EY Regulatory Alert. Executive summary. Committee suggests sweeping changes to Companies Act, open for public comments.

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1 8 February 2016 EY Regulatory Alert Committee suggests sweeping changes to Companies Act, open for public comments Executive summary Regulatory alerts cover significant regulatory news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest regulatory issues. For more information, please contact your EY advisor. This Regulatory alert summarizes the key recommendations of the Companies Law Committee ( Committee ) on the Companies Act, 2013 ( Act ) and the rules therein The Committee studied recommendations and suggestions received from various stakeholders as well as international best practices. Broadly, the committee s recommendation seeks to tackle three types of issues: Addressing the transitional-cum implementation problems; Removal of inconsistencies between the Act, SEBI framework and the accounting standards; and Difficulties faced by corporates in doing business Key recommendations include incentives to start-ups, clarity on dividend repatriation, relaxation for inter-corporate funding and private placement norms, disclosures relating to ultimate beneficial ownership and doing away with certain approval requirements The report of the Committee is open for public comments till February 15, 2016

2 Background The Act was enacted in phases from September 2013 onwards and brought significant changes in Indian corporate law provisions for regulation of corporates. Subsequent to implementation, various representations were made to the government on practical difficulties faced In view of the challenges faced, certain amendments were made in May 2015 and at the same time, a committee was also constituted to look into other implementation issues Accordingly, Ministry of Corporate Affairs ( MCA ) constituted the Committee under the chairmanship of the Secretary, Ministry of Corporate Affairs 1. The Committee consisted of a former judge of the Delhi High Court, various representatives of RBI, SEBI and other professional bodies such as Institute of Chartered Accountants of India The Committee submitted its report on February 1, 2016 with various recommendations and it is open for public comments Key highlights Some of the significant changes recommended are as follows: Moving beyond the concept of legal ownership to ultimate beneficial ownership. This recommendation of the Committee comes in light of global practices including recommendations of Financial Action Task Force and recent India level developments under SEBI guidelines and Prevention of Money Laundering Act There are recommendations to suggest that while complete beneficial ownership is to be disclosed to the corporate law authorities but only a certain part of it would be publicly accessible in the interest of confidentiality Various incentives proposed for startups (yet to be defined) such as: ESOPs can be issued to promoters of start-ups who are working as employees or whole time directors (currently, ESOPs cannot be issued to promoters); Issuance of sweat equity shares upto fifty percent of equity capital (currently stands at twenty five percent for other companies); and Removal of deposit limits for first 5 years to raise deposits from shareholders, all other provisions may continue to apply Removal of restrictions on multilayered investment companies (currently, a company cannot invest through more than two layers of investment companies) Removal of restriction on maximum layers of subsidiaries for certain classes of companies (this provision has not yet been notified) Ability to declare dividend freely from the accumulated balance in profit and loss account without any restrictions prescribed under the dividend rules Interim dividend may be declared anytime up to convening of annual general meeting for the said financial year instead of end of such financial year and also considering the profits till the date of declaration Companies to be permitted to advance loans to certain persons in whom the director is interested, subject to approval of the shareholders by a special resolution. Such loans can only be granted for principal business activities and not onward lending (currently, such loans are expressly prohibited) 1 Vide an office order dated 4th June,

