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Case Study: SEBI Settlement Order in the Matter of SREI Multiple Asset Investment Trust (a Category II AIF)

In this post, we look into the Adjudicating Officer’s (“AO”) Order dated November 29, 2017, in the matter of SREI Multiple Asset Investment Trust (“Fund”) and SREI Alternative Investment Managers Limited (“Investment Manager”) and the way the matter proceeded further, leading finally to a settlement on July 25, 2018 under the SEBI (Settlement of Administrative and Civil Proceedings) Regulations, 2014. The AO’s order cannot be considered to be conclusive because of the subsequent settlement order. However, a review of the entire saga provides some insight into how the Securities and Exchange Board of India (“SEBI”) interprets relevant provisions of the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).

Factual Matrix and Issues Raised before the AO:

The Fund had launched a scheme which was to primarily focus on financing brownfield assets which carries a lower execution risk as compared to greenfield assets. The following issues were dealt with in the proceedings before the AO;

  1. The Fund, instead of making investments of the amount raised from the investors, had gone on to grant loans to several entities, allegedly in breach of the AIF Regulations.
  2. Out of the investible corpus of the Fund, amounts in excess of 25% of the investible corpus were given to investee companies on two occasions, allegedly another breach of the investment conditions prescribed in the AIF Regulations.
  3. The Fund had acted in contravention of the decision of the investment committee of the Fund, and also had failed to follow the investment strategy as specified in their private placement memorandum.
  4. The Investment Manager failed in maintaining the minimum continuing interest of INR 5 crore in the Fund mandated in the AIF Regulations.

Summary of the AO’s order:

In the foregoing paragraphs the arguments on behalf of the Fund/Investment Manager and the reasoning adopted by the AO are summarized:

Issue 1: The defence taken by the Fund/Investment Manager was that the private placement memorandum of the Fund clearly stated that it was the Fund’s investment strategy to invest in forms of finance/loans to various companies. Further, the AO pointed out that the fund was registered as Category II AIF which included a “debt fund” that invests primarily in debt and debt securities. Thus, the Fund was not in contravention of Reg. 2(1)(b) of the AIF Regulations in giving loans as per its investment strategy.

Issue 2:  Reg. 15(1)(c) of the AIF Regulations require the investment commitment to not be more than 25% of the investible corpus of the Fund. According to the Fund, on the alleged date of investment (i.e. June 29, 2015), the investment commitment was indeed only 25%. However, post the investment (i.e. July 9, 2015), due to redemption of units of the Fund and distribution to investors, the total corpus of the Fund fell, and resultantly the investment commitment rose to about 28%. It was argued that since this was just an after-effect of the redemption of units, this was not an infringement of the said regulation. However, the AO ruled that the defence was inadmissible as they themselves had admitted to the investment being in excess of the 25% threshold post July 9, 2015.

Issue 3: According to the minutes of the investment committee of the Fund, and also as mentioned in the Fund’s private placement memorandum, the Fund had decided on the range of interest rates it would charge on their loans (14-16%), and also decided what the corpus of investment for each investee under the scheme would be (INR 50 crore–INR 200 crore). The Fund/Investment Manager took the defence that these ranges were only indicative in nature, and it was not intended that they would be strictly bound by them. However, the AO cited Paragraph 2(c) of SEBI’s Circular No. CIR/IMD/DF/7/2/2015 dated October 1, 2015 which prescribed that all managers shall carry out all the activities of the AIF in accordance with the placement memorandum circulated to all unit holders and amended from time to time in accordance with AIF Regulations and circulars issued by SEBI. It was decided that terms of the private placement memorandum must be complied with without any deviation, unless amended following the due process of law.

The AO here tried to propagate strict compliance of SEBI’s 2015 Circular to safeguard the interests of the investors. However, reference may be made to SEBI’s Circular No. CIR/IMD/DF/14/2014, dated June 19, 2014 which at Paragraph 2(b) states that only in cases of material deviations from the placement memorandum, the manager is bound to provide an exit to the investors. The investors are to be informed of any changes post-facto and are not bound to take prior approval. The strict compliance with placement memorandum that the AO’s order demands needs careful consideration, therefore.

Issue 4: Under Reg. 10(d) of the AIF Regulations, an Investment Manager is required to have a continuing interest in the Fund of not less than 2.5% or INR 5 crores (whichever is lower) in the form of investment. The defence taken was that the contribution of the Investment Manager reduced to INR 3.13 crore after some of its contribution was repaid to it as an investor of the Fund. The AO however decided that the continuing interest requirement had no exception and must be complied with at all times.

Developments after the AO’s order:

Interestingly, regarding the AO’s decision on whether the Fund could give out loans, the final settlement order dated July 25, 2018 published by SEBI indicates a different conclusion. The settlement order was prepared in consultation with the High-Powered Advisory Committee (HPAC) of SEBI. According to the said settlement order, a new show-cause notice dated February 2, 2018 was issued to the Fund for using the investible corpus for the purpose of giving loans.

Further, the Fund and Investment Manager were required to provide an undertaking by way of an affidavit, confirming that they would stop granting loans, the amounts given as loans shall be taken back and, in the future, there will be no loan activity. The reasoning for such conclusion is not captured in the settlement order.

Our Suggestions based out of the matter:

The AO’s order exhibits the strict nature of compliance demanded by SEBI with respect to AIFs in general. The following key suggestions are provided for all Funds and Investment Managers:

  1. It is highly advisable that appropriate protections through indemnities and limiting liabilities are provided in the fund documents for trustees, managers, or settlors. Furthermore, adequate insurance policies to protect the downside from such statutory penalties is also highly recommended.
  2. In light of the strict compliance demanded from the provisions of the private placement memorandum, it becomes increasingly important to draft them with extra attention to the investment strategies that will be adopted and to leave ample flexibility for the manager to execute the same.
  3. The order also reinforces focus and importance of regular monitoring of all regulatory compliances.


  1. Order of the Adjudicating Officer, dated November 29, 2017:
  2. Order of the Securities Appellate Tribunal, dated May 4, 2018:
  3. SEBI’s Settlement Order, dated July 25, 2018:
  4. SEBI’s Circular No. CIR/IMD/DF/14/2014, dated June 19, 2014:
  5. SEBI’s Circular No. CIR/IMD/DF/7/2/2015 dated October 1, 2015:

Authors: Mr. Avaneesh Satyang and Ms. Sohini Mandal


Treatment of Related Party and Related Party Transactions

Transactions between “related parties” are all too common and a host of legislations define the term “related party”. From law and tax stand-point, the requirement is to ensure reasonable judgment while making commercial decisions and to curb any undue advantages and misappropriation of assets, opportunities or information for personal profits that may be available by reason of “being related”. Various statutes have tried to address and regulate related party transactions by way of disclosures and pre and post transaction compliance. In this post, we have attempted to provide a brief overview of treatment of related party transactions (“RPT”) under various statutes.

