The Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (PAS Amendment Rules) usher in a new era of digitization in the corporate domain by extending the benefits of dematerialization of shares to private companies. It’s essential to grasp the nuances of the updated dematerialization compliance regulations to ensure stress-free operations in the new financial year.
In the past, only unlisted public companies were mandated to undertake dematerialization of shares. However, by aligning the provisions of dematerialization of shares for private companies with those previously applicable to their public counterparts, regulators aim to foster a level playing field while fortifying investor confidence.
What is Dematerialisation of shares?
Dematerialization of shares is the process of converting physical share certificates into electronic form in the digital realm. It involves the elimination of paper-based certificates and the maintenance of share ownership records electronically through a depository system.
Applicability of Dematerialisation Compliance under the PAS Amendment Rules 2023
The dematerialization mandate that officially came into effect on 27th October 2023, applies to private companies, excluding small companies as per the Companies Act, 2013. Applicable Companies are required to issue securities solely in dematerialized form and facilitate the dematerialization of all existing securities within 18 months of the conclusion of the financial year ending on March 31, 2023. This means the deadline for compliance is September 30, 2024.
Critical Definitions
To navigate the dematerialization of shares for private companies smoothly, it’s crucial to understand some key terms-
1. Small Companies- Meaning & Exceptions
As per Section 2(85) of the Companies Act, 2013, coupled with Rule 2(1)(t) of Cos. (Specification of definitions details) Rules, 2014, a “Small Company” is a company other than a public company, characterized by:
- A paid-up share capital of ₹4 crores or less, or a higher amount specified, not exceeding ₹10 crores.
- A turnover of ₹40 crore or less, or a higher amount specified, not exceeding ₹100 crore.
Regardless of monetary thresholds, the classification of “Small Companies” does not levy on the following entities:
- a) Holding Companies.
- b) Subsidiary Companies.
- c) Companies registered under Section 8 of the Companies Act, 2013, or Section 25 of the Companies Act, 1956.
- d) Companies governed by any Special Act.
- e) Body corporates governed by any Special Act.
- Depository Participant (DP) & Depository
Acting as an agent or registered stockbroker, a DP facilitates interaction between investors and depositories. A depository, in turn, holds securities electronically, such as shares, debentures, and mutual fund units, on behalf of investors. Examples include- NSDL or CDSL. Liaising with a depository participant facilitates the dematerialization of securities, manages electronic shareholding records, and ensures compliance with regulatory requirements.
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Registrar and Transfer Agents (RTAs)
These entities, registered with SEBI, manage share registry maintenance and share transfer activities on behalf of public companies. Their functions include collecting applications, maintaining records, and processing allotments.
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Dematerialisation Request Form (DRF)
A crucial document, the DRF form for dematerialisation enables investors to convert physical securities into electronic form or transfer them between Demat accounts for seamless management of securities.
Benefits of Dematerialising Shares for Relevant Private Limited Companies
Prime benefits of dematerialisation of shares comprise-
- Elimination of Physical Certificates:
Dematerialising shares eliminates the risk of loss, theft, or damage associated with physical share certificates, ensuring the security of ownership.
- Preventing Malpractices:
By maintaining electronic records of share ownership, dematerialisation reduces the likelihood of fraudulent activities such as share forgery or unauthorized transfers.
- Ease in Doing Transactions such as Transfer or Pledge
Dematerialisation simplifies the process of transferring shares, pledging them as collateral, or engaging in other financial transactions, facilitating smoother operations for relevant private limited companies.
- Elimination of Backdated Transactions
Dematerialization guarantees the prevention of backdated transactions through the maintenance of electronic records by Depository Participants (DPs). Unlike physical share certificates, susceptible to manipulation, electronic records offer real-time recording of all share transactions.
- Convenience for Investors:
Investors benefit from the ease of managing electronic securities, with the ability to monitor holdings and execute share transactions. Shareholders can conveniently transfer shares electronically, through Demat accounts.
