Constitutional Validity of the NCLT: A Brief Background

The business standard and livemint both report that the Supreme Court has upheld the constitutional validity of the National Company Law Tribunal (‘NCLT’). The judgement of the Supreme Court is not yet available. In the meantime though, it is worth recapitulating the contours of this dispute.

The legislature through the Companies (second amendment) Act, 2002 had made provisions for setting up the NCLT and the National Company Law Appellate Tribunal. The NCLT was conferred the power to hear all the matters relating to amalgamation, reconstruction of companies, winding up, reduction of share capital and other related matters. Previously these powers were conferred on the High Courts. Though the amendment to set up the NCLT was made in 2002, it has not been able to see the light of day. This reason being a pending appeal before the Supreme Court of India. The appeal was preferred by the Union of India against the judgement of the Madras High Court in R. Gandhi v. Union of India. In Gandhi the Madras High Court had held that setting up of the NCLT was Unconstitutional.

The fundamental challenge to the constitutionality of the NCLT revolves around the point, whether a complete transfer of matters from the jurisdiction of the High Court to a quasi judicial body would in principle be against the indispensable constitutional principles of independence of the judiciary and separation of powers. In the Gandhi case the madras high court had answered the question in the affirmative. Essentially two simple question needs determination insofar as the constitutionality of the NCLT is concerned:

1. Whether in principle setting up of the NCLT and excluding the jurisdiction of the High Court is constitutional?

2. Whether in its present form, the provisions relating to the appointment, tenure, qualification etc. of members of the NCLT is such that it keeps the basic constitutional principles of independence of judiciary and separation of power intact?

The first question seems to be squarely covered by the Supreme Court judgement in the L. Chandrakumar case. In the Chandrakumar case a seven judge bench of the Supreme Court had held that the power of judicial review of the high court under art. 226 cannot be excluded by the legislature through a constitutional amendment; as such a power conferred on the high court constitutes the basic structure of the constitution. In essence, the Supreme Court stated that a specialized tribunal can be set up as long as that tribunal performs a supplementary role as opposed to a substitutive role to the High courts. Simply put, if the power of judicial review is kept intact then there is no constitutional issue in setting up a specialized tribunal. On this point it seems the setting of the NCLT is clear of any constitutional hurdles or the ratio of Chandrakumar. The following paragraph from the Gandhi judgement clarifies the point:

“Parliament is thus competent to enact law with regard to the incorporation, regulation and winding up of Companies. The power of regulation would include the power to set up an adjudicatory machinery for resolving the matters litigated upon, and which concern the working of the companies in all their facets. The Law Commission, as noted by the Supreme Court in the case of Chandra Kumar, had also recommended the creation of specialist Tribunals in places of generalist Courts. Creation of National Company Law Tribunals and Appellate Tribunals and vesting in those Tribunals the powers exercised by the High Court with regard to company matters cannot be said to be unconstitutional.”- Para 57

Needless to say, the second point is the critical issue as far the constitutional validity of the NCLT is concerned. In the Gandhi case the Madras High Court after the perusal of several provisions relating to the appointment, tenure, qualification etc of the members of the NCLT. had come to this conclusion:

“In the light of foregoing discussions it is declared that until the provisions in parts 1B and 1C of the Companies Act introduced by the Companies (Amendment) Act, 2002, which have been found to be defective in as much as they are in breach of the basic constitutional scheme of separation of powers and independence of the judicial function, are duly amended, by removing the defects that have been pointed out, it would be unconstitutional to constitute a Tribunal and Appellate Tribunal to exercise the jurisdiction now excercised by the High courts or the Company Law Board.” Para 123

In light of this background what one can hope from the Supreme Court Judgement is guidelines relating to the appointment, tenure etc. of the members of the NCLT so as to make it constitutionally viable.

Narco-analysis, Brain-Mapping, Polygraph Test Unconstitutional

In a recent landmark judgement Selvi v. State of Karnataka, the supreme court had held that compulsory narco-analysis, brain-mapping and polygraph tests are in violation of article 20(3) and article 21 of the constitution.

