Author name: CBCL

P-Notes 2.0: Analyzing SEBI’s Proposed Ban on Derivative-Based ODIs

Leave a Comment / Capital Markets and Securities Law /

[By Vaibhav Kesarwani & Rudraksh Sharma] The authors are students of Gujarat National Law University, Gandhinagar.   Introduction The issues related to Offshore Derivative Instruments or Participatory Notes commonly known as P-notes have been under discussion in the Indian regulation system for more than a decade and a half now. These instruments enabled the foreign investors to trade in the Indian securities without the requirement of obtaining registration from the Securities and Exchange Board of India. However, this mechanism has also attracted criticisms in terms of regulatory arbitrage, opaqueness, and potentially used for activity for suspicion arousing purposes like manipulation and gambling.  The recent consultation paper released by SEBI in regards to investment by Foreign Investors through Segregated Portfolios/ P-notes/ Offshore Derivative Instruments on 6th August, 2024 points to such issues and recommends stricter measures in this regard. This article delves into the key discussions and proposals made by the consultation paper, specifically the proposed dis-allowance of existing exceptions related to use of derivatives by ODI issuers, including the  use of ODI with derivatives as underlying as well as hedging of the ODIs with derivative positions on stock exchange.  The Evolution of ODI Regulations in India Before SEBI’s circular on Offshore Derivative Instruments under the FPI regulations 2014, Participatory Notes were a common channel for foreign investors to invest in Indian market. However, the absence of registration and associated regulation prior to 2014 raised concerns of abuse, such as round-tripping of funds, money laundering, and tax evasion.   In 2017, SEBI barred the extension of ODIs for the purpose of trading in derivatives for the speculative purposes with an exception in the case of hedging. In 2017, SEBI barred the extension of ODIs for the purpose of trading in derivatives for the speculative purposes with an exception in the case of hedging. Subsequently, in 2019, restrictions were imposed on the issuance of ODIs referencing derivatives by FPIs. ODIs could only be hedged with derivative positions on Indian stock exchanges for two purposes: first, to hedge equity shares held by the FPI on a one-to-one basis; and second, to hedge ODIs referencing equity shares, within market-wide position limits, subject to a 5% limit for single stock derivatives.  Due to these stringent conditions, the total value of ODIs as a percentage of the Assets Under Custody of FPIs has dropped significantly, from 44.4% in 2007 to just 2.1% in the current year i.e. 2024. Despite this decline, the consultation paper has highlighted two major potential loopholes with the regulatory framework which are discussed below:   Firstly, the additional disclosure requirements introduced by the FPI Regulations, 2019, and the SEBI Circular dated August 24, 2023, for large and concentrated investments by FPIs, are not directly applicable to ODI subscribers. This opens up the window for foreign investors to avoid detailed disclosure requirements through taking positions through the ODI channel.   Secondly, that the ODIs are not governed in the same manner as direct investments made by FPIs especially with regards to the disclosure of ownership and control. This divergence opens up a fair amount of scope for regulatory arbitrage and this is something that SEBI seeks to counter with the measures under consideration.   Proposed Regulatory Changes The consultation paper proposes several key changes to the ODI framework to enhance transparency and reduce regulatory arbitrage. These changes, including new disclosure requirements, mandatory separate registration for ODI issuance, and a ban on ODIs with derivatives as underlying, could significantly impact the Indian economy by affecting market liquidity, foreign capital inflows, and the overall growth of the ODI system. The changes are discussed in detail henceforth:  Applicability of Disclosure Requirements to ODI Subscribers: SEBI’s August 2023 circular requires FPIs to disclose ownership and control information if they exceed concentration and size thresholds. These disclosure requirements will now apply directly to ODI subscribers as well. This would involve ODI issuers and their DDPs regulating as well as reporting on the achievement of these criteria at the ODI subscriber level. For concentration criteria, it is recommended that the ODI issuer and the DDP of the issuer should closely monitor each ODI subscriber. The ODI issuer should provide daily reports on the positions taken by the ODI subscriber(s) to the custodian or DDP. In terms of size criteria, monitoring should be carried out by the ODI issuers, their DDPs, and depositories. This should cover ODI subscribers and their related group companies, meaning any ODI subscriber with 50% or more voting rights or control, over such companies. Mandatory Separate Registration for ODI Issuance: In order to facilitate better compliance with the one to one hedging requirement and to enhance monitoring SEBI has suggested that ODIs should be issued only through a specially allotted FPI registration. This registration would not allow for any proprietary investments, thereby eliminating ambiguity regarding the issuance of ODIs and their operation as a distinct activity from FPI.  Prohibition on Issuing ODIs with Derivatives as Underlying: The paper suggests to abolish the current exemptions which have been enabling ODI issuers to issue ODIs with derivatives as underlying. This would mean that ODIs may only make reference to cash equity, debt securities or other acceptable investment and they have to be 100 per cent hedged with the same instrument for the entire life of the ODI. The existing ODIs with derivatives as the underlying are to be closed within period of 1 year from the date of issuance of the proposed framework and the existing ODIs with cash positions as the underlying but hedged with derivatives are to be either closed or hedge with the said cash position on one-to-one basis in a period of 1 year from the date of issuance of the proposed framework.  Although the first two proposals can strengthen the regulatory framework for Offshore derivative instrument and align the Indian regulation with overseas jurisdiction, the proposed prohibition for ODIs with derivatives as underlying is an extreme step that needs to be scrutinized before implementation. Even if it will benefit to prevent regulatory arbitrage, it can have

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Unlocking Credit With Digital Payments: Analyizing NPCI’s Proposed Digital Payment Scores

