Presentation on SBO Rules & layers of subsidiaries

Transcription

1 / info@vinodkothari.com / vinod@vinodkothari.com Presentation on SBO Rules & layers of subsidiaries Vinod Kothari Vinod Kothari & Company Kolkata Krishna Building 224 AJC Bose Road Kolkata Phone: / /7715 E: corplaw@vinodkothari.com New Delhi A/11, Hauz Khas, New Delhi Phone: / E: delhi@vinodkothari.com Mumbai , 175, Shreyas Chambers, D.N. Road, Fort, Mumbai Phone: / E: bombay@vinodkothari.com

2 2 Copyright The presentation is a property of Vinod Kothari & Co. No part of it can be copied, reproduced or distributed in any manner, without explicit prior permission. In case of linking, please do give credit and full link

3 3 About Us Vinod Kothari & Co., Based in Kolkata, Mumbai, Delhi We are a team of consultants, advisors & qualified professionals having over 28 years of practice. Our Organization s Credo: Focus on capabilities; opportunities follow

4 Scope of the presentation Different forms of corporate entities and holding structures; Existing compliances under applicable law; Concept of layers of subsidiaries and related restrictions; Concept of SBO; Laws related to SBO;

5 5 Different forms of corporate entities and holding structures

6 Classification of company 6 Classification of company No. of member Nature of object Public Private For Profit Not for profit Not small company Small Company OPC Multi person cos By shares Liability Limited By guarantee Holding Unlimited Control Access to capital market Subsidiary Joint Venture Associate Public Private listed unlisted listed unlisted NCDs Equity Non convertible Preference share NCDs

7 Further classification On the basis of nature and span of business: Operating companies Special Purpose Vehicles; Investment vehicles Core investment companies General Investment Companies On the basis of level of activity: Active companies Defunct companies Dormant companies Vanishing Companies Based on tax scam/money-laundering in ownership structure Shell companies or benami companies 7

8 8 Typical holding structure UBO Individuals Family Shareholders Trusts AIFs Investing vehicles IC -1 IC-2 CIC Operating entities Op-1 Op-2 Op-3 Op-4

9 9 Why shareholding structures are tall? Operating entities proliferate As stand-alone businesses are hived off into different vehicles Better valuations Better management Regulatory considerations principal business or only business requirements Holding company structure required in case of banking entities Parking of specific assets into family-owned entities investments Brands Real estate Tax reasons Good reason in the past was the ability to transfer shares of unlisted entities based on book value Rule 11UA as amended now travels down the vertical chain Capital gains in offshore jurisdictions Opacity Transfer of a holding structure in offshore jurisdiction may be done without exposing to capital gains tax in operating entity jurisdiction Vehicles are created to look like independent entities Avoiding accounting classifications of associates, related parties, or the like Requirements of local jurisdiction/preferred tax treaty country Local law in offshore jurisdiction may require local incorporation Tax treaty may favour a particular tax residency status

10 10 Regulatory concerns about complicated holding structures Corporate structures used as smokescreens to garb the real owners Tax frauds Illicit or criminal activities Panama Papers, LuxLeaks etc exposed massive use of international tax havens for garbing the real identity of owners FATF/OECD/G20 concerns about transparency in corporate ownership Driven largely by AML/CTF considerations Provisions of Indian law to ensure accountability of corporate entities Declaration of beneficial interest sec 89 Prohibition of benami properties Limits on layers of subsidiaries sec 2 (87) Prohibition on investment through more than 2 investment companies sec. 186 (1) Prohibition on corporate directorship Law does not require Particulars of nominator to be filed in case of nominee directors

11 11 Layers of subsidiaries and related restrictions

12 Establishment of Holding- subsidiary relation 12 Companies A and B Company A holds more than half of the total voting power of company B? Company A has the power to appoint or remove all or majority of the directors? Yes No No Yes Control is established by way of composition of board of directors Control is established by way of voting rights on shares held Is the company within the prescribed layers of subsidiaries? No Holdingsubsidiary relationship is not established Yes Holding- subsidiary relationship is established Will result in violation.

13 13 Concept of Layers What is meant by layer? Section 2(87) refers it to mean subsidiary or subsidiaries of the holding company Layer should mean the number of nodes in a vertical chain by which resources get transferred The intent is to NOT limit the number of subsidiaries a company can have. Legislative basis and limit on layers of subsidiaries Strangely, the limit on layers comes through a definition section, and penal provisions are contained in subordinated law MCA vide its Notification dated September 20, 2017 notified the Companies (Restriction on Number of Layers) Rules, 2017 Limit of two layers of subsidiaries Effective from September 21, 2017 Existing layers grandfathered, but required to be reported

14 14 Reason behind limiting the number of layers The Joint Committee on Stock Market Scam* provided that on account of layers it became difficult to link the source of fund with the actual users to which these fund were put. The multiple layers of companies are used by the companies for siphoning of funds and for money laundering There does not seem to be similar restriction in other jurisdictions * EPORT%20on%20stock%20market%20scam.pdf.pdf

