Posts

Ratification of RPTs:  a rescue ship or an alternative to compliance?

/0 Comments/in , , , , /by
– 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:

  1. Does ratification effectively rectify non-compliance arising from the failure to obtain prior approval?
  2. What happens if the required conditions for ratification by the AC are not fulfilled?
  3. 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.”

Further, the Apex Court, in the matter of Maharashtra State Mining Corporation v Sunil S/O Pundikaro Pathak [2006 (5) SCC 96] reiterated the principle of ratification:

“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.”

As explained by the Bombay High Court in Pravinkumar R. Salian v. Chief Minister and Minister of Co-operation, Mumbai [2004(2)MHLJ12],[1] The essential conditions for a valid ratification include the following:

  • 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 –

  1. An act which is ultra-vires the company cannot be ratified.[2]
  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]
  3. Acts can be ratified by passing a resolution.[4]
  4. There can be no ratification without an intention to ratify.[5]
  5. The person ratifying the act must have complete knowledge of the act.
  6. Ratification relates back to the date of the act ratified i.e., has retrospective effect.[6]
  7. 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:

  1. The SEC Regulations do not prescribe the requirements with respect to approval, review or ratification, however, companies are required to have policies and procedure in place for dealing in RPTs, viz., approval, review and ratification of RPTs [Item 404(b)(1) of SEC Regulation S-K], to be disclosed as a part of non-financial reporting.  
  2. 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.
  3. 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.
  4. 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

BasisListing RegulationsCompanies Act, 2013
Governing ProvisionReg. 23(2)(f)Section 177(4)
Authority to ratifyIndependent directors forming part of the ACAll members of the AC
Permitted valueRs 1 crore, aggregated with all ratifiable transactions during a FYRs 1 crore per transaction
Prescribed timelinesEarlier of:
– 3 months from date of transaction – Next AC meeting		Within 3 months from the date of transaction
What if the value / timeline is exceededTransaction shall be voidable at the option of the AC
Disclosure requirementsDetails of ratifications to be disclosed along with the half-yearly disclosures of RPTs under Reg. 23(9)No additional disclosures prescribed
Ratification of material RPTsAC does not have the authorisation to ratify material RPTsNA  
Consequences of not getting AC approval for RPTThe 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:

  1. 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.

  1. 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.

  1. 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.

It should be noted that w.e.f. April 1, 2025, pursuant to the Industry Standards Note on minimum information to be placed before the Audit Committee, Minimum Disclosures as prescribed therein is required to be placed before the Audit Committee.

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.

  1. 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 in Premier 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.

  1. 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.

  1. 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 be made invalid or nullified, and void means something that is invalid or null. 

In Pankaj Mehra v. State of Maharashtra [2000 (2) SCC 756], the Supreme Court drew a distinction between “void” and ‘voidable’:

“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.

[1] (2004) 2 MahLJ 12.

[2] Rajendra Nath Dutta and Ors. V. Shibendra Nath Mukherjee and Ors., (1982) 52 CompCas 293 Cal.

[3] Rajendra Nath Dutta and Ors. V. Shibendra Nath Mukherjee and Ors., (1982) 52 CompCas 293 Cal.

[4] Bulland Leasing & Finance Pvt. Ltd. v. Neelam Miglani, Delhi District Court, CC No.: 470664/16, 2018,

[5] Sudhansu Kanta v. Manindra Nath, AIR 1965 Pat 144.

[6] Parmeshwari Prasad Gupta v. Union of India, 1973 AIR 2389.

[7] New Fleming Spinning And Weaving Company Ltd. v.  Kessowji Naik, (1885) ILR 9 Bom 373.

Read more:

Bo[u]nd to ask before transacting: High value debt issuers bound by stricter RPT regime

FAQs on Standards for minimum information to be disclosed for RPT approval

Related Party Transactions- Resource Centre

Broadening the MSME landscape: Impact of revised limits

/0 Comments/in , , /by

– Sourish Kundu, Executive | corplaw@vinodkothari.com

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: 

CategoryInvestment in Plant and Machinery or Equipment (₹ crores)Annual Turnover (₹ crores)
CurrentRevisedCurrentRevised
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:

  1. 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.  

