture the conscious call of the investor to route the investment through several intermediary entities and then reach its destination. This has to be seen factually whether the intermediate entity is acting as an investment vehicle for its shareholders or is it making its own independent investment decisions. One may also look at the stake of investment in the investee company to determine whether the investor is using the investee company as a conduit for its own investments. In case an investment company has a diversified portfolio of shareholders, it becomes difficult to establish that the investment company is acting on the instructions of its shareholders. Purpose of the investment can also be used to determine whether the transaction is a bonafide one or not.
In the above example, will A be charged for violation of section 186?
It is the holding company which will be held as having violated the section. The section is applicable to such a scenario where A makes investment through more than 2 layers of subsidiaries. The idea is to trace the investments made by A and thereby keep the structure easy. Thus, when D makes an investment in E, the section will be attracted.
This can serve as an impediment for the other loops in the layers from making further investments out of their own funds. The applicability of this section under such circumstances can be mitigated if it can be proved that the investment in E was out of the own funds of D and not out of the investment made by A.
Ambiguous proviso?
The proviso to Section 186(1) contains two clauses that provide exemptions from its restrictions:
Foreign Company acquisition: If a company acquires a foreign entity that already has investment subsidiaries beyond two layers, the restrictions of Section 186(1) will not apply, provided that such a structure is permitted under the laws of the host country.
Mandatory investment subsidiary: If a company has a subsidiary that is legally required—by any law, rule, or regulation—to establish an investment subsidiary, the restrictions of Section 186(1) will not apply in this case either
Note that in both the above clauses, the word ‘investment subsidiary’ is used and not investment company as used in 186(1). This creates ambiguity regarding the scope of the sub-section. Whether 186(1) is applicable on only investment companies which are subsidiaries? Or is it to extend even to those investment companies which are not subsidiaries? Seemingly restricting the scope of 186(1) only to investment subsidiaries would somewhat defeat the purpose of 186(1) since tracking of funds in a holding-subsidiary structure is far easier than in a non holding-subsidiary relationship.
Rule 3 of the Companies (Restriction on Number of Layers) Rules, 2017 provides a little guidance on the inter-play between 186(1) and 2(87) by providing that the provisions of the rules are not in derogation to the proviso to 186(1). Which means that the so-called exemptions in clause i) and ii) of proviso to Section 186(1) will not get affected by the restriction of 2(87). In other words, restrictions of section 2(87) will not extend to exemptions claimed under clause i) and ii).
The above structure is exempt as per clause i) of proviso to 186(1) and is also permissible under 2(87) since restrictions of 2(87) do not apply to the exemptions of 186(1).
The above structure is breaching the limit of 2 layers of subsidiaries as laid down in 2(87), however since the above is allowed as per clause ii) of proviso to 186(1), the same is permissible under 2(87) as well.
Note that the term ‘not in derogation of’ is not used in the context of 186(1) but only for its proviso. This raises the question whether an investment company which is not a subsidiary will be counted for determining the number of layers under section 2(87) and whether an alternate arrangement of investment companies and subsidiaries can be utilized to create a complex group structure which is seemingly legal.
The above structure is legal as per law since A is investing in E through not more than 2 investment companies. Further, there is no violation of 2(87) since B, C and D are not subsidiaries of A
Similarly, the above structure, which is complicated and may induce diversion of funds, is legal as per law. Since there are only 2 investment companies in the structure and the number of subsidiaries for C is not more than 2.
If we factor in the exemption given to the first layer of WOS, then the above structure is also permissible. All we have to see is whether there are more than 2 investment companies in the structure and whether any one holding company has more than 2 subsidiaries or not.
No restriction on horizontal investments
It is to be noted that 186(1) does not restrict horizontal investments i.e. a company can invest in multiple entities and those entities can further invest in one single entity.
In the above example, there is no restriction on A investing capital through B and C into D since the investment is flowing through a horizontal set of entities. There can be more entities on the level of B and C and it will not be a violation of 186(1) even if those entities are investment companies and/or subsidiary companies of A. What is restricted is the vertical proliferation of investment entities to route funds.
Difference between 186(1) and 2(87)
While the intent of Section 2(87) aligns with that of Section 186(1) in terms of curbing opaque investment structures, the distinction lies in the specific mechanisms each provision seeks to regulate. Section 186(1) aims to restrict the creation of more than two investment companies, whereas Section 2(87) focuses on limiting the formation of more than two subsidiaries. It is clear that an investment company, which is also a subsidiary, would fall under the purview of both of these provisions. However, there are certain differences between the 2 as tabulated below:
Criteria
2(87)
186(1)
Applicability
On all companies except Banking company; Non-banking financial company, Insurance company,a Government company
On all companies.