15 Exempted layers foreign subsidiaries There are two carve outs First proviso to rule 2 (1): acquisition of a foreign company with subsidiaries beyond 2 layers, if formed in accordance with the law of jurisdiction One layer consisting of one or more WOSes will be excluded First carve out Meaning of acquisition: Does it mean acquisition, or even organic acquisition is an acquisition? Is the idea to permit acquisition of a foreign company already having more than 2 layers? Possible scenarios: 1. Ind1 has no subsidiaries. Wants to acquire F1, which has more than 2 layers 2. Ind1 has 2 Indian subsidiaries Ind2 and Ind3. Ind3 wants to acquire F1, which has no subsidiaries. 3. Ind1 has 2 Indian subsidiaries Ind2 and Ind3. Ind3 wants to acquire F1, which has more than 2 subsidiaries. 4. Ind1 has 2 Indian subsidiaries Ind2 and Ind3. Ind3 wants to form an overseas subsidiary F1. Scenario 1 is clearly permitted. Scenario 3 also seems permitted If so, then there is no reason to not permit scenario 2 and 4. 15

16 16 Exemption for one layer of WOSes Second proviso to Rule 2 (1): One layer which is represented by a WOS shall not be considered in computing the limit; Singular cannot include plural in this case: In context, that principle of interpretation does not hold Expression one layer makes it clear In any case, the whole intent is to limit layers hence, singular cannot include plural WOS should be of the reporting entity and not WOS of a partly owned subsidiary.

17 17 No restriction on horizontal propagation A Controls Controls Controls Controls Controls B C D E F RESULT: A is Holding of B, C, D,E and F : As no restriction on number of subsidiaries horizontally.

18 18 Exempted companies Banking Companies NBFC-ND-SI NBFC-Non SI, CICs, HFCs not exempted Insurance Companies, Government Companies Exemption from applicability of rules.

19 19 Illustration 1 Company A Ltd Holds 100 % Company B Holds 60 % Company B1 Holds 60% Company C Company C1 Holds 100 % Vertical structure 1: Company B being a WOS will be exempted Vertical structure 2: Company C1 is not WOS of Company A. Not an exempted layer for Company A but for Company C Holds 58 % Company B2 Company C2 Holds 52% Company C3 Holds 68%

20 20 Illustration 2 A Ltd. C Ltd. is not the subsidiary of A Ltd. B Ltd. (A holds 51%) C Ltd. (B holds 60%) D Ltd. is not the subsidiary of B Ltd. D Ltd. (C holds 52%) In this case, each company is limited to one layer only?

21 21 Illustration 3 Controls A Controls B C 50% D 50% In this case, Company D is layer 1 or layer 2?

22 22 Illustration 4 LLP A Controls A Ltd Controls B Ltd C Ltd Controls B Ltd C Ltd Controls Controls Controls D Ltd D LLP Whether restriction on layer will apply to LLP A? Whether layer D LLP will be reported?

23 23 Illustration 5 A Ltd Controls A Ltd Controls B Ltd C Inc (US) Controls B Inc (US) C FZ-LLC Controls Controls Controls D Ltd (India) Whether restriction on layer will apply routing of subsidiaries through foreign companies? D Ltd (Mauritius) Whether layer s B, C, D will be reported? Any restriction on further floating of subsidiaries?

24 24 Illustration-6 A Ltd Controls B Ltd Controls C Ltd 66.67% 66.67% D1 D % 33.33% 66.67% D %

25 25 Illustration-7 A Ltd B Ltd C Ltd 33.33% 33.33% 33.33% D Ltd Controls E Ltd F Ltd Controls

26 26 Illustration 8 Holds 58 % Holds 100 % Company B Holds 60 % Company B1 Company B2 Company A Ltd Holds 60% Company C Company C1 Company C2 Company C3 Holds 100 % Holds 52% Holds 68% Company B being a WOS will be exempted and hence, the permitted layer will be till Company B2. However, coming to the other vertical investment Company A is not the ultimate holding of Company C1. Therefore, for Company A, the permitted layer will be till Company C1 (unless falling under the exemption) and for Company C, the permitted layer will be till Company C3.

27 27 Illustration 9 Company A Ltd 100 % Company B 80 % Company C 80 % 51 % B1 Ltd C1 Ltd 90 % B2 Ltd [NBFC] C2 Ltd Not permitted In this illustration, C2 is not permitted because C1 is not a subsidiary of an NBFC.

28 28 Reporting Requirement The companies that have layers of subsidiaries in excess of the limit prescribed, even after considering the exemption, will have to: File form CRL-1 within a period of 150 days from the date of publication of these Rules in Official Gazette, i.e., by February 18, o MCA though its News & Important Updates section, has notified that the e-form CRL-1 is likely to be deployed shortly for filing purposes. Once made available, the form can be downloaded and filed without additional fee up to 19th March o Reporting of layers as on September 21, 2017 Abstain from having additional layers beyond the excess layers of subsidiaries existing as on September 21, Where the company reduces the layers subsequent to September 21, 2017, shall not have the number of layers beyond the number of layers it has after such reduction or maximum layers allowed in sub rule(1), whichever is more.

