Saturday, March 14, 2015

Transfer of Shares in Indian Company by One Non-Resident to Another Non-Resident

Facts of the Case:
  • A non-resident company called ABC Ltd. incorporated in a tax haven (say, Mauritius) has shareholding of 25% in a private Indian company called ABC India Pvt. Ltd.
  • It wishes to transfer its shareholding in the Indian company to another company incorporated outside India (say, in Australia) called ABC Australia Ltd.
  • The consideration for transfer of shares is Rs. 1 million.
  • There is no tax on capital gains in the tax haven (in this case Mauritius, as per the India-Mauritius DTAA)

  1. Can the Indian company refuse to acknowledge and register such transfer?
  2. What all procedures should be followed by ABC India Pvt. Ltd. to ensure compliance with various laws with respect to this share transfer from ABC Mauritius to ABC Australia?
  3. Will ABC India Pvt. Ltd. have to deduct any withholding taxes on the consideration received by ABC Mauritius, being an “Agent” of the latter as per the Income Tax Act?
Answer: Let us examine this case in light of the Companies Act 2013, the Stamp Duty laws, FEMA and RBI regulations, the Income Tax Act, 1961 and the India-Mauritius DTAA.

Companies Act, 2013

Can transfer of shares be restricted by other shareholders who hold 75% of the share capital?

The only restriction that can be placed on transfer of securities are those specified in any law or in the Articles of Association of the company. There is no general power to company to refuse the share transfer. [VB Rangaraj v. VB Gopalakrishnan 1991 AIR SCW 3020 = (1992) 1 SCC 160 = AIR 1992 SC 453]

Powers of Board to refuse transfer are only those specified in Articles. Board has no inherent or general powers to refuse a transfer [Hemangini Finance v. Tamilnadu Mercantile Bank Ltd. (1996) 22 CLA 108 (CLB)] The Articles cannot provide total prohibition on transfer. Further, the restriction on transfer should be fair and reasonable. However, regulations in Articles cannot be against provisions of any Act.

Relevant Extracts of Section 56 of the Companies Act, 2013

Section 56 (1): A company shall not register a transfer of securities of the company unless a proper instrument of transfer, in such form as may be prescribed, duly stamped, dated and executed by or on behalf of the transferor and the transferee and specifying the name, address and occupation, if any, of the transferee has been delivered to the company by the transferor or the transferee within a period of sixty days from the date of execution, along with the certificate relating to the securities, or if no such certificate is in existence, along with the letter of allotment of securities.

Provided that where the instrument of transfer has been lost or the instrument of transfer has not been delivered within the prescribed period, the company may register the transfer on such terms as to indemnity as the Board may think fit.

Section 56(4): Every company shall, unless prohibited by any provision of law or any order of Court, Tribunal or other authority, deliver the certificates of all securities allotted, transferred or transmitted within a period of one month from the date of receipt by the company of the instrument of transfer.

Relevant Extracts of Rule 11 of Companies (Share Capital & Debentures) Rules 2014

An instrument of transfer of securities held in physical form shall be in Form No. SH-4 (earlier Form 7B) and every instrument of transfer with the date of its execution specified thereon shall be delivered to the company within sixty (60) days from the date of such execution.

Other Matters under Companies Act, 2013

Any transfer of shares should be in strict compliance with the Articles of Association, failing which the transfer is liable to be set aside [Satyanarayan Rathi v. Annamalaiar Textiles Pvt. Ltd. (1999) 19 SCL 56 = 95 Comp Cas 386 (CLB); Cruickshank Co. Ltd. v. Stridewell Leather Pvt. Ltd. (1996) 86 Cmp Cas 439 =4 SCL 202 (CLB); Chotoo Sud v. Bhagwan Finance Corporation Pvt. Ltd. (2006) 66 SCL 223 (CLB)]

In a private company, transfer of shares has to be in accordance with Articles of the company and transfer in violation of provisions of Articles would be void. [Stridewell Leathers v. Shoe Specialities Pvt. Ltd. (2001) 33 SCL 797 (CLB)]

The share transfer must be authorized by the Board of Directors, as all powers of company, except those specified in Act or Articles, are vested in Board. Authority can be delegated to one Director.
A security should be duly transferred or transmitted within one month from the date of receipt of instrument of transfer [Section 56(4)(c) of Companies Act, 2013]

