There are distinct advantages of dematerialised forms of securities for both the holder as well as law enforcement agencies.
It brings greater transparency due to electronic records of shareholding available to the company, ministry as well as market regulators
Litigation concerning common issues of taxation, transfer, gift and inheritance of share certificates can be minimised
Securities can be more conveniently pledged, or used as collateral due to digitised ownership.
Under the Rule 9B of the Allotment Rules, every private company, which is not a small company, has to mandatorily ensure that all its shares are in dematerialised form by September 30, 2024.
All private companies that qualify as small companies as per the provisions of the Companies Act, 2013 are required to dematerialise their shares within 18 months from the end of such financial year in which the company no longer retains its status as a small company.
All new issues of securities must only be in demat form.
The rules provide that new issuance of securities by private companies has to be solely undertaken in dematerialised form.
Moreover, private companies that plan to buyback shares or issue bonus shares or rights issues have to ensure that holdings of securities by promoters, directors and key managerial personnel are also dematerialised.
Section 8 Company (having share capital) is also other than small company and therefore mandatory for them to get the physical shares converted to demat before Sep 30, 2024.
The Bombay High Court, in the landmark case of National Securities Depository Ltd. v. Kamlesh Shah, 2012 SCC OnLine Bom 1638, discussed the procedure of dematerialisation of shares:
A shareholder who wants to dematerialize his shares in the depository system, can only do so if the Company of which he is the shareholder has made arrangements for joining the depository system by setting up/installing the necessary infrastructure i.e. establishing electronic connectivity with the depository as per the procedure specified by depository.
The holder who intends to dematerialize his securities has to deface and surrender the physical security certificates registered in its/his name to the DP (Depository Participant) along with Dematerialization Request Form (DRF).
The DP then sends the said certificates along with the DRF to the concerned Company/Registrar and Transfer Agent.
If the Company/Registrar and Transfer Agent after scrutiny of the security certificates and signature(s) finds the same in order, it cancels the physical security certificate and confirms the dematerialization in favor of the holder by authorizing the depository electronically, to credit the account of the holder, who had lodged them for dematerialization, for that many quantity of securities.
Listed companies - For listed companies, the Regulation 31(2) of the LODR Regulations requires that a listed entity ensure that 100% of shareholding of promoter(s) and promoter group is in dematerialized form and the same is maintained on a continuous basis in the manner as specified by the Board. This requirement is also echoed in Rule 9 of the PAS Rules, 2014.
Private companies - Under the new notification issued by MCA, now private companies are also mandatorily required to dematerialise the entire holding of securities of its promoters, directors and key managerial personnel before making any offer for issue of securities, or buyback or issue of bonus shares.
The following aspects of compliance must be adhered to by private companies undertaking dematerialisation of securities:
Amending of articles of association of the company to authorise shareholders to hold securities in dematerialised form
Appointment of a Securities and Exchange Board of India registered Registrar and Transfer Agent
Obtaining an International Securities Identification Number from NSDL or CDSL by following the required procedure and documentation. A Separate ISIN needs to be procured for all the existing different type of securities issued by such private company.
Amended PAS Rules clarify that the conditions contemplated under sub-rules (4) to (10) of 2018 Amendment Rules (applicable to unlisted public companies) shall equally apply to a private company as well.
These are as follows -
(8A) The company shall immediately bring to the notice of the depositories any difference observed in its issued capital and the capital held in dematerialized form.]
The grievances, if any, of security holders of unlisted public companies under this rule shall be filed before the Investor Education and protection Fund Authority.
The Investor Education and protection Fund Authority shall initiate any action against a depository or participant or registrar to an issue and share transfer agent after prior consultation with the securities and Exchange Board of India.
Additional compliance requirements for public company that has issued share warrants before the commencement of the Companies Act, 2013
If a public company has issued issued share warrants before the commencement of the Companies Act, 2013 where such warrants have not been converted into shares, the following are required:
Company must file Form PAS-7 within three months from the commencement of the Amendment Rules, informing the Registrar of Companies about details of such warrants.