3 The term total share capital replaced with total voting power for determining subsidiary and holding company (currently, convertible preference share capital with or without voting rights is considered for determining subsidiary or holding company) parties are related and not allowing them to vote on related party matters may be impractical. Therefore, such exemption may be extended to such cases as well Preferential allotment of partly paid shares to be permitted Currently, shareholders of private companies are permitted to vote on related party transaction, even in case they are a related party. However, such exemption is currently not available to public companies Accordingly, in case of joint ventures and closely held public companies, all No government approval required for managerial remuneration. Limits for yearly managerial remuneration to be enhanced Exemptions from certain corporate governance requirements for companies that have listed securities (other than equity shares) Other key recommendations of the Committee are summarised below: Provisions Changes to the definition clauses Associate Company Significant influence to be determined based on the control of atleast 20% of the total voting power instead of total share capital Holding Company Explanation inserted to amend the term company to include body corporate to essentially cover companies incorporated outside India Related Party - The term company to be amended to substitute it with body corporate to cover companies incorporated outside India Net worth - to include the accumulated balance of profit and loss account Private placement norms for issue of capital Clarification provided that in addition to preferential allotment norms 2, private placement provisions will also apply to convertible securities Formula based pricing in case of convertible securities to be permitted on the lines of RBI Regulations/FDI Policy (currently, upfront pricing is prescribed) Acceptance of deposits Minimum offer size to be Rs 20,000 which includes premium (currently, offer size is linked only to face value ) Proposal to consider introduction of norms to restrict renunciation of rights by shareholders. The Committee s intent is to restrict bypassing of private placement/preferential allotment provisions Private companies in infrastructure sector to be permitted to take deposits from their shareholders without any upper limit Exclusion of certain amounts qualifying as deposits such as: Advance for goods and services due for more than 365 days subject to conditions (currently, such advances are treated as deposit); 2 As per Section 62(1)(c) read with Rule 13 of the Companies (Share Capital and Debentures) Rules,

4 Provisions Debentures compulsory convertible into shares of company within ten years (currently, exclusion is for five years) Convertible notes (such as promissory notes) issued by certain companies 3 above a prescribed amount, convertible into equity shares or redeemable within 5 years, not to be treated as deposits Companies to be permitted to take deposits after a cooling off period of 5 years if earlier default has been made good with full disclosures Board and general meetings Accounts of companies Reduced requirement for maintaining deposit repayment reserve account from 15 percent each for last two years to 20 percent during the maturing year Private company and wholly owned subsidiaries of unlisted companies permitted to hold annual general meeting anywhere in India subject to prior consent of 100% shareholders Wholly owned subsidiaries of overseas companies would be permitted to hold extraordinary general meeting outside India Items to be transacted through postal ballot could also be transacted through e-voting in the general meetings Allow participation of directors through video conferencing on matters presently restricted (approval of annual financial statements, approval of mergers etc), subject to such participation not being counted for the purposes of quorum Interested directors to be counted for the quorum for private companies Certain clarifications and exemptions were also provided in relation to filings for the board and general meetings Provisions for consolidation of accounts and reference to term associates and joint ventures for purpose of consolidation should be aligned under the Accounting Standards and the Act Re-opening of accounts should be restricted to eight years instead of indefinite period (except in case of specific directions from government) In absence of a managing director, the chief executive officer (irrespective of his directorship in a company) to mandatorily sign the financials statements Requirement of certain repetitive and cumbersome disclosures under the board report were relaxed and simplified. Also, a separate format of board report for small companies recommended Auditors Decision by shareholders not to ratify the appointment before the expiry of term of auditor, would attract the provisions of removal of auditors Various clarifications were also provided on independence and reporting requirements by auditor 3 Committee has made reference of start-ups 4

5 Provisions Directors Directorship in a dormant company to be excluded for reckoning the limit of directorships Memorandum of Association ( MOA ) Residency requirement of directors in India, be tested based on financial year and not calendar year Existing director not to be appointed as an alternate director in the same company Threshold to be introduced for determining pecuniary relationships in relation to qualification for an independent director (currently, even minor pecuniary relationship attracts disqualification) Necessary clarifications were provided to address ambiguities relating to resignation, vacancy and disqualification of directors Companies to have an option to insert a generic object clause in MOA Alteration in MOA by change of name now permitted if default of statutory returns or payment of deposits etc is made good Debentures Creation of Debenture Redemption Reserve ( DRR ) permitted basis reference to redemption schedule for the next one year (instead based on the value of debentures issued) Corporate Social Responsibility ( CSR ) Maintenance of liquid funds and DRR would be essential irrespective of profits Companies permitted to issue debentures by creating charge or providing security of any other entity or any collateral security (in addition to assets of the company) Issue of perpetual debentures may be permitted on lines of RBI regulations for certain issuers (such as banks and systematically important NBFCs etc) The term average net profit to be replaced with net profit for calculation of CSR spend Company not required to constitute a CSR Committee for any financial year would not be required to spend on CSR for that financial year (currently, the said requirement is for three financial years) Audit Committee For related party transactions not requiring board or shareholders approval, audit committee to give its recommendation to the board in case it is not approving a particular transaction with related parties Audit committee to be permitted to ratify related party transactions subject to certain thresholds (currently, only board and shareholders are permitted to ratify related party transactions) Approval from audit committee not required in case of related party transactions between a holding company and its wholly owned subsidiaries, if the same is not requiring board s approval Dormant companies not required to constitute audit committee 5

