Tuesday, March 31, 2015

Financial Sector Legislation, Anti-terror Laws, Human Rights and the Indian Constitution

We all now know that the Supreme Court outlawed Section 66-A of the Information Technology Act in a recent order.  I wrote about the court's core findings in a column in the Mirror publications last Friday.

I would have been remiss in not writing about the court's rationale in the very same judgement, in refusing to strike down as unconstitutional, a different section of the same law - Section 69-A, which enables issuance of directions by the government blocking public access to electronic content.  This provision has poor variants across various sections in legislation governing the financial sector, in practice, rendering them similar to anti-terror laws.

Hence my column in Business Standard this Monday, pointing out how the safeguards found by the court to save Section 69-A as constitutional, are sorely lacking in legislation governing the financial sector.

The inter-play of securities regulations with human rights is gaining attention in jurisprudence globally.  The subject has drawn the attention of the European Court of Human Rights, which I refer to in my the Business Standard column.  That judgement is in French but for those who cannot comprehend French, the English press release provides an excellent summary.

Monday, March 30, 2015

Corporate Benevolence: Companies May Accept Gifts, and Tax Free

[The following post is contributed by Vinod Kothari of Vinod Kothari & Co. The author can be contacted at vinod@vinodkothari.com.]

When it comes the law imposing a requirement of spending on corporate social responsibility (CSR), which is 2% of the profits of the company, we come to notice all sorts of ingenious ways of companies trying to avoid or evade the requirement. Some might even go to the extent of treating personal events as spending on promoting art and culture, and therefore qualifies as a CSR spending. Some may want to book an expenditure on staff welfare as CSR.  In essence, companies are trying to find smart ways of working around the requirement.

On the other extremity of corporate benevolence is a practice, whereby four private  companies gifted, in all,  Rs. 1618.6 million by way of a gift to a  single donee company! The Income Tax Appellate Tribunal (ITAT), Mumbai, in a ruling of 11 March 2015 held that not only did the company have the power to accept gifts, such gifts being capital receipts in nature were not liable to be taxed.

 If someone thought the donor companies must be extremely prosperous entities and might, therefore, be flush with generosity, the facts at least do not suggest so, since all the four companies actually gifted all of their dividend income from a particular investment to the donee. Also, one must not think the donee company is a not-for-profit (NFP) company which usually does accept gifts or corpus contributions to carry out its philanthropic activities. In short, there is no philanthropy, suggestion of charity, or a social cause at all. Four donor companies, having significant investment in a particular company, give irrevocable instruction to the company whose shares they are holding, gifting all of their dividend income from the particular investment, to a particular donee. 

The ITAT seems to have confined itself to a narrow technicality of the question  involved in the case, maintaining a tunnel-vision to the question whether a company could accept a gift, and if it did, whether the gifts are of a capital nature. As far as the power to accept a gift, the power of a company to do anything which is otherwise legal is typically conferred by amending the charter documents of the company. In this case, the Memorandum of Association was amended to confer a power to accept gifts.

Having thus established the power to accept a gift, the ITAT went at length discussing technicalities, such as, whether a gift could be regarded as business income, “income from other sources”, etc., or whether the gift is purely a capital receipt.  Since there was no finding as to business connection of the gifts, the ITAT finally determined that the gifts were not arising out of the business of the donee company, and therefore, were purely capital receipts, and were therefore, tax free. Neither did the gifts have to appear in the profit and loss account of the donee and therefore, they were not even liable to be included for determination of “book profits”.

Respectfully, judicial and quasi-judicial authorities ought not to be confined to technicalities but must take a larger, rational view of the facts. The fact that the so-called “gift” was highly unusual and illogical is quite apparent. In fact, since all dividends from a particular investment were “gifted”, there was a at least a pointer to the real beneficial ownership of the shares, whose income was “gifted”.

