July 2019 marked the 50th anniversary of the first moon landing and Neil Armstrong's immortal words "that's one small step for man; one giant leap for mankind". Looking back at 2019 through an Indian private client lens, an interesting parallel can be drawn with that historic event. Over the past year, Indian private client law took a number of small steps which were potentially giant leaps for the legal regime. That is to say, although no noteworthy legislation was enacted, a number of amendments and rules were introduced to existing laws which mark a significant shift in the legal position.
This article examines three key legal developments which took place in the Indian private client space in 2019 and the main trends expected in 2020.
In 2018, following the recommendations of the Financial Action Task Force (FATF), the Companies Act 2013 was amended to introduce provisions on the disclosure of significant beneficial owners (SBOs) of companies incorporated in India. The detailing of the law was left to the executive through the drafting of rules. As the initial rules of 2018 lacked clarity, they were significantly amended in February 2019 following stakeholder feedback.
Under the rules, an 'SBO' is an individual who holds interests of at least 10% in the shares, dividends or voting rights of a company or significant influence or control through one or more intermediate entities. An SBO must disclose their status to the company, which in turn must disclose the same to the registrar of companies (ROC). The disclosures are public documents, available for inspection for a nominal fee. After a series of extensions, 31 March 2020 has been set as the last date to make such disclosures to the ROC (for further details please see "Significant beneficial ownership – India's pivot towards disclosure").
Failure to report or an incorrect disclosure could lead to a monetary penalty and the suspension of certain rights attached to the shares, including voting, dividend and transfer rights.
The amended SBO rules marked a paradigm shift towards transparency in India. With the prospect of SBO information becoming available to regulators and the public, promoters were prompted to carefully review their onshore and offshore holding structures, particularly to ensure that disclosures were aligned to actual beneficial ownership and information supplied under other laws.
Private client lawyers were kept busy resolving the interpretive ambiguities that still exist in the SBO rules despite the 2019 amendments, including in relation to trusts. Further guidance and clarifications resolving some of these issues will hopefully be made available before 31 March 2020.
Insolvency regime extended to personal guarantors
The Insolvency and Bankruptcy Code 2016 (IBC) is a landmark piece of legislation which codifies the Indian law on insolvency and bankruptcy. While the IBC provisions relating to corporate debtors were made enforceable earlier, the provisions relating to individuals who are personal guarantors to corporate debtors did not take effect until 1 December 2019.
The extension of the IBC to personal guarantors to corporate debtors is expected to have two key consequences:
- insolvency proceedings may be commenced under the IBC against such promoters if a business cannot repay the debt as per the terms of the debt; and
- any undervalued transaction which triggers a bankruptcy process and was entered into in the two years prior to the application for bankruptcy may be set aside. Consequently, a gift to a family member or contribution to a trust could be classified as an undervalued transaction and may be set aside in IBC proceedings.
In India, it is common for promoters of family businesses to guarantee the debt of the business. As such, any estate planning exercise for such promoters must factor in these IBC developments.
Shift in CSR approach
India is the only country to impose statutory corporate social responsibility (CSR) obligations. Certain companies which meet identified thresholds must contribute 2% of their net profits to CSR (Section 135 of the Companies Act). When this provision took effect in 2014, it was understood to be of a 'comply or explain' nature (ie, companies which did not spend the prescribed amount would not be penalised or forced to spend, but rather would have to explain the lapse in the annual report of the board of directors).
Concerned that companies were not spending the prescribed share of their profits on CSR, in 2019 the government adopted a stance departing from this understanding. Accordingly, in July 2019 Section 135 of the Companies Act 2013 was amended to provide as follows:
- Companies must transfer unspent CSR amounts (unless relating to any ongoing project) to a government fund within six months of the expiry of the financial year.
- Companies must transfer any unspent CSR amounts relating to an ongoing project to a special account within 30 days from the end of the financial year. If this amount remains unspent for three financial years thereafter, it must be transferred to a government fund.
These amendments are significant for private client lawyers dealing with charities for two key reasons:
- Companies which can no longer shelter under 'comply or explain' are considering setting up their own foundations to which they can contribute CSR amounts. Until now, one of the primary reasons for companies failing to pay their full CSR contribution was the difficulty in identifying credible third-party non-profit entities. By establishing their own non-profit entities, companies can eliminate such third-party risk in implementing their CSR programmes.
- Credible non-profits in India should start receiving higher contributions from companies seeking to meet the three-year deadline and will therefore need greater access to legal counsel.
Given the events of 2019, a few trends to watch for in 2020 are as follows:
- Taking a cue from the global drive for transparency, the dominant theme of 2020 will likely continue to be disclosure and transparency. The Indian SBO regime should dovetail with the exchange of information system under the common reporting standard and lead to:
- a greater emphasis on the simplification of structures and ease of reporting; and
- increasing regulatory scrutiny.
Moreover, every estate and succession planning exercise will need to analyse the SBO rules to align the need for transparency with a family's desire for confidentiality.
- In keeping with recent years, ongoing regulatory developments pertaining to corporate governance are expected to mature. In addition to management succession in family businesses, estate planning and family governance endeavours must be tailored for compliance.
- With the IBC provisions operational, clients will increasingly examine the possibility of setting up asset protection trusts to protect at least part of their wealth (including the family home) from creditors, to the extent permitted by law.
- Although certain states have enacted statutes on charities and non-profits, India has no uniform law on this subject. In states without such laws, regulatory oversight over charities and non-profits is extremely limited (except to the extent that they are scrutinised by income tax authorities). It is possible that 2020 might see movement towards the regulation of charities (if not comprehensive, then at least requiring greater disclosures).
- India does not levy estate duty at present, but there have been persistent rumours over the past few years that the government may introduce it to fund its vikas (ie, development) agenda and curb rising inequality. While it is impossible to predict whether estate duty will be introduced in the upcoming budget in February 2020, if it is, this would be a departure from the government's recent efforts to boost sentiments of wealth creators with the aim of providing impetus to India's stressed economy.
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