Introduction
“Supply” under GST Act, 2017 is a unique concept. It embraces certain supplies for which even no consideration has been received e.g. Supply of goods or services or both between related persons or between distinct persons as specified in section 25, when made in the course or furtherance of business vide para 2 of Schedule I read with clause ( c ) of sub-section (1) of Section 7. The transactions between related persons or between distinct persons has been introduced to curb tax evasion but it seems to have “butterfly effect” on the commercial world because it activates some transactions as “supply”, that the commercial world would never have thought of or intended. Unlike transactions with third parties, the transactions between related persons or between distinct persons can be maneuvered to a great extent to bend transactions in their favour. The distinctive factor in such type of transactions is that if misused, it can lead to grave consequences like misreporting, favorable treatment, manipulated valuation or loss of revenue. Due to this reason, transactions between related persons have always been specially dealt with globally and GST Act seems to be no exception.
Who are related persons
Though section 2 is the definition section but “related persons” has not been defined in section 2, rather it is defined in the way of explanation, appended to section 15 and stipulates that
For the purposes of this Act,-
(a) persons shall be deemed to be “related persons” if-
(i) such persons are officers or directors of one another’s businesses;
(ii) such persons are legally recognised partners in business;
(iii) such persons are employer and employee;
(iv) any person directly or indirectly owns, controls or holds twenty-five per or more of the outstanding voting stock or shares of both of them;
(v) one of them directly or indirectly controls the other;
(vi) both of them are directly or indirectly controlled by a third person;
(vii) together they directly or indirectly control a third person; or
(vii) they are members of the same family;
(b) the term “person” also includes legal persons;
(c) persons who are associated in the business of one another in that one is the sole agent or sole distributor or sole concessionaire, howsoever described, of the other, shall be deemed to be related.
Although this deeming provision seems to have no problem as such to understand the meaning of “related persons”, but a deep probe into the definition must create dilemma and confusion, particularly when the definition is required to be understood from the “control” perception.
What is control
Sub-clause (iv) to (vii) of clause (a) of explanation to section 15 has determined the term “related persons” from “control” perspective. But this important factor “control” to decide persons as “related persons” has not been defined in the GST Act.
When someone hears of the word “control”, what comes to his mind- a power, a right, an advantage, an authority, a command or a capacity?
What are the essential parameters of “control”? It has many shades of meaning.
According to the Cambridge dictionary, the meaning of control as verb is “to decide or strongly influence the particular way in which something will happen or someone will behave”. Merriam-Webster dictionary defines ‘control’ as, “to direct the behavior of (a person or animal); to cause (a person or animal) to do what you want; to have power over (something); to direct the actions or function of (something); to cause (something) to act or function in a certain way”. The word ‘control’, as a noun, has been defined in Black’s Law Dictionary (8th edition) as, “the direct or indirect power to direct the management and policies of a person or entity, whether through ownership of voting securities, by contract, or otherwise; the power or authority to manage, direct, or oversee”. As a verb, ‘control’ has been defined as, “to exercise power or influence over’, ‘to regulate or govern”. It could have manifold meanings but from common parlance the most universal one is to have the power to influence or regulate another person’s action or the course of events.
If we take the help of other statutes the meaning of “control” might be comprehensible to us.
A. The Companies Act, 2013
Clause (27) of section 2 of the Companies Act, 2013 defines ‘Control’ as under:
“control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
The definition is an inclusive definition and details the multiple manners in which control can be exercised and control can be accrued. The definition of control uses the word ‘control’ twice, because of unifying two related parts. The first part enumerates the nature and scope of control. As per this definition “control” is a right-
(i) a right to appoint majority of the directors or
(ii) a right to control the management or policy decisions exercisable.
The second part enumerates the ways of obtaining that right. This right can be obtained by –
(i) by virtue of their shareholding or management rights or
(ii) by virtue of shareholders agreements or
(iii) by virtue of voting agreements or
(iv) in any other manner.
Therefore the use of the word ‘includes’ at the first place indicates that there can be more possible ways to control the company which are not listed here. Whereas the use of ‘include’ at second place implies that there can be more possible ways to obtain management rights. This shows that the definition of control is very much open-ended.
Again from the definition of subsidiary company u/s 2(87) the Companies Act, 2013, it appears that the holding company has control over the subsidiary company.
Section 2(87) “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company—
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total share capital either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation.—For the purposes of this clause,—
(a) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
(b) the composition of a company‘s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;
(c) the expression company includes any body corporate;
(d) layer in relation to a holding company means its subsidiary or subsidiaries;
Thus, the ability to organize the composition of the board or the power to appoint or remove the majority of the board renders one company has control over another. The Delhi High Court in Oriental insurance Investment Corp. Ltd, 51 Comp. Cases 487 (Del) has held that this power may be enjoyed by virtue of being a majority shareholder or from certain special rights which are conferred by the Articles of Association of a company. The judgment in the case of Velayudhan (M) vs. ROC, 50 Comp Cases 33 (Ker) is on similar lines. It is the control of the second variety, i.e., control because of special rights, which is often a matter of debate.