Leave a Comment / Banking Law /

[By Aryan Dash & Debasish Halder] The authors are students of National Law University Odisha.   FROM UPI TO DPS: NPCI’S JOURNEY TOWARDS FINANCIAL INCLUSION India has witnessed a remarkable rise in digital payments over the past decade, facilitated by the National Payments Corporation of India (NPCI). NPCI, an umbrella organization for retail payments in India, has played a pivotal role in developing and promoting digital payment systems such as Unified Payments Interface (UPI), Bharat Interface for Money (BHIM), RuPay cards, and others. These initiatives have significantly reduced the dependence on cash transactions, fostering financial inclusion and digital literacy across the country.  NPCI has recently proposed the concept of Digital Payment Scores (DPS) as a tool for lenders to assess the creditworthiness of borrowers. DPS would analyse an individual’s digital payment behaviour, including factors like transaction frequency, volume, and patterns. This data-driven approach aims to provide lenders with an alternative risk assessment mechanism, supplementing traditional credit scoring models.  This blog examines NPCI’s role in advancing financial inclusion through DPS. It addresses key questions about how DPS can assess creditworthiness beyond traditional models, the necessary legal frameworks for privacy and fairness, and how to mitigate challenges like data security and algorithmic bias while promoting inclusivity in India’s financial landscape.  RETHINKING CREDIT ASSESSMENT BEYOND TRADITIONAL MODELS India’s credit scoring relies heavily on past credit history, leaving rural or underbanked populations without access to loans. Digital payments offer new avenues for creditworthiness assessment. Transaction data reveals income levels, spending habits, and financial stability. Timely bill payments and engagement with savings platforms demonstrate financial discipline. However, using alternative data sources raises privacy and bias concerns, necessitating robust ethical and regulatory frameworks. Fair and non-discriminatory lending practices require careful integration of such data.  LEGAL AND REGULATORY CONSIDERATIONS The implementation of DPS would require a robust legal and regulatory framework to address concerns related to data privacy, consent, and fair lending practices. Authorities would need to establish clear guidelines for data collection, usage, and security to ensure consumer protection and prevent discriminatory lending practices. Additionally, measures would be required to safeguard against potential biases and ensure transparency in the scoring methodology.  Data Privacy The implementation of DPS raises important data privacy considerations, particularly within the framework of the Information Technology Act, 2000, which includes provisions like the Right to be Forgotten. User consent is crucial, requiring clear and informed agreement from individuals regarding the collection and utilization of their digital transaction information. Clear communication regarding the purpose, scope, and potential consequences of DPS calculations is essential. Furthermore, data anonymization is critical to safeguard individual privacy. Robust anonymization techniques should be employed to ensure that transaction data used for DPS calculations undergo thorough anonymization, removing or obfuscating personally identifiable information while preserving relevant behavioral patterns.   To implement DPS effectively while ensuring data privacy, several techniques can be employed. Differential privacy adds randomness to data queries, preventing anyone from inferring personal information even if they know some details about an individual. Synthetic data generation creates fake datasets that replicate real transaction behavior, allowing safe analysis without exposing actual personal information.  Data masking replaces sensitive details with random values, protecting user data from unauthorized access. Pseudonymization substitutes real names with artificial identifiers, making it challenging to link transactions back to individuals while still enabling necessary analysis. Lastly, local suppression and global partitioning control data visibility, minimizing the risk of revealing identities while still allowing for meaningful insights. Together, these strategies enhance privacy protection in the context of DPS.   Additionally, stringent measures for secure storage and processing are imperative to maintain the confidentiality and integrity of the transaction data. This entails implementing strict data security measures, including secure storage, access controls, and rigorous encryption protocols during both data processing and transmission.  Fair Lending Practices The DPS model must be meticulously crafted and audited to mitigate potential biases stemming from factors such as income levels, geographic location, or digital literacy. These biases could inadvertently create unfair disadvantages for specific population segments, thereby undermining the overarching goal of financial inclusion. Transparency and explainability are paramount to ensure equitable lending practices. Thus, the DPS algorithm should be transparent and explainable, providing both lenders and borrowers with clear insights into how scores are calculated and the factors influencing the final assessment.   To reduce bias in the DPS model, several strategies can be employed. First, ensuring diverse data collection is key; datasets should include information from underrepresented groups to promote fair representation. Utilizing bias detection tools helps identify and correct any unfair patterns before they impact lending decisions.  Regular evaluation and monitoring of the scoring model can track fairness across different demographic groups, allowing for timely interventions when biases emerge. Involving human oversight in the development process ensures that diverse perspectives are considered, helping to identify issues that automated systems might overlook. Establishing clear ethical guidelines for data use further promotes responsible practices and compliance with legal standards.  However, legal challenges may arise, particularly if the DPS is categorized as a credit scoring system subject to regulations like the Fair Credit Reporting Act or similar laws in India. Such classification could lead to legal disputes, particularly if the scoring methodology is perceived as discriminatory or lacks adequate consumer protection measures.  Regulatory Framework for Credit Scoring At the heart of credit information regulation in India lies the CIRC Act, a legislative cornerstone that casts a wide net in defining credit information. Its expansive purview encompasses various financial transactions, from conventional loans to digital payment footprints. This broad definition, notably captured in Section 2d, sets the stage for integrating digital transactions—such as utility payments and e-commerce purchases—into the fabric of creditworthiness assessment. However, NPCI, as the vanguard of DPS provision, must tread cautiously, ensuring compliance with registration mandates under Section 5 of the CIRC Act and meticulous adherence to privacy guidelines outlined in the Credit Information Companies (Regulations), 2006.  Navigating the Privacy Paradox: Insights from the DPDP Act Amidst the regulatory tapestry, the DPDP Act emerges as a critical arbiter, safeguarding the sanctity of sensitive personal

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An interim Outreach: NUI Pulp and Paper Industries Pvt. Ltd. v. Ms. Roxcel Trading GMBH

