OFFICE SHARING ARRANGEMENT AMONG FOREIGN OWNED AND CONTROLLED COMPANIES | IS IT A REAL ESTATE TRANSACTION?

Recently, Department of Industrial Policy and Promotion (DIPP), via a Circular clarified that facility sharing arrangements between group companies through leasing/ sub-leasing arrangements shall not be treated as ‘Real Estate Business’ under the Foreign Direct Investment (FDI) Policy for the larger interest of business (subject to two conditions, elaborated below). This update up goes on to enunciate how this clarification will cause more problems than it solves.

FDI Policy: Under the FDI Policy, Indian companies which are recipient of any FDI are prohibited from engaging in `Real Estate Business`. Recently via press note 10 of 2014, DIPP defined the term `Real Estate Business` to mean `dealing in land and immoveable property with a view to earning profit or earning income there from and does not include development of townships, construction of residential/ commercial premises, roads or bridges, educational institutions, recreational facilities, city and regional level infrastructure, townships.`

Notably, the phrase ‘dealing in land and immoveable property’ includes within its ambit not only buying and selling of, but all transactions in relation to, land and immoveable property. Consequently, the phrase includes any lease or sub-lease entered into in relation to an immoveable property.

In India, it is a common practice for one company in a group to own/ lease office space and own facilities, which are then shared by other group companies. The use of office space by the other group companies is generally not done by leasing/ sub-leasing transaction but rather by entering into facility sharing arrangement. The reason is that leasing and sub-leasing entail creation of interest in the property while the facility sharing arrangement entitles the other group companies to merely use the premises like a license. Transactions of the latter nature address the commercial intent, i.e. one of the group companies bears the cost of the office space while the other group companies also use it. However, the DIPP Circular relates to arrangements of former nature which are not only rare but are also far from commercial reality, therefore the utility value of the DIPP Circular is a question mark.

Further, similar arrangements are also done for sharing servers, cafeteria/ water purifier services, elevators, key managerial officers etc. But as these are movable properties, they are not a subject matter of the DIPP Circular. It is also not clear if such transactions makes the lessor company a ‘service provider’ and therefore makes it liable to pay service tax.

Condition in DIPP Circular: DIPP Circular prescribes two conditions, and if the facility sharing arrangements between group companies through leasing/ sub-leasing arrangements conform with such conditions, they will not be categorised as ‘Real Estate Business’ transactions under the FDI Policy. This means that a FDI recipient Indian company will be permitted to act as a lessor in transactions of such nature. These conditions are the (a) arrangements should be at an arm’s length price calculated as per the Income Tax Act, 1961 (IT Act) and (b) annual lease rent earned by the lessor company should be less than 5% of such lessor company’s total revenue.

On analysing the two conditions closely, it will not be wrong to say that the lose drafting of the DIPP Circular gives rise to a number of problems.

Arm’s length pricing: How should the arm’s length price be calculated? As per the IT Act, arm’s length price means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. Now, if a company permits the use of its office space by its group companies on arm’s length price, the company will have to charge the group companies for such usage and a mere reimbursement will not do. If so, such arrangements shall yield profits for the company. This would mean that office space leasing/ sub-leasing would become a business of the company.

Issues under the company law due to arm’s length pricing: Given that due to the above calculation, the office space leasing/ sub-leasing would become a business of the company, it will have to be inserted as one of the objects of the company in its Memorandum of Association, in spite of the fact that the company in reality has no intention of engaging in any ‘Real Estate Business’. Further, as the group company will be a related party, such an arrangement (not being in the ordinary course of business) will require a board or shareholder’s approval (as the case may be) in terms of section 188 of the Companies Act, 2013.

Limit on the annual rent lease: Furthermore, for a facility sharing arrangement to not qualify as a ‘Real Estate Business’ transaction, the Indian company with FDI will have to ensure that the annual rent earned by it due to the facility sharing arrangements does not exceed 5% of its revenue. (a) Now, in the event the office space of a company is shared by multiple group companies then there is a possibility that the sum total of the rent earned from all such group companies together exceeds 5% of the company’s revenue, to meet the arm’s length pricing condition. (b) Secondly, in multiple cases the office space is owned or leased by a less revenue generating company and therefore it will be difficult for the company to ensure that the annual lease rental earned by it does not exceed a meagre 5% of its revenue. (c) Thirdly, as the revenues of a company fluctuate on yearly basis, the annual rent will have to be determined at the end of the year (so that the lessor company’s revenue figures are frozen) rather than at the beginning of the contractual cycle of the facility sharing arrangement.

