Category Archives: Articles

Space: Liabilities in India and other countries

Millions of pieces of space debris litter the space, be it defunct satellites (average lifespan of a satellite is 5-8 years) or the intentional destruction of satellites through anti-satellite missile testing (ASAT) demonstrated successfully by United States (US), Russia, China, and India (March, 2019). Disaster occurs when any debris travelling at high speeds strikes a working satellite/spacecraft, or falls back on earth.  There are mechanisms for tracking of more than 5,00,000 (Five Lakh)  space debris, so that liability can be fixed on the owner of the debris, while there are millions of smaller debris which cannot be tracked. Some examples of damage due to space debris include, damage of French satellite by debris from a rocket exploded a decade ago in 1996 and the destruction of functioning US Iridium satellite by collusion with a defunct Russian satellite in 2009. Countries have also developed certain mission control manoeuvres to avoid collision of debris with the spacecraft or satellites.

Space Law:

Liabilities related legislations are few in number. United Nations (“UN”) has published treaties governing space laws, requiring the member countries to ratify the treaties and to legislate suitable space laws in their respective countries. The five most important treaties of the UN are:

No. United Nations Treaties Ratification
1. 1967: Treaty on Principles Governing the Activities of States in the Exploration and Use of Outer Space, including the Moon and Other Celestial Bodies (“Outer Space Treaty”) To note that India, USA, UK, France, China etc. have ratified.*
2. 1968: Agreement on the Rescue of Astronauts, the Return of Astronauts and the Return of Objects Launched into Outer Space (“Rescue Agreement”)
3. 1972: Convention on the International Liability for Damage Caused by Space Objects (“Liability Convention”)
4. 1976: Convention on Registration of Objects Launched into Outer Space (“Registration Convention”)
5. 1979: Agreement Governing the Activities of States on the Moon and Other Celestial Bodies (“Moon Agreement”) To note that India and France have signed, while China has ratified. However, US, UK, Russia have not signed.*

*Countries that we have been reading for our compare and contrast.

Of the above 5 (five) treaties, the 1972 Liability Convention imposes a duty on nations/countries (“States”) to be responsible to the public activities undertaken as a sovereign country.  The Liability Convention mandate that the States are equally liable for both public as well as private activities undertaken on its soil, i.e., States need to take legislative action to regulate space activities on its soil, as they are liable to answer internationally for private space activities violating international space law. In case an Indian citizen launches a spacecraft from outside India say France, then it appears that both France and India are considered launching States.

A State can exercise three types of jurisdiction to attract liability for space activities as shown below:

  1. Territorial Jurisdiction: Most of the operations of the space are conducted at ground control stations by way of remote controlled activities. Whether to make a rocket shed its first stage or to make a telecommunications satellite to change frequencies by ground control stations, it will allow States to control activities in outer space, by way of control over the territorial sovereignty. Further, territorial jurisdiction also plays an effective role over launch activities.
  2. Personal Jurisdiction: Since a person’s nationality cannot be lost due to operation from a foreign soil, the State can exercise personal jurisdiction based on the control over any incorporated company or company headquartered in their territory.
  3. Registration Jurisdiction: No space object can be launched without registration by States. That is a sovereign right to exercise jurisdiction over even the earlier two territorial and personal jurisdictions.

Potential Liability: While certain other States have already framed the regulations for potential liability, India is still in the process of legislating, per below table of comparison on liabilities:

Country Description of State Law on Space
India ·       Under the Draft Space Activities Bill, 2017, Section 8(2)(h) proposes third party insurance

·       Section 12 mandates indemnification of Central Government subject to a quantum to be decided by the Government.

·       Section 13 proposes punishment with imprisonment of not less than 1 year but up to 3 years or with fine of not less than one crore rupees and for continuing offences with a fine of INR 50 Lakhs per day for not obtaining a license.

·       Section 25(2) proposes that any IP rights created onboard a space object shall be deemed to be property of Central Government

USA Section 16 of the Commercial Space Launch Act, 1984 mandates obtaining liability insurance under a license issued for an amount as is considered necessary by the Secretary of United States.
UK Section 10 of Outer Space Act 1986, mandates indemnification to Her Majesty’s government in the United Kingdom against any claims brought against the government in respect of damage or loss arising out of activities carried on by the licensee.
France Article 13 of the French Space Operation Act, 2008, mandates absolute liability for damage on ground and in air space for third party liabilities, while the liability is on a fault basis for damaged caused in outer space.  Further, there is a limitation for the term of liability up to one year from the date of fulfilment of obligations mentioned in the license.

Article 14-15 limits the claim for compensation from French Government to a fixed ceiling of 60 Million Euro and the private space operator is liable to reimburse for indemnifications exceeding 60 M Euro

The Department of Space is under the Prime Minister’s Office in India and there is a dire need to bring in a robust legislation to monitor and register private space activities. Even in the absence of any specific laws, the States are liable for any potential losses that may occur due to any damage caused by its citizens. With numerous space explorations being undertaken by private sector the world over, India too should encourage private space explorations and at the same time, also limit the liability on the exchequer.

Valuation of shares: Choosing the Valuer

Valuation in early stage companies should be market driven, as in, there is an investor willing to invest and a company which is primed to grow. The discussion between them should be the guiding factor.