There are other compliances, disclosure of methods of arriving at valuation for listed entities under SEBI (LODR) and Accounting Standards, which are we not touching upon.



Companies Act, 2013: The Directors of a Company are under a fiduciary duty to discharge the affairs of the Company in good faith. While acting in the authority of regulation of affairs of the Company, the Company may enter into transactions with related parties.

Who is a related party?

Section 2(76), Companies Act, 2013 r/w Rule 3 Companies (Specification of Definitions Details) Rules, 2014

Provides that in relation to a Company, a related party means: (i) a director or his relative; (ii) key managerial personnel or his relative; (iii) a firm, in which a director, manager or his relative is a partner; (iv) a private company in which a director or manager is a member or director; (v) a public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up share capital; (vi) anybody corporate whose Board, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;(vii) any person on whose advice, directions or instructions a director or manager is accustomed to act; and (viii) any body corporate which is—(a) a holding, subsidiary or an associate company of such company; (b) a subsidiary of a holding company to which it is also a subsidiary; or (c) an investing company or the venture of the company;

Rule 3, Companies (Specification of Definitions Details) Rules, 2014 provides that related parties would include any director (other than independent director) or key managerial personnel of holding company or his relative with reference to a Company.

What transactions are prohibited as RPT?

Section 188:  Prohibits the following transactions, unless approved by the Board:

a)    Sale, purchase or supply of goods and services; b) Selling or otherwise disposing of or buying property of any kind; c) Leasing of property of any kind; d) Availing or rendering of services; e) Appointment of agent for purchase or sale of goods, materials, services or property; f) Appointment of such related party to any office or place of profit in the company, or its subsidiary or associate company; g) Underwriting of any securities or derivatives of the company.

What are the prescribed conditions for entering into related party transaction?

Rule 15 of the Companies (Meetings of Boards and Its Power) Rules 2014:

Board Approval: All related party transactions need Board approval.

RPTs can be entered into after obtaining Board approval. Companies Act, 2013 prescribes the conditions that should be met for approval.

Voting: A director, who is interested in a contractual agreement with a related party shall abstain himself from such meeting wherein discussion on such matter are taking place. This restriction is not applicable in instance where the company in which ninety per cent. or more members, in number, are relatives of promoters or are related parties.

Shareholders’ Approval: In the below-mentioned cases, in addition to board approval, the Company also requires a shareholders’ approval via an ordinary resolution:

a)    If the following type of transactions amount to at least 10% of turnover of the company or Rs. 100 crore, whichever is lower :-

i.    Sale, purchase or supply of goods or materials ;

ii.   Selling, buying or otherwise disposing of property;

iii.  Leasing of property;

iv.  Availing or rendering of any services, directly or through appointment of agent.

The limit specified above shall apply for transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

b)    Appointment to office of profit to a company, it’s subsidiary, associate or holding at a remuneration exceeding INR 2.5 lakh per month.

c)    Remuneration for underwriting subscription of securities or derivative of exceeding 1%.

What are the exemptions under RPT?

i) any transactions entered into by a Company in its ordinary course of business entered at arm’s length basis (as explained below).

ii) Board approval shall not be required for transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.

What are the compliance for related party transactions?

RPT provisions provide for the following types of disclosures

i)     Board Meeting: Agenda of the board meeting shall disclose details such as the name of the related party, the nature of the relationship as well as all material terms of the contract and all financial payments due.

ii)    Interested Directors Disclosure: All directors shall provide a disclosure in MBP-1 of his concerns and interest in other companies.

iii)   Board Report: The justification for any RPT must be given in the Board’s report to the shareholders.

iv)   Disclosures made in Register: All companies have to maintain one or more registers in MBP 4, and shall enter the particulars of the RPT.

What are the powers of the Audit Committee in relation to RPT?

Under Section 177(4) of the Companies Act, 2013 it is required that the audit committee (if any constituted in accordance with Section 177) approves or modifies the RPT, post scrutiny as per the provisions of the Act.

For the above, the audit committee has the power to obtain professional advice from external sources and have full access to information contained in the records of the company.

Any transaction of amount not exceeding INR 1,00,00,000/- entered into by a director or officer of the company without obtaining the approval of the Audit Committee and not ratified by the Audit Committee within three months from the date of the transaction, shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it.

What is the penalty for non-compliance?

Any contract or arrangement into by a director or an employee without obtaining the consent or ratification of the Board or by a resolution in the general meeting is voidable at the option of the Board and the director shall have to indemnify the company for any loss occurred.

Any director or any other employee of a company, who had entered into or authorized the contract or arrangement in violation of the provisions shall

(i)    in case of listed company, be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees, or with both; and

(ii)   In case of any other company, be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees.

Related Person under Goods and Services Tax (GST) regime*

Under the GST regime, transactions between related persons are treated as Supply even if made without consideration. All transactions including those listed in Schedule 1 of the Central Goods and Service Tax, 2017 even if made without consideration are now taxed under the GST regime. The parties pay tax on the same and later claim it as an input tax credit.

What is the definition of Related Persons? Explanation to Section 15(5) of the Central Goods and Service Tax Act provides for the definition of Related persons

a)         persons shall be deemed to be “related persons” if––

(i)         such persons are officers or directors of one another’s businesses; (ii) such persons are legally recognized partners in business; (iii) such persons are employer and employee; (iv) any person directly or indirectly owns, controls or holds twenty-five per cent. or more of the outstanding voting stock or shares of both of them; (v) one of them directly or indirectly controls the other; (vi) both of them are directly or indirectly controlled by a third person; (vi) together they directly or indirectly control a third person; or (vii) they are members of the same family. 

b)         the term “person” also includes legal persons including entities incorporated outside India;

c)         persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.

This definition has been adopted from the Customs Valuation Rules, 2007, Rule 2(2). The only modification appears to be that under the Customs Valuation Rules, Explanation II, the persons who are associated in the business of one another where one is the sole agent or sole distributor or sole concessionaire, have to meet one of the abovementioned seven specified criteria to qualify as being ‘related’; however, under the Act, the persons associated in the business of one another shall qualify as ‘related persons’ merely by virtue of being the sole agent or sole distributor or sole concessionaire.

What transactions will be treated as Supply and be taxed even when made without consideration? Schedule 1 of the Act, 2017:

1.      Permanent transfer or disposal of business assets where input tax credit has been availed on such assets.

2.       Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business:

        Provided that gifts not exceeding fifty thousand rupees in value in a financial year by an employer to an employee shall not be treated as supply of goods or services or both.

