Category: Corporate Laws

In a landmark decision reinforcing the procedural sanctity of India’s insolvency framework, the Supreme Court of India allowed the appeal filed by Glas Trust Company LLC, setting aside the National Company Law Appellate Tribunal’s (NCLAT) order dated 02.08.2024 which had stayed the Corporate Insolvency Resolution Process (CIRP) admitted by the National Company Law Tribunal against Think and Learn Private Limited (“Byju’s”) vide order dated 16.07.2024. Glas Trust Company LLC is a financial creditor of Byju’s.

The Judgement pronounced on 23.10.2024 by the Supreme Court, has far-reaching implications for thewithdrawal of CIRP under the Insolvency and Bankruptcy Code, 2016 (IBC).

The appeal was preferred by Glas Trust Company LLC when Byju’s reached a settlement with the Board of Control for Cricket in India (BCCI) while CIRP against Byju’s were underway and on the basis of this settlement the CIRP was stayed by the NCLAT.

Brief facts of the case

Byju’s was admitted to the CIRP in July 2024 after NCLT, Bengaluru admitted an insolvency petition filed by BCCI (Operational Creditor) under Section 9 of IBC. The petition was based on a default by Byju’s amounting to INR 158 crore, arising from its contractual obligations under a sponsorship agreement with BCCI.

Following the initiation of the CIRP, Byju’s preferred an appeal against the order passed by the NCLT. The NCLAT subsequently stayed the insolvency proceedings after accepting a settlement agreement between BYJU’s and BCCI.

This settlement was recorded based on an undertaking by Riju Ravindran, that the repayment of the ₹158 crore would be funded personally by Riju Raveendran, brother of Byju’s founder Byju Raveendran, ensuring that the funds were his personal assets and not from any financial creditor.

Thereafter Glas Trust Company LLC preferred an appeal against the said order passed by the NCLAT before the Supreme Court and the present judgement was pronounced.

Observations made by the Supreme Court

The Supreme Court observed and held that the parties did not follow the due process under Section 12A of IBC and Regulation 30A of the Insolvency Resolution Process for Corporate Persons, Regulations, 2016, for withdrawal of CIRP. The aforementioned section and regulation state that the once CIRP is initiated and the Committee of Creditors (CoC) is not formed, any withdrawal request of the CIRP must be routed through the Interim/Insolvency Resolution Professional (IRP) and submitted before the NCLT. In the event that the CoC is constituted before the application for withdrawal is made by the applicant, the application for withdrawal must have the approval of ninety percent of the members of the CoC.

However, in this case, even though the CoC had not been constituted, the request was improperly brought directly by the parties before NCLAT during the appeal preferred by Byju’s against the order passed by the NCLT which initiated the CIRP against them, thereby bypassing the statutory process.

Further, the Supreme Court in arriving at its decision relied on the judgement “Swiss Ribbons (P) Ltd.vs Union of India (2019) 4 SCC 17”. In this judgement the Court had held that CIRP, once initiated, becomes a “proceeding in rem”—affecting the rights of all creditors/stakeholders—rather than a mere matter between the debtor and a specific creditor. Hence, once CIRP has been admitted the rights of all stakeholders have to be protected.

The Supreme Court found that the settlement between BYJU’s and BCCI was improperly handled as the withdrawal request was made directly to NCLAT during the appeal, rather than being presented to the NCLT through the IRP. This is done when the CIRP has been admitted and the CoC had not been constituted, as required by the IBC and Regulation 30A of the Insolvency Resolution Process for Corporate Persons Regulations, 2016.

On this basis, the Supreme Court set aside NCLAT’s order dated 02.08.2024, which had stayed the CIRP and allowed the settlement between Byju’s and BCCI.

While the Court did not rule on the merits of the settlement, it granted the parties liberty to follow the correct procedure laid out in the IBC for the withdrawal of CIRP. Additionally, the Court ordered that INR 158 crore, currently held in escrow by BCCI, be transferred to the CoC, which was constituted during the Supreme Court proceedings. The CoC is required to maintain this sum in a separate account, pending further directions from the NCLT.

As a result, the NCLT’s earlier order dated 16.07.2024 was restored, meaning the CIRP will continue and the moratorium under Section 14 of the IBC remains in effect.

Implications of the Judgment

This judgment clarifies that once a CIRP is initiated, individual settlements cannot by pass the statutory framework. Further, it reinforces the principle that CIRP is not merely a tool for debt recovery but a comprehensive process designed to protect the interests of all stakeholders.

By setting aside NCLAT’s order, the Supreme Court reaffirmed that CIRP, once initiated, is governed by a strict legal framework, and any deviation from this process undermines the fairness and transparency that the IBC seeks to uphold.

Contributed by Nishant Kantawala.   

Please feel free to reach out to us at aureus@aureuslaw.com should you require any assistance on the topic of this conversation. 