However, this point is highly regulated and the valuation has to be proven to the satisfaction of the tax officers. Such discretionary powers are causing heart-burn.

Due to the many changes, there is confusion of which valuation method to use, who to take the valuation certificate from, etc.

Prior to October 2017, any practising chartered accountant having an experience for more than 10 years or a merchant banker, was recognised to determine the valuation of the shares.

On 18 October 2017, the Ministry of Corporate Affairs (MCA) mandated that the valuation report has to be obtained from a Registered Valuer[1] in certain cases. This entailed that any company issuing securities under section 42 or section 62(1) (c) of the Companies Act 2013 (the Act), would require the valuation report from Registered Valuer, who is registered with the Insolvency and Bankruptcy Board of India as per Companies (Registered Valuers and Valuation) Rules, 2017 (“Registered Valuer Rules).

However, in terms of Rule 11 of the Registered Valuer Rules, there was a transitional arrangement until 31 January 2019, to get a valuation report from a practising CA with 10 years experience.

In addition to these requirements and conditions, the Central Board of Direct Taxes (CBDT) on 24 May 2018 amended the Rule 11 UA of Income Tax Rules, 1962, by omitting the words “or an accountant” from rule 11UA (2)(b). This change meant that the valuation report has to be obtained only from a merchant banker.

Now comes the difficulty with compliance. Compliance under section 42 of the Act and Rule 11 UA is difficult, since there are very few merchant bankers, who are Registered Valuers too.

As a result, many investors ask the companies to get valuation certificates from all the different valuers.

Scenario 1: Requirement of valuation certificate from both Merchant Banker and Registered Valuer

Any company which is not a start-up India registered[2] and issuing equity shares/preference shares to persons who are residents in India (excluding SEBI registered funds) and such issuance is under Private Placement basis. As this issuance entails compliance under section 42, 62(1) (c) of the Act and section 56(2) of the Income Tax Act 1961, the valuation report from both merchant banker and registered valuer is mandatory.

Scenario 2: Requirement of valuation certificate only from Merchant Banker.

Any company which is not a start-up India registered and issuing equity shares/preference shares as rights issue under section 62(1) (a) (Rights Issue) of the Act either to persons residents in India or persons residents outside India, then valuation report from merchant banker is sufficient.

Scenario 3: Requirement of valuation certificate only from Registered Valuer

Under the following circumstances, the valuation report from Registered Valuer is sufficient:

(a) Any company which is not a start-up India registered and issuing debentures on private placement basis in terms of section 42, 62(1) (c) of the Act;

(b) Any company which is a start-up India registered and issuing equity shares /preference shares/ debentures;[3]

To present this as a checklist:

Type of Company Scenarios Valuation Report Requirement
Merchant Banker & Registered Valuer Only Merchant Banker Only Registered Valuer who is a Chartered Accountant
Start-up India registered Company (see point below) Issuance of Equity Shares/Preference Shares (Private Placement Basis) X X Yes
Issuance of Equity Shares/Preference Shares (Rights Issue) X

 

X Yes
Issuance of Debentures X X Yes
Other Companies Issuance of Equity Shares/Preference Shares (Private Placement Basis) Yes X X
Issuance of Equity Shares/Preference Shares (Rights Issue) X Yes X
Issuance of Debentures X X Yes

 There are several open points.

Question on applicability of section 56(2)(x)

An open point on valuation report from merchant banker in case of issuance of shares by start-up India registered companies, still requires clarification. This is because, section 56(2)(x) of the Income Tax Act, 1961 mandates to a person who receives shares from a company to get the valuation report from a merchant banker. While the start-up company is exempted only under section 56(2)(viib), receipt of such shares by a person is not exempted. This point still requires clarification from CBDT.

Other open questions:

While it seems that the requirement of valuation report is clear under various enactments, there is still ambiguity in terms of say: (a) whom to approach in case of a person who received shares from Startup India registered company; (b) how to deal when there is difference in fair market value arrived by Registered Valuer and merchant banker. This might require approaching a valuer who is recognised under Companies Act and Income Tax Act, who is both a Registered Valuer and a merchant banker.

Happy to hear your thoughts.

___________

[1] Registered Valuer means a person registered with the Insolvency and Bankruptcy Board of India in accordance with Registered Valuer Rules.

[2]  Companies registered with Department for Promotion of Industry and Internal Trade as Start-up.

[3] Start-up companies are exempted from section 56(2)(viib) of Income Tax Act 1961 pursuant to notification from CBDT dated 11 April 2018.

Highlights of the Companies Amendment Act, 2019

The Ministry of Corporate Affairs has amended the Companies Act 2013 vide the Companies (Amendment) Act, 2019 (the “Amendment Act”) notified on 31 July 2019. The Amendment Act takes into account the amendments that were already notified in the Companies (Amendment) Ordinance, 2018, which came into force on 2 November, 2018.

