New dematerialisation rules for private companies
In October 2023, the Ministry of Corporate Affairs (MCA) made changes to the Companies (Prospectus and Allotment of Securities) Rules, 2014 (PAS Rules) by introducing rule 9B through the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (PAS Amendment Rules).
This new rule requires all private companies, except small and government companies, to convert their physical share certificates to electronic form, known as dematerialisation.
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What is dematerialisation?
Dematerialisation is the method of converting physical share certificates and other investment documents into an electronic format, which are then stored / kept in a demat account managed by a depository. In India, the two SEBI-registered depositories are:
- NSDL (National Securities Depository Ltd.)
- CDSL (Central Depository Services (India) Ltd.)
Your demat account will be with either NSDL or CDSL, depending on your Depository Participant (DP), like your bank or broker.
Understanding MCA’s rule 9B
Before Rule 9B, dematerialisation was optional for most private companies and mandatory only for public companies and some large private ones. This meant many private companies still used physical share certificates, which are prone to loss, theft, and forgery. Now, all private companies must convert their physical shares to electronic ones by September 30, 2024, and issue only electronic shares moving forward.
Key points of rule 9B:
- Mandatory dematerialisation: All private companies, except small companies (with paid-up capital under ₹4 crore and turnover under ₹40 crore) and government companies, must issue securities only in dematerialised form & facilitate the dematerialisation of all their securities as per the Depositories Act, 1996.
- Compliance timeline: If a private company is no longer classified as small based on financial records after March 31, 2023, it must comply with these rules within 18 months of the end of that financial year.
- Issuing securities: When offering, buying back, or issuing bonus or rights shares, private companies must ensure all securities held by promoters, directors, and key managerial personnel are dematerialised before such offers.
- Transfer and subscription: Security holders planning to transfer their securities must dematerialise them before the transfer. New subscribers to securities through private placement, bonus shares, or rights must ensure their securities are dematerialised before subscribing.
- Applicability of rule 9A: Rules from (4) to (10) of rule 9A will apply to the dematerialisation process under rule 9B.
- Exemption for government companies: These rules do not apply to government companies.
Dematerialisation of shares for US entities in Indian private companies
All private companies in India, except for small companies, need to convert their physical share certificates into electronic (dematerialized) forms by September 30, 2024. This rule applies to shares owned by foreign entities as well.
Criteria for a small company: Paid-up capital of less than INR 4 crore and turnover of less than INR 40 crore.
If you’re a foreign entity owning shares in an Indian private company, here’s what you need to do to comply with the dematerialisation requirement:
- Open a Demat Account: You’ll need to open a demat account with an Indian depository participant (DP) to hold your shares electronically. This requires obtaining a Permanent Account Number (PAN) from Indian tax authorities and completing KYC (Know Your Customer) procedures. Inkle can assist you in obtaining a PAN.
- Submit a Dematerialisation Request Form (DRF): Fill out and submit a DRF to your DP, along with your physical share certificates.
- Processing by DP and RTA: Your DP will forward your request to the company's Registrar and Transfer Agent (RTA) for processing.
- Verification and Approval: Once the RTA verifies and approves your request, your physical share certificates will be canceled, and your shares will be credited to your demat account in electronic form.
- Deadline Compliance: Make sure your shares are dematerialised before the September 30, 2024, deadline, unless the company qualifies as a "small company" based on its financials as of March 31, 2023.
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Step-by-step guide to dematerialising shares for private companies
Now that you know the rules for dematerialisation, let's walk through the process of complying with them.
Step 1: Update the Articles of Association (AoA)
- Amend your company’s AoA to allow shareholders to hold shares in dematerialised form. You might need legal assistance for this step.
Step 2: Appoint a Registrar and Transfer Agent (RTA)
- Hire a SEBI-registered Registrar and Transfer Agent. The RTA will act as an intermediary between your company and the depositories (CDSL or NSDL).
Step 3: Get an International Securities Identification Number (ISIN)
- Apply for an ISIN for each type of share your company has issued, such as common stock or preferred stock. This unique code helps identify your company’s securities globally.
Step 4: Open a Demat Account
- You need to open a Demat account with a Depository Participant (DP). DPs are typically banks or brokerage firms authorized to handle the dematerialisation process.
Step 5: Dematerialise Existing Shares
- Convert existing physical share certificates into electronic form through the DP. Shareholders will need to submit their physical certificates to the DP for this conversion.
Step 6: Dematerialise Shares for Promoters, Directors, and Key Managerial Personnel (KMP)
- Ensure that all promoters, directors, and KMPs have their shares in dematerialised form before issuing any new securities. They need to link their Demat accounts with the company to have their shareholdings electronically credited.
Step 7: Regular Reporting (PAS 6)
- Submit half-yearly returns using form PAS 6 to notify the Ministry of Corporate Affairs about the dematerialisation details.
Following these steps will help your company comply with the dematerialisation rules and ensure a smooth transition from physical to electronic shares.
Benefits of converting securities to demat form for a company
Converting securities into demat form offers several advantages:
- Safety: Shares in electronic form can't be defaced, mutilated, or stolen.
- Convenience: Shares can be easily transferred electronically between entities.
- Speed: Share transfers happen instantly upon authorisation.
- No Stamp Duty: You don’t have to pay stamp duty on the transfer of shares.
- Reliability: There’s no risk of bad deliveries, such as fake certificates, delays, or missing documents.
- Minimal Paperwork: The process involves much less paperwork.
- Cost-Effective: It reduces transaction and legal costs.
- Flexibility: Even a single share can be transferred.
- Easy Management: Ownership information and shareholder addresses are easy to maintain and update.
- Automatic Updates: You get automatic credit to your account for stock splits or bonuses.
