LEGAL UPDATE: INDIA
Issue 9 ... January - March 1996
Published by:
Nishith Desai International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.
E-mail: desai.nishith@gems.vsnl.net.in
The contents of the "Legal Update: India" should not be construed as legal opinion or professional advice. Since the sources are varied, at times it is difficult to verify the correctness of the information mentioned herein.

Content

  • BSE Announces Weekly Settlement.
  • Foreign Investors Allowed Automatic Share Transfer.
  • SEBI Proposes Venture Capital Norms.
  • SEBI Eases Lock-in Norms On Preferential Issues.
  • Arbitration & Conciliation Ordinance, 1996.
  • Property Transferred Under Merger, Liable For Stamp Duty.
  • FM Calls for bold and difficult Decisions.
  • CBDT Includes Rail Projects For Tax Benefits.
  • Leasing Cos. Set To Lose Depreciation Benefits.

BSE Announces Weekly Settlement

On February 26, 1996, the Bombay Stock Exchange (BSE) announced a series of measures aimed at globalising its operations.

The BSE will now adopt shorter settlement systems, crack down on price rigging, and increase the threshold limit for new listings. These moves are being contemplated in light of the fact that the National Stock Exchange (NSE) has threatened the very existence of the over-a-century-old BSE.

The BSE will now move from the present fortnightly settlement to a weekly settlement in specified shares. This will be welcomed by Foreign Institutional Investors (FIIs) who have long since been pleading for shorter trading cycles with a view to speed up deliveries and payments.

The BSE has also decided to raise the threshold limit for new listings from the existing Rs. 50 million to Rs. 100 million. A company which is already listed on an exchange and seeks a listing on the BSE will have to have a minimum issued equity capital of Rs. 50 million, a minimum book value of Rs. 100 million (capital and free reserves), and a minimum market capitalisation of Rs. 150 million.

Foreign Investors Allowed Automatic Share Transfer

On February 26, 1996, the Reserve Bank of India (RBI), announced the automatic transfer of shares of listed companies by foreign investors in favour of Indian residents. The sale must however be made at the prevailing market price on the stock exchange and through a registered merchant banker or stock broker.

The RBI will accordingly, grant permission on an automatic basis, under section 19(5) of the Foreign Exchange Regulation Act (FERA), 1973, for this purpose.

The RBI will now permit foreign investors to divest equity shares in listed and regularly traded Indian companies at a price arrived at by taking the average (daily high and low) for a week preceding the date of application, with the provision of 5% plus and minus variations.

The RBI is also permitting the sale of controlling block of shares of listed companies in favour of Indian promoters at a premium of up to 25% above the market price. The market price must be arrived at by taking the average (daily high and low) for a week preceding the date of application.

Earlier, according to the guidelines issued in September 1992, the price had to be arrived at after taking the average quotations of the shares on the stock exchange for one month preceding the date of application, or the prevailing market price on the date of application or the price sought for by the applicant, whichever was lower.

This is likely to induce transparency in deals pertaining to transfer of shares by foreigners in favour of Indian promoters. It will also curb mal-practices involved in the transfer of stakes that could help in gaining management control.

In case of unlisted or thinly traded shares, the earlier guidelines will continue to be applicable. These guidelines specify that the pricing will be guided by the net asset value and earnings per share of the share concerned.

SEBI Proposes Venture Capital Norms

On February 13, 1996, the Securities and Exchange Board of India (SEBI) released a consultative paper containing the draft regulations for Venture Capital Funds (VCFs). The SEBI intends to have the regulations notified at the earliest.

The SEBI proposes to allow VCFs to invest in unlisted companies, sick and potentially sick units, turnaround companies, and the research divisions of listed companies. VCFs will be disallowed from investing in non-banking finance companies.

In order to avail of certain tax benefits VCFs will have to comply with the guidelines issued by the Central Board of Direct Taxes (CBDT).

Since investments made by VCFs entail a high degree of inherent risk, the SEBI proposes that only investors in a position to correctly assess and evaluate such risks be allowed to invest in VCFs.

It is also suggesting that VCFs raise resources only from domestic or offshore institutional investors, corporate bodies, and high networth individuals. Offshore investors would have to comply with the guidelines on overseas venture capital investments. These guidelines are yet to be finalised.

The SEBI is also proposing that VCFs make an offer for sale of their existing holding in a company on a stock exchange, or give the original promoters an option to purchase the same.

Offer for sale on a stock exchange will attract the SEBI's listing requirements and the SEBI's guidelines for disclosure and investor protection.

VCFs will be permitted to invest up to 80% of their resources within a period of 3 years in equity or equity-related instruments of unlisted companies.

The SEBI also plans to retain with itself the powers of enquiry and inspection of VCFs. VCFs will have to submit half-yearly reports of their activities including their financial position to the SEBI. They will also have to register with the SEBI within 3 months from the date of notification of these regulations.

A two tier structure comprising of a Trust and an Asset Management Company (AMC) is being suggested for VCFs even though the SEBI is receiving representations against such a move. This is mainly because many existing VCFs are organised as single entities both as trustee and fund manager. The SEBI is also receiving representations saying that AMCs of VCFs should be allowed to manage more than one fund at a time.

Interestingly, the draft proposal does not include any minimum networth requirements for AMCs. In order to get registered with the SEBI, VCFs must be sufficiently equipped and have personnel with suitable financial, technical and managerial skills and expertise.

VCFs would, as part of their resource raising exercise, have to file an offer document (for restricted circulation among institutional investors), with the SEBI.

SEBI Eases Lock-in Norms On Preferential Issues

In a significant move, the Securities and Exchange Board of India (SEBI) has on January 30, 1996, decided to do away with the lock-in provisions on the preferential allotment of shares by listed companies.

The lock-in provisions will however, continue to apply to promoters. The SEBI feels that the pricing norms of preferential issues were adequate enough to protect investors.

As per the SEBI guidelines (issued on August 4, 1992) on preferential issue of shares under section 81(a) of the Companies Act, 1956, the issue of shares would have to be made at the average price of the weekly high and low of the shares quoted on a stock exchange during the 6 months preceding the date on which the meeting at which the resolution approving the issue had been passed.

The change in the lock-in provisions in the preferential allotment guidelines was made as the SEBI felt that this was hampering various companies employee stock option schemes.

The SEBI has clarified that such options would no longer attract any lock-in and the limit of 200 shares per employee has also been removed. The limit of 10 percent of share capital on employee stock options would however, still continue.

Listed companies having a 3-year dividend paying track record during the past 5 years will no longer be required to insist on minimum promoters contribution in public and rights issues. In such cases, there will also be no lock-in on these shares when allotted. Debenture issues, with an adequate safety rating given by any of the three rating agencies can be made without an acknowledgment card. However, the offer document will have to be lodged with the SEBI and if the SEBI does not object within a period of 21 days, the issue can be floated without the card.

Arbitration & Conciliation Ordinance, 1996

The Arbitration and Conciliation Ordinance, 1996 (ACO) has been promulgated to bring the law relating to arbitration (both domestic and foreign), and conciliation in line with international standards, in particular the UNCITRAL model. It has brought into force the Bill which was pending the approval of Parliament.

The Ordinance when it applies to foreign arbitration refers to International commercial arbitration which means an arbitration arising out of legal relationships that are considered as commercial under Indian law and where one of the parties is foreign (Part II. Part I applies when the place of arbitration is India, in which case, Indian law shall govern the dispute). It applies to awards validated by the New York and Geneva Conventions.

The main features of the ACO are mentioned below :
  • A judicial authority before whom a suit is filed may refer the parties to arbitration if there is an arbitration agreement between the parties to settle the dispute.
  • An award rendered by an arbitration tribunal shall be enforceable as a decree of the court before whom the award is filed for execution.
  • All awards may be enforced except when the court is satisfied that : the agreement is not valid; or the parties were under some incapacity according to the law applicable to them; or proper notice was not served on the party; or the award goes beyond the matters submitted for arbitration; or the tribunal was not established in accordance with the agreement; or the subject matter is not capable of settlement by arbitration; or the award is in conflict with the public policy of India, and the application for setting aside the award is filed within a period of 3 months of receipt of the award.

The court to which the aggrieved party approaches praying that the award be set aside will, to a large extent, refuse to interfere with the award unless there is reason to do so under the conditions set out above. The court will aid the arbitration process at every stage when the arbitrator may require the assistance of the court to make the arbitration process effective. This could be by way of assisting in taking evidence, securing the amount awarded, etc., though these may not be awards.

In the light of the ACO, the law relating to arbitration in India is on par with global standards.

Property Transferred Under Merger, Liable For Stamp Duty

In a landmark ruling given on February 2, 1996, the Bombay High Court, while disposing of separate writ petitions filed by companies like Hindustan Levers, National Organic Chemicals, and Western Hatcheries, to mention a few, held that the transfer of property on the merger of companies would be liable for the payment of ad valorem stamp duty under the Maharashtra Stamp Act (MSA).