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

Read more on MSMEs here:

The big buzz on small business payment delays

Primer on MSME Financing

Resources on MSME financing

FAQs on mandatory demat of securities by private companies

/1 Comment/in , , /by
FAQs on demat by private companiesDownload

You may refer to our other FAQs on dematerialization of shares here and you may also refer to our Snippet, detailed article and YouTube Video

SEBI revisits RPT regime for subsidiaries

/0 Comments/in , , , /by

Changes proposed in manner of RP identification, threshold for significant RPTs 

– Avinash Shetty, Manager and Sourish Kundu, Executive | corplaw@vinodkothari.com

Background of CP

Related Party Transactions (“RPTs”) have been one such evergreen and ever-evolving aspect of corporate governance that has been put to guardrails on a frequent basis. SEBI, in its Consultation Paper dated 7th February, 2025 has again rolled out a new set of proposals, this time primarily centered around RPTs undertaken by subsidiaries of a listed entity, but nevertheless leaving listed entities pondering on what their actionables might be. In this article, we have analysed the  proposals in brief.  

Discussion on Proposals

LODR Definition of RP to be extended to subsidiaries

Proposal: Following SEBI’s Informal Guidance on the manner of identification of Related Parties (“RPs”), which opined that the subsidiaries of LEs should maintain a list of their RPs in accordance with the Listing Regulations, instead of maintaining the same as per their respective applicable/local laws, SEBI now proposed to effectuate the same by way of appending an explanation to Reg. 2(1)(zc) that RP of subsidiary to be identified as per Reg. 2(1)(zb) of the Listing Regulations. 

Although the proposed insertion does not differentiate between a listed and an unlisted subsidiary, it is clearly understood that a listed subsidiary shall, by default, be following the holistically covered definition of RP given under Reg. 2(1)(zb). On the other hand, an unlisted subsidiary which may so far been following the definition of RP as given under the Companies Act, 2013 (“the Act”) might be expected to buckle up to bring in a lot more persons under the purview of the RPT regime as per the LODR definition – for the purpose of facilitating the parent’s RPT compliances. 

Possible concerns: While the SEBI’s approach of applying an entity-agnostic definition may seem to bring consistency and ease of collation of information across the group, but may raise several issues:

  1. For the identification of RPs of unlisted entities in India, one will have to look at the residual definition given in Reg. 2(2) of the Listing Regulation, which in turn, refers to the CA 2013. Therefore, applying the definition of RP to unlisted entities would mean expanding the direct applicability of Listing Regulations.
  2. Further, while assessing a related party under “applicable accounting standards”, the question would be whether the subsidiary would follow the accounting standards applicable to the listed entity or that applicable to the subsidiary itself. If it is contended that the unlisted subsidiary will refer to accounting standards as applicable to the listed entity, it would again be considered as a superimposition of inapplicable laws. Besides, there would be multiple interpretational issues given that AS/IndAS are vastly different.
  3. Imposing Companies Act or Indian law definitions on overseas entities may raise concerns about extra-territorial jurisdiction.
  4. Further, this might increase the compliance burden on the unlisted entities, requiring them to assess RPs under multiple laws.

The issues in putting the said proposal in action have been discussed in  detail in our write up on SEBI’s IG on RP identification by unlisted subsidiaries. 

Actionables: If the proposals take the shape of law, the following actionables might arise: 

  1. Revamping the list of RPs: Given that a broader segment of persons are covered in terms of 2(1)(zb), whether pursuant to the applicable accounting standards, i.e. IndAS 24 in most cases or inclusion of promoter/promoter group persons, the list of RPs of subsidiaries needs to be updated and kept updated on a regular basis. 
  2. Enforcing the enhanced RPT controls: Given that cross RPTs across a group also are subject to approval and/or ratification requirements under Regulation 23 of the Listing Regulations, the role of Audit Committee (“AC”) will widen to approve a greater number of RPTs, that is to say, now that an increased number of persons would be  covered in the list of RPs of subsidiaries, the scope of review would enlarge. 
Revised Thresholds for Subsidiary’s Significant RPTs