- Consolidation: A single demat account can hold multiple types of securities.
- Transparency: It improves the transparency of securities holdings.
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FAQs
Who is a depository?
In India, a depository is either National Securities Depository Limited (NSDL) or Central Depository Services (India) Limited (CDSL). They serve as central hubs for holding securities in digital format, maintaining accounts for Depository Participants (DPs) and their clients (beneficial owners). They also handle the electronic settlement of trades, transfer securities between DPs, and ensure the safekeeping and record-keeping of dematerialised securities.
Who is a depository participant (DP)?
Depository Participants (DPs) are like intermediaries between the depositories (NSDL or CDSL) and investors. They include banks and brokerage firms. DPs open demat accounts for investors, enabling them to hold their securities electronically. They facilitate the buying / selling of securities through the depository and provide account statements and other related services to investors.
Who is the registrar & transfer agent (RTA)?
RTAs are appointed by the company issuing the shares to manage its shareholder records. They maintain records of shareholders and their holdings and process corporate actions like bonus issues, stock splits, and dividend payments. RTAs act as a bridge between the company and the depository, ensuring accurate shareholder records and the smooth processing of corporate actions.
What fees are involved in dematerialising shares?
Opening and maintaining demat accounts come with fees. Make sure to check with your Depository Participant (DP) for details on these charges.
What documents are required for dematerialisation?
You’ll need KYC (Know Your Customer) documents and a PAN card (tax identification number) for both the company and its shareholders.
Are there any restrictions on share transfers?
Yes, the Companies Act requires alterations to the Articles of Association (AoA) for any share issues. DPs may not be restricted by these rules and could process share transfers without confirming AoA amendments. It’s important to implement checks at the depository level, such as freezing the ISIN, and inform the DPs about legal restrictions in the AoA to ensure they follow the correct procedures.
Should I be concerned about system capacity?
With millions of registered companies in India, depositories could face challenges handling the volume of dematerialisation applications. This may lead to delays, so it's a good idea to start the process early to avoid any inconvenience.
What is the last date to convert physical shares to demat? [2023-2024]
You have 18 months from the end of the financial year to comply with the dematerialisation rules. So, if your company's financial year ends on March 31, 2023 (the standard financial year), the deadline is September 30, 2024. However, if your company's financial year runs from January to December and ends on December 31, 2023, your deadline will be June 30, 2025. Make sure to mark these dates to stay compliant with the new rules.
What steps should a private limited company, which is a subsidiary of a foreign company, take for dematerialisation?
- Secure an International Securities Identification Number (ISIN) for each type of security.
- Ensure all shares are converted to electronic form within the legal timelines.
What should a security holder of a private limited company do for dematerialisation?
- Open a "demat account" with an authorised depository within the legal timelines.
- Convert your existing securities into dematerialised form within the legal timelines.
If no share transfer is planned and no new share issue is expected, why is it still important to act now?
It’s crucial to act now for several reasons:
- Regulatory Monitoring: The Registrar of Companies (ROC) can easily monitor electronic data, so any non-compliance will be quickly detected and penalized. Dealing with sanctions takes time and effort beyond just paying the fines.
- Time-Consuming Process: Setting up the required demat account can take time and requires cooperation with the depository. It’s better to handle this when there’s no rush.
- Operational Flexibility: Even if you don’t foresee the need to issue new shares or transfer existing ones now, operational needs might change. Having everything in place ahead of time ensures you can act swiftly without facing significant delays.
What are the requirements for share transfers in an M&A transaction under the PAS Amendment Rules?
For an M&A transaction involving the transfer of shares, the PAS Amendment Rules require that shares be dematerialised before the transfer. Here’s what you need to know:
- For the Transferring Shareholder: The transferring shareholder must complete the dematerialisation of their shares.
- For the Transferee: The transferee must open a demat account. This will be a condition precedent to closing the transaction if it takes place on or after the specified date.
What if an acquirer subscribes to shares of the target private company?
If an acquirer is subscribing to shares, the following must happen before closing:
- Dematerialisation for Promoters: The securities held by the promoters of the target company must be dematerialised.
- Demat Account for Acquirer: The acquirer must open a demat account.
Why should the timeline of the transaction consider the dematerialisation process?
Opening a demat account and completing the dematerialisation process takes time. It’s important to factor this into the transaction timeline to avoid delays and ensure everything is in place for a smooth closing.
Is a private company that is a holding or subsidiary of another private company required to dematerialise its shares?
Yes, if a private company is a subsidiary or holding company of another private company, it must comply with dematerialisation rules even if its paid-up capital and turnover fall within the small company parameters.
What types of securities need to be dematerialised?
The term “securities” covers all kinds, including equity shares, preference shares, debentures, warrants, and more. All these securities must be dematerialised.
Which section of the law governs the dematerialisation of securities?
The dematerialisation of securities is governed by The Companies Act, 2013, specifically section 134, along with sections 92, 143, 149, 178, 186, 188, and The Companies (Accounts) Rules, 2014, subject to periodic amendments.
Does a company need to appoint a registrar and share transfer agent (RTA)?
An RTA acts as an intermediary between the issuer and the depository, facilitating dematerialisation and corporate actions. They verify dematerialisation requests and forward them to the company. However, it's not mandatory to appoint an RTA if the company has its own in-house arrangement. If no RTA is appointed, the company must handle these activities itself to enable the dematerialisation of securities held by investors.
Do private companies covered under the dematerialisation section need to maintain a register of members?
No. According to Section 88 (3) of the Act, the register & index of beneficial owners maintained by a depository under Section 11 of the Depositories Act, 1996, will be considered the corresponding register & index for the purposes of the Companies Act.
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