The major changes under the Amendment Act are broadly aimed at:

  • to improve the existing prosecution system by imposition of stricter penalties, under various sections, on the companies as well as the officers in default. Although this will increase the monetary burden on the company but will gradually help to reduce non-compliances.
  • to re-categorize certain compoundable offences as civil defaults and remove the criminal liability attached to them. The amendment has re-categorized certain penal provisions, where defaults that were punishable with fine/ and imprisonment have been amended to penalty. Now, the offences can be easily adjudicated with the authorities without going into time-consuming application procedures.
  • to transfer some of the approval powers from NCLT to the Central government i.e. ROC to reduce the burden of tribunals.
  • to bring accountability to the CSR activities undertaken by the Companies not only in letter but in spirit too.
  • greater accountability with respect to filing documents related to creation, modification and satisfaction of charges; non-maintenance of registered office to trigger de-registration process; holding of directorships beyond permissible limits to trigger disqualification of such directors, have also been introduced in the Amendment Act. Reforms pertaining to declaration of commencement of business provision.

Key Highlights of the Amendment Act:

Sr. No.

Category Highlights on the amendments
1.

 

Approval for Change in Financial Year

Any company or body corporate which is a holding company or a subsidiary or an associate company of a company incorporated outside India and is required to follow a different financial year for consolidation of its accounts outside India, may change its financial year with the approval of Central Government.

Prior to amendment, Tribunal’s approval was required.

2. Requirement of obtaining approval for Commencement of Business

Companies incorporated after Amendment Act, shall commence its business or exercise any borrowing powers only after filing a declaration with respect to the receipt of paid up value of the shares from the subscribers to the memorandum and the verification of Registered office within 30 days from the date of incorporation in with the Registrar of Companies. The declaration shall be filed within 180 days from the date of Incorporation.

3. Physical verification of Registered Office of the Company

Pursuant to amendment in Section 12, the Registrar is empowered to do the physical verification of the Registered office of a Company if it has reasonable cause to believe that the company is not carrying on any business or operations also to remove the name of the Company from the register of companies.

4. Approval for conversion of Public Company to Private Limited Company

Erstwhile, the Tribunal had authority approve or reject any alteration in the Articles of the Company relating to conversion of a public company into a private company. Pursuant to this amendment, the Central Government is empowered.

5. Securities to be in Dematerialized Form

A new provision has been inserted to Section 29, whereby securities of certain class or classes of unlisted companies, the securities shall be held or transferred only in dematerialized form in the manner laid down in the Depositories Act, 1996 and the regulations made thereunder.

6. Registration of Charge (due date for filing is reduced)

Section 77 has been amended whereby the extended period of 270 days has been now restricted to 60 days for filing an application to register a charge.

7. Responsibility of Identifying beneficial owner

Sub-section 4A has been inserted whereby every company shall take necessary steps to identify an individual who is a significant beneficial owner in relation to the company and require him to comply with the provisions of section 90. The introduction of this section brings more clarity for casting duty on company to identify and report on Significant Beneficial Owner to the Registrar. Further, Central Government has been empowered to make rules for the section.

8. Consequence of non-filing of Annual Return

Penalty provisions on non-filing of the annual return within the prescribed timeline have been revised and a further penalty of INR 100 per day on continuing offence subject to a maximum of 5 Lakhs has been imposed.

9. Section 117 (Resolutions and Agreements to be Filed)

The word ‘fine’ has been substituted with the word ‘penalty’ in the penalty provision and an additional penalty on continuing offence of INR 500 per day subject to maximum of INR 5 Lakhs have been imposed.

10. Section 135 (Corporate Social Responsibility)

Clarification has been provided for calculation of profits in case of newly incorporated Company by inserting following words under sub-section 5 “or where the company has not completed the period of three financial years since its incorporation, during such immediately preceding financial years”. On the unspent amount, a provision has been added to transfer the unspent amount to a fund specified under schedule VII within six months from the expiry of financial year has been provided unless it relates to an ongoing project.

In relation to any amount being unspent which relates to an ongoing project shall be transferred to a separate account to be opened by the Company to be called as the Unspent Corporate Social Responsibility Account within a period of 30 days from the end of Financial Year and such amount shall be spent within the period of three financial years from the date of transfer and in case of failure such amount shall be transferred to a fund specified in Schedule VII within 30 days from the date of completion of third financial year.

In case of default, the company shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees and every officer of such company who is in default, shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both.”

11. Automatic Vacation in case of Disqualification of Director

A new clause (i) has been inserted under Section 164 as “he has not complied with the provisions of sub-section (1) of section 165” which is one of the grounds of disqualification of a director where, if he/ she breaches the limits of maximum directorship allowed thereunder.

It is to be noted that falling under any of the clauses of Section 164 leads to automatic vacation of office from all the existing companies.

12. Stock options to Independent Director

Provisions pertaining to the prohibition on entitlement of stock option by independent directors. However, this omission shall not have any impact as Section 149 (9) also provides similar prohibition.

Further, the minimum fine of 1 lakh rupees and maximum fine of 5 lakhs rupees have been replaced with a penalty of INR 1 lakh for the defaulting person and in addition where any default has been made by a company, the company shall be liable to a penalty of five lakh rupees.

13. Oppression & Mismanagement

There is an insertion of 3 new sub-sections to the Section, where for the purpose of class of companies as may be prescribed the matter shall only be made before principal bench of the Tribunal and if in the opinion of Central government there exists circumstances as mentioned under sub section 3 clause (a) (b) (c) and (d), the Central Government may initiate a case against such person and refer the same to the Tribunal with a request that the Tribunal may inquire into the case and record a decision as to whether or not such person is a fit and proper person to hold the office of a director or any other office connected with the conduct and management of the company.