Steps for Dematerialization Procedure- A Comprehensive Overview
Compliance with the dematerialization mandate requires a systematic approach, encompassing various stakeholders and meticulous attention to detail. Let’s delve into the essential steps that liable companies need to undertake to ensure adherence to the new regulations.
Step 1: Board Resolution
The journey towards dematerialization commences with a pivotal decision taken by the company’s board of directors. A formal resolution is passed, authorizing the dematerialization of securities. It’s imperative to ensure proper documentation for dematerialization in line with the company’s Articles of Association, laying the groundwork for subsequent actions.
Step 2: Selecting Depository Participant (DP) and Opening Demat Account
Next, the company embarks on the process of selecting a Depository Participant (DP) from a roster of registered entities. This DP plays a central role in facilitating the dematerialization process. Upon finalizing the DP, the company proceeds to create a Demat account, laying the foundation for the electronic management of securities.
Step 3: Appointment of Registrar and Share Transfer Agent (RTA)
To navigate the intricacies of dematerialization smoothly, the company appoints a Registrar and Share Transfer Agent (RTA) from a pool of registered entities. The RTA assumes responsibility for managing administrative and record-keeping aspects of securities held in electronic form, ensuring seamless operations within the Demat system.
Step 4: Execution of Tripartite Agreement
A crucial milestone in the dematerialization journey is the execution of a tripartite agreement. This agreement, forged between the depository, RTA, and the company, delineates the roles, responsibilities, and terms governing the dematerialization process. It serves as a blueprint for collaboration and ensures clarity in operations.
Step 5: Activation of International Securities Identification Number (ISIN)
Upon completion of requisite documentation and verification processes, the depository activates the International Securities Identification Number (ISIN). This unique identifier distinguishes one security from another, facilitating seamless trading, settlement, and record-keeping on a global scale.
Step 6: Educating the Shareholders
The company must diligently intimate its shareholders about the decision to dematerialize shares and provide comprehensive guidance on the process involved. Clear instructions are imparted, facilitating shareholders in opening Demat accounts with designated DPs.
Step 7: Ascertaining Completion and Compliance
The final step entails meticulous verification and validation to ensure the successful dematerialization of all shares. Before initiating any offer for the issuance of securities, buyback of securities, or the distribution of bonus shares or rights, applicable private companies, excluding small companies, must ensure that all securities held by their promoters, directors, and key managerial personnel are dematerialized. The company updates its records to reflect the transition to electronic form, paving the way for electronic trading and transfer of shares. Compliance is upheld, setting the stage for enhanced efficiency and transparency in share transactions.
Addressing Post Dematerialisation Concerns- A Strategic Approach
As companies transition towards gaining the benefits of dematerialising shares, managing concerns after dematerialisation of shares becomes paramount. Here’s a comprehensive guide to navigating this crucial phase with finesse and efficiency.
1. Liaising with Depository Participants (DPs)
Following dematerialisation, shareholders are advised to directly communicate with their respective Depository Participants (DPs), who manage their demat accounts.
Shareholders need to follow the below mentioned steps to get their shares dematerialised-
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In the case of individual shareholders-
To dematerialize shares, shareholders follow a structured process. Firstly, they choose a Depository Participant (DP), which could be a bank, brokerage firm, or another registered DP where they hold a demat account. Next, they obtain a Dematerialization Request Form (DRF) from the chosen DP and fill it with accurate details, including the ISIN and number of shares. After submission of the DRF to the DP, it undergoes verification. The DP then forwards the verified DRF to the main depository (NSDL/CDSL) for further processing. Once the depository verifies the request, it dematerializes the shares, converting them into electronic form, and credits the equivalent number of shares to the shareholder’s demat account. Finally, the DP notifies the shareholder of the successful dematerialization process, completing the procedure.
One must also note that the Registrar and Transfer Agent (RTA) appointed by the liable private company, whose shares are getting dematerialised, primarily handles the issuance of ISIN. RTAs typically do not directly handle the dematerialization of shares for individual shareholders. This process is managed through DPs.