The Supreme Court’s decision in Union of India vs. Rajeev Bansal (Civil Appeal No. 8629 of 2024) has resolved the ongoing controversy about reassessment proceedings initiated consequent to the notices issued between April 1, 2021, and June 30, 2021, under Section 148 of the Income Tax Act. These notices were issued following the extension provided under the Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Act, 2020 (TOLA) for completion of action needed during the period 20 March 2020 to 31 March 2021

First Round of Litigation

Initially, several High Courts ruled in favor of taxpayers, holding that the reassessment notices issued during the period April 1, 2021, and June 30, 2021, were invalid. The courts reasoned that the new reassessment provisions, introduced by the Finance Act, 2021, effective from April 1, 2021 (new regime), were not followed. However, in Union of India v. Ashish Agarwal, the Supreme Court, using its discretionary jurisdiction under Article 142 of the Constitution, deemed these notices as show-cause notices under the new regime (Section 148A(b)). The Court directed that taxpayer be given the material relied upon by the Revenue, an opportunity to respond and the procedure prescribed under the new reassessment provisions be followed. All legal contentions were kept open for both sides.

Second Round of Litigation

This led to the issuance of fresh reassessment notices, which taxpayers challenged on the grounds that they were time-barred and lacked the proper sanction from the specified authorities as prescribed under the new regime. Taxpayers argued that TOLA did not apply after April 1, 2021, and hence, notices issued after this date were invalid considering the new regime’s limitation of 3 years (for cases involving income escapement of less than ₹50 lakh) or 6 years (for amounts exceeding ₹50 lakh). These arguments were accepted by several High Courts, including those in Bombay, Delhi, Gujarat, Allahabad, and Rajasthan.

Supreme Court’s Ruling

In Rajeev Bansal, the Supreme Court overruled the High Court decisions, holding that the extension of time granted under TOLA for issuing reassessment notices up to June 30, 2021, applied even under the new regime, provided that the actions pertained to assessments becoming time-barred between March 20, 2020, and March 31, 2021 (the “Covid exclusion period”). The Court has held that notices issued during the period April 1, 2021 to June 30, 2021 (subsequently deemed as show-cause notice under the new regime (Section 148A(b)), will have to be read in context of the new regime effective April 1, 2021 and the directions issued by the Court in Ashish Agarwal.

In this context, where the alleged income escapement is less than ₹50 lakhs, the re-assessment for AY 2016-17 and AY 2017-18 would have become time-barred on March 31, 2020 and March 31, 2021, respectively. For cases exceeding the ₹50 lakh threshold, AY 2013-14 and AY 2014-15 would have similarly become time-barred on March 31, 2020, and March 31, 2021, respectively. Since notices for AY 2016-17 and AY 2017-18 (under the 3-year limitation) and AY 2013-14 and AY 2014-15 (under the 6-year limitation) could have been issued during the period from March 20, 2020 to March 31, 2021, TOLA extended the limitation period to June 30, 2021.

However, for AY 2015-16, where the 3/6-year limitation periods expired on March 31, 2019 and March 31, 2022, the issuance of reassessment notices did not fall within the Covid exclusion period ( March 20, 2020 to March 31, 2021). Therefore, the issuance of notices for this year falls outside the scope of TOLA and must be addressed separately based on its own merits—a position that was conceded by the Revenue before the Supreme Court.

A significant outcome for taxpayers is the court’s determination that the extension provided by TOLA is subject to the limitations and sanctions of the appropriate authority, as prescribed under the new regime. Regarding limitation periods, the Court clarified that TOLA only extends the deadline for completing the process until June 30, 2021, but it does not extend the statutory limitation period itself. This means that all the steps required prior to issuing a notice under Section 148—such as providing a show-cause notice (SCN) and supporting material to the taxpayer, evaluating their reply, obtaining approval from the specified authority, and issuing a valid notice—must be completed within the extended timeline.

Furthermore, in determining the limitation period, the Court ruled that the time between the issuance of the deemed notice under Section 148A(b) and the taxpayer’s response to the SCN should be excluded from the limitation period, as provided in the third proviso to Section 149 (due to a stay of proceedings and additional time granted to the taxpayer to furnish a response). For example, if a notice under Section 148A(b) is issued on June15, 2021, since the limitation period expires on June 30, 2021, the balance of 16 days will be available to the Revenue after the taxpayer gives his response to complete the proceedings and issue the notice.

Finally, the court noted that the new regime requires a higher level of approval from the sanctioning authority compared to the earlier regime, which is favorable to the taxpayer. Therefore, after April1, 2021, prior approval must be obtained from the appropriate authorities as specified under Section 151 of the new regime.

Conclusion

The Supreme Court’s decision in Rajeev Bansal balances the interests of both the Revenue and taxpayers by upholding the reassessment notices issued under TOLA’s extended timeline, while also ensuring that such notices follow the stricter procedural safeguards under the new regime. This ruling provides clarity on the application of TOLA and the new reassessment provisions, reaffirming that while the extension period applies, the limitation and procedural requirements of the new regime must still be followed. Taxpayers whose notices were issued after April 1, 2021, without meeting these criteria may still find relief on the ground of lacking jurisdiction, but those notices issued within the extended timeline and in compliance with the new regime will have to be defended on merit.

Contributed by Yatin Sharma.   