Prof Mrinal Satish in his article analyzes the judgement in some detail. The article is here. Prof. Satish is a visiting professor at NLSIU, Bangalore and had earlier completed his LLM from Yale University.

Right of Nominee of Shares

In a previous post on this blog Avantika had discussed a recent ruling of the Bombay High Court pertaining to the right of nominee of shares over legal heirs. The same judgement has been discussed by Somasekhar Sundaresan, Partner at J Sagar&Associates in a Business Standard article dated 10th May, 2010. The article is here.

Taxability of FIIs in India: Part 1

The economic times has stated here that the Bombay High Court has ruled that FII earnings aren’t taxable in India. This view/analysis is erroneous because the Bombay High Court did not have an occasion to consider the question of the taxability of FII earnings in India. In the concerned case, Prudential Assurance Company Ltd. v. DIT the assesse had obtained a ruling from the AAR in its favour i.e. the AAR held that the earnings of the petitioner a FII was not taxable in India. Subsequently there was a ruling by the AAR in Fidelity Northstar fund which stated that the earnings of a FII from selling of shares are taxable in India. Based on the Fidelity ruling the DIT proceeded to tax the petitioner on the ground that there was a change in law. It is in light of this background that the assesse invoked the jurisdiction of the Bombay high court under section 263 of the IT Act. The question before the court was whether the DIT was correct to hold that the AAR ruling obtained by the petitioner was not binding on the revenue as a consequence of a change in law brought about by the fidelity ruling. It is in this regard the Bombay high court held that the ruling obtained by the petitioner was binding on the revenue. The following paragraph of the Bombay high court judgement is apposite:

“Evidently, the Commissioner has ignored the clear mandate of the statutory provision that a ruling would apply and be binding only on the Applicant and the Revenue in relation to the transaction for which it is sought. The ruling in Fidelity cannot possibly, as a matter of the plain intendment and meaning of Section 245S displace the binding character of the advance ruling rendered between the Petitioner and the Revenue.”

It is clear that the question of taxability of FII’s in India had never arisen before the Bombay High Court. The following observation of the court manifests this point:

“We would clarify, in conclusion, that we have had no occasion having regard to the nature of the jurisdiction that was invoked by the Commissioner to inquire into the correctness of the ruling of the AAR in the case of the petitioner and we leave it open to the Revenue to take recourse to such remedies in law in respect of the ruling of the AAR, if so advised.”

Concluding the Bombay High Court does not in any way settle the law on the taxability of FII’s in India. In my subsequent posts I will attempt to analyse the present law (which remains largely unsettled) on the taxability of FII’s in India in light of the existing precedents.

RNRL v. RIL

The full text of the Supreme Court judgement in RNRL v. RIL is available here. I shall analyse some facets of the judgement in subsequent posts.

Computation of the PE "Duration Test" under the India- Mauritius Tax Treaty

In a recent decision in ADIT (Int’l taxation) v. Valentine Maritime (Mauritius) Ltd., ITAT Mumbai has thrown some light on the computation of PE “Duration test” under art. 5(2)(i) of the India-Mauritius tax treaty. In the present dispute the assesse, a Mauritian entity engaged in the business of marine and general engineering and construction had executed three contracts in the India. The duration of these contracts individually were less than “nine months” however if the contracts were taken cumulatively then the entire period would exceed the “nine month” threshold limit under Art. 5(2)(i) of the Indo- Mauritian Tax treaty.
The issue before the tribunal was whether the duration of the projects in the present dispute shall be taken cumulatively or separately. The contention of the revenue was that unlike the India UK DTAA, the India- Mauritius treaty does not specifically incorporate the provision that for the purposes of applying the “Duration test” each project site is to be considered separately. Thus, the revenue contended that under Art. 5(2)(i) of the India Mauritius tax treaty the duration of project sites are to be construed cumulatively and if such a period exceeds nine months then the assesse shall be deemed to be having a permanent establishment in India (PE). As a starting point it is first important to reproduce Art. 5(2)(i) of the India- Mauritius treaty:

Article 5 - Permanent Establishment

1. For the purpose of this Convention, the term 'permanent establishment' means a fixed place of business through which the business of enterprise is wholly or partly carried on.

