MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES

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2 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES

3 October 2017 Price : Rs. 100/- (Excluding Postage) THE INSTITUTE OF COMPANY SECRETARIES OF INDIA All rights reserved. No part of this publication may be translated or copied in any form or by any means without the prior written permission of The Institute of Company Secretaries of India. Disclaimer The objective of this publication is to create awareness and to educate about the consequences of misuse of corporate structure. This publication has reference to some of the publicly available media reports also, which are incorporated with intent to provide the recent information and not to bring disrepute to anyone. Although due care and diligence have been taken in preparation of this publication, the Institute shall not be responsible for and loss or damage, resulting from any action taken on the basis of the contents of this Publication. Anyone wishing to act on the basis of the material contained therein should do so after cross checking with the original source, relevant Act, Rules, and Regulations etc. Published by : THE INSTITUTE OF COMPANY SECRETARIES OF INDIA ICSI House, 22, Institutional Area, Lodi Road, New Delhi Phones : , , Fax : Website : info@icsi.edu Laser typesetting at AArushi Graphics Printed at : Chandu Press/100/October 2017 (ii)

4 Preface The above shloka is one of the most popular shloka of the Bhagvad Gita. Citing these words, one need not mention the source even; rather the source gains a lot much of its popularity because of the significance and relevance of these words in the modern day scenario especially corporate one. While the shloka definitely has a religious angle to it, the context and its relevance as on date can be put forth as follows: Stability and long term sustainability of the system happens because there are regenerative points. When the system attains disequilibrium and shows signs of being unstable and going out of control measures have to be taken to restore the equilibrium in the system. Since times immemorial, the fundamental features of business have been to provide profits for investors, employment to unemployed, growth to the economy and a much needed raise to the standard of living for its customers. Considering the fact that the benefits of the existence of businesses are humongous especially in a nation like India which is on its path of development, the same especially the corporate of the country have been promoted by the government by way of numerous schemes, incentives and benefits. At the same time, dedicated efforts have been made to put in place a legal structure which provides it with a rock solid foundation. Despite the above, various issues crop-up, bringing to light the loopholes requiring immediate preventive and curative measures. The very recent actions of the regulatory bodies against companies involved in dubious (iii)

5 transactions puts across a message that any corporate action which falls beyond the prescribed code of conduct shall entail consequences both for the companies and their Boards alike. This document has been prepared compiling the recent regulatory actions taken against corporate misfeasance with an intent to deliberate upon the finer nuances of this issue, the entailing consequences, the remedies, the global scenario and the ultimate takeaway of avoiding this route in whatsoever circumstances. I commend the dedicated efforts of CS Deepa Khatri, Deputy Director; and CS Kalpesh Mehta, Assistant Director under the guidance of CS Banu Dandona, Joint Director, Directorate of Corporate Law and Governance, and leadership of CS Dinesh Chandra Arora, Secretary, ICSI in writing the manuscript of this publication. I place on record my sincere thanks to CS Amit Gupta, Company Secretary in Practice and Mr. Vijay Kumar Jhalani, Government Nominee on the Council of ICSI for their valuable inputs while reviewing the draft of this publication. I am confident that through publication, ICSI shall play a crucial role in taking forward another initiative of the Government of India by bringing about awareness on the consequences of misusing corporate vehicles for money laundering and corporate benefits thereby restraining the same to a large extent. There is always scope for improvement. I would personally be grateful to readers and users for their suggestions/comments for bringing about further refinement in the Publication. Place: New Delhi Date: October 04, 2017 CS (Dr.) Shyam Agra grawal al President The Institute of Company Secretaries of India (iv)

6 CONTENTS SL. NO. TOPIC PAGE I POSSIBILITIES OF MISUSE OF CORPORATE STRUCTURE 1 II RECENT REGULATORY ACTIONS 8 III CONSEQUENCES OF MISUSE OF CORPORATE 19 STRUCTURE AND REMEDIES IV MEDIA REPORTS 27 V GLOBAL SCENARIO 39 VI FREQUENTLY ASKED QUESTIONS 48 (v)

