Understanding Beneficial Ownership in the Indian Corporate Landscape

The author is Vrinda Gaur, a third year student at Dr. Ram Manohar Lohiya National Law University.

INTRODUCTION

The recent announcement by the Ministry of Corporate Affairs that companies can approach NCLAT if the Beneficial Owner refuses to disclose his anonymous identity has once again sparked discussions surrounding the best compliance strategies to bring such anonymous entities by the books.

A beneficial owner is a natural person who enjoys all the benefits arising out of the entitlement of ownership of property, however, the title of ownership of property is vested in another individual’s name. Such ownership may be shared amongst a group of individuals, and certain legislations mandate the disclosure of such individuals if they hold a minimum threshold of the company’s shares. For instance, the Securities and Exchange Act of 1935 requires disclosure under Section 12 if a beneficial owner owns 5% share control in the company.

Though numerous such owners may voluntarily file for their disclosure, the issue arises when individuals opt to stay anonymous, regardless of the justification behind such anonymity. The author aims to analyse the status quo through the available jurisprudence, forecast future obstacles in achieving corporate transparency and propose a path forward.

UNDERSTANDING THE INDIAN NARRATIVE THROUGH JURISPRUDENTIAL STUDIES

Corporate vehicles like companies, trusts and foundations play a vital role in business and trade, but some are misused for illegal purposes like money laundering and corruption. Detecting these illegal activities is a challenge for due diligence teams.

In the Indian context, the most significant development took place when the Ministry of Corporate Affairs released the Companies (Significant Beneficial Owners) Amendment Rules, 2019 (“New SBO Rules”), which amended the Companies (Significant Beneficial Owners) Rules, 2018 (“SBO Rules”). The framework now includes terms like "significant beneficial owner" and "significant influence" to ensure compliance with FATF and OECD standards and prevent a beneficial owner from hiding under the veil of a director or nominee of a corporate body. The strict disclosure policy included in this amendment mandates that the beneficial owner report any significant beneficial ownership within 30 days of acquisition. Companies must also identify any Significant Beneficial Owners and promptly notify members holding at least 10% of shares, voting rights, and dividend rights. Additionally, the registry of these SBOs must be meticulously maintained.

In 2005, the PML Rules were brought into existence due to an amendment made to The Prevention of Money Laundering Act of 2002. Various assessments have been included in these regulations to determine the beneficial owner of multiple corporate bodies, including companies, trusts, partnership firms, and publicly traded entities. In the case of a company, a minimum threshold of over 25% interest has been established, while for a partnership firm or trust, the minimum ownership interest required for someone to be deemed a beneficial owner is 15%.

In 2018, the Securities and Exchange Board of India established rules and guidelines to ensure that significant beneficial owners are accounted for legally. These guidelines mandate that intermediaries registered with SEBI must identify the beneficial owners of clients, such as foreign portfolio investors when opening a securities account.

These are the dominant authorities regulating the beneficial ownership disclosure landscape in India.

DISSECTING THE CHALLENGES IN THE INDIAN CORPORATE LANDSCAPE

Despite the implementation of the aforementioned regulations and rules, resolving the issue at hand is not a simple task. The redressal mechanism appears to be complex and involves technicalities and intricacies that extend beyond the horizon of the problem, i.e., the identification of the SBO itself.

To begin with, there is a lack of clarity and legal interpretation regarding the alignment of disclosure regulations with other statutes like the Insolvency and Bankruptcy Code of 2016, the Income Tax Act of 1961, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, and other similar laws. For instance, in the Companies Act 2013, Section 90 states that a minimum shareholding interest of 25% can result in liability for violating this section. However, the SBO rules require a minimum threshold shareholding of only 10% to trigger liability. It remains unclear whether the 10% rule would override the 25% rule as there is little clarification or judicial precedent on this matter. This lack of coordination between different regulations and laws can cause confusion and uncertainty, leading to beneficial owners going unchecked.

Moving ahead, the Ministry of Corporate Affairs has once again reiterated that beneficial owners in companies must reveal their identity through an MGT-5 form. Failure to do so may result in NCLT intervention, which could freeze share transfers and limit rights. However, the question of accountability/ownership of these shares during the period of freeze remains unresolved and ambiguous, leading to a perplexing predicament.

