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Rights for wrongs: Potential deprivation of shareholders property rights using mandatory demat rule

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– Vinod Kothari and Payal Agarwal | corplaw@vinodkothari.com

The mandatory dematerialisation provisions under the Companies Act, 2013 requires companies to issue their securities and facilitate transfer requests in dematerialised form only. For private companies, the mandate has become effective since 30th June 2025, hence, every private company (barring a small company) is now required to issue securities in dematerialised form only. Not only do new securities need to be in demat format, the shareholders having existing shareholding in physical form are deprived of their shareholding rights in the form of participation in further rights issue, bonus issue etc. The purpose of mandatory demat rule is to bring shareholders and shareholding in companies in a transparent, tractable domain. However, can it be contended that every person who has not dematerialised his holdings is a non existing persona, or deserves to have his property rights defeated and redistributed to other shareholders? Can such a person be compelled to lose his rights entitlement in further issuance brought by the private company? Even more stark, can such a shareholder lose his rights to the accumulated surplus piled up in the company if the board of directors of the company suddenly decides to issue bonus shares? In simple words, can the mandate of dematerialisation, that is applicable on a company, be interpreted for deprivation of shareholders’ property rights? 

It is not that Rule 9B is new – since its original notification in October 2023, the applicability of the provisions was deferred from the original applicability date of 30th September, 2024 to 30th June, 2025. However, we need to understand that when it comes to private companies, there are lots of minority shareholders who have not converted their shareholdings into demat form. Reasons could be internal family issues, some issues with respect to holdings, or pure lethargy. Let no one make the mistake of assuming that private companies are small companies – private companies may be sitting with hundreds of crores of wealth – these may be family holding companies, JV companies, or even large companies with a restricted shareholding base. If the company is an old legacy company, for sure, the shares would have been in physical form, and may not have been demated. Now, suddenly, finding the law that has come into force, if the board of directors decides to come out with a bonus, the minority holding shares in physical form will be deprived of their right – which would mean, their share of wealth piled up over the years goes to the other shareholders. 

Mandatory dematerialisation prior to subscription to securities 

Sub-rule (4) of Rule 9B puts a condition on the securities holders to have the entire holding in demat form prior to subscription to the securities. The relevant extracts are as below: 

(4) Every holder of securities of the private company referred to in sub-rule (2),- 

XXX

(b) who subscribes to any securities of the concerned private company whether by way of private placement or bonus shares or rights offer on or after the date when the company is required to comply with this rule shall ensure that all his securities are held in dematerialised form before such subscription

The provision thus explicitly forbids a shareholder from participation in a rights issue or bonus issue – corporate actions that are very much a part of the pre-emptive rights of a person as an existing shareholder. 

Seeking mandatory dematerialisation: powers under section 29 of the Act

Note that Rule 9B has been issued in accordance with the powers contained in Section 29 of CA, 2013. The title of section 29 reads as “Public Offer of Securities to be in Dematerialised Form”, indicating the regulator’s intent of requiring mandatory dematerialisation of ‘public offers’. Sub-section (1)(b) of the said section originally referred to ‘public’ companies, however, the term ‘public’ was subsequently omitted, and sub-section (1A) introduced, so as to require the notified classes of unlisted companies to ‘hold’ and ‘transfer’ securities in dematerialised form only. The amendment was brought in 2019, thus, enabling the Government to bring private companies too within the ambit of mandatory dematerialisation. 

Bonus issue and the unfair treatment to physical shareholders

Rule 9B(4) explicitly refers to ‘bonus issue’, and states that physical shareholders are ineligible to ‘subscribe to the bonus issue’. First of all, the language of the provision is flawed in the sense that bonus issue is mere capitalisation of profits of the company – there is no ‘offer’ on the part of the issuer, and no ‘subscription’ on the part of the shareholder. The same is proportionally available to all shareholders in the ratio of their existing shareholding. 

Since bonus issue leads to capitalisation of profits, there is an effective distribution of profits to the shareholders, though the company does not incur any cash outflow. Depriving a shareholder of his right to bonus issue does not only result in non-distribution of the profits to such shareholder, but also, redistribution of his share of profits to other shareholders. There is a disproportionate distribution of profits, and the physical shareholders stand at a loss. 

Unclaimed dividend: why should the treatment not be the same?

A parallel reference may be drawn from the provisions applicable to payment of dividend, through which distribution of profit occurs, with an immediate cash outflow. Section 124 of CA, 2013 requires that any unclaimed/ unpaid dividend be transferred to a separate escrow account, and the details of the shareholders be placed on the website to provide notice to the shareholders for claiming the same. Even if the same is not claimed by the shareholders during the specified period, the same can still not be re-distributed amongst the other shareholders, rather, gets transferred to the Investor Education and Protection Fund, and may still be claimed by the shareholders. 

The concept of bonus issue, being much similar to that of dividend, the rights of the physical shareholders should not be compromised and the bonus shares should ideally be set aside in a separate suspense account with any DP. Before keeping such shares in the suspense account the issuer company should send intimation letters to such shareholders at their latest known address.

Listed shares and Suspense Escrow Demat Account

Pending dematerialisation of holdings of a shareholder, any corporate benefits accruing on such securities are credited to the Suspense Escrow Demat Account, and may be claimed by the shareholder. Reg 39 read with Schedule VI of LODR Regulations require all such corporate benefits to be credited to such demat suspense account or unclaimed suspense account, as applicable for a period of seven years and thereafter transferred to the IEPF in accordance with the provisions of section 124 of CA, 2013 read with the rules made thereunder. 

How physical shareholders are deprived of their rights to proportionate holding?

Under rights issue, an opportunity is given to the existing shareholders, in proportion to their existing shareholding, to subscribe to the further issue of shares by the company. Thus, any dilution in the voting rights and towards the value of the company is avoided. The alternative to rights issue is through preferential allotment, where the securities may be offered to any person – whether an existing shareholder or otherwise, in any proportion. Since this may lead to a dilution in the rights of the existing shareholders – the same requires: (a) approval of the shareholders through a special resolution and (b) a valuation report from the registered valuer. 

Both of the aforesaid are meant to protect the interests of the existing shareholders. On the other hand, in case of rights issue – neither shareholders’ approval nor a fair valuation requirement applies – on the premise that there is no dilution of rights of the existing shareholders. 

In fact, rights issue of shares can be, and in practice, are fairly underpriced, since there is no mandatory valuation requirement under the Companies Act, and while there are contradicting judgments on whether or not section 56(2)(x) of the Income Tax Act applies on dis-proportionate allotment under rights issue, the valuation under Rule 11UA may be based on historical values – and hence, may not reflect the fair value of the shares. 

Not being entitled to rights is like losing the proportional wealth in a company, resulting in re-distributing the property of the physical shareholders to the demat shareholders. This effectively steals a physical shareholder of his existing holding in the company, that gets diluted to the extent of the disproportionate allotment, and a loss in value on account of the underpriced share issuance.

Listed companies and the approach followed for rights issue 

For listed entities, there is no blanket prohibition on subscription of shares by physical shareholders, rather, necessary provisions are created to facilitate subscription to the rights issue by such shareholders as well [Chapter II of ICDR Master Circular read with Annexure I]. 

  • Where the demat account details are not available or is frozen, the REs are required to be credited in a suspense escrow demat account of the Company and an intimation to this effect is sent to such shareholder. 
  • Physical shareholders are required to provide their demat account details to the Issuer/ Registrar for credit of Rights Entitlements (REs), at least 2 working days prior to the issue closing date. 
  • The REs lapse in case the demat account related information is not made available within the specified time. 

Thus, there is no automatic deprivation of the rights of the physical shareholders to apply in a rights issue, rather, a systematic process is given to facilitate dematerialisation and subscription of shares. 

The problem is bigger for private companies: necessitating additional measures 

A listed entity has a large number of retail shareholders, however, with very small individual holdings. In contrast is a private company, where the number of shareholders are small and each shareholder would be holding a rather significant share. The larger the share of an individual shareholder, the more he is impacted by the nuisance of depriving participation in a rights issue. 

The technical requirement of securities being dealt with in dematerialised form only, cannot give a private company the right to arbitrarily bring up corporate actions to deprive the existing physical shareholders from their rights over the company. 