Leave a Comment / Insolvency Law /

[By Hamza Khan & Divyanshu Kumar] The authors are students of NALSAR University of Law, Hyderabad.   Introduction In the case of NUI Pulp v. Ms. Roxcel Trading GMBH, the National Company Law Tribunal (“NCLT”) exercised power under Rule 11 of the National Company Law Tribunal Rules, 2016 (“NCLT rules”) to prevent the Corporate Debtor from alienating or encumbering any disputed assets during the pre-admission phase of the Corporate Insolvency Resolution Proceeding (“CIRP”). This effectively established a temporary moratorium until the application of CIRP was either admitted or rejected by the Adjudicating Authority (“AA”). Although the National Company Law Appellate Tribunal (“NCLAT”) affirmed this ruling, the possibility of an interim moratorium during the pre-admission stage remains uncertain.  Through a comment on this landmark case, the authors aim to address two pertinent questions: firstly, whether an interim moratorium in the pre-admission phase is desirable, and secondly, whether the NCLT, under Rule 11 of the NCLT rules, possesses the authority to grant such a moratorium for a Corporate Debtor. In pursuit of answers to these questions, the authors will analyse the reasoning provided in NUI Pulp and look for judicial developments following this case. Subsequently, the authors would examine the reports by the Insolvency and Bankruptcy Board of India (“IBBI”) and recommendations by the Insolvency Law Committee (“ILC”) to determine the necessity of an interim moratorium during the pre-admission period. Finally, the authors will juxtapose Rule 11 of the NCLT with Section 151 of the Civil Procedure Code (“CPC”) to determine whether granting an interim moratorium is within the inherent powers of the NCLT.  Judicial Analysis of Interim Moratoriums in CIRP: NUI Pulp and its Developments In NUI Pulp, the Operational Creditor substantiated its concern with sufficient evidence, demonstrating that the management of the Corporate Debtor intended to sell assets, pending admission of CIRP application, thereby causing wrongful losses to all creditors, including the Operational Creditor. The NCLAT noted that, given the significant threat, the NCLT was justified in issuing an ad-interim order before admitting the application under Rule 11 of the NCLT Rules.  Following this line of reasoning in F.M. Hammerle, the NCLT granted interim injunctions in the CIRP prior to the admission of the application. In Phoenix ARC Private Limited v. Precision Realty Developers Private Limited, the NCLT noted “To make out a case for grant of injunction and that too at the pre-admission stage, the Applicant is required to make out a strong prima facie case,” thus setting a threshold akin to three-pronged test of grant of interim injunction while rejecting the application for want of evidence.   However conversely, in Go Airways, the court noted the absence of provisions empowering the NCLT to grant injunctions at the interim stage. Thus, while there are rare instances of interim moratoriums being granted, these are exceptions rather than the norm and resemble injunctions more than moratoriums. This reflects a lack of clarity in the jurisprudence, requiring a deeper analysis.  Interim Moratorium: The Need of the Hour According to the section 7(4) of Insolvency and Bankruptcy Code (“IBC”), the AA is required to admit an application within 14 days of its receipt, provided it fulfills the necessary criteria. However, in actuality, this process often takes longer due to various factors. A case in point is Asset Reconstruction Company Limited v. Nivaya Steel, where the application for admission into CIRP remained undecided for over a year.   The IBBI’s study revealed that at pre-admission stage of CIRP, due to the lack of imposition of moratorium, there is a high risk of deterioration of value of asset. The ILC report underscored that such prolonged delays could encourage asset siphoning by promoters and induce creditors to enforce debts. Following the UNCITRAL Guide to address this issue, countries like the UK and the US have incorporated the provision of an interim moratorium in their code. Referring to the same, the ILC recommended granting of discretion to the AA to balance the interests of stakeholders, recognizing potential harm to certain creditors by an automatic interim moratorium pending admission. The committee also recommended AA’s discretion to include the ability to modify or withdraw the moratorium order if unjustifiable harm to a creditor is proven.  The introduction of an interim moratorium is critically essential in India, where there is a shortage of judicial manpower to promptly address CIRP admission. This measure would effectively prevent individual creditors from taking action against the Corporate Debtor, thereby safeguarding its chances of revival. It would also deter the Corporate Debtor’s management from siphoning off its assets. Thus, following the ILC report, the IBC should be amended to incorporate provision for interim moratorium in part II of the IBC as well, and NUI Pulp is a welcome step in recognizing the need for interim moratoriums and seeking to preserve the value of the Corporate Debtor by taking such step. The need for introducing such a measure has been previously discussed and highlighted, yet there is no subsequent development regarding the same.  The scope of inherent powers of NCLT While acknowledging that in certain circumstances, grant of an interim moratorium could preserve the value of the Corporate Debtor and thus become crucial for achieving the very objective of the IBC, it is our opinion that the NCLT does not have the power to do so under Rule 11 of NCLT Rules, and the same is untenable in law.  This has been orally remarked by the NCLT in the subsequent case of Go Airways Interlocutory Application (“IA”) praying for interim moratorium. The NCLT stated, “there is no provision in IBC which grants the NCLT the power to impose interim moratorium”.  An in-depth analysis of the inherent powers given to the NCLT under Rule 11 would clearly substantiate the position taken in Go Airways.  Rule 11, which is under contention deals with the inherent powers of the NCLT to make orders in the interests of justice. This is identical to Section 151 CPC which grants similar powers to the civil court to meet the ends of justice and

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Evolving Trends in Interim Distribution under IBC, 2016: Insights from the KSK Mahanadi Judgment

