Author name: CBCL

Fortifying Non-Taxability Of Gain/Loss Entirely Due To Foreign Exchange Fluctuations

Taxation Law /

[By Aishwarya Mehta & Kaustubh Bajpayee] The authors are students at the Maharashtra National Law University, Nagpur.  INTRODUCTION Over and Over again, income tax officials find it difficult to ascertain whether a specific receipt is capital in nature and thus exempted from tax liability, or is a revenue receipt and thus, taxable. This imbroglio can be imputed to the fact that the Income Tax Act, 1961 does not lay down any explanation of the expressions “capital receipt” and “revenue receipt”. Hence, in cases where the monetary transaction does not fit appropriately into any provision of the Income Tax Act, 1961, there is a difference of opinion between the income tax officials and the taxpayers every time. On one side, the tax authorities try to expand the sphere of capital gains specified under Section 45 of the IT Act, 1961 by incorporating several transactions under its grab. Adversely, on the other side, the taxpayers assert that the transaction should pertain to capital accounts and thus are non-taxable. Lately, in the case of Aditya Balkrishna Shroff v ITO, the Mumbai bench of the Income Tax Appellate Tribunal (“ITAT”) expatiated on the tax implications of gains solely due to foreign exchange fluctuations on repayment of personal loans. The crucial points from the order are mentioned below. FACTS In the course of the audit assessment, the Assessing Officer (AO) observed that according to the Annual  Information Return (AIR) and capital account of the Assessee (“Aditya Shroff”), he received Rs. 1,12,35,236. When the assessing officer scrutinized this entry further, the assessee elucidated that he had furnished an interest-free personal loan of USD 2,00,000 (INR90,30,758) to his cousin in Singapore when the foreign exchange rate was 1 USD=INR 45.14. The Assessee also explained that the remittance was made under the Liberalized Remittance Scheme (LRS) provided by the Reserve Bank of India in 2004. The cousin paid back the amount of USD 2,00,000 (INR 1,12,35,326) on May 24, 2012, when the foreign exchange rate was 1 USD=INR 56.18. The assessee explained that due to fluctuation in the foreign exchange rate, the amount received on repayment of the personal loan was more than the amount originally advanced and hence, the receipt is non-taxable. The assessing officer observed that the variance of this transaction was of an income nature and thus taxable. Further, the AO instituted penalty proceedings against him for not disclosing the correct income. The assessee filed an appeal against this order. The appeal filed by the Assessee before the Commissioner of Income Tax was set aside and the order of the AO was approved on the pretext that only a rupee loan is admissible under the regulations of the Foreign Exchange Management Act (“FEMA”). Thus, the gain received by the assessee should be considered as income from other sources. Discontented with the decision, the assessee filed an appeal with the ITAT. ISSUE Whether the gain received on a personal loan solely due to foreign exchange fluctuation is a capital receipt or included in the nature of income? DECISION The ITAT recognized the appeal and held that the gains received on personal loans solely due to foreign exchange fluctuation are to be considered a capital receipt on the following grounds:- The authorities can’t modify the nature of receipt by expanding the scope of the expression- “income”, which is taxable as per Section 2(24) of the IT Act, 1961. As per Section 2(24)(vi) of the IT Act, 1961, it is coherent that only such capital gains are taxable as specified under Section 45. Hence, all other capital receipts falling outside the scope of this section are non-taxable. It is indubitable that the repayment of interest-free personal loans is capital in nature. This perspective of authorities can be considered as putting the cart before the horse- as the subordinate authorities determined the head of income under which the transaction should be taxed, without ascertaining the nature of the same. The transaction was purely personal in nature and the gain on the personal loan was solely due to the foreign exchange fluctuation. Even if FEMA sanctions the loan in Indian rupees only, it is not the responsibility of income tax officials to identify whether the loan was permitted in concurrence with the provisions of FEMA. However, non-conformity under FEMA is inconsequential to the analysis under Income Tax Act. CRITICAL ANALYSIS This order illuminates that any gains on repayment of interest-free personal loans solely due to the forex fluctuation cannot be considered taxable income in the hands of the recipient. Nevertheless, the ITAT could have referred to the case of Sutlej Cotton Mills Ltd v. Commissioner of Income Tax, West Bengal, where the supreme court laid down a test regarding tax liability of gain/loss solely due to foreign exchange fluctuation. The Supreme court held that:- “any gain/loss attributable to appreciation/ depreciation in value of the foreign currency would be trading profit or loss if the foreign currency is held by the on revenue account or as a trading asset or as part of circulating capital embarked in the business. But if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature”. The ITAT applied the same test in the case of  Havells India Limited v ACIT, where the taxpayer received foreign exchange gain on redemption of shares in the foreign subsidiary. The bench held that the gain on exchange was just an outcome of repatriation of the consideration received in Euro, to INR. Hence, the forex gain cannot be considered a fraction of the consideration received on redemption of shares. CONCLUSION The judgement of the ITAT, Mumbai came when the economic fallout from the pandemic continued to cause hardship for a few fragments of the society. During COVID-19, a number of rich individuals imparted financial assistance to their NRI folks who were outrageously distressed. This decision has fortified that all the receipts in the capital sector are taxable only when they are specified in

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Success Fees in a CIRP not chargeable – Or is it?