Proposal: Moving on to thresholds for significant RPTs – an RPT of the subsidiary to which the holding LE is not a party requires prior approval of the AC of the holding LE before it can be entered into, if the value of such RPT exceeds 10% of annual standalone turnover, as per the latest audited financial statements of the subsidiary, taken together with all transactions during a FY. [Pursuant to Regulation 23(2)(c) of the Listing Regulations] (hereafter referred to as “significant RPTs”)

However, as discussed in the CP, there may be cases where a transaction by a subsidiary of a LE exceeds the material RPT threshold, requiring shareholder approval, but does not exceed 10% of the subsidiary’s standalone turnover, thus bypassing the AC approval. For example, if a subsidiary has a standalone turnover of ₹12,000 crore, a transaction of ₹1,100 crore would cross the material RPT threshold of ₹1,000 crore . This would require shareholder approval. However, since ₹1,100 crore is below 10% of the subsidiary’s standalone turnover (₹1,200 crore), AC’s approval would not be needed.

The proposal seeks to include the absolute threshold of Rs. 1,000 crores as well in determining significant RPTs. Significance would be determined on the basis of value of transaction being Rs. 1,000 crores or 10% of annual standalone turnover of the subsidiary, whichever is lower. In our view, however, this proposal is more clarificatory in nature as it is difficult to envisage that any RPT proposal going to shareholders of an LE can go directly without coming before the AC of the LE. We have covered this scenario in our FAQs on RPT as well.

A specific carve out from the above requirement has been set down in respect of listed subsidiaries on which corporate governance norms and RPT framework norms are applicable. 

Further, in order to impose RPT controls on SME listed entities, SEBI in its Board Meeting held on 18th December, 2024 approved, among other items, the materiality threshold of Rs. 50 crores or 10% of annual consolidated turnover, whichever is lower. Accordingly, for the purpose of determining significant RPTs of an unlisted subsidiary of SME LE, the threshold is Rs. 50 crores or 10% of annual consolidated turnover, whichever is lower. Note that the provision is applicable to a subsidiary of an SME LE – this is clear from para 5.3.1 of the CP.

The proposal as to thresholds is as tabulated below: 

Limits for Significant RPTs (whichever is lower)Having financial track record*Not having financial track record*
Subsidiaries of Main Board LEsRs. 1,000 crores or 10% of annual standalone turnoverRs. 1,000 crores or 10% of standalone net worth
Subsidiaries of SME LEsRs. 50 crores or 10% of annual standalone turnoverRs. 50 crores or 10% of standalone net worth

*Note:

  1. Here, the financial track record shall mean the entity has published financial statements for at least one year.
  2. In case the net worth is negative: Aggregate of share capital and share premium is to be considered. Basically, the negative P/L should be ignored.
  3. Computations as to Net worth or Share Capital plus Share Premium, as the case may be,  is to be certified  by a practicing chartered accountant less than 3 months prior to seeking of requisite approval. 

Actionables: Unlisted subsidiaries of listed entities will have to reassess their transactions falling under significant RPTs to be taken to the listed parent’s AC.

Insertion of the word “listed” in Regulation 23(5)(b)

Although the change is merely clarificatory in nature, it is pertinent to note that there has been some ambiguity for RPT approvals, when RPTs are  being entered into between a holding company and its wholly owned subsidiary (WoS). Given that applicability of the Listing Regulations encompasses only listed entities, it was implied that the holding company referred is a listed holding company whose accounts are consolidated and presented to shareholders at the general meeting, and not an unlisted one. 

This interpretive addition of the word “listed” aims to remove any ambiguity in respect of the exemptions granted for certain RPTs involving WoS. 

Conclusion: 

The impact of the changes, if and when notified, may be expected to be as far fetched and require a revised understanding of the RPT regime to some extent, even if not entirely, similar to the rippling effect of the SEBI (LODR) (3rd Amendment) Regulations, 2024 dated 12th December, 2024. Further, there are certain aspects such as revision in definition of RPs for subsidiaries, which would require an introspection not just on the part of the subsidiaries of LEs, but at the group level as well. Needless to say, RPT – regime and controls, has always been a trending topic and changes w.r.t the same, although the first of this year, can definitely not be expected to be the last.

The RPT framework under the Listing Regulations has already been amended 7 times, and every time, it becomes tougher, all in the name of “Ease of Doing Business”. A document collating the evolution of RPT framework over the years is here: https://lnkd.in/gZ3Ca5yQ

Read more on Related Party Transactions here.