3.      Supply of goods—

a)      by a principal to his agent where the agent undertakes to supply such goods on behalf of the principal; or

b)      by an agent to his principal where the agent undertakes to receive such goods on behalf of the principal.

c)       Import of services by a taxable person from a related person or from any of his other establishments outside India, in the course or furtherance of business

How do you determine the value of taxable supply?

Section 15 of the CGST Act r/w Rule 2, 4 and 5 of the GST Valuation Rules

Section 15 provides for the determination of the value of taxable supply.

a)   the price actually paid or payable for the said supply of goods or services or both where the supplier and the recipient of the supply are not related and the price is the sole consideration for the supply.

Inclusions: all taxes, cess, amount to be paid in relation to supply, incidental expenses, interest or late fee, subsidies etc.

Exclusions: discounts etc.

Rule 2 provides for the determination of value of supply of goods or services or both between distinct or related persons, other than through an agent will be:

a.   be the open market value of such supply;

b.   if open market value is not available, be the value of supply of goods or services of like kind and quality;

c.   if value is not determinable under clause (a) or (b), be the value as determined by application of rule 4 or rule 5, in that order.

If the supply is of good intended for further supply the value shall, at the option of the supplier, be an amount equivalent to ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person.

Provided where the recipient is eligible for full input tax credit, the value declared in the invoice shall be deemed to be the open market value of goods or services.

Rule 3 provides that if the supply is via an agent the value of supply shall be the open market value of the goods being supplied, or at the option of the supplier, be ninety percent of the price charged for the supply of goods of like kind and quality by the recipient to his customer not being a related person, where the goods are intended for further supply by the said recipient;

Rule 4 and Rule 5 provides for the determination of value based on cost and for the residual method for determination of the value of supply.

Treatment of Related Persons under Income Tax Act, 1961

(Please obtain the opinion of a tax expert)

What is the definition of Relative? Rule 2(41) of the Act, 1961 provides that a relative, in relation to an individual, means the husband, wife, brother or sister or any lineal ascendant or descendant of that individual.
For the purpose of calculation of business income:

How is Specified Persons defined?


Although Section 40 A(2) does not make specific reference to related party but disallows expenses or payments made to specified persons

These specified persons are as below:

a)    In case of an individual: relatives or associates or any person in whose business or profession the assessee himself or his relative has a substantial interest.

b)    In case of a company, firm, association of persons, HUFs; any director, partner, member of association, member of the family or their relatives, members of family or their relatives, any person in whose business or profession, as mentioned or relative has substantial interest, any individual, company or firm or association of persons or HUFs who have substantial interest in the business or profession of the assessee, any other company carrying on business or profession in which the abovementioned company have substantial interest.

–      Substantial interest means: In case of a company, beneficial ownership of not less than 20% voting power and at least 20% of the profits in any other case.

Interestingly, the Court In CIT v V.S. Dempo And Co. Pvt.Ltd336 ITR 209, has held that a subsidiary is not a related party for the purpose of section 40 (2)(b).  

What are associated enterprises and how are arms-length transactions determined?

Chapter X, Section 92 of the Income Tax Act, 1961 provide that any income arising from an international transaction shall be computed at arm‘s length price.

Section 92 A provides that associated enterprise in relation to other enterprise, shall mean an enterprise which participates, directly or indirectly, or through one or more intermediaries, in the management, control, or capital of the other enterprise. The same is determined on various thresholds such as:

a)       Voting power: directly or indirectly, holds shares carrying atleast 26% of voting power.The question arises hereon since contractually many entities provide voting rights to even preference shareholders. Since statutorily voting rights are now given to preference holders, thus may not be considered for the purpose of the limit of 26%.

b)       Loan advancement: if the loan advanced by an enterprise to another constitutes atleast 51% of the book value of total assets of the latter (the borrowing enterprise).

c)      Guarantee for borrowing: guarantees at least 10% of the total borrowings of another enterprise.

d)      Appointment of Management/ Managerial Personnel’s: if more than 50% of the Board of Directors or members of the Governing Board, or one or more Executive Directors or Members of the Governing Board of an enterprise is appointed by another.

e)      Dependability: If manufacturing or processing of goods or articles of an enterprise is wholly reliant on use of certain intangible assets of another or if atleast 90% of raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise are supplied by the other enterprise and the prices and other vital terms are fixed by the other enterprise;

f)       Sale of Manufactured Goods: if the goods or articles manufactured or processed by an enterprise are sold to another enterprise, and the prices and other vital terms are fixed by the other;

Control of another enterprise: if two enterprises are controlled by the same individual or by his/her relatives. On the other hand, if an enterprise is controlled by a Hindu Undivided Family (HUF) and the other enterprise is controlled by a member of such HUF or their relatives.

Further, Section 92F provides for the definition of arms length as the price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions”

How Is the Computation of arms’ length price done?

Section 92 C of the Income Tax Act, 1961 provides for the methods of computation of arms-length for transactions with related parties, which are: (i) comparable uncontrolled price method;(ii) resale price method;(iii) cost plus method;(iv) profit split method;(v) transaction net margin method and (vi)such other method as maybe prescribed by the Board.

 Disclaimer: Related Party transactions, law, treatment in books of account, tax impact is very nuanced. This note is only from knowledge sharing perspective and any action to be taken should with an expert’s guidance.

Authors: Ms. Ayushi Singh and Ms. Sohini Mandal


Ecommerce: Intermediary’s liabilities and duties

The Delhi High Court in the case of Christian Louboutin SAS v. Nakul Bajaj and Ors.[i], (hereinafter Louboutin case) has dealt in detail the circumstances where an E-commerce platform could be considered as an intermediary and when it loses the safe harbour  under the Information Technology Act, 2000 (“Act”).

The facts of the case are as follows. The defendant has been operating a website named (“Website”) offering for sale, various luxury products including the plaintiff’s brand of luxury shoes under the brand “Christian Louboutin”. The plaintiff (Christian Louboutin SAS), claims that the Website gives an impression that it is in some manner affiliated, sponsored or has been approved by the plaintiff for selling the plaintiff’s luxury products. The plaintiff therefore claimed that the display of plaintiff’s product on the Website results in the infringement of trade mark rights of the plaintiff and dissolution of the luxury status enjoyed by its products and brands.

The defendant’s claimed that the Website is an intermediary, as it not selling the products, but is merely enabling booking of such products through its online platform and that it is only booking orders on behalf of the sellers whose products are being displayed on their platform.

E-commerce platform and their role as intermediaries

In an e-commerce marketplace platform, it usually displays the name of the sellers and assists the customers by providing reviews of the various sellers who are listed on the platform. It also provides for other services such as online payment, maintaining warehouses, delivery and the like. The question that arises is at what point can the platform can say it is only an intermediary.