Companies are artificial persons. Companies come into existence only for business or non-business purpose as mentioned in their constitutional documents. Companies do not have an existence beyond the law; therefore, they are a fiction created by law. They are instrumentalities for carrying out certain operations. Natural persons have a life much beyond their business or employment – they have relations, sentiments, bondages, and so on. Therefore, there is a case for natural love and affection due to which dealings such as gifts, settlements, inheritance etc take place in case of natural persons.

A company, on the other hand, is an artifice. It has no brain of its own except those who are behind the company. And it does not have any heart. Evaluating the artificial persona of the company, it might have seemed a no-brainer to say that whatever goodwill, liking or attachment the company has been able to create, which tempts someone to give a gift to the company, might have obviously been in course of business of the company. The company could not, in any case, have an existence outside its business. Presumably, no company could be doing anything which is not a part of its charter documents, or things in furtherance of its charter documents. Since what is in the charter of the company is its business existence, it is difficult to envisage how a capital receipt could arise not in course of business  of the company.

It is quite common for NFP companies to obtain gifts, as that is the very nature of the company. Sometimes, start-ups also receive gifts. However, in the present case, it is income out of a certain investment which is gifted by shareholders of one company to another.

It is highly likely that the Income Tax Department will take the matter further in appeal. However, if the ITAT ruling becomes the last word on the subject, it will usher in a series of similar transactions. The transaction, from the perspective of a tax planning, makes tremendous sense. Since dividends are tax free, the dividends gifted away cannot be taxed in the hands of the donor company on the principle of sec 60 of the Income-tax Act (transfer of income without transfer of the underlying assets). There is no case for bringing the dividends in the profit and loss account of the donor company, as the company has ceased to have beneficial interest in the dividends, having gifted them away. As regards the donee company, the dividend stream will escape the profit and loss account, as it is a capital receipt, and therefore, will escape book profits tax. Effectively, the device of one holding company gifting its dividend stream to another company may become an easy way to escape book profits tax on inter-corporate dividends.

- Vinod Kothari

Sunday, March 29, 2015

SEBI Guidelines for International Finance Centres

[The following post is contributed by Yogesh Chande, who is an Associate Partner with Economic Laws Practice, Advocates & Solicitors. Views of the author are personal.]

The report (2007) of the High Powered Expert Committee (HPEC) on ‘Mumbai: An International Financial Centre’ had in its report suggested the setting up of International Financial Centre in Mumbai.

The Minister of Finance in his budget speech (2015-2016) stated that, “While India produces some of the finest financial minds, including in international finance, they have few avenues in India to fully exhibit and exploit their strength to the country’s advantage. GIFT in Gujarat was envisaged as International Finance Centre that would actually become as good an International Finance Centre as Singapore or Dubai, which, incidentally, are largely manned by Indians. The proposal has languished for years. I am glad to announce that the first phase of GIFT will soon become a reality.” 

Pursuant to announcement in the Union Budget 2015-2016 on Gujarat International Finance Tec-City (GIFT), SEBI’s board on 22 March 2015 approved the SEBI (International Financial Services Centres) Guidelines, 2015 (“IFSC Guidelines”). SEBI on 27 March 2015 issued the IFSC Guidelines for facilitating and regulating financial services relating to securities market in an IFSC set up under section 18(1) of Special Economic Zones Act, 2005.

In terms of the IFSC Guidelines, the following entities have been permitted to operate in an IFSC:

Infrastructure Companies in Securities Market

1. Stock exchanges;
2. Clearing corporations;
3. Depositories.


4. Includes a stock broker, a merchant banker, an underwriter, a portfolio manager, a foreign portfolio manager, an investment adviser and those persons who are associated with the securities market.


