SUMMARY | RECOMMENDATIONS MADE BY COMPANY LAW COMMITTEE

 The Companies Act, 2013 (2013 Act) was enacted with a view to bring Indian company law in tune with global standards. However, as is the case with every new legislation the enactment of this new Act also led to chaos and confusion in the industry. The Government continued to receive representations from the industry and stakeholders that the 2013 Act needed further review. Thus, a Company Law Committee (CLC or Committee) was constituted with a mandate to make recommendations on issues arising from the implementation of the 2013 Act and examining recommendations received from other agencies such as the Law Commission of India. The CLC submitted its report on 1 February 2016 (Report) and recommended several changes to the 2013 Act with a view to ensure its effective implementation. The Ministry of Corporate Affairs (MCA) has invited comments on this Report by 15 February 2016.

It is pertinent to mention that as per the Report, the committee’s recommendations will result in changes to about 78 sections of the 2013 Act and more than 100 changes in the 2013 Act itself. This update summarizes the important recommendations made by the Committee in the Report:

1. Definitions:
• Associate Company [Section 2(6)]: CLC recommends amending this definition in order to make it consistent with the term associate company as defined under the Accounting Standards. Associate Company as defined under Accounting Standard-28 excludes joint ventures. Thus, CLC recommends that joint ventures, as defined in the Accounting Standard 28, be included in the explanation clause to Section 2(6) of the 2013 Act and the term ‘significant influence’ should be amended to mean 20% of the total voting power and not total share capital, since total share capital also includes preference share capital.
  
  
• Subsidiary Company [Section 2(87)]: CLC recommends that since equity share capital forms the basis for determining the holding-subsidiary status of companies by virtue of it conferring voting power on the holder of the shares, the term total share capital should be replaced with total voting power. Further, CLC also recommends that the restrictions on layering of subsidiaries as contained in the proviso of the said section be omitted in order to enable companies to raise funds more effectively, which in turn will help smooth functioning of companies and also for structuring purposes.
  

2. Private Placement [Section 42]:
• PAS-4: Given that the nature of information, which is to be disclosed in the Form is extensive, CLC recommends discontinuing the preparation, filing and circulation of PAS-4. Further, in order to protect the interest of the investors, CLC recommends that the disclosures which are made under Explanatory Statement referred to in Rule 13(2)(d) of Companies (Share Capital and Debenture) Rules, 2014, should be embodied in the Private Placement Application Form.
  
  
• Making simultaneous offer of securities: CLC acknowledged that there may be instances wherein companies may be required to make simultaneous issue of different forms of instruments namely, preference shares or non-convertible debentures and the current prohibition on making a fresh offer of securities, if allotments to be made under the prior offer are pending, has hampered the ability of companies to meet their financial requirements. Thus, CLC recommends that subject to the offer being made to a maximum of 50 persons or such higher number as may be prescribed, a company can simultaneously keep more than one issue of securities open in a year, while ensuring that the regulatory concerns are not compromised.
  
  
• PAS-5: CLC recommends that the requirement of filing Form PAS-5 should be discontinued. Also, Section 42 (7) of the Act should be amended to state that offers under Section 42 shall be made only to such persons whose details as prescribed under the rules have been recorded by the company prior to making an offer. Such details should not be filed with the Registry. In order to ensure accountability and transparency during the private placement process, CLC recommends that the relevant special/board resolution authorising the company to circulate the application form and collect monies should be filed with the Registry.
  
  
• Valuation of convertible securities: CLC recommends that the valuation report, as required to be obtained by companies, need not be filed with the Registry or circulated, however, the same is required to be made available to the investors. The Committee further recommends that the current provisions under the 2013 Act requiring price of securities to be decided in advance should be modified and provisions allowing pricing to be done on the basis of a formula (on the lines of RBI Regulation/FDI Policy) should be considered.
  

3. General Meetings:
• Annual General Meeting (AGM) [Section 96(2)]: On the basis of suggestions received from the industry, CLC has agreed to amend the relevant provisions of the 2013 Act to state that private companies and wholly owned subsidiaries of unlisted companies can convene AGM at any place in India, provided that 100% shareholder approval is obtained in advance by the company.
  
