Variable Capital Companies 

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Payal Agarwal l payal@vinodkothari.com

The Union Budget 2024 refers to permitting a flexible mode for financing leasing of aircrafts and ships, and pooled funds of private equity through a variable capital company (VCC) structure. Variable Capital Companies (VCCs), as the name suggests, are companies in which the capital is not static, that is to say, the investor has the option to withdraw capital based on the satisfaction of certain conditions. In a traditional company form of entity, the capital is static, and any reduction in capital (except buyback upto a specified extent), attracts specific procedure, including most importantly, approval from NCLT and other regulatory/ statutory authorities. 

Read more: Variable Capital Companies 

Globally, similar structures exist in various countries, known by different names, such as – Variable Capital Companies in Singapore and Mauritius, Open Ended Investment Companies (OEIC) in the UK, and a specific form of collective asset management companies in Ireland and Luxembourg. 

In the context of India, the discussions around VCC are not new, the IFSCA has been exploring opportunities to bring a legislative framework for incorporation of the VCC form of entity. In fact, an Expert Committee, under the Chairmanship of Mr M S Sahoo, had released a report providing recommendations for bringing a legal framework for VCCs in IFSC in October, 2022. 

What are VCCs?

VCCs are a relatively new form of corporate structure, an investment vehicle housing multiple funds under one entity, while ringfencing the asset pools of each sub-fund distinctly – like a Protected Cell Company (PCC).

In jurisdictions such as Mauritius, the VCC has an option to elect to have a separate legal identity for each of its sub-fund, however, the same would require each sub-fund to be incorporated as a separate company. Even if the sub-funds are not incorporated as separate legal entities, their properties remain distinct from the umbrella fund (VCC) and any liability attributable to a specific fund is discharged solely from the assets of such a sub-fund. 

Most importantly, as the name suggests, these structures have a flexibility on pay-outs to the investors. Such flexibility is provided in the form of permitting redemption of the shares of the fund at any time at a price related to the net present value of the scheme property, subject to the shares being fully paid-up. 

Introduction of VCCs in IFSC 

The Report recommended VCC structure to be first introduced in IFSCs owing to the preparedness of international players in dealing with such structures since VCC structures are already existent in various other jurisdictions. Based on the functioning of the VCC-structure in IFSCs, the same may be subsequently introduced in the domestic Indian financial system too. 

Regulatory framework for VCCs in IFSC

Under the IFSC regulatory ecosystem, VCCs are proposed to be recognised under the IFSCA Act, 2019. Additionally, the activities of the VCC should be governed by the IFSCA (Fund Management) Regulations, 2022. 

The Report suggests a VCC to be incorporated as a company, and the sub-funds thereof to derive their character from the VCC instead of being recognised as separate legal persons. There is a segregation of assets and liabilities at each sub-fund level, and as such, each sub-fund is bankruptcy remote from the insolvency proceedings initiated against another sub-fund. 

Conditions w.r.t. “variability” of capital in VCC 

Unlike a company which has a fixed paid-up capital, in case of a VCC, the paid-up capital, at all times, reflects the value of the net assets of the VCC. 

The Report suggests VCCs may raise funds in both equity and debt form, issuing different classes of equity and debt securities to represent the interest of the holder in the specific sub-fund to which the securities relate to. The Report also proposes the introduction  of “management shares” and “participating shares”, similar to the concept already prevalent in Singapore.

The recommendations suggest redemption of participating shares, carrying economic rights, at the net asset value of the scheme, subject to the shares being fully paid-up. On the other hand, for management shares, containing voting rights, the same is proposed to be irredeemable, however, the VCCs should have an option to buyback such shares with requisite approvals and following due procedure. 

In view of the flexibility that VCC provides, the structure is getting increasingly popular. In Singapore, since the launch of provisions around VCCs in 2020 vide the Variable Capital Companies Act, 2018 in January, 2020, a total of 969 VCCs have been incorporated till 2022, representing around 2000 sub-funds. 

Read our other articles on Union Budget 2024

  1. Union Budget 2024: Did it hit the mark?
  2. Bye bye to Share Buybacks
  3. Scaling up skilling by using CSR funds: Any takers?

Union Budget 2024: Did it hit the mark?