Insolvency Law /

[By Divyanshi Srivastava]  The author is a law graduate of Guru Gobind Singh Indraprastha University. The Insolvency and Bankruptcy Code, 2016 (“IBC”/ “Code”) was enacted to fix an ailing system. Due to the multiple contrary and complex legal arrangements, a simple, coherent, and effective framework was the need of the hour, and the IBC is a denouement of the same. However, despite its exhaustive nature, the journey of the Code, since its birth has been a bittersweet symphony, traversing numerous challenges. While the Code is a specialized and dynamic piece of legislation, given its young age, the jurisprudence around it is still inchoate. In this respect, where Section 5(13) of the IBC provides that “insolvency resolution process costs” would include any fees payable to resolution professional (“RP”) and any costs incurred by the RP in running the business of the Corporate Debtor (“CD”). The section is silent about the success fee. Further, the Code also does not have any provision stipulating that RPs can charge a success fee. In this respect, when in a recent case of Jayesh N. Sanghrajka, erstwhile R.P. of Ariisto Developers Pvt. Ltd. v. Monitoring Agency nominated by Committee of Creditors of Ariisto Developers Pvt. Ltd., the Hon’ble National Company Law Appellate Tribunal (“NCLAT”) was presented with an issue surrounding success fees charged by RP and whether the same formed part of the commercial wisdom of the Committee of Creditors (“CoC”), the NCLAT categorically held otherwise. And further laid down that success fee which is more in the nature of the contingency and speculative cannot be charged by the RP. Conspectus of the Case The judgment emanated from an appeal filed by the RP (“Appellant”) of Ariisto Developers Pvt. Ltd. (“Corporate Debtor”) against the observation of the National Company Law Tribunal (“NCLT”/ “Adjudicating Authority”). Since in the matter, the Respondent was the Monitoring Committee – a formal party – and the issues were primarily legal in nature, the Appellate Tribunal appointed an Amicus Curiae, as the response of the Respondent was not necessary. In the impugned order, the Adjudicating Authority had approved the resolution plan submitted by Prestige Estates Projects Ltd. for the CD but disallowed the success fees amounting to Rs. 3 Crores charged by the RP as unreasonable. Aggrieved by the same, the Appellant filed an appeal and contended that the approval of the success fees by the CoC was a commercial decision of the CoC, and hence, could not have been interfered with. The Appellant, as ammunition to its argument, referred to an IBBI Circular, dated 12/06/2018 and relied upon Regulation 34 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 stating that the CoC has to fix the expenses which will be incurred by the RP and such expenses include the fee for the RP. The Amicus Curiae per contra, referred to Section 208(2) of the Code and submitted that the Insolvency Professional is required to abide by the code of conduct stipulated in the said section and therefore, has to take reasonable care and diligence while performing his duties. The Amicus Curiae also referred to the said circular and submitted that as per the provisions, it is clear that the remuneration charged by the RP need to be “a reasonable reflection of the work undertaken”. Moreover, the Amicus Curiae contended that reliance upon the said IBBI Circular by the Appellant was misplaced as the same did not provide, prescribe, recommend, promote, endorse or sanctify payment of success fees. The Amicus Curiae even argued that a perusal of the provisions surrounding the subject makes it clear that RPs have to perform their duties objectively. The Appellate Tribunal, at the outset, iterated that the Code or Regulations thereunder have not provided for any fee on a speculative basis and the term “success fee” itself is contradictory to the fundamental principle that insolvency professionals shall render their services for a fee which is a “reasonable reflection of their work.” The NCLAT also noted that irrespective of the stage at which the success fee is claimed, charging such a fee would only have an adverse impact on the insolvency resolution process, as RPs are required to perform their duties under the Code independently and disinterested. Further, the Appellate Tribunal, agreeing with the submission of the Amicus Curiae that a Circular cannot be equated with the Rules and Regulations framed under the provisions of the Code, noted that even the Circular dated 12/06/2018 does not make success fee or contingency fee payable and an indirect reference to the same cannot be understood to mean that success fee is legally chargeable or payable. Furthermore, the NCLAT also approved the Amicus Curiae’s reliance on the decision in Alok Kaushik v. Bhuvaneshwari Ramanathan &Ors., wherein it was held that the NCLAT has the power to determine the fee and expenses payable to a professional; and finally held that success fee in the instant matter could not be charged and “even if it is to be said that it is chargeable, we find that in the present matter, the manner in which, it was last minute pushed at the time of approval of the Resolution Plan and the quantum are both improper and incorrect.” Analysis The said decision of the Appellate Tribunal that success fee which is contingent and speculative is not chargeable, is not only pertinent but also in harmony with the Bar Council of India Rules, 1975. For as per Rule 21of Chapter II of Part VI of the said Rules, advocates are barred from stipulating fees which is contingent on the result of the litigation. Moreover, the Hon’ble Supreme Court in the case of V.C. Rangadurai v. D. Gopalan has held that the relationship between a lawyer and their client is fiduciary in nature, and therefore, lawyers have to act in the best interest of their clients. At the same time, the relationship between the RP and CoC is fiduciary in nature is rather apparent and therefore, incontrovertible; and since the RP has to manage

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A Framework of Selective Distribution Agreement in India- A Clarion Call