An ideal approach towards preventing companies from taking an unfair advantage of the non-dematerialised holdings of some shareholders vis-a-vis dematerialised holdings of other shareholders would be by requiring them to keep the corporate actions attributable to the physical shareholders in abeyance, pending dematerialisation of securities. 

Therefore, for instance, in case of rights issue, along with the circulation of offer letter to the shareholders, a dematerialisation request form may be circulated, requiring the shareholders holding shares physically to apply for such dematerialisation. Pending dematerialisation of the securities, shares may be held in a suspense account or may be reserved for the shareholders in any form, and may be credited to the demat account of such shareholders, once the same is available. 

In the absence of any measures for protection of interest of the physical shareholders, the disproportionate treatment to such shareholders pursuant to a corporate action, may be looked upon as the use of law with a mala fide intent, one done with the intent of differentiating between shareholders of the same class – which could not have been possible otherwise, if the shares were held in demat form. 

Thus, one may contend that the ‘right’ is used for a ‘wrong’, thus challenging the constitutional validity of such law.  

Deprivation of property rights require authority of law

Article 300A of the Constitution of India provides for the right to property, stating that “No person shall be deprived of his property save by authority of law”. The Article has been subject to various judicial precedents, although primarily in the context of land acquisition related matters. The Supreme Court, in the matter of K.T. Plantation Pvt. Ltd. vs State Of Karnataka, AIR 2011 SC 3430, has considered ‘public purpose’ as a condition precedent for invoking Article 300A, in depriving a person of his property. 

117. Deprivation of property within the meaning of Art.300A, generally speaking, must take place for public purpose or public interest. The concept of eminent domain which applies when a person is deprived of his property postulates that the purpose must be primarily public and not primarily of private interest and merely incidentally beneficial to the public. Any law, which deprives a person of his private property for private interest, will be unlawful and unfair and undermines the rule of law and can be subjected to judicial review. But the question as to whether the purpose is primarily public or private, has to be decided by the legislature, which of course should be made known. The concept of public purpose has been  given fairly expansive meaning which has to be justified upon the purpose and object of statute and the policy of the legislation. Public purpose is, therefore, a condition precedent, for invoking Article 300A.

Failure to dematerialise: can there be genuine reasons or mere lethargy? 

One may argue that the shareholders have the responsibility to ensure their holding is dematerialised, and hence, a physical shareholder rightfully suffers the consequences of its own lethargic attitude. However, that should not be considered reason enough to deprive one of its rights to the property legally owned and held by it. 

Practically speaking, there may be various reasons for which a shareholder may not be able to dematerialise its existing shareholding in a company, thus becoming ineligible for participation in rights/ bonus issues. For instance, the title of a shareholder might be in dispute, pending which, dematerialisation would not be possible. Another practical issue might be due to loss of share certificates, and the investee company, pending issuance of duplicate share certificates and dematerialisation thereof, may come up with a bonus issue.  

Concluding Remarks:

The dematerialisation provisions, brought to do away with bogus shareholders, might be used to steal away the rights of validly existing shareholders, on the pretext of non-fulfilment of a technical requirement. In view of the mandatory issuance in demat form, a physical shareholder might not be able to ‘hold’ the shares pending dematerialisation, however, the same does not snatch away the ‘entitlement’ of the shareholder to such rights, and cannot, at all, be re-distributed to other shareholders. This cannot, and does not, seem to have been the intent of law, however, in the absence of clear provisions requiring the company to hold such rights in abeyance for the physical shareholders, may lead to inefficacy.

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Repetitive Overhaul: RPT regime to get softer

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Repetitive Overhaul: RPT regime to get softer

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– Team Corplaw | corplaw@vinodkothari.com

SEBI rolls out Consultation Paper: Materiality threshold for RPTs to be scale-based, Industry Standard to get softer, de minimis exemptions

Since 2021, the RPT framework for listed entities has been witnessing repetitive changes, and the current year 2025 has seen SEBI on a regulatory fast track in relation to RPTs.  Be it the launch of RPT Analysis Portal, offering unprecedented visibility into RPT governance data, or the Industry Standards Note (‘ISN’), requiring seemingly a pile of information w.r.t RPTs, both in the month of February, 2025. Originally scheduled to be effective from FY 25, the applicability of ISN was later pushed on to July 1, 2025, and while on the verge of becoming effective, on June 26, 2025, SEBI notified Revised RPT Industry Standards, prescribing tiered but somewhat simplified disclosure formats effective September 1, 2025.

Even before the ISN could become effective, a 32-pager consultation paper proposing further amendments to RPT provisions has been rolled out by SEBI on August 4, 2025.

Based on the “Ease of Doing Business” theme, the Consultation Paper proposes  amendments in the RPT framework, based on recommendations from the Advisory Committee on Listing Obligations and Disclosures (ACLOD). The proposals aim to address practical challenges faced by listed entities while maintaining robust governance standards.

Below we present the proposed amendments and our analysis of the same.

1. Materiality Thresholds: From One-Size-Fits-All to several sizes for short-and-tall

Proposal in CP

A scale-based threshold mechanism is proposed through a new Schedule XII to LODR Regulations, such that the RPT materiality threshold increases with the increase in the turnover of the company, though at a reduced rate, thus leading to an appropriate number of RPTs being categorized as material, thereby reducing the compliance burden of listed entities. The maximum upper ceiling of materiality has been kept at Rs. 5,000 crores, as against the existing absolute threshold of Rs. 1000 crores.

Proposed materiality thresholds:

Annual Consolidated Turnover of listed entity (in Crores)Proposed threshold (as a % of consolidated turnover)Maximum upper ceiling (in Crores)
< Rs.20,00010%2,000
20,001 – 40,0002,000 Crs + 5% above Rs. 20,000 Crs3,000
> 40,0003,000 Crs + 2.5% above Rs. 40,000 Crs5,000 (as proposed)

Back-testing the proposal scale on RPTs undertaken by top 100 NSE companies show a 60% reduction in material RPT approvals for FY 2023-24 and 2024-25 with total no. of such resolutions reducing from 235 and 293, to around 95 to 119. The 60% reduction may itself be seen as a bold admission that the present framework is causing too many proposals to go for shareholder approval.

Historical Benchmark

The absolute threshold of Rs. 1000 crores, for determination of RPTs as material was brought pursuant to an amendment in November 2021, following the recommendations of the Working Group on RPTs. The proposal of WG was based on the data between the years 2015 to 2019, which showed that only around 70 to 91 resolutions were placed for material RPT approvals by the top 500 listed entities.

Our Analysis and Comments

  • Turnover as a single metric is not a measure of materiality: Scale-based tests align materiality with turnover, introducing proportionality, but the question remains whether turnover itself is at all an appropriate yardstick to measure materiality.

Turnover is an inadequate metric for determining the materiality of RPTs. Materiality should reflect the likely financial impact of a transaction, which may have little or no correlation with turnover. For instance, transactions involving investments, asset acquisitions or disposals, or borrowings pertain to the balance sheet rather than the revenue-generating side of operations. Even if an item pertains to revenues, there are businesses where gross profits ratios are low, and therefore, turnover will be high. Globally, jurisdictions like the UK adopt a more nuanced, consonance-based approach [Refer Annex 1 of UKLR 7] using different parameters viz. gross assets test, consideration test, and the gross capital test for different transaction types to ensure relevance and proportionality. Section 188 of the Companies Act, 2013 also adopts a similar multi-metric approach, applying turnover and net worth, depending on the nature of the transaction.

It is also critical to recognise the wide disparity in asset-turnover ratio across industries. A trading company might turn its assets over 20 times annually, while a manufacturing entity with a 90-day working capital cycle may show a turnover approximately four times its assets. On the other hand, entities in the financial sector, such as NBFCs and banks, generate turnover largely through interest income, which is barely 6 to 10 percent of the asset base. Therefore, applying a turnover-based threshold to such entities results in thresholds being disproportionately low when compared to the actual scale of transactions, thereby distorting the materiality assessment.

Given these sectoral variations and the diversity of transaction types, a flat turnover-based threshold oversimplifies the assessment and may result in both overregulation and underreporting. A more calibrated, transaction-specific materiality framework, drawing on consonance-based criteria as seen in Regulation 30 of the LODR Regulations, would offer a more balanced and effective approach. SEBI may consider moving towards such a harmonised model to ensure that materiality thresholds meaningfully reflect the substance of transactions, rather than relying on a single yardstick.