Section 2(w) of the Information Technology Act defines an intermediary as an “intermediary, with respect to any particular electronic records, means any person who on behalf of another person receives, stores, or transmits that record or provides any service with respect to that record or provides any service with respect to that record and includes telecom service providers, network service providers, internet service providers, web-hosting service providers, search engines, online payment sites online auction sites, online- market places, and cyber cafes.”

In Google France SARL, Google Inc. v. Louis Vuitton Malletier SA & Ors. (hereinafter, ‘Google France’), one of the point noted it that “it is necessary to examine whether the role played by that service provider is neutral, in the sense that its conduct is merely technical, automatic and passive, pointing to a lack of knowledge or control of the data which it stores.”

The Google France case has laid out certain principles on the liability of intermediaries and the Louboutin case makes a reference to it. Below are some useful excerpts from the judgement:

  1. Exemptions from liability of intermediaries are limited to the technical process of operating and giving access to a communication network. Such an exemption is needed for the purposes of making the transmission more efficient.
  2. The activity of the intermediary is merely technical, automatic and passive – meaning thereby that the intermediary does not have any knowledge or control over the information which is transmitted or stored.
  3. The intermediary gets the benefit of the exemption for being a “mere conduit” and for “caching”, when it is not involved in the information which is transmitted/translated.
  4. If any service provider deliberately collaborates with the recipient of a service, the exemption no longer applies.
  5. In order for the service provider to continue to enjoy the exemption, upon obtaining knowledge of any illegal activity, the service provider has to remove or disable access to the information.
  6. In order to constitute a mere conduit, the service provider should not initiate the transmission, select the receiver of the transmission, or select or modify the information contained in the transmission.
  7. The storage of the information has to be automatic, intermediate and transient.
  8. The provider should not obtain any data based on the use of the information.
  9. For claiming exemption from damages, the service provider should not have any knowledge of the illegal activity, and upon acquiring knowledge, should expeditiously remove or disable the information.
  10. Service providers do not have a general obligation to monitor the information which is transmitted or stored.

In the case of  L’Oreal SA & Ors. v. eBay International AG & Ors.[ii], the Court of Justice of European Union held that an operator which provides assistance “which entails, in particular, optimizes the presentation of the offers for sale in question, or promotes them”, even if the operator has not played active role and he provides the above service, the operator can claim protection as an intermediary. However, the said intermediary, if upon becoming aware of the facts which lead to an inference that the offers made on the website were unlawful, failed to act expeditiously, then the exemption ceases.

It is essential to determine whether the service provider played an active role or not, and whether it has the knowledge or control over the data which is stored by it. Further, if the service provider has no knowledge, then upon obtaining knowledge of the unlawful activity, it should expeditiously remove the data or disable access, failing which the service provider may become liable.

In Inwood Laboratories, Inc. v. Ives Laboratories, Inc.[iii], the question of contributory negligence with regard to infringement of trademark by the online service provider and the manufacturer (famously known as ‘Inwood Test’) observed that “if a manufacturer or distributor intentionally induces another to infringe a trademark, or if it continues to supply its product to one, whom it knows or has reasons to know is engaging in trademark infringement, the manufacturer or the distributor is contributorially responsible for any harm done as a result of the deceit”.

In the Louboutin case, the Honourable High Court of Delhi, observed that the defendant had a membership fee to place an order for goods on the Website, guaranteed authenticity that the products procured and sold were from the international boutiques and luxury stores, shipping to customers would be only after quality checking.

The Court opined that the safe harbour provisions for intermediaries under section 79 of the Act is not absolute. An active participation by the intermediaries is to be examined and if there is an active participation then the ring of protection or exemption granted to the intermediaries would not apply.

With regards to trademark infringement, section 101 of the Trade Marks Act states “that a person shall be deemed to apply a trade mark when (a) the mark is placed, enclosed or annexed to any good which are sold or are exposed for sale, (b) when the mark is used in relation to the goods or services in any sign, advertisement, invoice, catalogue, business paper price list”. Further, section 102 states that “a person shall be deemed to falsely apply to goods or services a trade mark, who without the assent of the proprietor of the trade mark (a) applies such mark or a deceptively similar mark to goods or services or any package containing goods; (b) uses any package bearing a mark which is identical with or deceptively similar to the trade mark of such proprietor, for the purpose of packaging filling or wrapping therein any goods other than the genuine goods of the proprietor of the trade mark”. Therefore, when an ecommerce website actively participates and allows storing of counterfeit goods, it would be aiding in the infringement of the trademark.

In the Louboutin case, the Delhi HighCourt held that the defendant had not sold the plantiff’s products on its Website, though the Website did advertise and promote the plaintiff’s brand and products. The Court did not order for damages/ rendition of accounts.

The Court did give the following directions to the defendant on the activities of running the Website as an intermediary so as to (i) disclose the complete details of all its sellers, their addresses and contact details on its website (ii) obtain a certificate from its sellers that the goods are genuine (iii) If the sellers are not located in India, prior to uploading a product bearing the Plaintiff’s marks, it shall notify the plaintiff and obtain concurrence before offering the said products for sale on its platform (iv) If the sellers are located in India, it shall enter into a proper agreement, under which it shall obtain guarantee as to authenticity and genuinity of the products as also provide for consequences of violation of the same (v) Upon being notified by the Plaintiff of any counterfeit product being sold on its platform, it shall notify the seller and if the seller is unable to provide any evidence that the product is genuine, it shall take down the said listing and notify the plaintiff of the same, as per the Intermediary Guidelines 2011 (vi) It shall also seek a guarantee from the sellers that the product has not been impaired in any manner and that all the warranties and guarantees of the Plaintiff are applicable and shall be honoured by the Seller. Products of any sellers who are unable to provide such a guarantee would not be, shall not be offered on the Defendant’s platform (vii) All meta-tags consisting of the Plaintiff’s marks shall be removed with immediate effect.

It is certainly interesting to note the thought process of the Court and the direction that it took, in this judgment.

Author: Mr. Anuj Maharana


[i] Christian Louboutin SAS v. Nakul Bajaj and Ors., CS (COMM) 344/2018

[ii] L’Oreal SA & Ors. v. eBay International AG & Ors., Case C-324/09

[iii] Inwood Laboratories, Inc. v Ives Laboratories, Inc.,456 U.S. 844

Anti-dilution protection in shareholders agreement – Implementation under Indian laws

Anti-dilution protection is one term which is present in almost every investment transaction. From the perspective of the founders, especially in case of a start-up or an early stage company, it is very important to understand the implications of having such a provision in the shareholders agreement (SHA). Founders generally tend to agree to so-called “standard” terms in the SHA, when in dire need of the investment. An anti-dilution provision has to be reviewed closely in order to ensure it is not too harsh on the founders and also since the transaction documents set precedents for the subsequent round of investments. This article discusses some of the main methods of anti-dilution protection usually seen in transactions in India and some of the difficulties associated with actual implementation of such anti-dilution provisions.