14. Powers of Tribunal in case of Oppression & Mismanagement

A new sub-section (4A) has been inserted to cast responsibility on the tribunal to record its decision at the conclusion of hearing case in respect of sub-section (3) of section 241, specifically as to whether or not the respondent is a fit and proper person to hold the office of director or any other office connected with the conduct and management of any company.

15. Section 243 (Consequence of termination or modification of certain agreements)

New Sub-sections (1A) and (1B) to the section has been inserted whereby in case a person is declared as not a fit or proper person pursuant to section 242(4A) under the case of oppression and mis-management, shall not hold the office of a director or any other office connected with the conduct and management of the affairs of any company for a period of five years from the date of the said decision provided that the Central Government may, with the leave of the Tribunal, permit such person to hold any such office before the expiry of the said period of five years.

Further, according to Section 243(1B), any person on being removed as Director or any other office connected with the conduct and management of affairs of the company, shall not be entitled to, or be paid, any compensation for the loss or termination of office.

16. Petition for winding up by Registrar

There is an amendment in sub-section (3) which enables the Registrar to present a petition for winding up under section 271 with the only exception mentioned in clause of Section 271 which talks about the situation where if the company has, by special resolution, resolved that the company be wound up by the Tribunal the Registrar may not present such petition.

17. Compounding of offences

The amendment has increased the limit of offence for compounding before the Regional Director from 5 Lakh rupees to 25 Lakh rupees in 441(1)(b). Further, it has been clarified in sub-section (6), that any offence which is punishable under this Act with imprisonment only or with imprisonment and also with fine shall not be compoundable.

18. Penalty for repeated default

New Section 454A has been inserted which talks about the penalty of repeated default. In this section a company or an officer of a company or any other person shall be liable to the twice the amount of penalty, who had already been subjected to the penalty under the Act. However, the subsequent default has to be repeated within 3 years from the date of order imposing penalty for earlier default.

Product Liability vis-a -vis the Consumer Protection Act, 2019

In India, we do not have one specific statute which covers the legal framework for product liability claims.

Product Liability prior to the Consumer Protection Act, 2019

Prior to the Consumer Protection Act, 2019 (“New Act”) there was no specific product liability theory in India. In the absence of a statutory law, courts were guided by the principles of justice, equity and good conscience and more than often guided by the provisions of English Law. The often cited case of Donoghue v. Stevenson[i] lay down the position where one owes a duty of care to another, and if such duty of care is breached, there is negligence irrespective of whether any contractual relationship exists between the parties or not.

Before we proceed with understanding the concept of product liability as mentioned in the New Act, we make it evident that there were certain laws in India which protected the interests of the consumers against faulty products. Some of the laws which have protected the interest of the consumers against faulty products would include, among others:

  • The Consumer Protection Act, 1986;
  • The Indian Contracts Act 1872;
  • The Sale of Goods Act 1930;
  • The Drugs and Cosmetics Act, 1945; and
  • The Prevention of Food Adulteration Act, 1954.

Though these laws touched on product liability to some extent, none of them could lay a comprehensive legal framework. These statutes were not able to identify a particular individual or entity in the supply chain against whom a consumer could raise a complaint. Thus, it was the need of the hour to establish a detailed product liability doctrine which would safeguard the interest of the consumers.

Product liability under the Consumer Protection Act, 2019

To strengthen the safeguards guaranteed to a consumer, the President gave his assent to the Consumer Protection Act, 2019 on 9th August, 2019. The New Act, introduces the concept of product liability, seeks to revamp the process and settlement of consumer disputes, establishes a Central Consumer Protection Authority as a central authority and Consumer Protection Councils at the district, state and national level, introduces penalties, covers unfair trade practices, unfair contracts, broadens the definition of a “consumer”, among other changes.

The New Act defines product liability[ii] as “the responsibility of a product manufacturer or product seller, of any product or service, to compensate for any harm caused to a consumer by such defective product manufactured or sold or by deficiency in services relating thereto.” The impact is that it is not only the manufacturer who will be liable to compensate a consumer but also the seller if it fulfils the conditions mentioned in the New Act[iii]. The New Act allows a person to raise a product liability action by means of filing a complaint before a District Commission or State Commission or National Commission[iv].

Manufacturer Liabilities

The New Act sets out the following scenarios in which a product manufacturer shall be liable:

  • the product contains a manufacturing defect, or
  • the product has a defective design, or
  • there is a deviation from the manufacturing specifications, or
  • the product does not conform to an express warranty given by the manufacturer (even when the manufacturer proves that it was not negligent or fraudulent in making the express warranty for the product), or
  • the product does not contain adequate instructions or any warning regarding improper or incorrect usage of correct usage to prevent harm.

Service Provider Liabilities

Similarly, a service provider shall be liable for:

  • providing services which were faulty, imperfect, deficient or inadequate, or
  • proving inadequate instructions and warning to prevent harm, or
  • providing services which do not conform to the warranty or the terms and conditions mentioned in the contract.

