Tag: Financial Statements

In June 2018, the Indian government notified the Companies (Significant Beneficial Ownership) Rules, 2018 (the “SBO Rules”) imposing reporting obligations on individuals having significant beneficial ownership in companies However, the SBO Rules did not provide a great deal of clarity on the nature and extent of disclosure, and therefore, the reporting obligation was put on hold.

Pursuant to consultations with various stakeholders, the Indian government has notified the Companies (Significant Beneficial Ownership) Amendment Rules, 2019 the (“SBO Amendment Rules”).  Now, a “significant beneficial owner” will mean any individual (acting alone or together or through one (1) or more persons or a trust) who possesses one (1) or more of the following rights in an Indian company (the “Reporting Company”):

• Holds indirectly, or along with any direct holdings, at least 10% of the shares;
• Holds indirectly, or along with any direct holdings, at least 10% of the voting rights in the shares;
• Holds indirectly, or along with any direct holdings, the right to receive at least 10% of the total distributable dividend or any other distribution in a financial year; or
• Has the right to exercise or actually exercises significant influence or control other than by virtue of his or her direct shareholding. For this purpose, “significant influence” has been defined as the power to participate in the financial and operating policy decisions of the reporting company.

In respect of the foregoing rights, the SBO Amendment Rules clarify that an individual cannot be considered as a significant beneficial owner if he or she holds the above-mentioned rights or entitlements directly.  Further, the SBO Amendment Rules define the term “indirectly” in respect of each possible category of member of a Reporting Company apart from an individual.  For instance, if the member is a body corporate, the individual must hold either a majority stake in that body corporate or a majority stake in the ultimate holding company of such body corporate.  For this purpose, a “majority stake” will mean holding:

• More than 50% of the equity share capital of the body corporate;
• More than 50% of the voting rights in the body corporate; or
• The right to receive more than 50% of the distributable dividend or any other distribution by the body corporate.

The deadline for significant beneficial owners to report significant beneficial ownership interest to their respective Reporting Companies under Form No. BEN-1 has been set as May 9, 2019.  This reporting obligation is not applicable, among others, to alternate investment funds, real estate investment funds and government owned entities or local authorities.  Upon receipt of the disclosure, the Reporting Company will have to comply with obligations of maintaining registers and filing returns as per the SBO Rules.

In our view, the SBO Amendment Rules provide much needed clarity on the meaning of significant beneficial ownership, enabling such owners and Reporting Companies to identify whether their interest is required to be reported. Moreover, while the compliance burden still remains, the streamlining of the definition of indirect holdings has exempted a large number of individuals who were previously considered to be included under the purview of the SBO Rules.

Verification of registered office address

The Indian government has introduced a reporting requirement for verification of the details of the registered office of an Indian company.  Pursuant to the new requirement, all companies incorporated on or before December 31, 2017 will be required to file Form INC-22A on or before April 25, 2019 and provide the following:

• Latitude and longitude of the registered office address;
• Photograph of the registered office showing the inside and outside of the building;
• Photograph of at least one (1) director or key managerial personnel, who will affix his or her signature on the form, while such director or key managerial personnel is inside the registered office;
• E-mail address of the company; and
• Details of the current statutory auditors, cost auditors, company secretary, chief financial officer and directors of the company.

This requirement will not apply to companies which:

(i) Have been struck off from the register of companies

(ii) Are in the process of being struck off

(iii) Are under liquidation

(iv) Have been amalgamated or dissolved.

If a company fails to file Form INC-22A before the due date, it will not be permitted to file various other e-forms mandatorily required under the Act until Form INC-22A has been duly filed along with a penalty of INR10,000 (Indian Rupees Ten Thousand).

The objective behind introducting this reporting requirement is to ensure that companies maintain active and operational registered offices.  In our view, this reporting requirement is unlikely to achieve this objective, as practically speaking, there is no way for the authorities to verify whether the address provided by a company actually continues to function as the registered office over a period of time.  Moreover, the requirement for providing photographs of the director and the office building appear to be unnecessary and cumbersome.

Reporting for dealings with MSEs

In November 2018, the Indian government had directed all companies who receive goods or services from MSEs (which are defined based on capital investments and turnover thresholds) and have delayed payments to such MSEs beyond forty-five (45) days from the date of acceptance of such goods or services to file a half-yearly return disclosing the details of such pending dues.