Competition Law /

[By Vridhi Kashyap & Tanisha Mishra] The authors are students at the National Law University and Judicial Academy, Assam.  Introduction Selective Distribution Agreement (SDA) is one of the facets of vertical agreements. It allows the company to select retailers based on some pre-determined criteria, upon the fulfilment of which the outlet becomes the authorised distributor of the company. This arrangement allows the company to maintain sanctity in its distribution channel, as non-authorised dealers are not allowed to deal with the company’s product. It is an attractive mode of distribution because it allows the company to protect its brand image and intellectual property by selecting only a few authorised outlets. The outlets represent the company and are unique in appearance and mode of conducting business. SDA also prevents free riding and favours retailers by creating incentives for them. SDA, which is based on exclusivity, may seem anti-competitive, however, it is legal under EU regulations. The famous Metro v. Commission decision established three requirements that must be met before a company can legally have an SDA. The conditions are threefold: first, the firm must deal with a product that necessitates a special distribution agreement; second, the qualitative criteria must apply to all potential retailers without any discrimination; and third, any restriction imposed in view of having a restricted circle must not go further than it is objectively necessary.  The firms that usually fulfil these criteria are the tech know-how companies that require skilled personnel in the outlets, branded companies, especially those dealing with luxury products or cosmetics, and newspapers, which have a short life span and need careful distribution. In the Indian context, Competition Act, 2002 (Act) doesn’t take note of SDA, however, under 3(4)(b) and 3(4)(c) of the Act, exclusive distribution and supply agreements can be anti-competitive if they cause Adverse Appreciable Effect on Competition (AAEC). While the Act is absolutely right in incorporating that, recently there have been many companies, which fall under the category luxury and tech know-how businesses who feel the need to indulge in SDA, and the Act fails to address these concerns. This article argues that laws on SDA must be formulated in India because of the lack of uniformity and stability in the precedents. Tracing the Precedents: An Analysis The deliberation on SDA was initiated and highlighted in Ashish Ahuja v. Snapdeal and Anr.  (Snapdeal case)  which emerged in 2014, where Ashish Ahuja, the informant, moved the court under Section 19(1)(a), and alleged that Snapdeal and SanDisk Corporation had colluded to restrain the informant from selling SanDisk products on the e-commerce platform of Snapdeal. SanDisk further required the informant to be its authorised dealer and to procure materials from its authorised distributors in India, to be able to deal with its products. The Competition Commission of India (CCI) held that SanDisk wasn’t abusing its position in the market by having authorised distributors, as it could do so in order to protect the sanctity of its distribution channel. By this judgement, the CCI upheld SDA and the liberty of a company to select whom it deals with. However, in Shamsher Kataria v. Honda Siels Cars India Ltd. and Ors., (Kataria judgment) CCI held that the spare-parts market was a relevant market, and it observed that companies like Honda Siel cars, Volksvagen and twelve other car manufacturers, supplied spare parts to their authorised dealers only, while restricting and hindering the businesses of non-authorised repairers in the open market. It was found that the Original Equipment Manufacturers (OEMs) had charged exorbitant prices for spare parts and also restricted the access to such spare parts, resulting in denial of market access to the independent repairers. Therefore, CCI held the manufacturers were liable under Section 3 and 4 of the Act and imposed fines accordingly. While the conclusion is laudable and precise, CCI failed to discuss the SDA provisions which it upheld in the Snapdeal case. In a similar case in the EU, the Friedrich Grohe Armaturenfabrik GmbH & Co. (Grohe), a manufacturer of plumbing fixtures, formulated rules for its authorised dealers regarding their dos and don’ts. One of the criteria was to restrict its authorised distributors from the resale of the products in the open market, in defence of which they argued that their products were semi-finished and needed technical and professional assistance in installation, which the authorised dealers were capable of. The commission examined the case along the lines of SDA and nonetheless held such practices to be anti-competitive. Therefore, adopting SDA doesn’t mean the company can indulge in anti-competitive arrangements and such a narrative in the Indian context through the Kataria judgment would have further strengthened the position and relevance of SDA in the Indian laws. In the case of Tamil Nadu Consumer Products Distribution Association v. Vivo Communications Technology Company and Ors., the informant, which was an association to protect distributors from exploitation, alleged that Vivo had imposed unfair conditions on its distributors, in contravention of Section 3 and 4 of the Act. One of the conditions was that the distributors weren’t allowed to select their retailers, and it was under the company’s control to choose its retailers. The CCI rejected the complaint, claiming that the informant had not provided any concrete evidence to support this argument. However, the CCI should have had upheld that Vivo had the right to select its distributors and its retailers, as the commission had concluded in the Snapdeal case. By doing that, another precedent could have been added in favour of SDA. Position of Online Sales The manufacturer who is legally allowed to adopt SDA can impose some anti-competitive restrictions as per the EU’s guidelines on vertical agreements. One of the highly debated restrictions is the usage of online platforms.Usually, manufacturers restrict their dealers from selling accessories online, claiming the lack of control they have over online sales and delivery. Moreover, they believe that online sales do not meet the standards provided by them, through their brick and mortars, which thus impacts the brand image. Imposing such a restriction

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Dealing with Cross-Border Insolvencies: An Analysis of the Jet Airways saga

