PE funds face challenges identifying beneficial owners

By Vandana Pai and Hardik Dave, Bharucha & Partners

The significant beneficial owner (SBO) regime in India was introduced by the Companies Act 2013 (act), the Prevention of Money Laundering Act, 2002 (PMLA act) and associated rules. The framework followed recommendations from the Financial Action Task Force (FATF). The FATF suggested that adequate, accurate, up to date, and timely information on beneficial ownership and control by legal persons be obtained, or accessed, rapidly and efficiently by competent authorities through a register of beneficial ownership or other alternative measures.

Previously, the PMLA act read with the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 (PMLA rules), provided that an SBO was the company holding, or entitled to hold, 25% of the shares, capital or profits of the company, or having the right to appoint a majority of the company’s directors or control its management or policy decisions. However, the PMLA rules were amended in March 2023 to lower the threshold to match those prescribed by the act and the Companies (Significant Beneficial Owners) Rules, 2018 (rules).

Vandana Pai, Bharucha & Partners
Vandana Pai
Partner and Head of the Investment Funds Practice
Bharucha & Partners

Section 90(1) of the act read with rule 2(1)(h) of the rules require that a declaration be made if an individual directly or indirectly holds 10 per cent or more of the shares or voting rights in the Indian company, or has the right to, or actually exercises, significant influence or control over the Indian company. Where members are not individuals, the key issue is determining whether any individual can be said to have an indirect holding in an Indian company.

Explanation III of rule 2(1)(h) of the rules prescribes the mechanism for identifying an SBO in different types of corporate structures. Explanation III(v) deals with members of an Indian company who are pooled investment vehicles (PIV), or entities controlled by PIVs, special purpose vehicles (SPV). If the PIV or SPV is domiciled in the jurisdiction of a member state of the FATF, and the securities market regulator of that state is a member of the International Organisation of Securities Commissions (jurisdiction requirements), the individual who is a general partner, or investment manager, or where the investment manager is a body corporate, the chief executive officer, must be disclosed as the SBO. Where a PIV does not satisfy the jurisdiction requirements, an individual holding more than 50% in the PIV must be disclosed as the SBO.

Most private equity funds (PE) invest through many layers of entities, with PIVs set up across multiple jurisdictions. While some PIVs may be set up in FATF member jurisdictions, others may reside in non-FATF jurisdictions such as Cyprus and the Cayman Islands. Limited partners are unlikely to hold more than 50% in a PE.

There appears to be a gap in the law as a PIV which is a body corporate but does not satisfy the jurisdiction requirements need not disclose its SBO if no individual holds more than 50% in the PIV. Further, it is unclear how the SBO is to be determined where many PIVs have pooled money through a single SPV, and these PIVs are wholly owned limited partnerships with no C-suite employee.

The rules require that every Indian company identify and report the beneficial owner. Indian companies are thus empowered to seek details from investor entities. If the investor fails to provide the requisite information to the Indian company or if the information provided is not satisfactory, the Indian company may apply to the National Company Law Tribunal within 15 days of receipt.

The company may seek an order directing that the shares, in respect of which SBO details were sought, be subject to transfer restrictions, and that voting and dividend rights be suspended. As the structures of most PEs are kept strictly confidential, questions arise as to whether Indian investee companies will actually be able to probe the investing entity’s corporate structures and gain access to the required information, including details of any entities between the ultimate beneficial owner and the investing entity.

Given the intent behind the FATF recommendations, it is important that the Ministry of Corporate Affairs creates a more transparent and robust mechanism to identify SBOs and ensure that clarifications and amendments leave no room for misinterpretation.

Vandana Pai is a partner and head of the investment funds practice, and Hardik Dave is an associate at Bharucha & Partners.

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