2. The term 'permanent establishment' shall include:

(i) a building site or construction or assembly project or supervisory activities in connection therewith, where such site, project or supervisory activity continues for a period of more than nine months.

On a plain reading of the above quoted provision it is clear that Art 5(1) lays down a general test of “permanence” for establishing an entity as a PE. On the other hand Art 5(2)(i) lays down a specific “duration test” for establishing a building site, construction or assembly project as a PE. In the present dispute the tribunal has laid down the scope and application of this “duration test”. The tribunal while rejecting the contention of the revenue stated that under art. 5(2)(i) the “duration test” is to be applied to individual projects separately and not cumulatively. The apposite part of the judgment is reproduced as under:

“In other words, each of the building site, construction project, assembly project or supervisory activities in connection therewith is to be viewed on standalone basis. Broadly, the underlying rationale of this approach is that various business activities performed by one and same enterprise, none of which constitutes a PE, cannot lead to a PE, if combined. In our humble understanding, the very conceptual foundation of this approach rests on the assumption that various business activities of the enterprise in different locations are not so inextricably interconnected that these are essentially required to be viewed as a coherent whole. The locations are thus separate places of business, and activities at different locations are, therefore, required to be viewed on standalone basis. In a typical building site, assembly or installation project, or supervisory activities in connection therewith, each of site or project is an independent unit, and the approach to these types of PEs recognize this normal business practice.”- Para. 9

The court also rejected the argument of the revenue that since the India- Mauritius treaty does not specifically exclude (like the India UK treaty) the application of the “duration test” to all projects taken cumulatively, it would necessarily mean that the duration of the projects should be tabulated together inorder to ascertain whether an entity qualifies to be a PE. The court stated as under:

“The provisions set out in protocol to the tax treaties need not necessarily be substantive provisions, and these can also be, and often are, merely clarificatory provisions 'ex abundanti cautela'. What is stated in the said protocol to Indo UK tax treaty is nothing other than what is anyway within the scope of the construction PE clause, as analyzed in the OECD Model Convention Commentary (adopted by the UN Model Convention Commentary as well) - an analysis, with which we are in considered agreement. The protocol provision is merely clarificatory in nature and is apparently set out as a measure of abundant caution. The absence of similar protocol clarification in other tax treaties entered into by India would not, therefore, warrant a different interpretation of the treaty provision.”- Para. 10

The tribunal further lays down two grounds under which the aggregation principle (duration of all the project sites taken together in computing the threshold duration) can be applied. Firstly, where the contracts have been artificially divided inorder to reap the benefits of the tax treaty. The onus of showing such an artificial division would be on the revenue. Secondly, when there is an inextricable interconnection and interdependence between the project sites so that they form a coherent whole. The test of “interconnection and interdependence” is an expanded version of the test laid down in the OECD commentary i.e. “coherent whole- geographically and commercially” test.

Right of Nominee versus Right of Heir: Transmission of ownership of shares through nomination

The Bombay High Court in the case of Harsha Nitin Kokate v.The Saraswat Co Op. Bank Ltd. & Ors put to rest the debate involving inheritance of shares by heirs and the legal right over the shares through nomination in consonce with section 109A of the Companies Act,1956. The application of a widow was therefore dismissed by the Court who held that the legal right and title of the shares after the death of the shareholder( the applicants husband in this case) would be with the nominee of the shareholder and not with the heir of the shareholder.

