CSR: A ‘Corporate Social Responsibility’ or a ‘Corporate Social Compulsion’?

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Analysis of Companies (Amendment) Act, 2019

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Highlights of Companies (Amendment) Bill, 2019

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by Vinod Kothari 

The Companies (Amendment) Bill, 2019 has been placed before the Parliament[1] on 25th July, 2019. While the Bill, 2019 is largely to enact into Parliamentary law the provisions already promulgated by way of Presidential Ordinance, the Bill also brings some interesting changes.

The key feature of the Bill is to replace the existing system of judicial prosecution for offences by a departmental process of imposition of penalties. As a result, while the monetary burden on companies may go up, but offenders will not be having to face criminal courts and the stigma attached with the same.

Some of the other highlights of the changes are as follows:

Dematerialisation of securities may now be enforced against private companies too

It is notable that amendments were made by the Companies (Amendment) Act, 2017 effective from 10th September, 2018 effective from 2nd October, 2018, whereby all public unlisted companies were required to ensure that the issue and transfer of securities shall henceforth be done in dematerialised mode only. This provision alone had brought about major cleansing of the system, as in lots of cases, shareholding records included men of straw.

However, the reality of India’s corporate sector is private companies, constituting roughly 90% of the total number of incorporated companies.

The provision of section 29 is now being extended to all companies, public and private. This means, that the Govt may now mandate dematerialisation for shares of private companies too. Whether this requirement will be made applicable only for new issues of capital by private companies, or will require all existing shares also to be dematerialised, remains to be seen, but if it is the latter, the impact of this will be no lesser than “demonetisation-2” at least for the corporate sector. Evidently, all shareholders of all private companies will have to come within the system by getting their holdings dematerliaised.

CSR is now mandatory, and unspent amounts will go to PM’s Funds

When the provision for corporate social responsibility was introduced by Companies Act 2013, the-then minister Sachin Pilot went public to say, the provision will follow what is globally known as “comply or explain” (COREX). That is, companies will not be mandated to spend on CSR – the board report will only give reasons for not spending.

Notwithstanding the above, over the last few months, registry offices have sent show-cause notices to thousands of companies for not spending as required, disregarding the so-called reasons given in the Board report.

Now, the rigour being added takes CSR spending to a completely different level:

  • If companies are not able to spend the targeted amount, then they are required to contribute the unspent money to the Funds mentioned in Scheduled VII, for example, PM’s National Relief Fund.
  • Companies may retain amounts only to the extent required for on-going projects. There will be rule-making for what are eligible on-going projects. Even in case of such on-going projects, the amount required will be put into a special account within 30 days from the end of the financial year, from where it must be spent within the next 3 years, and if not spent, will once again be transferable to the Funds mentioned in Schedule VII.
  • Failure to comply with the provisions makes the company liable to a fine, but very seriously, officers of the company will be liable to be imprisoned for upto 3 years, or pay a fine extending to Rs 5 lacs. Given the fact that the major focus of the Injecti Srinivas Committee Report, which the Ordinance tried to implement, was to restrict custodial punishment only to most grave offences involving public interest, this by itself is an outlier.

Unfit and improper persons not to manage companies

The concept of undesirable persons managing companies was there in sections 388B to 388E of the Companies Act, 1956. These sections were dropped by the recommendations of the JJ Irani Committee. Similar provisions are now making a comeback, by insertions in sections 241 to 243 of the Act. These insertions obviously seem a reaction to the recent spate of corporate scandals particularly in the financial sector. Provisions smacking similar were recently added in the RBI Act by the Finance Bill.

The amendment in section 241 empowers the Central Govt to move a matter before the NCLT against managerial personnel on several grounds. The grounds themselves are fairly broadly worded, and have substantial amplitude to allow the Central Govt to substantiate its case. Included in the grounds are matters like fraud, misfeasance, persistent negligence, default in carrying out

obligations and functions under the law, breach of trust. While these are still criminal or quasi-criminal charges, the  notable one is  not conducting the business of the company on  “sound business principles or prudent commercial practices”. Going by this, in case of every failed business model, at least in hindsight, one may allege the persons in charge of the management were unfit and improper.

