Posted on by Nikita Bhatia

Dematerialisation of Shares of Private Companies

The Ministry of Corporate Affairs (MCA) has introduced a significant change with the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (PAS Amendment Rules) as notified by notification no. GSR 802(E) dated 27th October 2023. This mandates private companies, to convert physical securities into dematerialized (electronic) form within eighteen months of their financial year ending March 31, 2023, i.e., September 30, 2024.

Requirement under the law

  • Every private company which is not a small company as on March 31, 2023, has to ensure that all its shares are in dematerialized form by September 30, 2024.
  • For all such other private companies which would qualify as a ‘small company’ as per the provisions of the Companies Act, 2013 (the “Act”), the requirement to dematerialize all their shares would become applicable within 18 (eighteen) months from the end of such financial year in which such company would no longer qualify as a small company.
  • Post the last date for demat, any new issuance of securities by the private companies has to solely be undertaken in a dematerialized form.

Impact on private companies:

The requirement of compulsory dematerialization of shares is bound to have additional compliance costs for private companies. However, in the long run, this move shall aim to improve the ease of doing business in India as this would ensure that any further issuance by private companies, share transfer, buyback, rights issues etc., would become a much faster and smoother process.

Compliance requirement for foreign investors:

On account of compulsory dematerialization, the foreign investors would need to open demat accounts with depositories in India for the purpose of making investments in private companies in India. This would also involve obtaining a Permanent Account Number (PAN) with tax authorities in India, fulfilling of know your customer (KYC) norms of the depositories, payment of additional fees, apostille of documents etc.

However, this being a one-time requirement, this may provide much more benefits to the foreign investors in the long run such as consolidation of investments in various private companies in India under one demat account, smoother and faster process for share transfer in case of exit from investment, lesser risk of loss of share certificates like in the case of physical share certificates etc.

Consequences of non-compliance

On the Company:

In case the company fails to undertake dematerialization of its securities on or before September 30, 2024, it shall not be able to issue any further securities, buyback of securities, or issue of bonus shares or rights offer after such due date unless the entire holding of securities of its security holders has been dematerialized.

On the Share Holders:

In case the security holders of the company fail to undertake dematerialization of their securities on or before September 30, 2024, they shall not be able to transfer, purchase, or subscribe to any securities of the company unless such securities are dematerialized before transfer, purchase, or subscription, as the case may be.

Non-applicability:

It is important to note that the requirement for Dematerialization of Securities does not apply to specific types of companies, including Nidhi Companies, Government Companies, Wholly Owned Subsidiary Companies of Public Companies, and Small Private Limited Companies.

However, private companies which are subsidiaries of foreign companies do not fall within the ambit of small companies and this section is applicable to them.

Conclusion:

While the amendment does not prohibit the holding of shares of a private company in physical form, but any person(s) holding such shares in physical form, would have to ensure that these shares are converted into dematerialized form in case, they wish to transfer the same post the last Date.

Although the compulsory dematerialization of the shares of private companies appears to be a complicated and time taking compliance, it may prove to be a step in the right direction and will lead to a more transparent and efficient system of share transfers, more financial inclusivity and better bankability of the shares.

Notes:

  • A company for the purposes of this rule will be considered as a small company if it qualifies as a small company as per the audited financial statements of the period ended March 31, 2023.
  • As per Section 2(85) of the Act, a small company is a company, other than a public company, whose maximum paid-up capital is INR 4,00,00,000 (Indian Rupees Four Crores only)and maximum turnover is INR 40,00,00,000 (Indian Rupees Forty Crores only).
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