In case of default, company is punishable with minimum fine of Rs. 25,000 which shall extend upto Rs. 5 lakhs. Every officer of the company who is in default is punishable with imprisonment of six months or fine which shall not be less than Rs. 10,000 but which may extend to Rs. 1 lakh, or both. [Section 56(4)(c) of Companies Act, 2013]

If the company fails to register the transfer within one month, the aggrieved person (transferee) can appeal to NCLT and NCLT can direct the company to register the transfer [Section 58(5) of Companies Act, 2013]. But the company can obviously refuse to register the transfer if the transfer is not as per the Articles of Association or the application is not duly stamped or for any other valid reason.

So long as the Transfer Deed is not registered, the transferee has not the perfected right of property which he would have if he had been the registered holder of the shares. Until the actual entry of name of transferee on the register, the transferor remains legal owner of the share. [LIC v. Escorts Ltd. (1986) 1 Comp LJ 91 = AIR 1986 SC 1370 = (1986) 1 SCC 264 = 59 Comp Cas 548]

A Transfer Deed is improper if:
  1. Document is not “duly stamped”
  2. Transfer deed is not signed by proper authority
  3. Signature of authorized person does not tally with signature available on record
  4. Original certificates not attached
  5. Instrument of Transfer not in prescribed Form SH-4
  6. Incomplete transfer deed
  7. Date stamp on transfer deed beyond limit
  8. Transfer deed submitted after book closure date

The Board may decline to recognize any instrument of transfer if:
  1. The instrument of transfer is not in the form as prescribed in rules;
  2. The instrument of transfer is not accompanied by the certificate of the shares to which it relates and such other evidence as the Board may reasonably require to show the right of the transferor to make the transfer is not submitted (e.g. Power of Attorney, Board resolution, etc.)

Transfer of shares is complete between transferor and transferee only when instrument of transfer is signed and the share certificates are handed over. [Martin Castelino v. Alpha Omega Ship Management (2001) 33 SCL 210 (CLB)]

Transfer Deed can be signed by holder of Power of Attorney (PoA) on behalf of the transferor. Such PoA should be registered with the company beforehand or certified copy should be furnished along with the Transfer Deed. If PoA was already registered with company by submitting certified copy, its registration number and date of registration with the company shall be given on reverse of Transfer Deed at the place provided for that purpose in Form SH-4.

Transfer can be declined if it is in violation of Section 50 i.e. if Transfer Deed is not duly stamped or not lodged within prescribed time or if signature differs. [Hemagiri Finance v. Tamilnadu Mercantile Bank Ltd. (1996) 22 CLA 108 (CLB)]

Procedure for Registering Transfer or Refusal Thereof by the Board

Usually, the following steps are followed by a private company to give effect to the transfer of shares:
  1. Transferor should give a notice in writing for his intention to transfer his share to the company.
  2. Get the share transfer deed and transfer form in SH-4 duly executed both by the transferor and the transferee.
  3. The transfer deed should bear stamps according to the Indian Stamp Act and Stamp Duty Notification in force in the State concerned.
  4. The signatures of the transferor and the transferee in the share transfer deed must be witnessed by a person giving his signature, name and address.
  5. Relevant share certificate or allotment letter must be attached with the share transfer deed and delivered to the company.
  6. The share transfer deed should be deposited with the company within sixty (60) days from the date of such execution by or on behalf of the transferor and by or on behalf of the transferee.
  7. After receipt of share transfer deed, the Board shall consider the same. If the documentation for transfer of share is in order, board shall register the transfer by passing a resolution.

If a private company refuses to register transfer, it shall, within 30 days from date of lodgment of transfer deed send notice of refusal to the transferee and the transferor. The Board will have to give reasons for refusal to transfer, if it decides to refuse the transfer [Section 58 of Companies Act, 2013]
Right of refusal is not lost even if refusal is not communicated within prescribed period. However, penalty can be imposed. Further, transfer can be refused only for bona fide reasons and not arbitrarily or for collateral purposes. [Shailesh Prabhudas Mehta v. Calico Dyeing (1994) 80 Comp Cas 64]

Stamp Duty on Share Transfer Deed

Amount of Stamp Duty: Presently, the stamp duty payable is @25 Paise per Rs. 100 of consideration (and not on the basis of face value of shares). Therefore, for a consideration of Rs. 1 million the stamp duty amount will be Rs. 2,500/-

The term “duly stamped” means that the stamp should be of adequate value and crossed out if it is not an e-stamp.