Restriction on
Holding companies having more than 2 layers of subsidiaries
Investing through more than 2 investment companies
Entity at the end of the loop of the layer
Can be a body corporate
Has to be a company
Criteria of establishing relationship
Subsidiary can be either by way of control of composition of board of directors or by way of investment in total share capital of company
Holding company has to invest through investment companies. Investment can be in any security.
Conclusion
While the intention behind 186(1) is clear – to ensure greater accountability and prevent the concealment of ownership or the diversion of funds through complex, multi-layered corporate setups – the practical implications of this restriction present challenges, especially for businesses with long-established and legitimate vertical investment structures. Additionally, the distinction between Section 186(1) and Section 2(87) of the Act further complicates the regulatory landscape, particularly in terms of the relationship between subsidiaries and investment companies. Clearer guidelines and more specific interpretations of the law will be essential to ensuring its effective implementation without stifling operational flexibility.
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https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-03-10 18:10:562025-03-10 18:11:56Regulatory Updates for the month of February 2025
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2025-02-12 16:55:002025-02-12 20:08:13FAQs on mandatory demat of securities by private companies
Our Resource Centre on Related Party Transactions can be viewed here
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Vinod Kotharihttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngVinod Kothari2025-02-12 04:06:002025-02-12 12:10:34Evolution of concept of related parties and related party transactions
Buyback was considered as one of the most effective means of scaling down of capital by a company and distribution of accumulated profits, until the tax law changes pursuant to the Finance Act, 2024 effective 1st October, 2024. With buybacks becoming ineffective, one may want to look at reduction of capital u/s 66 of the Companies Act, 2013 (‘Act’) as an alternate route for scaling down capital. In fact, the section has been worded in a manner that seems to suggest that the capital reduction procedure u/s 66 can serve various objectives, as also highlighted in various rulings of NCLT and NCLAT, including the Supreme Court.
Manner of capital reduction u/s 66
Section 66 of the Act reads as:
Subject to confirmation by the Tribunal on an application by the company, a company limited by shares or limited by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner and in, particular, may—
XXX
Thus, the opening sub-section of the section seems to suggest that the share capital may be reduced in any manner, as the company may approve by a special resolution, upon confirmation by the NCLT.
However, the section is further followed by clauses specifying the manner in which the capital reduction may be effected.
(a) extinguish or reduce the liability on any of its shares in respect of the share capital not paid-up; or
(b) either with or without extinguishing or reducing liability on any of its shares,—
(i) cancel any paid-up share capital which is lost or is unrepresented by available assets; or
(ii) pay off any paid-up share capital which is in excess of the wants of the company,
alter its memorandum by reducing the amount of its share capital and of its shares accordingly:
(a) Extinguishment of uncalled capital
Clause (a) deals with extinguishment of uncalled capital. Hence, if a company has issued shares at a face value of say, Rs. 10 each, of which Rs. 8 per share has been paid-up, the company may reduce the share capital, by extinguishing the liability towards the uncalled and unpaid capital of Rs. 2 per share.
This results in a reduction in the face value of the share capital, although, no reduction in the voting rights or shareholding percentage of the shareholders, if effected proportionately for all the shareholders.
(b) (i) Cancellation of deteriorated capital
Clause (b)(i) deals with the capital that gets deteriorated on account of the deterioration in the value of the assets. This assists in reflecting the true value of the company by cancelling such value of the capital that is not represented by assets of equivalent value.
For instance, the face value of each share of the company is Rs. 100, represented by assets worth Rs. 80, for each share. In this case, the company may write-off its share capital to the extent of Rs. 20 per share.
(b) (ii) Payment of the excess paid-up capital available with the company
Clause (b)(ii) deals with the payment of capital that is in excess of the requirement of the company. This is similar to Clause (a), except that in case of the former, the capital was unpaid, and hence, there is no cash outflow in the hands of the company. In case of the latter, that is, under Clause (b)(ii), the capital having already been paid by the shareholders, the cancellation of the same requires payment on the part of the company to the shareholders.
Sources of payment for capital reduction
Where capital reduction is on account of the loss in the value of assets, the same would technically, not result in any payment from the company to its shareholders. In other cases, however, there is a cash outflow on the part of the company, and hence, it becomes relevant to understand the sources from which such payment can be made.