29 29 Who is to report? Ultimate holding company or every holding company? Subsidiaries/ holding entities of exempted companies? Foreign holding companies?

30 30 Onus of non compliance Yes Is Holding Company an Indian Company? No No non compliance on holding. It can have more than prescribed layers. As foreign company cannot be governed by Indian law. There is no non compliance by Holding Company No Is prescribed layers breached? Yes Onus of non compliance is on Holding Company. Holding is vicariously responsible for its subsidiary.

31 31 Proviso to Section 2 (87) vs 186(1) Criteria Proviso to Section 2(87) Section 186(1) Applicability On all companies [Except few exceptions mentioned in above question] Restriction on Holding company having more than 2 layers of subsidiaries On all companies [Except few exceptions mentioned in question no. 6] Investing through more than 2 layers of investment subsidiaries Entity at the end of the loop of the layer Can be a body corporate Has to be a company Investment through Can be through bodies corporate Has to be necessarily through investment companies Onus of complying with the section Criteria of establishing relationship Holding company Subsidiary can be either by way of control of composition of board of directors or by way of investment in total share capital of company Holding company Holding company has to invest through investment subsidiaries. Investment can be in any security.

32 32 Penal provisions If any company contravenes any provision of these Rules then o the company and o every officer of the company who is in default shall be punishable with fine which may extend to Rs. 10,000 and where the contravention is a continuing one, with a further fine which may extend to Rs for every day after the first during which such contravention continues.

33 33 Concept of Beneficial Owners (BOs)

34 34 Who are beneficial owners? As per Black's Law Dictionary, Beneficial owner is a legal term where specific property rights ("use and title") in equity belong to a person even though legal title of the property belongs to another person. However, following are the legal definition of Beneficial Owner ( BO ), defined under different regulations:

35 35 BO as per FATF The Financial Action Task Force (FATF), an intergovernmental body established in 1989 by the G7 group of major economies, has defined beneficial owner as: The natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes persons who exercise ultimate effective control over a legal person or arrangement. Further it is explained that ultimately owns or controls and ultimate effective control refer to situations in which ownership/control is exercised through a chain of ownership or by means of control other than direct control.

36 36 SEBI s Guidelines on Identification of Beneficial Ownership SEBI Master Circular No. CIR/ISD/AML/3/2010 dated December 31, mandated all registered intermediaries to obtain sufficient information from their clients in order to identify and verify the identity of persons who beneficially own or control the securities account, as part of their Client Due Diligence policy. SEBI has prescribed uniform Know Your Client (KYC) requirements for the securities markets vide circular nos. CIR/MIRSD/16/2011 dated August 22, 2011 and MIRSD/SE/Cir-21/2011 dated October 5, SEBI provided the uniform guidelines on identification of BO, based on GoI s consultation with regulator, vide circular no. CIR/MIRSD/2/2013 dated January 24, 2013.

37 37 BO as per RBI s Master Direction - Know Your Customer (KYC) Direction, 2016 Where the customer is a company- The beneficial owner is the natural person(s), who, whether acting alone or together, or through one or more juridical person, has/have a controlling ownership interest or who exercise control through other means. Explanation: 1. Controlling ownership interest means ownership of/entitlement to more than 25 per cent of the shares or capital or profits of the company. 2. Control shall include the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements. The same as defined in Rule 9 of the PML (Maintenance of Records) Rules, 2005

38 Need to identify BO 38

39 39 Misuse of legal persons & arrangements A number of important studies* by the FATF and the World Bank and United Nations Office of Drugs and Crime s (UNODC), Stolen Asset Recovery Initiative (StAR), have explored the misuse of corporate vehicles for illicit purposes, including Money Laundering ( ML ) /Terrorist Financing( TF ). In general, the lack of adequate, accurate and timely beneficial ownership information facilitates ML/TF by disguising: o the identity of known or suspected criminals; o the true purpose of an account or property held by a corporate vehicle, and/or o the source or use of funds or property associated with a corporate vehicle. *

40 40 Ways of obscuring BO information Shell companies corporate entities which do not have any active business operations or significant assets in their possession can be established with various forms of ownership structure, especially in cases where there is foreign ownership which is spread across jurisdictions; Complex ownership and control structures involving many layers of shares registered in the name of other legal persons; unrestricted use of legal persons as directors;

41 41 formal nominee shareholders and directors where the identity of the nominator is undisclosed; informal nominee shareholders and directors, such as close associates and family; trusts and other legal arrangements which enable a separation of legal ownership and beneficial ownership of assets; use of intermediaries in forming legal persons, including professional intermediaries. bearer shares and bearer share warrants

42 42 International interest in beneficial ownership G7/OECD G7 tasks OECD to develop UBO initiatives G20 creates list of UBO principles Transparency International reports on beneficial ownership within the G20 First global Anti- Corruption Summit focuses on beneficial ownership Full implementati on of EU 4AMLD beneficial ownership requirements FAFT first recommen dations on beneficial ownership United Nations committee raises the issue of financial crime in relation to UBO World Bank guidance delivered on UBO G20 reaffirms FAFT commitm ent IACCC, EU, G20 and FAFT all indicate intentions to strengthen beneficial ownership transparency

