INCOME TAX APPELLATE TRIBUNAL, AHMEDABAD

ITA No.58/Ahd/2009 – Asst. Year :2005-06

M/s Manishkumar & Co.

Vs.

Income-tax Officer

Date of pronouncement : 08/12/11.

O R D E R

Per D. K. Tyagi, Judicial Member.

This is an appeal filed by the Assessee against the order of ld. CIT(A) dated 7.10.2008. Following grounds have been raised in this appeal:-

(1) The ld. CIT(A)-IV, Baroda erred in law and on facts in confirming addition of Rs.13,77,000/- u/s 68 of the IT Act.

(2) The ld. CIT(A)-IV, Baroda erred in law and on facts in confirming the disallowance of Rs.6,893/- being 10% of vehicle expenses repairs and depreciation.

2. The first ground relates to addition of Rs.13,77,000/- made u/s 68 by the AO. During the assessment proceedings the assessee was asked by the AO to prove the identity of the lender, genuineness of the transaction and creditworthiness of the lender in respect of the loan of Rs.13,77,000/- shown in the name of Shri Madanlal J. Panjabi. The assessee was only able to furnish the death certificate of Madanlal J. Panjabi. No other evidence including that from the legal heir of Mr. Panjabi was submitted The AO therefore, made the addition of Rs.13,77,000/- u/s 68 of the Act. Before ld. CIT(A) also no details could be submitted by the assessee. The ld. CIT(A), therefore, confirmed the action of the AO. Further aggrieved, now the assessee is in appeal before us.

3. Heard both the parties and perused the record. We deem it proper to give one more opportunity to the assessee to substantiate his claim of credit of Rs.13,77,000/- from Shri Madanlal J. Panjabi and for this purpose the matter is restored back to the AO for fresh adjudication after providing reasonable opportunity of being heard to the assessee. This ground is allowed for statistical purposes.

4. The second ground relates to addition of Rs.13,786/- being 20% of vehicle expenses and depreciation of Rs.68,931/-. This addition was made by the AO by observing that personal use of the vehicles could not be ruled out. The ld. CIT(A) has reduced the disallowance to 10% of the total expenses. We, however, feel that this addition to be restricted to 5% of the total expenses. This ground is partly allowed.

4. In the result, the appeal filed by the assessee is partly allowed for statistical purposes.

Order was pronounced in open Court on 08/12/11.

Had earlier discussed the issue as to whether hostile takeovers are permissible under the Takeover Regulations, 2011. SEBI has now clarified the position in the FAQs:

15. Whether hostile offers/bids are permitted under the new regulations?

There is no such term as hostile bid in the regulations. The hostile bid is generally understood to be an unsolicited bid by a person, without any arrangement or MOU with persons currently in control.

Any person with or without holding any shares in a target company, can make an offer to acquire shares of a listed company subject to minimum offer size of 26%.

This is also incidental to a distinction made for voluntary offers by persons holding less than 25% of the voting rights and those made by persons holding greater than 25% (please see FAQs no. 17 to 20). In the latter case, various conditions apply that make voluntary offers somewhat more difficult to effectuate.

A notable omission in the FAQs pertains to the concept of “control” and whether negative control through veto rights would qualify for the purpose. The issue continues to remain open given the lack of a decision from the Supreme Court in the Subhkam case, and it is not surprising that SEBI has chosen to keep its cards close to the chest.Finally, the manner of addressing some of the substantive issues through FAQs (which are expressly stated to be non-binding) rather than through appropriate regulatory mechanisms such as a circular (as Sandeep Parekh suggests) is less than desirable.

Number of IDs

The Bill requires listed companies to have at least 1/3rd independent directors on their board. This is a slight departure from clause 49 of the listing agreement, which requires at least 50% IDs in case the chairperson is in an executive capacity or a promoter or related to a promoter, and hence this represents a dilution from the existing position. This might, however, have relatively minimal impact, if at all.

Definition of Independence

The definition of an ID has been considerably tightened. For example, if a director is a chief executive of an NGO that receives funding from the company to a certain extent, the person would not qualify as an independent director. Moreover, the definition now includes positive attributes of independence (that was not the case under clause 49): the candidate must be “a person of integrity and possess the relevant expertise and experience” in the opinion of the board. The Central Government is also vested with the power to prescribe qualifications for IDs. Every ID is also required to declare that he or she meets the criteria of independence.