Capital reduction essentially means a reduction in the capital of the company, being excess than required, and hence, remaining unutilised. Further, in terms of Section 52 of the Act, the application of securities premium, except for the purpose as specified in sub-section (2) or (3) thereof, as applicable, constitutes a reduction in share capital.
Capital reduction as a means of profit distribution?
A part of the consideration may also be payable from the accumulated profits of the company, thereby, also leading to distribution of profits through capital reduction. However, the same is considered as deemed dividends, for income tax purposes, attracting tax implications, as discussed in later paragraphs below.
Capital reduction for consideration other than cash
The consideration payable on account of capital reduction need not necessarily be paid in cash, the same may also be paid through other means, that is, by distributing property owned by the company. In re Aavishkaar Venture Management Services Private Limited, the NCLT Mumbai affirmed the permissibility of capital reduction for consideration other than cash, against an observation of the Regional Director, Western Region, having reference to other judicial precedents.
Capital reduction by creation of liability in any other form
An extended and striking version of capital reduction for consideration other than cash is the creation of resultant liability in the hands of the shareholders against capital reduction. In Ulundurpet Expressways Private Limited, the NCLT Mumbai rejected the scheme of capital reduction, proposing capital reduction through creation of resultant loan to be repaid to the shareholders over a period of time. It was stated that:
“…the scheme of section 66(1)(b)(ii) of the Companies Act, 2013 only enables a company to pay off excess capital to its shareholders, which is considered in excess of wants of the company. The facts of the case clearly shows that such reduced share capital can not be said to be in excess of wants of the company on the date of passing of special resolution. Accordingly, such reduction is not permissibleunder the terms of Section 66(1)(b)(ii) of the Companies Act, 2013.”
The matter was put to appeal before NCLAT, that reversed NCLT’s order, thereby allowing such a scheme of capital reduction. The appellant had referred to two similar cases where the consideration was to be discharged over a period of time and was kept outstanding as a loan between the Company and its shareholders, and such a scheme had been approved by the NCLT Mumbai. NCLAT referred to various rulings in the context of capital reduction, and concluded that the same is permissible under section 66 allowing capital reduction “in any manner”, being a domestic issue. In Indian National Press (Indore) Ltd (1989) 66 Comp Cas 387 (MP), the High Court held:
“The need for reducing capital may arise in various ways, for example, trading losses, heavy capital expenses, and assets of reduced or doubtful value. As a result, the original capital may either have become lost or a company may find that it has more resources than it can profitably employ. In either case, the need may arise to adjust the relation between capital and assets. The company has the right to determine the extent, the mode and incidence of the reduction of its capital. But the court, before it proceeds to confirm the reduction of capital, must see that the interests of the minority and that of the creditors are adequately protected and there is no unfairness to it, even though it is a domestic matter of the company. The power of confirming or refusing to confirm the special resolution of a company to reduce its capital is conferred on the court in order to enable it to protect the interest of person who dissented or even of persons who did not appear, except on the argument and hearing of the petitioner.”
Other cases where the capital reduction has been effected through creation of liability to be discharged over a period of time include Tamil Nadu Newsprint & Papers Ltd (CP No. 17 of 1995) wherein redeemable non-convertible debentures were issued in consideration for reduction of capital, Dewas Bhopal Corridor Private Limited (CP No. 252 of 2022) and Godhra Expressways Private Limited (CP No. 254 of 2022) etc. NCLAT also cited various judgements stating capital reduction as a matter of domestic concern, discussed in the paragraph below.
Proportionate rule or selective reduction?
A question that has been raised time and again in the context of capital reduction is, whether the same needs to be effected in a proportionate manner for all the shareholders, or whether it can also be structured in a manner so as to selectively reduce/ extinguish the rights of some shareholders, thereby, reducing their overall holding in the company, including a complete buy-out of the minority shareholders.
Ruling disallowing minority buy-out through capital reduction
A recent ruling by NCLT Kolkata (pronounced on 19th September, 2024) in the matter of Philip India Ltd answers the aforesaid question of selective reduction in negative. The judgement considers the two clauses u/s 66(1) to conclude that Section 66 cannot be invoked for buying out the minority stake, and that the petition is liable to be dismissed since “…share capital reduction is only incidental to the main objective of buy back of shares…”
Relevant clause of section 66
Application to the case
Sec 66(1)(a)
Not applicable as the capital reduction is not sought for extinguishing or reducing the share capital that has not been paid-up
Sec 66(1)(b)(i)
Not applicable since nothing has been pleaded to show that the the reduction in share capital is for cancellation of paid-up capital, which is lost or unrepresented by available assets
Sec 66(1)(b)(ii)
Not applicable since it is not pleaded that they wanted to pay off capital which is in excess of the wants of the Company. In fact, there are borrowings/ liabilities in the balance sheet of the petitioner
The matter has been appealed for and currently pending before the NCLAT.