43 43 Significant implementation challenges on BO 1/3 Complex ownership structures of the legal entities Legal entities established in high secrecy jurisdiction (i.e., Samoa, Cayman Islands, Panama) False accountholder s declarations on UBOs Limited information available on offshore accountholders Unqualified staff

44 44 Significant implementation challenges on BO 2/3 Insufficient accuracy and accessibility of basic information relating to company registration; Less rigorous implementation of customer due diligence (CDD) measures by key gatekeepers such as company formation agents, lawyers, and trust-and-company service providers; Lack of sanction on companies which fail to update information held by national company registries, or to keep information about their shareholders or members up-to-date; and Obstacles to information sharing such as data protection and privacy laws which impede competent authorities from getting timely access to adequate, accurate and up-to-date basic and beneficial ownership information. Source: Beneficial-Ownership-Sept-2016.pdf

45 45 Significant implementation challenges on BO 2/3 The BO collection process adds a huge burden on the business s operations; The lack of publicly available UBO registry data remains a loophole in the entire AML effort; Complexity and broadness of the BO data, with global footprint; Non-standard documentation in offshore financial centers (OFCs); Flexible change of ownership in OFCs; Navigating multiple layers of ownership; Non-cooperation, grudging, or boilerplate disclosure Source:

46 46 BO is best visualized as a series of direct or indirect relationships. a) An illustration of simple indirect shareholding is as follows: Mr. X A Ltd Holds 70% B Ltd Holds 100% Mr. Z In this illustration, Mr. X is the direct owner of A Ltd and owns 30% shareholding. Mr. Z is an indirect owner of A ltd and owns 70% shareholding.

47 47 b) An illustration of simple indirect shareholding is as follows: P1 P2 P3 Holds 100% Holds 100% A Ltd B Ltd C Ltd Holds 100% Holds 0.43 % P3 Holds 5 % Holds 65.5 % P Ltd Holds % Q Ltd P4 Holds 100% Holds 50% Holds 50% Target Co. In this illustration, there are multiple levels of indirect ownership. The three beneficiaries are clearly highlighted. P2 has a 32% interest in the target co. (50% x 65% = 32%), P3 has 14%, and P4 has 50%. Note that P3 has both a direct and indirect interest in P Ltd.

48 48 c) An illustration of looping relationship (multi-level indirect shareholding) is as follows: P1 X Ltd Holds 1 % In this illustration, we have a seemingly an unimportant 1% owner. But, in reality, this individual is the UBO, with all the profits being delivered to the UBO in merely 1% shares. Holds 100 % Holds 99 % Y Ltd The same is not possible in India, but of course, it is possible for a company not being a holding co

49 Complex looping relationship 1/2 49 Individual P Individual Q Individual R Individual S 50% 50% 50% 50% Buys shares of A Ltd from P Buys shares of A Ltd from Q Buys shares of B Ltd from R Buys shares of B Ltd from S A Ltd B Ltd 50% 50% C Ltd Benefit of Section 19 (1) (c) of Act, 2013 comes to rescue. Subsequent to transfer no real capital in the company

50 Complex looping relationship 2/2 50 Individual P Individual Q Individual R Individual S 50% 50% 50% 50% Buys shares of A Ltd from P Buys shares of A Ltd from Q Buys shares of B Ltd from R Buys shares of B Ltd from S A Ltd B Ltd 50% 50% C Ltd Who is the real SBO? Subscribes to 1% of shares in the company Individual X

51 51 Laws related to SBO - India Section 89 and 90 requirement of disclosure of ultimate beneficial owner; Rules issued on SBO by MCA SEBI Guidelines on Identification of Beneficial Ownership; Prevention of Money-laundering (Maintenance of Records) Rules, 2005 FATCA rules and identification of a natural person as UBO of entities;

52 Law relating to Beneficial interests as per Companies (Amendment) Act,

53 53 Definition of Beneficial Interest The Companies (Amendment) Act, 2017, amends section 89 of the Companies Act, 2013 to define the term Beneficial Interest in the following way: For the purposes of this section and section 90, beneficial interest in a share includes, directly or indirectly, through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person to exercise or cause to be exercised any or all of the rights attached to such share; or receive or participate in any dividend or other distribution in respect of such share."

54 54 Filing of beneficial interest sec. 89 Beneficial interest, if different from the interest of a registered holder, needs filing under sec. 89 Meaning of beneficial interest added by sub-section (10) to say, beneficial interest includes right or entitlement to any of the rights of a member, or right receive or participate any dividend The section has to be read with opening lines of sec. 89 Name of the person is entered in the register of members, but person does NOT hold beneficial interest That is to say, if the beneficial interest holder s name is borne on the register of members, there is no case of applying sec. 89/90 With extended definition, provisions may be attracted In case of voting arrangements voting rights transferred without registering transfer of shares; Pledge, Irrevocable PoA Transfer of dividend rights. Deletion of reference to sec 403 Filing must be done within 30 days Beyond 30 days will attract additional fee as well as condonation.