Leave a Comment / Insolvency Law /

[By Arzoo Kedia] The author is a student of Hidayatullah National Law University.   Introduction The insolvency regime in India is governed by the Insolvency and Bankruptcy Code (“IBC”) of 2016 and has been at the forefront of innovation. IBC has spurred several novel ideas, such as specifying only one class of financial creditors voting ignoring the security, and having the operational creditors left out during the vote on the resolution plan, all of them otherwise being protected by their rights pre-insolvency. These provisions are considered to be one of the strongest cross-class cramdown provisions in the world. Apart from this, the other distinctive features of IBC include Section 29A (debar the defaulting promoter), Section 32A (immunity from prosecution for past acts), Section 12A (allowing withdrawal of the Corporate Insolvency Resolution Process [CIRP] upon settlement), and the sale of a company as a going concern in liquidation to ensure that the company is rescued.  However, under these new developments, the lengthy time of CIRP has, in most cases, remained a heavy financial drain on the creditors. A recent order by the National Company Law Tribunal (“NCLT”) Hyderabad in the KSK Mahanadi Power Company case, allowing an interim distribution to the creditors before the final resolution plan, is a welcome development in this light. This article examines the evolution of interim distribution in Indian insolvency law, with specific reference to the KSK Mahanadi Judgment, and discusses its broader implications for insolvency proceedings in India.  The article is structured as follows: It first gives an overview of the historical context and legal basis of interim distribution in India and elsewhere, which then leads to an analysis of the absolute priority rule with a focus on its flexibility in the Indian context. Finally, it goes deep into the specific implications of the KSK Mahanadi Judgment and the emerging trends in judicial discretion in the absence of legislative clarity. The conclusion will discuss whether there might be a need for legislation to be rewritten and contrast the approach taken within the UK insolvency systems.  Historical Context and Legal Basis An interim distribution is a temporary measure that involves distributing a portion of the assets while the case is still ongoing. It can be arranged through mutual agreement between the parties, or either party may request the court to order it. Although quite new in India, interim distribution has its origin in the laws of other jurisdictions, in particular, in the United Kingdom. In the UK, insolvency legislation stipulates that, administrators are allowed to make interim distributions while going through the administration process. This helps manage the cash flow needs of creditors whilst the insolvency process is still on.  The legal basis is strained in India and highly underdeveloped, and the IBC does not expressly provide for it, though the NCLT has occasionally allowed this to ensure that the interests of creditors are protected. The principle was first actually laid down by the National Company Law Appellate Tribunal (“NCLAT”) in the resolution of the IL&FS group. This directive, among several others, was passed by the NCLAT in May 2022, which directed IL&FS to release funds towards public funds, even before the final resolution process of the relevant IL&FS entity. The case of KSK Mahanadi Power Company further made the trend of decisions clear, as in long-drawn insolvency processes, financial relief is almost a rarity. Recently, the NCLT’s Hyderabad bench approved an interim distribution in the case of KSK Mahanadi Power Company, a company that had accumulated a cash balance of over ₹9,000 crores while under the Corporate Insolvency Resolution Process (“CIRP”) for an extended period, surpassing the 270-day timeline. Given the extended duration of the process and the need to protect creditor interests, the NCLT sanctioned the distribution of ₹6,400 crores from the surplus cash among the lenders, even before the resolution plan had been approved.  This decision was driven by the specific circumstances of the Indian market and the extended CIRP timeline. It marks the first instance in which creditors will recover a portion of their dues before the approval of a resolution plan, setting a precedent for future cases. The legal rationale for this decision lies in the necessity of balancing the creditors’ interests with the ongoing operation of the company, ensuring that creditors are not unfairly disadvantaged by delays in the resolution process.  Although the IBC does not explicitly address interim distributions, several provisions implicitly support this practice. Section 53 establishes the order of priority for the distribution of liquidation proceeds, emphasizing that secured and higher-ranking creditors must be paid before unsecured creditors and shareholders. However, this section does not address the treatment of interim distributions, allowing room for judicial interpretation. Section 29A bars delinquent promoters from participating in the resolution process, ensuring that interim distributions are made to credible and eligible parties. Additionally, Section 32A provides immunity to companies and their assets from prosecution for past actions, facilitating smoother interim distributions by removing legal barriers related to the previous management’s conduct. These provisions collectively contribute to a framework where interim distribution can be justified as a means of balancing the interests of all stakeholders, particularly in cases where the insolvency process is expected to be lengthy.  The Absolute Priority Rule and Its Application to India’s Law of Insolvency The absolute priority rule is a fundamental concept in insolvency law, particularly in countries like the United States, where it is strictly adhered to. This rule requires that senior creditors must be fully paid before any funds are distributed to junior creditors or equity holders during liquidation. It is designed to ensure fairness in the distribution of a debtor’s assets, guaranteeing that those with higher priority claims are not disadvantaged during the insolvency process. However, this rule is not explicitly included in India’s IBC. The IBC’s method for handling creditor payments, particularly during the resolution process, provides a certain level of flexibility. This is because the doctrine established by courts and tribunals has been to entrust decisions regarding the distribution of resolution

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Royalty Payments Distinguished from Taxes: A Strategic Win or A Race to the Bottom?