In the instant case the applicant, the widow of the shareholder filed a suit for an interest in the shares which she claimed to have sold. The court affirmed that the foremost question in the instant case was whether the applicant had any legal right or title over such shares.
Her husband proir to his death in 2007 had made his nephew the nominee to the shares in the prescribed form of the Depository Participant. The effect of S.109A therefore results in vesting absolute rights of the nominee over the shares, notwithstanding other laws being in force. Consequent to the dematting of shares in 1996, the amendment in 1998 resulted in the inclusion of Sec.109A to govern nomination of shares. Shares being intangible movable property which can be bequeathed through word of mouth or over the internet result in transfer of rights over these with the change in holders. Therefore it became important for the inclusion of S.109A governing nomination. Furthermore in accordance with S.9.11 of the depositories Act,1996, which relates to the Transmission of Securities in the case of nomination, the shares automatically get transferred to the nominee so appointed on the death of the Nominating person.Consequently such nomination comes into effect notwithstanding anything contained in a testimentory disposition or any other nomination under any other law relating to securities at the time being in force.
The counsel for the plaintiff argued that the nominee would serve only as a trustee for the shares and thus the plaintiff being the widow of the deceased is entitiled to the right over these shares. However the Court went on to further disagree and concluded that it is the property of the shares which has been transferred along with exclusive rights of ownership. The Court further lay stress on the term 'vest' used in the statutory provision of the Companies Act as well as S.9.11 of the Depositories Act,1996 and concluded that the term has to be interpreted in the light of S. 109A to mean that the right and title over the property of the shares along with the absolute ownership belongs with the nominee. The use of the term 'vest' in other legislations as used in S.39 of the Insurance Act denotes the right to receive payment of the policy without conferring absolute ownership in the nominee.Thus the court acknowledged the right of the nominee over the property of the shares in consonance with s,109A of the Companies Act,1956 and dismissed any right of the plaintiff over such shares of the deceased husband.

The judgement has conclusively detremined the application and ambit of the S.109A of the aforementioned Act so far as a nomination has been made with regard to transmission of shares. Further it has dismissed any presumption which would prevent the nominee from absolute ownership of the shares.

Laws Relating to "Sweat Equity Shares" in India

Though it is premature to comment on the root cause of the Indian Premier League (IPL) fiasco, it would not be incorrect to assert that the term “sweat equity” has certainly been at the forefront of the initial mess. So what is “sweat equity” and what are the legal regulations surrounding it. This post attempts to answer some of these questions.

Generally at the time of incorporation, IPO or other similar instances the company issues equity shares for a certain price i.e. monetary consideration (this is subject to the company being limited by shares). The cash that is collected through such a mechanism forms the capital of the company. Contrastingly, sweat equity is issued by the company to its directors /employees at a discount or for consideration other than cash i.e. to say that the consideration is generally kind and not cash (S.79A, Explanation II). It requires no Einstein to figure out that the basic idea behind the issuance of sweat equity shares is to incentivise the employees by providing them with some direct stake in the company. Sweat equity shares are quite akin to Employee Stock Option Plans (ESOPs), but there are some differences between the two. For e.g. sweat equity shares is grant of shares at discount or without any monetary consideration whereas ESOPs are grant of an option to purchase shares at a predetermined price (Compare section 2(15A) and section 79A of the companies Act, 1956).

S. 79A of the companies act, 1956 is the primary legal provision governing the issuance of sweat equity shares. S. 79A(1) confers a right on the company to issue sweat equity shares if certain conditions as laid down in the same provision are fulfilled. The conditions are as follows:

1. Issuance of such shares is authorized by a special resolution by the company

2. The resolution specifies the number of shares, current market price, consideration (if any) and the class of employees to whom such shares are issued

3. One year has elapsed after the date of commencement of business.

4. For listed companies, other regulations of SEBI are complied with

5. For unlisted companies, the guidelines as may be prescribed by the Central Government( Generally would be the Ministry of Corporate affairs (MCA))

S. 79A seems to lay down broad guidelines for the issuance of sweat equity shares, but the provision by no means is exhaustive. I say this because clause (4) and clause (5) [please note that clause 5 is actually a proviso under s. 79A(1), but for convenience I have used it as a distinct clause since the meaning does not change at all] grants power to SEBI and MCA to issue any further regulations or guidelines.