Reduction of capital – an alternate to buyback and minority exit?

/0 Comments/in , /by

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: 

  1. 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 permissible under 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 66Application 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 principle was reiterated in Poole v. National Bank of China, 1907 AC 229 and Westbern Sugar Refineries Ltd., (1951) 1 All. E.R. 881 (HL) etc. 

“…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.”

In Brillio Technologies Pvt Ltd. vs ROC & RD, referring to various judgements including the ones cited above, the NCLAT held that: 

“…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

XXX

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.” 

In Commissioner of Income Tax v. Vania Silk Mills (P.) Ltd, (1977) 107 ITR 300 (Guj) the expression “extinguishment of any right therein” has been interpreted in a wider fashion. 

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 – 

XXX

(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 gainsCapital loss on account of capital reduction No consideration paid on capital reduction 
Amount (Rs.)Amount (Rs.)Amount (Rs.)
A.Consideration received on capital reduction 1,00,00010,000–
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 20,00020,00020,000
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”. 

Our other resources on the subject:

[1] Read a detailed article on the same at Bye Bye to Share Buybacks

Closure and Scaling Down of Business

FAQs on Share Buybacks

Affixing Vicarious Liability on Directors: See a Breakthrough

/0 Comments/in , , /by

Introduction:

It is well established that a company, being an artificial legal entity, conducts its day-to-day operations through a collective body of individuals known as the Board of Directors. This body bears direct responsibility for the company’s functioning and decision-making. Consequently, in instances of default, both the company and its directors are often held accountable. Under Section 2(60) of the Companies Act, 2013 (hereinafter referred to as “the Act”), directors can be designated as “officers who are in default,” thereby making them personally liable in specific situations.

Despite its artificial nature, a company is recognized as a separate legal entity under the law. Therefore, for any offence committed by a company, it is primarily the company itself that is liable to face legal consequences. However, this fundamental principle is sometimes overlooked, and directors are held accountable for the corporation’s adverse actions. This stems from the perception that directors act as the “mind” of the company and control its operations.

Recently, the Supreme Court of India, in Sanjay Dutt & ORS. v. State of Haryana & ANR (Criminal Appeal No. 11 of 2025), reaffirmed the distinction between the company’s liability and that of its directors. This decision underscores the importance of adhering to the principle of separate legal personality, ensuring that directors are not unfairly held liable unless their personal involvement or negligence in the offence is established.

Brief facts of the Case: 

The case under discussion revolves around a complaint lodged under the Punjab Land Preservation Act, 1900 (PLPA) against three directors of a company, alleging environmental damage caused by uprooting trees using machinery in a notified area. The appellants (directors of Tata Realty and related entities) sought to quash the complaint, asserting that the alleged actions were conducted by the company and not attributable to them personally. The complaint, however, excluded the company as a party and focused on the directors’ liability under Section 4 read with Section 19 of the PLPA.

Key observations by the Supreme Court:

  1. Primary Liability of the Company: The Court emphasized that the company itself, as the licensee and beneficiary of the land, was primarily liable for any violations. Excluding the company from the complaint undermined the case’s premise.
  1. Vicarious Liability Not Automatic: The Court reiterated that directors cannot be automatically held vicariously liable unless the statute explicitly provides for such liability or there is evidence of their personal involvement in the offence.
  1. Lack of Specific Allegations: The complaint failed to attribute specific actions or responsibilities to the directors. It merely assumed liability based on their official positions, which is insufficient for criminal prosecution.
  1. Legal Fiction Requires Explicit Provision: Vicarious liability in criminal matters requires clear statutory backing. The PLPA contains no provisions imposing vicarious liability on directors for offences committed by the company.

Understanding the Concept of Vicarious Liability:

The concept of vicarious liability allows courts to hold one person accountable for the actions of another. This principle is rooted in the idea that a person may bear responsibility for the acts carried out by someone under their authority or on their behalf. In the corporate context, this doctrine extends to holding companies liable for the actions of their employees, agents, or representatives.