Contemporary Issues, Insolvency Law /

[By Shivam Bhattacharya & Naman Jain]  The authors are students at the Gujarat National Law University.  The recent order of the Mumbai Bench of the NCLT approving the resolution plan for the revival of Jet Airways has marked the end of one of the earliest cases of cross-border insolvency determined under the Insolvency and Bankruptcy Code, 2016 (hereinafter “Code”). The final determination by the Court has in addition to providing insights into the working of the Code, also laid bare some of its limitations for resolving cross-border insolvency disputes. In pursuance of this, the authors intend to examine the entire case in light of the recent judgment by presenting the facts, orders and judgments passed. This article will also analyze the limitations of the Code in this regard and elaborate on how adopting some of the provisions of the UNCITRAL Model Law could help in dealing with similar insolvency disputes. Background The present case begins with the initiation of ‘corporate insolvency proceedings’ against Jet Airways and concludes with the final approval of the resolution plan for its revival by the NCLT. It spans three different Court orders over a period of two years. Company Petition No. 2205 (IB)/MB/2019 in NCLT, Mumbai Bench Three petitions were filed against Jet Airways, the Corporate Debtor in this case, for the initiation of Corporate Insolvency Resolution Process (CIRP) against it for the huge outstanding debt is owed. During the first hearing, the NCLT Bench was apprised of the fact that insolvency proceedings against Jet Airways had already begun a month prior in theDistrict Court of Netherlands. The Bench in this regard opined that conducting concurrent proceedings in the same matter would cause delay and vitiate the proceedings in the case. The reasoning put forth was that the two sections, Section 234 and 235 in the CODE for recognizing the orders of a foreign jurisdiction, mandate the requirement of the Indian Government to have reciprocal arrangements with the foreign country. However, the Court noted that in the instant case there were no reciprocal arrangements were made with the Dutch authorities. Furthermore, the Bench also took into consideration that the registered office of ‘Jet Airways’ and their primary assets were located in India, and therefore the NCLT had the requisite jurisdiction in the instant matter. The Bench via its order dated 20th June 2019set aside the proceedings of the Dutch Court and declared it as a nullity. The initiation of the corporate insolvency resolution process in India against Jet Airways was accepted by the NCLT. Company Appeal (AT) (Insolvency) No. 707 of 2019 in NCLAT, Delhi The order passed by the NCLT bench on the aspect of non-recognition of the Dutch proceedings was challenged before the NCLAT by the Dutch Trustee. The NCLAT considered the appeal and directed the ‘Resolution Professional’(hereinafter “RP”), appointed on behalf of Jet Airways, to consider the feasibility of having a joint ‘corporate insolvency resolution process in coordination with the Dutch Trustee.  The RP along with the Dutch trustee reached an agreement for facilitating the resolution process through a ‘Proposed Cooperation’model. Both the parties reached a final agreement on the proposed model and submitted it to the NCLAT for approval. The NCLAT accepted the model via its order dated 26th September. The Bench also allowed the Dutch Court Administration to attend the meetings of Jet Airways. Interlocutory Application No. 2081 of 2020 in NCLT, Mumbai Bench An application for the final approval of the ‘Resolution Plan’ was filed before the Mumbai Bench of the NCLT. The Bench via its order dated 22nd June 2021accepted the ‘Resolution plan’ on a majority of the points, and gave a time period of 90 days to the consortium for taking the necessary regulatory approvals and permissions from the DGCA. The Bench ordered the formation of a Monitoring Committee for overseeing the entire process. Though the final determination by the Benchmarked the end of India’s first cross-border insolvency case settled under the Code, however, it raised some key concerns regarding the inadequacy of insolvency provisions in the Code. Analysis and Suggestions With transnational business increasing at a rapid pace and big corporations setting up offices in multiple jurisdictions, this decision by the NCLT assumes much significance. The final order passed has revealed several lacunae present in the Code for dealing with insolvency cases involving foreign creditors or debtors. A major point of contention was the ‘non-recognition of the proceedings which took place in the Dutch Court by the NCLT in its earlier order. The subsequent confusion and delay caused, led to the increasing chorus for including uniform provisions within the ambit of the Code, for dealing with cross-jurisdictional insolvency cases. In pursuance of this, it can be inferred that a major drawback of the provisions within the Code for resolving cross-border disputes is that it mandates the formation of separate and individual bilateral agreements with other countries for enforcing the provisions of the Code. Such a type of arrangement would in addition to requiring a lot of time and negotiations also increase the probability of conflicting claims being made from both sides in connection with the judicial proceedings undertaken by their respective Courts. In light of the aforementioned discussion, the authors are of the opinion that adopting the provisions of the UNCITRAL Model Law would be integral for reducing instances of conflict between the insolvency laws of two or more different jurisdictions. The Model Law provides for three essential and inherent provisions which aim at placing both the national and the foreign creditors or debtors on an equal pedestal. Firstly, the principle of recognition in the Model Law provides for the recognition of the Court proceedings in a foreign jurisdiction, which ensures that no unnecessary time is lost and the dispute is resolved in an effective manner. It also allows proceedings to be conducted in a parallel and concurrent manner.  Secondly, the ‘principle of access’ allows the foreign creditors and debtors to attend the Court proceedings taking place in a different jurisdiction. In essence this principle aids in bringing

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Mens rea and Insider trading: A comparative study of the Indian and US regulatory frameworks