It is in this regard the SEBI came out with a regulation in 2002 titled SEBI (Issue of Sweat Equity) Regulations, 2002. Needless to say the regulation only applies to listed companies. It would not be feasible to reconcile all the facets of the regulation here, apart from just briefly touching upon the clauses dealing with the aspect of pricing of shares and valuation of intellectual property. Clause 7 of the Regulation specifies that the minimum price of sweat equity share should be (a) the average of the weakly high and low of the related equity shares during the last six months preceding the “relevant date” or (b) the average of the weakly high and low of the related equity shares during the two weeks preceding the “relevant date”; whichever is higher. “Relevant date” is defined as the date which is thirty days prior to the date on which the general meeting is convened as per s. 79A(1) of the companies act, 1956. As for the valuation of intellectual property or know how, clause 8 of the Regulation specifies that a merchant banker shall make such valuations after consultation with industry specific experts (it is to be noted that valuations of intellectual property and know how are important as sometimes the employees are given sweat equity shares in return for any know how that the employee may provide to the company).

Similarly for unlisted companies in 2003 the MCA came out with rules titled Unlisted Companies (Issue of Sweat Equity) Rules, 2003. As per the Rules the minimum price of sweat equity shares and the valuation of intellectual property are to be determined by an independent valuer. The MCA rules also imposes a restriction on the company not to issue sweat equity shares for more than 15% of the total paid up share capital in a year or shares of the value of 5 crores; whichever is higher.

The law with regard to sweat equity shares revolves mostly around the conditions for issuance of such shares. However one may be curious to know what happens after the employee is allotted the sweat equity shares. In this regard the law only prescribes that the sweat equity shares shall be locked in for a period of three years after the date of allotment i.e. to say that the employee or the director cannot dispense of these shares within a period of three years (See clause 12 and clause 10 of the 2002 SEBI regulations and 2003 MCA Rules).

Interestingly in India which is based on a “promoter controlled model” i.e. most of the shares of a given company are owned by a family group, the issuance of sweat equity shares could be fraught with difficulties. An illustration would drive home the point. Consider a Pvt. Ltd. company X having a shareholding pattern of 80:20 held by family Y and another company Z respectively. Now, if Y inducts a family member as an employee then it can easily offer sweat equity shares to the employee at a discount or any other consideration except cash and further increase the shareholding of the family Y without actually paying the actual price of the shares. The reason why family Y can easily do that is because in case of a special resolution family Y can easily have its way considering its 80% shareholding. The law relating to issuance of sweat equity shares should be based on the basis of the corporate structure prevalent in India and not merely a legal transplant i.e. borrowed from some other countries like the UK or the US where the corporate structure is quite different(shareholding is much more dispersed in companies).

In subsequent posts I shall discuss the taxability of sweat equity shares.

CCI-CAT SPAT

In a recent development the competition commission of India (CCI) has moved an appeal before the Supreme Court against the Competition Appellate tribunal (CAT). The dispute arose when the CAT halted an investigation carried out by CCI pursuant to a complaint lodged by Jindal Steel. It was the case of Jindal steel that SAIL and Indian Railways were engaged in a cartel like behaviour. S. 19(1)(a) confers power on the CCI to inquire into any alleged contravention of S.3 (anti- competitive agreement) and S.4 (abuse of dominant position) either suo moto or on a receipt of a complain from any other person. The matter before the Supreme Court could give rise to interesting questions of law as to the specific powers conferred to the CCI and the CAT under the Competition Act, 2002. This post discusses some of the legal aspects that may arise before the Honourable Supreme Court.


The issue before the Supreme Court would be whether the CAT has powers to halt an investigation carried out by the CCI. Interestingly the CAT did not find a place in the statute as it was originally drafted in 2002. The CAT was only brought about by the Competition (Amendment) Act, 2007 through the incorporation of Chapter VIIA. One of the arguments in this regard could be that the intention of the legislature from the very inception of the Act was to confer all the investigative powers on the CCI and the introduction of the CAT was only to exclude the jurisdiction of the High Court for a faster disposal of competition matters (an appeal from the CAT directly lies before the Supreme Court as u/s 53T). Nevertheless a closer analysis of the relevant provisions of the Act also reveals that CAT has superseded its powers.