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8 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 1 POSSIBILITIES OF MISUSE OF CORPORATE STRUCTURE INTRODUCTION Corporate vehicles play an essential role in the global economic system. Corporate entities have been credited for their immense contribution to rising prosperity in market-based economies. They are the basis of most commercial and entrepreneurial activities in market-based economies and contribute to the prosperity and globalisation of any country. In recent years, the issue of the misuse of corporate structure entities for illicit purposes has drawn increasing attention from policy makers and regulators. There has been growing concern that these vehicles may be misused for illicit purposes, such as money laundering, bribery and corruption, shielding assets from creditors, illicit tax practices, market fraud, and other illicit activities. DIFFERENT MECHANISMS OF MISUSE CORPORATE STRUCTURE Corporate structure may be misused by using variety of means including corporates, trusts, foundations, partnerships, chain of corporate subsidiaries etc. When speaking about corporate entities, it shall be noted that these vehicles are legal forms of business that are established to conduct commercial activities and to hold assets. For misuse, the preferable entities are those which enable to hide an identity of the owner and successfully keep assets out of the reach of creditors and other claimants. The entities that are used, for example in bankruptcy cases, to shift the individuals assets are mainly shell companies and trusts established in other favourable jurisdictions (also called tax havens), from where it is very difficult to gain any information and enforce confiscation. Any jurisdiction, that possesses regulations permitting effectively to conceal the ultimate identity behind a corporate veil and at the same time, has provisions that restrain authorities from obtaining and sharing 1

9 2 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES information on ownership and control for regulatory/supervisory and law enforcement purposes, may be a target of the misuse of such business forms. Identification of Misused Corporate Structure Those entities which misuse the corporate structure commonly have the following attributes: Nominal/meagre paid up capital Huse reserves mostly consisting of high share premium Deployment of funds by these companies in unlisted/listed companies with no dividend income from these investment; high proportion of cash in hand (or cash equivalents) Mostly such companies are private limited companies Common directors across such companies Such Companies do not have any operational income Involved in dubious transactions; Involved in diversion of loan funds along with creating fake invoices Involved in round-tripping (Round tripping is a means of tax evasion and black money generation); Used for converting black money into white. Companies share common registered office addresses

10 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 3 Below are the most common forms of misuse of corporate structure Corporate Trusts foundations partnerships Fictitious entities Corporate Corporate form has the benefit of formation of an entity having a different legal entity separate from the individuals involved in formation of company. The legal separation of the individual from the assets vested in a company may be used as a protection for doing illicit activities. The more relevant distinction made to tackle corruption relates to each company s purpose rather than to their legal definition. Private limited companies and public limited companies whose shares are not traded on a stock exchange may be preferred form for such activities. Some of the mechanisms which are reportedly being used for laundering of black money by the corporate: Spending in Corporate Social Responsibility activities The statutory corporate social responsibility (CSR) norms introduced two years ago were expected to revolutionise funding of social causes, but some sections of India Inc may now be abusing these for laundering of black money, according to sources privy to such transactions. Some companies are using charitable trusts to fabricate CSR spending, at least two sources who have helped craft and execute such transactions said. They spoke to ET on the condition of anonymity. India is the first and only country to have statutorily mandated corporate social responsibility for certain class of companies but the law allows a lot of leeway. CSR spends disclosed by companies need not be vetted by statutory auditors unlike other spending. Moreover, financials of charitable trusts also come under little statutory scrutiny. This combination of factors has left the new CSR norms wide open for abuse.

11 4 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES Share Application Money used for illegitimate purposes Share application money has reportedly emerged as a convenient way for promoters to channel equity investments into their companies to guise questionable, perhaps illegal, financial practices. Share application money represents an investment that has come in to a company without corresponding shares being issued to investors, and can thus be reversed. Several promoter investments in companies all had share application money that was a large multiple of their equity capital. These companies continuously use share application money for four purposes: illegal (channelling black money into a company and legitimising it), contentious (moving funds between multiple entities to shake off a money trail), ingenious (paying lower taxes) and strategic (keeping its options open). The fact that share application money was larger than issued capital means the intention was never to convert in to shares, but to route money. Hiding identity of people A company may hide the identity of persons who are beneficial owners. A beneficial owner is a natural person that is, a real, live human being, not another company or trust who directly or indirectly exercises substantial control over the company or receives substantial economic benefits from the company. Companies with Bearer Shares or Share Warrants Bearer shares often come up for discussion in the context of antimoney measures because they allow for anonymous transfers of control. Bearer shares are company shares that exist in certificate form, and whoever is in physical possession of the bearer shares is deemed to be their owner. Transfer requires only the delivery of the instrument from person to person (in some cases, combined with endorsement on the back of the instrument). Unlike registered shares (for which ownership is determined by entry in a register), bearer shares typically give the person in possession of the certificate (the bearer) voting rights or rights to dividend. Almost identical in terms of function are unregistered share warrants. A share warrant may be thought of as a voucher entitling the holder to the