5. Alternative Investment Funds;
6. Mutual Funds.

In terms of the IFSC Guidelines, following are the modes in which capital and debt could be raised / issued:

i) A domestic company including a body or corporation established under a Central or State legislation can raise capital in currency other than Indian Rupee in compliance with the provisions of Foreign Currency Depository Receipts Scheme, 2014;

ii) Companies of foreign jurisdictions can raise capital in currency other than Indian Rupee in compliance with provisions of the Companies Act, 2013 and SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 as if the securities are being issued under chapter X and XA thereof, dealing with issuance of Indian Depository Receipts (“IDR”) and rights issue of IDR.

iii) A company incorporated in India or outside India is eligible to issue debt securities subject to certain prescribed conditions.

Criteria for setting up of Infrastructure Companies in Securities Market in an IFSC


a) Stock Exchange: Can be formed by an Indian recognised stock exchange or a stock exchange of a foreign jurisdiction.

b) Clearing Corporation: Can be formed by an Indian recognised stock exchange or a clearing corporation or any recognised stock exchange or a clearing corporation of a foreign jurisdiction.

c) Depository: Can be formed by an Indian registered depository or any regulated depository of a foreign jurisdiction.


At least 51% of the paid up equity share capital needs to be held by those seeking to form a stock exchange or a clearing corporation or a depository. Change in equity shareholding merely requires intimation to SEBI within fifteen days of acquisition of equity shares.

Minimum networth:

In case of a stock exchange and a depository, the initial minimum networth needs to be INR 250 million and INR 500 million in case of a clearing corporation. The initial minimum networth needs be to increased to INR 1000 million over a period of three years from date of approval in case of a stock exchange and a depository, and to INR 3000 million over a period of three years from date of approval in case of a clearing corporation.

Relaxation of certain provisions:

The IFSC Guidelines have provided for certain relaxations to stock exchanges, clearing corporations and depositories to be set up in an IFSC from the provisions of Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 and SEBI (Depositories and Participants) Regulations, 1996; dealing with transfer of a certain percentage of profits of these entities every year to the relevant “fund” prescribed under the applicable regulations. Infrastructure companies in securities market operating in an IFSC are required to adopt the broader principles of governance prescribed by International Organization of Securities Commissions (IOSCO) & principles for Financial Market Infrastructures (FMI), and such other governance norms as may be specified by SEBI, from time to time.

Trading on stock exchanges:

The stock exchanges operating in an IFSC can provide platform for trading in securities and products in such securities in any currency other than Indian rupee such as: (i) equity shares of a company incorporated outside India; (ii) depository receipt(s); (iii) debt securities issued by eligible issuers; (iv) currency and interest rate derivatives; (v) index based derivatives.

Operations of intermediaries in an IFSC

Intermediaries seeking to operate in an IFSC which are intending to provide financial services relating to securities market need to be formed as a “company” form of organisation. The IFSC Guidelines currently do not envisage any other form of organisation like a “limited liability partnership”. Intermediaries operating within the IFSC can provide financial services to prescribed categories of clients only, such as a person not resident in India or a non-resident India. A person resident in India cannot be a client of such an intermediary. Similar requirement is also applicable to those who intend to avail investment advisory or portfolio management services from intermediaries operating as such in an IFSC. The IFSC Guidelines permit a portfolio manager operating in IFSC to invest in securities which are listed in IFSC, and also in unlisted securities issued by companies incorporated in IFSC, or those issued by companies belonging to foreign jurisdiction. Intermediaries are obliged to appoint a senior management person as “designated officer” to ensure compliance with the regulatory requirements.

Issue of capital and issue of debt securities

Unlike in case of entities mentioned in the first two paragraphs under the section relating to modes of raising capital, in case of issue of debt securities, Chapter V of the IFSC Guidelines does not expressly state that, such debt securities should be in a currency other than Indian Rupee. Companies mentioned in the first two paragraphs above have an option to list their securities on stock exchanges set up in an IFSC, unlike in case of an issuer issuing debt securities which needs to be mandatorily listed. In case of issue of debt securities, the requirements relating to appointment of trustees, creation of debenture redemption reserve, entering into an agreement with a depository/custodian, reporting of financial statements and trading on stock exchanges including clearing & settlement of debt securities through a clearing corporation set up in an IFSC is mandatory.