  • Regulatory Lag: It took SEBI almost 4 years, i.e., from 2021 to 2025, to conclude that the threshold of ₹1,000 crores is too small, and that it requires an upward revision, which is now proposed to be increased to ₹5,000 crores. In the context of India’s rapidly growing economy, where turnover figures are expected to rise steadily, even this upwardly revised absolute threshold may soon lose relevance. Frequent threshold shifts risk “chasing” market realities rather than anticipating them. SEBI’s decision to cap at ₹5,000 crore reflects caution but may quickly become outdated.

2. Significant RPTs of Subsidiaries: Plugging Gaps with Dual Thresholds

Existing provisions vis-a-vis Proposal in CP

Pursuant to the amendments in 2021, RPTs exceeding a threshold of 10% of the standalone turnover of the subsidiary are considered as Significant RPTs, thus, requiring approval of the Audit Committee of the listed entity. The CP proposes the following modifications with respect to the thresholds of Significant RPTs of Subsidiaries:

  • ‘Material’ is always ‘Significant’: There may be instances where a transaction by a subsidiary may trigger the materiality threshold for shareholder approval, based on the consolidated turnover of the listed entity, but still fall below the 10% threshold of the subsidiary’s own standalone turnover. As a result, such a transaction would escape the scrutiny of the listed entity’s audit committee. This inconsistency highlights a regulatory gap and reinforces the need to revisit and revise the threshold criteria to ensure comprehensive oversight in a way that aligns with evolving group structures and scale of operations. RPTs of subsidiary would require listed holding company’s audit committee approval if they breach the lower of following limits:
  • 10% of the standalone turnover of the subsidiary or
    • Material RPT thresholds as applicable to listed holding company
  • Exemption for small value RPTs: The threshold for Significant RPTs is subject to an exemption for small value RPTs based on the absolute value of Rs. 1 crore. Thus, where a transaction between a subsidiary and a related party (of the listed entity/ subsidiary), on an aggregate, does not exceed Rs. 1 crore, the same is not required to be placed for approval of the Audit Committee of the listed entity, even if the aforesaid limits are breached.
  • Net Worth Alternative: For newly incorporated subsidiaries which are <1 year old, consequently not having audited financial statements for a period of at least one year, the threshold for Significant RPTs to be determined as below:
  • 10% of standalone net worth of the subsidiary (or share capital + securities premium, if negative net worth),
    • as on a date not more than 3 months prior to seeking AC’s approval
    • certified by a practising CA

Our Analysis and Comments

●      De-minimis exemption for significant RPTs of subsidiaries

The exemption for RPTs up to Rs. 1 crore in absolute terms might provide some relief for the holding entities, particularly, entities having various small subsidiaries, which, on a standalone basis, may not be material for the listed entity at all – however, the RPTs being significant at the subsidiary’s level still required approval of the parent’s audit committee. However, still the exemption threshold may be further enhanced to a higher limit, as a de minimis exemption of Rs. 1 crore entails the subsidiary having a turnover of mere Rs. 10 crores, which, from the perspective of a listed entity is a not a very practically beneficial scenario.

For newly incorporated companies not having a financial track record, linking the significant RPT threshold with net worth brings additional compliance burden in the form of certification requirements from PCA. Net worth alternative introduces valuation and certification burdens for newly incorporated entities, in which case It may be considerable to extend a blanket first year exemption of upto Rs. 5 crore, to balance ease of doing business for newly incorporated subsidiaries, the very decision of which would be stemming from the management of the parent listed entity. In fact, insisting on the net worth certificate itself seems unnecessary, as the net worth is mostly based on paid up capital, which does not warrant certification.

●      Need for easing inclusion of RPs of subsidiaries as RPs of listed entity

First of all, a statement of fact. The number of related parties of listed entities went for a significant explosion in November, 2021, where the definition of RP of a listed entity included RPs of subsidiaries. For any diversified group, there are typically several subsidiaries, each of them with their own independent boards.

While the proposals pertain to significant RPTs of subsidiaries, the most crucial component of the RPT framework lies in identification of RPs, which, under the current framework, covers RPs of subsidiaries as well. These RPs may be, many a times, companies in which the directors of the subsidiaries are holding mere directorships, often, an independent directorship. There is absolutely no scope of conflict of interests in dealing with companies where a person is interested, solely on account of his directorship where there is no direct or indirect shareholding or ownership interest. Such a situation has an explicit carve out under the Ind AS 24 as well, where an entity does not become a RP by the mere reason of having a common director or KMP [Para 11(a) of Ind AS 24]. While the Companies Act treats a company as an RP based on common directorship (in case of a private company), however, the extension of such definition to RPs of subsidiaries is pursuant to the provisions of SEBI LODR and hence, appropriate exclusions may be specified for under LODR.

3. Tiered Disclosures: Balancing Transparency and Burden

Existing provisions vis-a-vis Proposal in CP

The Industry Standards Note on RPTs, effective from 1st September, 2025 provides an exemption from disclosures as per ISN for RPTs aggregating to Rs. 1 crore in a FY. The proposal seeks to provide further relief from the ISN, by introducing a new slab for small-value RPTs aggregating to lower of:

  • 1% of annual consolidated turnover of the listed entity as per the last audited financial statements, or
  • Rs. 10 crore

In such cases, the disclosures are proposed to be given in the Annexure-2 of the Consultation Paper. The disclosure as per the Annexure is in line with the minimum information as is currently required to be placed by the listed entity before its Audit Committee in terms of SEBI Circular dated 22nd November, 2021 (currently subsumed in LODR Master Circular dated November 11, 2024). In the event of the same becoming effective, disclosures would be required in the following manner as per LODR:

Value of transactionDisclosure RequirementsApplicability of ISN
< Rs. 1 croreReg 23(3) of SEBI LODRNA – exempt as per ISN
> Rs 1 crore, but less than 1% of consolidated turnover of listed entity or Rs. 10 crores, whichever is lower (‘Moderate Value RPTs’)Annexure-2 of CP (Paragraph  4  under  Part  A  of  Section  III-B of SEBI Master Circular dated November 11, 2024)Proposed to be exempt from ISN
Other than Moderate Value RPTs but less than Material RPTs (specified transactions)Part A and B of ISNYes
Material RPTs (specified transactions are material)Part A, B and C of ISNYes
Other than Moderate Value RPTs but less than Material RPTs (other than specified transactions)Part A of ISNYes

 Our Analysis and Comments

The proposal would result in creation of multiple reference points with respect to disclosure requirements. As per the existing regulatory requirements, the disclosure requirements before the Audit Committee comes from the following sources:

  • Rule 6A of Companies (Meetings of Board and its Powers) Rules, 2014 – for listed entities incorporated as a company
  • Reg 23(3)(c) of SEBI LODR – for omnibus approvals
  • SEBI Circular dated 26th June, 2025 read with Industry Standards Note on RPTs – effective from 1st September 2025, for all RPTs other than exempted RPTs (aggregate value of upto Rs. 1 crore)

The proposal leads to an additional classification of RPTs into moderate value RPTs where limited disclosures in terms of the draft Circular will be applicable. While the introduction of differentiated disclosure thresholds aims to rationalise compliance, care must be taken to ensure that the disclosure framework does not become overly template-driven. RPTs, by nature, require contextual judgment, and a uniform disclosure format may not always capture the nuances of each case. It is therefore important that the regulatory design continues to place trust in the informed discretion of the Audit Committee, allowing it the flexibility to seek additional information where necessary, beyond the prescribed formats.

4. Clarification w.r.t. validity of shareholders’ Omnibus Approval

Existing provisions vis-a-vis Proposal in CP

The existing provisions [Para (C)11 of Section III-B of LODR Master Circular] permit the validity of the omnibus approval by shareholders for material RPTs as:

  • From AGM to AGM – in case approval is obtained in an AGM
  • One year – in case approval is obtained in any other general meeting/ postal ballot

A clarification is proposed to be incorporated that the AGM to AGM approval will be valid for a period of not more than 15 months, in alignment with the maximum timeline for calling AGM as per section 96 of the Companies Act.

Further, the provisions, currently a part of the LODR Master Circular, are proposed to be embedded as a part of Reg 23(4) of LODR.