Uncategorized /

[By Rishika Sharma & Rishi Raj]  The authors are students at the Maharastra National Law University, Aurangabad.     Introduction To achieve the goal of safeguarding the interests of the investors, the Securities Regulators around the globe have consistently imposed stricter insider trading regulations to ensure and sustain capital market transparency and fairness. It was given broad powers, including the ability to enact regulations prohibiting insider trading as it deemed fit but not enough which can include mens rea as an essential of insider trading. Before we proceed to examine the role of mens rea in insider trading it is essential to elucidate this topic. The watchdog of the Indian securities regulator i.e., Securities and Exchange Board of India (SEBI) prohibits the practice of insider trading under SEBI (Prohibition of Insider Trading) Regulations, 2015 (SEBI Regulations). The SEBI Regulations define insider trading as an offence against dealing with a company’s securities on the basis of unpublished price sensitive information (UPSI) to gain an undue advantage over the other people who do not have such information. Regulation 2(1)(n) of the SEBI Regulations provides that information that is related to a company or its securities, that is not generally available to the public, which upon disclosure is likely to affect the price of securities can be termed as UPSI. A comparative study of the need for inclusion of mens rea This article seeks to examine the necessity of mens rea in the provisions of insider trading in the USA and India. These regimes were chosen because the United States, as one of the world’s largest financial markets, may serve as a model for India’s securities market. Further, the authors are of the opinion that India needs adequate penal laws to protect investors’ interest in the securities market which prohibits the practise of insider trading and those laws must meet the regulations of developed nations. 2.1 The Indian position  It would be very prudent to start analysing the Indian regulatory framework where mens rea has not been recognised as an essential of insider trading. Regulation 3(1) of SEBI Regulations states that any person who is in the possession of UPSI shall be considered to be an “insider” irrespective of how the person gained such information. In addition to this, Section 15G of the Securities and Exchange Board of India Act, 1992 (SEBI Act) lays down the penalty for violation of the provisions of Insider trading. In Hindustan Lever Limited v. SEBI wherein it was contended that for imposing any penalty under insider trading it is essential to prove that the purchase was made for making profit or to avoid loss. While rejecting the contentions Securities Appellate Tribunal observed that information or knowledge is irrespective of Insider trading. It is noteworthy here to observe that the SEBI Act does not recognise the need for the inclusion of mens rea in insider trading. It is not considered an essential element in insider trading and a person can be convicted regardless of his intentions. The Securities Appeal Tribunal, however, did not always have the same view. A contrary view was taken by it in Rakesh Aggarwal v. SEBI wherein it held that intention or knowledge has to be taken into cognizance in case of insider trading even though the statute doesn’t particularly bring mens rea as an essential criterion but it was subsequently overruled. However, in SEBI v. Cabot International Capital Corporation, the Bombay High Court held that the punishment prescribed in the SEBI Act and SEBI Regulations are for the non-compliances of the provisions. The proceedings relating to Section 15G are neither criminal nor quasi-criminal, as the Act and The Regulations provides that there is no question of proof of mens rea is required as a fundamental component for the imposition of penalty. The SEBI Act and SEBI Regulations were enacted to punish those individuals who are in default of statutory provisions and hence the intention of the parties committing such violation becomes wholly irrelevant. Therefore, it is noteworthy to observe that the statutory provisions contradict the principle of “no mens rea, no punishment” which is a settled principle in common law countries. Further, the authors are of the opinion that the present provisions make somehow mens rea is not an essentials of insider trading. This negates the purpose of criminalising insider trading as a means of gaining an unfair advantage based on price-sensitive information. The mere possession of unpublished price-sensitive information should not be considered as sufficient grounds for insider trading. Further, it is noteworthy to observe that the views adopted by the Indian judiciary and regulatory authorities is wrong and hence, mens rea must be included as a fundamental of insider trading. 2.2 The US position  The US frequently acts as the “gold standard” for many emerging economies, it is necessary to understand what constitutes mens rea in order to attract criminal responsibility for insider trading offences committed within the jurisdiction of the US. The U.S. Securities and Exchange Commission (SEC) defines Insider trading in a much broader sense when compared to the Indian provisions. Instead of only buying or selling securities on the basis of UPSI, SEC also includes “breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, non-public information about the security” under the ambit of insider trading. In 1984, for the first time, the US Supreme Court in Dirks v. SEC observed that the mens rea must be considered while determining the Insider trading proceedings. Further, in deciding whether or not the insider has violated a fiduciary obligation, the Court reached its conclusion by using a test to determine if the tippee committed the insider trading offence. The Court laid down a test to determine the Insider’s knowledge by [i] insider’s personal benefit from his disclosures [ii] absence of personal gains and [iii] absence of breach by the insider. Hence, after the Dirks judgement, in US v. Newman, the Court ruled out the term “mens rea” and made it far more difficult

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The Tale of Venture Capital Funds: A New Breeding Ground of Tax Evasion?

Contemporary Issues /

[By Aarushi Kapoor] The author is a fourth year student at the Hidayatullah National Law University. Introduction The Customs Excise and Service Tax Appellate Tribunal (hereinafter ‘Tribunal’), Bangalore bench, in ICICI Econet and Internet Technology Fund v. Commissioner of Central Tax, has recently confirmed the service tax liability on the expenses incurred by the venture capital fund (hereinafter ‘VCF’), as the consideration received towards the asset management services which are employed for the administration of funds. The VCFs are incorporated as trusts. Such incorporation in the form of the trusts is always a favourable mode of incorporation because of the application of the principle of mutuality. According to this principle, a trust is not separate from its beneficiaries and hence, the activities pursuant to such an institution cannot be taxed. However, this judgment has challenged this long age industrial practice. Pertinent Facts In the present case, ICICI Econet and Internet Technology Fund was a VCF created to make large investments in portfolio companies using the contributions received from a variety of investors. For the management of these contributions, an investment manager or the asset management companies was appointed to analyse the investments received in the form of contributions and decide the future course of actions in the form of investment and disinvestment. The contributories were referred to as unit holders. It is imperative to mention that in the present case, the asset management companies in addition to providing advisory services also contributed to the fund and hence, were entitled to the payments which included a payment equal to the capital invested plus a promised rate of return like the other unit holders. Issues which required consideration This return on investment paid to the asset management companies in this instance was much more than the quantum of the investment made by them. It is here, where the bone of contention appeared. The main question before the tribunal was whether the enhanced amount being paid to the asset management companies comprised of the operating expenses and carried interest in addition to the legitimate return of investment. It was to this question, that the tribunal actually answered in affirmative by concluding that payments included payments of carried interests being made to the asset management companies in the disguise of return on investment, and hence this amount attracted the service tax liability in the hands of asset management companies. Critical Analysis: An Insights into the Implications After having discussed the background of the issue at hand, it now becomes essential to discuss the implications that this decision is likely to have on the equity industry. VCF is no longer a trust The structure of the trust is based on the principle of mutuality. According to this doctrine, whenever there is an oneness of the contributors to the fund and the recipients from the fund and the fund has been constituted for the convenience and common benefits of the members backed by the impossibility that the contributors derive profit from such contributions, mutuality comes into play. As an implied conclusion, it follows that a person cannot make profit out of himself. Hence, this profit cannot be regarded as income and hence, it is not taxable. However, accordingly to the decision of the Tribunal, the VCFs which were traditionally incorporated as trusts, have been denied to continue applying doctrine of mutuality. Accordingly to the reasoning of the Tribunal, the VCFs breached the principles of mutuality by breaking the closed circuit within which only the trust and the beneficiaries used to interact. In contravention, the VCFs made an attempt to engage in pure commercial operations in order to provide a favourable return to the contributories. In other words, it could be said that the contributions received from the contributories were invested in the portfolio companies and arrangements were created in a manner to ensure that a profitable return at the end is distributed. This resulted in the collapse of the closed circuit within which the doctrine of mutuality operated. The tribunal instead warned that the structure of the VCF fund was a mere façade. The aim of such a foul play was to provide every opportunity and fortune to the investment management companies to avoid taxation. The intent was somehow to benefit themselves through earning performance fees in the form of carried interests. Fails to analyze the other factors One of the most critical analyses of the judgment rendered by the tribunal is the fact that the order is very case specific. It is important to keep in mind that while making a judgment that is likely to have an impact on the entire private equity industry, a holistic consideration of the facts and circumstances in required. However, the judgment fails to analyse the status quo on such considerations. For instance, the detailed list of payments which the VCFs are legally entitled to make to the asset management companies as a consideration for the services rendered. The Chapter 10 of the Master Circular on Mutual Funds explains list of fees, charges and expenses which can be ideally charged by the collective investment schemes pursuant to the regulations and approval of SEBI. However, under the same guidelines, there is a prohibition on the collective investment schemes like VCFs to charge the expenses related to the payment of performance or management fees to the investment management companies. So as a necessary corollary, it can be deduced that the logical reasoning of the tribunal is backed by the SEBI regulations and circulars.[1] However, what needs to be determined is the fact that whether the enhanced payment made to the asset management companies by the VCFs comprised of the lawful payments or the prohibited performance fees. The tribunal has failed to take into account the balance sheets of the VCFs and contractual arrangements between the VCFs and the asset management companies. Detrimental for Private Equity and Management Industry The above decision of the tribunal is likely to have a very detrimental impact on the private equity Industry especially in India.