  
• Extra-Ordinary General Meeting (“EGM”) [Section 100]: CLC recommends that wholly owned subsidiaries of companies incorporated outside India should be given relaxation to convene EGM outside India. Thus, CLC recommends deleting the explanation to Rule 18 (3) and inserting explanation to Section 100 granting exemption to wholly owned subsidiaries of companies incorporated outside India to convene EGM outside India.
  
  
• Postal Ballot [Section 110]: Section 110 prescribes list of items, which are mandatorily required to be transacted by way of postal ballot. This mandatory list becomes redundant for companies, which are required to conduct voting using electronic means. Thus, CLC recommends amending the relevant provisions of 2013 Act and the rules to provide that if a company is required to provide for electronic voting, then the same items could be covered in its General Meetings also.
  

4. Independent Directors [Section 149(6)]: The criteria for appointment of independent director as mentioned in 2013 Act states that an independent director must not have any pecuniary relationship with the company, holding company, associate company, etc. Thus implying that even minor pecuniary relationships would be covered within the captioned section, even though such transactions do not compromise the independence of the director. In light of the above, and in order to bring it in harmony with the SEBI listing agreement, the Committee recommends that the test of materiality be introduced in determining the pecuniary relationship.
   
   
5. Loans to Directors [Section 185]: CLC recommends that companies should be allowed to advance loans to other person, including subsidiaries in which the director is interested, subject to the company obtaining prior approval of the shareholders by way of special resolution. Further, loans extended to persons, including subsidiaries, falling within the restrictive purview of Section 185 should be used by the subsidiary company for its principal business activity only, and not for further investment or grant of loans.
   
   
6. Loans and Investment by companies [Section 186]: CLC recommends that layering restrictions on investment companies should be removed. Further, CLC also suggests that an explanation should be provided to clarify that use of the word person in sub-section 2 of Section 186 does not include employees of the company who have been given loans as a part of conditions of service or pursuant to any approved scheme for all employees by the company.
   
   
7. Related Party Transactions [Section 188]: The Committee recommends withdrawal of the MCA Circular No 30/2014, which clarified the requirements of second proviso to Section 188 (1) of the Act. The Committee recommends that all related parties cannot vote on related party transaction.
   
   
8. Prohibition on forward dealing and insider trading of securities [Section 194 and 195]: CLC recommends that both the Sections should be omitted, in view of the practical difficulties expressed by the stakeholders.
   
   
9. Managerial Remuneration: (i) CLC recommends that the requirement of obtaining government approval for authorising payment of managerial remuneration in excess of the prescribed limits should be done away with. (ii) CLC also recommends that Schedule V be amended such that remuneration payable to managerial personnel who is not related to any director or promoter of a company or who is not a promoter of the company, and is a professional with relevant knowledge and domain experience; and does not hold more than 2% of the paid up equity share capital of the company or its holding company, should be approved by way of ordinary resolution and not by way of special resolution. In other cases, however, the requirement for special resolution of the shareholders should be retained. (iii) The Committee further recommends that the limits of yearly remuneration prescribed in the Schedule be enhanced.
   
   
10. Charge [Section 77]: Given that the 2013 Act does not set out the specific list of charges which are required to be filed with the Registry, pledges and liens created were also required to be filed with the Registry. Such filings of pledges and liens created various practical difficulties, relating to the quantum and frequency of registrations required, especially for NBFCs and Clearing Corporations. Thus, the Committee recommends that prescriptive powers should be provided under Section 77 (3) to allow certain liens or securities or pledges to be exempted from filing.
    

11. Board Meetings:
• Video Conference: The rules framed under 2013 Act specify a list of items which cannot be dealt with via video conferencing or any other audio visual means. CLC observed that this requirement completely bars the participation in the board meeting via video conferencing even if the requisite quorum as prescribed under the 2013 Act is physically present. CLC therefore recommends flexibility be provided to allow participation of directors through video conferencing, subject to such participation not being counted for the purpose of quorum. However, such directors, though not counted for the purposes of quorum, may be entitled to sitting fees.
  