5. Exemptions & Definitions: Pruning Redundancies

Problem Statement

Proviso (e) to Regulation 2(1)(zc) of the SEBI LODR Regulations exempts transactions involving retail purchases by employees from being classified as Related Party Transactions (RPTs), even though employees are not technically classified as related parties. Conversely, it includes transactions involving the relatives of directors and Key Managerial Personnel (KMPs) within its ambit. Additionally, Regulation 23(5)(b) provides an exemption from audit committee and shareholder approvals for transactions between a holding company and its wholly owned subsidiary. However, the term “holding company” used in this context has remained undefined, leaving ambiguity as to whether it refers only to a listed holding company or includes unlisted ones as well.

Proposal in CP

The Consultation Paper proposes two key clarifications:

  1. The exemption related to retail transactions should be expressly limited to related parties (i.e., directors, KMPs, or their relatives) to grant the appropriate exemption.
  2. The exemption for transactions with wholly owned subsidiaries should apply only where the holding company is also a listed entity, thereby excluding unlisted holding structures from this relaxation

Our Analysis and Comments

Under the existing framework, retail purchases made on the same terms as applicable to all employees are exempt when undertaken by employees, but not when made by relatives of directors or KMPs. This has led to an inconsistent treatment, where similarly situated individuals receive different regulatory treatment solely on the basis of their relationship with the company. The proposed language attempts to streamline this by including such relatives within the exemption, but it introduces its own drafting concern.

  • The phrasing – “retail purchases from any listed entity or its subsidiary by its directors or its employees key managerial personnel(s) or their relatives, without establishing a business relationship and at the terms which are uniformly applicable/offered to all employees and directors and key managerial personnel(s)” – creates a potential loophole. As worded, the exemption could be interpreted to cover purchases made on favourable terms offered to directors or KMPs themselves, rather than being benchmarked against terms applicable to employees at large. The intended spirit of the provision seems to be to exempt only those transactions where the terms are genuinely uniform and non-preferential. A more appropriate construction would make it clear that the exemption is intended to apply only where such transactions mirror employee-level retail transactions, not privileged arrangements for senior management.
  • Regarding the exemption under Regulation 23(5)(b) for transactions between a holding company and its wholly owned subsidiary, this clarification seeks to align the treatment under Regulations 23(5)(b) and 23(5)(c). While this provides helpful interpretational guidance, incorporating the word “listed” directly into the text of the Regulation itself could offer greater precision and eliminate the need for retrospective explanations. Since unlisted holding companies are not subject to LODR, they are unlikely to have interpreted the exemption as applicable in the first place. As such, a simple prospective clarification might serve the purpose more effectively.

Conclusion

SEBI’s August 2025 proposals are largely aimed at relaxation, though in some cases, the ability to think beyond the existing track of the law seems missing. With the new leadership at SEBI meant to rationalise regulations, it was quite an appropriate occasion to do so. However, at many places, the August 2025 proposals are simply making tinkering changes in 2021 amendments and fine-tuning the June 2025 ISN. In sum, SEBI’s iterative approach to RPT governance demonstrates commendable responsiveness but calls for a holistic RPT policy road-map, harmonizing LODR regulations, circulars, and guidelines. Only a forward-looking, principles-based framework, will deliver the twin objectives of ease of doing business and investor protection in the long run.

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Paradox of privacy

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Whether private NBFCs-ML are required to appoint IDs?

– Neha Malu, Associate | finserv@vinodkothari.com

Independent directors have long been regarded as critical instruments of corporate governance. They bring fresh perspectives, specialized knowledge and most importantly, an element of unbiased oversight to board deliberations. Think of them as neutral referees who ensure fair play in business operations and uphold the integrity of boardroom decisions. Their presence helps reduce conflicts of interest, curb excessive promoter influence and encourage more balanced and professionally informed decision-making.

Under the Companies Act, 2013, section 149 read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014 lays down the categories of companies that are mandatorily required to appoint independent directors[1]. These categories do not include private companies. The rationale is intuitive: private companies, by their very nature of being closely held, are presumed to function under greater internal control, thereby reducing the perceived need for external board oversight. The whole basis of “privacy” of a private company will be frustrated if there are independent persons on its board.

Further, wholly owned subsidiaries are explicitly exempted from the requirement to appoint independent directors under rule 4(2), regardless of their nature or size.

And accordingly, a point of regulatory discussion arises in the case of (i) private NBFCs and (ii) NBFCs that are wholly owned subsidiaries, classified in the middle layer or above under the SBR Master Directions. While the Companies Act, 2013 does not mandate the appointment of independent directors for private companies and explicitly exempts WOS from such requirement, the corporate governance provisions under the SBR Master Directions require the constitution of certain committees, the composition of which hints towards the presence of independent directors.

This gives rise to a key question: Does a private NBFC or a wholly owned subsidiary, solely by virtue of its classification under the middle layer or above, become subject to an obligation to appoint independent directors?

Committees for NBFC-ML and above, the composition of which includes IDs

Upon classification as an NBFC-ML or above, conformity with corporate governance standards becomes applicable. Below we discuss specifically about the committees, the composition of which also includes IDs:

Name of the CommitteeCompositionRemarks
Audit Committee [Para 94.1 of the SBR Master Directions]Audit Committee, consisting of not less than three members of its Board of Directors. If an NBFC is required to constitute AC under section 177 of the Companies Act, 2013, the Committee so constituted shall be treated as the AC for the purpose of this para 94.1.As per section 177, an AC shall comprise a minimum of  three directors, with Independent Directors forming a majority. Hence, in case the NBFC is not covered under the provisions of section 177, the same may be constituted with any three directors, not necessarily being independent directors.
Nomination and Remuneration Committee [Para 94.2 of the SBR Master Directions]Composition will be as per section 178 of the Companies Act, 2013.The provisions indicate that the NRC shall have the constitution, powers, functions and duties as laid down in section 178. In this context, Companies Act requires every NRC to consist of at least three non-executive directors, out of which not less than one-half should be independent directors.
IT Strategy Committee [Para 6 of the Master Direction on Information Technology Governance, Risk, Controls and Assurance Practices]The Committee shall be a Board-level IT Strategy Committee (a) Minimum of three directors as members (b) The Chairperson of the ITSC shall be an independent director and have substantial IT expertise in managing/ guiding information technology initiatives (c) Members are technically competent (d) CISO and Head of IT to be permanent inviteeChairperson of the Committee is required to be an ID.
Review Committee [Master Direction on Treatment of Wilful Defaulters and Large Defaulters]The Composition of the Committee shall be as follows: The MD/ CEO as chairperson; and Two independent directors or non-executive directors or equivalent officials serving as members.Where the NBFC has not appointed IDs, NEDs or equivalent officials to serve as members of the Committee.

Divergent Market Practices

With respect to appointment of IDs on the Board and induction in the Committees, two interpretations are seen in practice in the case of private companies and WOS:

First, since the Companies Act does not mandate the appointment of independent directors in the case of private companies and explicitly exempts WOS, private NBFCs and WOS often rely on these statutory exemptions. The SBR Master Directions make a general reference to the Companies Act without distinguishing between company categories, which further supports the view that these entities constitute the relevant committees without appointing independent directors.

Second, given that NBFCs in the middle layer or above have crossed the ₹1,000 crore asset threshold and fall under enhanced regulatory scrutiny, some take the view that such entities should align with the intended governance standards and appoint independent directors, even if not required under the Companies Act.

Closing thoughts

The SBR Framework takes into account the systemic concerns associated with different NBFCs and thus classifies them into different layers. The corporate governance norms are applicable to ML, UL and TL NBFCs, which, given their asset sizes, are expected to operate at huge volumes and carry a great magnitude of risks. Such NBFCs may have access to public funds (by way of bank borrowings, debenture issuance etc.), wherein large lenders or public would have exposures and consequent high systemic risks. Hence, looking at the constitution (that is whether the NBFC is a private limited or public limited) becomes less important, and looking at the size, activity and function becomes more important. 

Thus, it may not be right to conclude that NBFCs registered as private companies and WOS can do away with the mandatory composition prescriptions merely due to the constitutional form of their entity. Looking at the intent and idea of SBR Framework, the applicable NBFCs may be required to appoint independent directors irrespective of the form of their constitution. The scale-based regulation emanates from the idea that NBFCs having high risk should be effectively monitored. Thus, the regulations should be followed in spirit to effectively mitigate the risks arising in the course of the NBFC’s functioning.

