Anti-Avoidance provision in SEBI: A game-changer for market regulation and foreign investors

[By Tanishq vijay]

The author is a student of Gujarat National Law University.

 

Introduction

Anti-avoidance provisions prevent taxpayers from using contrived and non-commercial arrangements to abstain from or reduce their tax liability.[1] These provisions in the realm of market regulation can be relevant in curbing tax leaks from corporate entities who devise various schemes to circumvent share market rules.

SEBI has recently pitched before the committee appointed by the Supreme Court looking after Adani mayhem for anti-avoidance provisions to regulate corporates who devise innovative schemes to avoid share market rules.[2] SEBI wants a proviso similar to General Anti Avoidance Rules (GAAR) in the Income Tax Act 1961. This will help regulators stop activities like insider trading and transactions violating market rules.[3]

General Anti-Avoidance Rules

GAAR is a system to prevent tax evasion. It is covered under Chapter X-A of the Income Tax Act of 1961.[4] It contains impermissible avoidance arrangements, which are entered into to create tax benefits. A transaction that is a result of misuse of the act or does not have a bona fide explanation or commercial solidarity to it is covered in this arrangement.

The Hon’ble SC in Vodafone International Holdings B.V v. Union of India & Anr.[5] GAAR intends to prevent tax avoidance, which is inequitable and undesirable.” The court further provided valuable insight into the necessity of legislation of this nature. The lack of provisions and effective legislation gives rise to judicial uncertainty. Hence, maintaining market stability and complying with market rules and regulations will prevent tax avoidance motives and boost genuine commercial transactions.

Instances of Anti-avoidance Provisions in SEBI

The Securities and Exchange Board of India Act, 1992 (SEBI Act hereinafter)  does not provide for any specific anti-avoidance provision.  Within the framework of the SEBI Act, 1992, Section 12A stands as the closest provision addressing anti-avoidance measures. [6]  This section explicitly prohibits the use of manipulative, deceptive to defraud or deceive any person engaged in stock exchange securities. It also prohibits insider trading. It gives powers to SEBI to take action against those who try to use deceptive practices to defraud investors. Still, the problem with this is that it deals mainly with defrauding a company or stock exchanges which may include siphoning of a company’s funds or artificially increasing or decreasing the prices of the stock exchanges. It does not provide for a compliance regime against corporate transactions that seek to avoid compliance with the rules of SEBI.

Chapter VIA of the SEBI Act, 1992[7], delves into penalties and adjudication. It is founded on the tenet that anyone who violates or disregards any provision of the Act, the regulations, or any directions issued by SEBI is subject to penalty or adjudication, regardless of whether they had any malicious intent or rationale. However, we cannot equate it with Anti-avoidance rules as it is a specific provision intended towards imposing and adjudicating penalties in case of an artificial increase or  a decrease in share price. At the same time, anti-avoidance in market regulation is a more general principle based on substance over form, where transactions inconsistent with the economic stability and leading to immoral gains to a corporation are discouraged.

Enhancing Transparency in foreign portfolio investors

SEBI has recently proposed more transparency and stricter disclosure norms for Foreign Portfolio Investors (FPI) in the backdrop of the Adani-Hindenburg saga. SEBI wants additional information regarding foreign investors investing in Indian entities with a concentrated holding in one single entity so they can be monitored more closely.[8] FPIs with over 25,000 crores or 50% Asset Under Management (AUM) must make additional disclosures. This was done so that promoters do not circumvent the minimum public shareholding requirement.[9] Under the Prevention of Money Laundering (Maintenance of Records) Rules 2005, a ‘beneficial owner’ is defined as an individual with a controlling ownership interest of more than 25% in the case of companies.[10]

SEBI aims to obtain granular information regarding ownership, economic interest and control rights of these FPIs, which will help categorise these based on risk. SEBI had observed that some foreign investors have a large portion of investments in a single company for an extended period.[11] The current requirement for minimum public shareholding is 25% which means that the company’s promoters must maintain at least 25% of its share capital to the public. To bypass this regulation, the promoters invest through FPI by concentrating a substantial portion of the equity in one single investee company ultimately resulting into a deflective image of the actual situation of the publicly traded shares.

SEBI has also observed that it is difficult to identify the beneficial owner of FPI based simply on economic interest. Most investor entities fall below the threshold required for identification as Beneficial owners.[12] The same Beneficial Owner holds ownership in FPI through different entities, each falling below a certain requirement that needs to be followed to become a beneficial owner, leading to decreased transparency. For example, there is a FPI company based in Mauritius named ABC Funds. It has multiple shareholders in the name of X,Y,Z Ltd holding 9% each and 73% being held by others. SEBI’s guidelines states that Beneficial Owner of an FPI is a natural person who owns or controls more than 25 of that FPI. However, here ABC Funds Beneficial owner is hidden by different entities below 25%. This leads to a creation of a loophole in SEBI’s requirements resulting in exploitation of disclosure agreements and a breach in transparency.

This is one instance of anti-avoidance measures to bring transparency in market regulation. The big corporates will not be able to use loopy laws to circumvent the shareholding requirement resulting in irregular increase or decrease in the price of shares.

Impact of Anti-avoidance provision in SEBI on foreign institutional investors

According to section 2 (f) of the SEBI (FII) Regulations 1995, FII is “institutions established or incorporated outside India which proposes to invest in India in securities”[13]. Companies pool large amounts of money from investors and invest it in securities, real estate, and other assets.[14]

Anti-avoidance proviso in SEBI can impact FII in numerous ways, such as :-

  • Increase compliance cost due to disclosure of ownership, control rights, transaction, etc., to SEBI.
  • Unwinding of massive investments in the Indian securities market if found in violation of Anti-avoidance provision
  • There could be a possibility of potential discouragement in foreign investments due to a stricter compliance regime.