Leave a Comment / Taxation Law /

[By Adwitiya Gupta & Suprava Sahu] The authors are students of Gujarat National Law University.   Introduction The Supreme Court in Mineral Area Development Authority v M/s Steel Authority of India, by an 8:1 majority, overturned the 1989 decision, which decreed that royalties paid by miners on minerals are a tax. This decision gives states the power to tax mining activities, through which the states can now collect more revenue through taxes in addition to the existing royalties.  One of the central questions put before the bench was whether or not royalty under Section 9 of the Mines and Mineral (Development and Regulation) Act,1957 (MMDR Act) is in the nature of tax.   Before 1990, most precedents held that royalty was not in the nature of a tax. Later, India Cement Ltd v. State of Tamil Nadu & Ors overturned the trajectory of judicial precedents by holding that ‘royalty is a tax.’ Various courts have relied on the decision taken in the case of India Cement Ltd v. State of Tamil Nadu & Ors. until 2004 when the SC pointed out a typographical error in the India Cements Case as a “constitutional, legal, and moral” obligation to correct the mistake, the court held that royalty was not a tax. An inconsistency arose regarding the India Cements case being decided by a nine-judge bench, whereas Kesoram being decided by a five-judge bench. Since a smaller bench does not have the power to overturn the decision, this resulted in a conflict between both judgments. Leaping into 2011 and the present case, the court observed the evident inconsistency between the two cases and opted to refer the matter before a nine-judge bench for a conclusive ruling on the legal stance.   Understanding Royalty and Taxes Royalty can generally be understood as a payment made by a lessee to the lessor based on the quantity of minerals extracted from the land. The concept of royalty on minerals dates back to ancient times when kings would impose a tax on those extracting minerals from their lands. According to the ancient law, mineral wealth was not vested in the king, but the king was entitled to receive revenue from his subjects. Post-independence, the Mines and Minerals Act of 1948 was passed with the objective of regulating mines and, oil fields and mineral development. Later, the MMDR Act of 1957 was enacted to centralize the regulation of mines and oil fields under the Union Government, replacing the earlier 1948 Act.   Section 9 of MMDR Act 1957 provides for royalty in respect to mining leases. The essential elements of royalty are:   It is a consideration or payment made to the proprietor of the minerals;  It flows from a statutory agreement (a mining lease) between the lessor and the lessee;  It represents compensation to the lessor for granting the lessee the privilege to extract minerals.   It is usually based on the quantity of minerals extracted.   Whereas Taxes, in general, are monetary charges imposed by the government on individuals or property to generate revenue needed for its functions. In the case of Commissioner, Hindu Religious Endowment, Madras v. Sri Lakshmindra Thirta Swamiar of Sri Shirur Mutt, the court enumerated essential characteristics of taxes as the following:   Tax is a mandatory exaction of money by a public authority;  It is imposed under statutory power irrespective of the consent of the taxpayer;  Demand to pay tax is enforceable by law;  It is imposed for public purposes to cover state expenses without providing specific benefits to the taxpayer;  It is a part of the common burden.   The Inconsistency Explained: Tax v/s Royalty. One of the key questions analyzed in the Mineral Area Development Authority v M/s Steel Authority of India was whether a royalty is a tax. In order to arrive at a conclusion regarding this crucial question, the court analyzed various judgments dealing with this question. In the case of Laddu Mal v. State of Bihar, the division bench held that a royalty is a levy in nature of tax owing to its compulsory nature of exaction. Further, in  Laxminarayana Mining Co. v. Taluk Development Board highlighted that the provisions of the MMDR Act pertaining to levy, fixation, and collection of royalty and recovery as arrears of land revenue provides that the expression ‘royalty’ under section 9 connotes the levy of a tax.   However, several High Courts observed a contrary view. In Dr.  Shanti Swaroop Sharma v. State of Punjab, the court disagreed with the decision of Laddu Mal and upheld royalty cannot be said to be a ‘compulsory exaction’ based on the rationale that compulsion to pay royalty arises out of the contractual conditions of the mining lease and not through the force of law. It relied on the fact that the State Government can collect royalty in a similar manner as unpaid land revenue, but that does not qualify it as tax. The India Cement case marked a significant change by defining royalty as a tax. Over the next decade, this influenced numerous high court and Supreme Court decisions, altering the judicial perspective on whether royalty and tax are the same or different.   In the case of State of MP v. Mahalaxmi Fabric Mills, the court deliberated on the possibility of a typographical error in the India Cements judgment.  However, the bench held that the arguments in the India Cements case concluded that royalty was in the nature of a tax, so there was no possibility of typographical error. In State of WB v. Kesoram Industries Ltd, the court again considered the possibility of an error in the India Cements case. Justice Lahoti felt duty-bound to correct the typographical error and held that the India cement judgment mistakenly conveyed that ‘royalty is a tax’ instead of conveying that ‘cess on royalty is a tax.’ Justice clarified that the intention of India Cement was to hold that “royalty” itself was not considered a tax, but the intended meaning was that “cess on royalty,” which is an additional charge, is viewed as a

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​​​The Tempest of GAAR-SAAR: A Symphony or Cross Road for Tax Avoidance?

Leave a Comment / Taxation Law /

[By Vibhor Maloo & Shubhanshu Dubey] The authors are students of HNLU, Raipur.   Introduction As tax evasion tactics become more sophisticated, India’s legal framework is changing significantly. The recent Telangana High Court (HC) ruling has initiated a debate on whether ​​General Anti-Avoidance Rules’ (GAAR) pervasive powers, which empower tax authorities to scrutinize and invalidate transactions primarily aimed at avoiding taxes, even if they comply with the letter of the law which preempt the more targeted approach of Specific Anti-Avoidance Rules (SAAR). SAAR targets particular types of transactions known to lead to tax evasion, such as bonus stripping of shares or dividend stripping. The interaction between GAAR and SAAR is crucial as it balances broad authority with specific rules. GAAR’s broader scope can override SAAR’s targeted approach, as seen in the Telangana High Court ruling, impacting how tax authorities enforce anti-avoidance measures and how taxpayers structure transactions. While SAAR has been amended to include bonus stripping of shares, this judgment underscores GAAR’s precedence and raises questions about its broader implications. Prior to the introduction of GAAR in Chapter XA of the Income Tax Act, 1961, tax evasion in India was mainly addressed through judicial decisions, often referred to as Judicial Anti-Avoidance Rules (JAAR). Simultaneously, the presence of SAAR in Chapter X of the IT Act aided in regulating certain specific transactions that led to tax evasion.  While the SAAR has been amended to encompass bonus stripping of shares, the judgment affirms GAAR’s broader application and precedence. However, it also highlights concerns about the lack of objectivity in GAAR provisions, the discrepancy with specific provisions under SAAR, and the risk of deterring legitimate transactions due to GAAR’s broad interpretation. In the post-assessment year 2018-19, GAAR was introduced to regulate complex tax avoidance outside SAAR’s scope. Over the years, strife has arisen between SAAR and GAAR, though the CBIT has clarified that both can co-exist.  Unraveling Tax Complexity: Role and Evolution of Anti-Avoidance Jurisprudence The Indian legislative landscape aims to negate Impermissible Avoidance Arrangements (IAA) under Section 96 of the IT Act, targeting arrangements designed to avoid taxes rather than serve a legitimate business purpose. These arrangements are primarily aimed at avoiding taxes rather than serving a legitimate business purpose and are based on the ‘purpose test’. The test involves analyzing the commercial intent behind the arrangement to determine its legitimacy under GAAR where it considers the business intent, the element which prompts detailed analysis of the arrangement, and the abuse of tax provisions. GAAR and SAAR, help to avoid these transactions that aim at preventing tax payments through illegitimate complex processes.   ​​​The Vodafone Case demonstrated flaws in the system of transactions outside the scope of SAAR. This case highlighted the limits of SAAR, which deals only with specific tax avoidance practices. Since the transaction did not fall under predefined categories, SAAR could not be applied. The case demonstrated the need for broader rules like GAAR to tackle complex tax avoidance schemes that go beyond the scope of SAAR. This eventually led to the introduction of GAAR in the Indian tax system. In the Common Law Jurisprudence, the case of  WT Ramsay v. Inland Revenue Commissioners, the purposive interpretation approach was considered, and it was held that the evaluation should be based on the impact in the entirety of the complete series of transactions, rather than the tax implications of each step. This concept applies only when the relevant legislation requires it, and each step severally does not have to be considered artificial for the principle to apply. This highlights the necessity of assessing transactions on their aggregate economic content rather than individual stages.  In Craven v. White explained the limitations of the Ramsay Principle which is a statutory interpretation principle to counter tax mitigation. The Ramsay principle seeks to contest tax avoidance strategies by scrutinizing ​​pre-ordained transactions, which are are pre-planned steps solely aimed at achieving tax benefits, lacking genuine economic or business purpose, that lack actual economic substance and are not justified by moral grounds, the same will lead to destructive commercial effects. In UK v. Duke of Westminster, it was held that every individual has the right to legally organise their affairs to reduce the tax burden, and if they succeed, they cannot be forced to pay more. The verdict reflects that a laissez-faire economy has to be considered where every person has the right to manage his tax affairs.  In contrast, the Duke of Westminster case emphasises the distinction between lawful tax avoidance and evasion, directing both GAAR and SAAR in India to ensure transactions are genuine rather than just tax-driven. In Mc​     ​Dowell & Company Limited v Commercial Tax Officer, it was clearly stated that controversial methods should not be used in tax planning, as they could lead to significant economic harm. Therefore, the consideration of IAA flows from a detailed jurisprudential debate considering primarily the business intent and the commercial substance; however the same has been disputed to date considering the complexity of the transactions involved.  Labyrinth of Anti-Avoidance: Interpreting Telangana HC’s Verdict  Mr Ayodhya Rami was investigated by the Income Tax Authorities (ITA) for discrepancies in the taxable income assessment, including issues of bonus stripping with shares of REFL, a limited company. Bonus Stripping of shares involves buying shares before a bonus issue, selling them at a loss after the bonus issue, and using the loss to offset capital gains. He disclosed the capital loss from the sale of REFL shares, subsequently, the ITA initiated proceedings against him. Mr Ayodhya argued that SAAR should apply instead of GAAR, claiming GAAR shouldn’t apply to transactions covered by SAAR. The court found Ayodhya’s argument contradictory and noted that SAAR’s interpretation did not cover bonus stripping.  The issue was whether the transactions including the issuing and transferring bonus shares were legitimate commercial transactions or merely a tax avoidance strategy. The Court determined that the transactions concerning the bonus shares and their sale lacked genuine business substance and were fundamentally deemed artificial arrangements intended to avoid tax requirements. Additionally,