[1] Pursuant to the provisions of section 149(4) of the Companies Act read with rule 4 of the Companies (Appointment and Qualifications of Directors) Rules, 2014, following companies are mandatorily required to appoint independent directions: listed companies, public companies having paid up share capital of ten crore rupees or more; or turnover of one hundred crore rupees or more; or having in aggregate, outstanding loans, debentures and deposits, exceeding fifty crore rupees as per the latest audited financial statements.

Read more:

What is a non-banking financial company?
Resources on Scale Based Regulations

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Understanding the Governance & Compliance Framework for AIFs

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– Payal Agarwal, Partner | payal@vinodkothari.com

Alternative Investment Funds (AIFs) are private investment vehicles registered with and regulated by SEBI. Private investment vehicles, as is understood, are investment vehicles that pool investments from investors on a private basis, and make investments in investee entities based on the investment objectives disclosed to the investors. The returns from such investments, net of the expenses incurred by the vehicle, is distributed back to the investors. A typical AIF structure would look like:

The general obligations of AIFs are provided in the SEBI (Alternative Investment Funds) Regulations, 2012 read with the circulars issued from time to time. In addition to that, the Standard Setting Forum for AIFs (SFA) formulates implementation standards for various compliance requirements, as required by SEBI from time to time.

As may be understood, the AIF takes funds from its investors and makes investments in the investees. As between the sponsor/ manager of the Fund and the investors, there is a fiduciary relationship – since the investment decisions taken by the fund manager is on behalf of the investors, and in accordance with the investment objectives disclosed to the investors. Investor protection and transparency and proper due diligence of the investees become crucial in the context of an AIF. As compared to a traditional company, the AIFs are intermediaries between the investors and investees. This article discusses the various compliance requirements as applicable to AIFs.

Governance structure of AIFs

  • Governing body of AIF: Depending on the legal form of the AIF, the governing body of the AIF may compose of trustee (in case of a trust), directors (in case of a company) or designated partners (in case of an LLP).
  • Manager: The primary responsibility of ensuring compliance with the applicable provisions by an AIF is on the manager of the AIF. Similarly, ensuring compliance with the internal policies and procedures of an AIF is also the responsibility of the manager. The manager is appointed by an AIF, and the Sponsor may also be the manager of the Fund.
  • Investment Committee: Constituted by the manager, the Investment Committee approves the decisions of the AIF and is responsible for ensuring that such decisions are in compliance with the policies and procedures laid down by the AIF. The Investment Committee may be composed of internal members (employees, directors or partners of the Manager) as well as external investors (with the approval of the investors in the AIF/ Scheme). The external members may include ex-officio members who represent the sponsor, sponsor group, manager group or investors, in their official capacity. Pending clarification from RBI, currently non-resident Indian citizens are not permitted to act as an external member in the Investment Committee [Reg 20(7) of AIF Regulations read with Chapter 14 of AIF Master Circular].

The responsibilities of the Investment Committee may be waived by the investors (other than the Manager, Sponsor, and employees/ directors of Manager and AIF), if they have a commitment of at least Rs. 70 crores (USD 10 billion or other equivalent currency), by providing an undertaking to such effect, in the format as provided under Annexure 11 of the AIF Master Circular, including a confirmation that they have the independent ability and mechanism to carry out due diligence of the investments.

  • Key Management Personnel: Key Management Personnel (KMP) of the Manager has been defined to mean:
    • members of key investment team of the Manager, as disclosed in the PPM of the fund;
    • employees who are involved in decision making on behalf of the AIF, including but not limited to, members of senior management team at the level of Managing Director, Chief Executive Officer, Chief Investment Officer, Whole Time Directors, or such equivalent role or position;
    • any other person whom the AIF (through the Trustee, Board of Directors or Designated Partners, as the case may be) or Manager may declare as key management personnel. [Para 13.1.2. of the AIF Master Circular]

The responsibilities of the Manager are complied through the Key Management Personnel of such Manager.

  • Compliance Officer: The Compliance Officer is appointed by the Manager, and is responsible for monitoring of compliance with the applicable laws and requirements as applicable to the AIF. Compliance Officer, shall be an employee or director of the Manager, other than Chief Executive Officer of the Manager or such equivalent role or position depending on the legal structure of Manager [Para 13.1.1. of the AIF Master Circular].

The Compliance Officer is responsible to report any non-compliance observed by him within 7 days from the date of observing such non-compliance.

  • Custodian: The Sponsor/ Manager of the AIF is required to appoint a custodian, registered with SEBI, for safekeeping of the securities of the AIF. An associate[1] of the Sponsor/ Manager may also act as a custodian, subject to compliance with certain conditions[2]. The custodian provides periodic reports to SEBI with respect to the investments of AIFs that are under custody with the custodian in accordance with the standards formulated by SFA.

The various roles and responsibilities at the different levels of the governance structure is discussed below.

Code of Conduct for AIFs [Reg 20(1) of AIF Regulations]

The Code of Conduct, as prescribed under the AIF Regulations, puts forth various requirements applicable to the AIFs and other relevant entities. The Code of Conduct is applicable to various responsibility centers charged with the governance requirements in an AIF. The requirements are given in the Fourth Schedule to the AIF Regulations read with Para 13.3. of the AIF Master Circular.

The applicability to various stakeholders along with the requirements are given in the table below:

Person covered by the CoC Requirements to be adhered to under the CoC
AIF
  • Undertake business activities and investments in accordance with the investment objectives in the placement memorandum and other fund documents [to be ensured by the Manager]
  • Be operated in the interest of all investors, and not limited to select investors, sponsor, manager etc [to be ensured by the Manager]
  • Ensure timely and adequate dissemination of information to all investors
  • Ensure existence of effective risk management process and appropriate internal controls
  • Have written policies for mitigation of any potential conflict of interest
  • Prohibition on use of any unethical means to sell, market or induce any investor to buy its units
  • Have written policies and procedures to comply with anti-money laundering lawsnot offer any assured returns to any prospective investors/unitholders.
  • Manager of AIF
  • KMP of Manager
  • KMP of AIF
  • Abide by the laws applicable to AIFs at all times
  • Maintain integrity, highest ethical and professional standards in all its dealings
  • Ensure proper care and exercise due diligence and independent professional judgment in all its decisions
  • Act in a fiduciary capacity towards investors of AIF and ensure that decisions are taken in the interest of the investors
  • Abide by the policies of AIF in relation to potential conflict of interests
  • Not make any misleading or inaccurate statement, whether oral or written, either about their qualifications or capability to render investment management services or their achievements
  • Record in writing, the investment, divestment and other key decisions, together with appropriate justification for such decisions;
  • Provide appropriate and well considered inputs, which are not misleading, as required by the valuer to carry out appropriate valuation of the portfolio;
  • Prohibition on entering into arrangements for sale or purchase of securities, where there is no effective change in beneficial interest or where the transfer of beneficial interest is only between parties who are acting in concert or collusion, other than for bona fide and legally valid reasons;
  • Abide by confidentiality agreements with the investors and not make improper use of the details of personal investments and/or other information of investors;
  • Not offer or accept any inducement in connection with the affairs of or business of managing the funds of investors;
  • Document all relevant correspondence and understanding during a deal with counterparties as per the records of the AIF, if they have committed to the transactions on behalf of AIF
  • Maintain ethical standards of conduct and deal fairly and honestly with investee companies at all times; and
  • Maintain confidentiality of information received from investee companies and companies seeking investments from AIF, unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
  • Ensure availability of the PPM to the investors prior to providing commitment or making investment in the AIF and an acknowledgment be received from the investor
  • Ensure scheme-wise segregation of bank accounts and securities accountsnot offer any assured returns to any prospective investors/unitholders.
  • Members of Investment Committee
  • Trustee/ Trustee company
  • Directors of Trustee company
  • Directors of AIF
  • Designated Partners of AIF
  • Maintain integrity and the highest ethical and professional standards of conduct
  • Ensure proper care and exercise due diligence and independent professional judgment
  • Disclose details of any conflict of interest relating to any/all decisions in a timely manner to the Manager of the AIF, adhere with the policies and procedures of the AIF with respect to any conflict of interest and wherever necessary, recuse themselves from the decision making process;
  • Maintain confidentiality of information received regarding AIF, its investors and investee companies; unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
  • Not indulge in any unethical practice or professional misconduct or any act, whether by omission or commission, which tantamount to gross negligence or fraud
  • Not offer any assured returns to any prospective investors/unitholders.
Compliance with Stewardship Code

The AIFs, being institutional investors, it is mandatory for AIFs to comply with the Stewardship Code in terms of Para 13.4 of the AIF Master Circular. This is applicable in respect of investments in listed equity instruments. Annexure 10 of the Master Circular specifies the broad principles of stewardship and provides guidance for its implementation. Further, the AIFs are required to report the status of implementation of the principles atleast on an annual basis (periodicity may differ for different principles), through the website of the AIFs. Such report may also be sent as a part of annual intimation to its clients/ beneficiaries. An article on the stewardship responsibilities of institutional investors may be read here.