What is Anti-Dilution Protection?

Before moving to anti-dilution, we need to understand the concept of dilution. Dilution is the decrease in the shareholding percentage of a shareholder in a company due to increase in the number of outstanding shares. For example, when a company receives subsequent round of investment, the shareholding percentage of the existing investors gets diluted. It is good to have the value of a company increase in subsequent rounds of funding. However, there might be situations when a company may not perform or grow as expected due to which the value of the share decreases. In such a scenario, anti-dilution protection is triggered by the existing investors to maintain their shareholding percentage in the company to a certain extent (which is explained below).

Essentially, anti-dilution protection is such protection given to the existing investors of the company when new shares are issued in a subsequent round at a price per share which is lower than the price paid by the existing investors. It is pertinent to note that anti-dilution protection is applicable only when shares are issued at a price per share which is lower than the price paid by the existing investors and not for every subsequent issue of shares. The reason being that, if shares are being offered to subsequent investors at a price per share which is higher than the price per share paid by the existing investors, even though their percentage shareholding in the company reduces, the value of the shares held by them increases.

Anti-Dilution Protection and its Variants

In India, the two commonly used forms of anti-dilution protection are: (a) Full Ratchet and (b) Broad Based Weighted Average.

Full Ratchet: Under this method, if shares are issued at a subsequent round of investment at a price per share that is lower than the price per share paid by the existing investors of the company, then the price of the shares/ conversion price of the existing investors will be revised to the price at which the new shares being issued. In such scenario, either additional shares will be issued to the existing investors for the surplus consideration after such price adjustment without the existing investors making any further payments or conversion price would be revised to the price of such shares being issued. Thus, the full-ratchet method does not consider the number of shares held by the existing investors or the number of shares being issued in the subsequent investment round, but only considers the price at which the new shares are being issued and the new price will be applied to all the shares held by the existing shareholders. Thus, the full ratchet method of anti-dilution protection is very harsh on the Company and the Founders as compared to the broad based weighted average method. Also, the shareholding percentage of the founders may get diluted to a very large extent if a full ratchet provision is implemented.

Broad Based Weighted Average: As compared to full ratchet mechanism, broad based weighted average method uses a formula which considers the number of shares issued in a subsequent round of investment and the number of shares held by the existing investors. Therefore, the broad based weighted average method is fair to the founders as well as to the investors and is adopted more frequently in investment transactions. The weighted average formula used in the transaction documents describe how the weighted average price is determined by taking into the consideration the existing price or the conversion price of the shares, number of outstanding shares prior to the new issuance, the number of shares to be issued and the purchase consideration to be received by the company with respect to such issuance.

Implications of Anti-Dilution Provision 

Pricing Guidelines under Indian Laws:

Any further issuance of shares by a Company registered in India shall adhere to various provisions of the Companies Act, 2013 (the “Act”), Foreign Exchange Management Act, 1999 including rules and regulations notified thereunder, regulations prescribed by Securities Exchange Board of India (“SEBI”) (if applicable) and Income Tax Act, 1961 (the “IT Act”).

In India, implementation of anti-dilution protection is complex considering the existing laws. For instance, shares issued to foreign investors need to be in compliance with the pricing guidelines as provided in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“FDI Regulations”). As per the pricing guidelines, capital instruments which are issued or transferred to a foreign resident has to be priced as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a chartered accountant or a SEBI registered merchant banker or a practicing cost accountant in case of an unlisted company.

Convertible Instruments: Additionally, in case of convertible instruments, the price/ conversion formula of the instrument should be determined upfront at the time of issue of the instrument and the price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the FDI Regulations. Therefore, even adjusting the conversion ratio of a convertible instrument can pose complexities.

Considering aforementioned guidelines, enforcement of anti-dilution provisions and issue of shares pursuant to the same, especially to non-residents will be very difficult. Also, implementation of anti-dilution which results in issuance of new shares for no consideration, would not be allowed under the Act (which is applicable for both resident and non-resident investors).

Tax: Further, there is a complication which has to be examined under tax laws. As per section 56 (2) (x) (c) of the IT Act, when any person receives shares for a consideration which is less than the aggregate fair market value (FMV) by an amount exceeding fifty thousand rupees, the aggregate FMV of such property as exceeds such consideration is taxable as ‘income from other sources’ in the hands of the person receiving such shares.

Our thoughts:

Considering the nuances associated with the issuance of shares at a price below FMV or for no consideration, the actual implementation of anti-dilution provisions poses a lot of difficulties. Unless certain exceptions are brought in the existing laws, actual implementation could be a challenge in India, especially with respect to foreign investors.

Authors:  Mr. Paul Albert and Mr. Ashwin Bhat

Determination of Significant/Ultimate Beneficial Ownership under the Indian Laws and Laws of other jurisdictions

The global scenario was riddled with the issue of money laundering, bribery, corruption, insider trading, tax fraud, terrorist financing and other illegal activities. These global issues were suggested to be combated by the Financial Action Task Force (FATF), an inter-governmental body established in 1989. The FATF was set up with the objective to lay down standards and promulgate efficient execution of legal, operational and regulatory measures for combating these.

The Guidance on Transparency and Beneficial Ownership released in October 2014 (which can be accessed at (“Recommendations”), noted that corporate entities such as companies, trusts, foundations, partnerships and other types of legal persons and arrangements enter into an array of activities, both entrepreneurial and commercial in nature. The Recommendations note that these entities have been misused on more than one instance in various money laundering, bribery, corruption, insider trading, tax fraud, terrorist financing and other illegal activities. An exposure of some of these activities became widely known as “The Panama Papers”. These entities made it easier to convert and camouflage the income received from these activities as a part of the revenue stream of the corporate entities and the FATF operates to unmask this camouflage and promote transparency.

The Ministry of Corporate Affairs (MCA) notified the provisions surrounding disclosure of Significant Beneficial Ownership on 6 June 2018. In addition to notifying the provisions under the Companies Act, 2013 (Act), the MCA notified the Companies (Significant Beneficial Owners) Rules, 2018 (“Rules”) on June 13, 2018. Section 90 of the Act read with the Companies (Significant Beneficial Owner) Rules, 2018 are notified with an intent to ensure adequate, accurate and timely information on the beneficial ownership of companies to the regulatory authorities and to identify and verify the identity of the individuals who ultimately own and control a corporate entity.