  
• Interested Director: Given that private companies have been exempted from the provisions of Section 184 (2), which prohibits interested directors from participating in the board meetings, CLC recommends that since Section 184(2) and Section 174(3) are related sections with respect to interested directors, related exemption under Section 174(3) to enable such participating interested Directors for the purposes of quorum, should be given to private companies using the power of exemption available to the Government under Section 462 of 2013 Act.
  

12. Companies (Share Capital and Debentures) Rules, 2014:
• Issue of Sweat Equity Shares [Rules 8(4) and 12]: CLC recommends that start-up companies can issue sweat equity shares in excess of the 25% ceiling and up to 50% of their paid up equity share capital. Further, CLC has also recommended that in order to encourage start-up companies, ESOPs can be issued to the promoters, who work as employees or employee directors or whole time directors, which will help them gain when the valuation of the company goes up in the future, without in any way impacting finances of the company in the initial years.
  
  
• Preferential Allotment of partly paid up shares [Rule 13(2)(c)]: Currently, the captioned rule does not allow preferential allotment of partly paid up shares. However, given that the Department of Industrial Policy and Promotion vide its Press Note No 9 (2015 Series) dated 15 September 2015 allowed partly paid shares and warrants as eligible capital instruments for the purposes of FDI policy. The Committee also recommends amending this Rule in order to allow preferential allotment of partly paid-up shares.
  

MHCO COMMENTS:

A majority of the amendments that have been recommended and discussed above, are to the Sections under the 2013 Act which can only be amended by the legislature and thus will require approval of both the Houses of Parliament. Also, it can be argued that these recommendations made by the Committee will drive the ease of doing business but it may dilute some of the governance recommendations made in the 2013 Act.

This update was released on 12 February 2016.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

RETROSPECTIVE AMENDMENTS TO PAYMENT OF BONUS ACT

The Payment of Bonus Act, 1965 (``Bonus Act``) requires payment of compulsory bonus to certain employees of establishment which employs 20 or more persons. The erstwhile provisions of the Bonus Act provided for payment of bonus to the employees drawing a salary not exceeding Rs 10,000/- per month and who has worked for not less than 30 days in an accounting year. Further, the erstwhile provisions of the Bonus Act provided that in the event the wage / salary of an employee exceeds Rs 3,500/- and Rs 500/- per month then, the bonus shall be calculated on the salary as being Rs 3,500/-.

AMENDMENT: The Payment of Bonus (Amendment) Act, 2015 (``Amendment Act``) received Presidential assent on 31 December 2015. The Amendment Act provides for major changes in the eligibility limit and calculation of bonus of the employees under the Bonus Act.

Increase in Eligibility Limit: The Amendment Act has widened the scope and eligibility of payment of bonus to employees from the earlier drawn salary of Rs 10,000/- to now Rs 21,000/-.

Calculation of Bonus: Further for the purpose of calculating bonus, the salary limit which was earlier Rs 3,500/- has now been revised to Rs 7,000/-.

Retrospective Amendment: This Amendment Act is made applicable retrospectively from 1 April 2014. However, Kerala High Court has stayed the retrospective applicability of the Amendment Act. Vide the interim order the Kerala High Court has held that the Amendment Act shall be applicable prospectively from 2015-16.

MHCO COMMENTS:

Amendment Act is a positive move by the Government as it revises the limits for payment of bonus as per the realities of today’s economic scenario. However, the Amendment Act should have been made applicable prospectively as retrospective application of the Amendment Act has caused unrest amongst employers and has given birth to uncalled litigation.

This update was released on 9 February 2016.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

PROPOSED AMENDMENTS TO THE AIF REGULATIONS

Alternative Investment Funds (AIF(s)) play a vital role in Indian economy as they drive the economic growth and contribute significantly to nation building. To regulate AIF's under one regulation, Securities and Exchange Board of India (SEBI) in 2012 notified SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). In 2013, SEBI further notified amendments to AIF Regulations. We had provided our legal update on the AIF Regulations and the amendments which can be seen here.