12 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 5 right to acquire shares. Concerns have been raised in forums that companies that issue bearer shares are used extensively for illegal activities, such as tax evasion and money laundering. Shell companies As per OECD report (2001) on Behind the Corporate Veil -Using Corporate Entities For Illicit Purposes, the term shell company refers to the entity that has no independent operations, significant assets, current business activities or employees. Organisation for Economic Co-operation and Development (OECD) Glossary defines a Shell Company as A shell company is a company that is formally registered, incorporated, or otherwise legally organized in an economy but which does not conduct any operations in that economy other than in a pass-through capacity.. Shells tend to be conduits or holding companies and are generally included in the description of Special Purpose Entities. Shell companies, when used illicitly, are generally used in combination with additional mechanisms to obscure beneficial ownership. The mechanisms include exercising control surreptitiously through contracts (rather than standard ownership and control positions), adding layers of corporate vehicles, hiding behind bearer shares, and ensuring that the beneficial owners are located (or the identifying information is stored) in another jurisdiction. Shell Companies also known as Paper, Briefcase, Post-box, Shelf, dabba companies. A study conducted by the Performance and Innovation Unit of the UK Cabinet Office noted that U.K. shell companies have been involved in almost all complex UK money laundering schemes. Using corporate vehicles as conduits to perpetrate illicit activities is potentially appealing because these vehicles may enable the perpetrators to cloak their malfeasance behind the veil of a separate legal entity. A report commissioned by the EC concluded that the ability of legal entities to effectively conceal the identity of their beneficial owners stimulates their use for criminal activities. Trust The concept of trust originated from the English common law and today, trusts are used primarily in common law jurisdictions. A trust is an important, useful, and legitimate vehicle for the transfer and

13 6 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES management of assets. Trusts provide an effective mechanism for managing assets given to minors, individuals who are incapacitated, and others who are otherwise inexperienced in financial management. Trusts can also be used to promote charitable purposes and for estate planning. The trust is a vehicle that provides for the separation of legal ownership from beneficial ownership. To establish a trust, the trust creator (the settlor ) transfers the legal ownership of a property to a person or corporate entity (the trustee ). The trustee holds and manages the property, in accordance with the provisions of a trust deed, for the benefit of the beneficiaries, who are identified in, or ascertainable from, the trust deed. To create a valid trust, the settlor is required to give up control of the assets he has transferred to the trustee. In turn, the trustee is obligated to observe the terms of the trust deed and has a fiduciary duty to act honestly and in good faith in the best interest of the beneficiaries or, in the event there are no named beneficiaries, in the best interest of the trust. One form of misuse of trusts is to conceal the existence of assets from tax authorities, creditors, ex-spouses, and other claimants or to conceal the identity of the beneficial owner of assets. Trusts can also be misused for money laundering purposes. In addition, trusts may be used to perpetrate fraud. For example, settlors attempting to evade taxes may transfer assets into a trust and then falsely claim that they have relinquished control over the assets. Once the assets are transferred into an offshore trust, it is very difficult and expensive to locate them and to identify their beneficial owners. Even if the trust assets are found, creditors will incur considerable time and expense in the attempt to repatriate the assets. Public trusts are a favoured route to launder money because they are not adequately governed or monitored. Though some states such as Maharashtra have their own law such as the Bombay Public Trusts Act, 1950, trusts are not governed by a nationwide law. If a state law doesn t exist such as in Delhi, these trusts are governed by the Indian Trusts Act of 1882 that applies to private trusts. There is no centralized repository like the registrar of companies for corporates of information on. Various other forms like multiple layers of companies, Foundations, partnerships Fictitious entities are reportedly corporate structure which are being misused. Primary reasons for misusing the corporate structure :

14 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 7 For masking the true ownership of assets Benami Properties To hide bad money or money amassed out of corrupt practices Link of terror & drug money- financial network of anti-national and underworld operators Tax Evasion Money laundering Abusive impacts of misuse of corporate structure The misuse of corporate vehicles for illicit purposes impacts the domestic as well global financial system. In particular, such practices may cause the following harmful effects in any economy: (a) Drug smuggling (b) Corruption (c) Arms smuggling (d) Mafia (e) Sanctions Busting (f) Bribery (g) Terrorist Financing (h) Tax Evasions (i) Money Laundering (j) Asset Shifting (k) Improper Insider dealings (l) Criminal financial schemes (m) Investment in Benami Properties

15 8 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES RECENT REGULATORY ACTIONS The regulator is also keeping a close watch on cases where entities are availing LTCG (Long Term Capital Gains) benefits through sham transactions in stocks. Constitution of Task Force on Shell Companies for effectively tackling the malpractices Government is monitoring the malpractices of shell companies in comprehensive manner adopting whole of the Government approach. In order to create a credible deterrence, a whole of government approach will be adopted through coordinated efforts and by leveraging technology. A Task Force on Shell Companies under the Joint Chairmanship of Revenue Secretary and Secretary, Ministry of Corporate Affairs was constituted in February, 2017 for effectively monitoring the malpractices of shell companies/ponzy companies/khoka companies in a comprehensive manner adopting whole of the government approach. Other members of the Task Force are from Department of Financial Services, Central Board of Direct Taxes, Central Board of Excise & Customs, Central Bureau of Investigation, Enforcement Directorate, Serious Fraud Investigation Office and Financial Intelligence Unit. Decisions taken by the Task Force focusing upon most effective and expeditious actions against shell companies and associated persons by the agencies concerned have duly been taken forward. Brief highlights of actions taken against shell companies in recent past include the following: (i) With a view to have consolidated relevant information at one place and based upon inputs from all law enforcement agencies, the Serious Fraud Investigation Office under the Ministry of Corporate Affairs has undertaken the exercise of preparing comprehensive digital database of shell companies and their associates that were identified by various law enforcement agencies. 8