6 Provisions Restriction on powers of the board Loan and investment by company Related party transactions Prohibition on forward dealing and insider trading of securities Appointment of key managerial personnel ( KMP ) Conversion of partnership firm into company Application of Act to foreign companies Revised thresholds for constituting audit committee to keep smaller listed companies outside its purview To include securities premium for the purpose of calculating the borrowing limits which the board can approve without corresponding shareholders consent (currently, paid-up capital and free reserves are only considered) Loans given to employees by a company should not be subject to approval and minimum interest rate requirements 4 Currently, the Act provides exemption from approval requirements 4 for investment in shares by way of right issue by a company ie Indian company. The current exemption is proposed to be extended to rights issue by body corporates to include overseas companies Circular issued by MCA clarifying the meaning of related party for a particular transaction/ arrangement to be withdrawn 5 to avoid misinterpretation Deletion of provisions in case of private companies Board to be empowered to designate whole time officers of the company as KMP, other than those prescribed in the Act 6 To permit a whole time KMP, holding necessary qualifications, to hold more than one position in the same company at the same time A person resident outside India can now be appointed as a managing director/ whole time director of an Indian company (currently, only a person resident in India can be appointed as managing director/whole time director) Partnership firms, etc. with two or more members permitted to convert into companies (currently, the conversion is permitted with minimum seven members). However, in case of conversion with less than seven members, conversion permitted only to a private company Process for conversion of an LLP into a company to be made simpler Thresholds of transactions etc. of foreign companies to be prescribed, such that foreign companies with insignificant transactions are outside the purview of the Act Penalties Penalties to be reduced for certain defaults by one person companies and small companies (like filing of annual returns, financial statements etc) Steep increase in fees for delay/ non-compliance in annual statutory filings Penalty provisions to be relaxed and rationalised for certain defaults (like disclosure of interests by directors, making offer for subscription of securities 4 As prescribed in Section 186 of the Act 5 Circular no. 30/2014 was issued by MCA in relation to Section 188 (1) clarifying related parties for a particular transaction/ arrangement 6 As prescribed in Section 203 of the Act 6

7 Provisions on private placement etc.) Only frauds above a prescribed threshold to attract severe penalties as mentioned under the Act. Frauds below the prescribed thresholds and which do not involve public interest to be made compoundable Other key changes Companies which have defaulted on repayment of loans and interest etc. permitted to issue shares with differential voting rights after a cooling off period of 5 years from end of financial year in which default was made good Conversion of genuine 5 debt into equity would be treated as allotment of shares for cash consideration for filing purposes Appropriate amendments in the Act with respect to revival and rehabilitation and winding up to be carried out at the time of enactment of the Bankruptcy Code Comments The Committee has addressed practical difficulties faced by various stakeholders. Various changes have been suggested to address the ambiguities with the overarching intent to facilitate ease of doing business in India For the first time in corporate laws, the Committee has sought to introduce a new concept of ultimate beneficial ownership. This is a key change and may have a significant impact in various spheres particularly for large Indian groups with complex structures as well as overseas groups However, there are certain areas which may require consideration, such as: Clarity on definition of control to exclude certain minority rights such as veto rights (the Committee considered and rejected the same); Providing clarification on the timelines for formation of National Company Law Tribunal; Applicability of compliance requirements for private companies which are subsidiaries of public companies (the Committee considered and rejected the same); Interest free loans to wholly owned subsidiaries (the Committee has considered and rejected the same) Further, given that this is a set of recommendations open for public comments; it will be important to see which changes are finally implemented alongwith the timing and legal provisions for the same 5 Term not defined 7

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