Policies to be formulated by AIFs

In order to ensure that the decisions of the AIF are taken in compliance with all applicable laws and regulations, PPM, investor agreements and other fund documents, detailed policies and procedures are required to be kept in place in terms of Reg 20(3). The policies are jointly approved by:

  • Manager and
  • Relevant governing body of the AIF (viz., the trustee/ trustee company/ board of directors/ designated partners etc)

The Manager is required to ensure that the decisions taken by the AIF are in compliance with such policies and procedures.

Further, the policies should be reviewed periodically, on a regular basis and whenever required as a result of business developments, to ensure their continued appropriateness.

Audit

Annual Audit of terms of PPM

The AIF is required to file Private Placement Memorandum (PPM) with SEBI through a Merchant Banker for the launch of Schemes. The format of PPM is specified under Annexure 1 read with the requirements specified under various other circulars from time to time. In order to ensure that the activities of the AIF are in compliance with the terms of PPM, annual audit of the terms of PPM is required to be done. In this regard, the following needs to be noted:

  • Scope of audit: Compliance with all sections of the PPM. Further, audit of the following sections is optional, viz., ‘Risk Factors’, ‘Legal, Regulatory and Tax Considerations’ and ‘Track Record of First Time Managers’. The format of PPM audit report may be accessed here.
  • Eligibility to conduct audit: an internal or external auditor/legal professional
  • Periodicity of PPM audit: Annual
  • Timeline: within 6 months from the end of the Financial Year
  • Reported to: Governing Body (Trustee or Board of Directors or Designated Partners) of the AIF, Board of directors or Designated Partners of the Manager and SEBI
  • Non-applicability: if no funds are raised from investors, subject to submission of a certificate from CA to that effect within 6 months from end of FY
  • Exemptions: (i) Angel Funds, (ii) AIFs/ Schemes with each investor having a minimum commitment of Rs. 70 crores (USD 10 mn or equivalent), upon providing a waiver for the same. 
Audit of accounts

Reg 20(14) of the AIF Regulations require the books of account to be audited by a qualified auditor annually.

Valuation of Investments of AIF

Reg 23 read with Chapter 22 of the AIF Master Circular specifies the requirements with respect to the valuation of the investments of AIF. The valuation is required to be done by an independent valuer, on a half-yearly basis (may be made an annual requirement subject to consent of 75% of investors in value).

Eligibility criteria have been specified for acting as an independent valuer:

  • shall not be an associate of manager or sponsor or trustee of the AIF
  • shall have at least three years of experience in valuation of unlisted securities
  • shall be a registered valuer with IBBI and a member of ICAI, ICSI or ICMAI or shall be a holding or subsidiary of SEBI-registered CRA

The Manager shall specifically inform the investors, the reasons/ factors for deviation in valuation, in case the deviation is more than:

  • 20% between two consecutive valuations, or
  • 33% in a financial year

In case of Cat III AIFs, the listed and unlisted debt securities are required to be valued by an independent valuer, and the NAV is required to be reported on a quarterly basis for close ended funds, and monthly basis for open ended funds.

Investor complaints and Grievance Redressal Mechanism

Resolution of investor complaints is a role of the Manager of AIF [Reg 24 of AIF Regulations]. Reg 24A requires the Manager to redress investor grievances in a prompt manner, but within a maximum of 21 days from receipt of grievances. The AIF is required to be registered on the SCORES portal for receipt of investor grievances. Further, in terms of Reg 25, the dispute resolution mechanism provided by SEBI (SMARTODR) is applicable to AIFs as well. Refer details under Master Circular for Online Resolution of Disputes in the Indian Securities Market dated 28th December, 2023.

Further, in terms of Para 17.4 of the AIF Master Circular, the AIFs are required to maintain data on investor complaints received against the AIF/ its Schemes on a quarterly basis within 7 days from the end of the quarter, in addition to the disclosure in the PPM. The data includes the following:

S. No. Investor Complaints received from Pending as at the end of the last quarter Received Resolved Total Pending at the end of the quarter Pending complaints > 3months Average Resolution time ^ (in days )
1 Directly from Investors            
2 SEBI (SCORES)            
3 Other Sources            

Matters requiring consent of investors of AIF

The AIFs act in a fiduciary capacity towards the investors, and manage the funds of the investors invested in the AIF. Thus, the decisions of AIF are required to be taken in the interests of the investors. Some matters require approval of the investors of a specified majority, prior to undertaking such activity:

Regulatory reference Matter requiring approval Requisite majority in terms of value of investment 
Reg 9(2) Material alteration to fund strategy 2/3rd of unitholders
Reg 13(5) Extension of tenure of close-ended funds (upto 2 years) 2/3rd of unitholders
Reg 15(1)(e) Investment in associates or units of AIFs managed/ sponsored by its Manager, Sponsor or associates of its Manager or Sponsor 75% of investors
Reg 15(1)(ea) Purchase or sale of investments from/ to: Associates Schemes of AIF managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsoran investor who has committed to invest at least fifty percent of the corpus of the scheme of AIF 75% of investors, excluding investor covered under (c) where purchase/ sale is from such investor
Reg 20(10) Appointment of external members (other than ex-officio members) in Investment Committee other than as disclosed in the fund documents 75% of investors
Reg 23(2) Reducing frequency of valuation of investments from six months to 1 year 75% of investors
Reg 29(9) In-specie distribution of investments of AIF due to lack of liquidity or enter into liquidation period 75% of investors

Disclosure to investors

The funds of the investors invested in the AIF are managed by the Manager and Sponsor in a fiduciary capacity. In order to ensure transparency, various disclosure requirements apply in terms of Reg 22 of the AIF Regulations – either on a periodic basis or upon the happening of certain events.

Periodic disclosures

The periodic disclosures include:

  • financial, risk management, operational, portfolio, and transactional information regarding fund investments
  • any fees ascribed to the Manager or Sponsor; and any fees charged to the AIF or any investee company by an associate of the Manager or Sponsor

Further, in terms of clause (g) of Reg 22, the following information is required to be disclosed within 180 days from the year end (60 days from the end of each quarter for Cat III AIF):

  • financial information of investee companies.
  • material risks and how they are managed which may include:
    • concentration risk at fund level;
    • foreign exchange risk at fund level;
    • leverage risk at fund and investee company levels;
    • realization risk (i.e. change in exit environment) at fund and investee company levels;
    • strategy risk (i.e. change in or divergence from business strategy) at investee company level;
    • reputation risk at investee company level;
    • extra-financial risks, including environmental, social and corporate governance risks, at fund and investee company level.