The next issue stems from Section 89 of the Companies Act 2013. This section calls for nominee shareholders to disclose to the company the shares held by them on behalf of a third person. However, there are currently no explicit penal sanctions against such nominees if they fail to disclose the third person. This often goes against the best practice of disclosure requirements and renders the entire exercise futile.

It is evident that India has failed to effectively identify and manage the risk of money laundering, particularly when it comes to assessing the risks associated with Beneficial Owners. India has failed to conduct such assessments on a regular basis between 2014 and 2021. Though in 2022 an assessment was conducted, there was little acknowledgement of industry-specific standards for different sectors of the economy. This lack of action is a clear violation of Principle 2 of the 114th G20 High-Level Principles on Beneficial Ownership Transparency. Moreover, the previous transparency report raises serious concerns about this matter, and it is imperative that steps are taken to rectify this issue.

Finally, while information about SBOs can be accessed by relevant authorities from the Registrar of Companies, India does not have a unified database for the centralisation of information which can pose challenges to timely access to the information within and beyond the domestic jurisdiction. Further, sometimes, though the information is available, it does not go beyond the name and the registration number.

REARRANGING THE STUMBLING BLOCKS

In the wake of the Panama Scandal, which involved the leak of approximately 11 million files from the Panama-based law firm Mossack Fonseca, jurisdictions worldwide have increased their vigilance and taken punitive measures against numerous beneficial owners who were hiding within and beyond their domestic jurisdiction. First and foremost, the scale of the problem demands that all nations collaborate to address the issue with a consistent approach. To guarantee complete transparency regarding beneficial ownership, it is imperative that the guidelines delineated in the FATF White Paper for Public Consultation are strictly adhered to. Financial Action Task Force became the first International Organisation to roll out global standards to tackle the conundrum of anonymous beneficial owners with the sole aim to ensure transparency of legal persons. Since 2012, it has been holding regular consultations and publishing reports on the issue at hand, to resolve the most common hurdles that countries need to dodge for ensuring an effective system of identification of Beneficial Ownership of legal persons.

It is crucial for the legislative framework to establish a clear definition of the scope of beneficial ownership, as emphasized in the white paper. Although India has made progress by implementing SBO rules, PML rules, and SEBI guidelines, there is still a lack of consensus on a uniform threshold for beneficial ownership shareholding. It is imperative for either the judiciary or the legislature to take a proactive role in ensuring consistency among the laws.

A similar approach of legislative or judicial interpretation to ascertain the accountability of frozen shares owned by a beneficial owner and the omission of a nominee to disclose a third party is imperative. Moreover, outlining stringent punitive sanctions for such nominees would serve as a deterrent and prompt them to disclose all significant beneficial owners.

In order to meet the FATF's recommendations, the governmental agencies in India should ensure that risk assessments are conducted in a routine manner, at least once a year. The purpose of a risk assessment is to determine the extent of risk associated with entities that may be used for illicit activities such as money laundering, terror financing, and corruption. Such assessments would help in the identification of risk and categorisation of entities in addition to formulating mitigation strategies and continuous improvement. India has a lot to gather from jurisdictions like the UK, France and Italy which have in place industry-specific guidelines for carrying out assessments and provide training of relevant personnel within reporting entities on conducting risk assessments effectively. These jurisdictions have in place a stringent policy of Enhanced Due Diligence where higher-risk entities, including those with complex ownership structures or connections to high-risk jurisdictions, are subject to enhanced due diligence measures. India should follow a similar path to ensure that the financial evils committed by SBOs do not go unchecked.

Finally, ensuring consistent record-keeping and establishing a centralised database would ultimately uphold best practices of verification and accountability leading to a greater degree of public trust and prevention of misuse of legal structures. In circumstances of suspicious activities, such records would ensure the conduction of effective investigations, tracing illicit funds and facilitating cross-border data sharing in addition to holding entities accountable for financial crimes.

CONCLUSION

Though there exist other significant complexities related to this issue, we must wait before proceeding to those until the above-discussed rudimental challenges that substructure the primary concern are redressed.

Submitting an SBO declaration is critical in the corporate realm, given the substantial financial implications and the possibility of severe repercussions under various laws and regulations. Though India has taken progressive strides in this respect, it has a considerable gap to fill, which can be done by implementing these practical approaches.

To create a progressive corporate environment and become an attractive location for corporate investments, it is crucial to address the issues mentioned and comply with the FATF guidelines regarding the disclosure of beneficial owners. This will help establish a promising corporate investment jurisdiction in the coming years.