Yatin is a Partner with Aureus Law Partners with more than two decades of experience in Tax, Corporate and Exchange Control Laws.  He is a qualified Chartered Accountant, Lawyer and an Insolvency Resolution Professional . 

Please feel free to reach out to us at aureus@aureuslaw.com should you require any assistance on the topic of this conversation.  

2024-10-07

Contributed by Yatin Sharma.   

Yatin is a Partner with Aureus Law Partners with more than two decades of experience in Tax, Corporate and Exchange Control Laws.  He is a qualified Chartered Accountant, Lawyer and an Insolvency Resolution Professional . 

Please feel free to reach out to us at aureus@aureuslaw.com should you require any assistance on the topic of this conversation.  

The import of Supreme Court Decisions in case of Paschimanchal Vidyut Vitran Nigam Ltd. versus Raman Ispat Private Limited & Ors. and State Tax Officer v. Rainbow Papers Ltd. is that statutory/government dues may constitute secured creditors consequent to specific provision under the applicable law creating a charge on the assets of the corporate debtor. The case of Rainbow Paper (earlier of the two decisions) dealt with Sec. 48 of the Gujarat VAT Act which contains specific provision to the effect that “any amount payable by a dealer or any other person on account of tax, interest or penalty for which he is liable to pay to the Government shall be a first charge on the property of such dealer, or as the case maybe, such person.” Similar provisions exist under Sec. 82 of the CGST Act, 2017 and Sec 142A of the Customs Act, 1962 and therefore dues under such laws would have the same fate. However, this may not imply an across-the-board application for all statutory dues, particularly under the Income Tax Act which does not appear to contain a similar provision for creating a charge over assets of the taxpayer against dues. The nature of statutory dues, whether secured or otherwise, will need to be determined on a case-to-case basis.

However, the aforesaid two decisions of the Apex Court appear to have created an ambiguity whether statutory dues, even where secured, should be regarded under the category of ‘secured creditor’ [Sec 53(1)(b)] or as a separate class of Government Dues [Sec. 53(1)(e)] as specifically provided in the liquidation waterfall. The ambiguity arises on account of contrary observations of the Court in the aforesaid orders.

In Paschimanchal Vidyut decision (later of the two decisions), the Court observed that: “The Gujarat Value Added Tax Act, 2003 no doubt creates a charge in respect of amounts due and payable or arrears. It would be possible to hold [in the absence of a specific enumeration of government dues as in the present case, in Section 53(1)(e)] that the State is to be treated as a ‘secured creditor’. However, the separate and distinct treatment of amounts payable to secured creditor on the one hand, and dues payable to the government on the other clearly signifies Parliament’s intention to treat the latter differently – and in the present case, having lower priority. As noticed earlier, this intention is also evident from a reading of the preamble to the Act itself.”

Contrary to the above, in Rainbow Papers decision against which a review petition was preferred but dismissed, the Court observed that “Section 48 of the GVAT Act is not contrary to or inconsistent with Section 53 or any other provisions of the IBC. Under Section 53(1)(b)(ii), the debts owed to a secured creditor, which would include the State under the GVAT Act, are to rank equally with other specified debts including debts on account of workman’s dues for a period of 24 months preceding the liquidation commencement date.”

The Apex Court has considered the priority of secured statutory dues under the liquidation waterfall differently, and the ambiguity may now only be resolved by consideration of the issue by a larger bench of the Court. Until then, stakeholders will have to confront the uncertainty around the matter.

Having regard to the broader objective of IBC, there is enough literature to suggest that the framework of IBC laws favor waiver of government dues in pursuit of reviving viable businesses and promoting economic growth. However, over time concerns have been raised by statutory authorities that benevolent provisions have been misused and their interests completely ignored in resolution plans. A balance may therefore need to be drawn. Perhaps an option could consider secured government dues higher in priority [Sec 53(1)(b)] in case of liquidation whereas lower in priority [Sec. 53(1)(e)] in case of successful resolution. The IBBI, which has typically been proactive, needs to step in and address the lacuna in law by advancing suitable amendment in law, preferably as early as in the winter session of parliament, to resolve this debate. Leaving this impasse as an exercise of interpretation of law by the SC, which can be rather time consuming, will be counterproductive and only lead to uncertainty, costs, and litigation.

Contributed by Yatin Sharma. Yatin can be reached at yatin.sharma@aureuslaw.com.

The Supreme Court (SC), as the ultimate judicial authority, has stated the law of land concerning application of Most-Favored-Nation (MFN) clause as contained in the Protocol of India’s Double Taxation Avoidance Agreements (DTAAs) with some of the OECD member countries (Netherland, France and Switzerland). It is now settled by the court that the benefit of MFN provision in protocol to DTAA for reduction of rate of tax at source on dividend, interest, royalties or fee for technical services (FTS), or restrictive scope of FTS based on concession (“make available clause”) given under DTAA with other OECD member country does not have an automatic application. The benefit must be extended through appropriate notification by the government. The road ahead is now clear and for all to follow. However, the decision has far-reaching implications for numerous taxpayers who have over the years benefited by taking a non-taxable position basis restrictive scope of FTS by importing the “make available” clause or lower WHT rate from other DTAAs.