Once the NCLT has passed an order against such managerial person, such person shall not hold as a director, or “any other office connected with the conduct and management of the affairs of any

Company”. This would mean the indicted person has to mandatorily take a gardening leave of 5 years!

Disgorgement of properties in case of corporate frauds

In case of corporate frauds revealed by investigation by SFIO, the Govt may make an application to NCLT for passing appropriate orders for disgorgement of profits or assets of an officer or person or entity which has obtained undue benefit.

[1] https://www.prsindia.org/sites/default/files/bill_files/Companies%20%28Amendment%29%20Bill%2C%202019_0.pdf

Employee share based payments: Understanding the taxation aspects

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By Rahul Maharshi (rahul@vinodkothari.com), (finserv@vinodkothari.com)

Introduction

Employee share based payments (ESBPs) are an effective way of incentivising employees. ESBPs work as a two way growth strategy for both company as well as the employees. On one hand, it helps the employees to participate in the growth of the entity and in turn reap out the benefits from it, on the other hand it helps the entity to boost the growth rate and align the vision of the employees with that of the company. The ESBPs work as a catalyst for the employee growth as well as the growth of the company.

The theme of this article revolves around the taxation aspects of different types of ESBPs, but before we proceed further, let us have a quick understanding about the different types of ESBPs. Read more →

Applicability of NFRA Rules on overseas subsidiaries and associates: Conflict between the Rules and FAQs

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Pammy Jaiswal

Partner, Vinod Kothari and Company

 

Background

National Financial Reporting Authority (‘NFRA’) being a quasi-judicial authority has been empowered by the Central Government to independently regulate and monitor the accounting and auditing standards (‘A&AS’). The intent of NFRA is to oversee the quality of A&AS of large entities as mentioned under Rule 3 (1) of the NFRA Rules.

Evidently NFRA intends to oversee the A&AS of large entities in terms of being listed or the size of the company or being functionally different entities like electricity companies or insurance companies, etc. Such entities have the presence of its subsidiaries and associates all around the world which may be contributing materially in terms of Rule 3 (1) (e) of the NFRA Rules to the net worth and turnover of the Indian parent entity.

While the last date for filing one time return by bodies corporate is approaching fast i.e. 31st July, 2019, there seems to a lot of ambiguity in the applicability of the NFRA Rules.

This note has been prepared with the intent to showcase the conflict between the provisions of the Companies Act, 2013 (‘Act’) read with its allied Rules and the FAQs issued by NFRA.

Various Provisions of the Act applying to bodies corporate

  • Applicability section of the Act

The first section of the Act laying down the applicability of the Act clearly mentions the following under clause (f) of sub-section (4) – “such body corporate, incorporated by any Act for the time being in force, as the Central Government may, by notification, specify in this behalf, subject to such exceptions, modifications or adaptation, as may be specified in the notification.”

This provision makes it very clear that the Ministry of Corporate Affairs (‘MCA’) has been vested with the powers of applying the provisions of the Act to any bodies corporate. Further, the provision is also quite clear that such body corporate may be either incorporated under the Act or any other Act. This implies that even for foreign companies, the MCA has the power to apply the provisions of the Act subject to the changes as may be notified.

  • Definition of the term body corporate

Section 2 (11) defines the term ‘body corporate’ to include a company incorporated outside India. Here also, the intent of law is explicitly clear to cover the bodies corporate governed by foreign laws.

  • Chapter 22 of the Act

Section 379 (2) of the Act provides that a foreign company which is substantially owned and controlled by an Indian citizen or by an Indian company is required to comply with the provisions of the Act as mentioned thereunder.