55 Filing of undisclosed beneficial interest holders new sec 90 Sec 90 is a new provision altogether; mandates filing of undisclosed beneficial interest Once again, in view of the opening language of sec. 89, if the shareholder is the beneficial owner as well, the section has to applicability Significant beneficial ownership 25% of shareholding in a company, or Right or actual exercise of control Right or actual exercise of significant influence Means control of at least twenty per cent. of total voting power, or of business decisions under an agreement Section applies when all the following conditions satisfied Significant beneficial interest is held by an individual Whether acting alone or together, with one or more persons or trusts Including persons or trusts outside India Is the section similar to UBO identification? That could have been the only possible intent; However, the language does not seem to suggest that; Since is defined in terms of sec. 89, which applies only where beneficial interest is different from interest of registered shareholder 55

56 56 Beneficial interests register Beneficial interests are to be filed as per the Rules to be laid Company to file with the Registrar Company to maintain a register of beneficial interests If the company has information about significant beneficial interest of someone, which is not notified to the company, the company may notify the person seeking information Provision to apply to NCLT to force the person to declare beneficial interest.

57 57 Declaration in case of pledge etc. Whether sec. 89 & 90 shall apply in case of pledge Yes, if the all the rights attached thereto are also transferred in case of transfer pending registration Yes. in case of pooling of voting rights. Yes

58 58 Steps taken by MCA in relation to identification of SBOs MCA on 15 th February, 2018, has come out with the Companies (Beneficial Interest and Significant Beneficial Interest) Rules, 2018 (hereinafter called as Draft SBO Rules ); MCA on June 14, 2018, has issued the Companies (Beneficial Interest and Significant Beneficial Interest) Rules, 2018 ( Final Rules )* and enforced section 90 of the Amendment Act. o However, the meaning of beneficial interest has been notified by MCA on June 22, 2018 by a corrigendum enforcing 21(iii) of Amendment Act, 2017.** As per the definition provided in the Act, the government is empowered to prescribe other holding % for the determination of the SBO. Accordingly, the Rules provides the threshold of not less than 10%. * **

59 59 Meaning of shares as per the Final Rules Explanation II to Rule 2(e) of the Final Rules: Compulsorily Convertible Preference Shares; Compulsorily Convertible Debentures; Global Depository Receipts. Beneficial ownership of preference shares or other securities [other than CCPS and CCDs] does not appear to be relevant for Section 90

60 60 Determining natural persons as per the Rules where the member is a company the SBO is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trusts, holds not less than 10% share capital of the company or who exercises significant influence or control in the company through other means where the member is a partnership firm the SBO is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trusts, holds not less than 10% of capital or has entitlement of not less than ten per cent. of profits of the partnership where no natural person is identified under (i) or [ii) mentioned above the SBO is the is the relevant natural person who holds the position of senior managing official where the member is a trust fthrough trusteej the identification of beneficial owner(sj shall include identification of the author of the trust, the trustee, the beneficiaries with not less than 10% interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership

61 Illustrations 61

62 62 When is a Company required to identify SBO? Whether all members are Natural Persons (NP)? Yes SBO not applicable No Whether members are pooled investment vehicle? Yes No Whether persons other than NP hold 10% or more of shares + CCD + CCP + GDR Yes No Whether persons other than NP exercise significant influence? Yes SBO to be identified. No Whether person other than NP exercise control? No Yes SBO need not be identified

63 63 Illustration 1: Government of India Company A Company B 100% 20% Company B has a member which is a company (Company A). However, no natural person can be identified holding 10% in Company A. In this case, senior managing official of Company B will be regarded as SBO and accordingly declaration shall be obtained from the said official.

64 64 Illustration 2: 30% Mr. M Company A 60% Company X No Natural person identified Company B 40% where a natural person is identified under (i) or (ii), the senior managing official need not be regarded as SBO.

65 65 Illustration 3: Can there be a situation where a natural person is a registered owner as well as SBO? Mr. A s direct holding in X Ltd : 5 %. However, as per Para (i) of Explanation I of Rule 2 (e) of SBO Rules, Mr. A is the natural person who holds 10% or more in Y Ltd. In this case, Mr. A is registered owner as well as SBO. a) Whether Mr. A is an SBO for X Ltd? No, as he is the registered owner. Mr. A X Ltd Y Ltd 5% 95 % 15% (registered owner)

66 66 b) Whether Mr. A is the SBO for Y Ltd? Yes. as per Para (i) of Explanation I of Rule 2 (e) of SBO Rules, Mr. A is the natural person who holds 10% in X Ltd. Therefore, Mr. A will be regarded as SBO in Y Ltd. c) Who has the onus to declare to Y Ltd? In the aforesaid case, it will be the onus of X Ltd to obtain declaration from Mr. A to be submitted to Y Ltd.