16 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 9 (ii) Enforcement Directorate conducted nationwide searches in 16 states on in respect of shell companies and related professionals who were believed to the behind the creation and operation of these Companies. (iii) The CBI has registered 30 cases against 201 shell companies during the last 3 years viz. 2014, 2015, 2016 and the current year as on (iv) Out of these, charge-sheets have been filed in 17 cases. (v) As on , Ministry of Corporate Affairs has removed 1,62,618 Companies from the Register of Companies by following the due process under Section 248 of the Companies Act, Further, the exercise of identification of the directors of the companies defaulting in filing of Financial Statements or Annual Returns for continuous period of three financial years has been undertaken as part of the ongoing process for disqualification for reappointment as director in that company or in other company for a period of five years u/s 164(2) of the Companies Act, (vi) FIU-India has also alerted its Reporting Entities on shell companies for enhanced due diligence. Disclosure of information in respect of specific persons, however, is prohibited except as provided under section 138 of the Income-tax Act, Comprehensive digital database of shell companies and their associates Mechanism for sharing of information between various law enforcement agencies is already in place under the Regional Economic Intelligence Council (REIC) and Central Economic Intelligence Bureau (CEIB) forums. Further, with a view to streamline and strengthen the information sharing mechanism, a new Standard Operating Procedure (SOP) on sharing of information between various law enforcement agencies has been agreed to under the aegis of the Task Force. In creation of a database, there would be challenge to prove that these entities are shell companies. STEPS TAKEN BY VARIOUS AGENCIES Central Board of Direct Taxes (CBDT) There are many companies which are currently being examined by the

17 10 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES CBDT through a committee to check if they are legitimate or are being operated as shell companies. Each and every bank account is under the scanner of Income Tax department to find out possible tax evasion. Individuals are advised to declare their income sources. If that does not happen, intrusive action against such persons may be taken against tax evaders. The Government is also taking action against shell companies which have been main route for converting black money into white. Source: The Indian Express, dated 6 th March, 2017 Income tax Department The Income Tax Department has detected over 1,155 shell companies in the last three years through which non-genuine transactions of more than Rs. 13,300 crore were carried out which were used as conduits by over 22,000 beneficiaries. Enforcement Directorate As a part of the mandate given to the Enforcement Directorate (ED) under a Special Task Force (STF), the ED launched a nationwide crackdown against shell companies and conducted searches at 100 locations across 16 states to check the circulation of black money. Multiple teams, comprising 300 officers, visited these locations and raided the premises of firms in prominent places like Delhi, Chennai, Kolkata, Chandigarh, Patna, Ranchi, Ahmedabad, Bhubaneswar and Bengaluru among others. The agency reportedly found more than 700 shell companies at one address in Mumbai. The agency had attached assets worth crores of such companies. The action is being carried out under the provisions of the Prevention of Money Laundering Act (PMLA) and the Foreign Exchange Management Act (FEMA) to check money laundering and illegal foreign exchange transactions. Source: Prime Times. in India News Dated 13 th April, 2017 Central Bureau of Investigation CBI intends to prosecute the shell companies who were not filing returns for corruption and other associated offences. It also plans to refer cases

18 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 11 to appropriate authorities set up under laws including the Companies Act, Benami Transactions (Prohibition) Act and the Income Tax Act. Fraudulent shell companies can further expect to face harsh action including freezing of bank accounts and disciplinary actions against professionals for malpractice in assisting deviant shell companies. According to sources, the companies were used in round-tripping and diversion of loan funds along with creating fake invoices. CBI can now charge fraudulent companies under various laws. Source: Dailyhunt, dated 8 th May, 2017 Reserve Bank of India Government has requested the RBI to circulate the details of defaulting companies to all the banks with the advice to exercise enhanced due diligence while dealing with these companies. The government s advice on freezing the bank account of such companies comes in the backdrop of the Ministry of Corporate Affairs removing a total of 1,62,618 companies from the Register of Companies as on July 12. The government has requested the Reserve Bank of India (RBI) to freeze accounts of the defaulting companies who have not filed their financial statements and returns. The central bank, however, said that, at present, it has no powers to freeze such accounts. Source: The Indian Express, dated 29 th July, 2017 Securities and Exchange Board of India SEBI vide its letter bearing no. SEBI /HO/ISD/OW/P/2017/18183 dated August 7, 2017 has forwarded a list of 331 shell companies and has directed the Exchanges to identify the companies listed on their trading platform and initiate following measures : 1. Trading in all such listed securities shall be placed in Stage VI of the Graded Surveillance Measure (GSM) with immediate effect. If any listed company out of the said list is already identified under any stage of GSM, it shall also be moved to GSM stage VI directly. Under the stage VI of GSM framework, trading in these identified securities shall be permitted only once a month under trade to trade category. Further, any upward price movement in these securities shall not be permitted beyond the last traded price and additional surveillance deposit of 200 % of trade value shall be