Legal Framework under Indian Laws

Framework under the Companies Act

The intent of Section 90 of the Companies Act, is to determine the identity of the person behind the curtain who is having a significant ownership of the company and is essentially controlling the management and daily affairs of the company. (For a more detailed reading regarding the applicable rules and the intricate nuances, please refer to our earlier post, which can be accessed here.  

Reading of the Act and the Rules together, every person who, while acting alone or together or through one or more persons or through a trust, hold beneficial interest of not less than 10% of the shares in the company with the names of such owners not being entered in the register of members of the company as the holder of such shares would qualify as significant beneficial owners and are required to make a declaration to the company in which significant beneficial ownership is held. The declaration should specify the nature of beneficial interest by way of Form No. BEN-1. The Company is under an obligation to make a filing of Form No. BEN-2 on receipt of the declaration received by the significant beneficial owner within 30 (thirty) days of receipt of the declaration. The Company is under an additional obligation to maintain a register of significant beneficial owners and keep them open for inspection by shareholders of the Company. The availability of register for inspection is in line with the original intent of promoting transparency regarding the structure of companies. The onus of disclosure regarding significant beneficial ownership has been laid primarily on natural persons holding, either directly or indirectly, independent of their domicile or residential status. The company can serve a notice seeking information under Form BEN-4. The person on whom the notice has been served is required to revert to the company within 30 days of receipt of notice. Wherein the company is not satisfied with information provided or person fails to furnish required information, is entitled to apply to the Tribunal within 15 days of expiry of the period mentioned in the notice.

Framework under other Indian legislations

The identification and reporting of significant beneficial ownership is an issue that has been earlier dealt with under other legislations as well before the Act and Rules. The various legislations that it has been dealt with under earlier are:

Prevention of Money Laundering Act, 2002 (PMLA): The PMLA puts an onus on the banks, financial institutions and intermediaries for the identification of beneficial owners of their clients. The PMLA defines a beneficial owner as “an individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control over a juridical person.”

SEBI Guidelines: The concept of beneficial ownership has been dealt under the SEBI guidelines by way of Master Circulars release by SEBI which are:

a. SEBI Master Circular No. CIR/ISD/AML/3/2010 dated December 31, 2010: This Master Circular puts a mandatory onus on all registered intermediaries to obtain all information about their clients and additionally are required to identify and verify the identity of persons who beneficially own or control the securities account as part of their Client Due Diligence policy.

b. SEBI Master Circular No. CIR/MIRSD/16/2011 dated August 22, 2011 and MIRSD/SE/Cir21/2011 dated October 5, 2011: This Master Circular mandates the identification of beneficial owners by way of Prescribed uniform Know Your Client (KYC) requirements for the securities markets.

c. SEBI Master Circular No. CIR/MIRSD/2/2013 dated January 24, 2013: This Master Circular provides uniform guidelines on identification of BO, based on Government of India’s consultation with regulator.

RBI Master Direction on KYC, 2016 (Master Direction) and Rule 9 of the PML (Maintenance of Records) Rules, 2005: The Master Direction defines a beneficial owner as “a natural person(s), who, whether acting alone or together, or through one or more juridical person, has/have a controlling ownership interest or who exercise control through other means”. The Master Direction defines controlling ownership interest as ownership of/entitlement to more than 25 per cent of the shares or capital or profits of the company and control as the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.

Legal framework under other jurisdictions[1]

Jurisdiction Term used Governing legislation Definition
United Kingdom Person with significant control Companies Act, 2006[1] Designated ‘person with significant control’ (PSC) defined as individual who holds directly or indirectly more than 25% of shares/voting rights in company; has right to appoint or remove majority of board of directors; or has right to exercise/actually exercises significant influence or control over company/trust/ firm.
United States of America Beneficial Owner FinCEN’s Beneficial

Ownership Rules[2]

Any individual who, directly or indirectly, owns 25 percent or more of the legal entity customer; and One individual who has “significant responsibility to control, manage, or direct the legal entity.
Brazil Final beneficiary The Brazilian Federal

Revenue’s Normative


An individual that holds control or significantly influences the legal person to be registered, which occurs when the individual (i) holds, directly or indirectly, percentage superior to 25% of the corporate capital of such person or (ii) holds or exercises great influence, directly or indirectly, on the corporate deliberations and has the power to appoint the majority of the managers of the legal entity, even without controlling it.
European Union Beneficial Owner European Commissions

Anti-Money Laundering


Any natural person who ultimately owns or controls customer, and/or natural person on whose behalf transaction or activity is conducted.

[1] Section 790C read with Schedule 1A of the Companies Act, 2006

[2] Section 1010.230(d), FinCEN’s Beneficial Ownership Rules

[3] Article 8, The Brazilian Federal Revenue’s Normative Instruction 1634

[4] Paragraph 13, Directive (EU) 2015/849 of the European Parliament and of the Council, 20 May 2015

Key Differences between Indian and legislations from other jurisdictions

Key Points of Legislations under other jurisdictions Indian Legislation Differences
United Kingdom i.    Individual who holds directly or indirectly more than 25% (twenty-five) of shares/ voting rights in company;

ii.   has right to appoint or remove majority of board of directors; or

iii.  has right to exercise/ actually exercises significant influence or control over company/ trust/ firm.

i.    the natural person who holds 10% (ten) of the share capital of the Company;

ii.   who exercises significant influence;

iii.  control through other means

The provisions in UK and India differs in:

i.    the threshold of the shareholding percentage.

ii.   An additional qualification regarding the right to appoint or remove majority of board of directors in the UK legislation.

United States of America i.    Individual who, directly or indirectly, owns 25 percent or more of the legal entity customer; and

ii.   One individual who has “significant responsibility to control, manage, or direct the legal entity.

The point of difference between the US and Indian provisions is the threshold of the share holding percentage.
Brazil Individual that holds control or significantly influences the legal person to be registered, which occurs when the individual:

i.    holds, directly or indirectly, percentage superior to 25% of the corporate capital of such person or

ii.   holds or exercises great influence, directly or indirectly, on the corporate deliberations and has the power to appoint the majority of the managers of the legal entity, even without controlling it.

The points of difference between the Brazil and Indian provisions are:

i.    the threshold of the share-holding percentage.

ii.   The Indian provision lays an emphasis on the concept of control whereas in the Brazilian provision, a person may be deemed as a final beneficiary if influence is exercised even without there being the presence of control.

European Union Any natural person who ultimately owns or controls customer, and/or natural person on whose behalf transaction or activity is conducted.

The key point of difference between the EU provision and the Indian provision is that where a prescribed threshold has been provided under the Indian law, the EU legislation lacks one. The EU lays an emphasis on who the ultimate owner behind the corporate veil is without prescribing a minimum threshold as a qualification.

From the comparison elucidated above, it can be seen that the threshold for determination of significant beneficial ownership is more stringent in India as compared to the legislations of other jurisdictions. The lower threshold increases the scrutiny of ultimate ownership. It would help if there is clarity on “exercising control through other means” constitute.

