Identifying the real owners

The Companies (Amendment) Bill, 2016, if implemented, will prevent misuse of companies for hiding financial transactions and funding illegal activities

One of the most important amendments proposed to the Companies Act by the recently introduced amendment Bill relates to the widely pervasive problem of shell companies and lack of transparency in the ownership structures of several unlisted companies in India. While separation of the legal identity of a company from its shareholders is a key feature of the company law, this also creates opportunities for regulatory arbitrage and abuse. Complex corporate holding structures that straddle across multiple jurisdictions are often used to evade tax, siphon off money and fund illegal activities. Such structures have made it increasingly difficult for the government to keep track of the real owners (and their transactions).

The amendment Bill introduces a new provision (Section 90) that will require individuals holding 25 per cent or more beneficial interest in the shares of a company or having the right to exercise significant influence or control over it to make appropriate disclosures about such interests. Such persons will be called 'significant beneficial owners' of the company. The company itself will have an obligation to identify such 'significant beneficial owners' and record such information in a register. This will also have to be filed with the Registrar of Companies (RoC), thereby giving the much-needed access to the government. Most importantly, the information captured by this mechanism will include the identity of individuals who exercise control or significant influence over the company without directly or indirectly holding any shares. This provision seems to be targeted at shell companies where actual owners have no direct or indirect ownership interest, but are the real owners for all practical purposes. If any person wilfully withholds information about the real owners at the time of making the required declaration, he can be tried for the offence of fraud and imprisoned for up to ten years.

The Companies Act already has a provision on declaration of beneficial interest in a share, which is largely modelled on a similar provision in the old Companies Act. However, the said provision does not obligate the company to work towards identifying such information. It only requires it to report the information as submitted. The new provision casts a positive obligation on the company to uncover information about beneficial owners of the company and report it to the RoC. It also requires the company to move the National Company Law Tribunal for necessary directions when the information is not forthcoming.

The Prevention of Money Laundering Act (PMLA) also defines 'beneficial owner', and requires 'reporting entities' (which include banks and financial institutions) to record details about the 'beneficial owners' of their clients. The Securities and Exchange Board of India requires market intermediaries to collect information about the 'beneficial owners' of their customers. However, in so far as the actual mechanism for collecting such information is concerned, the reporting entities under PMLA and Sebi-regulated market intermediaries are largely left to their own devices. The proposed amendment imposes a direct obligation on the companies to record and report such information.

It is pertinent to note that a similar regime for recording and reporting such information will be implemented in the UK next month. The Small Business, Enterprise and Employment Act, 2015, introduced the concept of 'people with significant control over the company' in the Companies Act, 2006. Soon, the UK Act will require unlisted companies to identify such persons and disclose the details in a publically available register. The phrase 'people with significant control over the company' includes people having 'significant influence or control' over the company. Interestingly, the UK government has also issued statutory guidance on interpretation of the words 'significant influence', which maybe relevant for interpreting the proposed amendment. The said guidance note states that an absolute right to take a decision on matters such as 'adopting or amending the company's business plan', 'changing the nature of the company's business, 'making any additional borrowing from lenders', 'appointment or removal of the CEO', or 'establishing or amending any profit-sharing, bonus or other incentive scheme of any nature for directors or employees' and the like may amount to 'significant influence' for this purpose.

It also notes that if a person has veto rights in the company for the purpose of protecting his minority interests, this is 'unlikely' to be seen as 'significant influence' unless such rights relate to adoption or amendment to the business plan. The guidance note also states that 'a company founder who no longer has a significant shareholding in the company s/he started, but makes recommendations to the other shareholders on how to vote and those recommendations are always or almost always followed', may have significant influence over the company. It may be useful to keep track of the developments in the UK for avoiding any pitfalls and building an even better regime for such disclosures in India.

(The author is head - corporate law and financial regulation vertical at Vidhi Centre for Legal Policy)