In the case of Indostar Capital v. CIT,[15], it was recognised that the majority of foreign institutional investors use the route of Mauritius by establishing companies in Mauritius which companies/individuals of third country own, resulting in artificial tax avoidance leading to sham and bogus transactions. By bringing additional disclosure requirements, SEBI could curb their market influence.

In the case of Vodafone International Holdings BV v. Union of India[16], it was accredited that foreign investors avoid the lengthy registration and approval processes of acquiring holding structures through which they develop equity interest in foreign-invested Indian companies. These holding structures have influence under SEBI and even company law. The anti-avoidance rule has to be seen as “piercing the corporate veil”. If any of these structures use practices like circular trading, then anti-avoidance can bring it down, showing that the transaction was a sham and bogus.

The Anti-avoidance proviso in SEBI prevents the misuse of the Foreign Institutional Investor route by foreign investors who seek to control the Indian Securities market. Bringing this proviso will impose additional disclosure requirements that may impact the FII inflow and increase costs but will protect the Indian economy by bringing transparency and clarity to security transactions. Therefore, there is a short-term loss which can be expected in FPI, but in the long term, it would prove to be beneficial.

Conclusion and Way Forward

Anti-avoidance provision being brought up by SEBI for market regulation would curb down on fraudulent actions used by investors to save themselves on market rules and regulations. Activities like insider trading, artificial inflation of share prices, etc. SEBI would be able to control entities who avoid complying with laws. This will create a safety net in the securities market against high-risk investors.

Anti-avoidance is far more than just preparing against tax avoidance or avoiding bogus transactions in the securities market it is a way to avoid disasters like the Adani-Hindenburg saga. High-risk concentrated FPIs that could shatter the market are controlled by such provisions.

SEBI has to bring higher disclosure requirements of corporate transactions and assets of foreign investors. If such disclosure is not followed, then there have to be penalties and even suspension of trading rights. A law could allow SEBI to conduct investigations into audits of suspected transactions. SEBI in its proposal to the SC committee emphasized corporate transactions too. These involve due diligence and balancing the dual requirement followed by the securities market of multiple countries when FPI and FII are involved so that there is no risk of overlapping and the investor does not face the brunt of both sides.

With increasing investments and growing uncertainty in the securities market, it is the right time to bring an Anti-Avoidance proviso by SEBI.

 

[1] Anti-Avoidance Rules, Canada.ca (March 2016), https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/16-4/16-4-anti-avoidance-rules.html.

[2] Pavan Burugula, Market regulator pushes for anti-avoidance provisions, Mint (May 21, 2023), https://www.livemint.com/news/india/sebi-seeks-anti-avoidance-provisions-to-target-corporates-devising-innovative-structures-to-avoid-compliance-with-share-market-rules-in-mumbai-11684689128747.html.

[3] Pavan Burugula, Market regulator pushes for anti-avoidance provisions, Mint (May 21, 2023), https://www.livemint.com/news/india/sebi-seeks-anti-avoidance-provisions-to-target-corporates-devising-innovative-structures-to-avoid-compliance-with-share-market-rules-in-mumbai-11684689128747.html.

[4] Income-tax Act, 1961, No. 43, Acts of Parliament, 1961 (India).

[5] Vodafone International Holdings B.V v. Union of India & Anr., 2012 SCC 6 613.

[6] Securities and Exchange Board of India Act, 1992, § 12A, No. 15, Acts of Parliament, 1992 (India).

[7] Securities and Exchange Board of India Act, 1992, No. 15, Acts of Parliament, 1992 (India).

[8] Moneylife Digital Team, SEBI Wants Foreign Investors-FPIs To Come Clean on Ownership; Releases Consultation Paper, Moneylife (May 31 2023), https://www.moneylife.in/article/sebi-wants-foreign-investors-fpis-to-come-clean-on-ownership-releases-consultation-paper/70952.html.

[9] Khushboo Tiwari, Sebi proposes enhanced disclosure requirements for high-risk FPIs, Business Standard (May 31, 2023), https://www.business-standard.com/markets/news/sebi-proposes-enhanced-disclosure-requirements-for-high-risk-fpis-123053100243_1.html.

[10] Moin Ladha , Kevin Shah and Priyal Sanghvi, India: Foreign Investment By Bordering Countries – Bringing Clarity To Press Note 3, Mondaq (April 6, 2022), https://www.mondaq.com/india/inward-foreign-investment/1179698/foreign-investment-by-bordering-countries–bringing-clarity-to-press-note-3.

[11] Sachin Kumar, Sebi seeks more info from foreign portfolio investors, The New Indian Express (June 1, 2023), https://www.newindianexpress.com/business/2023/jun/01/sebi-seeks-more-info-fromforeign-portfolio-investors-2580643.html.

[12] Moneylife Digital Team, SEBI Wants Foreign Investors-FPIs To Come Clean on Ownership; Releases Consultation Paper, Moneylife (May 31 2023), https://www.moneylife.in/article/sebi-wants-foreign-investors-fpis-to-come-clean-on-ownership-releases-consultation-paper/70952.html.

[13] Securities And Exchange Board of India (Foreign Institutional Investors) Regulations, 1995, The Gazette of India, Pt. II Sec. 3 (November 14, 1995).

[14] Rashmi Ranjan Panigrahi, Foreign Institutional Investors: A Study of Indian Firms & Investors, National Seminar on―Emerging Trends in Management & Information Technology (ETM&IT-2016) 69, 71 (2016).

[15] Indostar Capital v. CIT, 2019 SCC OnLine Bom 13177.

[16] Vodafone International Holdings BV v. Union of India, (345 ITR 1).

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