Covid-19 Archives - NLIU CBCL

Abolition of DDT- Tale of its Impact on Corporate Governance

[By Rohit Maheshwary and Shrutika Lakhotia] The authors are students at School of Law, Christ (Deemed to be University), Bengaluru. Introduction The Finance Act, 2020 has brought in some relief for the companies by swapping the Dividend Distribution Tax (“DDT”) with the classical system of dividend taxation and thus functioning as a raindrop in the drought. The Finance Minister, Ms. Nirmala Sitharaman, has closed the doors of the DDT while paving a way out for tax liability on the shareholders, thus following the relics of 1997. This means that the company distributing dividends will be exempted from paying tax on it and the burden to discharge the liability has been shifted in the hands of shareholders receiving the dividend. Before the enactment of the Finance Act, 2020, the DDT was provided under section 115-O of the Income Tax Act, 1961 (“Act”). It states that the amount declared, distributed, or paid by the company by way of dividends will be subjected to additional income-tax at the rate of fifteen percent. The government’s approach to tax a non-income based transaction has attracted a lot of criticism by various stakeholders in the past.[i]The DDT caused an excessive tax burden on the companies distributing the dividend since the effective tax rate amounted to 48.5% (inclusive of the corporate tax rate at 25%). The DDT has been referred to as the epitome of “double taxation” as well as “surrogate tax”. To clear the air, the Apex Court in the case of Union of India & Ors. v. M/s. Tata Tea Co. Ltd. has upheld the constitutionality of section 115-O of Act. Raison D’être to Abolish DDT The rationale purported by the government to bring this change in the dividend tax policy is worth mentioning. The government decided to abolish the DDT for the benefit of the small retail investor who had to face the brunt of high tax in the form of DDT levied at the rate of 20.56% in comparison to the tax levied at the rate of 5% or 10% on the income of the shareholders falling in the lower tax bracket. Further, the move to abolish the DDT is intended to welcome investments from the foreign shareholders since, the denial of the tax credit paid in the form of the DDT caused excessive tax burden on the foreign investors. This decision to abolish the DDT impacts, various stakeholders, in different ways. However, the present article analyses the impact of DDT abolishment on one of the most crucial aspects of company law jurisprudence- “Corporate Governance.” In 1994, the King Commission portrayed Corporate Governance minimally as “the system by which companies are directed and controlled.” Impact on Indian Corporate Governance Any corporate structure possesses a unique characteristic of separation between ownership and management. This structure efficiently functions on the well-established premise that the management works for the best interest of the company and the shareholders. However, this is not always true because sometimes the managers may prove to act otherwise and prioritize their self-interest. Having said this, it is pertinent to refer to the “Free Cash Flow Theory” as suggested by Jensen in 1986.[ii] The study conducted by Jensen in 1986 reveals that the companies having excess cash under the opportunistic management’s hand will invest in unprofitable projects. This tends to burden the shareholders with the cost and reduces the firm’s value.[iii] The presence of the “corporate insiders” in a company deepens the hole and aggravates this problem. Corporate insiders are the persons who tend to dominate the affairs of the company because they hold detailed knowledge of the working of the company.[iv] In practical terms, a corporate insider uses the excess cash for satisfying their personal needs and political agendas instead of investing in profitable projects.[v] One such instance can be drawing huge remuneration from the company. This also undermines the duty of the managers to act faithfully towards the owners of the company. Therefore, when the management or the corporate insiders do not offer to distribute the profits of the company in the form of dividends or otherwise amongst the shareholders, it results in the reduction of the rate of return on equity capital and decreasing the value of the firm. In the erstwhile DDT regime, the managers could escape from their actions of not distributing surplus cash to the investors by shifting the blame on the excessive tax burden on the company when a dividend is paid to its shareholders. This practice gives the managers an “excuse” to use the retained earnings for their benefits and thereby sabotaged the shareholders’ interest. With the abolition of the DDT, the seesaw of conflicting interests between the managers and the shareholders would balance out. One may examine the standards of corporate governance through the lens of dividends distributed by the company. The Jobs And Growth Tax Relief Reconciliation Act, 2003 This link between the dividend distributed and the corporate governance standards can also be witnessed by looking at America’s dividend tax policy of 2003. Unlike India, America always followed the classical system of dividend tax. However, the corporate behaviour in America changed with the enactment of The Jobs and Growth Tax Relief Reconciliation Act (“Tax Reform”), 2003. Before the enactment of the Tax Reforms, the dividend tax in the hands of the shareholders receiving dividends was levied at the rate of 35 percent whereas the Tax Reform provided huge relief for the shareholders by levying tax at the rate of 15 percent. One of the main considerations for the enactment of the Tax Reform was to enhance the corporate governance practice in the company.[vi] The Joint Economic Committee (2003) also supported the outlook that the reduced tax rate would result in good corporate governance since the distribution of dividends would attract a healthy appetite for investment in the company. Moreover, this would provide shareholders with a greater degree of control over the company’s resources. Another key aspect of the enactment of the Tax Reform was the increased dividend payouts by the company.[vii] Hence, the