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Predicament of NPAs in India – Can bad banks solve it?

Banking Law /

[By Karma Shah and Diya Vaya] The authors are third year students at the Gujarat National Law University. Introduction Our nation is facing a massive issue of Non-Performing Assets (hereinafter “NPAs”). Put simply, an NPA is any bank asset or receivable that has stopped making payments to the bank and has remained unpaid for a specified amount of time. The Reserve Bank of India (hereinafter “RBI”), in its Master Circular, dated 30th August, 2001, has given an extensive definition of NPAs, which aids Indian banks in identifying and treating NPAs. In this definition, the RBI has specified the period after which assets stop giving returns as a meagre 90 days. NPAs are a threat to the Indian economy, as due to the strict prudential norms set by the RBI with respect to NPAs, banks have virtually stopped lending. This has led to the downfall of economic growth. An increase in NPAs leads to several unfavourable outcomes for the economy as a whole. These include, but are not limited to first, lower profit margins for banks and an increase in rates by banks for achieving a higher profit margin, second, reduction of liquidity in the organised financial sector, third, increased work-load on the judiciary, leading to an increased social cost to the society and lastly, stressed balance sheets of banks, less return to investors, and other such tangential issues. To combat this threat to the nation’s economy, Ms. Nirmala Sitharaman (hereinafter “the finance minister”) proposed the introduction and setting up of ‘bad banks’ in the 2020-2021 Union Budget. Moreover, most recently, i.e., on 16th September 2021, the finance minister laid down the framework for the National Asset Reconstruction Company Ltd. (hereinafter “NARC”), India’s first ‘bad bank’. This blog aims to, first, explain the meaning of bad banks and their crucial need in the contemporary Indian economy. Second, examine the recent framework establishing bad banks laid down by the finance minister, and third, analyze the impact on the banks and the national economy. Bad Banks – Meaning and Function Bad banks are those institutions that, simply put, buy the NPAs and bad loans of banks and other financial institutions in exchange for cash and/or securities. The first-ever bad bank set up in the world was by Mellon Bank in the USA. In practice, a bad bank plays the role of asset reconstruction. It buys the NPAs, bad loans, and other risky assets from various financial institutions, specifically banks. The bad bank then manages and recovers these over time. Hence, contrary to a conventional bank, their core and primary function is the recovery of NPAs and bad loans. Banks essentially isolate and divide their assets into two separate categories. One category contains the illiquid assets, including the NPAs, risky securities, non-strategic assets from businesses that are no longer beneficial to the bank, non-performing loans, and other high-risk or troubled assets. The second category contains the good and beneficial assets that perform well and represent the bank’s core business. A bad bank, a corporate structure, takes the NPAs and bad loans of such banks and provides cash and/or government securities in return. This allows the bank to clear their balance sheets, infuse themselves with liquidity, and helps them focus on their core business instead of trying and recovering the NPAs. The Critical Need for Bad Banks in the Indian Economy  The Covid-19 pandemic has led to an unprecedented negative impact on our economy. Cash flow has reduced, leading to issues of loan repayments, tax payments, and interest payments. Furthermore, NPAs have been blocking the progress of our economy since the last decade. In such a desperate financial scenario, the need of introducing bad banks in the Indian Economy was critically felt due to the following reasons: First, primarily to resolve the NPA crisis. NPAs have been a constant obstacle preventing the Indian economy from unleashing its true potential. NPAs have started to drastically increase in Indian Banks since 2013, forming almost 10% of the loans provided by the banks. As per RBI, NPAs of all the scheduled commercial banks have increased from 2.35% in 2011 to 8.21% in 2021, amounting to an increase of almost 250% in a decade. Moreover, due to the onset of Covid-19, RBI has presented a warning in its July 2021 Financial Stability Report that the gross NPA ratio may increase to 9.80 percent by March 2022 under the baseline scenario; and to 11.22 percent under a severe stress scenario. India has the third-highest gross NPA ratio. When a bank has a high NPA ratio, it spends a high percentage of its profits covering consequential losses incurred due to the high NPAs. This creates a situation of decelerating the cash flow in the economy, reducing the lending frequency of the banks and ultimately affecting the economy as a whole. . In this scenario, NARC is a much-needed expert entity required to fuel the economy’s growth, provide capital to banks and resolve the financial crisis. Second, to provide support to the Insolvency and Bankruptcy regime (hereinafter “IBC”). The IBC was enacted with the objective of debt recovery and reducing the NPAs in the economy, among others. However, it did not perform as per expectations. Furthermore, it is argued that the IBC and associated debt recovery mechanisms are still at a nascent stage in India. For IBC to resolve all issues of NPAs plaguing our economy it requires greater judicial capacity, manpower and time. This can be provided by the bad bank, which creates a separate entity for quicker and more efficient one-time resolution and debt recovery. Now, banks need not worry about debts and can focus on strengthening the economy. Furthermore, the appreciable role played by bad-banks in other countries is the greatest testimony of its potential to resolve the issue of NPA’s in India and accelerate economic growth. Hence, a bad bank is necessary to tackle the issue of the large stock of NPAs in the economy as a one-time solution. Impact of the recent framework on Banks and Indian Economy On September 16, 2021, the finance minister set