19 12 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES collected form the Buyers which shall be retained with Exchanges for a period for five months. Accordingly, securities mentioned in Annexure II shall be moving to GSM framework under Stage VI w.e.f. August 8, Therefore, as per the provisions of GSM framework, the securities shall not be available for trading from tomorrow. Trading in these securities shall be permitted once a month (First Monday of the month). 2. The shares held by the promoters and directors in such listed companies shall be allowed to be transferred by depositories only upon verification by concerned exchanges and they shall not be allowed to transact in the security except to buy securities in the said listed company until verification of credential / fundamental by Exchanges is completed. 3. Exchanges shall initiate a process of verifying the credentials/ fundamentals of such companies. Exchanges shall appoint an independent auditor to conduct audit of such listed companies and if necessary, even conduct forensic audit of these companies to verify its credentials/fundamentals. 4. On verification, if Exchanges do not find appropriate credentials/ fundamentals about existence of the company, Exchanges shall initiate the proceeding for compulsory delisting against the company, and the said company shall not be permitted to deal in any security on exchange platform and its holding in any depository account shall be frozen till such delisting process is completed. 5. Out of the list of shell companies, if securities of any of the listed company are under suspension, the trading in such securities shall be placed under GSM Stage VI directly on revocation of suspension by Exchange. Source: BSE Notice, dated 7 th August, 2017 Serious Fraud Investigation Office (SFIO) There are about 12 lakh registered companies in India; and only half of such lakh companies file their annual return. This means that large number of these companies may be indulging in financial irregularities. In a sample analysis of shell companies, the government said, it found that Rs 1,238 crore cash had been deposited in these entities during November-December period. Serious Fraud Investigation Office (SFIO) has filed criminal prosecution for cheating national exchequer after investigation

20 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 13 of entry operators running a group of 49 shell companies and other proprietorship concerns. With a view to have consolidated relevant information at one place and based upon inputs from all law enforcement agencies, the Serious Fraud Investigation Office (SFIO) has undertaken the exercise of preparing comprehensive digital database of shell companies and their associates that were identified by various law enforcement agencies. MINISTRY OF CORPORATE AFFAIRS Removal of Name of Companies from Register of Companies According to information available with the Ministry, the Registrars of Companies (ROCs) in various states and union territories had issued notices to more than two lakhs firms under the Companies Act, 2013, and sought to know why their names should not be struck off and strict action would follow in case the responses are not satisfactory. These notices have been issued under Section 248 of the Act. This section pertains to striking off names of companies on certain grounds. It is reported that as on July 12, 2017 the Corporate Affairs Ministry has removed 1,62,618 companies from the Register of Companies by following the due process under Section 248 of the Companies Act, According to India today dated 5th September, 2017, the Government stuck off over 2.1 lakh companies from the records of the registrar of companies in a major crackdown against those who could be part of a large nationwide black money matrix. Disqualification of defaulting directors It is understood that as part of the government s intensified efforts against the black money menace, the exercise of identification of the directors of the companies defaulting in filing of financial statements or annual returns for continuous period of three financial years has been undertaken as part of the ongoing process for disqualification for reappointment as director in that company or in other company for a period of five years. As on 13 th September, 2017, over 1 lakh directors of shell companies are identified as defaulters by the government as an continued effort to crack down against shell companies. [The Economic Times dated September 13, 2017]. It may be noted that section 164 deals with Disqualifications for Appointment of Director.

