KPMG IN INDIA

KPMG Flash News 6 January 2011 TAX

RBI liberalizes regulatory framework for Core Investment Companies – releases Core Investment Companies (Reserve Bank) Directions, 2011 Background The Reserve Bank of India (‘RBI’) had earlier issued Guidelines governing the regulatory framework for Core Investment Companies1 (‘CICs’) i.e. companies which have their assets predominantly as investments in group companies (hereinafter referred to as ‘CIC Guidelines’). RBI has now issued the Core Investment Companies (Reserve Bank) Directions, 20112 giving legal sanctity to the earlier CIC Guidelines (hereinafter referred to as ‘CIC Directions’). Concurrently, through the CIC Directions, RBI has liberalized the regulatory framework for CICs to, interalia, include the following: CICs having total asset3 size of Rs. 100 crore or more but not

accessing public funds are not treated as Systemically Important CICs (‘CIC-ND-SI’) and consequently exempted from the requirement of obtaining RBI registration and complying with the CIC regulations

Raising funds through instruments compulsorily convertible into

equity shares within 10 years from issue date are not considered as ‘public funds’ for determining CIC-ND-SI.

The leveraging capacity of CICs shall increase since instruments

compulsorily convertible into equity shares within 10 years from issue date are not included as a part of ‘outside liabilities’ while calculating the leverage ratio.

1 DNBS (PD) CC.No. 197/03.10.001/2010-11 dated 12 August, 2010 2 Notification No. DNBS (PD) 219/CGM(US)-2011 dated 5 January, 2011 3 Total assets means total of all assets appearing on the assets side of the Balance Sheet

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Regulatory Framework

CIC is defined to mean a Non-Banking Financial Company (‘NBFC’) carrying on the business of acquisition of shares and securities and which satisfies the following conditions as on the date of last audited balance sheet: It holds at least 90 percent of its Net Assets4 as investment in equity shares, preference shares,

bonds, debentures, debt or loans in group companies; Its investments in the equity shares (including instruments compulsorily convertible into equity

shares within 10 years from issue date) in group companies is at least 60 percent of its Net Assets;

It does not trade in its investments in shares, bonds, debentures, debt or loans in group companies

except through block sale for dilution or disinvestment;

It does not carry on any other financial activity referred to in Section 45-I(c) and 45-I(f) of the RBI Act, 1934 except investment in bank deposits, money market instruments including money market mutual funds, government securities, bonds or debentures issued by group companies, loans to group companies or guarantees issued on behalf of group companies.

A CIC, which is not a CIC-ND-SI, is exempted from:

Obtaining RBI registration as a CIC and complying with section 45 IA of the RBI Act, 1934

Complying with Non-Banking Financial (Non-Deposit Accepting or Holding) Companies

Prudential Norms (Reserve Bank) Direction, 2007 A comparison between the regulatory framework prescribed for CIC-ND-SI in the CIC Guidelines and CIC Directions is discussed below:

Particulars CIC Guidelines CIC Directions Our Comments

Definition of CIC-ND-SI

CIC-ND-SI means a CIC with an asset size of Rs. 100 crore or more. For this purpose, all CICs belonging to a group will be aggregated

CIC-ND-SI means a CIC fulfilling both the following conditions: (i) having total assets of Rs. 100

crore or more, either individually or in aggregate alongwith other CICs in the Group and;

(ii) raises or holds public funds

For the above: “Public funds" shall include funds raised either directly or

CICs having total asset size of Rs. 100 crore or more but not accessing public funds are exempted from the requirement of obtaining RBI registration and complying with the CIC regulations

The total assets of all CICs in the group shall be aggregated for determining Rs. 100 crore threshold (irrespective of whether these CICs have accessed public funds or not). Thus,

4 Net assets = Total assets excluding (i) cash and bank balances;(ii) investment in money market instruments and money market mutual funds; (iii) advance payments of taxes; and (iv) deferred tax payment.