Initially developed within the framework of tort law, the doctrine of vicarious liability later found application in criminal law, particularly in cases involving offences of absolute liability. This marked a departure from the once-prevailing notion that corporations, as artificial entities, could not commit crimes. Modern legal interpretations now recognize that a corporation may be held criminally liable if its human agents, acting within the scope of their employment, engage in unlawful conduct.

Doctrine of Attribution:

Currently, a company does not have the immunity to safeguard itself under the blanket of laxity of mens rea, an important component for the constitution of a criminal intent. It was established that corporations are  liable for  criminal and civil wrongdoings if the offences were committed through the corporation’s ‘directing mind and will’. This attribution of liability to the corporations is known as the ‘Doctrine of Attribution’

‘Doctrine of Attribution’ says that in the event of an act or omission leading to violation of criminal law, the mens rea i.e. intention of committing the act is attributed to those who are the ‘directing mind and will’ of the corporations. It can be said that Doctrine of Attribution is a subset of Principle of Vicarious Liability wherein a corporation can be held responsible even in case of a criminal liability.

The landmark judgment in H.L. Bolton (Engineering) Co. Ltd. v. T.J. Graham & Sons Ltd., (1957 1 QB 159) provided a foundational understanding of corporate liability. The court compared a corporation with a human body, with its directors and managers representing the “mind and will” of the organization. These individuals dictate the company’s actions and decisions, and their state of mind is legally treated as that of the corporation itself. Employees or agents, by contrast, are viewed as the “hands” that execute tasks but do not represent the company’s intent or direction.

This conceptual framework underscores that while corporations are artificial entities, they can be held criminally liable when those who embody their directing mind commit offences. The recognition of corporate criminal liability has since evolved, balancing the need for accountability with the distinction between the roles of employees and the decision-makers within an organization.

You can read more about the corporate criminal liability here.

Analyzing the Sanjay Dutt Judgment:

  1. Liability must be expressly mentioned

In the present case, the Court underscored the principle that vicarious liability cannot be imposed on directors or office-bearers of a company unless explicitly provided by statute. This was reiterated in Sunil Bharti Mittal v. Central Bureau of Investigation, (AIR 2015 SC 923) where it was held that individual liability for an offence must be clearly established through direct evidence of involvement or by a specific statutory provision. Without such statutory backing, directors cannot be presumed vicariously liable for a company’s actions.

The Court further emphasized that statutes must clearly define the scope of liability and the persons to whom it applies. This clarity is essential to prevent ambiguity and ensure that only those genuinely responsible for the offence are held accountable.

  1. Personal involvement of Directors :

The Court reaffirmed that corporate liability does not inherently extend to directors unless supported by statutory provisions or evidence of personal involvement. In Pharmaceuticals Ltd. v. Neeta Bhalla and Anr. (AIR 2005 SC 3512), it was held that directors are not automatically vicariously liable for offences committed by the company. Only those who were directly in charge of and responsible for the conduct of the company’s business at the time of the offence may be held liable.

The judgment further emphasized that liability must stem from personal involvement or actions beyond routine corporate duties. Routine oversight or general authorization does not suffice to establish criminal liability unless it can be shown that the director personally engaged in, or negligently facilitated, the unlawful act.

  1.  ‘In charge of’ and ‘responsible to’

In K.K. Ahuja vs V.K. Vora & Anr. (2009 10 SCC 48), the Supreme Court analysed the two terms often used in vicarious liability provisions, i.e., ‘in charge of’ and ‘responsible to’. It was held that the ‘in-charge’ principle presents a factual test and the ‘responsible to’ principle presents a legal test. 

A person ‘responsible to’ the company might not be ‘in charge’ of the operations of the company and so in order to be vicariously liable for the act, both the principles must satisfy. It stated as, “Section 141 (of the Negotiable Instrument Act, 1881), uses the words “was in charge of, and was responsible to the company for the conduct of the business of the company”. There may be many directors and secretaries who are not in charge of the business of the company at all.”

  1. The Complainant’s Burden of Proof:

Under Section 104 of the Bharatiya Sakshya Adhiniyam, 2023, the burden of proof lies on the complainant. It is the complainant’s responsibility to make specific allegations that directly link a director’s conduct to the offence in question. This principle was reiterated in Maksud Saiyed v. State of Gujarat (AIR 2007 SC 332), where the Court held that vague or generalized accusations against directors are insufficient.