67 67 Illustration 4: Mr. A X Ltd Y Ltd Z Ltd 10% 90% 15% (registered owner) a) Whether Mr. A is an SBO for X Ltd? No, as he is the registered owner. b)whether Mr. A is the SBO for Y Ltd? Yes. As per Para (i) of Explanation I of Rule 2 (e) of SBO Rules, Mr. A is the natural person who holds 10% in X Ltd. Therefore, Mr. A will be regarded as SBO in Y Ltd. c)whether Mr. A is the SBO for Z Ltd? No. As per Para (i) of Explanation I of Rule 2 (e) of SBO Rules Mr. A holds 9% (10% of 90%) in Y Ltd which is the corporate shareholder of Z Ltd. Therefore, Mr. A will not be regarded as SBO for Z Ltd.

68 68 Illustration 5: Capital Structure of X Ltd comprises of a) 10 Equity shares of Rs 10 [Rs 100]; b) 15 CCPS of Rs. 10 [CCPS Rs. 150] {Assumption 1 CCPS to be converted in 2 Equity Share} and c) 10 CCDs of Rs. 10 [CCDs Rs 100] {Assumption 2 CCDs to be converted in 1 Equity Share}. Now we ascertain if Mr. A can be regarded as SBO for Z Ltd: Mr. A Holds Rs. 25 of Equity X Ltd. Equity Rs. 100; CCPS Rs. 150 & CCDs Rs. 50 Holds 50% Equity Z Ltd. So, Mr. A s % of share capital held in X Ltd (corporate member of Z Ltd) = 5/ ( ) i.e. 5/30 = 11.11% Therefore, Mr. A will be regarded as SBO of Z Ltd.

69 69 SBO is to declare for which all companies? Example 1: A holds SB interest in P Ltd, which vertically owns Q Ltd, R Ltd, S Ltd and T Ltd. Should A disclose to each of them? Obviously the answer is yes. Example 2: A holds 60% of P Ltd, which holds 60% of Q Ltd, can A take the position that I have complied with my obligation having disclosed to P Ltd, and P Ltd should have disclosed my indirect holding to Q? Can A say that he is no idea about P s holding of Q? The answer is no. Example 3: A holds 60% of P Ltd, and P Ltd holds 60% of Q Ltd, and Q Ltd holds 60% of R Ltd. A holds some 5% directly into R Ltd. so should A disclose to P Ltd, Q Ltd and R Ltd? The answer is yes. The one who has control or significant influence cannot plead unawareness.therefore, right upto the vertical spectrum, A will have to keep disclosing

70 70 Whose senior managing official should be regarded as SBO? Senior managing official of the reporting entity will be regarded as SBO where no natural person is identified. The word used in the Explanation is or. Accordingly, where a natural person is identified under (i) or (ii), the senior managing official need not be regarded as SBO. o Similar to Para 32 of FAFT Guidance on Transparency and Beneficial Ownership* *

71 71 Scope of the provisions Includes Indian residents as well as non residents Issue is how does the law apply itself to those who are not within Indian jurisdiction? That is where Section 90 (5) comes to the rescue The obligation is not only on the holder, but also on 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.

72 72 Exemption under draft rules Where the registered owner is a body corporate whose equity shares are listed on any stock exchange or is a wholly-owned subsidiary of such body corporate. SEBI and PMLA refer subsidiaries. Foreign listed companies should also be exempted. Should mean equity listed. Exempted companies shall be exempted from requirements under Rule 5, 6 and 7. o However this exemptions are not the part of the Final Rules.

73 73 Exemption under the Final Rules The rules shall not apply to the holding of shares of companies/body corporates, in case of pooled investment vehicles/investment funds such aso Mutual Funds, o Alterative Investment Funds (AIFs), o Real Estate Investment Trusts (REITs) and o Infrastructure Investment Trusts (lnvlts) regulated under SEBI Act. Pooled investment vehicles operate as a blinker.

74 74 Onus of disclosure Collaborative exercise which the Company and the SBO has to ensure. There are two options: Option 1: the Company waits for its shareholders holding beyond the threshold, to submit declaration in Form Ben No.1 Option 2: the Company may identify the shareholders, other than natural persons, holding more than 10% of shares (equity + CCPS+CCDs+ GDRs) or exercising significant influence or control as on June 13, 2018 and seek information from them in Form No. BEN -4

75 75 a) As per CA 13 SBO as related party SBO, being a natural person, may be regarded as a related party if o he is the person on whose advice, directions or instructions a director or manager is accustomed to act [Section 2(76) (vii) of CA 13].

76 76 b) As per IND-AS 24 A related party is a person or entity that is related to the entity that is preparing its financial statements (in this Standard referred to as the reporting entity ). (a) A person or a close member* of that person s family is related to a reporting entity if that person: xxx (ii) has significant influence** over the reporting entity; or xxx (b) An entity is related to a reporting entity if any of the following conditions applies: xxx (vii) A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity). *Close members of the family of a person are those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity including: (a) that person s children, spouse or domestic partner, brother, sister, father and mother; (b) children of that person s spouse or domestic partner; and (c) dependants of that person or that person s spouse or domestic partner. **20 per cent or more of the voting power of the investee/ power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. (IND-AS 28)

77 Application to the Tribunal 77

78 78 Application by the company The Co. shall apply to the Tribunal within a period of fifteen days of the expiry of the period specified in the notice - where that person fails to give the company the information required by the notice within the time specified therein; or where the information given is not satisfactory for an order directing that the shares in question be subject to o restrictions with regard to transfer of interest, o suspension of the right to receive dividend; o suspension of voting rights; o any other restriction on all or any of the rights attached with the shares in question.