Seller Liabilities

The New Act even makes a product seller liable for a product liability claim if:

  • it has exercised substantial control over the designing, testing, manufacturing, packaging or labelling of the product, or
  • it altered or modified the product and such alteration or modification was a substantial factor in causing the harm, or
  • it has made an express warranty which is independent of the warranty made by a manufacturer and such product failed to conform to such express warranty made by the product seller which caused the harm, or
  • the identity of the manufacturer is not known or if known the service of notice or process or warrant cannot be affected on the manufacturer or it the manufacturer is not subject to the law which is force in India, or
  • the product seller has failed to exercise reasonable case in assembling, inspecting or maintaining the product or it did not follow the warnings or instructions for the product provided by the manufacturer while selling such product and such failure was the proximate cause of the harm caused to such product.

Exceptions to a product liability action claim

The New Act envisages certain scenarios where a product liability action cannot be brought against the product seller. No liability will be fastened on the product seller if at the time of harm, the product was misused altered or modified.

Further, a product liability action will not be fastened on the product manufacturer if it fails to provide adequate warnings or instructions, if:

  • the product was purchased to be used at a workplace and the product manufacturer had provided warnings to such employer, or
  • the product was sold as a component to be used in another product and necessary instructions and warnings had been given by the manufacturer, and the harm was caused to the complainant from the use of the end product, or
  • the product was one which was legally meant to be used under the supervision of an expert or a class of experts and the product manufacturer had employed reasonable means to give warnings or instructions for usage to such expert or class of experts, or
  • the complainant was under the influence of alcohol or any prescription drug while using the product which was not prescribed a medical practitioner, or
  • such instructions or warnings are obvious or commonly known to a user or a consumer of such product or which the consumer should have known, taking into account the characteristics of such product.

Implications

As per the New Act if the central authority is satisfied on the basis of investigation that there is sufficient evidence to establish violation of consumer rights or unfair trade practices, it may pass an order which could include:

  • recalling of goods or withdrawal of the goods;
  • reimbursement of the price of the products or services so recalled to the purchaser; and
  • discontinuation of practices which may be unfair and prejudicial to the consumers interest.

In addition, if the central authority is satisfied after investigation that any advertisement is false or misleading or is in contravention to consumer rights, it might issue a direction to the manufacturer or endorser or advertiser or publisher to discontinue such advertisement or modify the same.

Therefore, we see that the New Act is being cautious to employ responsibilities even on the endorsers or publishers of an advertisement. In this regard, the central authority may impose a penalty on a manufacturer or an endorser which may extend to Rs. Ten lakhs (Rupees One million). A subsequent contravention may result in levying the penalty to the tune of Rs. Fifty lakhs (Rupees Five million).

Further, the central authority may also prohibit the endorser from making endorsements of any product or service which may extend to one year and on a subsequent contravention to the tune of three years.

Additional safeguards placed for e-commerce companies

The central authority with a view to protect the interest of the consumers from the e-commerce entities who make direct sales to the consumers will provide for measures in the future which will protect the consumer from unfair trade practices in e-commerce.

____________________________

[i] [1932] UKHL 100

[ii] Section 2(34) of the Consumer Protection Act, 2019

[iii] Section 82 of the Consumer Protection Act, 2019

[iv] Section 2(35) of the Consumer Protection Act, 2019

Economic Downturn : Double impact for MSMEs

The news paper articles are talking about an impending economic downturn. The automobile industry is witnessing it already and so are many other sectors feeling the heat. A downturn means not only a reduction in revenues and squeezed profits, but also an issue on not receiving payments on time. Tax rates and rebates are certainly helpful.

Under Companies Act, if a company has not paid any Micro Small and Medium Enterprises (MSME) for more than 45 days, then the company has to inform the Registrar of Companies of the outstanding dues. This is one small step to address the giant issue of non-receipt of money.

There are several benefits that a MSME can avail and this post touches upon some of them.

Eligibility criteria for MSME

Micro, Small & Medium Enterprises Development (MSMED) Act, 2006 mandates any MSME to file Udyog Adhaar Memorandum (UAM) in Form-I appended to the Gazette Notification No.S.O.2052(E) dated June 30, 2017. Also, Section 7 of the MSMED Act, provides the below classification of enterprises, which is proposed to be enhanced through a 2018 Bill, which is yet to be passed by parliament:

Type of Enterprise

(All figures in INR)

MSMED Act, 2006 2018 Bill
Manufacturing Services All enterprises
Investment in Plant and Machinery in INR Investment in Equipment in INR Annual Turnover in INR
Micro 25 lakh 10 lakh 5 crore
Small 25 lakh to 5 crore 10 lakh to 2 crore 5 to 75 crore
Medium 5 to 10 crore 2 to 5 crore 75 to 250 crore

 Benefits available to MSME

Section 15 of the MSMED Act, 2016 mandates maximum of 45 days for making payments by a buyer to the goods/service supplied by an MSME, failing which Section 16 imposes a compound interest at three times the notified bank rate. The MSME facilitation centre also acts as a conciliator/arbitrator to decide the cases within 90 days of a dispute. This is the most important factor and if this process can be made more robust, then one of the biggest pain points of MSMEs will get addressed.