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Expanding Horizons: Payment Banks and Strategic Partnerships

Leave a Comment / Banking Law /

[By Dhawni Sharda & Anshika Agarwal] The authors are students of National Law University Odisha.   INTRODUCTION   Through Budget 2024, the Government of India has pioneered an ambitious objective to set up over a hundred Payment banks as a significant step towards financial inclusion and security. These banks have been a modicum between the formal banking institutions and the unbanked population. This fosters greater financial literacy, encouraging savings and ensuring economic security amongst the economically weaker sections of society.   However, whether an increase in the number of these payment banks would provide the solution for the problems plaguing  them is a question to be addressed. The authors, through this article, aim to highlight the strategic importance of partnerships between payment banks and institutions like Micro Finance Institutions (MFIs) and Business Correspondents (BCs) . While BCs enable access to unbanked areas, MFIs provide financial services like microcredit, micro-insurance, and savings, etc. This is done.to overcome the inherent barriers in their performance.  Starting with the rationale behind setting up such banks to analysing the recent actions faced by such banks for the failure of compliances, the authors adopt such an approach concerning how the lacuna of these banks can be resolved through strategic partnerships and tie-ups which can further broaden the understanding of such payment banks as beyond the digital wallets and can lead to being a host of variety of services.   TRACING THE ORIGIN AND AFTERMATH   Given the significant risks associated with Prepaid Payment Instrument(PPI) model such as concerns around KYC compliance, and the need for quick access to payment services at the grassroots level, a recommendation was made to establish the payment banks. These banks provide their essential payment services and function such as a digital wallet wherein the customers like MSME’s and low-income individuals can maintain their bank balance and use it to serve their needs.   With all this in process, payment banks started functioning as a miniature model of scheduled commercial banks. These banks were required to follow certain mandates as prescribed by RBI in the same way as Scheduled Commercial Banks do. Alongside, these banks were granted rights and privileges which came with the grant of the license.   Their performance was further enhanced by their strategy of branchless banking wherein the network of such banks was spilled over semi-urban, and rural areas. This phenomenon got fillip when these banks started entering into strategic partnerships.   STRATEGIC TIE-UPS   In recent years, the financial infrastructure of the underbanked areas has been boosted by the various deals between traditional banks, fintech companies, and payment banks. Doing so would ultimately broaden the horizon of the payment banks and help them to overcome their limitations which they would otherwise encounter if they would operate solely.   Microfinance institutions have already an established customer base in the low-income regions. Payments banks can use these channels to venture into new markets thereby leading to reduced cost, financial inclusion, and efficiency in operations.   In a deal, Multilink announces tie-up with NSDL payments bank. This move would contribute to financial services to all societal sections. To elaborate it further Multilink has around 3000 distributors, 200 mass distributors, and 60 API distributors. They even have strong associations with  renowned platforms like IRCTC, Yes Bank, TATA AIG, Kotak Life, and so on. This NSDL-Multilink partnership would help customers perform all banking facilities around the clock through BC agent points.  Such partnerships are entered not only to avail the benefits of a well-established clientele base created by the MFIs/BCs, but also to avail the advantage of merging resources leading to efficiency in operations. Additionally, established monitoring and audit regulations are available to the payment bank.  SPOT ON ANALYSIS   Going Beyond the Conventional Perspective.   Going beyond the brick-and-mortar aspect of payment banks wherein they function as digital wallets, such collaborations with BCs or MFIs would become a good source of lending, thus fulfilling the debt gaps or the cash crunch requirements in the lower segment areas. If these two entities join hands, the issue of such operational needs of the banks would also be fulfilled.   Improved Market Offerings   The host of activities undertaken by the BCs can prove to be catalysts in the performance of the payment banks through their aid and assistance considering the low-cost model of BCs in branchless banking. So, these BCs can act as nodes to the branchless banking model of the payment banks, thereby amplifying the scope of financial activities.    Additionally, Payments banks can use MFIs’ strategic partners which have an established base in providing cross-banking marketing services to their clients, besides their experience in providing financial services to the low-income segment. This can work as a win-win situation for both the parties.   Plugging the Internal Problems   The abovementioned problems relate to the external issues which can be resolved through such alliances. However, certain internal issues are barriers to their expansion.   Payment banks in their initial years of set-up need to meet the high fixed costs leading to elevated break-even points. This further leads to the higher need for significant transactional volumes and substantial scale. In the process of doing the same, payment banks spend a considerable amount of time and resources in increasing profitability. Consequently, they miss on their sole purpose of creating better market offerings and attaining RBI’s objective of financial inclusion.   Need for Diversification   These payment banks fulfill the dire needs of the micro-finance institutions wherein these institutions plan to makeover their negative image of being involved in the unethical practices used in lending activities. In the wake of this situation, the state government came up with laws that completely put a halt to their operations. Given such a payment bank with a strong government and institutional support at the backend, the MFIs would get a relaxation in terms of regulatory oversight permitting their free and fair operations.   WAY FORWARD   Strategic partnerships are not an easy path to tread since these payment banks can’t enter such strategic alliances as independent entities because they are subsidiaries implying that they are controlled and influenced by their