79 79 Order of Tribunal The Tribunal mayo after giving an opportunity of being heard to the parties concerned, make such order restricting the rights attached with the shares o within a period of sixty days 60 days of receipt of application or such other period as may be prescribed [section 90(7)] 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 by the Tribunal.

80 80 Penal provisions Declaration of SBO If any person fails to make the declaration, he shall be punishable with fine which shall not be less than 1 lakh rupees but which may extend to 10 lakh rupees and where the failure is a continuing one, with a further fine which may extend to 1000rupees for every day after the first during which the failure continues. Register of SBO If a company, required to maintain register and file the information, 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 10 lakh rupees but which may extend to 50 lakh rupees and where the failure is a continuing one, with a further fine which may extend to 1000 rupees for every day after the first during which the failure continues. False or incorrect information 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 (which deals with p unishment of fraud - imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud)

81 81 SEBI s Guidelines on Identification of Beneficial Ownership SEBI Master Circular No. CIR/ISD/AML/3/2010 dated December 31, mandated all registered intermediaries to obtain sufficient information from their clients in order to identify and verify the identity of persons who beneficially own or control the securities account, as part of their Client Due Diligence policy. SEBI has prescribed uniform Know Your Client (KYC) requirements for the securities markets vide circular nos. CIR/MIRSD/16/2011 dated August 22, 2011 and MIRSD/SE/Cir-21/2011 dated October 5, SEBI s Guidelines on Identification of Beneficial Ownership ( Guidelines), dated January 24, 2013, is divided into two sections: (a) For clients other than individuals or trusts (b) For client which is a trust

82 82 Identification of BO by clients other than individuals or trusts, i.e., company, partnership or unincorporated association/body of individuals as per the Guidelines Intermediary to identify the BO of the client and take reasonable measures to verify the identity of such persons, through the following information: 1. The identity of the natural person, who, whether acting alone or together, or through one or more juridical person, exercises control through ownership or who ultimately has a controlling ownership interest. o Controlling ownership interest means ownership of/entitlement to:- o more than 25% of shares or capital or profits of the juridical person, where the juridical person is a company; o more than 15% of the capital or profits of the juridical person, where the juridical person is a partnership; or o more than 15% of the property or capital or profits of the juridical person, where the juridical person is an unincorporated association or body of individuals.

83 83 In cases where there exists doubt under above mentioned point, as to whether the person with the controlling ownership interest is the beneficial owner or where no natural person exerts control through ownership interests, the identity of the natural person exercising control over the juridical person through other means. o Control through other means can be exercised through voting rights, agreement, arrangements or in any other manner. Where no natural person is identified under both the above mentioned points, the identity of the relevant natural person who holds the position of senior managing official. Exemption in case of listed companies Where the client or the owner of the controlling interest is- (a) company listed on a stock exchange, or is a majority-owned subsidiary of such a company, Then it is not necessary to identify and verify the identity of any shareholder or beneficial owner of such companies.

84 84 BO as per Rule 9 of PML(Maintenance of Records) Rules, te.gov.in/pmla_rules.pdf 2005

85 85 Where the client is a company The beneficial owner is the natural person(s), who whether acting alone or together, or through one or more juridical person, has a controlling ownership interest or who exercises control through other means. Controlling ownership interest means ownership of or entitlement to more than 25% of shares or 25% of capital or 25% of profits of the company; Control shall include the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements;

86 86 natural person(s) who, Where the client is partnership firm whether acting alone or together, or through one or more juridical person, has ownership of/entitlement to more than fifteen per cent. of capital ;or more than fifteen per cent of profits of the partnership;

87 87 Where the client is an unincorporated association or body of individuals natural person(s) who, whether acting alone or together, or through one or more juridical person, has ownership of/entitlement to more than fifteen per cent. of the property ;or more than fifteen per cent. of the capital; or more than fifteen per cent of profits of the such association or body of individuals.

88 88 Where no person identified under company/ partnership or unincorporated association or body of individuals natural person(s) who holds the position of senior managing official;

89 89 Where the client is a trust Include identification of BO shall include identification of: author of the trust the trustee the beneficiaries with 15%. or more interest in the trust And any other natural person exercising ultimate effective control over the trust through a chain of control or ownership

90 90 Where the client or the owner of the controlling interest is a company listed on a stock exchange, or is a subsidiary of such a company Not necessary to identify and verify the identity of any shareholder or beneficial owner of such companies

91 International scenario 91

92 How countries fair? 92

93 93 Framework in UK UK was the was the only country rated in the Transparency international Report as having a very strong legal framework for the identification of the Ultimate Beneficial Ownership (UBO) of assets or companies.

