Need to Comply with Laws Regarding Beneficial Ownership

Several years ago, when Panama Papers leaked it brought to light how offshore companies were being used for tax avoidance through total anonymity without complying with the Financial Action Task Force (“FATF”) requirements[1] of identifying beneficial owners of these companies. Panama Papers exposed offshore companies in certain jurisdictions were being set up for money laundering and terrorist financing.

The recent advisory by the Ministry of Corporate Affairs (“MCA”) (dated 11 October 2023) to all corporates requires every individual holding beneficial interest, whether directly or indirectly, of at least ten percent in shares of such a company to disclose to the company the nature of his/her interest within 90 days of acquiring such ownership. This advisory triggers the need for an analysis of the term “beneficial owner” and “significant beneficial owner”.

What is Beneficial Ownership?

Beneficial ownership of shares in simple terms means possessing the right to benefit from the shares.

A beneficial owner is a “natural person” who has the right to benefits attached to shares in a company, which may be through direct ownership of shares or indirectly through an agreement.

To tighten the grip on the wrongdoers, the Government of India recently amended the Prevention of Money Laundering (Maintenance of Records) Rules, 2005, inter-alia, to revise the thresholds for determining the beneficial ownership to 10% or more from the previous limit of 25%, through notification dated March 07, 2023, and September 04, 2023.

The term "beneficial ownership” has been defined differently under various Indian statutes.

The Companies Act 2013 (“Companies Act”) defines beneficial interest in section 89(10) as:

“(10) For the purposes of this section and section 90, beneficial interest in a share includes, directly or indirectly, through any contract, arrangement or otherwise, the right or entitlement of a person alone or together with any other person to—

(i) exercise or cause to be exercised any or all of the rights attached to such share; or

(ii) receive or participate in any dividend or other distribution in respect of such share.”

A legal owner/shareholder, vis-à-vis a beneficial owner/shareholder, is also referred to as a nominee shareholder who can be a natural person or a legal person and is nominated as such by the beneficial owner to hold shares on behalf of and for the benefit of another person i.e. the beneficial shareholder and is listed in the register of members instead of the beneficial owner.

The Prevention of Money Laundering Act, 2002[2] defines beneficial owner under section 2(fa) 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[3] who exercises ultimate effective control over a juridical person.”

Under Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 the beneficial owner is defined as under -

(a) where the client is a company, the beneficial owner is the natural person(s), who, whether acting alone or together, or through one or more juridical person, has a controlling ownership interest or who exercises control through other means.

Explanation. - For the purpose of this sub-clause-

1. "Controlling ownership interest" means ownership of or entitlement to more than twenty-five percent of shares or capital or profits of the company;

2. "Control" shall include 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;

(b) where the client is a partnership firm, the beneficial owner is the natural person(s), who, whether acting alone or together, or through one or more juridical person, has ownership of/entitlement to more than fifteen percent of capital or profits of the partnership;

(c) where the client is an unincorporated association or body of individuals, the beneficial owner is the natural person(s), who, whether acting alone or together, or through one or more juridical person, has ownership of or entitlement to more than fifteen percent of the property or capital or profits of such association or body of individuals;

(d) where no natural person is identified under (a) or (b) or (c) above, the beneficial owner is the relevant natural person who holds the position of senior managing official;

(e) where the client is a trust, the identification of beneficial owner(s) shall include identification of the author of the trust, the trustee, the beneficiaries with fifteen percent or more interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership; and

(f) where the client or the owner of the controlling interest is an entity listed on a stock exchange in India, or it is an entity resident in jurisdictions notified by the Central Government and listed on stock exchanges in such jurisdictions notified by the Central Government, or it is a subsidiary of such listed entities, it is not necessary to identify and verify the identity of any shareholder or beneficial owner of such entities.

Further, Securities and Exchange Board of India (“SEBI”) Master Circular No. SEBI/HO/AFD/PoD1/P/CIR/2023/130 dated July 31, 2023, for AIFs was modified as mentioned below:

“The investor, or its beneficial owner as determined in terms of sub-rule (3) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005, is not the person(s) mentioned in the Sanctions List notified from time to time by the United Nations Security Council and is not a resident in the country identified in the public statement of Financial Action Task Force as –

(i)              a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or

(ii)             a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies.”