S. 53A(1)(a) stipulates that the central government shall by notification establish a Competition Appellate Tribunal to hear appeals against any direction issued or decisions made or order passed by the commission under sub- section (2) and (6) of section 26,S. 27,S. 28,S. 31,S. 32,S. 33, S.38,S. 39, S.43,S. 43A,S.. 44,S. 45 and S. 46 of the act. In this regard it is worthwhile to examine some of the orders/directions that the CCI may pass under the above mentioned sections. S. 26(2) states that if the CCI finds no prima facie case after the receipt of any complains or information, it shall “close the matter” and pass necessary orders. Similarly S. 27 stipulates that CCI may pass appropriate orders if “after the inquiry” it finds a certain agreement in contravention of S. 3 & S. 4 of the Act. Further s. 33 confers power on the CCI to pass interim orders incase it finds “during the course of inquiry” that prima facie an anti-competitive practise is being carried out by the party against whom an allegation has been made. It is evident from S. 26 and S. 27 read with S. 53A (1)(a) that the jurisdiction of the CAT can be invoked only when the CCI has concluded the inquiry and passed any orders or directions. S. 33 read with S. 53A (1)(a) does provide the CAT with the power to hear appeals during the course of the inquiry, but that is only in cases where the CCI has passed an interim order. The CAT has no power under any of the provisions of the Act to intervene prematurely and halt any investigation carried out by the CCI. In case the Supreme Court finds otherwise, it would then necessarily require a legislative correction. As in principle the CCI being the regulator under the Act just as SEBI, IRDA etc. under their respective statutes should have the power to decide whether to investigate in a given case or not, otherwise the CCI will be stripped of all its powers and will end up as a toothless body.

BEYOND THE SAMSUNG JUDGEMENT

Beyond the Samsung judgment: An analysis by the Special Bench Tribunal Ruling in the case ITO v. Prasad Production Ltd.

In another recent judgment which put to rest the ambiguity in the interpretation of Section 195 of the Income Tax Act, 1961, a special bench constituted under section 255(3) of the Income Tax Act, 1961 ruled in favour of the assessee holding that section 195 of the said Act would apply only if the sum received was chargeable in India. Furthermore if the payer had a bona fide belief that he is not liable to tax he is under no obligation to follow the procedure in section 195 of the Act except comply with the RBI manual. The bench further held that section 195(2) was not mandatory in character as the CBDT circular had provided for an alternative procedure.
This case was similar to the recently decided Samsung case of the Karnataka High Court. The bench however after detailed analysis of the Samsung case diverted from the same stating that the Karnataka High Court had sub-silentio disregarded the CBDT Circular of July 2009 which prescribed an alternate procedure for remittance to a foreign entity without applying to the Assessing Officer for a No Objection Certificate. Further it was also per incurium as several precedents of the High courts and Supreme Court had been disregarded by the High Court.
In the present case the assessee company had been awarded a contract by the government of Andhra Pradesh to establish an IMAX theatre at Hyderabad. The assessee company entered into an agreement with IMAX ltd, Canada for the subsequent purchase, of equipment, maintenance and installation for which a certain consideration was remitted without withholding tax. The Assessing Officer concluded that the amount remitted was for the service provided by IMAX, Canada thereby qualifying it under section 9(vii) of the Act. The bench ruled that the sum remitted was auxiliary to the sale of the equipment and not independent services thereby not qualifying it under section 9. Further the Bench relied on a number of precedents and the decision in the Mahindra case whereby the pre-requisite of section 195(2) was held to be the chargeability of the sum remitted.
It is interesting to note that the Special bench debated in detail on the applicability of section 195 in consonance with the most cited Supreme Court judgments like the Transmission case; et al. It further made a detailed analysis of the binding nature of precedents for tribunals to follow keeping in mind the necessity for a thorough reasoning encompassed by different courts of law and their interpretation of the same. The bench systematically interpreted the different judgments in consonance with the principles governing tax law in India. In its considered decision it concluded that the tax payer had the first right to determine the chargeability of the sum of money being remitted, thereby enhancing the power of the tax payer.