Rules on Offer-for-Sale modified to allow non-promoter shareholders to sell a significant stake on-market
In January, the Securities and Exchange Board of India (SEBI) modified the ‘Comprehensive Framework on Offer for Sale (OFS) of Shares through Stock Exchange Mechanism’. The OFS mechanism allows shareholders of listed entities to divest significant stakes on the stock exchanges through a public bidding process with a seller defined floor price, mitigating the risk of a precipitous price reduction.
The changes significantly relax the eligibility criteria for investors seeking to offload shares held in listed companies through the OFS route. Prior to the modification, only promoters (i.e., controlling shareholders) and other shareholders holding at least 10% of the share capital of a listed company could sell their shares through the OFS mechanism. Under the new rules, the OFS route can be accessed by any shareholder so long as the transaction value is at least INR 25 crore (~USD 3 million).
The revised framework opens up an alternate avenue for foreign portfolio investors (FPI)1 to exit through the stock exchanges. Thus far, the OFS route was not available to FPIs since a single FPI’s holdings in a company was capped at 10% of its share capital. While FPIs were free to trade shares on the stock exchanges through ‘block’ or ‘bulk’ trades, these routes have their own limitations.2
Changes to the regulatory framework for Infrastructure Investment Trusts and Real Estate Investment Trusts
Change in tax treatment of returns to unitholders
The recently announced Union Budget 2023-24 (Budget) amended the tax treatment for distributions from Infrastructure Investment Trusts (InvIT) and Real Estate Investment Trusts (REIT) to unitholders, potentially impacting returns for unitholders.
Pre-Budget position: SEBI regulations required InvITs and REITs to upstream 90% of their net distributable cashflows to unitholders annually. Such distributions were taxed on a pass-through basis, i.e., income received from special purpose vehicles (SPV) such as rental income, interest, dividends, etc., was taxed directly in the hands of unitholders and there was no separate tax at the trust level. Separately, a portion of unitholders’ investment in the trust could be characterised as debt to the trust (instead of equity in the trust) and returns on this portion (being repayment of debt) were taxed neither at the trust level nor in the hands of the unitholders.
Changes made by the Budget: Although tax treatment of clearly identified pass-through payments from SPV remains unchanged, all other receipts (except the identified pass-through payments of rental income, interest and dividends) from an InvIT or a REIT to its unitholders are to be taxed in the hands of the unitholder as ‘income from other sources’. This would also include payments characterised as repayment of debt, which were earlier exempt from tax.
These receipts are taxable only to the extent that the aggregate value per unit received by unitholders (including that received in previous years) exceeds the issue price of the unit. While the provision applies prospectively, distributions already made to unitholders in previous years would be aggregated for this purpose.
Further, since the issue price remains the same even if there are subsequent transfers, secondary transactions would need to account for the tax impact on future distribution flows (aggregated with past distributions) on the valuation of each unit.
Enhanced corporate governance norms
SEBI has mandated additional corporate governance and disclosure rules for InvITs, REITs and their investment managers bringing their governance requirements substantially at par with listed companies. Such rules for listed companies, as set out under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, include:
- constitution of mandatory board committees (audit committee, nomination and remuneration committee, stakeholders relationship committee and risk management committee) with specified composition including a minimum number of independent directors;
- minimum number of board meetings to be conducted in a year;
- code of conduct for the board of directors;
- specific approval requirements for related party transactions;
- supervision of appointments of senior management by the nomination and remuneration committee of the board of directors;
- disclosure and compliance obligations for directors, promoters, senior management, and key managerial personnel, including caps on and disclosure by directors on committee membership, compliance with code of conduct, disclosure of transactions involving a conflict of interest with the entity and prior approval of the board for entering into profit-sharing arrangements.
These requirements have now also been made applicable to investment managers of InvIT and managers of REITs.
Requirement to have a sponsor throughout the life of the trust
The InvIT and REIT regulations allow a sponsor of a listed REIT or InvIT to get declassified as a sponsor (after the mandatory lock-in period of three years), if its unitholding reduces to below 10% and it is not in control of the investment manager of the InvIT/REIT.
SEBI has recently released a consultation paper proposing that InvITs or REITs be required to have at least one sponsor throughout their life with a view to ensure that the incentives of the sponsors are aligned with that of other unitholders. The proposal further allows sponsors to reduce their unitholding to 5% of the total unit capital after three years with staggered reductions permitted thereafter, subject to a minimum of 1% unit holding.
Changes to the insurance regulatory landscape
Discretion in determining commissions
The insurance regulator – the Insurance Regulatory and Development Authority of India (IRDAI) – has done away with specific regulatory caps on payment of commissions to insurance intermediaries (such as corporate agents and insurance brokers) through the new IRDAI (Payment of Commission) Regulations, 2023.
While the overall expenses of management of insurers (i.e., all operating expenses of the insurance company including commissions) will continue to be capped, there will no longer be any regulatory sub-caps for commission payments to intermediaries on a product-by-product basis. For general insurance companies, expenses-on-management are capped at 30% of the gross premium written in India in the financial year, subject to certain exceptions such as expenses towards ‘insurtech’ initiatives.