The development thus requires course correction and proactive remedial evaluation by the taxpayers to mitigate continuing exposure arising from past positions.

Implication for payer of income – Payers who may have taken a non-taxable position with regard to FTS payments to non-resident (in light of MFN “make available” import) or applied lower WHT rate on the strength of a withholding tax order issued by the revenue authorities would arguably have adequate grounds to defend against any penal consequence of incorrect/non withholding of taxes.  However, the exposure may potentially arise if the revenue authorities pursue the payer in the capacity of a representative assessee/agent should the recovery from the recipient not be possible.

On the other hand, payers who may have claimed the benefit suo-motu will have reason to be concerned and could potentially face consequences of failure to deduct/short deduction which may include recovery of tax, interest and penalty. While one may argue against levy of penalty considering the issue was settled only by the SC by reversing the favorable decisions of lower courts, this may entail a prolonged legal battle. The payers may need to consider a look back period of at least 7 years from the end of relevant financial year, taking cue from the limitation period prescribed for passing order holding an assessee in default for withholding tax non-compliance in relation to domestic payment.

Concern may also arise regarding potential disallowance of expense, specifically where no WHT has been deducted, in ongoing proceedings or a potential risk of reopening of assessment on account of wrongful claim of deduction.

Implication for recipient of income – The law is well established that the primary obligation to pay taxes is that of the recipient of income. The failure of the payer to withhold taxes as appropriate does not absolve the recipient to declare and pay appropriate taxes. Under reporting of income or short payment of tax consequent to application of lower WHT rate, on the strength of MFN provisions pre-SC decision, will thus very likely attract departmental scrutiny. The potential action could be rectification of past order as a consequence of SC judgment or reopening of past years due to escapement of income, subject to period of limitation. The revenue authorities can rectify past orders suo-motu or on application of the taxpayer up to a period of 4 years from the end of financial year in which the order, subject of rectification is passed. On the other hand, reassessment notices can be issued up to a period of 6 years from the end of relevant assessment years in case of AY 2021-22 and prior years, and 10 years for subsequent years (3 years where income escaped is less than 50 lacs).

Given the risk, taxpayers must evaluate the exposure and strategies a remediation plan proactively rather than adopt a reactive mode. For instance, a taxpayer may be better off filing a suo-motu application for rectification where possible, explore declaration through an updated return for tax years not picked for scrutiny assessment or voluntarily compute and discharge tax liability, etc. rather than wait for adversarial departmental action such as reassessment notices for detailed scrutiny or notice deeming assessee in default. A proactive approach will enable ring-fence the exposure toward tax, interest and penalty. There are other nuances that may need to be considered ie. for instance, whether any reassessment notices merely on account of wrong application of WHT rate would at all pass the primary test of “escapement of income” for any action of reassessment.

The CBDT had issued Circular No. 3/2022, dated 3rd February 2022 clarifying its position that beneficial provision of certain OECD treaty member countries cannot be automatically imported in other treaties such as with The Netherlands, France, the Swiss Confederation, Sweden, Spain and Hungary by reason of MFN clause in Protocol without specific notification. The position was aggressively defended by the revenue authorities before the SC with success. Having thus reached so far, it is unlikely that the revenue authorities will let this success pass only as an academic win without milking the opportunity to garner additional tax resource. In this light, taxpayers impacted by the ruling, whether as a person responsible for deducting tax or recipient of income, must evaluate the options and formulate a sound strategy of remediation rather than react to uncertainties.

Yatin Sharma and Abhishek Dutta.

The Hon’ble Supreme Court in the case of CELIR LL BAFNA MOTORS (MUMBAI) PVT. LTD. & ORS. has in a significant ruling held that consequent to amendment of section 13(8) of SARFAESI Act, 2002 w.e.f. 1-9-2016, the right of redemption of mortgagor stands extinguished upon publication of the auction notice.

The pre amended Section 13(8) of the Act provided that if the dues of the secured creditor together with all costs, charges and expenses incurred by borrower/ mortgager are tendered to the secured creditor at any time before the date fixed for sale or transfer, the secured asset shall not be sold or transferred by the secured creditor, and no further step shall be taken by him for transfer or sale of that secured asset. The position of law thus emerged that the mortgager has the right to redeem the mortgaged property anytime till the transfer was completed in favour of the auction purchaser through the process of registration of the sale certificate and delivery of possession of the secured asset. The provision was in consonance with section 60 of the Transfer of Property Act, 1882 which read with section 17 of the Indian Registration Act, 1908 provides a mortgagor the right to redeem the mortgaged property before the execution of the conveyance and registration of transfer of the mortgagor’s interest in the property by registered instrument.

The law was amended in 2016 which now provides that:

“ Where the amount of dues of the secured creditor together with all costs, charges and expenses incurred by him is tendered to the secured creditor at any time before the date of publication of notice for public auction or inviting quotations or tender from public or private treaty for transfer by way of lease, assignment or sale of the secured assets”,

The secured assets shall not be transferred by way of lease assignment or sale by the secured creditor and steps taken by the secured creditor for transfer by way of lease or assignment or sale of the assets before tendering of such amount under this sub-section, no further step shall be taken.