Areas of conflict

While the consolidated financial statements of the Indian parent entities include the accounts of the subsidiaries and associates also, it cannot be argued that the quality of auditing and accounting is anywhere less relevant than the A&AS of the Indian parent. Therefore, it seems in fitness of things under clause (e) of Rule 3 (1) of the NFRA Rules to include foreign subsidiary and associates if they fulfil the condition of materiality under the said Rules (foreign subsidiaries and associates whose income or net worth exceeds 20% of the consolidated income and net worth of the Indian parent [‘material subsidiaries and associates]).

However, the FAQs[1] issued by NFRA have taken a different stand altogether with respect to the applicability of the NFRA Rules. It states that only those material subsidiaries and associates are covered under the scope which are having place of business in India.

While it sounds very surprising that if this wouldn’t have been the case, the condition of the foreign subsidiaries and associates which has an Indian parent, doing business back in India is very unlikely.

In any event, if merely by not having a business in India absolves the material subsidiaries and associates from the overview of the NFRA that would frustrate the whole intent and objective of the NFRA and allow such subsidiaries and associates to escape from the regulation of NFRA by virtue of the additional clause in the FAQs.

It seems that this condition of having business in India should have either be mixed with section 379 of the Act which talks about foreign companies having business in India or should may have actually been intended to be referred to the Indian parent’s business in India.

Further, if the question is one of jurisdiction as of how the Act extends its application to foreign bodies corporate not having business in India is concerned, it may be noted that section 1 (4) of the Act allows the Central Government to extend the provision of Act to bodies corporate, and it may therefore, it may be construed that in a manner of speaking is actually extended to foreign bodies corporate which have a business connection in India by virtue of having an Indian parentage.

Conclusion

One of the major questions in front of the stakeholders is the jurisdiction of NFRA which the FAQs have seemingly restricted to bodies corporate having place of business in India. However, considering the other provisions of the Act, it is quite clear that NFRA has been constituted not only to govern the auditors registered in India but also those in abroad as MCA has left number of provisions open under the Act which applies to bodies corporate.

If one interprets the applicability of NFRA on Indian bodies corporate, the whole intent and object of setting this regulatory body will get frustrated.

Related articles –

  1. https://vinodkothari.com/2019/07/faqs-on-national-financial-reporting-authority-nfra-rules-2018/
  2. https://vinodkothari.com/wp-content/uploads/2019/07/MCA-Notifies-NFRA-Rules.pdf

 

[1] https://nfra.gov.in/sites/default/files/FAQ.pdf

FAQs on National Financial Reporting Authority (NFRA) Rules, 2018

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MCA set to deploy the eForm for reporting details of SBOs

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Ambika Mehrotra

corplaw@vinodkothari.com

Background

Amendment to Section 89 and insertion of Section 90 are one of the key amendments brought in by the Companies (Amendment) Act, 2017 (‘Amendment Act’).  The said provisions were enforced w.e.f. June 14, 2018and Companies (Significant Beneficial Owners) Rules, 2018 were notified[1] (‘SBO Rules’). MCA, thereafter, issued General Circular No 7/ 2018[2]for extending the last date of filing eForm BEN-2 and 08/ 2018[3] to the effect that the format of declaration to be submitted by Significant Beneficial Owner (SBO) will undergo revision.

MCA on February 8, 2019[4] amended SBO Rules by amending the definition of significant beneficial owner. The due date for submission of declaration in Form BEN-1 was 90 days from the said amendment. However, eForm for filing the said declaration with MCA was not made available.

MCA, on July 1, 2019, issued Companies (Significant Beneficial Owners) Second Amendment Rules, 2019[5]thereby notifying eForm BEN-2 required to be submitted by companies.

Scope of Section 90

Section 90 focuses on the identification of a ‘significant beneficial owner’ through his ‘indirect holdings’ in an entity, which is to be considered only where the individual has majority interest in the vehicle holding stake in the “reporting company”, or in the ultimate holding entity of such holding vehicle. That is to say, simply direct holding or direct control, or direct significant influence (without any indirect holdings) were not required to be reported as significant beneficial interest under the Rules, irrespective of the magnitude of direct holding. Therefore, the direct holding of interest by an individual is relevant only if the direct holding may be clubbed with indirect holding.