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Practical Issues in Conducting Virtual Meetings of Shareholders: A Case for Co-operation versus Activism

Leave a Comment / Company Law / CBCL

[By Gaurav Pingle] The author is a practicing Company Secretary. Corporate governance has always emphasized on building an environment of trust, transparency, and accountability necessary for fostering long-term investment, financial stability, and business integrity. This in turn contributes to supporting stronger growth and more inclusive participation of stakeholders, required especially when the global economy is badly hit due to the COVID-19 pandemic. From the perspective of accountability and transparency, it is desirable that there is regular communication between a company’s management and its shareholders. MCA unveils framework for virtual general meeting An integral aspect of corporate governance is to ensure that owners (i.e. shareholders, in case of companies) should have a right to participate in, and to be sufficiently informed of, decisions concerning fundamental corporate changes. The owners should also have an opportunity to participate effectively and vote in the general meetings. Taking into consideration the critical situation of COVID-19 and nation-wide lockdown where gathering of shareholders physically looks impossible, the Ministry of Corporate Affairs (“MCA”) has unveiled a framework for companies to conduct shareholders’ meeting through video-conferencing (VC) or other audio-visual means taking into consideration the aforementioned important aspects of corporate governance. MCA, through its several circulars and clarifications[i], has prescribed a procedure for conducting shareholders meetings and thereby obtaining their approval. Sending of Financial Statements to shareholders In case of an Annual General Meeting (“AGM”), companies are required to send the financial statements, Auditor’s Report, Directors’ Report to its members. Until now, the companies were sending it by registered post or courier. Owing to the difficulties due to COVID-19 pandemic, where courier services have been suspended owing to the nationwide lockdown, MCA has allowed companies to send the said documents by e-mail to the registered e-mail addresses of the shareholders. One of the major challenges for listed companies is communicating with its shareholders and getting their e-mail addresses registered. In most of the cases, the members are either not traceable or contact details are not updated. Taking into consideration such practical difficulties but at the same time ensuring effective participation, the depositories and registrars are also assisting listed companies in co-ordinating with the shareholders. Listed companies are ensuring that all the shareholders are served with the notice of general meeting. However, it is important to note that under Section 101 of the Companies Act, 2013 (“the Act”) any accidental omission to give notice to, or the non-receipt of such notice by any member shall not invalidate the proceedings of the meeting. MCA has also directed listed companies to publish notice by way of advertisement in two newspapers (preferably having electronic editions) and are also required to disclose necessary information of the AGM through video conference. Voting at general meeting conducted via video-conferencing According to the Securities and Exchange Board of India’s (“SEBI”) principles governing disclosures and obligations of listed entity, shareholders shall be informed of the rules, including voting procedures that govern general shareholder meetings. The shareholders have an opportunity to ask questions to the board of directors, to place items on the agenda of general meetings, and to propose resolutions, subject to reasonable limitations. With this objective, the MCA has directed companies to ensure that such meetings of shareholders are conducted by two-way teleconferencing or Webex with a minimum capacity of at least 1,000 members to participate on a first-come-first-served basis. It would be a herculean task for listed companies in conducting such meetings of shareholders, especially, for the companies whose operations are largely affected by COVID-19. Presently, companies and market intermediaries are developing an online system or platform to ensure that such proceedings of the AGMs are in the proper flow and at the same time shareholders are able to propose resolution(s) and ask questions. A secured system needs to be developed wherein the shareholder can ask questions/counter-questions in the general meeting for a limited time and company management provides their response to the same. The Chairman of the company would also need technical assistance in conducting the AGM through VC. The Chairman would also need the assistance of directors, company secretary, chief financial officer, chief executive officer, etc. in replying to the queries raised by the members. Taking into consideration the overall uncertainty due to COVID-19 and genuine curiosity of investors, it is expected that there would be active participation of investors in the AGM through VC than the regular AGMs convened years before. Passing of resolution by postal ballot and e-voting for approving scheme of amalgamation In one of the cases[ii] before the Bombay High Court, the issue was, “whether the resolution for approval of Scheme of Amalgamation can be passed by a majority of the equity shareholders casting their votes by postal ballot, which includes electronic voting, in complete substitution of an actual meeting.” The High Court observed that at the heart of corporate governance lies transparency and a well-established principle of indoor democracy that gives shareholders qualified, yet definite and vital rights in matters relating to the functioning of the company in which they hold equity. Principal among these is not merely a right to vote on any particular item of business, so much as the right to use the vote as an expression of an informed decision. That necessarily means that the shareholder has an inalienable right to ask questions, seek clarifications, and receive responses before he decides which way he will vote. It may often happen that a shareholder is undecided on any particular item of business. At a meeting of shareholders, he may, on hearing a fellow shareholder who raises a question, or on hearing an explanation from a director, finally make up his mind. Interestingly, the High Court also observed that greater inclusiveness demands the provision of greater facilities, not less, and certainly not the apparent giving of one ‘facility’ while taking away a right. Taking into consideration the observations of Bombay High Court, it will be difficult for corporate restructuring activities of listed companies during this period of COVID-19 and lockdown. Passing of resolution by shareholders’

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FDI Policy Revision, 2020: A Dagger in the Arm of China or a Shot in the Dark?