There has been considerable debate on the implications of the amendment with courts taking divergent views. Some courts holding favorably had ruled that the even after the 2016 amendment, the right of redemption would continue till the execution of a conveyance i.e. issuance of sale certificate in favour of the auction purchaser.

Bringing the differing views to rest, the Apex court has ruled that under the provisions of amended section 13(8) of the SARFAESI Act, the right of the borrower to redeem the secured asset stands extinguished on the very date of publication of the notice for public auction under Rule 9(1) of The Security Interest (Enforcement) Rules, 2002. The right of redemption available to the borrower under the emended law is drastically curtailed and would be available only till the date of publication of the notice and not till the completion of the sale or transfer of the secured asset in favor of the auction purchaser. The court has further observed that once the auction notice is published in accordance with Section 13(8) of the SARFAESI Act, the right of redemption of mortgage is not available to the borrower unless and until the auction is held to be bad and illegal in the facts of the case.

The Apex Court has overruled the position of law laid by the Telangana High Court in the case of Concern Readymix and Amme Srisailam and Punjab and Haryana High Court in the case of Pal Alloys and Metal India Private Limited while affirming the position of law laid by the Andhra Pradesh High Court in Sri Sai Annadhatha Polymers and Telangana High Court in the case of K.V.V. Prasad Rao Gupta.

The law now settled by the Apex Court has far-reaching implications for borrowers/mortgagers who now stand subjected to dispossession of the mortgaged property if not redeemed or settled before the publication of notice for public auction. A timely intervention by the borrowers now becomes imperative to safeguard their interest.

Contributed by Yatin Sharma. Yatin can be reached at yatin.sharma@aureuslaw.com.

Hello Readers,

As you may be aware, the Finance Act 2012 had introduced provision of section 56(2(viib) of the Income Tax Act, 1961.  Via this newsletter, we bring to you the salient features of the recent changes to the scheme introduced.

To give a context, the provision of section 56(2)(viib) intended to tax consideration received by closely held companies from residents for issue of shares that exceeds the face value of share. The provision covered consideration exceeding the fair market value of shares. The provision was made applicable only to residents with specific carveout for consideration for shares issued by a venture capital undertaking from a venture capital company, venture capital fund, specified fund or class of persons as notified. The provision was introduced as an anti-abuse measure to prevent circulation of unaccounted domestic money through share sale-purchase transactions. The Finance Act, 2023 has however extended the applicability of the provision to all categories of person, thereby bringing within the purview issuance of shares to non-resident.

Considering wide impact of the amendment, the government has by way of Notification No. 29/2023 dated 24 May 2023 excluded investment made by the following categories of foreign investors from applicability of the provisions:

• Government and Government related investors, international or multilateral organizations and entities controlled by the Government or where direct or indirect government ownership is seventy-five percent or more;
• Banks or Entities involved in Insurance Business;
• Entities resident of 21 specified jurisdictions which are registered with SEBI as Category-I Foreign Portfolio Investors; endowment funds associated with a university, hospitals or charities; pension funds; Broad Based Pooled Investment Vehicle or fund where the number of investors is more than fifty (other than hedge fund or a fund which employs diverse or complex trading strategies). The specified jurisdictions notably exclude Singapore and Mauritius.

Further, as a result of the above amendment, representations were received from various stakeholders raising concerns that genuine non-resident investors may have to face undue hardship in matters related to valuation of shares etc. To address the concerns, the government has on 26 May 2023 issued draft notification for public comments proposing changes to the valuation rules as prescribed under Rule 11UA of the Income Tax Rules on the aspect of determining the fair valuation of the shares to assuage the concerns of various stakeholders.

Rule 11UA of the Income Tax Rules currently prescribes valuation based discounted cash flow (DCF) or net asset value (NAV) method. As per the draft rules, in addition to NAV and DCF method, the following are proposed for recognition as fair valuation:

• where consideration is received by a venture capital undertaking for issue of shares, from a venture capital fund or a venture capital company or a specified fund, the price of the equity shares corresponding to such consideration will be regarded as the fair market value of the equity shares provided the consideration has been received within a period of ninety days of the date of issue of shares which are the subject matter of valuation.
• where any consideration is received by a company for issue of shares, from any notified entity, the price of the equity shares corresponding to such consideration will be regarded as the fair market value of the equity shares provided the consideration from notified entity has been received within a period of ninety days of the date of issue of shares which are the subject matter of valuation.
• Further in relation to consideration received from a non-resident, the fair market value of the unquoted equity shares can be additionally determined by a merchant banker in accordance with any of the following methods:
  • Comparable Company Multiple Method;
  • Probability Weighted Expected Return Method;
  • Option Pricing Method;
  • Milestone Analysis Method;
  • Replacement Cost Methods.

The proposed Rules further provide a safe harbor of 10 percent to accommodate variation between issue price and fair valuation determined as per prescribed valuation methods.

We will keep you updated as and when any further changes occur in this space. Thank you for your time. Till we meet again.