The new regulations provide insurers with greater flexibility to devise marketing strategies and compensation models for intermediaries.
Clarity on lock-in restrictions
To provide greater certainty to investors in determining their exit horizon, the IRDAI has specified the lock-in period for all types of investments in insurance companies.
Earlier, the regulations specified a five-year lock-in period for the original shareholders of a new insurance entity at the time of grant of license and the IRDAI would prescribe lock-ins on a case-by-case basis for all subsequent investments (whether primary or secondary),3 at the time of granting its approval for the transaction.
Now, the lock-in period will be based on the timing and nature of investment, as follows.
Timing of investment Nature of investment (Promoter/Investor) Lock-in period Greenfield investments, i.e., investments at the time of registration as an insurer with the IRDAI Promoter Five years Investor Five years Investment within five years of registration with IRDAI Promoter or Investor Earlier of: (i) five years from investment; or (ii) eight years from registration with IRDAI Investment between five to ten years of registration with IRDAI Promoter Earlier of: (i) three years from investment; or (ii) twelve years from registration with IRDAI Investor Earlier of: (i) two years from investment; or (ii) eleven years from registration with IRDAI Investment after ten years of registration with IRDAI Promoter Two years from investment Investor One year from investment
The lock-in requirements may be relaxed by the IRDAI in case of implementation of an initial public offering of the insurer.
Scope of ‘angel tax’ extended to premium received in investments from non-residents
The Finance Act, 2023 has extended the angel tax provision under Section 56(2)(viib) of the Income Tax Act, 1961 to fundraising from non-resident investors.
Thus far, this provision applied only to fundraises from resident investors. Specifically, if a privately held company issued shares at a price above fair market value (FMV) to Indian residents, the excess price received was treated as income of the company and was subject to tax (this tax is referred to as ‘angel tax’ since it predominantly impacts startups raising angel investments at high valuations).
Extension of this provision to investments by non-resident investors will impact fund-raising at a premium from non-residents as well as conversion of existing convertible instruments (preference shares or debentures) held by non-residents in Indian companies.
It is worth noting that Indian exchange control rules separately require that an Indian company cannot issue shares to non-resident investors at a price which is less than the FMV of the shares. Therefore, while the angel tax provision prescribes a ceiling value (beyond which there would be a tax implication for the investee company), FEMA regulations prescribe a floor price. However, there is some flexibility in the specific valuation methodologies that may be utilised to arrive at the FMV for these two requirements.
The government has informally indicated that certain types of foreign institutional investors such as sovereign wealth funds and FPIs could be exempted from this provision, however, no formal notification has been issued thus far.
(To refer to our detailed update on this development, click here.)
Proposed enhancement of corporate governance standards and ESG disclosures for listed companies
With a view to strengthen corporate governance standards for publicly traded corporations, SEBI has released consultation papers proposing amendments to the rules around corporate governance and environmental, social and governance (ESG) disclosures.
The key proposals on corporate governance are:
Requirement to obtain shareholders’ approval (including approval of a majority of public shareholders) for any agreement which imposes or has the effect of imposing restrictions or creating a liability on the listed entity other than in the normal course of business. While the proposal is drafted in very broad terms, the implications for various transactions/agreements relating to a listed company will need to be considered on a case-by-case basis.
The consultation paper also proposes that shareholders’ approval should be required for ‘special rights’ entrenched in the charter documents of listed entities, such as director nomination rights, reserved matter/affirmative voting rights, etc. Such provisions will need to be ratified through a fresh shareholders’ approval every five years.
Separately, listed companies would be required to disclose agreements affecting their management and control, even if they are not a party to such agreements. Once these proposals are implemented, the often-undisclosed vote-along arrangements that strategic investors in listed entities may negotiate with key shareholders, may be subject to public disclosures/repeated ratifications.
- Disclosure of commercial rationale and approval of majority of public shareholders for business transfers undertaken through business transfer agreements.
- Requirement of shareholders’ approval for continuing directors at least once every five years.
The consultation paper on ESG disclosures requires listed entities to include the impact of their supply chains on climate change as part of ESG disclosures. SEBI has also discussed certain specific parameters such as employment practices, use of natural resources, emissions and wastages, etc., which can be included in this respect. A framework for regulating ESG rating agencies, in line with the regulatory framework for credit rating agencies, has also been proposed.
While SEBI has approved these proposals in its board meeting on 29 March, the specific amendments are yet to be published.
 The foreign portfolio investment route is an alternative to the foreign direct investment route for investment by offshore investors into Indian companies. An FPI is required to be registered with SEBI.
 For instance, the trading price for a block trade is required to be within a band of ±1% of either the previous day closing price (for a block trade executed in the morning session i.e., from 0845 to 0900 hrs IST), or the volume weighted average price of the trades executed between 1345 – 1400 hrs (for a block trade executed in the afternoon session i.e., from 1405 to 1420 hrs IST).
 PE investors (holding more than 10% of the total investment on a pass-through basis) were subject to a five-year lock-in regardless of the mode of initial investment (primary or secondary).