21 14 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES Apart from serving show cause notices to companies that have been not submitting their financial statements under the Companies Act for a long time, the Corporate Affairs Ministry is in the process of preparing a database of shell firms which would further help in curbing illegal business activities. RECENT AMENDMENTS IN COMPANIES ACT, 2013 Commencement of provision relating to restrictions on number of layers of subsidiaries [proviso to clause (87) of section 2 of the Companies Act, 2013] The proviso to section 2(87), along with layering restriction on investment subsidiaries under section 186(1) of Companies Act, 2013 were incorporated in the Act with a view to check misuse of multiple layers of subsidiaries for diversion of funds/siphoning off funds as a measure of minority investor protection and is in consonance with recommendations of the Hon ble Standing Committee on Finance. In view of reports of misuse of multiple layers of companies, where companies create shell companies for diversion of funds or money laundering, Ministry of Corporate Affairs had decided to commence the proviso to section 2(87). In terms of the provisions, No company, other than a company belonging to a class specified in sub-rule (2), shall have more than two layers of subsidiaries. Provisions proposed under Companies (Amendment) Bill, 2017 The Ministry of Corporate Affairs constituted the Companies Law Committee (the CLC or the Committee ) under the chairmanship of the Secretary, Ministry of Corporate Affairs vide an office order dated 4th June, 2015 to review the provisions of the Companies Act, 2013 in view of representation received on practical difficulties faced during implementation of Companies Act, It has recommended incorporating provisions with regard to disclosure of significant beneficial ownership to the Registrar. The relevant extracts from the report are under: Beneficial Interest in Shares, Register of Beneficial Owners of a Company Misuse of corporate vehicles for the purpose of evading tax or laundering

22 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 15 money for corrupt or illegal purposes, including for terrorist activities has been a concern worldwide. Complex structures and chains of corporate vehicles are used to hide the real owner behind the transactions made using these structures. Realizing this, jurisdictions world over have been putting in place mechanisms to identify the natural person controlling a corporate entity. Following recommendations of Financial Action Task Force (FATF), India has also tightened the concepts of beneficial interest and beneficial owner as contained in the Prevention of Money Laundering Act as well as introduced a comprehensive definition through SEBI guidelines. The SEBI guidelines issued in 2010 are aimed at identifying beneficial owners of security accounts held by various intermediaries. However, since then, jurisdictions world over have taken significant steps on beneficial ownership provisions. Changes have been made by many jurisdictions, for example Russian Union and UK in their laws to bring in transparency in company ownership and control. The English Companies Act, 2006 was amended in 2015 to require certain companies and LLPs to create and maintain a Persons with Significant Control Register and make it available to public, as well as file the information with the UK Companies House. A publicly accessible central registry of UK company beneficial ownership information has also been established. Regulatory concerns have been raised in India also, drawing on examples set by these jurisdictions. The Ministry of Finance has suggested to introduce a Register of Beneficial Owners by mandating it in the Companies Act. Section 89 of the Companies Act, 2013 deals with the concept of beneficial interest in a share which obligates every person acquiring/holding beneficial interest in a share as well as the legal owner to make a declaration to the company in respect of such beneficial interest. In view of the absence of a definition of beneficial interest in a share in a company, absence of any obligation on a company to collect information on beneficial ownership, the absence of the concept of beneficial ownership in a company, no enabling provisions to maintain a separate register on beneficial ownership, in the Act, the existing provisions are considered inadequate for the purpose of mandating a register of beneficial owners of the company. The Committee, therefore, recommended to amend the Act to mandate the following: a) Provide a definition of beneficial interest in a share, and beneficial ownership in a company. The existing definition under SEBI Circular/ Guidelines and the Prevention of Money Laundering Act may be

23 16 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES used as a basis for the definition in the Companies Act, The rules issued under the United States Securities Exchange Act of 1934 define beneficial ownership in a security, which can be used as a basis for the definition of beneficial interest in a share. b) Companies and individuals may be obligated to obtain information on beneficial ownership. In this regard, companies may be empowered to seek information from members and in case of failure to supply the required information, apply sanctions in the form of suspension of rights against the beneficial interests subject to adequate safeguards. c) Companies would also be mandated to maintain registers of beneficial owners and provide the information to the registry (MCA21). Periodic updating may also be mandated. Data privacy concerns may be addressed by making only part of the filed information available to the public. d) Companies not complying with the requirements may be liable to fine and criminal prosecution. In accordance with the recommendations, the Companies (Amendment) Bill, 2017 proposes to substitute section 90 with the following section: For section 90 of the principal Act, the following section shall be substituted, namely : Section 90: Investigation of beneficial ownership of shares in certain cases 90. (1) Every individual, who acting alone or together, or through one or more persons or trust, including a trust and persons resident outside India, holds beneficial interests, of not less than twenty-five per cent. or such other percentage as may be prescribed, in shares of a company or the right to exercise, or the actual exercising of significant influence or control as defined in clause (27) of section 2, over the company (herein referred to as significant beneficial owner ), shall make a declaration to the company, specifying the nature of his interest and other particulars, in such manner and within such period of acquisition of the beneficial interest or rights and any change thereof, as may be prescribed : Provided that the Central Government may prescribe a class or classes of persons who shall not be required to make declaration under this sub-section.