Best regards,

Research Desk at Aureus Law Partners

Should you have any queries, please feel free to reach out to our Practice Leader – Tax at yatin.sharma@aureuslaw.com.

Background

In India, existing Trusts were required to apply for registration/approval on or before 30 June 2021. However, on consideration of difficulties in the electronic filing of Form No. l0A, the Central Board of Direct Taxes (the Board) extended the due date for filing Form No. 10A in such cases to 25 November 2022 (Refer: Circular No. 22 of 2022 dated 1 November 2022). Such registration/approval are valid for a period of 5 years. Thus, existing Trusts are required to apply for fresh registration/approval and once the registration/approval is granted it is valid for five years.

New Trusts are required to apply for provisional registration/approval at least one month prior to the commencement of the previous year relevant to the assessment year from which the said registration/approval is sought. Such provisional registration/approval is valid for a maximum period of three years.

Provisionally registered/approved Trusts again need to apply for regular registration/approval in Form No. 10AB at least six months prior to the expiry of the period of provisional registration/approval or within six months of the commencement of activities, whichever is earlier. This registration/approval is valid for a period of five years.

Clarifications issued

On consideration of difficulties in electronic filing of Form No. 10AB the Board extended the due date for electronic filing to 30 September 2022 (Refer: Circular No 8 of 2022 dated 31 March 2022).

The Trusts once approved/registered for five years are required to apply at least six months prior to the expiry of the period of five years.

Deduction under section 80G of the Act in respect of a donation made by a donor to a fund or institution would be allowed to the donor only if a statement of such donations is furnished by the donee in Form 10BD. The certificate of such donation is required to be provided in Form No. 10BE. Further, Form No. 10BD and Form No. 10BE are required to be furnished on or before the 31st May immediately following the financial year in which the donation is received.

Finance Act, 2023 has, inter aIia, amended section 115TD of the Act, so as to provide that the accreted income of the Trusts not applying for registration/ approval, within the specified time, would be made liable to tax in accordance with the provisions of section 115TD of the Act. This amendment has come into effect from 01.04.2023 and therefore applies to assessment year 2023-24 and subsequent assessment years.

Extension of dates for filing

for Registration and Approvals

Several Trusts could not apply for registration/ approval within the required time due to genuine reasons. This led to rejection of applications simply on the ground that these were delayed.

In order to mitigate genuine hardship in such cases the Board has extended the due date of making an application till 30 September 2023 for both Forms 10A and 10AB.

The extension of due date as mentioned would also apply in case of all pending applications. Hence, in cases where the Trust has already made an application in Form No. 10AB but such application has been furnished after 30 September 2022 and where the Principal Commissioner or Commissioner has not passed an order before the issuance of this Circular, pending application in Form No. 10AB may be treated as a valid application. Also, in cases where the Trust had already made an application and the Principal Commissioner or Commissioner has rejected it only on account of delay, the Trust would be allowed to furnish a fresh application.

It has also been clarified that provisional registration of a Trust shall be effective from the assessment year relevant to the previous year in which the application is made and would be valid for a period of three assessment years.

for submission of Statement of Donation / Certification of donation

In consequence of the above, an extension has also been granted to the due date for furnishing of statement of donation / certificate of donation in respect of the donations received during the financial year 2022-23 to 30 June 2023.

for submission of Statement of Accumulation/Deemed Application

Finance Act, 2023 provides that Statement of Accumulation is required to be furnished at least two months prior to the due date of furnishing return of income.

The due date for furnishing the option for deemed Application of Income has been prescribed at least two months prior to the due date of furnishing return of income.

Now it has been clarified that the Statement of Accumulation would be required to be furnished at least two months prior to the due date of furnishing Return of Income so that it may be taken into account while auditing the books of account. However, the Accumulation/Deemed Application shall not be denied to a Trust as long as the Statement of Accumulation/Deemed Application is furnished on or before the due date of furnishing the return.

One of the conditions required to be fulfilled by the Trusts to be eligible to claim exemption is that where the total income of any Trust exceeds the maximum amount which is not chargeable to income-tax in any previous year, it is required to get its accounts audited.

It has also been clarified that account payee cheque drawn on a bank or an account payee bank draft or use of electronic clearing system through a bank account would be acceptable as mode of payment of taxes in addition to UPI and electronic transfers.

From the Aureus Law Partners’ research desk.  Published on 29 May 2023. 

Reach out to us at aureus@aureuslaw.com.  

Introduction

According to Jame Koloski Morries, “Venture capital is defined as providing seed, startup, and first stage financing and also funding expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit-oriented institutional funding sources, Venture Capital also provides management in leveraged buyout financing”.

Venture Capital (VC) firms bring to the table expertise regarding the business in which it is investing, as well as managerial capability, aside from the funds required.

Not only is VC fund invested in businesses that use new technology to produce new products, they will typically, continuously involve themselves with the investments by way of providing managerial and other support.

While it is commonly understood that the VC investments are made in equity of the target entity, it is often seen that VCs insist on a modified instruments, often in the form of Compulsorily or Optionally Convertible Debentures or Preference Shares, etc.  Depending on the nature of the business and appetite of the VC firm in that business, it is possible that other creative instruments for investment may also be used.   Ordinarily, debt instruments ensure a running yield on the portfolio of the venture capitalists, and hence, may be considered safer by the VC, apart from providing a liquidity preference above equity holdings.