Significant Beneficial Owner

Under Companies (Significant Beneficial Owners) Rules, 2018, “significant beneficial owner” means:

“an individual referred to in sub-section (1) of section 90 (holding ultimate beneficial interest of not less than ten per cent.) read with sub-section (10) of section 89, but whose name is not entered in the register of members of a company as the holder of such shares, and the term ‘significant beneficial ownership’ shall be construed accordingly;

Explanation I. - For the purpose of this clause, the significant beneficial ownership, in case of persons other than individuals or natural persons, shall be determined as under–

(i) where the member is a company, the significant beneficial owner is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trusts, holds not less than ten per cent. share capital of the company or who exercises significant influence or control in the company through other means;

(ii) where the member is a partnership firm, the significant beneficial owner is the natural person, who, whether acting alone or together with other natural persons, or through one or more other persons or trusts, holds not less than ten per cent. of capital or has entitlement of not less than ten per cent. of profits of the partnership;

(iii) where no natural person is identified under (i) or (ii), the significant beneficial owner is the relevant natural person who holds the position of senior managing official;

(iv) where the member is a trust (through trustee), the identification of beneficial owner(s) shall include identification of the author of the trust, the trustee, the beneficiaries with not less than ten per cent. interest in the trust and any other natural person exercising ultimate effective control over the trust through a chain of control or ownership;

Explanation II.—It is hereby clarified that instruments in the form of global depository receipts, compulsorily convertible preference shares or compulsorily convertible debentures shall be treated as ‘shares’ for the purpose of this clause;”

Significance of identifying beneficial ownership

In recent times there has been evolution in legislation of several jurisdictions wherein incorporation of legal entities now requires submission of KYC documents of ultimate beneficial owners who are investing in the entity being established. This enables safeguarding the economy from money laundering and terrorist financing by identifying the beneficial owner i.e. the individual who is investing his/her funds into the entity as such funds may have been obtained through illegal activities. 

To that effect, several jurisdictions have sanctions in place to combat illegal activities and prevent investment from countries known for terrorist financing. The Government of India implements sanctions which may be against specific individuals, organizations, or countries. The Ministry of Home Affairs notifies a list of individuals, groups and organizations which are suspected of being or classified as terrorist organizations.

Disclosures and reporting requirements under the Companies (Management and Administration) Second Amendment Rules, 2023 and Companies Act

1.     The Ministry of Corporate Affairs had advised through notification dated 27 October 2023, that every company must have a designated person who will be responsible for providing information regarding beneficial interest in shares of the company, to the Registrar of Companies. The designated officer may be any of the company secretary, key managerial personnel or directors of the company. 

2.     The MCA requires that a declaration in respect of beneficial interest is made to the company by the person holding such interest specifying the nature of interest, details of the person in whose name the shares are registered within 30 days of acquiring such interest. Similarly, a disclosure is required to be made to the company by the person registered as the legal shareholder who does not hold beneficial interest in such shares. In addition, the company is required to make a disclosure of these declarations to the ROC within 30 days from the date of receipt of above declarations.

It is of significance to note that the right of beneficial holder is not enforceable when declaration is not made. Sub-section (9) of section 89 provides that a beneficial owner cannot enforce his rights in shares in which he holds beneficial interests, if he fails to make declaration of beneficial interests with the company as per provisions of subsection (2) of section 89 or sub-section (3) of section 89 of the Act. Such interest shall not be enforceable by the beneficial owner or any other person claiming through him.

Allowing a beneficial owner different from the legal owner enables an individual to have full control over a company by appointing another person (being the second shareholder) as nominee shareholder who holds shares on behalf of the beneficial owner.

Anhad Law’s Perspective

While non-disclosure under the Companies Act, Prevention of Money Laundering Act, and SEBI regulatory framework invites punitive actions against wrongdoers, it may also signify a potential influx of illicit funds into the economy from criminal organizations or high-risk countries.

In this context, disclosures mandated by the aforementioned legislations assume critical importance. They not only empower companies to safeguard against investments acquired through dubious channels but also serve the broader economy by fostering corporate transparency. These disclosures act as indispensable tools in combating tax evasion, money laundering, and other unlawful activities by pinpointing the ultimate individual owner(s) of assets

Ruchika Tandon, Associate Partner, can be contacted at delhi@anhadlaw.com

[1] In March 2022, the FATF agreed on tougher global beneficial ownership standards in its Recommendation 24 by requiring countries to ensure that competent authorities have access to adequate, accurate and up-to-date information on the true owners of companies. The standard will help prevent the organised criminal gangs, the corrupt and sanctions evaders from using anonymous shell companies and other businesses to hide their dirty money and illicit activities.

[2] The Prevention of Money Laundering Act which was enacted to combat the activities that disguise the source of money obtained from illegal sources, requires among other things disclosure of beneficial owner.

[3] "person" includes--

(i) an individual,

(ii) a Hindu undivided family,

(iii) a company,

(iv) a firm,

(v) an association of persons or a body of individuals, whether incorporated or not,

(vi) every artificial juridical person not falling within any of the preceding sub-clauses, and

(vii) any agency, office or branch owned or controlled by any of the above persons mentioned in the preceding sub-clauses;