1 Comment / Contemporary Issues / CBCL

[By Kartikey Sahai] The author is a fifth year student of Institute of Law, Nirma University. Introduction India and China, two of the top 10 economic superpowers of the world have, in a way, put to terms, their political debacle with India blowing a major cog in the wheel of China’s upper handedness, by putting restrictions on Chinese investment in India. On April 17, 2020, the Department for promotion of Industry and Internal Trade (“DIPP”) brought in an amendment to the extant Consolidated FDI Policy, 2017 (“Press Note 3”).[i] Consequent to this revision, an amendment was also brought about to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 on April 22, 2020. Prior to the introduction of this amendment, investments by non-resident entities were allowed in those sectors which are not prohibited as per the extant FDI Policy, with the exceptions of entities based out of Bangladesh and Pakistan. Post the inception of this amendment, the Government of India has revised this policy to include the provision for investment by entities based out of countries sharing land borders with India (read: China) or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can now invest only after obtaining prior approval from the Government of India. The objective of the revised policy, as stated in the Press Note 3, is to curb opportunistic takeovers/acquisitions of Indian based companies during the subsistence of the Covid-19 pandemic, in lieu of the People’s Bank of China buying out 1.01% stake in HDFC bank, worth approximately 1.75 crores shares of the bank.[ii] However, this revision brings about a crucial question relating to the financial sector into beckoning. Is the Indian industrial contingent ready to exclude Chinese investment into Indian companies, at the behest of government approval? Increased reliance of Indian industries on Chinese investments As per the quarterly fact sheet on FDI released by the DIPP up to March 2019, China ranks 18th out of the 164 countries that have FDI equity inflows in India, amounting to a total of INR 13,954.82 crores.[iii] Sectors such as the automobile industry (60%), the metallurgical industry (14%) and the electric equipment industry (4%), amongst others, attract the maximum FDI equity inflows.[iv] Another startling fact that needs to be taken account while evaluating the recent policy revision is that before the current NDA government came into power in 2014, the FDI equity inflows from China never crossed the 1000 crore mark, but as soon as the new government came into power, for two years consecutively, the figures reached the staggering mark of INR 3066.24 crores in 2014 and INR 2196.11 crores respectively.[v] Furthermore, as per the Secretary-General of India-China Economic and Cultural (“ICEC”) Council, China invested an estimate of about INR 2000 crores in 2017, in comparison to INR 700 crores invested by China in Indian companies in 2016.[vi] Moreover, despite issues such as Doklam which are clouding the bilateral ties between the two countries, India-China bilateral trade have amassed a whooping USD 71.18 billion in 2016 and USD 84.44 billion in 2017.[vii] Additionally, with the changes in the extant FDI policy of India, investments through indirect route have to be taken into account as well, such as that of INR 3500 crores invested by the Singapore subsidiary of the techno-giant Xiaomi.[viii] Interpreting ‘Beneficial Ownership’ under the revised FDI Policy The revised FDI policy, as amended by the press note of April 2020 seeks to hinder non-approved foreign investments into India from countries where the beneficial owner of an investment into India is situated or resides. However, the term beneficial ownership has not been defined anywhere, neither in the extant FDI policy, nor the FEMA rules. To analyze the problem in an in-depth manner, a glance may be had at Section 90 of the Companies Act read with Companies (Significant Beneficial Owners) Rules, 2018 which define the term ‘significant beneficial owner’, which is analogous to beneficial ownership. The relevant rules have laid down certain criterion for determining beneficial owners, such as individuals, who either directly or indirectly, hold 10% of the shares or 10% of the voting shares or have a right to receive a minimum of 10% of the total distributable dividend or have a right of significant control in such company. These Rules provide further clarifications as to how to ascertain the significant beneficial owner. However, as per these rules, only an individual may be deemed to be a significant beneficial owner. On the other hand, the revised FDI policy merely refers to the term ‘beneficial owner’, without clarifying whether it applies to individuals or body corporates as well. The Prevention of Money Laundering Rules, 2005 prescribe that a beneficial owner is a natural person, who alone or jointly in conjunction with a natural or artificial person, holds above 15% or 25% control over capitals or profits of the relevant company.[ix] Moreover, SEBI has also reiterated that a similar definition be adopted for the determination of beneficial ownership for the purpose of KYC as well.[x] However, such definition cannot be used for the purpose of ascertaining the meaning of beneficial ownership under the revised FDI policy, as these legislations were brought about mainly to nab the accused alleged to have been involved in laundering money and thus hold an altogether different connotation. International investment obligations envisioning the debacle The revised FDI policy has not put forth an enforceability date from which this revised policy will be brought into force. If India is intending to go big this time, it might as well grant retrospective effect to the tune of 5 to 10 years to strike a dagger in the heart of China’s involvement in the Indian market. This revision in the extant FDI policy of India has not brought about happy reactions with China terming this move as ‘discriminatory and against the general trend of liberalization of trade’.[xi] Even when it comes down to the bilateral obligations of India, it is not at the right side

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