Funds operating in IFSC

A person resident in India is not eligible to make an investment in an alternative investment fund (“AIF”) or a mutual fund (“MF”). It appears that, this condition on investment in an AIF or a MF is in relation to investing in the units of a scheme of an AIF or a MF, and does not prohibit investment by a person resident in India in the AIF as a sponsor, or in the asset management company (“AMC”) of the MF as a shareholder. An AIF and a MF are permitted to accept money from eligible investors only in foreign currency. As regards the capitalisation norm of a MF, the IFSC Guidelines prescribes that the AMC of a MF needs to have a minimum networth of USD 2 million, which should be increased within three years of commencement of business to USD 10 million.


An IFSC caters to a person resident outside the jurisdiction in which it is set up. An IFSC plays a significant role in development and penetration of capital markets and contains a large number of internationally significant financial institutions. It is expected that, IFSC Regulations will enable India to garner billion of dollars worth financial services business that is otherwise lost to foreign countries. To ensure that the IFSC Guidelines are effective and achieve the intended objective, it will be critical that, apart from SEBI, the concerned agencies in the government machinery and the Reserve Bank of India work relentlessly in periodically reviewing the regulatory structure pertaining to functioning of IFSC, evolve a smooth mechanism for dispute resolution, develop an effective bankruptcy procedure and above all provide a predictable and a stable tax regime.

- Yogesh Chande

Thursday, March 26, 2015

SEBI Amends Delisting, Takeovers and Buyback Regulations

[The following post is contributed by Yogesh Chande, who is an Associate Partner with Economic Laws Practice, Advocates & Solicitors. Views of the author are personal.

SEBI has with effect from 24 March 2015 amended the following regulations:

(a)    SEBI (Delisting of Equity Shares) Regulations, 2009 (“Delisting Regulations”);

(b) SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”); and

(c) SEBI (Buy-Back of Securities) Regulations (“Buy-Back Regulations”).

Following are the highlights of the amendments to the Delisting Regulations:

i. A promoter or promoter group cannot propose delisting of equity shares of a company, if any entity belonging to the promoter or promoter group has sold equity shares of the company during a period of six months prior to the date of the board meeting in which the delisting proposal was approved in terms of Regulation 8(1B).

ii. Prior to granting its approval to delisting, the board of directors is obliged to:

(a) make disclosure to the recognized stock exchanges that the promoters/acquirers have proposed to delist the company;

(b) appoint a merchant banker to carry out due-diligence and make a disclosure to this effect to the recognized stock exchanges;

(c) obtain details of trading in shares of the company for a period of two years prior to the date of board meeting by top twenty five shareholders as on the date of the board meeting convened to consider the proposal for delisting, from the stock exchanges and details of off-market transactions of such shareholders for a period of two years, and furnish the information to the merchant banker for carrying out due-diligence.

iii. The board of directors of the company while approving the proposal for delisting has to certify the following after taking into account the due diligence report of the merchant banker:

(a) the company is in compliance with the applicable provisions of securities laws;

(b) the acquirer or promoter or promoter group or their related entities, are in compliance with Regulation 4(5) which broadly deals with them adopting any fraudulent or unfair or manipulative practice;

(c) the delisting is in the interest of the shareholders.

iv. The merchant banker appointed by the board of directors of the company is obliged to carry out due-diligence upon obtaining details from the board of directors of the company. The merchant banker can also call for additional details from the board of directors of the company for such longer period as may be deemed fit.

v. The report of the merchant banker should contain following details:

(a) the trading carried out by the entities belonging to acquirer or promoter or promoter group or their related entities was in compliance or not, with the applicable provisions of the securities laws; and