Any changes in terms of PPM or other fund documents are required to be intimated to the investors on a consolidated basis within 1 month from the end of each financial year [Para 2.5.3. of AIF Master Circular]

Event-based disclosures

These events are required to be disclosed ‘as and when occurred’:

  • any inquiries/ legal actions by legal or regulatory bodies in any jurisdiction
  • any material liability arising during the AIF’s tenure
  • any breach of a provision of the placement memorandum or agreement made with the investor or any other fund documents
  • change in control of the Sponsor or Manager or Investee Company
  • any significant change in the key investment team

Matters requiring reporting to SEBI

Reg 28 provides power to SEBI to seek such information from the AIFs, as may be required, from time to time. In addition to such powers, there are various specific reporting requirements that are applicable on AIFs under various applicable provisions. These include:

Regulatory reference Matters requiring reporting to SEBI Timelines
Reg 20(12) Any material change from the information provided at the time of application Promptly
Reg 26 Information for systemic risk purposes (including the identification, analysis and mitigation of systemic risks) when so required by SEBI
Para 2.5.2 Any changes in the terms of PPM and other fund documents, along with DD certificate from Merchant Banker  within 1 month from the end of FY
Para 15.1 Reporting on investment activities of AIF in the format specified by SFA 15 calendar days from end of each quarter
Para 15.2 Any violations reported in the Compliance Test Report (refer detailed discussion below) As soon as possible
Reg 20(11) r/w Para 15.4. Investments of AIF that are in custody of the custodian Quarterly

Compliance with provisions applicable to SEBI-registered intermediaries

An AIF, in its capacity of a SEBI-registered intermediary, is required to comply with the SEBI (Intermediaries) Regulations, 2008 read with the circulars issued thereunder. These include, for instance, compliance with the circulars/guidelines as may be issued by SEBI with respect to KYC requirements, Anti-Money Laundering and Outsourcing of activities [Para 13.5 of AIF Master Circular].

The guidelines with respect to anti-money laundering and KYC requirements are contained in a Master Circular dated 6th June, 2024 on the subject. Our various resources on KYC and anti-money laundering can be accessed here.

Compliance Test Report

The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days. 

A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible. This requirement is in addition to the obligation of the Compliance Officer to report a non-compliance, within 7 days of becoming aware of the same. The format of CTR is provided in Annexure 12 of the AIF Master Circular.

Other compliances

SEBI specifies various compliances applicable to the AIFs from time to time. The compliances as applicable to the AIFs for the first time during FY 25-26 has been dealt with in our article Regulatory landscape for AIFs: what’s new? Further, there are certain requirements applicable on special categories of AIFs, viz., angel funds, Special Situation Funds, Social Venture Funds etc. Further, there are various prudential requirements applicable to receipt of funds from investors and making of investments by the AIFs.

See our other resources on AIFs:

[1] Associate means:

  • a company or a limited liability partnership or a body corporate
  • in which a director or trustee or partner or Sponsor or Manager of the Alternative Investment Fund or a director or partner of the Manager or Sponsor
  • holds, either individually or collectively, more than fifteen percent of its paid-up equity share capital or partnership interest, as the case may be

[2] The conditions include:

(a) Minimum net worth of the Sponsor or Manager of at least twenty thousand crore rupees at all points of time;

(b) fifty per cent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates;

(c) the Custodian and the Sponsor or Manager of AIF are not subsidiaries of each other;

(d) the custodian and the Sponsor or Manager of AIF do not have common directors; and

(e) the Custodian and the Manager of AIF sign an undertaking that they shall act independently of each other in their dealings of the schemes of AIF.

Should you expect adjustment in profits for “Expected Credit Loss”?

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– Customised profits for CSR and managerial remuneration under Section 198 of the CA, 2013

– Pammy Jaiswal and Sourish Kundu | corplaw@vinodkothari.com

Background

The presentation of the profit and loss account has been outlined under the Schedule III of the Companies Act, 2013  (‘Act’) and the profit computation method has been provided for under the applicable accounting standards [See IND AS 1]. The basic principle is to showcase a true and fair view of the financial position of a company. Having said that, it is also significant to mention that the Act provides for an alternative method for computing net profits, the basic intent of which is to arrive at an adjusted net profit which does not have elements of unrealised gains or losses, capital gains or losses and in fact any item which is extraordinary in its very nature. The same is contained under the provisions of section 198 of the Act. This section, unlike the general computation method, has a limited objective i.e., calculation of net profits for managerial remuneration as well as corporate social responsibility. 

There are four operating sub-sections under section 198 which provides for the adjustment items:

  1. Allowing the credit of certain items – usual income in the form of govt subsidies
  2. Disallowing the credit given to certain items – unrealised gains, capital profits, etc.
  3. Allowing the debit of certain items – usual working charges, interests, depreciation, etc
  4. Disallowing the debit of certain items – capital losses, unrealised losses, usual income tax, etc

It is important to note that items other than those mentioned above need not be specifically adjusted unless their nature calls for adjustment under the said section. Now if we discuss specifically for items in the nature of Expected Credit Loss (‘ECL’) for companies following IND AS, it is important to understand the nature of ECL in the context of making adjustments under section 198 of the Act. See our write on Expected Credit Losses on Loans: Guide for NBFCs.

Understanding ECL and Its Accounting Treatment

Reference shall be drawn from Ind AS 109 which defines ‘credit loss’ as ‘the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. cash shortfalls), including cash flows from the sale of collateral held.’ ECL is essentially a way of estimating future credit losses, even on loans that appear to be fully performing at the time of such analysis (Stage 1 assets). It is based on expected delays or defaults, and the estimated loss is recorded as a charge to the profit and loss account, based on a 12-month probability of default.

As per Ind AS 109, ECL is used for the recognition and measurement of impairment on financial assets both at the time of origination as well as at the end of every reporting period. ECL is a forward-looking approach that requires entities to recognize credit losses based on the probability  of future defaults/ delays.

However, this does not result in a reduction in the carrying value of the asset (unless the asset is already credit-impaired, i.e., Stage 3). In that sense, while ECL reflects asset impairment, it does not operate like a direct write-down. And unlike conventional provisioning, ECL is not a “provision” under traditional accounting – it is a loss allowance rooted in forward-looking estimations. Further, it is also important to understand that the booking of ECL does not mean that there has been a credit loss in the actual sense, the same is a methodical manner of estimating the probable default risk association with the asset value.

Treatment of ECL under Section 198 

Section 198 requires excluding unrealised or notional adjustments, such as fair value changes or revaluation impacts in terms of Section 198(3) of theAct.

The section also refers specifically to actual bad debts, under  Section 198(4)(o). This raises the natural interpretational question: should model-driven, probability-weighted ECL charges – which do not reflect realised losses – really be allowed to remain deducted while computing such customised profits? Well, the answer lies in the requirement and nature of such an item being required to be deducted from the profit and loss account under IND AS 109.  

Alternative approaches -Treatment of ECL

The question around the treatment of ECL can be viewed from two perspectives. The first being the nature of ECL and the second on the routine treatment and calculation of ECL. If we look at the nature, it is clear that while it is imperative for companies to compute ECL at the time of origination as well as at the end of every reporting period, it is important to note that there is no loss or default in the actual sense. This means that the amount computed as ECL has not been an actual default. 

On the other hand, if we look at the need for such computation and the methodical approach to arrive at the value of ECL, the same is likely to be considered as a usual working charge which is charged to the profit and loss account. Accordingly, we have come across two possible and permissible approaches to the treatment of ECL while computing the profits under section 198. The same has been discussed below with the help of illustrations.

Approach 1: Disallowing ECL in the year of its booking and subsequent adjustment of bad debt

Year 1Year 2
PBT – 1000
Depreciation – 20
ECL – 40
Loss on sale of fixed asset – 15		PBT – 1200
Depreciation – 20
ECL – 35
Actual Bad Debt – 15
Profit on sale of equity shares – 25
Year 1AmountYear 2Amount
PBT                                                                                  1000PBT                                                                                  1200
Depreciation                                                                     –Depreciation                                                                    –
Add: ECL                                                                            40Add: ECL                                                                            35
Add: Loss on sale of fixed asset                                    15Less: Profit on sale of equity shares                                                    (25)
PBT u/s 198                             1055PBT u/s 198                                  1210

Notes: 

  • ECL has been ignored in profit computation u/s 198 considering the same is an unrealised loss and therefore reversed.
  • Depreciation and actual bad debt has not been adjusted again as it has already been deducted under normal profit computation.
  • Capital gains and losses have been adjusted/ reversed under the computation.