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Redefining the Scope of Section 3(1): Towards a Purposive Interpretation

Uncategorized /

[By Shubham Gandhi & Aditya Puri] The authors are students at the Dharmashastra National Law University, Jabalpur.  The Competition Act, 2002 (“the Act”), as legislated by the Parliament, is a special statute that governs the practices conducted in a market and ensures that healthy competition is maintained. The legislature in the Competition (Amendment) Bill, 2020 has stressed the need to identify a legislative way to cover agreements that otherwise do not fall in the ambit section 3(3) and 3(4). Considering the scheme of the Act, the question which arises is whether the Act contains enough space to accommodate the independent application of section 3(1) read with (“r/w”) 19(3) or the two agreements, i.e., horizontal and vertical agreements, are exhaustive of the scope of anti-competitive agreements as restricted by the Act under section 3(3) and 3(4) of the Act, respectively. This issue is yet to be settled with finality by the Apex court of the land. The author(s) in this article will throw open the discourse with regards to scope and extent of umbrella provisions viz. section 3(1), undertake a purposive interpretation of the Act to disseminate the scheme of section 3(1), highlight the precedents recognizing the extent of section 3(1) and will exemplify the growing need to curb advance anti-competitive agreements which do not fall under section 3(3) or 3(4) of the Act. Underlying Purposive Interpretation The words used in the literal sense are the most reliable source of interpretation. It is to be emphasized that statutes invariably have some purpose of accomplishing. The sympathetic discovery of the purpose is the best guide to the intended meaning of the statute. In clear terms, the apex court in Excel Corp v. CCI laid down that, “In ordinary circumstances, once the ‘plain meaning’ of the words in a statute has been identified there is no need for further interpretation. Different considerations can apply, however, in cases where a statute would be unconstitutional if interpreted literally.“ The preamble of the Act provides for sustenance and protection of competition, ensuring the freedom of trade for the other participants of the market in light of economic development of the country, and preventing practices that have the potential of causing an adverse effect on competition, as laid down in the judgment of CCI v. SAIL. The factor of “economic development” is a dynamic phenomenon requiring flexibility on the part of the commission to accommodate the changing nature of anti-competitive agreements. To achieve the said purpose, the Act bestowed upon the commission the power to take action under section 18 of the Act. The literal semantics of section 3(1) nowhere suggests that the scope of agreements mentioned therein are limited to the ones categorically mentioned under sections 3(3) and 3(4), i.e., horizontal and vertical agreements, respectively. The section explicitly uses the phrase “any agreements” while prescribing the anti-competitive agreements. To disseminate our argument, reproduction of section 3(1) is necessary: “No enterprise or association of enterprises or person or association of persons shall enter into any agreement in respect of production, supply, distribution, storage, acquisition or control of goods or provision of services, which causes or is likely to cause an appreciable adverse effect on competition within India.” It is just a matter that the horizontal and vertical agreements are certain in structure and scope that they deserve a categorical mention. Further, the other agreements not mentioned under section 3 are, in author(s) view, not certain in scope and structure to be bestowed with a categorical mention. Also, the definition of ‘agreements’ under section 2(2) has been left wide and open to facilitate the inclusion of even a blink of an eye. In such a scenario, defining the contours of all the agreements covered under section 3 is nearly impossible. It is the contention of the author(s) that agreements stipulated under sections 3(3) and 3(4) are only illustrative of “any agreements” under section 3(1). They do not exhaust the scope of section 3(1). Hence, the legislators used the phrase “any agreement” to leave the scope of the section open-ended to accommodate the ever-changing dynamics of anti-competitive agreements entered by market players to “eliminate practices having an adverse effect on the competition, to protect the interest of the consumers.” Therefore, any interpretation inclining towards restricting the reading of section 3(1) to horizontal and vertical agreements would be a creative exercise unnecessarily narrowing the scope of section 3(1). The approach adopted by CCI The CCI first decided the issue regarding the standalone application of section 3(1) in the case of Ramakant Kini v. Dr. Lh Hiranandani Hospital, wherein the commission categorically stated that if the agreement does not fall within the ambit of section 3(3) or 3(4) due to its nature, then resort shall be made to section 3(1) r/w 19(3) to serve the purpose of the Act. Although the Ramakant case was overruled by order of COMPAT, as the agreement in the specific case does not vitiate the principles of AAEC, it does not discuss the interpretation done by CCI regarding 3(1). After that, the CCI in P.K Krishnan v. Paul Madavana, while referring to the Ramakant Kini Judgment, held that “in Dr. L. H. Hiranandani Case (Ramakant Kini case) the position is quite clear that an agreement, even if it is not falling under section 3(3) or 3(4) of the Act, is amenable to the jurisdiction of the Commission under section 3(1) if the same has an appreciable adverse effect on competition.” CCI again accepted this line of reasoning in the case of Rohit Medical Store v. Macleods Pharmaceutical Ltd. The author(s) find the interpretation adopted by CCI in the aforementioned cases in line with the preamble. Also, section 18 puts the commission under a duty to prevent practices from having adverse effects on competition. Moreover, it is observed in various cases, like      Builders Association of India v. Cement Manufacturers’ Association and CCI v. Co-ordination Committee of Artists, that the associations always contend that they were merely an association of people and did not undertake any economic