24 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 17 (2) Every company shall maintain a register of the interest declared by individuals under sub-section (1) and changes therein which shall include the name of individual, his date of birth, address, details of ownership in the company and such other details as may be prescribed. (3) The register maintained under sub-section (2) shall be open to inspection by any member of the company on payment of such fees as may be prescribed. (4) Every company shall file a return of significant beneficial owners of the company and changes therein with the Registrar containing names, addresses and other details as may be prescribed within such time, in such form and manner as may be prescribed. (5) A company shall give notice, in the prescribed manner, to any person (whether or not a member of the company) whom the company knows or has reasonable cause to believe (a) to be a significant beneficial owner of the company; (b) to be having knowledge of the identity of a significant beneficial owner or another person likely to have such knowledge; or (c) to have been a significant beneficial owner of the company at any time during the three years immediately preceding the date on which the notice is issued, and who is not registered as a significant beneficial owner with the company as required under this section. (6) The information required by the notice under sub-section (5) shall be given by the concerned person within a period not exceeding thirty days of the date of the notice. (7) The company shall, (a) where that person fails to give the company the information required by the notice within the time specified therein; or (b) where the information given is not satisfactory, apply to the Tribunal within a period of fifteen days of the expiry of the period specified in the notice, for an order directing that the shares in question be subject to restrictions with regard to transfer of interest, suspension of all rights attached to the shares and such other matters as may be prescribed. (8) On any application made under sub-section (7), the Tribunal may, after giving an opportunity of being heard to the parties concerned, make such order restricting the rights attached with the shares within

25 18 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES a period of sixty days of receipt of application or such other period as may be prescribed. (9) The company or the person aggrieved by the order of the Tribunal may make an application to the Tribunal for relaxation or lifting of the restrictions placed under sub-section (8). (10) If any person fails to make a declaration as required under subsection (1), he shall be punishable with fine which shall not be less than one lakh rupees but which may extend to ten lakh rupees and where the failure is a continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the failure continues. (11) If a company, required to maintain register under sub-section (2) and file the information under sub-section (4), fails to do so or denies inspection as provided therein, the company and every officer of the company who is in default shall be punishable with fine which shall not be less than ten lakh rupees but which may extend to fifty lakh rupees and where the failure is a continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the failure continues. (12) If any person wilfully furnishes any false or incorrect information or suppresses any material information of which he is aware in the declaration made under this section, he shall be liable to action under section 447.

26 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 19 CONSEQUENCES OF MISUSE OF CORPORATE STRUCTURE AND REMEDIES In view of the recent actions taken by the regulators, the possible consequences to the companies which are using the corporate structure for illicit purposes can be as under: Declaration of directors as disqualified Striking off names of companies Officers of the company may be penalised under provisions relating to fraud Freezing of bank accounts of the companies Freezing the bank account of disqualified directors Reputation risk DIRECTORS TO BE DISQUALIFIED FROM APPOINTED AS DIRECTORS The directors of companies may be disqualified to be re-appointed in the same company or appointed in any other company in terms of section 164 of the Companies Act, The statutory provision Section 164 of the Companies Act, 2013 (the Act) states various disqualifications for directorship of a company. A person who incurs any of these disqualifications is ineligible to be appointed as a director of any company in India. (2) No person who is or has been a director of a company which (a) has not filed financial statements or annual returns for any continuous period of three financial years; or (b) has failed to repay the deposits accepted by it or pay interest thereon 19

27 20 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more, shall be eligible to be reappointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so. Rule 14 of the Companies (Appointment and Qualification of Directors) Rules, 2014 reads as follows: 14. Disqualification of directors sub-section (2) of section 164. (1) Every director shall inform to the company concerned about his disqualification under sub-section (2) of section 164, if any, in Form DIR-8 before he is appointed or re-appointed. (2) Whenever a company fails to file the financial statements or annual returns, or fails to repay any deposit, interest, dividend, or fails to redeem its debentures, as specified in sub-section (2) of section 164, the company shall immediately file Form DIR-9, to the Registrar furnishing therein the names and addresses of all the directors of the company during the relevant financial years. (3) When a company fails to file the Form DIR-9 within a period of thirty days of the failure that would attract the disqualification under subsection (2) of section 164, officers of the company specified in clause (60) of section 2 of the Act shall be the officers in default. (4) Upon receipt of the Form DIR-9 under sub-rule (2), the Registrar shall immediately register the document and place it in the document file for public inspection. (5) Any application for removal of disqualification of directors shall be made in Form DIR-10. The following defaults committed by a company ( the defaulting company ) would attract subsection (2) of section 164: (a) the defaulting company has not filed financial statements or annual returns for any continuous period of three financial years; (b) the defaulting company has failed to repay the deposits accepted by it, or pay interest on the deposits accepted by it, or