Approach 2: Allowing ECL in profit computation and netting off actual bad debt from the same in subsequent period

Year 1Year 2
PBT – 1000
Depreciation – 20
ECL – 40
Loss on sale of fixed asset – 15		PBT – 1200
Depreciation – 20
ECL recovered – 35
Actual Bad Debt – 15
Profit on sale of equity shares – 25
Year 1AmountYear 2Amount
PBT                                                                                 1000PBT                                                                                 1200
Depreciation                                                                    –Depreciation                                                                     –
ECL                                                                                     –ECL                                                                                      –
Add: Loss on sale of fixed asset                                   15Actual bad debt                                                                           –
ECL recovered                                                                    –
Less: Profit on sale of equity shares                          (25)
PBT u/s 198                            1015PBT u/s 198                           1185

Notes:

  • ECL has been considered in profit computation u/s 198  and therefore, not adjusted to reverse the impact
  • Similarly, ECL recovered has been considered part of normal or routine adjustment and hence, not reversed.
  • Actual bad debt is not to be considered at the time of profit computation under  the regular computation since it can be adjusted from the ECL already booked.
  • Capital gains and losses have been adjusted/ reversed under the computation.

Concluding remarks

All listed companies are required to comply with Ind AS and given that an instance of a company having nil receivables is a rare occurrence, the discussion on how ECL is to be treated while computing net profit in terms of Section 198 becomes more than just an academic debate.

As long as the impact of any P&L item being extra ordinary in nature is taken off from the profits computed u/s 198, the same serves the purpose and intent of section 198 of the Act. ECL, while valid for accounting, is fundamentally an estimated, non-actual loss. It exists because accounting standards demand alignment of income with credit risk  and not because a real outflow has occurred. However, it cannot be said that ECL already deducted while calculating profit before tax as per applicable accounting standards will be reversed while calculating profits in terms of Section 198. 

Further, given that ECL is based on expectation calculated using due accounting principles, the actual bed debt, if within the ECL limit, does not impact the P&L. On the contrary, in case of the actual bad debt being in excess, the P&L warrants a subsequent debit of the net amount. For example, under approach 2 if the actual bad debt would have been 50, i.e. in excess of the ECL booked in the previous period by 10, the normal profit computation would have allowed a debit of 10.

In fact, both the approaches lead to the fulfilment of the intent of section 198 and hence, it is not necessary to consider any one approach as correct. Having said that, it is imperative to follow uniform practice in this regard in the absence of which the profits u/s 198 may be impacted. 

Therefore, where the statutory and accounting frameworks intersect – but are not necessarily aligned – companies must adopt a carefully considered, principle-based approach as even a single line item like ECL can materially influence the base for managerial remuneration and CSR spending unlike other estimate based items such as revenue deferrals viz. sales returns or warranties, which are made as a matter of accounting prudence, but does not represent outflows for statutory computation purposes. Accordingly, there is no reason for deviating from the Indian GAAP principles for the purpose of customised calculation of net profits for specific purposes. 

Read more: 

Cash in Hand, But Still a Loss? 

Impact of restructuring on ECL computation

Knowledge Centre for Corporate Social Responsibility (CSR)

Tailored to Fit Practically: Disclosure for RPTs under Revised Industry Standards

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Disclosure requirements rationalised and simplified under the ISN for RPTs

Team Corplaw | corplaw@vinodkothari.com

  • Revised regulatory regime on RPT disclosures before Audit Committee & Shareholders
    • Reg 23 of LODR Regulations
    • Industry Standards Note on Minimum information to be provided to the Audit Committee and Shareholders for approval of Related Party Transactions  (as revised) dated June 26, 2025 (“RPT ISN”).
  • Applicability of RPT ISN
    • with effect from 1st September, 2025 (‘Effective Date’)
Approval of ACApproval of shareholders (in case of material RPTs)Date of execution of RPTsApplicability of RPT ISN
Before Effective DateBefore Effective DateAfter Effective DateNot Applicable
Before Effective DateAfter Effective DateAfter Effective DateNot Applicable
After Effective DateAfter Effective DateAfter Effective DateApplicable
  • Any subsequent material modification, renewal, ratification etc. after the Effective Date should require detailed disclosures as per RPT ISN
  • Exemption from applicability of RPT ISN
    • Exempted RPTs: RPTs exempt from approval requirements under Reg 23(5) of LODR
    • Small value RPTs: Transactions with a related party for an aggregate value of upto Rs. 1 crore in a FY
    • RPTs placed for quarterly review under Reg. 23(3)(d).
  • Minimum information to AC divided into 3 parts
    • Part A – Minimum information of the proposed RPT, applicable to all RPTs (Para A1 to A5)
    • Part B – Additional information applicable to proposed RPTs of specified nature (Para B1 to B7)
    • Part C – Additional information applicable to Material RPTs (as per Reg 23 of LODR) of specified nature (Para C1 to C6)
  • Certification requirement to AC (‘KMP certificate’)
    • From
      • CEO/ Managing Director/ Whole-time Director/ Manager and
      • CFO of the listed entity
    • To the effect that
      • RPTs proposed to be entered are in the interest of the listed entity
    • Role of AC
      • To review the certificate – the fact to be disclosed in the notice to shareholders
  • Minimum information to shareholders
    • Information as may be required under CA, 2013
    • Information as placed before AC in terms of RPT ISN
      • AC may approve redaction of commercial secrets and such other information that would affect competitive position of listed entity
        • Subject to affirmation that, in its assessment, the redacted disclosures still provide all the necessary information to the public shareholders for informed decision making
    • Justification as to the transaction in the interest of the listed entity
    • Basis for determination of price and other material terms and conditions of RPTs
    • Affirmation that AC has reviewed the KMP certificate on proposed RPTs
    • Disclosure of approval of AC and recommendation of board
    • Web-link and QR code of third-party reports/ valuation report, if any, considered by AC
  • Role of Management
    • Management to provide information against each line-item
      • Indicate NA, where field is not applicable along with reason for non-applicability
  • Comments/ decision of AC
    • AC may provide comments on any line-item, based on its discretion
    • Rationale to be disclosed, in case an RPT is not approved
    • Comments and rationale to be minutised
  • Furnishing of valuation/ third party report
    • To be furnished to AC, if any
    • Web-link and QR code to be disclosed in shareholders’ notice, if considered by AC

Our analysis of the detailed disclosure requirements on relevant line-items are being collated in the form of FAQs. Keep checking our website for more.  

Our other resources

Related Party Transactions- Resource Centre

Yeh Rishta kya kahlaata hai! – the strange case of “promoters-in-law”

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Vinod Kothari | vinod@vinodkothari.com

Here is a tale of three families, and trust, almost every business family in the country may fit in the tale. (All names are completely hypothetical.)

Family One – Jaani family, owning large number of listed companies in the country. Ashok, son of the founder, got married to Rani, daughter of the founder of Maani family.

Maani family – once again another leading industrial houses in the country. Rani, daughter of the founder, has two siblings – Prashik, and Vimla. Prashik runs the family’s businesses. Vimla got recently married to Varun, from Dhyaani family.

Camera shifts to Dhyaani family, where Vimla got married to Varun. Relations are made between equals – hence, Dhyaani family is no less in stature than the Maani family and the Jaani family.

All the families have variety of listed and unlisted companies in their control. In most cases, shareholdings of operating entities are through investing vehicles, which are held in the name of individuals of the families.

Given the definition of “promoter group”, Ashok is a promoter. Ashok’s wife, Rani is obviously an “immediate relative” and hence a part of promoter group.

By definition (if we read it to mean parents, brother, sister and child of the spouse too), Rani’s father, the founder of the Maani family, becomes a part of the “promoter group” for Jaani family. So also will be Prashik. Vimla, though married in Dhyaani family, being sister of Rani, will also be part of “promoter group”.

Now look at the consequences. All bodies corporate where 20% shareholding is held by the individuals of Maani  family – founder, Prashik and Prashik’s mother, will form part of the promoter group of the Jaani family. 

We don’t stop here – all entities where Vimla, now a part of Dhyaani family, will also need to identify bodies corporate where she holds 20%, and these entities will be reported as a part of the PG for Jaani family.

The same process will have to run for Maani family and Dhyaani family – hence, the focus may actually shift over to the country’s business tycoons one by one.

The sweep of the definition of “promoter group” may have had its own intent, but it cannot be stretched to include सगे सम्बन्धी where there is no evidence of commonality. Sadly enough, SEBI rules require a listed company to list out the names of all such सगे सम्बन्धी entities, no matter whether there is a shareholding overlap or not. And all these entities will be identified as “related parties” too.

Our other resources on promoter/promoter group can be accessed below: