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Greater scrutiny of Chinese investors in India

The concept of beneficial ownership has assumed renewed significance for Chinese companies in India with the introduction of Press Note 3 which makes prior government approval mandatory for every investment being made by legal entities whose beneficial ownership can be traced to a country which shares land borders with India. In the absence of specific guidelines being issued under Press Note 3, it is highly likely that such ownership will now be determined with reference to the prevailing rules under Companies Act, 2013.

Section 90 of the Companies Act, 2013 and Companies (Significant Beneficial Owners) Amendment Rules, 2019 [1] (SBO Rules) notified by Ministry of Corporate Affairs which came into force on 8 February 2019, provide for a declaration to be submitted by the company to Registrar of Companies (ROC) about the significant beneficial owner (SBO) and compliance in relation to the same to enable government authorities to keep a track of the actual holders of the ownership of the corporate entity.

The first step is to identify the significant beneficial owners of the Company i.e. individuals who acting alone or together, or through one or more persons or trust, including a trust and persons resident outside India:
  1. hold indirectly, or together with any direct holdings, not less than 10% of the shares;
  2. hold indirectly, or together with any direct holdings, not less than 10% of the voting rights in the shares;
  3. have right to receive or participate in not less than 10% of the total distributable dividend, or any other distribution, in a financial year through indirect holdings alone, or together with any direct holdings;
  4. have right to exercise, or actually exercises, significant influence or control, in any manner other than through direct holdings alone.
If the shareholder of the reporting company is a body corporate (whether incorporated or registered in India or abroad) then an individual shall be an SBO if such person: (1) holds majority stake in that member; or (2) holds majority stake in the ultimate holding company (whether incorporated or registered in India or abroad) of that member.

Majority stake for this purpose has been defined as:

  1. holding more than one-half of the equity share capital in the body corporate; or
  2. holding more than one-half of the voting rights in the body corporate; or
  3. having the right to receive or participate in more than one-half of the distributable dividend or any other distribution by the body corporate.

To put it simply, the rules seek to establish the identity of an individual who is the ultimate beneficial owner or controller of the investing entity. This means there the anonymity of the ultimate beneficial owner cannot be lawfully concealed from Indian authorities. Even with the use of unconventional investment structures such as variable interest entities (VIEs) it will be difficult to avoid the application of the SBO Rules due to the broad definition of control.

Even assuming a hypothetical situation where a Chinese investor decides to bear a disproportionately high level of risk by using a third-party nominee shareholder of non-Chinese nationality to avoid prior government approval while making initial investment, it will be difficult to mitigate such risk on an ongoing basis. This is because the SBO Rules necessitate continual disclosures which are enforced through criminal penalties including imprisonment up to one year.

The SBO Rules place responsibility on SBO (for submitting the declaration) as well as on the reporting company (for finding out the SBO and filing of the declaration with ROC). The reporting company is required to serve notice in Form No. BEN-4 seeking information in accordance with Sub-section (5) of Section 90 of the Companies Act, 2013, to all its members (other than individuals) of a company, if they hold not less than 10% of shares or voting rights, or right to receive or participate in dividend or any distribution payable in a financial year and to any person (whether or not a member of the company) whom the company knows or has reasonable cause to believe:
  1. to be SBO of the company;
  2. to be having knowledge of the identity of SBO or another person likely to have such knowledge; or
  3. to have been SBO of the company at any time during the three years immediately preceding the date on which the notice is issued, and who is not registered as a SBO with the company, and cause such individual to make a declaration in Form No. BEN-1.
The reporting company will then have to file a return in e-Form No. BEN-2 with ROC, every time when it received declaration in Form No. BEN-1 from the SBOs, within a period of 30 days from the date of receipt of such declaration by it. Also, every individual, who subsequently becomes SBO, or where his significant beneficial ownership undergoes any change shall have to file a declaration in Form No. BEN-1 to the reporting company, within 30 days of acquiring such significant beneficial ownership or any change therein.

Application of the newly introduced FDI approval requirement along with the accompanying SBO Rules signals a crucial turning point for Chinese investments in India. The initial experience of submitting applications for FDI approval indicates that Indian government agencies are likely to probe the disclosures made by Chinese investors including by way of scheduled personal interviews until they are satisfied that they have identified the ultimate beneficial owner or controller of the proposed investment.

It is likely that such increased scrutiny could also extend to ongoing compliances of existing Chinese investors in India. Despite claims that India is trying to attract more FDI in the post-covid19 era, it is difficult to deny that the burden of compliance on current and future Chinese investors just went up.

Written By:
  1. Santosh Pai - Santosh is a Partner with Link Legal India Law Services and has 14 years of experience. He is enrolled as an Advocate in India and has qualified as a Solicitor(NP) with the Law Society of England & Wales, London. His work experience gained in India, China, UK and Thailand encompasses cross-border M&A, joint ventures, greenfield investments, technical collaborations and policy research. His other areas of interest include cross-cultural negotiations, business development and public speaking. He is also a practitioner of the 'Policy Governance' model of board governance. And

  2. Anuj Trivedi - Anuj is a Partner with Link Legal India Law Services and has about 13 years of experience in Merger and Acquisition, Private Equity and corporate commercial space. His experience spans across various sectors including infrastructure, automobiles, manufacturing, insurance and hospitality.

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