Appointment

One of the key criticisms of the current regime for IDs is that they are appointed like any other director, thereby leaving promoters with tremendous influence in determining the identity of the IDs. That has been partially addressed by making a nomination and remuneration committee mandatory (a departure from clause 49 that does not mandate a nomination committee). The committee is required to consider candidates for appointment as IDs and to recommend them to the board. This brings about greater objectivity to the ID nomination process, at least to some extent. However, the Bill does not go to the extent of providing greater participation by minority shareholders in the ID appointment process through methods such as cumulative voting or proportionate representation, which continue to be optional for companies to adopt rather than a mandatory requirement.

Furthermore, the Bill contemplates the establishment of a data bank of IDs, from which persons may be chosen by companies.

Tenure

In order to ensure that IDs maintain their independence and do not become too familiar with the management and promoters, minimum tenure requirements have been prescribed. The initial term shall be 5 years, following which further appointment of the director would require a special resolution of the shareholders. However, the total tenure shall not exceed 2 consecutive terms.

Remuneration

Under the Bill, IDs are entitled only to fees for attending meetings of the board, and possibly commissions within certain limits. The Bill expressly disallows IDs from obtaining stock options is companies. While it is understandable that excessively remunerating IDs could impinge upon their independence, the present provisions leave little room for companies to attract the required talent by remunerating directors for the services they provide. Since the Bill also imposes significant responsibilities and duties on IDs, as we shall see, positions for IDs on listed companies are unlikely to find takers of the requisite calibre unless they are appropriately remunerated. Attempts to achieve a proper balance may be fraught with difficulties under the present dispensation.

Roles and Functions

Schedule IV of the Bill contains a code that sets out the role, functions and duties of IDs and incidental provisions relating to their appointment, resignation and evaluation. While the guidelines are useful in specifying the roles and functions so as to introduce clarity, they are extremely prescriptive in nature. This makes the role of IDs quite onerous, and may enhance the level of monitoring of listed companies, which is crucial for corporate governance. The downside, of course, is that it could instil fear in the minds of potential IDs that may dissuade them from taking up the position.

Liability

In order to balance the extensive nature of functions and obligations impose on IDs, the Bill seeks to limit their liability to matters directly relatable to them. The Bill limits the liability of an ID “only in respect of acts of omission or commission by a company which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he had not acted diligently.” This again seems to be a reaction to specific instances in the recent past where IDs were subject to legal action for no fault of their own, as evident from the Nagarjuna Finance episode that occurred in 2009. While it is useful to provide a limitation of liability clause, much would depend on the manner in which this is interpreted by courts based on the specific facts and circumstances of individual cases. Other ways of addressing the liability issue would be to expressly provide for directors and officer liability insurance, which are also specified in the Bill.In sum, while several concerns regarding board independence have been addressed in the Bill, some areas require refining as discussed above. Although the intention is noble, the implementation could give rise to difficulties. Corporate governance norms are dynamic in nature and require reconfiguration periodically to keep pace with the changing business climate. Usually, while the basic governance framework is dealt with by statute, the details are dealt with codes of conduct that are more flexible in nature. Since the catastrophes that marked the India corporate sphere in the last 2 or 3 years have assumed significant political overtones, they have resulted in excessive reaction in terms of detailing every single governance norm concerning IDs in the legislation itself. While it may address some immediate problems, it is bound to result in a great amount of rigidity. Experience clearly evidences the enormous difficulties in amending companies legislation in India, and any changes in the governance norms in the future is likely to be as cumbersome. The question remains whether there has been a knee-jerk reaction to current scandals that may adversely impact genuine businesses during times ahead.

In order to induce a greater level of clarity in directors’ duties, the Companies Bill, 2011 has a specific provision that deals with the subject matter. Clause 166 of the Bill is substantially similar to the provision contained in the Companies Bill, 2009, with some iteration. The UK too adopted the strategy of codifying directors’ duties in the Companies Act, 2006 (sections 171-177).

The following are some of the primary duties specified by the Companies Bill, 2011:

- to act in accordance with the articles;

- to act in good faith and in the best interests of the company, its employees, the shareholders, the community and for the protection of the environment;

- to exercise due and reasonable care, skill and diligence, and exercise independent judgment;

- not to involve in a situation that presents a conflict of interest;

- not to achieve any undue gain or advantage (and to return any equivalent amount to the company if such gain or advantage is indeed made); and

- not to assign office.

In case of any breach of duties, it would also amount to a criminal offence with punishment of Rs. 1 lakh to Rs. 5 lakhs. This is different from the common law position where there is an only civil liability for breach.