28 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 21 to redeem any debentures issued by it on the due date, or pay interest due on any debentures issued by it, or pay any dividend declared and such failure to pay or redeem continues for one year or longer. The consequences of any default mentioned above are that a person who is or has been a director of the defaulting company cannot be re-appointed as a director of the company in respect of which any of defaults has taken place; and cannot be appointed as a director of any other company for five years from the date on which any of those defaults takes place. For example, if Mr X is a director of A Ltd, which has committed any of the abovementioned defaults, then- he can continue as a director of A Ltd till he is sought to be reappointed (say at an annual general meeting on his retirement by rotation); if he is a director of B Ltd (or any other company / companies) being a non-defaulting company, he can continue to be its director even after A Ltd has committed the default; he cannot be appointed as a director of C Ltd or any other company of which he is not a director when the default is committed by A Ltd. Further section 167 deals with the provisions related to Vacation of Office of Director. Section 167(1)(a) provides that the office of a director shall become vacant in case he incurs any of the disqualifications specified in section 164. Companies (Amendment) Bill, 2017 proposes to insert the following proviso to section 167(1)(a) Provided that where he incurs disqualification under sub-section (2) of section 164, the office of the director shall become vacant in all the companies, other than the company which is in default under that subsection. ; In this regard, the Ministry of Corporate affairs has issued a notice, which reads as under: Any person disqualified under section 164(2) of the Companies Act,

29 22 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 2013 [the Act] is advised not to act as director during the period of the disqualification and not to file any document or application with MCA as the same shall be summarily rejected. However, this shall be without prejudice to the liability of the said person for violation of section 164(2) read with section 167 of the Act including the action under section 448 r/w 447 of the wherever warranted. STRIKING-OFF NAMES OF COMPANIES Registrars are empowered to exercise its power under section 248 of the Companies Act, Section 248 of the Act, deals with power of the ROC to remove name of a company from the register of companies in certain circumstances such as failure to commence business within one year of incorporation, or for not carrying on business for two consecutive years without applying for the status of a dormant company. Regulator has struck off the names of companies from the register of companies on account of their failure to comply with the requirements of law, suspicious transactions and for failure to carry out any operation within a year of incorporation or for the preceding two financial years. In case, the company is inactive company and has plans to carry on business in some future date, the company may be legitimately exist and apply for getting dormant status. The definition of an inactive company under the Act is provided under the Explanation to section 455, which states that inactive company means a company which has not been carrying on any business or operation, or has not made any significant accounting transaction during the last two financial years, or has not filed financial statements and annual returns during the last two financial years. Section 455 pertains to obtaining of dormant status by such inactive companies on an application made to concerned ROC or on suo moto basis by such ROC upon failure of filing financial statements/annual return for two consecutive financial years. Further, the ROC is required to maintain a register of dormant companies. It is relevant to mention here that even if a company has been given the status of a dormant company in terms of the section 455, such a company requires to comply with certain requirements such as filing of returns, having minimum number of directors, etc. Recently, the ROC has also exercised its powers under sub-section (6) of section 455, by striking off the name of such dormant companies, who have failed to maintain the status as a dormant company. Section 252(1) of the Companies Act, 2013 provides that the name can

30 MISUSE OF CORPORATE STRUCTURE PREVENTION & REMEDIES 23 also be restored by way of an appeal filed by such companies against the orders of the ROC within three years from the date of the order of the ROC to the National Company Law Tribunal (NCLT).Previously under the erstwhile Companies Act, there was only one resort for restoration of name, i.e., application by certain person within a period of twenty years from the date the name had been struck-off. Statutory provisions Power of Registrar to Remove Name of Company from Register of Companies As per section 248 (1), where the Registrar has reasonable cause to believe that (a) a company has failed to commence its business within one year of its incorporation or (b) a company is not carrying on any business or operation for a period of two immediately preceding financial years and has not made any application within such period for obtaining the status of a dormant company under section 455, he shall send a notice to the company and all the directors of the company, of his intention to remove the name of the company from the register of companies and requesting them to send their representations along with copies of the relevant documents, if any, within a period of thirty days from the date of the notice. (2) Without prejudice to the provisions of sub-section (1), a company may, after extinguishing all its liabilities, by a special resolution or consent of seventy-five per cent members in terms of paid-up share capital, file an application in the prescribed manner to the Registrar for removing the name of the company from the register of companies on all or any of the grounds specified in sub-section (1) and the Registrar shall, on receipt of such application, cause a public notice to be issued in the prescribed manner: Provided that in the case of a company regulated under a special Act, approval of the regulatory body constituted or established under that Act shall also be obtained and enclosed with the application. (3) Nothing in sub-section (2) shall apply to a company registered under section 8. (4) A notice issued under sub-section (1) or sub-section (2) shall be