Apart from all the above complications, looking objectively at the DIPP Circular, one does not understand its need. Office space sharing arrangements between group companies are not entered into to make profits and therefore cannot be construed as a ‘Real Estate Business’. These transactions are done for commercial ease.

MHCO COMMENTS

DIPP Circular has complicated an uncomplicated situation as it categorises transactions which are not in the nature of `Real Estate Business` as transactions for `Real Estate Business`. The situation has become further obscure by introduction of impractical and conflicting conditions (with no thought given to the consequences of complying with such conditions), to be met to qualify such anyway `Not Real Estate Business` transactions into `Not Real Estate Business` transactions.

(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 contact@mhcolaw.com for any assistance.)

NET NEUTRALITY

In the last few months, net neutrality has been an intensely contested and debated topic in the field of telecommunications law. Net neutrality is the core principle governing internet. Telecom operators and internet service providers through technology can now control the speed of internet to access few of the websites, contents of internet, etc. Net neutrality essentially means ensuring that the users have equal access to all sites, at the same access speed for each site (independent of telco selection) and at the same data cost for access to each site. It is of utmost importance that this access to internet be neutral so as to ensure access to knowledge at the same rate and also to ensure equal freedom of doing online business.

INTRODUCTION OF AIRTEL ZERO

Airtel Zero plan announced in April 2014, violated the principle of net neutrality and would have split the internet into two a free internet and a paid internet. Such a scheme would allow internet companies to buy data from certain websites and only such sites would be available on a free internet. The result would be that users shall get access to only limited internet sites on the free internet. Further, every time a user of this scheme tried to access a site that was not available as part of the free internet, he/she would be notified that he/she cannot use that site without buying a data pack. It is likely that the consumers would continue using the free internet rather than buy a data pack. Therefore, the launch of the Zero plan led to a public uproar against the Airtel propaganda. By the end of December 2014, Airtel announced that it would not be implementing the scheme and shall await further directions from Telecom Regulatory Authority of India (TRAI).

ROLE OF TRAI

In March 2015, TRAI released a consultation paper on the regulatory framework for Over The Top (OTT) services such as Skype, Whatsapp, Viber, GoogleTalk, etc. The objective of this consultation paper was to analyse the implications of the growth of OTTs and consider whether or not changes were required in the current regulatory framework. This paper was criticised for being lop-sided in the favour of a differential price for the Internet Services Provider and for having contradictory statements. In April 2015, TRAI invited the public to express their opinions on this debate and received over a million emails.

In May 2015, Telecom Minister has said that the Government is in favour of ensuring non-discriminatory access to the Internet for all citizens of the country and would in most likelihood disallow controversial 'Zero Rating' plans floated by companies which do not meet the principles of net neutrality.

A six-member committee was constituted by the Department of Telecom to examine various aspects of net neutrality. This committee recommended that zero-rating plan does not violate net-neutrality and urged the government to adopt the policy of net neutrality, as it is globally defined. It also took the view that since this matter is essentially tariff-related; the final call should to be taken by TRAI, which is the ultimate authority on tariffs for the telecom sector.

ARGUMENTS OF TELECOM OPERATORS

Telecom companies argue that they have spent billions of dollars in setting up infrastructure and building telecom networks. They have been subjected to strict regulatory scrutiny, and yet millions of applications unfairly ride free on their networks. Many of these applications are worth billions of dollars and have millions of subscribers. Applications such as Skype, Viber, WhatsApp, etc compete with the voice and message offerings of the telecom companies, thus reducing their income.

ARGUMENTS OF CONSUMERS

It is worth noting that telecom companies do benefit from the applications that piggy-back on them. Increased usage of applications indicates more data consumption and more inflow of money. The licence to violate net neutrality could have a disastrous impact on justice as telecom companies would be in a position to ensure some sites are served faster than others, as certain companies will receive paid prioritization over others.

It could also become costlier for the users to use certain applications. The user would not experience the rest of the web world outside of the zero-rated sites and many would be denied the knowledge of what their choices on the internet are, violating their right to choose. They would miss out on all the new applications launched globally. Further, it would be harder for small Indian companies to raise the funding to enable them to be featured on this new free internet thus, resulting in only the bigger companies being available to the masses which are more than likely to opt for free internet.