(b) entities belonging to acquirer or promoter or promoter group or their related entities have carried out or not, any transaction to facilitate the success of the delisting offer which is not in compliance with the provisions of Regulation 4(5).

vi. The stock exchange is now required to issue the in-principle approval for delisting within five working days, as against thirty working days.

vii. The public announcement should now be made within a period of one working day of the receipt of in-principle from stock exchange.

viii. No entity belonging to the acquirer, promoter and promoter group of the company can sell shares of the company during the period from the date of the board meeting in which the delisting proposal was approved till the completion of the delisting process.

ix. The letter of offer should be dispatched to the shareholders within two working days of the date of the public announcement, as against forty five working days.

x. The bidding period should now open within seven working days from the date of the public announcement.

xi. Tendering of shares in a delisting offer and settlement will now have to be facilitated through the stock exchange mechanism.

xii. The bidding period should remain open for a period of five working days.

xiii. The floor price for delisting will have to be now determined in terms of regulation 8 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.

xiv. A delisting offer shall now be considered successful only if following conditions are satisfied:

(a) the post offer promoter shareholding (along with the persons acting in concert with the promoter) taken together with the shares accepted through eligible bids at the final price determined as per Schedule II, reaches ninety per cent of the total issued shares of that class excluding the shares which are held by a custodian and against which depository receipts have been issued overseas; and
(b) atleast twenty five per cent of the public shareholders holding shares in the demat mode as on date of the board meeting referred to in Regulation 8(1B) had participated in the Book Building Process.

This requirement [mentioned in xiv (b) above] shall not be applicable to cases where the acquirer and the merchant banker demonstrate to the stock exchanges that they have delivered the letter of offer to all the public shareholders either through registered post or speed post or courier or hand delivery with proof of delivery or through email as a text or as an attachment to email or as a notification providing electronic link or Uniform Resource Locator including a read receipt.

In case the delisting offer has been made in terms of regulation 5A of the Takeover Regulations, the threshold limit of ninety per cent for successful delisting offer will have to be calculated taking into account the post offer shareholding of the acquirer taken together with the existing shareholding, shares to be acquired which attracted the obligation to make an open offer and shares accepted through eligible bids at the final price determined as per Schedule II of the Delisting Regulations.

xv. Across the Delisting Regulations, the term “promoter” has been replaced with the term “promoter/acquirer”.

xvi. The post-offer public announcement now needs to be issued within five working days of the closure of the offer, as against eight working days.

xvii. SEBI has now been conferred with powers to relax strict enforcement of the Delisting Regulations, subject to certain conditions.

xviii. The pre-requisites for delisting a “small company” have been modified.  

xix. Certain disclosure requirements in schedule I (contents of the public announcement) have also been amended to reflect the aforesaid amendments to the Delisting Regulations.

xx. As regards schedule II, para 1 to 11 shall not be applicable in respect of book building process where settlement is carried out through stock exchange mechanism.

The notification amending the Delisting Regulations is available at - http://www.sebi.gov.in/cms/sebi_data/attachdocs/1427261684807.pdf

Following are the amendments to the Takeover Regulations:

i. Subject to the acquirer declaring his intention upfront to delist the target company at the time of making the detailed public statement, the target company can be delisted in accordance with the Delisting Regulations (“Delisting Offer”).

ii. In case of failure to delist the target company, the acquirer will have to make an announcement within two working days in respect of such failure and will have to comply with all applicable provisions of the Takeover Regulations. The acquirer will have to accordingly file the draft letter of offer with SEBI within five working days of the announcement.

iii. The shareholders who have tendered shares in the Delisting Offer will be entitled to withdraw such shares tendered, within 10 working days from the date of the announcement of failure to delist.

iv. The offer price shall stand enhanced by an amount equal to a sum determined at the rate of 10% per annum for the period between the scheduled date of payment of consideration to the shareholders and the actual date of payment of consideration to the shareholders. “Scheduled date” means the date on which the payment of consideration ought to have been made to the shareholders in terms of the timelines in the Takeover Regulations.

v. Delisting of the target company is not permitted where a competing offer has been made.

vi. The acquirer will have to facilitate tendering of shares in an open offer by the shareholders and settlement of the same, through the stock exchange mechanism.

vii. In case of a Delisting Offer, the completion of the acquisition of shares which triggered an open offer can be completed by the acquirer only after making the public announcement regarding the success of the delisting proposal.