Venture Capitalists finance high risk-return ventures. Some of the ventures yield very high return in order to compensate for the heavy risks related to the ventures at the time of exit.  It depends on what the exit is defined as, however, typically a VC would retain several rights of exit upon the happening of specific occurrences.

Since VC funds invest on the basis of the business plan, when the business may not exist in the ground, they take a significant project risk. Private equity funds, however, come in when the business has taken off.  They prefer to invest in the growth of the business, when proof of concept is established, and scalability of the business is clear. Thus, VC funds can be viewed as ‘seed capital’, while PE funds can be viewed as “growth capital”.

The definition of the two types of funds under SEBI (Alternate Investment Funds) Regulations, 2012 is as follows:

• “Private equity fund” means an Alternative Investment Fund which invests primarily in equity or equity linked instruments or partnership interests of investee companies according to the stated objective of the fund.
• “Venture capital fund” means an Alternative Investment Fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model.

Investments by both PE and VC Firms are illiquid investments. While a PE would invest in the expectation of an IPO, most VC Firms do not remain in the target entity till the IPO stage.

PE funds may even invest post public issue or at the time of public issue of the target. These are called Private Investment in Public Equity (PIPE).  While the VC funds may not have a clear investment horizon and may be in the target entity for a longer investment horizon.  However, PE funds typically have a shorter investment horizon – anywhere between 5 – 7 years would be a typical time period.

Angel Funds, VC Funds and PE Funds are essentially progressions in terms of project risk, investment liquidity and stages in the life cycle of the business. Angels normally enter a business at the lowest valuations with PEs entering at the highest valuation amongst the three kinds of investors (Angel, PE and VC).

The Process

Normally, upon deal origination (which may depend on the internal policies of the VC firm, and the area of interest that they may have), the step that follow is roll out of a Term Sheet. It is entirely possible that the VC move to Evaluation or Due Diligence before rolling out the Term Sheet.  In case the business is absolutely new then the an evaluation into the quality of the entrepreneur is undertaken, before appraising the characteristics of the product, market or technology. Most venture capitalists ask for a business plan to make an assessment of the possible risk and expected return on the venture.  Oftentimes, the above procedure runs in parallel with the negotiation on a draft Term Sheet.

Thereafter, the process of Valuation may commence. Investment valuation is a specialised process, where various factors are considered including but not limited to the entrepreneur’s track record, the product itself, and whether it is innovating, overall economic scenario, unique proposition of the venture, size of the market and so on and so forth.

Assuming that the aforesaid steps are accomplished and an acceptable Term Sheet has been signed, the next step would be Deal Structuring.

Once the venture has been evaluated as viable, the venture capitalist and the investment company negotiate the terms of the deal, i.e., the amount, form and price of the investment. This process is termed as deal structuring. The discussions would also include protective covenants and earn-out arrangements. Covenants include the venture capitalists’ right to control the target company and to change its management if needed, buy back arrangements, acquisition, making Initial Public Offerings (IPOs), etc.  Discussions and agreement entered into would specify the entrepreneur’s equity share and the objectives to be achieved.  Various rights are retained by the VC, including that of replacement of the management in case the objectives are not met, or in case of specific circumstances arising.

The next important question, apart from the day to day operations and the VC Firm’s level of intervention in it is that of exit.  There could be:

• Initial Public Offerings (IPOs)
• Acquisition by Another Company
• Buyback or Repurchase of the Venture Capitalist’s Share by the Investee Company / Promotors
• Purchase of VC Firm’s Share by a Third Party

From a process perspective, the following stages are key:

Sourcing of proposal:  PE / VC funds receive proposals from Investment Banks as well as from the targets directly.  Most funds may not wish to directly engage with the promotors, especially when the promotors do not have a significant track records, and would prefer to pursue proposals that are initiated by Investment Bankers.

• Initial contact / flier / pitch:  This refers to the stage when the Investment Bank or the promotor sends out a pithy flier, which may be just a page or two, outlining the bare details of the project – essentially, the issuer, the business and the nature of the proposed transaction.
• Non-Disclosure Agreement:  If the fund is interested, they would seek further information by way of emails or by way of discussions.  To cover the subject matter and to ensure no possible leakages, a non-disclosure agreement is typically signed by the parties.
• Information memorandum: Post the non-disclosure agreement, an Information Memorandum is shared between the parties. This may contain the following:
  • Highlights
  • Executive Summary
  • Promoter background
  • Industry background, regulatory environment, market structure and competitors
  • Key drivers of success in the business and the overall value chain
  • Company background, its management team and clients
  • Business model of the company
  • Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis of the company vis-à-vis the chosen business model
  • Capital expenditure plan and proposed means of financing
  • Revenue model and strengths / uncertainties associated with each stream of revenue
  • Cost and Margin structure
  • Historical financials
  • Projected financials for about 5 years, or longer for long gestation projects
  • Patents or any intangible assets owned by the company
  • Key successes of the company
  • Litigation or tax issues associated with the company or its promoters
  • Proposed transaction, including purpose of mobilisation, size of mobilisation, proposed dilution and the valuation.
  • Justification for valuation
  • Risks associated with the investment
  • Likely exit possibilities for the investor
  • Time frame, or any other key aspect not covered above

This document is required to be professionally prepared in the interest of completeness and should ordinarily be vetted by professionals who would be assisting in the transaction should it go forward.