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Team Finserv and Corplaw | finserv@vinodkothari.com

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Read our other publications on the Budget 2024:

  1. Bye bye to Share Buybacks
  2. Scaling up skilling by using CSR funds: Any takers?
  3. Variable Capital Companies

Simplifying the KYC process and business identifier

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Anita Baid, Vice President | finserv@vinodkothari.com

Backdrop

The regulations for conducting customer identification and due diligence by financial sector entities have been laid down by RBI and SEBI, in accordance with the provisions of Prevention of Money Laundering Act and Rules. Under the current regime, the KYC process extends from physical KYC to digital and video-based KYC as well. The physical process of collecting KYC documents and verifying the same involves a lot of paperwork. On the other hand, the Digital KYC Process is a facility that allows lenders to undertake the KYC of custom​​ers via an authenticated application, specifically developed for this purpose, hence making it a paperless process. The Digital KYC process, however, also requires physical interaction. Video-based KYC is both paperless and without any physical intervention.

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Budget 2023 and Gift IFSC: Making Things Happen

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Anirudh Grover, Executive | finserv@vinodkothari.com

Background and Existing Framework

The International Financial Services Centre (“IFSC”) situated in the GIFT city is deemed to be a quasi-foreign territory from the lens of Foreign Exchange Management Act, 1999 however a domestic area under the tax regime. The objective of setting up specified territory lies in the benefits an IFSC jurisdiction provides in the form of free flow of foreign transactions and investor confidence; this setting up is commonly termed as onshoring the offshore. 

In order to materialize the underlying objective, a specific regulatory framework has been designed which includes the incorporation of the following major entities:

  1. Finance Companies: The concept of Finance Companies are pari materia to the concept of non-banking financial companies, the unified regulator IFSCA has issued regulations specifically dealing with the concept of Finance Companies. The detailed write up of which can be found in our write up.
  2. Fund Management Entities (‘FMEs’): FMEs are entities which act as pooling vehicles for various kinds of investors, this concept of FME’s is equivalent to the concept of Alternative Investment Fund. A designated regulatory framework has been specially established by the unified regulatory for governing the framework of FMEs in IFSC, the details of which can be captured from our write up
  3. Banking Units: As far as Banking Units are concerned, the IFSCA has outlined a framework through which Indian banks or foreign banks can set up their shop in the form of branches in IFSC GIFT City. The IFSCA (Banking) Regulations, 2020 are the principal regulations governing the Banking Units established in the IFSC GIFT City. My colleague has already covered the regulatory overview on this aspect in our write up. 

Apart from these entities there are other entities as well which are running their businesses from IFSC GIFT City which includes Fintech Entities, Capital Market Intermediaries and Insurance Intermediaries. The Union Budget of 2022 paved the way for bringing fundamental changes in the IFSC jurisdiction which resulted in the establishment of a regulatory framework namely IFSCA (Setting up and Operation of International Branch Campuses and Offshore Education Centres) Regulations, 2022. By virtue of these regulations now Foreign Universities have been allowed to set up their base in IFSC. Further the Union Budget 2022 also laid the ground for establishment of an Arbitration Centre which would allow disputes to be resolved in record time. 

Albeit these announcements came out to be a key in evincing interest in the IFSC jurisdiction however it is perceived that there are certain pivotal areas of law which require further modifications/clarifications which is expected to be a part of the Union Budget of 2023.

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National financial information repository: One more or one for all?

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– Lovish Jain, Executive | lovish@vinodkothari.com

Some days ago, Mr. Vinod Kothari had commented on a LinkedIn post :

“Do we realise how many places does a lender (NBFC, Bank) register information about a loan? There are 4 credit information companies (such as CIBIL) where the credit data, including performance history, is uploaded. If the exposure is Rs 5 crores or above, in the aggregate over the banking system, information goes on CRILC too.

RBI has recently written to NBFCs reminding them of the obligation to register details with NeSL, an information utility under IBC, irrespective of whether the provisions of Code apply (for example in case of individuals), or whether the lender in question is at all contemplating resorting to IBC as a remedy (for example, consumer loans).

If the loan is a secured loan, the details need to be filed with CERSAI. If the secured loan borrower is a company, details need to be filed with RoC too. If the security interest is on immovable property, one needs to file particulars with land registry. If the security interest is on motor vehicles, the hypothecation is registered with Vahan portal too.

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A shocker for the bond markets: Withholding tax to apply on listed bonds, without grandfathering 

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Team Financial Services | finserv@vinodkothari.com

Section 193 of the Income Tax Act[1] provides for TDS payment in case of interest on securities. Currently listed debentures are exempt from TDS without any limit. The exemption comes way of clause (ix) of the proviso to sec. 193.

The said clause is now sought to be deleted. The deletion, if affirmed by the statute, will be effective from 1st April, 2023, thereby meaning that any interest paid by companies on listed bonds will now be subject to tax.