The notification amending the Takeover Regulations is available at - http://www.sebi.gov.in/cms/sebi_data/attachdocs/1427261613075.pdf

Following is the amendment to the Buy-Back Regulations:

The acquirer or promoter will have to facilitate tendering of shares by the shareholders and settlement of the same, through the stock exchange mechanism.

The notification amending the Buy-Back Regulations is available at - http://www.sebi.gov.in/cms/sebi_data/attachdocs/1427261741142.pdf

- Yogesh Chande

Wednesday, March 25, 2015

SEBI’s Restraint Order: Impact on Joint Accounts

[The following post is contributed by Yogesh Chande, who is an Associate Partner with Economic Laws Practice, Advocates & Solicitors. Views of the author are personal.

The author discusses a recent SEBI order regarding the scope of a restraint passed by it earlier on a noticee from dealing in securities. By now clarifying that joint accounts too are within the purview of the prohibition, it has the effect of expanding the scope of the restraint order, but at the same time it may be considered necessary to prevent a circumvention of the restraint.]

In a recent order, the Whole Time Member (“WTM”) of SEBI refused to grant relief to two daughters of a noticee to allow operation of their two separate beneficiary demat accounts which were frozen on account of a restraint imposed by the interim order of SEBI on their mother, who happened to be the second holder with the daughters in their respective demat accounts. As per the submissions made by the daughters, the mother was made the second holder of the demat accounts only for convenience.

Earlier, based on a preliminary examination in the trading of the scrip of a particular listed company, SEBI, by its ad interim ex-parte order dated December 04, 2013 (interim order), had restrained certain entities including the mother from accessing the securities market and further prohibited them (including the mother) from buying, selling or dealing in securities in any manner whatsoever, until further directions.

It was also submitted by the daughters that no restraint has been placed on them from buying, selling or dealing in securities as per the interim order. Restraint, if any, is on their parents. Therefore, operations in the aforesaid beneficiary demat accounts may be permitted.

The WTM however refused to grant relief on the following grounds:

(a) The daughters claimed that the securities lying in the beneficiary demat accounts have been purchased using funds from their respective bank accounts, which are also held by them along with their mother as the joint holder; however, the daughters failed to substantiate this claim on the basis of any evidence. No material was brought on record before the WTM to prove that the securities lying in the aforesaid beneficiary demat accounts were purchased by both the daughters using their own funds.

(b) The contract notes produced by the daughters before the WTM only showed the purchases made from the respective trading accounts and were not considered sufficient proof of ownership of securities lying in the respective beneficiary demat account of the daughters.

(c) The copies of income tax returns submitted by the daughters only showed the income/ capital gains or losses made by them and the same did not reflect the beneficial owner of the securities lying in their demat accounts.

(d) The WTM also observed that the first holder (each of the daughter) is the joint beneficial owner of the securities lying in the joint account with the second holder i.e. the mother in terms of section 2(i)(a) of the Depositories Act, 1996. Thus, the legal presumption that the mother is joint beneficial owner of the securities lying in the aforesaid beneficiary demat accounts cannot be rebutted merely on the basis of a certificate issued by a chartered accountant.

The WTM concluded by stating that, if the request of the daughters is acceded to, it is likely that the said beneficiary demat accounts would be used by the mother for sale or purchase of securities, thereby defeating the purpose of the interim order and ongoing investigation.

- Yogesh Chande