Author: Mr. Spandan Saxena


[1] Disclaimer: It is recommended that the reader refer the laws of the analyzed jurisdictions and consult a person who is an expert in the following jurisdictions. The aforementioned jurisdictions have merely been used for an analytical purpose and do not constitute a legal opinion in any manner whatsoever.

[2] Section 790C read with Schedule 1A of the Companies Act, 2006

[3] Section 1010.230(d), FinCEN’s Beneficial Ownership Rules

[4] Article 8, The Brazilian Federal Revenue’s Normative Instruction 1634

[5] Paragraph 13, Directive (EU) 2015/849 of the European Parliament and of the Council, 20 May 2015

Contract Labour: Principal Employers Responsibilities

The Contract Labour (Regulation and Abolition) Act, 1970 (the “Act”) is one of the most significant labour legislations in India as the objective of the Act is to prevent exploitation of blue-collar workers and ensure facilitation of better conditions of work for them. One of the significant stakeholders, under this legislation, are the ‘principal employers’, who may not always be completely aware of their specific obligations under the legislation. However, the role of principal employers is very important for better implementation of the Act. In view of this, we have attempted to provide a brief overview of how principal employers can be more compliant under the contract labour legislation and ensure effectiveness of the regime.

Some of the important provisions and definitions under the Act are reflected below for ease of reference:-

Applicability of the Act

The Act applies to every establishment in which 20 or more workmen are employed or were employed on any day of the preceding twelve months as contract labour and to every contractor, who employs or has employed 20 or more workmen on any day of preceding 12 months[1]. This threshold for applicability, however, varies in certain states. For instance, in Maharashtra and Andhra Pradesh, the Act becomes applicable only if 50 or more workmen are employed or were employed on any day of the preceding 12 months as contract labour[2]. In West Bengal, on the other hand, the Act applies to every establishment employing 10 or more workmen[3]. Also, the Act is not applicable to establishments in which work only of an intermittent or casual nature is performed.

Who is a Principal Employer?

As per Section 2 (1) (g) of the Act, a principal employer would mean and include the head of any government or local authority; the ‘owner’ or ‘occupier’ or ‘manager’ of a factory (under the Factories Act, 1948); owner, agent or manager of a mine; or any person responsible for the supervision and control in an establishment. Establishment means any office or department of the Government or local authority or any place where industry, trade, business, manufacture, or occupation is being carried on[4].

Every principal employer to whom the Act becomes applicable has to take registration under the Act. In the event the principal employer does not obtain registration as required under the Act, he shall be punishable with imprisonment which may extend to 3 months or with fine which may extend to Rs. 1,000/- or with both and in case of continuing contravention, there will be an additional fine of Rs. 100/- for every day during which such contravention continues after conviction for the first such contravention. If the principal employer liable to be punished under the Act is a company, the company as well as every person in charge of, and responsible to, the company for the conduct of its business at the time of commission of the offence shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly unless any such person can prove that the offence was committed without his knowledge or that he exercised all due diligence to prevent the commission of such offence.

Who is a Contractor?

As per Section 2 (1) (c) of the Act, a contractor would mean any person, who supplies contract labour for any work of an establishment and includes a sub-contractor. Every contractor to whom the Act applies has to take license under the Act.

 Who is a Workman and what is Contract Labour?

The definition of ‘workman’ under the Act includes any person employed in or in connection with the work of any establishment to do any skilled, semiskilled or un-skilled manual, supervisory, technical or clerical work for hire or reward, whether the terms of employment be express or implied, but excludes certain categories as such[5]. As per section 2 (1) (b) of the Act, “a workman shall be deemed to be employed as ‘contract labour’ in or in connection with the work of an establishment when he is hired in or in connection with such work by or through a contractor, with or without the knowledge of the principal employer”.

Certain Important Obligations of a Principal Employer

  • With the objective of improving the working conditions of contract labour, the Act has various provisions for providing basic facilities/ amenities to contract labour such as canteens, rest-rooms, first aid facilities, etc. The liability to provide these facilities are on the contractor. However, in the event a contractor does not provide these facilities to the contract workers, the liability is on the principal employer to provide these facilities. Any expenses incurred by a principal employer in providing these facilities to the contract labour can be recovered from the contractor.
  • The Act also imposes an obligation on the contractor to pay the wages to the contract workers within such period as fixed by the Government. However, the principal employer has to nominate a representative duly authorised by him who should be present at the time of disbursement of wages. The duty of such representative of the principal employer shall be to ensure that the wages are being paid to contract labour in accordance with the Act. The contractor has to ensure that the wages are disbursed in the presence of the authorised representative of the principal employer.
  • In the event the contractor fails to make the payment or makes short payment, then the liability is on the principal employer to pay the wages in full or the unpaid balance due. The principal employer can recover the amount so paid from the contractor either by deducting from any amount payable to the contractor or as debt payable by the contractor.

It is important to note here that penalties are sometimes imposable on the principal employer, in case of non-compliance under certain other labour welfare legislations. For instance, non-payment of provident fund contribution, non-maintenance of provident fund records is punishable with respect to a principal employer by imprisonment for a term which may extend to 1 year, or with fine which may extend to Rs. 4,000/- or with both[6]. Non-maintenance of ESI records by either contractor or principal employer is punishable with simple imprisonment up to 1 year or fine up to Rs. 4,000/- or with both[7].

Prohibition of Contract Labour in Core Activities

The Act prohibits use of contract labour in certain core activities of an establishment if the same has been specifically prohibited through a notification of the Central or State Government. Therefore, the principal employer and the contractor has to ensure that they are not employing contract labour in any of the core activities. For instance, the State of Andhra Pradesh has amended the Act to state that a core activity is one for which an establishment is set up and includes any activity which is essential or necessary to the core activity but activities related to canteen and catering services, sanitation works, loading and unloading operations, etc. does not come under the ambit of core activities unless these activities themselves are not the core activities of such establishment[8]. However, the principal employer may engage contract labour to a core activity if such activity is normally done through contractors or such activity does not require full time workers or if there is a sudden increase in the volume of work in the core activity which needs to be completed in a specified time[9].

 Absorption and Regularisation of Contract Labour

Absorption of contract labour and their status once the contract comes to an end has always been one of the most contentious issues with respect to contract labour. In the case of Air India Statutory Corporations v United Labour Union[10], a three-judge bench of the Hon’ble Supreme Court held that the contract workers had a right to be absorbed as permanent workers on abolition of contract labour. However, this decision was overruled by a five-judge bench of the Hon’ble Supreme Court in the case of Steel Authority of India v National Union Water Front Workers and Others[11], where it was held that contract labour does not have a right to get absorbed as regular employees since nothing in this regard has been mentioned explicitly in the Act. The apex court in the case of Secretary, State of Karnataka v Uma Devi[12], inter alia, held that contractual employees does not have a right to be absorbed.

