Beneficial Ownership: The PN3 Conundrum
Updated: Aug 22, 2020
[This article is authored by Shambhavi Shekhar]
Press Note 3, 2020, (“PN3”) issued by the Ministry of Commerce and Industry, through the Department for Promotion of Industry and Internal Trade (“DPIIT”) on April 17, 2020, has opened doors for a lot of discussions and deliberations. Aimed primarily at reviewing the existing Foreign Direct Investment (“FDI”) Policy of 2017 and to safeguard the economic interests of Indian companies against exploitative and opportunist motives in the wake of a pandemic, PN 3, imposes restrictions on the receipt of FDI from countries sharing land borders with India (“restricted countries”) or when any investment is made in India and the “beneficial owner” of such an investment is either situated in or has the citizenship of those countries, by allowing investments only through the Government approval route. Further, in situations of transfer of ownership of present or future FDI resulting in beneficial ownership which falls in the aforementioned restrictions, then such a change would also call for obtaining government approval. Thus, there is no embargo, but only stricter regulation with respect to both, primary and secondary investments. Consequently, to give effect to PN 3, the Department of Economic Affairs, vide a notification dated April 22, 2020, substituted the existing proviso under Rule 6(a) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 by way of Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2020 (“NDI Rules”). Interestingly, neither the PN3 nor the amended NDI Rules define beneficial ownership, thereby opening floodgates of speculation around its interpretation, until a subsequent clarification is issued. This article aims at drawing references under existing statutes in respect of the term.
Beneficial Ownership - A Comparative Interpretation
The generic meaning of the term “beneficial” can be found in the Black’s Law Dictionary  as “tending to the benefit of a person; yielding a profit, advantage, or benefit; enjoying or entitled to a benefit or profit. This term is applied both to estates (as a "beneficial interest") and to persons (as "the beneficial owner")”. Further, it also defines a ‘general and beneficial owner’  to mean “the person whose interest is primarily one of possession and enjoyment in contemplation of ultimate absolute ownership”.
A closer look at the Foreign Exchange Laws of India finds that, albeit used but the term has not been given a particular definition even under the Foreign Exchange Management Act, 1999 (“FEMA”) or any of the regulations made thereunder. The FDI Policy, however, contains that while calculating indirect foreign investment, if any declaration has been made either under S. 89 of the Companies Act, 2013 or even under the old Companies Act of 1956 (S. 187 C), to the effect that any ‘beneficial interest’ is held by an entity which is not an Indian resident, in that scenario, even if the investment is made by Indian citizen who is also a resident, it would be considered as a foreign investment. The same has also been reiterated in the NDI Rules. Further, if more than fifty percent of the capital of a company s owned ‘beneficially’ either by resident Indian citizens or Indian companies, it would be said to have been owned by resident Indian citizens. Thus, even the FDI policy is silent as to the exact meaning of the term. In the context of the recent amendment, it may have a profound impact on investments received by India. In cases where the FDI is received from a country to which the restrictions of PN3 do not apply but the investing entity itself has investments from any of the restricted countries, government approval may still be required. However, no threshold has been provided, in order to categorize an investment as one which may or may not give rise to beneficial ownership and further lead to an opportunistic takeover or acquisition. This may trigger the imposed restrictions even if a relatively insignificant shareholding is exercised by any of the restricted countries in an investing entity. Entities, therefore, need to be vigilant and take necessary approvals. The term envisages different meanings and interpretations under different Indian enactments.