Rulings allowing minority buy-out through capital reduction
While NCLT Kolkata disallowed selective capital reduction, there is a plethora of rulings – both under the existing 2013 Act and the erstwhile 1956 Act, as well as English rulings allowing selective capital reduction, where the same is not unfair or inequitable.
In British and American Trustee and Finance Corporation v. Couper, (1894) AC 399, the House of Lords of England held that:
“…if there is nothing unfair or inequitable in the transaction, I cannot see that there is any objection to allowing a company limited by shares to extinguish some of its shares without dealing in the same manner with all other shares of the same class. There may be no inequality in the treatment of a class of shareholders, although they are not all paid in the same coin, or in coin of the same denomination.”
“…the general rule is that the prescribed majority of the shareholders is entitled to decide whether there should be a reduction of capital, and, if so, in what manner and to what extent it should be carried into effect”
The principle has been followed and restated in various rulings of the Indian courts from time to time.
In Reckitt Berickiser (India) Ltd (2005) 122 DLT 612, the Delhi High Court approved the scheme of capital reduction resulting in paying off the minority public shareholders based on the aforesaid judicial dicta, while also laying down the principles for capital reduction in the following manner:
(i) The question of reduction of share capital is treated as matter of domestic concern, i.e. it is the decision of the majority which prevails.
(ii) If majority by special resolution decides to reduce share capital of the company, it has also right to decide as to how this reduction should be carried into effect.
(iii) While reducing the share capital company can decide to extinguish some of its shares without dealing in the same manner as with all other shares of the same class. Consequently, it is purely a domestic matter and is to be decided as to whether each member shall have his share proportionately reduced, or whether some members shall retain their shares unreduced, the shares of others being extinguished totally, receiving a just equivalent.
(iv) The company limited by shares is permitted to reduce its share capital in any manner, meaning thereby a selective reduction is permissible within the framework of law (see Re. Denver Hotel Co., 1893 (1) Chancery Division 495).
(v) When the matter comes to the Court, before confirming the proposed reduction the Court has to be satisfied that (i) there is no unfair or inequitable transaction and (ii) all the creditors entitled to object to the reduction have either consented or been paid or secured.”
The aforesaid has been referred to in various judgements such as in RS Livemedia Pvt Ltd, and Bombay Gas Company Ltd, thereby answering the question of permissibility of selective capital reduction in affirmative.
On the question of whether the special resolution which proposes to wipe out a class of shareholders (through capital reduction) after paying them just compensation can be termed as unfair and inequitable, the Bombay High Court, in Sandvik Asia Ltd. vs. Bharat Kumar Padamsi (2009) SCC Online Bom. 541 has answered in negative, having reliance on the judgment of the House of Lords in the case of British and American Trustee and Finance Corpn (supra). The Bombay High Court also referred to the judgment of the SC in Ramesh B. Desai v/s. Bipin Vadilal Mehta, (2006) 5 SCC 638 for the same.
“As the Supreme Court has recognised that the judgment of the House of Lords in the case of British & American Trustee and Finance Corporation Ltd. is a leading judgment on the subject, we are justified in considering ourselves bound by the law laid down in that judgment. As we find that there is similarity in the facts in which the observations were made in the judgment in the case of British & American Trustee and Finance Corporation, we will be well advised to follow the law laid down in that case.”
“…Section 66 of the Companies Act, 2013 makes provision for reduction of share capital simpliciter without it being part of any scheme of compromise and arrangement. The option of buyback of shares as provided in Section 68 of the Act, is less beneficial for the shareholders who have requested the exit opportunity.”
The aforesaid ruling does not only permit selective reduction of capital, it expressly puts capital reduction u/s 66 as an alternative to buyback of shares u/s 68 where the former is more beneficial to the shareholders than the latter. The ruling has also been referred to by NCLT Mumbai in Reliance Retail Ltd.
