The law surrounding beneficial ownership in India is still in its nascent stage, with the Central Government having notified Section 90 of the Companies Act, 2013 (Act) as well as Companies (Significant Beneficial Owners) Rules, 2018 (Rules) last year1. While the concept is nascent, their logical evolution is seemingly spontaneous evidenced by the introduction of the Companies (Significant Beneficial Owners) Amendment Rules, 2019 in early 20192. Though the swift modifications are indicative of the Government’s willingness to tackle the misuse of corporate vehicles for money laundering or terrorist financing by ensuring greater transparency, the Rules are riddled with uncertainty and confusion. Once again, to make information transparent, the lawmakers are stifling the law-abiding intellectuals to come up with creative methods to strengthen the ever-vulnerable Corporate veil of Indian Corporates.

The Rules were enacted in compliance with India’s obligation as a member of the Financial Action Task Force (FATF) and were a by-product of the FATF Recommendations3. As per the definition provided in the Act, a significant beneficial owner (SBO) means a person who, acting alone or together with another individual or through a trust or a person resident outside India, holds beneficial interest of not less than 25%, in the shares of a company and includes a person who exercises or has the right to exercise significant influence or control over the company. In simpler terms, a SBO is the face behind the mask of the registered owner and is the one who may be responsible for the underlying activity of the company in question. Maintaining a database of SBOs will enable authorities to “follow the money” and ascertain the identity of the beneficial owners in financial investigations involving suspect accounts/assets held by corporate vehicles.

Rule 2(1)(h) of the Rules prescribes a twin test i.e. an objective and a subjective test for determining as to who is a SBO of a reporting company by providing that a significant beneficial owner must: –

• Hold indirectly, or together with any direct holdings, not less than 10% of the shares;
• Hold indirectly, or together with any direct holdings, not less than 10% of the voting rights in the shares;
• Have the right to receive or participate in not less than 10% of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings;
• He/she has right to exercise, or actually exercises, significant influence or control, in any manner other than through direct holdings alone.

Notably, if an individual does not hold any right or entitlement indirectly under sub-clauses (i), (ii) or (iii), he shall not be considered to be a significant beneficial owner4. The requirement under sub-clauses (i), (ii) and (iii) are components of the objective test and the last requirement falls under the subjective test prescribed under the Rules.

The objective test attempts to conclusively determine the indirect holding of an individual, by recourse to the parameters prescribed under Explanation III to Rule 2(1) (h) of the Rules depending on the status of such individual’s relationship to the member of the reporting company. It is noteworthy that, the parameters prescribed for a partnership are significantly more onerous, since every partner of a partnership firm will be a significant beneficial owner, much higher than the threshold prescribed for other legal entities.

The subjective test ascertains the significant influence or control by referring to the definition of significant influence under the Rules, which defines it as the power to participate, directly or indirectly, in the financial and operating policy decisions of the reporting company but not having sole or joint control of such policies. While this definition is a departure from the definition provided under the Act, the definition for control remains the same as the one employed under the Act.

Once it is determined that an individual is a significant beneficial owner in a reporting company, the Rules place an obligation on not just the individual who is an SBO, but also on the reporting company to ensure that such significant beneficial ownership must be disclosed by the individual to the reporting company and then intimated by the such company in prescribed form to the Registrar of Companies (ROC) within the prescribed period. The Rules also cast an obligation on the reporting company to take necessary steps to find out its significant beneficial owners and cause such individuals to file a declaration. Further, in addition to the aforesaid general obligation, where the member (not being an individual) of the reporting company holds not less than 10% of shares or voting rights or the right to receive or participate in the dividend or any other distribution payable in a financial year, the reporting company is required to give notice to such member seeking information on the beneficial ownership of such member.

Where any SBO fails to give required disclosure under the Rules then such individual(s) shall be liable for imprisonment for a term which may extend to one year or with fine which shall not be less than one lakh rupees but which may extend to ten lakh rupees or with both and where the failure is continuous, with a further fine which may extend to one thousand rupees for every day after the first day during which the failure continues. In addition to the above, the Rules also provide for penalty for the Reporting Company’s failure to maintain register of SBOs or to file return of significant beneficial owners with ROC, etc.

The Rules, though aimed at increasing transparency, suffer from several ambiguities such as:

• Whether both equity and preference shares should be considered for significant beneficial owner determination, or only equity shares and convertible instruments;
• Whether, while determining the shareholding of the individual in the body corporate (which is a shareholder of the reporting company), should one also factor in cross holdings through other holding companies i.e. whether effective shareholding must be considered or direct shareholding; and,
• Whether a pledgee holding shares as an investment must file a declaration as an SBO.

In addition to the above, there is also a lack of clarity over the lowering of the threshold for classification as significant beneficial owner from 25% provided under the Act to 10% under the Rules. However, whether the government, in making substantive changes to the provisions governing significant beneficial owner, has exceeded the powers delegated to it by the legislature, is a question to be determined by a competent court.

A corporate entity is a legal person distinguishable from individuals who incorporate it. The very idea and essence of corporate structure is to facilitate risk taking ability of entrepreneurs. These artificial creatures are very important to any economy. The concept of corporate personality is like catnip for left wingers, since it validates their world view that corporations are soulless thugs who spread misery in pursuit of profit. However, when there are existing provisions to lift the corporate veil whenever there is fit and proper case to do so, there should be no need to increase the workload of uploading more and more information on statutory portals thereby giving more teeth to red tapism and dampening business spirits.

As the American saying goes, “You can shear a sheep many times but you can skin him only once”.