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Particulars CIC Guidelines CIC Directions Our Comments indirectly through public deposits, commercial papers, debentures, inter-corporate deposits and bank finance but excludes funds raised by issue of instruments compulsorily convertible into equity shares within 10 years from the issue date

CICs in the group accessing public funds may be required to obtain registration and comply with CIC norms (even though its total assets do not exceed Rs. 100 crores)

Raising funds through instruments compulsorily convertible into equity shares within 10 years from issue date are not regarded as ‘public funds’

Definition of ‘Companies in the Group’

Not defined “Companies in the Group” means an arrangement involving two or more entities related to each other through any of the following relationships : Subsidiary – parent (defined in terms of AS 21), Joint venture (defined in terms of AS 27), Associate (defined in terms of AS 23), Promoter-promotee (as provided in the SEBI (Acquisition of Shares and Takeover) Regulations, 1997) for listed companies, a related party (defined in terms of AS 18), Common brand name, and investment in equity shares of 20% and above

Group companies have been liberally defined and should cover most of the related companies. This should positively help to avail liberalized CIC regime for group companies as compared to NBFC regulations

Registration with RBI

Required (whether they were specifically exempted in the past from registration with the RBI or not)

No change -

Time limit for obtaining RBI registration

- Existing CIC-ND-SI: Within six months from date of the Notification. CIC-ND-SI can continue existing business till disposal of their application by the RBI.

- CICs whose asset size would cross Rs. 100 crores at a later date: Within three months of crossing the asset limit

No change -

Capital requirement

Ongoing maintenance of a minimum Capital Ratio whereby its Adjusted Net Worth (‘ANW’) shall be at least 30% of its aggregate risk weighted assets on balance sheet and risk

No change in requirement of 30% capital adequacy requirement Mechanism for calculating risk weighted assets on balance sheet and risk adjusted value of

-

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Particulars CIC Guidelines CIC Directions Our Comments adjusted value of off balance sheet items as on the date of the last audited balance sheet as at the end of the financial year. ANW is calculated as follows: Owned Fund Add: 45% of Revaluation reserve arising from revaluation of quoted investments (if any) as per latest audited Balance sheet at end of financial year Add: 50% unrealized appreciation in the book value of quoted investment Add: Increase in equity share capital since last Balance sheet date Less: Diminution in the aggregate book value of quoted investments Less: Reduction in equity share capital since last Balance sheet date

off balance sheet items has been prescribed ANW: (i) Requirement to adjust 45%

of Revaluation reserve arising from revaluation of quoted investments removed from the definition of ANW

(ii) Investments are now defined to include investment in shares, stocks, bonds, debentures or securities issued by the Government or local authorities or other marketable securities of a like nature

Leverage ratio

Outside liabilities shall not exceed 2.5 times of its ANW calculated as on the date of the last audited balance sheet as at the end of the financial year Outside Liabilities means total liabilities as appearing on the liability side of Balance Sheet excluding paid up capital and reserves and surplus but including all forms of debt and obligations having characteristics of debt whether created by issue of hybrid instruments or otherwise, and value of guarantees issued whether appearing on balance sheet or not

No change in the leverage ratio Definition of Outside Liabilities amended to exclude instruments compulsorily convertible into equity shares within 10 years from issue date

The leveraging capacity of CICs shall increase since instruments compulsorily convertible into equity shares within 10 years from issue date are not included as a part of ‘outside liabilities’ while calculating the leverage ratio. However, instruments compulsorily convertible into equity shares within 10 years from issue date continue to be excluded from the definition of ANW

Exemption from : (i) maintenance of statutory minimum Net Owned Fund (‘NOF’); and (ii)

Exemption available provided CIC-ND-SI meets the above conditions regarding capital adequacy and leverage ratios

No change It may be interesting to note while the extant NBFC regulations provided that exemption from exposure norms is available only if ‘public funds’ have not been accessed by the NBFC, this condition is relaxed under the CIC Guidelines. Thus, CIC-

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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Particulars CIC Guidelines CIC Directions Our Comments requirements of Non-Banking Financial (Non- Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 including requirements of capital adequacy and exposure norms

ND-SI are exempted from exposure norms, even when public funds are accessed

Submission of statutory auditors certificate for compliance with the guidelines

Annually within 1 month from finalization of balance sheet

No change -

Conclusion

With the amendment in CIC Guidelines, large industrial groups having holding companies and not accessing public funds would be saved from registration and compliance under the CIC regulations. Also, wide definition of Group companies and exclusion of compulsorily convertible instruments from definition of ‘public funds’ & leverage ratio computation are welcome liberalizations by RBI.

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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after a thorough examination of the particular situation.

© 2011 KPMG, an Indian Partnership and a member firm

of the KPMG network of independent member firms

affiliated with KPMG International Cooperative (“KPMG

International”), a Swiss entity. All rights reserved.

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