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From Green Bonds to ESG debt: SEBI’s new blueprint for sustainable finance 

Leave a Comment / Capital Markets and Securities Law /

[By Tejas Venkatesh] The author is a student of Jindal Global Law School.   Introduction On 16th August 2024, the Securities and Exchange Board of India (“SEBI”) released a consultation paper on Expanding the Scope of Sustainable Finance Framework in the Indian Securities Market. The purpose of the paper is to solicit public comments on the appropriateness and adequacy of the proposed new framework for ESG debt securities and sustainable securitized debt instruments. The new framework incentivizes sustainable debt financing and also provides much-needed flexibility to issuers who aim to pursue projects that align with their ESG objectives. Yet, the proposal raises certain vital concerns.  SEBI’s Existing regime on Sustainable financing in India SEBI’s approach to encouraging sustainable finance has mainly focused on the Indian debt markets. The focus on the debt market seems to stem from the need for a large pool of potential investments in various sustainable projects. An estimate by the Reserve Bank of India (“RBI”), indicates that a green finance pool of up to 2.5% of the GDP is necessary to meet the infrastructure gaps resulting from disastrous climate events in India.   In 2023, in an effort to boost investments in the sustainable debt financing market, SEBI introduced the Securities and Exchange Board of India (Issue and Listing of Non-Convertible Securities) (Amendment) Regulations, 2023, wherein it allowed for the issuance of “Green Debt Securities” as a debt security instrument to raise funds for sustainable projects like renewable energy plants, clean transportation, pollution prevention and biodiversity conservation projects. Although the issuance of “Green Debt Securities” was allowed under the SEBI (Non-Convertible Securities) Regulation, 2021, the scope and ambit of activities that could be financed through the instrument remained vague and ambiguous until an illustrative list of activities was provided in the amended regulations in 2023. Further, the board continuously revised and expanded the scope of activities to include blue, yellow, and transition bonds as other sub-forms of green debt securities under the regulations.  In order to align the framework for the issuance of green debt securities with globally accepted standards like the Green Bond Principles (GBP), issued by the International Capital Markets Association (ICMA), SEBI introduced additional disclosures for green debt securities. The focus of the revised disclosure requirements was on ex-ante disclosures regarding the utilization of proceeds, the process for evaluation and selection of a project, management of proceeds, and improved reporting mechanisms. Impact reporting and involvement of third-party reviewers or certifiers were sought to be strengthened to ensure transparency and reliability in the utilization of bond monies by issuers.  However, the growing need to adopt an intersectional approach for tackling economic, social, and environmental aspects of sustainable development has been felt. Further, the tremendous lag in funding for the attainment of Sustainable Development Goals (SDG) has prompted SEBI to propose the introduction of Social Bonds, Sustainable Bonds, and Sustainability Linked Bonds (which together with Green Debt Securities would be termed ESG debt securities). Additionally, to leverage the underlying sustainable finance credit facilities for the benefit of potential investors, SEBI also seeks to introduce ‘Sustainable Securitised Debt Instruments’ as a form of finance that has the backing of the underlying sustainable credit.  Proposed framework for ESG debt securities The introduction of Social Bonds and Sustainable Bonds marks an addition to the theme of Use of Proceeds (UoP) Bonds, wherein the proceeds are earmarked for specific projects designed to achieve the intended impact. Whereas, Sustainability-Linked Bonds (SLB) are categorized as Key Performance Indicator (KPI) bonds wherein the proceeds are not tied to a specific project but are intended for the issuer to achieve self-imposed sustainability targets in the course of their operation.   Although SEBI has not specified the scope of projects falling within the ambit of Social Bonds, the Social Bond Principles (SBP) given by the ICMA provide valuable direction. The SBP includes a wide ambit of activities including projects that aim to provide affordable basic infrastructure like water, sanitation, health, housing, and food security. However, Sustainable Bonds are an effort to acknowledge the intersectional co-benefits that a combination of Green and Social projects present.   The extant framework for the regulation of Use of Proceeds Bonds (i.e. Green, social, and Sustainable Bonds) remains uniform with a special focus on core components such as the mechanism for categorization of projects, criteria for project evaluation and selection, managing proceeds, and reporting. However, the focus on transparency and accountability is diluted due to the voluntary nature of the guidelines given by the ICMA. The framework provides no liability mechanism in instances of greenwashing or failure to meet intended targets.   Unlike UoP Bonds, Sustainability-linked bonds are debt instruments that are catered to finance the incorporation and achievement of forward-looking ESG outcomes by the issuer. The core components of the bonds include the selection of Key Performance Indicators (KPIs) and calibration of Sustainability Performance Targets (SPTs) by the issuers. The focus is on the declaration of bond characteristics, reporting on the attainment of targets, and third-party verification of bond targets achieved.   Critical Analysis The new debt instruments raise several concerns as regards their ambit and effectiveness. First, the qualifying factor for the utilization of bond proceeds of a Social Bond is that the monies have to be committed to generating a ‘social impact.’ Although the ICMA Social Bond Principles (SBP) provide guidance on projects that can be pursued by the issuance of Social Bonds, pertinent questions regarding the quantification of the term “impact” arise. For instance, it is unclear whether a social project can avoid generating a negative environmental impact. Therefore, in instances such as affordable housing projects wherein the social impact contrasts with the environmental impact, there is no direction on what interest will prevail.  Further, the Social Bonds framework fails to differentiate between challenges posed by varied timelines for achieving the desired impact For instance, a loan-based social bond will achieve its social impact merely by financing the beneficiary using the proceeds received whereas other forms of social bonds require active collaboration between the beneficiary and the issuer. The