Now, the Indian government has directed all companies to provide details of amounts due to MSEs beyond forty-five (45) days as on January 22, 2019 in MSME Form 1 along with reasons for the delay in payment.  This reporting will have to be made within thirty (30) days of the date on which the Indian government notifies MSME Form 1, which is pending to be notified as on date.

Moreover, companies will also be required to file details of pending dues by October 31 of each year in respect of dues outstanding during the period from April to September and by April 31 for the period from October to March.

This reporting requirement has been introduced to ensure that MSEs, which do not have access to a large amount of capital, receive payment for their goods and services in a timely manner.  However, in our view, the requirement for filing the return every six (6) months will increase the compliance burden on companies.

Debenture is a long-term financial instrument that represents a loan made by an investor to a borrower, typically a corporate entity. It is issued under a formal agreement, which stipulates the terms of the loan, including the interest rate, repayment schedule, and the rights and obligations of both the issuer and the debenture holder.

Debentures are usually Secured or Unsecured:

• Secured Debentures:

These are backed by specific assets of the company, providing assurance to debenture holders that they can claim these assets in the event of default.

• Unsecured Debentures:

These are not backed by any specific assets, making them riskier for investors.

Importance of Debentures in Subsidiary Companies:

Subsidiary companies are entities that are controlled by a parent company, typically holding a majority of shares.

1. Capital Raising

Subsidiary companies often require funds for various purposes, such as expansion, acquisition of assets, or working capital. Issuing debentures provides a means of raising capital without diluting the ownership of the parent company. This is particularly advantageous for subsidiaries that may not have easy access to equity markets.

2. Fixed Cost of Financing

Debentures typically carry a fixed interest rate, which allows subsidiary companies to predict their financing costs accurately. This predictability aids in financial planning and budgeting, enabling the subsidiary to manage its cash flows effectively.

3. Flexibility in Financing

Debentures offer flexibility regarding maturity periods and repayment schedules. Subsidiary companies can structure their debenture issues to align with their cash flow needs, allowing for better financial management.

4. Tax Benefits

Interest payments on debentures are tax-deductible, which can enhance the financial efficiency of subsidiary companies. This tax advantage makes debt financing more attractive compared to equity financing.

5. Attraction of Diverse Investors

Issuing debentures can attract a wide range of investors, including institutional investors who prefer fixed-income securities. This diversification of the investor base can enhance the subsidiary’s financial stability and reputation in the market.

Regulatory Framework Governing Debentures in Subsidiary Companies:

In India, the issuance and management of debentures by subsidiary companies are regulated under the Companies Act, 2013, as well as the Securities and Exchange Board of India (SEBI) regulations. Key provisions are:

1. Issuance of Debentures

Section 71 of the Companies Act governs the issue of debentures, stipulating that a company may issue debentures subject to the conditions specified in the act. Companies must pass a resolution to approve the issue of debentures, which may require obtaining consent from the shareholders in certain cases.

2. Debenture Trust Deed

Debenture trust deed is a legal document that outlines the terms and conditions of the debenture issue, including the rights of debenture holders and the obligations of the issuing company. It must be executed in favor of a trustee representing the debenture holders to safeguard their interests.

3. Redemption of Debentures

Companies are required to outline a clear redemption plan for debentures in their issuance documents, specifying the maturity period and repayment terms. Provisions for the creation of a debenture redemption reserve may also apply, which is a fund set aside for the repayment of debentures upon maturity.

4. Interest Payments

Subsidiary companies must ensure timely payment of interest to debenture holders as stipulated in the debenture agreement. Failure to do so can lead to legal consequences and impact the company’s creditworthiness.

5. Filing Requirements

Subsidiary companies must comply with filing requirements under the Companies Act, including submitting necessary forms to the Registrar of Companies (ROC) concerning the issuance of debentures.

6. Regulations by SEBI

If the debentures are listed on stock exchanges, the subsidiary company must also comply with SEBI regulations, which impose additional disclosure and reporting requirements to protect investors’ interests.

Types of Debentures Suitable for Subsidiary Companies:

1. Convertible Debentures

These debentures give holders the right to convert their debentures into equity shares of the company after a specified period. This option can be attractive to investors, as it allows them to participate in the company’s equity upside.

2. Non-Convertible Debentures

These debentures cannot be converted into equity shares and typically offer higher interest rates compared to convertible debentures, compensating investors for the lack of conversion rights.

3. Redeemable Debentures

These debentures are issued with a specified maturity date, at which point the company must repay the principal amount to the debenture holders. This type allows for better cash flow management.