The amendment has a retroactive effect, as it applies even to bonds that may have already been issued. If the issuer and the investor have both entered into a securities transaction on the strength of the law then existing, and the bondholder suddenly comes under the purview of deduction of tax at source, this will be like acquiring a security with no safe harbor. It is notable that certainty of tax treatment for capital market transactions is an essential mainstay for the healthy growth of capital markets.

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Corporate law changes: small steps towards procedural simplification 

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– Anushka Vohra, Manager | corplaw@vinodkothari.com

The Budget 2023, proposes certain amendments, partly towards ease of doing business, and partly for certain rationalization measures.

The major amendments proposed are as follows:

  1. CSR expense not to result into GST set off

We had in our previous article, dealt with the question whether,GST paid, while acquiring goods or services for CSR activities would give rise to an input tax credit. Section 17(5)(h) of the CGST Act excludes “goods lost, stolen, destroyed, written off or disposed of by way of gift or free samples” for the purpose of availing ITC on payment of GST. The term ‘gift’ is not defined anywhere in the CGST Act. However, in layman’s language, gift means a thing given willingly to someone without payment.

While, there isn’t any explicit clarification to say whether input tax credit will be available or not, we relied on certain judicial pronouncements, some of which confirmed the availability of ITC benefit, and some denied it.

The Budget 2023, proposes that section 17(5) of the CGST Act shall be amended to the effect that input tax credit shall not be available in respect of goods or services or both received by a taxable person, which are used or intended to be used for activities relating to his obligations under corporate social responsibility referred to in section 135 of the Companies Act, 2013.

Hence, in case of the company being subjected to the obligation of spending on CSR, the GST benefit will be denied to the company. The expression is clearly related to the obligation under CSR in terms of sec. 135 – therefore, this denial of ITC benefit will be applicable only in case of the company.

The effective date of the amendment will be 1st April, 2023. Hence, once the Budget proposals are passed, any acquisition of goods or services for CSR purposes will be denied the benefit of GST set off.

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Meeting priority sector lending shortfalls: One more option

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Aanchal Kaur Nagpal, Manager | finserv@vinodkothari.com

Background

All scheduled commercial banks (including Regional Rural Banks and Small Finance Banks) are required to undertake priority sector lending. RBI mandates PSL to account for at least 40% of a bank’s Adjusted Net Bank Credit (ANBC) or Credit Equivalent of Off‐Balance Sheet Exposure whichever is higher, in accordance with the RBI PSL guidelines[1].

The intent behind prescribing PSL limits for banks is to enable certain sections of the society, though fairly credit-worthy but unable to obtain credit from the formal financial/ banking system, to access adequate credit. These sectors do not seem to be economically lucrative but are indispensable for the overall development and growth of India’s economy.

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Finance Bill 2023 amends section 56(2)(viib): How will it impact the startups?

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– Abhirup Ghosh, Partner | finserv@vinodkothari.com

Background

The Finance Bill 2023 has proposed amendments to section 56(2)(viib) of the Income Tax Act, which deals with tax on closely held companies for issuance of shares to residents at a premium where the shares are issued at a value higher than the fair market value. The objective of the change is to expand the scope of the section and bring shares issued to non-residents into the reach of the section. This proposal will particularly hit start-ups, which mostly issue equity shares and compulsorily convertible preference shares (CCPS) to their investors, and in most of the start-ups, at valuations which are far higher than the fair values at the time of issuance. 

Before we discuss the impact of the section, let us first understand the scope of the section at length.

Also, it is important to note that the focus of this article is to examine the potential impact of the amendment on startups, since, the majority of the foreign investments into closely held companies flow into the startups, therefore, this section will mostly affect the startup segment.

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The Munis of India: Facilitating municipal bonds

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Rhea Shah, Executive | finserv@vinodkothari.com

India may be said to be the land of munis and rishis; however, when it comes to what the capital markets know as munis, namely, municipal bonds, India lags substantially behind other bond issuing jurisdictions. The Municipal Bonds market is still at the nascent stage, thereby requiring a robust regulatory framework and other regulations to be in place for its effective functioning. Issued by municipal authorities and government entities to meet their day-to-day operational needs, munis in the Indian market context are generally seen as a favourable investment to make.   Our detailed articles on the subject may be viewed here[1].

Munis in the Economic survey

As per the Economic Survey, the yields of municipal bonds during the year 2022-2023 have seen a significant rise, thereby enhancing investors’ interest in the market. The Union Budget was expected to bring about favorable outcomes for munis thereby having an effect of promoting the further development of the market and simultaneously ensuring its due regulation.  In the recent period, there has been a resurgence of municipal bond issuances in India, with nine MCs raising around ₹3,840 crore during 2017-21.

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