Tax implications on capital reduction
Capital reduction qualify as “transfer” u/s 2(47) of IT Act
In order to qualify for taxability as capital gains, or claiming set-off of capital losses pursuant to a capital reduction, it is necessary that the transaction falls within the meaning of “transfer” u/s 2(47) of the IT Act. The term “transfer” has been defined in the following manner:
“transfer”, in relation to a capital asset, includes,—
(i) the sale, exchange or relinquishment of the asset ; or
(ii) the extinguishment of any rights therein ; or
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The question of whether reduction of capital amounts to ‘transfer’ has been a matter of discussion before courts, including the Supreme Court in several instances. The Supreme Court has, recently (pronounced on 2nd January, 2025), in the matter of PCIT v. Jupiter Capital Pvt Ltd 2025 INSC 38 considered the matter at length and answered in affirmative. In the facts of the case, while the number of shares held by the shareholder assessee had reduced on account of capital reduction, the shareholding pattern remained the same, due to which the Assessing Officer concluded that there is no “extinguishment of rights”, thereby the capital reduction cannot amount as ‘transfer’ u/s 2(47) and no capital losses can be booked by the assessee on the same.
The Supreme Court, having regard to its judgement in previous matters concerning the question of whether capital reduction amounts to transfer, dismissed the petition filed by Revenue, thereby, allowing the assessee to claim capital loss.
Reference was made of the decision of Supreme Court in Kartikeya V. Sarabhai v. Commissioner of Income Tax, (1997) 7 SCC 524, where, on account of capital reduction, the face value of shares were reduced although the number of shares remained the same. The SC, having regard to its another decision in Anarkali Sarabhai v. Commissioner of Income-Tax, Gujarat 138 I.T.R. 437 (pertaining to redemption of preference shares) held that:
“Section 2(47) which is an inclusive definition, inter alia, provides that relinquishment of an asset or extinguishment of any right therein amounts to a transfer of a capital asset. While, it is no doubt true that the appellant continuous of a share capital but it is not possible to accept the contention that there has been no extinguishment of any part of his right as a share holder qua the company. It is not necessary that for a capital asset. Sale is only one of the modes of transfer envisaged by Section 2(47) of the Act. Relinquishment of the asset or the extinguishment of any right in it, which may not amount to sale, can also be considered as a transfer and any profit or gain which arises from the transfer of a capital asset is liable to be taxed under section 45 of the Act.”
The views expressed in Kartikeya V. Sarabhai (supra) was reiterated in the matter of CIT v. G. Narasimhan, 1999 (1) SCC 510.
In Anarkali Sarabhai (supra), it was held that both reduction of share capital and redemption of shares involve the purchase of its own shares by the company and hence will be included within the meaning of transfer under Section 2(47) of the Income Tax Act, 1961. Relevant excerpts are reproduced below:
The view taken by the Bombay High Court accords with the view taken by the Gujarat High Court in the judgment under appeal. In the judgment under appeal, it was pointed out that the genesis of reduction or redemption of capital both involved a return of capital by the company. The reduction of share capital or redemption of shares is an exception to the rule contained in Section 77(1) that no company limited by shares shall have the power to buy its own shares. When it redeems its preference shares, what in effect and substance it does is to purchase preference shares. Reliance was placed on the passage from Buckley on the Companies Acts, 14th Edn., Vol. I, at p. 181: “Every return of capital, whether to all shareholders or to one, is pro tanto a purchase of the shareholder’s rights. It is illegal as a reduction of capital, unless it be made under the statutory authority, but in the latter case is perfectly valid.”
14. The word “extinguishment” is the kingpin of this expression. It is a word of ordinary usage having the widest import. Usually it connotes the end of a thing, precluding the existence of future life therein (see Black’s Law Dictionary, fourth edition, page 696). It has been variously defined as meaning a complete wiping out, destruction, annihilation, termination, cancellation or extinction and it is ordinarily used in relation to right, title, interest, charge, debt, power, contract, or estate (see Corpus Juris Secundum, volume 35, page 294). In Rawson’s Pocket Law Lexicon, the meaning assigned to it is : “the destruction or cessation of a right either by satisfaction or by the acquisition of one which is greater”. In Ramanlal Gulabchand Shah v. State of Gujarat AIR 1969 SC 168 at page 175, the word “extinguishment”, which is employed in conjunction with the expression “of any such rights” in Article 31A of the Constitution, was interpreted as meaning ” complete termination of the rights “.