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Front Running: A Non-Intermediary’s Accountability for the Ill-Gotten Gains

Capital Markets and Securities Law /

[By Renuka Nevgi]  The author is a student at Maharashtra National Law University, Mumbai.  Introduction: Meaning and Nature Front running is an illegal act of buying or selling securities based on non-public information regarding a substantial future transaction likely to influence the price. It includes entering into options or futures contracts before an imminent transaction while anticipating the fluctuation in the price after the information will become public. This term has been defined in the SEBI Circular dated 25th May 2012. Regulation 4(2)(q) of SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) Regulations, 2003 classifies front running as a manipulative, fraudulent and unfair trade practice. Furthermore, Sec. 12A(e) of the SEBI Act also lays down that a person shall not deal in securities directly or indirectly while possessing non-public information. Front running may take place in several ways through intermediaries as well as non-intermediaries. Orders can be placed in tranches and all such tranches placed before the last tranche of the Big Client will classify as front running transactions. This practice involves illegal usage of confidential information given to an intermediary resultantly amounting to unfair leverage. This article critically analyses the extant legal provisions as well as judicial decisions dealing with front running by non-intermediaries and juxtaposes it with those in the other jurisdictions. The author also attempts to provide constructive suggestions in order to impose effective strictures on this manipulative practice. Kinds of Front running According to the decision in case of SEBI v. Shri Kanaiyalal Baldevbhai Patel and Ors, front running consists of three forms of conduct: (1) ‘tippee trading’ which means trading by third parties who are given information or tipped on an impending block trade, (2) ‘self- front running’ implying the transactions wherein the purchasers or owners of block themselves involve in offsetting options or futures transaction by indulging in ‘hedging’, and (3) ‘trading ahead’ refers to a transaction in which an intermediary trades for own profit ahead of an impending customer block order. When confidential information is passed on to a third party, it results in the breach of duty prescribed by law. Specifically, if the tippee is cognizant of the breach and thereby induces the person to share such information, it is considered to be a ‘fraud’ by the recipient tippee. Front running behaviour can be classified into two categories as confirmed by a SEBI Order in the matter of Reliance Securities Ltd.: (i) ‘BBS’ or Buy-Buy-Sell: This is when the front-runner places own buy order preceding the last tranche of Big Client’s buy order. Subsequently, the front runner keeps selling the securities bought earlier at an escalated price. And (ii) ‘SSB’ or Sell-Sell-Buy: This happens when the front-runner places own sell orders preceding the last tranche of Big Client’s sell order. Consequently, the front-runner buys securities at a reduced price as and when the Big Client’s sell order gets executed. Indian judicial pronouncements w.r.t. non-intermediaries If only intermediaries are held responsible for front running, then the manipulators will get the leeway to engage in iniquitous activities through name lending or by masking their identity. However, as decided in the matter of Manish Chaturvedi & Ors., name lending is a serious offence and one cannot be absolved of the liability simply by claiming obliviousness. If these activities remain uncontrolled, then those who aid and abet such unfair practices will also detrimentally affect the interest of investors. When the accounts are rented out to third parties, they become the custodians of those securities or funds. Although the account holder still remains as the technical owner, the non-intermediary or third party employs its own resources which may be utilised for illegal purposes. The account holder may also receive direct or indirect gratification in return for the same. This deceitful practise helps the third parties to carry out fraudulent activities while concealing their identity. Under Indian law, the standard of proof required to establish front-running by third parties is a preponderance of probability, whereas any clinching evidence is not needed. The modus operandi is determined by collective analysis which leads to inference in relation to the conduct of the manipulators in the securities market. Circumstantial evidence including the pattern of trading could suffice to prove a fact. Different participants in the front running are broadly categorised as (1) ‘information carriers’ which have access to the content of non-public information (2) ‘front runner holder accounts’ that are registered owners of the trading accounts. (3) ‘mule account holders’ are the entities employed by the information carrier which operates the account set comprising of the trading account, Demat account and bank account. In case of defiance of PFUTP regulations, SEBI had also imposed penalties that that act as a deterrent to all those who indulged in serious violations. A maximum penalty of INR 25 crores or three times of profits generated from such practice can be imposed under the SEBI Act. Along with this, SEBI is also vested with the power to institute other civil suits under the SEBI (Intermediaries) Regulations, 2008 and criminal proceedings under Sec. 24 of the SEBI Act. Regulations in foreign countries In the jurisdiction of U.S., front running has been classified as a separate offence by the Financial Industry Regulatory Authority. The brokers or firms are not allowed to place their interests after gaining knowledge of an imminent trade. However, if such a trade is necessary to facilitate the execution of the client’s order, they can do it with the client’s free consent. Rule 5270 includes mule account holders because it has a wide scope since it includes members as well as the persons associated with members. Thus, the third-party traders are also impliedly included within the purview of frontrunning under the FINRA Rules. Likewise, under the EU Market Abuse Regulations, Rules 23 and 24 categorically include third parties whose account is used by the trader to obtain unfair gains indirectly. It also contains a presumption of the traders themselves placing the orders if such confidential information is used to

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