B. The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (hereinafter referred to as the “Takeover Regulations”) 1
Regulation 2(1)(e) of Takeover Regulations, 2011 has defined ‘control’ as –
| “control” includes the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner: Provided that a director or officer of a target company shall not be considered to be in control over such target company, merely by virtue of holding such position. |
This definition is basically a replica of the definition given in the Companies Act, 2013, except the proviso which stipulates that a director or officer of a company shall not be considered to be in control over such company, merely by virtue of holding such position.
“Control” not only embraces he power to appoint majority of the directors but also goes forward to include diverse other facets. The right to control the management or policy decisions of a company renders a person as being in control of that company. These rights typically arise by virtue of Shareholders or Share Subscription or Voting Agreements. Hence, under the Takeover Regulations it is not necessary for a person to be a majority shareholder. He could even be a minority shareholder but by virtue of certain Agreements he could be in control.
Such an issue typically arises in the case of private equity (PE) investors or venture capitalists. Any PE/FDI Investment may carry a veto right or an affirmative vote or special rights for the Investor. Thus, without the consent of the investor, the company cannot carry out certain substantial decisions, e.g., corporate reorganization, starting a new line of business, borrowing in excess of a limit, etc. The PE has power to stall a decision of the company. However, in most cases, he does not have power to carry out a decision on his own behest. Thus, if he refuses the company cannot go ahead but if he proposes and the company refuses then he cannot proceed on his own. A question often asked is that, does the grant of such special rights make the investor a person in control of the company? This is a question of fact. For instance, the Securities Appellate Tribunal in the case of SEBI vs Sandip Save, 41 SCL 47 (SAT) after examining various powers given to IDBI under a lending agreement held that IDBI was not in control over the company.
In the matter of Subhkam Ventures (I) Pvt. Ltd. wherein SEBI had taken a view that the rights conferred upon the acquirer, through the agreements, amounted to ‘control’ over the target company. Hon’ble SAT, in its judgment dated January 15, 2010, rejected SEBI’s view stating that none of the clauses of the agreements, individually or collectively, demonstrated control in the hands of the acquirer. Hon’ble SAT had observed that:
“…Control, according to the definition, is a proactive and not a reactive power. It is a power by which an acquirer can command the target company to do what he wants it to do. Control really means creating or controlling a situation by taking the initiative. Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power….The test really is whether the acquirer is in the driving seat….By no stretch of logic, can such an affirmative vote confer control over the day to day working of the company… Affirmative vote of the investor in these matters is necessary for protecting its investment….Such fetters fall far short of the existence of “control” over the target company. It must be remembered that every fetter of any nature in the hands of any person over a listed company cannot result in “control” of that person over that company… ”
However, Hon’ble Supreme Court, in its judgment dated November 16, 2011, stated that ‘keeping in view the above changed circumstances, it is in the interest of justice to dispose of the present appeal by keeping the question of law open and it is also clarified that the impugned order passed by the SAT will not be treated as a precedent.
C. The Competition Act, 2002
With the advent of Competition Act in 2002, it is seen that control has been tested by the Competition Commission of India from its own perspective. The definition of ‘control’ under the Competition Act, 2002 is provided by way of an Explanation to section 5 of the said Act as under-
| “Explanation — For the purposes of this section,—
(a) “control” includes controlling the affairs or management by— (i) one or more enterprises, either jointly or singly, over another enterprise or group; (ii) one or more groups, either jointly or singly, over another group or enterprise;” |
It is seen that the above definition of ‘control’ in the Competition Act, 2002 is a purposive definition and applies for the specific purpose of combination of enterprises by way of inter alia, acquisition of one or more enterprises or ‘control’ over an enterprise by one or more persons. From the language of Explanation to section 5 of the Competition Act, 2002, and regulation 2(1)(e) of the Takeover Regulations, it is noted that both contain inclusive definition.
It is, however, noted that while the definition under 2(1)(e) is specific with regard to control by way of (a) right “to appoint majority of the directors” or (b) controlling ‘the management or policy decisions’, the definition under section 5 is only specific with regard to “controlling the affairs and management‟. It is further noted that while under the Takeover Regulations controlling the “management or policy decisions” is relevant factor, under the Explanation to section 5 of the Competition Act controlling “the affairs and management” is relevant factor.
Conclusion
Are we confused or clear? The absence of the meaning of “control” in the GST Act and the multitude of Laws and Regulators taking different stands on the meaning of what constitutes “control” has created a very perplexed state of affairs. Different laws interpreting the same term in a different manner is more puzzling. There is no denying the fact that the term “control” has ripple effect on the transactions undertaken by the related persons, starting from nature of supply to valuation to Input Tax Credit. Let us hope that some clarifications or some judicial decisions might help to clear the obscurity.
1 – Discussion Paper on “Brightline Tests for Acquisition of ‘Control’ under SEBI Takeover Regulations”
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Disclaimer: The contents of this article are for information purposes only and do not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability.
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