Onus of making the declaration

The individual holding significant beneficial interest by virtue of holding shares or voting rights or right to distributable dividend or exercising significant influence was required to furnish the declaration in Form No. BEN-1 within 90 days of February 8, 2019 and thereafter in case of any change, to the reporting company. Herein, the onus lies on the individual to come forward and submit the declaration. The reporting companies on the other hand were required to give notice to members (other than individual) holding 10% or more of participating interest [either of shares, voting rights, or right to receive or participate in the dividend or any other distribution],  seeking information about the individual who is significant beneficial owner in the reporting company in Form BEN-4.

It is pertinent to note that the obligation of the individual to self-declare his significant beneficial holdings and the obligation of the company to send notice seeking information from members in terms of Rule 2Aare independent obligations.

Intimation to the ROC by the reporting entity

As per the SBO Rules as amended from time to time, the declaration of beneficial interest is required to be filed in e- Form BEN-2 with the Registrar in respect of such declaration, within a period of thirty days from the date of receipt of declaration by the company.

With the deployment of e-Form BEN -2 vide Companies (Significant Beneficial Owners) Second Amendment Rules, 2019, the Companies shall be required to intimate the same to the Registrar within 30 days of its deployment.

Companies are facing difficulty in identification of SBO in view of complex structures. Until receipt of declaration in Form BEN-1, companies will not be able to file eForm BEN-2.

Consequences of non-filing

Section 90(11) of the Act, 2013 provides for penal provisions for the failure of the part of the company and every officer in default in complying with the provisions of Section 90(4) i.e. filing of the above return  and changes therein with the Registrar with a fine:-

  • For company and every officer in default:- Rs. 10 Lakhs – Rs. 50 Lakhs
  • For Continuing default: – Upto Rs. 1000 for every day after first day of failure.

Analysis of e-Form BEN -2

  • Declaration of holding reporting company

 Pursuant to Rule 8 of the SBO Rules, which states that the rules are not applicable to the extent the shares of the reporting company is held by its holding reporting company. It is presumed that the SBO of the holding company is also the SBO of the subsidiary company for the shares held by the holding company.

First bullet of Field no. 3 requires the companies to report the details of such holding reporting company which shall be mapped through the CIN of such company.

  • Requirement to furnish copy of agreement

 In order to specify the manner in which significant beneficial interest is being held or exercised either indirectly or together with any direct holding or right, the form requires attachment of agreement in following cases:

  1. Exercise of control
  2. Exercise of significant influence

 This might be a serious constraint, as it may not be necessary that the companies might have in place a written and executed agreement specifying the control and/ or significant influence exercised by the members. However, at present the mode of mapping of control and/ or significant influence has only been done through the agreement to be attached in the form.

Conclusion

While, the eForm BEN-2 seems a derivative of the format of declaration Form BEN no. 1, companies will be able to report correctly subject to receipt of accurate declarations from the SBOs.

Other practical difficulties in reporting in the eForm can be ascertained once the eForm is deployed on MCA portal.

 

Other related articles on SBO can viewed here-

https://vinodkothari.com/2019/02/mca-revisits-sbo-rule/

https://vinodkothari.com/wp-content/uploads/2019/03/Final-FAQs-on-revised-SBO-Rules_17.03.2019-1.pdf

https://vinodkothari.com/wp-content/uploads/2019/03/Guide-to-identification-of-SBO-in-your-Company.pdf

https://vinodkothari.com/2019/02/new-sbo-rules-illustrations/

https://vinodkothari.com/wp-content/uploads/2019/02/Amended-SBO-Rules.pdf

 

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

[2]http://www.mca.gov.in/Ministry/pdf/GeneralCircularNo.7_06082018.pdf

[3]http://www.mca.gov.in/Ministry/pdf/GCCircularBen_10092018.pdf

[4]http://www.mca.gov.in/Ministry/pdf/CompaniesOwnersAmendmentRules_08020219.pdf

[5]http://www.mca.gov.in/Ministry/pdf/CompaniesSignificantRules_01072019.pdf