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Eliminating Broker Pool Accounts: SEBI’s Strategy for Enhanced Investor Protection

Leave a Comment / Capital Markets and Securities Law /

[By Sahil Sachin Salve] The author is a student of Maharashtra National Law Univeristy, Mumbai. Introduction: On June 5, 2024, SEBI issued a circular mandating that Clearing Corporations (CCs) directly credit securities to client demat accounts, effective October 14, 2024. Previously, SEBI had taken a significant step by discontinuing the use of pool accounts for mutual fund transactions from July 1, 2022. Initially, the direct payout into clients’ demat accounts was a voluntary practice but as per above circular from October 14, 2024 it will be mandatory for CCs to directly credit securities to client’s demat accounts. This move aims to enhance transparency and protect investors by ensuring that their securities are directly credited to their accounts, by passing intermediaries and reducing potential risks.  Such a new mechanism will replace the current practice where securities pass through broker pool accounts, which pose risks of misuse and lack transparency. The new mechanism aims to enhance investor protection, reduce misuse risks, and improve transparency. While it offers significant benefits like increased security and investor confidence, it also introduces challenges such as higher operational burdens, increased costs, and potential initial delays. Effective preparation and adaptation by stakeholders are crucial for a smooth transition.  Current Practice & Issues with current practice: Currently, the payout process involves transferring securities from the seller to depositories, then from the depositories to the Clearing Corporation (CC), and finally, the CC credits the securities into the broker’s pool account. This pool account, however, poses significant risks. It contains the securities of all the broker’s clients, making it challenging to distinguish between client-owned and broker-owned securities.  If brokers face financial difficulties or insolvency, the pooled securities could be jeopardized, leaving clients uncertain about the status of their investments and weakening their trust in the brokerage system. This practice has led to severe issues in the past, one example of such misuse is the Karvy Demat Scam of 2019. In this case, brokers misused approximately Rs. 2300 crore of investor funds by pledging them to banks for their use, affecting over 95,000 clients.  To prevent such scams and enhance investor protection, SEBI has mandated a new regime. This new mechanism requires Stock Exchanges, CCs, and Depositories to establish the necessary procedures and regulations to ensure compliance. By doing so, SEBI aims to safeguard client securities and restore confidence in the financial markets.  New Mechanism: SEBI has mandated that Trading Members (TMs) and Clearing Members (CMs) must now ensure the direct payout of securities to clients’ demat accounts via clearing corporations. This new rule effectively removes the broker’s pool account from the payout process, aiming to safeguard client securities and enhance transparency.  However, in some processes, the broker will still take part, for instance, “Funded stocks held by the TM/CM under the margin trading facility” must be handled differently. As per the amendment in the circular dated May 22, 2024, these funded stocks must be held by the TM/CM only through a pledge. These funded stocks, which are purchased with the financial assistance provided by the broker, must now be managed exclusively through a pledge system. This means that brokers are not allowed to retain full control over these securities; instead, they must be pledged as collateral to secure the loan provided for the purchase.  To ensure transparency and safeguard client assets, TMs and CMs are required to open a separate demat account named ‘Client Securities under Margin Funding Account’. This account is used solely for the purpose of margin funding, and no other transactions can take place within it. The separation of these securities from other accounts ensures that the client’s margin-funded stocks are clearly distinguished and protected from being mixed with other broker activities. Once a client purchases stocks using the margin trading facility, the securities are first transferred to the client’s demat account. From there, an auto-pledge is triggered, which means the stocks are automatically pledged in favour of the broker’s ‘Client Securities under Margin Funding Account’ without requiring specific instructions from the client. This pledge serves as collateral for the margin loan, ensuring the broker’s financial interest in the funded stocks while keeping the process seamless for the client. This new system enhances both operational efficiency and investor protection by keeping the broker’s involvement limited to secured pledges and reducing the risk of asset misuse.  Similarly, for unpaid securities (where the client has not paid in full), the procedure outlined in paragraph 45 of the May 22, 2024, circular will apply. The securities will be moved to the client’s demat account and will be automatically pledged under the reason “unpaid” to a distinct account named ‘Client Unpaid Securities Pledgee Account,’ which the TM/CM is required to establish.  The objective of these changes is to enhance operational efficiency and drastically reduce the risk of client securities being misused, which was a major concern in the old system where client and broker securities were pooled together. In the previous practice, brokers had control over pooled securities, creating risks of misuse, as seen in cases like the Karvy Demat Scam of 2019. SEBI’s new regime, by eliminating the need for broker pool accounts and directly crediting securities to client demat accounts, significantly strengthens investor protection. This mechanism not only prevents misappropriation of client assets but also restores and reinforces confidence in the financial markets.  Analysis of the New Securities Credit Mechanism: Benefits of New Mechanism: The new mechanism promises numerous benefits and enhanced protection for investors. By enabling the direct credit of securities to clients’ demat accounts, the risk of brokers misusing client securities is significantly reduced. Clients will have full control and visibility over their holdings, allowing them to track their investments accurately and reducing the likelihood of discrepancies. Separating client securities from broker-owned securities is crucial. This segregation prevents the mixing of assets and reduces the risk of brokers using client assets for unauthorized purposes such as leveraging or trading. This clear distinction between client and broker assets also aids in better risk management, ensuring that client assets are

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