If the share transfer deed does not bear the stamp payment as required, transfer cannot be recorded on basis of such transfer deed. Company can legitimately refuse to register such transfer deed.

FEMA Regulation/RBI Master Circular 

Relevant extracts of the RBI Master Circular No. 15/2014-15 dated 1st July, 2014 on Foreign Investments in India are reproduced below:

8B: Acquisition by way of transfer of existing shares by person resident in or outside India: Foreign investors can also invest in Indian companies by purchasing/acquiring existing shares from Indian shareholders or from other non-resident shareholders. General permission has been granted to non-residents/NRIs for acquisition of shares by way of transfer in the following manner:

8 B.I: Transfer of shares by a Person resident outside India: Non Resident to Non-Resident (Sale/Gift): A person resident outside India (other than NRI and OCB) may transfer by way of sale or gift, shares or convertible debentures to any person resident outside India (including NRIs but excluding OCBs).

Regulation 9 of The Foreign Exchange Management (Transfer of Security by a Person Resident outside India) Regulation 2000 states:

Transfer of shares and convertible debentures of an Indian company by a person resident outside India:-
(1) Subject to the provisions of sub-regulation (2), a person resident outside India holding the shares or debentures of an Indian company in accordance with these Regulations, may transfer the shares or debentures so held by him, in compliance with the conditions specified in the relevant Schedule of these regulations.
(2) (i) A person resident outside India, not being a non-resident Indian or an overseas corporate body, may transfer by way of sale, the shares or convertible debentures held by him to any person resident outside India:-
(ii) A non-resident Indian may transfer by way of sale or gift, the shares or convertible debentures held by him or it to another non-resident Indian.
Provided that the person to whom the shares are being transferred, in terms of Clauses (i) and (ii), has obtained prior permission of Central Government to acquire the shares if he has previous venture or tie up in India through investment in shares or debentures or a technical collaboration or a trade mark agreement or investment by whatever name called in the same field or allied field in which the Indian company whose shares are being transferred is engaged.

Thus, from a bare perusal of the above stated provisions of Foreign Exchange Management (Transfer of Security by a Person Resident outside India) Regulation 2000, read with the Master Circular on Foreign Direct Investment, it is evident that there is no bar under Indian laws on the transfer of shares of an Indian Company by a non-resident to a non-resident. A general permission has been granted by the RBI for the said transaction.

Income Tax Regulations

Article 13 of the India-Mauritius Double Tax Avoidance Agreement (DTAA) on Capital Gains states:
  1. Gains from the alienation of immovable property, as defined in paragraph (2) of article 6, may be taxed in the Contracting State in which such property is situated.
  2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in that other State.
  3. Notwithstanding the provisions of paragraph (2) of this article, gains from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft, shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.
  4. Gains derived by a resident of a Contracting State (Thomson Reuters Mauritius) from the alienation of any property other than those mentioned in paragraphs (1), (2) and (3) of this article shall be taxable only in that State (Mauritius).
  5. For the purposes of this article, the term "alienation" means the sale, exchange, transfer, or relinquishment of the property or the extinguishment of any rights therein or the compulsory acquisition thereof under any law in force in the respective Contracting States.

Keeping in mind the benefit of exemption from capital gains tax in India available on the basis of the India-Mauritius DTAA, and further, in light of the landmark judgment given by the Hon’ble Supreme Court in the Vodafone case which had similar facts, it can prima facie be stated that ABC India Pvt. Ltd. should not be liable to deduct withholding taxes on consideration received by ABC Mauritius Ltd.

However, in a country like India, such matters hold immense potential to attract the Income Tax Department and lead to litigation, where the contention of the Department is that the Indian company should have deducted withholding taxes on the capital gain made by the non-resident transferor. In such a scenario, the Indian company can safeguard itself by either taking an indemnity bond from the transferor, stating that the transferor will bear any expenses that may arise on the Indian company in case of any such litigation; or an Advance Ruling can be applied for on the matter by ABC India Pvt. Ltd. or ABC Mauritius Ltd.