The Companies Act, 2013, vide S.89, requires that a declaration be made, in respect of any beneficial interest in the shares (no holding threshold provide).  This means if any person holds certain shares on behalf of the real owner or as a trust, all particulars of the beneficiary has to be disclosed. Per Contra, the person who now acquires the beneficial interest in the shares also needs to disclose the particulars of the person in whose name his shares were registered. S. 90 deals with the investigative part of beneficial ownership. However, it lays down the criteria for the determination of ‘significant beneficial ownership’ (“SBO”). An individual is a significant beneficial owner when he alone or with others (even a person resident outside India) who either holds the beneficial interest of at least 25% of the shares or has the right to exercise significant influence over the company. For the purposes of both these sections, i.e. 89 and 90, ‘beneficial interest’ includes the right of a person either in his individual capacity or with others, first, to exercise all or any of the rights which are attached to the shares held by him or second, to participate in dividend or other distributions associated with such shares, as enshrined u/S. 89(10). This has to be read along with the Companies (Significant Beneficial Owners) Rules, 2018 (“2018 Rules”) which lays down categories and their holding requirement in order to be classified as SBOs. For a company that is a member, SBO is the natural person holding at least 10% in the company’s share capital or exercises significant control. This was substituted by the Companies (Significant Beneficial Owners) Amendment Rules, 2019 (“2019 Rules”) which laid down that an individual would be an SBO if he alone or along with others, either, holds at least 10% of the shares, or holds at least 10% of the voting rights or possesses the right to receive at least 10% of the dividends/other distributions (direct or indirect holdings) or exercises significant influence over the company. As per Rule 2, significant influence means the power to participate in key policy decisions of the company pertaining to finances and operations. However, the mere exercise of control without any other of the aforementioned rights shall not make an individual an SBO. The whole rationale behind the introduction of these rules was to identify the actual owners who hold a beneficial interest in the company and the same to be reported. However, on one hand, S. 90 envisages a minimum holding of 25% whereas the SBO Rules provide for at least 10%. In absence of any clarification, the exact threshold of beneficial ownership cannot be determined and investors might need to take the government approval even if a minute shareholding exists by the restricted countries.
Sectoral regulators, Securities, and Exchange Board of India (“SEBI”) have ‘Know Your Customer’ (“KYC”) requirements. Pursuant to the SBO Rules, on December 07, 2018, it issued a circular mandating all listed entities to disclose SBO related details. Prior to that, on April 10, 2018, it issued another circular regarding the KYC requirement for Foreign Portfolio Investors (“FPI”). It stated that the identification of beneficial owners would be based on the Prevention of Money Laundering (Maintenance of Records) Rules, 2005, i.e, on ownership basis. For identifying beneficial owners in companies, the threshold is 25% ownership while for partnership firms or associations of persons, the threshold is 15% ownership or entitlement. This threshold can be reduced to 10% for FPIs from “high-risk jurisdiction”. Identifying the actual control flow has been stressed upon by the Securities Appellate Tribunal as well. In the case of Sahara Asset Management Company v. Securities and Exchange Board of India,  it stated that “in the securities market, SEBI Act empowers SEBI to take actions in the interest of protecting the interests of the investors and hence lifting the corporate veil to the extent to identify who controls a regulated entity cannot be faulted”.
The Prevention of Money Laundering Act, 2002 (“PMLA”) defines ‘beneficial owner u/S. 2(fa)’. It refers to an individual who has the final ownership or control of any of the clients of the entity who is reporting u/PMLA or individuals on whose behalf any transaction is carried out or who has the ultimate control over a juridical person.  Here, reporting entity includes banks and financial institutions, persons carrying on games of chance (See-casinos), and other persons engaged in other professions and activities as notified by the Central Government. The threshold for identification of beneficial owner is 25% ownership of either shares or capital and even profits in the company, as provided under Rule 9(3) the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005. This is known as the ‘controlling ownership interest’. Control means the right to partake in policy decisions, appoint majority directors, and even control management of the company. The threshold in case of a partnership firm and an association of persons is 15% ownership in capital and profits whereas, for a trust, it is 15% or more interest in the trust.
The absence of a concrete definition and threshold under PN3 has sparked a lot of speculations in the minds of industry stakeholders, investors, and investees alike. The aim of reviewing the FDI Policy was to safeguard the economic interests of Indian companies in the wake of the pandemic and avoid takeovers and acquisitions carried out with opportunist motives. It came as a clarion call when the People’s Bank of China raised its stake in HDFC. Amidst varying speculations and keeping in mind the object of the review, it can be said that if at all parallels are to be drawn with existing definitions, the SBO Rules can be said to be comparatively better aimed towards achieving the object, subject to any new clarification which may be issued by the Government of India. However, apart from this clarification, a few loopholes need to be plugged too such as investments from Special Administrative Regions of China (SAR) such as Hong Kong, where entities have a strong Chinese presence. Also, pursuant to this review, the NDI Rules have been amended but only with respect to FDI. Other investment modes still need to be considered. Further, how will these changes reflect in the light of the Bilateral Investment Treaty between India and China, is still a speculative topic. In light of these, a clarification is much awaited; especially as regards beneficial ownership so that a clear threshold is put in place, failing which, investment by any entity having any percentage of beneficial ownership from the restricted countries would require prior approval.
 Black’s Law Dictionary, Available here.
 Black’s Law Dictionary, Available here.
 S. 89, Companies Act, 2013.
 2017 SCC OnLine SAT 173.
 S. 2(fa), The Prevention of Money Laundering Act, 2002.
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