Subject to certain conditions, below are few other benefits available to MSMEs:

  • Interest subvention/rebate by 2% on any new/incremental loans
  • Online Delayed Payment Monitoring portal
  • Exemption from 2% TDS on cash withdrawal above INR 1 Crore
  • No merchant discount rate (MDR) chargeable on accepting debit/credit cards transaction
  • Online bill discounting system by selling trade receivables (TreDS)
  • Legacy dispute resolution scheme for closure of pre-GST litigations
  • Each bank to provide up to 1 Crore finance for woman in Greenfield investment
  • Credit guarantee scheme to cover liability of collateral free credit
  • Capital subsidy of 15% for technology upgrading
  • Capital subsidy of 25% to promote energy conservation
  • 75% subsidy for acquiring product quality certification
  • 75% financial assistance for business incubation for innovative ideas
  • 25% financial assistance for air-fare, space rent for international trade fairs
  • 4% per annum interest on working capital for interest subsidy eligibility certificate holders
  • INR 25,000 financial support on domestic patent and 50% discount on trademark processing
  • 75% financial assistance for obtaining bar code registration

Link for a complete list of Schemes: https://my.msme.gov.in/MyMsme/Scheme.aspx

Compliances to be undertaken by a company towards MSME

Companies registered under the Companies Act, 2013 are also forewarned by the Ministry of Corporate Affairs (MCA) to settle payments due to MSMEs within 45 days of the deemed acceptance of the goods or services.  Further, MCA, vide Notification dated January 22, 2019, has mandated filing of a half yearly return in MSME Form I by April 30th and October 31st every year by specifying the reasons for delay and amount of all outstanding payment due to MSMEs. Non-compliance will lead to punishment with penalty up to INR 25,000 for the company and either imprisonment up to 6 (six) months or fine for each of the key managerial persons.  Hence the companies are required to enquire if the suppliers are registered as an MSME or have obtained an UAM, to be in compliance.

Cancellation of MSME or Udyog Adhaar Memorandum

The MSMED Act, 2006 is silent on the closure procedure and hence, a physical application need to be filed with the respective General Managers of District Industry Centres in respective Districts, to withdraw the registrar. It is recommended that MSME who do not fall within the eligibility criteria as they grow their businesses to cancel their registration. It helps in avoiding the  misuse of registration.

There are many benefits that MSMEs can avail, but the bureaucracy and the process has to be demystified substantially.

Income Tax clearance: M &A or secondary transactions

Obtaining a no objection certificate or prior permission under section 281 of Income Tax Act, 1961 (Section 281 Certificate) is a mandatory ‘conditions precedent’ in a merger, acquisition or a secondary transaction. A general disdain is the time it takes to obtain the permission. Without the permission, the transaction could risk being voided by the tax department.

This article analyses the significance of the Section 281 Certificate, when should it be procured and implications if not procured.

tax certificate

Breaking down Section 281

As per Section 281 of the Income Tax Act (“Act”), in the event an assessee creates a charge or parts with the possession (by way of sale, mortgage, gift, exchange or any other mode of transfer whatsoever) of, any of his assets in favour of any other person, during the pendency of any proceeding under the Act or after the completion thereof, but before the service of notice under Rule 2 of the Second Schedule of the Act, such charge or transfer shall be void as against any claim in respect of any tax or any other sum payable by the assessee as a result of the completion of the said proceeding or otherwise. As per the explanation to the section, ‘asset’ includes shares and securities as well.

The section has the following exceptions in which case, such charge or transfer is not void:

  • if it is made for adequate consideration and without notice of the pendency of such proceeding or, as the case may be, without notice of such tax or other sum payable by the assessee; or
  • if it is made with the previous permission of the assessing officer.

It may also be noted that this section applies to cases where the amount of tax or other sum payable or likely to be payable exceeds Rs.5000 and the assets charged or transferred exceed Rs.10,000 in value.

In a nutshell, section 281 of the IT Act requires an assessee to obtain the permission of the assessing officer before creating a charge on certain assets or transfer of certain assets in the event there are ongoing tax proceedings or pending claims/demands against such assessee. The main objective of section 281 is to safeguard the interests of the revenue against assessees who may fraudulently part with their assets to avoid payment of taxes.

Process for obtaining Section 281 Certificate

The Central Board of Direct Taxes through its Circular No. 4/2011 [F. NO. 402/69/2010-ITCC], dated 19-7-2011 (“Section 281 Circular”), has issued certain guidelines for obtaining the Section 281 Certificate. The format of the application (which also mentions the documents and other information to be provided) is also provided in the said Circular. The assessing officer may, at his discretion, ask for additional documents. The application is to be filed at least 30 (Thirty) days prior to the proposed transaction. The Section 281 Circular also contains the circumstances under which Section 281 Certificate could be granted by the assessing officer, the timelines within which the assessing officer has to grant/refuse the permission under section 281 and the validity of the certificate granted. It is interesting to note that the Circular provides for an approval timeline of 10-15 days.

It may also be noted that the assessing officer would require the approval from the Range Head for granting permission if the value of assets being transferred or on which charge is being created, or the amount of charge being created is Rupees Ten crores (Rupees Hundred Million) or more.

Analysis of Section 281

Going by the strict interpretation of section 281, the Certificate is required only when an assessee creates a charge or parts with possession of any asset, under the following circumstances:

  • If the transfer is made during the pendency of any proceeding under the Act, or
  • After the completion of any proceeding under the Act but before the service of notice under rule 2 of the Second Schedule of the Act.