4. Irredeemable Debentures

Irredeemable debentures do not have a fixed redemption date and may remain outstanding indefinitely. They can provide a steady income stream for the issuing subsidiary but may be less attractive to investors due to their uncertain repayment timeline.

(a) Increase in share capital: A company can increase its share capital by issue of new shares by an ordinary resolution in the general meeting if the increase is within the authorised capital. But for increase beyond the authorised capital, the company is required to alter the capital clause of its Memorandum of Association by special resolution and to give its notice to the Registrar within 30 days of resolution.

No accounting entry is required to be passed in the books of the company for the increase in its authorized share capital. But when new shares are offered for subscription, accounting entries will be very much the same as has been explained in an earlier chapter.

(b) Decrease in share capital by cancelling the unissued shares: A company can cancel the shares which have not been subscribed or agreed to be subscribed by any person and this diminishes the amount of share capital. But no company can cancel the unpaid amount on shares already issued or agreed to be subscribed without the sanction of the Court as the same leads to reduction of capital. As the cancellation of unissued shares does not affect the issued share capital of a company, no accounting entry is required. Only the details of authorized share capital are to be changed in the Balance Sheet

(c) Consolidation of share capital: A company may consolidate any of its shares of smaller denomination (value) into shares of higher denomination. To make this change effective, share capital account with old denomination is closed and share capital account with new denomination is created. The accounting entry is:

Share Capital (Old denomination) Account                                Dr.

To Share Capital (New denomination) Account

(d) Sub-division of share capital: This implies converting shares of higher denomination into shares of smaller denomination. The entry is:

Share Capital (Old denomination) Account                                 Dr.

To Share Capital (New denomination) Account

(e) Conversion of shares into stock and reconversion of stock into shares: A company, if so authorised by its Articles, may convert any of its, fully paid shares into stock. The stock can be reconverted into fully paid up shares of any denomination. When shares are converted into stock, the share capital account will be closed by transfer to stock account by means of the following journal entry:

(Say) Equity Share Capital Account                                           Dr.

To Equity Stock Account

Conversely if stocks are reconverted into shares, stock account will be closed by transfer to share capital account.

(f) Reserve Capital: Section 99 of Companies Act provides that a company may by special resolution decide that any portion of uncalled amount on shares issued will be called up only on its liquidation. Such portion of share capital is known as reserve capital. No accounting entry is required to give effect to it.

(2) Reduction of Share Capital: Usually internal reconstruction involves reduction of share capital. Section 100 to 105 of Companies Act deal with it. Accordingly, it can be carried out by a company only It is authorised by its Articles, and a special resolution is passed to that effect. It also requires confirmation of the Court.

Capital reduction can take any of the following three forms:

• Extinguishing or reducing the liability on shares held by shareholders in respect of uncalled or unpaid amount : This does not affect the paid-up value of shares; only partly paid shares become fully paid by reducing the face value of the shares to the level of their paid-up value. No journal entry is necessary to record this event. However, some accountants prefer to pass the following entry to record this fact:

Share Capital (partly paid-up) Account                      Dr

To Share Capital (fully paid-up) Account

• Paying off the surplus paid-up capital: The share capital may be reduced by paying off the paid-up capital which is in excess of the needs of the company. This can be done with or without reducing the liability on the shares. Thus, surplus capital can be paid off in the following two ways: (a) Paying off surplus paid-up capital without reducing the face value of shares: In such a case, the following entries are passed:

(i) Share Capital Account                               Dr.                 with the amount to be paid off

To Sundry Shareholders Account

(ii) Sundry Shareholders Account                  Dr.                  with the amount paid off

To Bank Account In this case, the company shall have the right to call up in future the amount paid off on the shares.

(b) Paying off surplus paid-up capital by reducing the face value of shares: For example, for a fully paid share of Rs. 10, paying off Rs. 5 and reducing the face value of share from Rs. 10 to Rs. 5. The following entries are passed in such a case. () Share Capital (Old Face Value) Account Dr. (with total amount of old capital) To Share Capital (New Face Value) Account (with the amount to be kept as new capital)

To Sundry Shareholders Account                   Dr             (with amount to be paid oft)

(ii) Sundry Shareholders Account                  Dr. with the amount paid off To Bank Account

In this case, the company shall not have any right to call up in future the amount paid off on these shares.