In 2015, SEBI established the Alternative Investment Policy Advisory Committee (AIPAC), which was headed by Mr Narayan Murthy for further developments of alternative investments by removing hurdles in making alternative investments etc. AIPAC very recently submitted its Report and SEBI has invited comments on thisReport by 10 February 2016.

In this update, we have briefly summarised recommendations made by AIPAC in the Report:

1. Taxation
   
   
• To Make Tax Pass-Through Work Effectively: Given that AIFs are simply vehicles that pool the savings of investors for professional fund management over a long-term period, it is imperative that the tax pass-through system is made simple and effective. In this regard, the Report recommends the following: (a) the exempt income of AIFs should not suffer tax deducted at source (TDS)of 10%; (b)exempt investors should not suffer tax withholding of 10%; (c) investment gains of AIFs should be deemed to be ‘capital gains’ in nature; (d) The tax rules applicable to ‘investment funds’ in Chapter XII-B of the Income Act, 1961 (IT Act) should be extended to all categories of AIFs; (e) Losses incurred by AIFs should be available for set-off to their investors; (f) Non-resident investors should be subject to tax rates in force in the respective Double Tax Avoidance Agreements (DTAA).
  
  
• Eliminate Deemed Income: Given that the income of an AIF arises only when it receives dividend or interest income during the holding period in a portfolio company, or realises capital gains at the time of exit from the portfolio company, it is important to understand that investments made in portfolio companies are capital contributions and not the income of the portfolio company. Thus, in light of these principles, it is recommended that AIFs as well as portfolio companies are exempted from Section 56(2)(viia)and 56(2)(viib), respectively, of the IT Act.
  
  
• Clarify Indirect Transfers: The Report recommends to seeks clarification from CBDT that investors in the holding companies or entities above eligible investment funds investing in India, are not subject to the indirect transfer provisions.
  
  
• Make Safe-Harbour Effective for Managing Funds from India: Given that the safe harbour rules enacted by the Government under Section 9A of the IT Act, have not been effective so far, the Report recommends changes in the conditions provided thereunder, namely: (a) investor diversification;(b) control or management of portfolio companies; (c) tax residence; (d) arm’s length remuneration of fund managers; and (e) annual reporting requirements. These changes will help fund managers to manage their investments from India.
  
  
• Make Foreign Direct Investment (FDI) in AIFs Work Efficiently: While the Government’s move to allow FDI in SEBI-registered AIF is a welcome measure, in order to make the same effective, the Report recommends that the Government should: (a) clarify the rules for investment by non-resident Indian investors in AIFs on a non-repatriation basis; (b) eliminate ambiguity to enable NRIs to invest in AIFs using funds in their rupee NRO accounts; (c) provide for TDS on distribution of income to non-resident investors in AIFs in accordance with DTAA tax rates in force; (d) grant permission to LLPs to act as sponsors and/or managers of AIFs; and (e) relax Indian tax compliance obligations for non-resident investors in AIFs.
  
  
• Securities Transaction Tax (STT): The Report recommends that Government should introduce STT at an appropriate rate on all gross distributions of AIFs and investments, short-term gains and other income and eliminate any withholding of tax. Post the levy of STT, income from AIFs should also be tax free to investors.

2. Unlocking Domestic Capital Pools
The Report observes that merely 10-15% of the equity capital required by start-ups, medium enterprises and large companies is funded from domestic sources, and the remaining is funded from overseas, owing to constraints on the traditional sources of funding to supply risk capital. Given this scenario, the Report inter alia recommends that: (a) regulators such as RBI and IRDA must be convinced to encourage institutions regulated by them to invest in AIF asset class; (b) all banks, pensions, provident funds, insurance companies and charitable endowments which invest in equities must utilize a minimum of 2-5% of the corpus or annual contribution of that amount in SEBI approved Category 1 AIF; (c) investment limits for banks and insurance companies in AIF must be increased from 10% to 20%; (d) For banks, investments in AIF should be treated as priority sector investments and it should not impact the banks’ capital market exposure; and (e) charitable or religious funds should be permitted to invest in SEBI – registered Social Venture Funds. 