It appears that strict interpretation seems narrow.

In most cases, in a M & A or in a secondary sale of securities, the purchaser insists on Section 281 Certificate to de-risk a possibility of a tax claim which in turn would impact the purchase consideration. As an extension to that, the purchaser also wants to apriori know of the possibility of tax claims, before releasing the purchase consideration. Hence, Section 281 Certificate is almost always a Conditions Precedent to the transaction. In cases where it takes a long time to obtain the Section 281 Certificate, the purchaser reluctantly moves it as a “conditions subsequent” but with a personal guarantee or specific indemnities from the seller/s to de-risk the possibility of the transaction being considered void by the tax authority.

Differential Voting Rights: Helping Tech Companies to an easy climb up the mountain of entrepreneurship

There is a common and a convenient rule of one vote – one share practised by most of the companies. This rule is generally referred to as voting rights on ordinary shares. However, when there is a requirement to deviate from this rule, the concept of differential voting rights comes into play. This differential voting rights are known as DVRs in India and dual-class shares or DCS in the international perspective. These DVRs are rights which are disproportionate to their economic ownership. When a promoter or shareholder wants to retain decision making powers and rights, they can do so by retaining shares with superior voting rights or by issuing of shares with lower or fractional voting rights to other investors.

The concept of DVR has been captured in the Companies Act, 2013 under Section 43 (a)(ii) which says, that a company limited by shares may have equity share capital with differential rights on voting, or dividends, or otherwise. Rule 4 of the Companies (Share Capital and Debentures) Rules, 2014, provides certain conditions which are required to be complied with, for issuance of shares with differential rights. SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015, (“SEBI (LODR) Regulations, 2015”) also dealt with DVRs, but, it prohibited the listed companies from issuing shares with superior voting rights.

The need for DVR

In the current era, India is going through vast developments and advancement in many sectors especially the technology and information technology sector. These developments and advancements require huge capital. For raising capital, the companies seek investments, but these frequent and vast investments may lead to dilution of founder/ promoter stake. In order to cope with this, issuance of DVRs are helpful.

The journey of the framework

Earlier in 2000, the concept of DVR came to India through the Companies Act, 1956, whereby Indian companies were allowed to issue DVRs. However, in 2009, the Securities and Exchange Board of India (SEBI) had disallowed the issue of shares with superior rights to voting or dividend by listed companies, but they were permitted to issue shares with fractional voting rights. In order to bring the new framework, SEBI had invited comments from public on a Consultation Paper named ‘Issuance of shares with Differential Voting Rights (DVRs)’ (Consultation Paper[1]). It dealt with both the shares with superior rights (Superior Rights Shares or SR Shares) and inferior rights (Fractional Rights Shares or FR Shares). The framework got approved by SEBI in its board meeting on June 27, 2019 , permitting issuance of SR share by listed company and disallowing issuance of FR shares.

A walk through in to the new framework

Eligibility conditions: 

A company to be eligible to issue DVRs in form of SR shares, shall adhere to the following conditions:

  1. The company issuing SR share shall be technology company. SEBI defines a technology company as one that is “intensive in the use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition”.
  2. The SR shareholder should be a part of a promoter group and whose collective net worth does not exceed INR 500 crore. The investment made by SR shareholders in the shares of the issuer company will not be considered while determining the collective net worth.
  3. The SR shall be issued only to promoters/founders who hold an executive position in the company.
  4. The issuance of the SR shares should be authorized by passing a special resolution in the general meeting.
  5. SR shares have been held for at least 6 months prior to filing the Red Herring Prospectus (RHP).
  6. SR shares should have voting rights in the ratio of minimum 2:1 and maximum 10:1 compared to ordinary shares.

Listing and lock-in period: Post the IPO, the issuer company can list the SR shares on Stock Exchanges. However, SR shares are subject to lock-in after the IPO, until they are converted into ordinary shares. Transferring, pledging or lien of SR shares among promoters is prohibited under the framework.

Rights of SR shares: Except for voting on resolutions, the SR shares will be treated at par with ordinary shares in all other aspects. The total voting rights of SR shareholders (including ordinary shares), post listing should not exceed 74%.

Additional rules for companies with SR shareholders pertaining to enhanced corporate governance: The listed  companies issuing SR shares shall comply with the following rules for “enhanced corporate governance” such as:

  1. i) As prescribed under the SEBI (LODR) Regulations, 2015, Independent directors should comprise at least 1/2 of the board and 2/3 of committees (excluding the audit committee) and
  2. ii) The audit committee should only have Independent Directors.

Coat-tail provisions: After the IPO, the SR shares will be given same treatments as ordinary equity shares in terms of voting rights with respect to the following matters:

  1. Appointment or removal of Independent Directors and/or Auditors
  2. Cases where promoter is willingly transferring control to another entity
  3. Related Party Transactions involving SR Shareholder as per SEBI (LODR) Regulations, 2015
  4. Voluntary winding up of the Company
  5. Alteration of the Articles of Association or Memorandum of Association, except any such changes affecting the SR shares
  6. Voluntary Resolution Plan initiated under Insolvency & Bankruptcy Code, 2016
  7. Funds utilized for purposes other than business
  8. Substantial value transaction based on materiality threshold as prescribed under SEBI (LODR) Regulations, 2015
  9. Passing of special resolution for buy-back or delisting of shares
  10. Any other provisions as notified by SEBI from time to time

Sunset clauses: SR shares can be converted under two circumstances:

  1. Time based: After 5 years of listing, the SR Shares shall be converted to Ordinary Shares. By passing a resolution, the validity can be extended only once by 5 years. However, the SR shareholders shall not be allowed to vote on such resolution.
  2. Event based: In the event of demise, resignation of SR shareholders, merger or acquisition where the control would be no longer with SR shareholder, etc., the SR shares shall be compulsorily get converted into Ordinary Shares.