(c) Cancelling the paid-up capital: Where existing capital of the company is not represented by available assets, cancellation of paid-up capital to that extent is the most common method adopted by a company in such a case. The purpose is to improve the profitability of the existing company in tune with the real values of assets as against the given book values which do not represent the actual financial position of the enterprise. Under it, a meeting of different classes of shareholders is called-up and where borrowed capital is also lost, the debenture holders and creditors are also invited in the meeting and they are made to agree to sacrifice their claims to certain extent and their sacrifices are utilized to write off the accumulated losses and fictitious assets and to adjust the over-valuation of assets. For this purpose, a new according called Capital Reduction Account (or Reconstruction Account or Reorganisation Account) is opened to which sacrifices of different parties are credited and through which accumulated losses and fictitious assets are written off and over-valuations of assets adjusted. The preparation of Reconstruction Account is preferred when debenture holders and creditors too have to accept some reduction in their claims in addition to the shareholders and/or where there is appreciation in the value of any asset. The scheme of entries is as follows:

• On reduction of paid-up capital:

Share Capital Account                                  Dr. with the amount of reduction

To Capital Reduction Account                      or To Reconstruction Account

If the denomination or description of capital is changed (e.g. the face value of shares is changed or rate of dividend is changed in case of preference shares), the old Capital Account is closed and new capital account is created with the new amount and the difference is transferred to Capital Reduction Account

Notes: (i) If any reserve appears in the books of the company, the same should be transferred to Capital Reduction Account so that no such reserve could be utilized for payment of dividend in future.

(ii) The Capital Redemption Reserve Account and Securities Premium Account can also be reduced in the same manner as the share capital account.

(iii) After granting the scheme of capital reduction, the Court may order the use of words “and reduced” after the name of the company for such period as it deems fit.

• If debenture holders and creditors too make some sacrifice:

Debentures Account                  with the amount of sacrifice Sundry Creditors Account

To Capital Reduction Account

3. If there is appreciation in the value of an asset:

Respective Asset Account                                Dr. with the amount of appreciation

To Capital Reduction Account

4. On utilizing Capital Reduction Account for writing off accumulated losses, fictitious assets, and over-valuations of assets:

Capital Reduction Account                                  Dr

To Profit & Loss Account

To Goodwill Account

To Patent Account

To Trade Marks Account

To Preliminary Expenses Account

To Discount on Shares and Debentures Account

To Unrecorded Liability Account (if any) To Asset Account

To Capital Reserve Account (with the balance left, if any)

Companies generally raise funds by issuing as share capital or through borrowing from lenders. A debenture is one of ways of company borrowing where the company agrees to repay the debt where may also be a charge over the company’s assets to ensure the repayment of this debt. Debenture is an alternative form of investment in a company that is more secured than investment in shares because company must pay interest and it will be paid before the dividend payment. Debenture holders also get privilege, if the company which issued the debentures becomes bankrupt. A disadvantage is that debenture holders have no share in the company and therefore have no control over it.

Following provisions of the Companies Act, 2013 governs the floatation, issue and allotment with regards to the debentures:

• Section 2(30): Definition;
• Section 44: Nature of debentures;
• Section 71: Provisions relating to issue and allotment of debentures;
• Rule 18 of the Companies (Share Capital and Debenture) Rules, 2014: Rules pertaining to issue and allotment of debentures.

Governing Sections:

Section 2(30): Definition of Deposit: “debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not.

Section 44: Nature of Share and Debenture.

Section 71: Provision relating to Debentures.

Section 117(3) (a)A copy of every resolution or any agreement, in respect of the matters specified in sub-section [1](3) of section 17 together with the explanatory statement under section 102, if any, annexed to the notice calling the general meeting in which the resolution is proposed, shall be filed with the Registrar within thirty days of the passing of resolution.

Section 179 (3) (c,d): (c) to issue securities, including debentures, whether in or outside India;

*(d) to borrow monies;

Section 180(1) (c): The Board of Directors of a company shall exercise the powers “borrow money”, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, only with the consent of the company by a special resolution, namely.

Section 56(4) (d): Within a period of six months from the date of allotment in the case of any allotment of debenture.

Section 42: Offer or invitation for subscription of securities on Private Placement.

Governing Rules:

• Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014:
• Rule 24 The Companies (Management and Administration) Rules, 2014: Resolutions and agreements to be filed.
• Rule 1(c) of The Companies (Acceptance of Deposits) Rules, 2014: “Deposit” does not include

“Any amount raised by the issue of debentures secured by a first charge or a charge ranking paripassu with the first charge on any assets referred 73 Proviso to in Schedule III of the Act excluding intangible assets of the company or debentures compulsorily convertible into shares of the company within five years.”

Rule 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014: Process of Issue and allotment of Securities (Debentures).