A valid complaint must include:

  1. Clear and specific allegations detailing the director’s role in the offence.
  2. Evidence linking the director’s actions to the company’s criminal liability.
  3. Statutory provisions or legal grounds for attributing vicarious liability.

Referring to Susela Padmavathy Amma and M/s Bharti Airtel Limited (Special Leave Petition (Criminal) No.12390-12391 of 2022), wherein it was reaffirmed by the Supreme Court that even when statutes explicitly provide for vicarious liability, merely holding the position of a director does not automatically render an individual liable for the company’s offences.

To establish a director’s liability, the Court emphasized the need for specific and detailed allegations that clearly demonstrate the director’s involvement in the offence. It must be shown how and in what manner the director was responsible for the company’s actions.

The Court further clarified that there is no universal rule assigning responsibility for a company’s day-to-day operations to every director. Vicarious liability can only be attributed to a director if it is proven that they were directly in charge of and responsible for the day-to-day affairs of the company at the time the offence occurred.

  1. MCA Directive to RD and ROCs: Circular Dated March 2, 2020:

It’s noteworthy that, even MCA, vide its General Circular no. 1/2020 dated 2nd March, 2020, directed Regional Directors and Registrar of Companies that at the time of serving notices relating to non-compliances, necessary documents may be sought so as to ascertain the involvement of the concerned officers of the company.

  1. Duties of Directors under the Companies Act, 2013

Section 166 of the Act lists down duties of directors of a company. To summarise, directors must adhere to the company’s articles, act in good faith for members’ benefit, exercise due care and independent judgment, avoid conflicts of interest, undue gain. However, of note, it does not mention that a director shall be responsible for all the affairs of a company. 

In addition to the above case, the following related judgements are also noteworthy:

  1. Pooja Ravinder Devidasani vs. State of Maharashtra and another, (2014) 16 SCC 1: In this case, the Court asserted that, only those persons who were in-charge of and responsible for the conduct of the business of the Company at the time of commission of an offence will be liable for criminal action.
  1. S.M.S. Pharmaceuticals Ltd. vs Neeta Bhalla and another, (2005) 8 SCC 89: the Court considered the definition of the word “director” as defined in Section 2(13) of the Companies Act, 1956. It held that “…There is nothing which suggests that simply by being a director in a company, one is supposed to discharge particular functions on behalf of a company. It happens that a person may be a director in a company but he may not know anything about the day-to-day functioning of the company…”.
  1. SEBI vs. Gaurav Varshney, (2016) 14 SCC 430: The Court held that even a person without any official title or designation such as “director” in a company may still be liable, if they fulfill the main requirement of being in charge of and responsible for the conduct of business at the relevant time. Liability is contingent upon the role one plays in the affairs of a company, rather than their formal designation or status.
  1. Maharashtra State Electricity Distribution Company Limited and Anr., v. Datar Switchgear Limited and Ors., (10 SCC 479): The Supreme court held that wherever by a legal fiction the principle of vicarious liability is attracted and a person who is otherwise not personally involved in the commission of an offence is made liable for the same, it has to be specifically provided in the statute concerned and it is necessary for the the complainant to specifically aver the role of each of the accused in the complaint.

Vicarious liability must be explicitly provided for in the statute and supported by clear evidence of personal involvement and criminal intent. Also, it is necessary for the complainants to make specific averments in the complaints.  

Conclusion:

The above judgments reinforces the principle that corporate and individual liabilities are distinct. Vicarious liability of directors is not presumed and can only be imposed with statutory backing or compelling evidence of personal involvement. By placing the burden of proof on the complainant, the judiciary ensures fairness and prevents misuse of the legal system to harass directors without substantive evidence. This balanced approach safeguards both corporate governance and individual accountability.

You can read more about this subject here.

Disclosures in Financial Statements: Role of CS

/0 Comments/in , , /by
ICSI Conference – Financial Statements – disclosures under the CA and role of CS.pptxDownload

Read our other resources:

Disclosure in financial statements: Relationship with struck off companies

Changes in Auditors’ Report and Financial Statements to reveal camouflaged financial transactions

MCA introduces a cartload of additional disclosures in the Financial Statements