15. The word “extinguishment” is here used in a similar context, namely, in combination with the expression “of any rights therein”. This expression again has a wide ambit and coverage. The word “therein” refers to “capital asset” mentioned earlier in the definition. So far as the expression “any rights” is concerned, it was observed by this court in Commissioner of Income-tax v. R.M. Amin [1971] 82 ITR 194 at page 201, while interpreting this very provision :
” ……the word ‘ any ‘ is a word which ordinarily excludes limitation or qualification and it should be given as wide a construction as possible, unless, of course, there is any indication in the subject-matter or context to limit or qualify the ordinary wide construction of that word……There being no contrary intention in the subject-matter, or context, the words ‘any rights’ must include all rights……”
16. It was there pointed out that where the capital asset consists of incorporeal property, such as a chose-in-action, the bundle of rights which constitutes such incorporeal property would be comprehended within the meaning of the words “any rights”. It would thus appear that the expression. “any rights therein ” is wide enough to take in all kinds of rights–qualitative and quantitative–in the capital asset.
In view of the judgements cited above, the SC held that:
“…the reduction in share capital of the subsidiary company and subsequent proportionate reduction in the shareholding of the assessee would be squarely covered within the ambit of the expression “sale, exchange or relinquishment of the asset” used in Section 2(47) the Income Tax Act, 1961.”
Distribution of accumulated profits taxable as “dividend”
Reduction of capital results in extinguishment of some rights on the part of the shareholders, and hence, can be construed as “transfer” within the meaning of sec 2(47) of IT Act, resulting in the tax implications u/s 54 (capital gains or loss, as the case may be).
However, as stated above, some part of the consideration may be paid out of the accumulated profits of the company. To that extent, the consideration received by the shareholders is taxable as dividend u/s 2(22)(d) of the IT Act. The section reads as below:
(22) dividend includes –
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(d) any distribution to its shareholders by a company on the reduction of its capital,to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933, whether such accumulated profits have been capitalised or not;
Thus, to the extent the consideration for capital reduction is paid from the accumulated profits of the company, the same would be taxable as dividend in the hands of the shareholders. In Commissioner of Income-Tax v. Urmila Remesh, 230 ITR 422, the Supreme Court clarified that:
Section 2(22) of the Act has used the expression `accumulated profits’ Whether capitalised or not”. This expression tends to show that under Section 2(22) it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of the share-holders. By using the expression “whether capitalised or not” the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts should, in other words, be in the nature of profits which the company could have distributed to its share-holders. This would clearly exclude return of part of a capital to the company, as the same cannot be regarded as profit capable of being capitalised, the return being of capital itself.
This was further reiterated in the matter of G. Narasimhan (supra).
Whether the new buyback taxation rule applies on capital reduction?
In various rulings, capital reduction has been employed as a means to buy back the shares of the minority investors. Therefore, a question arises on whether the new taxation rule on buyback (refer our article here) would apply to capital reduction as well.
Here, reference may be made to the language of Section 2(22)(f) of the IT Act, that reads as:
(f) any payment by a company on purchase of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013 (18 of 2013)
The provision, thus, clearly refers to buyback u/s 68 of the Act, whereas, capital reduction is effected u/s 66 of the Act. On the other hand, distribution of profits on capital reduction is explicitly covered u/s 2(22)(d) of the IT Act. Hence, there is no reason one should take a view that the new rules on taxation of buyback also extends to capital reduction.
Illustration showing tax implications upon capital reduction
The below table contains a few illustrations with respect to the tax implications upon reduction of capital.
Sl. No.
Particulars
Part consideration from accumulated profits & Capital gains
Capital loss on account of capital reduction
No consideration paid on capital reduction
Amount (Rs.)
Amount (Rs.)
Amount (Rs.)
A.
Consideration received on capital reduction
1,00,000
10,000
–
B.
Amount paid out of accumulated profits
30,000
–
–
C.
Amount taxable as deemed dividends u/s 2(22)(d) [(B)]
30,000
–
–
D.
Cost of acquisition of shares
20,000
20,000
20,000
E.
Amount taxable as capital gains/ (loss) [(A) – (C) – (D)]
50,000
(10,000)
(20,000)
Conclusion
The aforesaid discussion reveals how capital reduction has been given the widest possible meaning by the courts and tribunals, in the interpretation of the expression “in any manner”. Capital reduction can be used in scaling down the capital in any manner, so long as the same is (i) not unfair or inequitable to the shareholders and creditors, and (ii) duly approved by the shareholders through a special resolution. Though the process requires an approval of NCLT, the role of the Tribunal is supervisory in nature, since the matter is one of “a domestic affair”.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Payal Agarwalhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngPayal Agarwal2025-01-30 16:55:312025-01-31 23:52:15Reduction of capital - an alternate to buyback and minority exit?
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