At the outset, it is necessary to note that this is only a partial codification of directors’ duties. It is not possible to prescribe rules for every situation in which directors’ actions can be judged. That necessarily has to be left for a principles-based determination, usually by judges in specific cases, and hence the role of courts in implementing these duties cannot be taken away. While the statutory provisions do give some guidance, much would depend on the manner in which courts interpret these duties, on which previous jurisprudence is scant. Moreover, with issues surrounding delays and costs in the court system, it is not clear if a body of judge-made law (in terms of principles) is likely to emerge to guide the actions of directors. Hence, it is not clear if the codification of the duties will necessarily result in a tangible enhancement when it comes to enforcing the duties.

One crucial change from the duties contained in the Companies Bill, 2009 is noteworthy. The previous Bill required directors to act in the best interest of the company. This epitomizes the shareholder model of corporate governance wherein the primary role of the directors is to protect the interests of the shareholders, and at most the interests of creditors in the event of insolvency. However, the new Bill also requires directors to act in the interests of “employees, the shareholders, the community and for the protection of the environment”. This encapsulates the stakeholder model of corporate governance wherein the directors are required to take into account the non-shareholder constituencies as well. This is consistent with the renewed emphasis on CSR, which has been discussed earlier. While it seems unlikely that any duties owed by directors in connection with non-shareholder constituencies can be justifiable or enforceable in a court of law, this at least prevents shareholders from initiating actions against directors for not solely (or even primarily) considering shareholder interests. A similar debate was played out when the Companies Act, 2006 was enacted in the UK (and specifically section 172 thereof) where the end-result was the concept of an “enlightened shareholder value” model.

In developed markets, one of the key mechanisms used for enforcement of corporate law is shareholder actions against the company or its management for breach of duties and obligations owed under law. Such shareholder actions can be either direct actions for breaches of duties owed to the shareholders directly in which case the remedies will flow to the shareholders, or they can be derivative actions where shareholders bring them on behalf of the company for breach of duties owed to the company where the remedies would flow to the company. Despite the popularity of such actions in countries such as the US, UK and several leading jurisdictions in the Commonwealth, such private shareholder actions are indeed sparsely used in India. This is evident from the fact that while shareholder suits were filed in the U.S. immediately after the Satyam scandal was revealed (and subsequently settled by the company for hundreds of millions of dollars), no significant action was initiated by the Indian shareholders who were left without any remedy for false representations in the financial statements.

In terms of shareholder remedies in India, there is a fair amount of vibrancy in direct actions in the form of claims for oppression and mismanagement brought before the Company Law Board (CLB) under sections 397 and 398 of the Companies Act, 1956. While the CLB has been active in considering these cases, their scope is fairly limited and may not necessarily be available for all instances of breaches of duties either by the company or the management. On the other hand, derivative actions, which are customarily used by shareholders to seek remedies on behalf of the company for breaches of duties by directors and senior management, are rarely utilised by shareholders in India. In a recent study to be published shortly, Professor Vikramaditya Khanna and I found that in the last sixty years only about 10 derivative actions have reached the level of the High Courts or the Supreme Court, of which only 3 have been finally allowed to be pursued. There are a number of substantive and procedural hurdles due to which shareholder derivative actions are rare in India. For example, derivative actions rely on principles of common law in the absence of a statutory provision, and they have to be brought in the normal civil courts, which are subject to delays and heavy costs that make them ineffective.

Considering some of these difficulties, the Companies Bill, 2009 introduced a specific clause on class actions by shareholders as a method to ensure greater enforcement of corporate law. However, as anticipated, this was met with stiff resistance from the industry which feared that this will lead to the opening of floodgates resulting in companies having to face numerous lawsuits from shareholders. The Government seems to have given in to the concerns expressed by the industry, and consequently a substantially whittled down provision has been introduced in the Companies Bill, 2011.

Scope of the Action

Clause 245 provides that a certain number of shareholders or depositors can bring an action before the National Company Law Tribunal (NCLT). The action can be against the company for restraining it from various acts such as those that are ultra vires the memorandum and articles of association, that are based on a resolution of shareholders obtained through suppression of material facts, or that are contrary to the provisions of the Companies Act or any other law. More importantly, a new addition in the 2011 version is that shareholders can claim damages for fraudulent actions, unlawful conduct or misstatements made by the company and its directors, and in certain cases its auditors (including the audit firm) or any expert or advisor or consultant of the company. This new provisions seems to be a result of the discourse that emanated from the Satyam episode so as to pin responsibility not only on insiders of the company but also on various gatekeepers who are responsible for ensuring compliance with the law.

Certain other provisions also support the creation of a regime for shareholder actions. For example, failure to comply with an order of the NCLT will result in a criminal offence. Moreover, the NCLT may provide that the cost of bringing the action may be defrayed by the company or other responsible person. This is a key insertion especially in derivative actions where shareholders may not have the incentive to initiate an action if they have to directly bear the cost, while the ultimate relief will flow to the company.