Also, Courts have ordered for regularisation of contract labour, in cases where it has been found that the principal employers employed contract labour where the purpose seems to be to avoid providing benefits available to permanent workers, or if the ultimate control is with the principal employer[13].

Engagement between Principal Employer and Contractor

A principal employer would typically have a contract for service with a contractor whereby the contractor will undertake to provide certain number of contract labour to the principal employer from time to time. Some of the important elements that needs to be considered as a part of these agreements, in view of the above discussions, are as follows:-

  • Scope of work for which contract labour is required (cannot be core activities or of perennial nature[14]);
  • Contractors representation of having complied and obligation to continue to be compliant with all responsibilities and obligations of a contractor under the Act and applicable state rules.
  • Periodic reporting and submission of records and documentary evidences pertaining to contributions made, registers maintained, etc., by the contractor to the principal employer.
  • Payment of service fee to contractor by principal employer;
  • Enabling clause for deductions from service fee payable, in case any expense is incurred by a principal employer on behalf of a contractor (as mentioned briefly above).
  • Zero control of principal employer over contract labour.

Separately, as good governance measures, the agreements between principal employers and contractors may also have provisions for conducting regular awareness programmes for making the contract labour aware of their rights and privileges under the Act. Also, independent committees may be set up which can be approached by contract labour in case of any grievance.

[1] Section 1(4) of the Act

[2] as visited on 16 October 2018

[3] as visited on 16 October 2018

[4] Section 2(1)(e) of the Act

[5] Section 2(1)(i) of the Act

[6] Section 14(1) of the Employees Provident Fund and Miscellaneous Provisions Act, 1952 r/w Para 76 of the Employees Provident Fund Scheme, 1952

[7] Section 44 r/w section 85 of the Employees State Insurance Act, 1948

[8] Section 2 (1) (dd) of Contract Labour (Regulation and Abolition) (Andhra Pradesh) (Amendment) Act, 2003

[9] Section 10 (1), ibid

[10] (1997) 9 SCC 377

[11] (2001) LLR 96

[12] AIR 2006 SC 1806

[13] Hindalco Industries Limited v Association of Engineering Workers – 2008 LLR 449 (SC)

[14] National Federation of Railways Porters, Vendors & Bearers Vs. Union of India (UOI) and Ors.  – JT ((1995) 4 SC 568)

Author: Paul Albert


Mumbai ITAT Provides Further Relief and Clarity on Valuation of Preference Shares

ACIT v Golden Line Studio Pvt. Ltd.

ITAT, Mumbai

I.T.A. No. 6146/Mum/2016 (Assessment Year 2011-12)

Judgment date: 31/8/2018

Factual Matrix of the Dispute

The case revolves around an instance of issuance of non-convertible redeemable preference shares (“RPS”) by a company called Golden Line Studio Pvt. Ltd. (the Assessee) to its holding company. The stance taken by the Assessing Officer (“AO”) in this case was that the RPS were issued at a premium of INR 490/- over the face value (INR 10/-) of the shares which seemed excessive and amenable to tax.

Brief Description AO’s Contentions

The AO in this case contended that there was no basis provided by the Assessee to justify the premium amount on the RPS, and thus had a Net Asset Valuation of the Assessee done, basis which the AO arrived at a fair market value of the RPS INR 38/- per share and contended that the share premium for the RPS also ought not have been more than INR 28/- per RPS.

The CIT(Appeals) in this case took a view that the AO was resorting to the provisions under Section 56(2)(viib) of the Income Tax Act, and since the provisions was only effective from Assesment Year 2013-14, it would not apply to the present instance.

However, the AO clarified before the CIT(A) and also before the ITAT, that the AO sought to assess the income from the share premium received by the Assessee under Section 68 of the Income Tax Act. According to the AO’s contention, under Section 68 of the Act, the Assessee is required to prove the “nature” and “source” of the receipts, otherwise income tax could be levied as unexplained cash credits. The AO implied that the excessive share premium was not accompanied with an appropriate justification as to the ‘nature’ of the receipt.

Tribunal’s Decision

The Tribunal disagreed with the contentions of the AO, and stated that the AO had misdirected himself in assessing the net asset value of the company for the RPS. The Tribunal pointed out that since Section 56(2)(viib) was not in play here, the AO did not have support of any provision of the Income Tax Act to assess the excess premium. The Bombay High Court’s decision in Vodafone India Services P Ltd v Union of India & Ors (2014) had settled that receipt by way of share capital is capital receipt, thus not assessable.

Moreover, the Tribunal observed and held that the ‘nature’ of the ‘share premium’ receipts was also not questionable because of the AO’s misdirected efforts confusing the different footings of equity and preference shares.

The ratio of this order is summarized as below:

Preference Shares and Equity Shares stand on different footing, the net asset value of a company really represents the value of Equity Shares and not the Preference Shares.”

It is so because preference shares are like quasi-debt instruments whereas equity shares are nothing but participating rights of the shareholders in the company. The valuation of equity shares is dependent on the intrinsic value of the company as they have rights in assets/funds of the company. On the other hand, valuation of quasi debt instruments like preference shares is entirely made on the basis of the returns received by the investor of such instruments.

In this case, the investor would receive a return of approx. 10% per annum, as the RPS were redeemable at a price of INR 750/- after 5 years of their issuance. Book value of the company related to the equity shares as such shares reflect the ownership over the assets of the company, but because of the different considerations involved in the quasi-debt nature of RPS, book value of assets cannot justify their pricing.

Important Takeaways

Share Premium as Capital Receipt

The ruling reinforces that share premium is a capital receipt and capital receipts should not be taxed unless a provision of the Act specifically deals with the aspect.

The Statutory Framework reflects the judicial opinion of various tribunals and courts

It is interesting to note that the holding of the Tribunal that net asset value of shares do not apply to preference shares is reflected in the valuation rules under the Income Tax Rules as well. Rule 11UA lays down the formula under the net asset value method for valuation of the fair market value of equity shares. However, for shares other than equity shares, Rule11UA(1)(c)(c) clearly states that open market valuation method will be adopted to determine the fair market value.

Relief for Early Stage Companies

The ruling definitely provides some relief to early stage companies where investments are often raised by issuance of preference shares at premium, on valuations based on DCF method rather than NAV method. However, the ruling is restricted to RPS specifically, where there is a fixed return involved. As such, the principles that could be extended for valuation of compulsorily convertible preference shares, remains to be seen yet.

Authors: Avaneesh Satyang and Sohini Mandal