3. Promoting Onshore Fund Management
The Report observes that currently, approximately 95% of venture capital (VC) and private equity capital (PE) is contributed by overseas investors and the majority of overseas investors (i.e. 98% of total foreign VC/PE capital) and their managers prefer to domicile their funds offshore, i.e. in countries with stable and favourable tax and regulatory regimes on fund management, since their FDI and Foreign Portfolio Investment (FPI) regimes are considered to be far more consistent in contrast to the changing tax and regulatory regimes specific to VC/PE Funds in India. Two major factors which have led to this situation are (a) the lack of clarity in taxation; and (b) severe restrictions on the operational freedom of fund managers domiciled in India. In order to overcome this, the Report recommends: (a) creating parity between Indian and offshore regulations and with their respective DTAA; (b) allowing foreign investment from international limited partners directly into domestic AIFs by bringing changes to the FDI policy/FEMA and the policy on TDS; (c) creating level playing field between the fund managers domiciled in India and those located offshore, which is not the case in India currently; (d) enabling more foreign funds to be domiciled in India and brought under the purview of SEBI by ensuring clear policies and their consistent application over the entire life of fund vehicles; (e) an immediate clarification from CBDT that exempts the income flowing through AIFs from suffering any withholding tax; (f) amending the safe-harbour norms for ease of doing business. 


4. Reforming the AIF Regulatory Regime:
The Report observes that most regulatory efforts have rightly focused on protecting minority shareholder interests and improving compliances, however, there has been a limited direct regulatory effort focused on PE and VC industry itself. Thus, the Report recommends the following: 


• Regulation ofthe Fund Manager and not the Fund: The Report recommends the repeal of (i) SEBI (Portfolio Manager) Regulations, 1993, (ii) SEBI (Alternative Investment Funds) Regulations, 2012; and (iii) SEBI (Investment Adviser) Regulations, 2013and the introduction of a regulatory framework / policy to govern the fund manager such that the fund manager is responsible for all the investment activities of the client. The Report further recommends that new SEBI (Alternative Investment Fund Managers) Regulations (AIFM Regulations) should replace all the above-mentioned Regulations. A registered Investment manager under the AIFM Regulations will provide discretionary or non-discretionary investment advisory/ management services to investors who could be individuals/ a group of individuals or open-ended/ close-ended funds or clients seeking customized products. Investment manager will have specific capitalization requirements, which could provide for sub-categories based on the nature of the AIFM’s business (i.e. discretionary, non-discretionary, customized or collective investments). The funds raised by registered investment manager will follow the SEBI guidelines and notify SEBI under an appropriate reporting framework.
  
  
• Amendments in AIF Regulations: It is recommended that the definition of ``venture capital fund`` in Category I AIF is amended to include funds that invest in ``growth`` stage ventures.
  
  
• Classification of Category III AIF: The Report recommends creating sub-categories, namely under Category III AIF: (a) Category III Sub-category A for an AIF which will primarily invest in public markets and will not employ leverage including through investment in listed or unlisted derivatives (except for the purpose of hedging the investments). The said new category will invest on a long-term basis with a minimum life of 3 years; and (b) Category III Sub-category B for ‘Complex Trading Fund’, i.e. funds which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. This classification will segregate a diverse range of strategies under the Category III umbrella into 2 distinct buckets based on investment horizon, underlying securities and investment objectives. This will further aid in matching investors with appropriate strategies.
  
  
• 10% Restriction of Investible Funds: Clause 15(d) of the AIF Regulations state that Category III AIF shall invest not more than 10% of the investible funds in a single Investee Company. It is recommended that 10% restriction of ‘investible funds’ in a single Investee Company should be replaced with the reference to the ‘market value’ of such securities at the time of investment.

MHCO COMMENT

In a global scenario, where countries compete for capital, the success of alternative investments in India in long-term will depends on its tax policy which require to be globally competitive. AIF's can make a significant contribution to India’s GDP and the implementation of AIPAC’s can help India attract large capital flows.

This update was released on 3 February 2016.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.