Changes to be incorporated in various laws pursuant to DVR framework:

The Companies Act, 2013: As stated earlier, under Section 43(a)(ii) of the Companies Act, 2013, and Rule 4 of the Companies (Share Capital & Debentures) Rules, 2014 framed under the Companies Act, 2013 prescribes that shares with DVRs in a company, shall not exceed 26% of the total post-issue capital. However, the new framework extends the limit to 74%. Therefore, corresponding changes are required to be brought in the Companies Act, 2013.  Another limiting factor in the Companies Act, 2013 is that “the company must have a consistent track record of distributable profits for the last 3 years”, but criteria for 3 years is silent on IPOs.  Such a criteria may not be helpful and rather impossible for all start-ups. Therefore, this matter should also be taken into consideration.

Securities Contracts (Regulation) Rules, 1957 (‘SCRR’): A company with multiple classes of equity shares at the time of undertaking an IPO, is required to make an offer of each such class of equity shares to the public in an IPO. Further, Rule 19(2)(b) of SCRR provides that minimum dilution and minimum subscription requirements as prescribed have to be complied with, separately for each class of the equity shares. It is a mandatory requirement under the rule that all kinds of shares shall be listed. There is no provision for listing one kind of share and not listing another. As the new framework demands for listing of SR shares without offering to public, it leads to a doubt for a company with different classes of shares whether it should proceed with listing all kinds of share or keep few of such equity shares unlisted. Therefore, a clarification is required in this regard.

SEBI (LODR) Regulations, 2015: Under regulation 41(3) of SEBI (LODR) Regulations, 2015, it has been stated that listed entity shall not issue shares which may confer to a person SR right on equity shares which are already listed. Therefore, an amendment is required which permits the grant of SR shares to equity shareholders.

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“SEBI Takeover Code”): Regulation 3 and 4 of SEBI Takeover Code provides that when an acquirer is holding 25% or more of the shares or voting rights in a target company, it has an obligation to make a public announcement of an open offer. Based on the stated Regulation of SEBI Takeover Code and the new DVRs framework, Regulation 10 is required to be amended in such a manner that Regulation 3 would not get triggered for making an open offer if the stated threshold is crossed by reason of SR shares getting lapse or converted into ordinary equity shares, provided that there is no attendant change in control in favor of the person crossing such threshold.

Further, Regulation 29 of SEBI Takeover Code requires disclosure for acquisition of additional voting right by holder of ordinary equity share. Since the change in voting rights brought after the conversation of SR shares to ordinary shares, which is an involuntary act on behalf of holder of ordinary equity share, there is a requirement of bringing change in format of disclosure under Regulation 30 of SEBI Takeover Code.

The pros and cons of DVRs:

Advantages from the perspective of issuer:

  • It solves the biggest issue of raising fund without diluting the voting right or the control of the founders/promoters over the company.
  • when there is ordinary equity shares issued to outside investors, there is a possibility that such shareholders acquire majority of the shares of the company and gain control over the management of the company, where as in the case of SR shares, this possibility is minimised.

Disadvantages from the perspective of issuer:

  • It is a challenge for the issuer to find such investors who are not interested in control and management of the company even after investing huge amount of money.
  • Issuing of SR shares is not considered a good corporate governance.

Advantages from the perspective of investor:

  • It is beneficial for those investors who are getting a higher rate of dividend over the ordinary shareholders.
  • The DVRs with FR shares are generally offered at a discount for equal number of shares.

Disadvantages from the perspective of investor:

  • DVRs with SR shares with the founders or large proportion of DVRs with FR shares with public investors, make management excessively powerful and can raise issues of corporate governance.
  • As a result of separating voting right from economic interests, there might be possibilities externalities like management entrenchment, excessive compensation of management, reduced dividend pay-out etc.

Conclusion

When we know that India is still considered to be a developing country and it has a lot of              competition with various other developed and developing states. India should have such corporate and commercial laws which are at par with the corporate and commercial laws of other countries. While India is giving majority of its space for incorporation and functioning of technology companies, it should have DVRs related laws like in US, Canada, Hong Kong etc. Such laws will help in raising the capital of tech companies. The applicability of DVRs law in India will not just help in growth and development of the tech companies in India, but it will also lead Indian tech companies to be good competitors for the tech companies incorporated in other nations.  It would help the promoters/founders of the company to grow their business fast. The only thing to be kept in mind by the companies while adopting such laws  is that, they shall also maintain a good corporate governance in their company.

Authors: Srisha Choudhary and Alivia Das

References:

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/apr-2019/1554115093453.pdf#page=1&zoom=auto,-16,800