Within six months from the commencement of the Amendment Rules, such public companies must require the bearers of share warrants to surrender the warrants to the company and get the shares dematerialised in their account.
The respective companies must place a notice for such bearers in Form PAS-8 on their website (if any) and publish the same in a newspaper in the vernacular language.
On part of an investor, the opening of a demat account would involve providing information of PAN (Permanent Account Number) as well as fulfilling KYC norms of depositories. For foreign investors, it may also involve additional documentation in the form of apostille of documents, furnishing residency proofs and payment of fees. In addition, investors are also required to provide details of ultimate beneficial ownership and management.
However, with the amendments to the Indian Stamp Act, 1899 applicable from July, 2020 onwards, stamp duty on issue and transfer of dematerialised securities has been lowered. This would reduce the overall transaction costs.
The amendment states that existing holders of physical form of securities of private companies can continue to do so. However, any transfer of the securities after the deadline of dematerialisation of securities can only be done if the shares are held in demat form.
If the shareholder of a public company’s share warrants fails to submit the warrants within 6 months, the company is required to proceed to convert these warrants into dematerialized form and subsequently transfer them to the Investor Education and Protection Fund (under section 125 of the Companies Act, 2013).
In National Securities Depository Ltd. v. Kamlesh Shah, 2012 SCC OnLine Bom 1638, it was held that the following is the procedure for opening an account by an investor -
The prospective account holder will have to open an account in the depository system with a DP (Depository Participant) by furnishing an application (account opening form).
As per Section 5 of the Depositories Act, 1996, the investor is required to enter into an agreement with the DP in the specified format under the Bye Laws of the depository.
Once the DP has accepted the application, the applicant investor will be issued a Client account (Client Identity for short “Client Id”) number. The Client Id is a unique number with respect to the DP with which the investor is holding a Beneficial Owner account.
The DP's are also identified in the depository system by a unique DP identity (DP Id) number. The combination of Client Id and DP Id forms the unique identification number for any person who desires to hold his securities in the depository system and the same is required to be referenced by the investor for dealings in the depository system.
In case of any non-compliance of requirements under the PAS Rules, including the amendment in 2023, there are no specific penal provisions stipulated under Section 29 of the Companies Act, 2013. However, as a general rule, the penalties under Section 450 of the Companies Act would apply. This includes a penalty of ?1000 per day for a continuing offence, subject to a maximum of ?2 lacs and ?50,000 for officers in default.
However, SEBI has also held that for public listed companies, the Depositories Act, 1996, Section 19D was added to the Act which provides a penalty of Rs. 1 lac for each day during which such failure continues or Rs. 1 crore whichever is less. Delay in dematerializing the shares held in the physical form is, indeed, a serious matter and the law requires stringent
penalty to be imposed for such delay. (Canaan International Infotech Limited v. Adjudicating Officer, Securities and Exchange Board of India, 2010 SCC OnLine SAT 34)
Is the dematerialisation requirement applicable to wholly-owned subsidiaries of private companies and private subsidiaries of foreign entities as well?
Yes, unlike the 2018 amendment that exempted wholly owned subsidiaries of unlisted public companies from complying with the requirement of dematerialisation, the 2023 amendment makes no such exemption. Hence, even private companies that are wholly owned subsidiaries of another private company would be required to comply with dematerialisation of existing and new securities. The same also holds true for subsidiaries of foreign entities.
Does dematerialisation and involvement of multiple parties impact the beneficial owner status?
Under Section 10(3) of the Depositories Act, 1996, the Beneficial Owner (the person who holds securities in the depository system) has all the rights and liabilities, and the depository neither has any voting rights in respect of the dematerialized shares held in the depository system nor does it suffer any liabilities in respect of such securities. It is the Beneficial owner of the shares held with a depository who is treated as a member of the company and is entitled to all benefits that are declared and issued by the Company.
Compliance Calendar LLP is a Legal, Tax and Compliance Firm who can help you convert physical shares into demat with end-to-end services. If you need consultation, feel free to email us to info@ccoffice.in or WhatsApp/ Call us at +91-9988424211