94 Framework in UK The Small Business, Enterprise and Employment Act 2015 ( Act ), requires all UK companies (other than publicly traded companies, which were already subject to existing legislation) to maintain a register of People with Significant Control ( PSC ) over them. 94 An individual with significant control over a UK company shall meet one or more of these five conditions: o o o o o Direct or indirect ownership of more than 25% of the company s shares. Direct or indirect holding of more than 25% of the company s voting rights. Direct or indirect power to appoint or remove the majority of the company s board of directors. Otherwise has the right to exercise, or actually exercises, significant influence or control over the company. Has the right to exercise, or actually exercises, significant influence or control over a trust or firm that is not a legal entity, which in turn satisfies any of the first four conditions as they apply to the company. The legislation s objective is to move beyond a simple register of shareholders and instead create a public record of anyone who exercises control over a company.

95 95 Requirements in various countries Country Term used Name of governing regulation Definition of BO United Kingdom Person with significant control Companies Act, 2006 Designated person with significant control (PSC) defined as individual who holds directly or indirectly more than 25% of shares/voting rights in company; has right to appoint or remove majority of board of directors; or has right to exercise/actually exercises significant influence or control over company/trust/ firm. United States Beneficial Owner FinCEN s Beneficial Ownership Rules Any individual who, directly or indirectly, owns 25 percent or more of the legal entity customer; and One individual who has significant responsibility to control, manage, or direct the legal entity.

96 96 Country Term used Name of governing regulation Brazil Final beneficiary The Brazilian Federal Revenue s Normative Instruction European Union Beneficial Owner European Commissions Anti Money Directive Definition of BO An individual that holds control or significantly influences the legal person to be registered, which occurs when the individual (i) holds, directly or indirectly, percentage superior to 25% of the corporate capital of such person or (ii) holds or exercises great influence, directly or indirectly, on the corporate deliberations and has the power to appoint the majority of the managers of the legal entity, even without controlling it. Any natural person who ultimately owns or controls customer, and/or natural person on whose behalf transaction or activity is conducted.

97 97 At a minimum, this includes, in case of corporate entities: (i) natural person who ultimately owns or controls legal entity through direct or indirect ownership of >25% of shares/ voting rights or ownership interest in entity; or (ii) if no person under point (i) is identified, or if there is any doubt that person identified is beneficial owner, the senior manager(s); and in case of trusts, foundations, or entities similar to trusts: (i) settlor; (ii) trustee(s); (iii) protector, if any; (iv) beneficiaries or class of persons in whose main interest legal arrangement or entity is set up or operates; (v) any other natural person exercising ultimate control over trust by means of direct/indirect ownership or other means.

98 Lower threshold limits in various countries * It is generally accepted that 25% is the global threshold for beneficial ownership, however, there are a number of variances across the globe, from regions who do not specify a particular limit to regions mandating 10% and even going as low as 2% in the case of high risk business in the Philippines. Cayman Islands British Virgin Islands Russia Hong Kong BO threshold 10% or lower if co appears to avoid requirement BO threshold 10% or Trustee / Settlor / Partner BO threshold 10% for gambling orgs & 25% for others BO threshold 10% for high risk & 25% for standard risk BO threshold 20% Argentina BO threshold 10% plus 1 share Cyprus BO threshold 2% for high risk & 25% for others Philippines

99 Tools for identifying BOs As per OECD, there are two for BO identification: The obligation to disclose to the market major holdings acquisitions or disposals The end investor registry system o These tools are not interchangeable, neither from a legal nor from an operative perspective. They serve different needs and perform different functions.

100 100 Manner of determining SBO As explained in FATF Guidance note -

101 Step 1 (a) The identity of the natural persons (if any, as ownership interests can be so diversified that there are no natural persons, whether acting alone or together, who exercise control of the legal person through ownership) who ultimately have a controlling ownership interest in a legal person, and (b) to the extent that there is doubt as to whether the persons with the controlling ownership interest are the beneficial owners, or where no natural person exerts control through ownership interests, the identity of the natural persons (if any) exercising control of the legal person through other means. Step 2 Where no natural person is identified under (a) or (b) above, entities should identify and take reasonable measures to verify the identity of the relevant natural person who holds the position of senior managing official. 101

102 Natural persons who may control the legal person through ownership interests; who directly or indirectly holds a minimum percentage of ownership interest in the legal person (the threshold approach). Shareholders who exercise control alone or together with other shareholders, including through any contract, understanding, relationship, intermediary or tiered entity (a majority interest approach) 102

103 Natural persons who may control the legal person through other means; such as personal connections to persons in positions described above or that possess ownership; who exerts control without ownership by participating in the financing of the enterprise, or because of close and intimate family relationships, historical or contractual associations, or if a company defaults on certain payments. control may be presumed even if control is never actually exercised, such as using, enjoying or benefiting from the assets owned by the legal person. 103

104 Natural persons who may exercise control through positions held within a legal person; The natural person(s) responsible for strategic decisions; The natural person(s) who exercises executive control over the daily or regular affairs of the legal person through a senior management position. 104