• Management presentation
• Initial Due Diligence
• Preliminary investment note:  This is typically prepared by the internal team of the fund, and is a document private to the fund.
• Non-Binding Letter of Intent:  Post the above, a Non-Binding Letter of Intent is issued by the fund outlining the nature of the investment, the kind of instrument, key parameters, investment conditions, amounts and other terms.  The LoI would also outline the key liquidity events, time frame, board representation, expected stake, costs and who is to bear them.  Any specific area of concern may also be addressed in such an LoI.
• Final Due Diligence (FDD): FDD occurs on several parameters including commercial, financial and legal.  Legal DD would normally cover the following:
  • Incorporation certificate and various registrations obtained by the company
  • Licences and approvals required for doing business, scheduled expiry date of each of these, likely terms of renewal on expiry, any permissions not obtained by the company, reasons therefor, and the implications in terms of costs, penalties and culpability of owners / managers
  • Approvals required for the proposed PE transaction within the company, from other business owners, from regulatory authorities and from any other commercial partners
  • Review of the memorandum and articles of association including confirmation that all changes to date are suitable reflected in them
  • Changes that will need to be incorporated in the memorandum and articles as part of the proposed transaction
  • Non-compete agreements executed by the company and their validity and duration
  • Claims made against the company by any party, the status of these claims with various authorities and relative strength of the parties to the claims
  • Meetings of the board and share-holders, the dates on which they were held and the compliance with regulatory requirements
  • Filing of annual returns, resolutions and other forms with the Registrar of Companies (ROC) and other regulatory authorities
  • Material contracts executed by the company for financing, sourcing etc. and especially contracts the company has made with owners or senior management of the company
  • Standard terms of employment with employees, and special arrangements made with senior management of the company
  • Confirmation of ownership of key assets reported by the company
  • Adequacy of insurance taken on the assets and other contingencies, the insurers, key clauses in the insurance policy, pending insurance claims, impact of claims on future premia payable on those insurance policies etc.
  • Patents, trademarks, brands, copyrights, industrial secrets, proprietary software and other intangible assets of the company, the certifications of their ownership and validity, measures taken to protect them, and any further steps to be taken on these matters if the proposed transaction goes through
  • Cases against the promoters or senior management, whether related to the business of the company or otherwise, and their status in relevant courts or with regulatory authorities.
• Final Investment Memorandum: This document covers all the areas through the Information Memorandum, and findings of the FDD, as well as valuations.  All the approvals and closing steps are also discussed in the Final Investment Memorandum.  This document is ordinarily discussed in the meeting of the directors / partners, and the authorised signatory for signing the Term Sheet is then decided and authorised.
• Term Sheet: Term Sheet can be seen as a binding LoI as opposed to a Non Binding LoI containing the details therein as well as addressing any other issues that may need to be addressed pursuant to the aforesaid steps.  The Term Sheet is then binding on the fund, while containing the term for which it would remain firm.
• Closure of the deal: After the term sheet is signed, and before the fund releases the money to the company, various other processes need to be completed, such as:
  • Drafting and execution of subscription agreement outlining the respective parties’ rights and obligations
  • Making relevant changes in memorandum and articles of association and other agreements with various parties, as may have been decided
  • Permission of Cabinet Committee on Economic Affairs, SEBI, RBI, Ministry of Finance, relevant Ministry for that industry, state government, local authorities etc.
  • Obtaining any no-objection certificates that may have been highlighted as part of the legal due diligence
  • If the transaction structure provides for any escrow arrangements or other guarantees, then effecting the same
  • If the deal is subject to any changes in the financial structure of the company including fresh borrowings, then obtaining firm commitments for the same and concluding the relevant documentation

There may be conditions subsequent and precedent as well that need to be fulfilled upon or before closure of the deal.

Key Investment Conditions

Certain investment conditions are typically addressed by the Funds in the course of the deal.  These are:

• Board Seat
• Right to change management
• Lock in of Promotors / Management
• ESOPs
• Assured Returns
• Veto Rights
• Right of First Refusal
• Right of First Offer
• Right to MIS
• Right to Audit
• IPO Facilitation

The aforesaid conditions are incorporated into the deal by way of various documents such as Share Subscription, Share Holders, Share Purchase Agreements.  The Memorandum and Articles of the Company are also amended in keeping with the transaction structure.

For the purposes of this article, one confines oneself to the practice aspects of PE / VC transactions.  Of course there are other nuances, such as taxation, regulations of AIFs by SEBI, and the entire ecosystem surrounding them, which may form a part of another offering from Aureus Law Partners.

Till then.

From the Aureus Law Partners’ research desk. 

For queries: aureus@aureuslaw.com