They also contend that this affects the entrepreneurial aspirations of millions by blocking the opportunity that various start-ups such as Google, Facebook and Flipkart had. The internet governs the world of business, communication and entertainment amongst numerous other things. Rejecting net neutrality gives telecom companies the unrestrained power to play the gatekeeper to a valuable resource. It goes without saying that this will unleash price discrimination and monopolistic tendencies in the market.

Naturally, if Airtel is permitted to go ahead with its zero-rated plan, every other telecom operator will follow suit. Telecoms could enter into exclusive deals by which some services are available to only certain telecom networks. Telecom networks do not want to be merely communication pipes that agnostically transfer data. The cost of their ambition will be the loss of the Internets openness.

MHCO COMMENT:

There are presently no laws enforcing net neutrality in India. Although TRAI Guidelines of 2003 for Unified Access Service License promote net neutrality, it does not enforce it. However, the consultation paper released by TRAI in March 2015 after taking into consideration Airtels Zero rating plan is in conflict with its guidelines published in 2003. Internet users await the final decision of TRAI on this crucial matter.

(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 contact@mhcolaw.com for any assistance.)

Companies (Amendment) Act, 2015

The Companies Act, 2013 (Companies Act) which is still partially to be implemented has been recently amended and notified by the Companies (Amendment) Act, 2015. The amendments are primarily incorporated for ease of doing business, meet the corporate needs and for removal of inadvertent errors. The following are the key changes that have been incorporated in the new Companies Act:

Minimum Paid-Up Capital: The earlier requirement of minimum paid up capital for private companies was Rs 1,00,000/- and for public companies was Rs 5,00,000/-. The amendment has now omitted the requirement of minimum paid up capital for both private and public companies for the ease of doing business.

Common Seal: Section 9 of the Companies Act, required a company to mandatorily have a common seal. The said requirement has been done away with. Further, there are consequential changes incorporated in Section 12(3)(b), Section 22 (2)(a) and Section 46 of the Companies Act with regards to the Common Seal. The amendment now provides that the signature of the officers of the Company shall suffice for legally binding the Company.

Prosecution for Accepting Deposit from Public: A new Section 76A has been inserted which provides for severe punishment including criminal liability against the officer of the Company for violation of provisions of the Companies Act in relation to acceptance of deposits from general public.

Resolution and Agreements: Section 117 of the Companies Act has been amended by inserting a proviso after section 117(3)(g) in order to restrict the inspection or obtaining of copies of board resolutions under Section 399 with the intent to keep certain information confidential.

Declaration of Dividend: Section 123(1) has been amended by inserting the provision whereby a company cannot declare dividend unless the carried over previous losses and depreciation not provided in the previous year(s) are set off against profit of the Company to provide financial stability to the companies.

Reporting of the Fraud: Section 134(3)(ca) and Section 143(12) have been inserted with respect to reporting of the fraud by the board and auditors respectively to increase transparency and also cast a duty on them to report the fraud. Further, an amendment to Section 143(12) now seeks to restrict the auditors obligations and limits it to report only material frauds to the Central Government which will bring great relief to both corporates as well as auditors.

Loans to subsidiary company: Section 185 inter alia prohibits a company (A) from extending loans/ guarantees to another company (B) if the director of A is interested in B. Earlier the Rules and now this amendment clarifies that if B is a wholly owned subsidiary of A then this prohibition is waived. It further waives such a prohibition if A gives guarantee in respect of a loan taken by B from any bank or financial institution, where B is a subsidiary of A.

Related Party Transactions: Section 188 has been amended whereby the approval of shareholders can be by way of an ordinary resolution as compared to previously required special resolution for related party transactions. The amendment further provides that the requirement of passing ordinary resolution shall not be applicable for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval. 

Special Bench: Section 419(4) provides that the president shall, for disposal of any matter relating to rehabilitation, restructuring, reviving and winding-up of companies constitute one or more special benches consisting of three or more members, majority necessarily being of judicial members. This section has now been amended and the word "winding-up" now been deleted which means that winding up matters shall be heard by an two member bench instead of a three member bench. Amendment of this provision would help in deciding winding up cases promptly. Further, Section 435(1) and section 436(1)(a) have been amended to reduce the burden on special courts such that special courts shall now try offences which are punishable with imprisonment of two or more years. Simultaneously, an additional provision is inserted in sub clause (1) of section 435 for the purpose of allowing a magistrate to try offences resulting in minor violations of the Companies Act.

MHCO COMMENTS:

This amendments signify that government is continuing to examine the Companies Act, 2013 with the aim to improving and ease of doing business in India. The aforesaid amendments are substantive and welcome.

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.