The aforementioned companies had completed mergers during the last two years, and the State Government had demanded payment of Stamp Duty on the transfer of property from the transferor company to the transferee company.

The term conveyance is defined in section 2(g) of the MSA and includes, every order made by the High Court under section 394 of the Companies Act, 1956, in respect of amalgamation of companies, by which property (whether moveable or immovable), is transferred to, or vested in, any other person.

The companies, in their writ petition questioned the constitutional validity of Section 2(g)(iv) and Article 25 of Schedule I to the MSA.

The Court while disposing of the writ petitions held that even though no formal conveyance deeds are made in such mergers, a decree passed by the competent court (under section 396 of the Companies Act, 1956) approving the merger scheme, holds good as a conveyance deed, thereby attracting the provisions of the imposition of stamp duty. The Central Government has the power (under section 396 of the Companies Act, 1956) to provide for amalgamation of companies in national interest.

Hindustan Levers, one of the companies who filed the writ petition, strongly objected to the imposition of stamp duty and suggested the charging of stamp duty on the valuation of transfer cap as an alternative.

FM Calls For bold and difficult Decisions

The Indian Finance Minister (FM), Dr. Manmohan Singh has made a clarion call for bringing the South-East Asian miracle to India.

While releasing the Economic Survey for 1995-96, the FM called for bold and difficult decisions to spur development. The steps include, realistic tariffs for infrastructure services, phased liberalisation of administered price and distribution system, commercialisation of government-owned public utilities, and aggressive courting of external capital.

CBDT Includes Rail Projects For Tax Benefits

The Central Board of Direct Taxes (CBDT) has issued a circular clarifying that a rail system will be included in the definition of the term infrastructure, under section 80-IA(12) of the Income-tax Act, (ITA), 1961.

The Finance Act, 1995, introduced a new sub-section (4A) in section 80-IA of the ITA which provides an enterprise operating and maintaining an infrastructural facility on build-operate-transfer (BOT) or on build-own-operate-transfer (BOOT) with a five year tax holiday.

It is mandatory however, for the enterprise to transfer the new infrastructural facility to the Central Government within a stipulated period.

The CBDT has clarified that this concession will be available only to an infrastructural facility meant for the development of a rail system and not to any other infrastructure facility including rolling stocks.

The CBDT has also clarified that the build-operate-lease-transfer (BOLT) scheme of the Indian Railways is eligible for the benefit of section 80-IA of the ITA, since it is not legally possible for any enterprise other than the Indian Railways to maintain and operate a railway system.

Leasing Cos. Set To Lose Depreciation Benefit

The Directorate of Investigation (DoI) attached to the Income-tax department in Ahmedabad and Mumbai has cracked down on the Gujarat State Electricity Board (GSEB) after it came across irregularities in GSEBs depreciation claims in its lease finance project.

It is understood that several State Electricity Boards (SEBs) have entered into sale-and-lease-back transactions. In such cases, the asset is sold to the finance company after revaluation. This asset is subsequently leased back to the SEB (which is generally a loss making concern) who cannot take advantage of depreciation benefits.

The DoI noticed that the leasing companies claimed the benefits of depreciation. The leasing industry claims however, that this is a common practice as in a finance lease, the rentals are received even though the asset is not yet fabricated or installed. The tax authorities do not agree with this contention.

The Central Board of Direct Taxes (CBDT) has confirmed that several instances of misuse of depreciation benefits have come to light. Following the current trend of events, sale-and-lease back deals entered into by SEBs will be scrutinized more closely by the tax authorities.

In fact, on February 18, 1996, the CBDT released new accounting standards for leasing companies. An outstanding feature is that only the lessee or the user of the assets may get the benefit of depreciation in case of a finance lease.

The Chartered Accountants of India (ICAI) has given its in-principle approval to the CBDTs proposed accounting standards for leasing companies.

A lease may be considered to be a finance lease if, the ownership of the asset is transferred to the lessee by the end of the lease term; or the lease contains a bargain purchase option; or in case the lessee owns the asset, 75% or more of the initial value of the asset would have been available as depreciation; or the current value of minimum lease payments at the beginning of the lease term is 90% or more of the initial value.

The rate of interest to be taken for discounting would be the highest rate of interest at which the lessor had taken loan from the bank or a rate of 20% in absence of this information. This covers almost 95% of the deals of the leasing industry.

Published by:
Nishith Desai International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.
The contents of the "Legal Update: India" should not be construed as legal opinion or professional advice. Since the sources are varied, at times it is difficult to verify the correctness of the information mentioned herein.