Special circumstance-
Shares held with Brokerage Firms: If a shareholder’s demat account is with a brokerage firm like Zerodha or Groww, the same procedure applies. The shareholder submits the DRF to the DP associated with the brokerage firm.
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In the case of foreign shareholders
In adherence to mandatory dematerialization regulations, foreign investors, particularly Non-Resident Indians (NRIs), aiming to invest in Indian private enterprises are required to initiate the establishment of demat accounts with Indian depositories. This process entails several steps, including obtaining a Permanent Account Number (PAN) from Indian tax authorities, fulfilling the Know Your Customer (KYC) criteria outlined by the depositories, remitting necessary fees, and obtaining apostilled copies of pertinent documents.
For NRIs seeking to open demat accounts in India, adherence to the regulations specified in the Foreign Exchange Management Act (FEMA) is also pivotal. Within this framework, NRIs have the option to open both repatriable and non-repatriable demat accounts for engaging in market trading or investment activities.
A repatriable demat account is intrinsically linked to a Non-Resident External (NRE) account, facilitating the seamless transfer and repatriation of proceeds from securities sales and investment gains abroad. Conversely, a non-repatriable demat account is associated with a Non-Resident Ordinary (NRO) bank account, subject to limitations on the transfer of funds to foreign destinations. To participate in secondary market transactions, NRIs must obtain Portfolio Investment Scheme (PIS) licenses from designated banks, enabling them to conduct investment operations within India.,
Processing by Depository Participants (DPs)
Upon receipt of the dematerialisation request, DPs diligently process the application received. If the securities are deemed to be in order, the information provided in the form is fed into the DPM (Depository Participant Management) software, provided by NSDL/CDSL to the DP. Subsequently, the system electronically generates a Dematerialization Request Number (DRN). This serves as a reference point throughout the dematerialisation journey, ensuring traceability and accountability in the process.
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Coordination with Issuer Company Compliance Team
Duly armed with the DRN and physical share certificates, DPs submit the documentation to the Issuer Company Compliance team. Here, the physical share certificates are canceled, marking a significant milestone in the dematerialization process. The Issuer Company then issues a formal letter to the Company Share Registrar and Transfer Agent (RTA), consenting to the dematerialization request.
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Processing by Registrar and Transfer Agent (RTA)
With the Issuer Company’s consent secured, the RTA assumes responsibility for processing the dematerialization request. Leveraging the provided documentation and concurrence, the RTA navigates the dematerialization process meticulously. Subsequently, shareholders witness the seamless credit of dematerialized shares in their respective accounts, marking the successful culmination of the post-dematerialization phase.
Implications of Non-Compliance with Dematerialization Mandate
Failure to comply with the dematerialization mandate by September 30, 2024, entails severe consequences for both the company and security holders. The company will be barred from issuing or allotting any type of securities, while security holders will be unable to transfer or subscribe to any security. The relevant company will also incur monetary penalties amounting to ₹10,000 initially, with an additional daily fine of ₹1,000 for each day the violation persists. The maximum cumulative penalty for the company is capped at ₹200,000. Officers of the company found to be in default will face similar penalties, including an initial fine of ₹10,000 and a daily penalty of ₹1,000 for continued violation. However, the maximum penalty for officers in default is limited to ₹50,000.
Conclusion
The mandatory dematerialization of shares, extending to private companies, marks a significant step in promoting transparency in the business world. As companies prepare for this amendment, it’s crucial to acknowledge the intricacies of the dematerialization of shares for private companies and adhere to the specified timelines. Adequate dematerialization compliance enables strain-free operations and instills investor confidence, while non-compliance bears severe penalties for both companies and security holders, underlining the criticality of adhering to regulatory mandates.
USAIndiaCFO professionals can offer invaluable assistance in handling the obligation of dematerialization of shares by providing superior guidance regarding setting up demat account for private companies in India, ensuring compliance with regulatory requirements, and facilitating efficient coordination with depository participants. Take the first step towards digital transformation and gain the benefits of dematerializing shares with us now!