The Bill also provides for consolidation of similar petitions, while also specifying the manner in which the lead applicant will be chosen.

Limitations

Significant checks and balances have been introduced to ensure that only genuine actions are entertained by the NCLT. First, there is a threshold limit in terms of the support required for bringing an action. The action must be supported by at least 100 shareholders, or such percentage of total number of shareholders or those holding such percentage of shares in the company as the Central Government may prescribe in the rules. Second, the NCLT is required to consider a number of factors while considering an application: whether the shareholders are acting in good faith or have any personal interest in the action, or whether the act or omission involved has been authorised or ratified by the shareholders. Third, frivolous and vexatious actions are discouraged by conferring the NCLT with the powers to impose costs on the initiating shareholders while rejecting applications on those grounds.In sum, while it is useful that the Companies Bill expressly provides for statutory remedies in the form of class actions, it may not automatically result in greater enforcement of corporate law through increased shareholder actions. One significant advantage of the Bill is that it takes shareholder actions (such as derivative actions) outside the purview of the court and places them within the jurisdiction of the NCLT, which, due to its specialised nature, is expected to be more efficient and time-sensitive than the normal court system. However, with the imposition of significant limitations on the ability of shareholders to bring an action, it is unlikely that there will be a spate of such actions against companies. Nevertheless, the recognition of such remedies under statute will provide some relief to affected minority shareholders.

MINISTRY OF CORPORATE AFFAIRS

NOTIFICATION

14th December,2011

G.S.R. (E).- In exercise of the power conferred by sub-section (1A) of section 81, read with section 642, of the Companies Act, 1956 (1 of 1956), the Central Government hereby makes the following rules to amend the Unlisted Public Companies (Preferential Allotment) Rules, 2003, namely:-

1. (1) These rules may be called the Unlisted Public Companies (Preferential Allotment) Amendment Rules, 2011.

(2) They shall come into force on the date of their publication in the Official Gazette.

2. In the Unlisted Public Companies (Preferential Allotment) Rules, 2003 (hereinafter referred to as the said rules), in rule 3, for clause (1), the following shall be substituted, namely: –

‘(1) “preferential allotment” means allotment of shares or any other instrument convertible into shares including hybrid instruments convertible into shares on preferential basis made pursuant to the provisions of subsection (1A) of section 81 of the Companies Act, 1956;

Provided that the name, father’s name, address and occupation of persons to whom such allotment is proposed to be made shall be mentioned in the resolution passed by the members under that sub-section:

Provided further that persons to whom such offer is proposed, shall not be more than forty-nine as per the first proviso to sub-section (3) of section 67 of the Companies Act, 1956;’

3. For rule 4 of the said rules, the following shall be substituted, namely:-

“4. Special Resolution.-

(1) No issue of Shares or any other instruments convertible into shares including hybrids convertible into shares on a preferential basis can be made by a company unless authorised by its articles of association and unless a special resolution passed by the member in a general meeting authorising the Board of Directors to make such issue.

(2) The special resolution referred to in sub-rule (1) shall be acted upon within a period of twelve months.”.

4. After rule 7 of the said rules, the following rule shall be inserted, namely:-

“8. Invitation and allotment of securities.-

(1) No fresh offer or invitation shall be made unless the allotment with respect to any offer or invitation made earlier have been completed in terms of sub-section (9) of section 60B of the Companies Act, 1956.

(2) Any offer or invitation not in compliance with sub-section (1A) of Section 81 read with sub-section (3) of section 67 of the said Act, shall be treated as a public offer and the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and the Securities and Exchange Board of India Act, 1992 (15 of 1992) shall be complied with.

(3) All monies payable on subscription of securities shall be paid through cheque or demand draft or other banking channels but not by cash.

(4) Any allotment of securities shall be completed within sixty days from the receipt of application money and in case the company is not able to allot the securities within the said period of sixty days, it shall repay the application money within fifteen days thereafter, failing which it will be required to be re-paid with interest at the rate of twelve percent per annum:

Provided that the monies received on such application shall be kept in a separate bank account and shall not be utilised for any purpose other than-

(i) for adjustment against allotment of securities; or

(ii) for the repayment of monies where the company is unable to allot securities.

(5) No company offering securities shall release any public advertisements or utilise any media, marketing or distribution channels or agents to inform the public at large about such an offer”.

[No. F. 2/21/2011-CL V]

Renuka Kumar

Joint Secretary to the Government of India

Note: – The principle rules were published in the Gazette of India, Extraordinary, vide notification number G.S.R. 922(E), dated the 4th December, 2003.

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