Disclosure of beneficial ownership by companies

General: These notes represent our views and comments on the draft rules proposed to be inserted in the Income Tax Rules 2002 for dissemination of information relating to beneficial ownership of a company.

This is an extremely important provision for companies, specially the listed companies, as the objective of these rules is to identify the ‘natural person’ who has more than 25% shareholding or the voting right or the ultimate control if the same is not exercised through shareholding and the voting rights.

Initial registration with FBR: Firms, AOPs to furnish details of beneficial owners

We reiterate our comments made at the time of introduction of Section 181E by the Finance Act 2022 that this information is not required or related to income of that person and is not a part of information under the Model OECD and UN Conventions and the treaty framework in general.

We are also not aware of any jurisdiction, including India, where beneficial ownership of assets is required. Taxation laws should be restricted to beneficial ownership of income.

We consider that this fine difference has not been appreciated by Pakistan’s legislature whilst incorporating this law where corporate law provisions are already there. It is our suggestion that this information be limited to beneficial ownership of income not assets which is an international principle.

Relevance in Pakistan

In Pakistan, a very large number of listed companies are owned by foreign entities and foreign trusts created by natural persons. A substantial part of such ownership was declared under the Foreign Assets Declaration laws introduced in 2018 and 2019.

On an overall financial and economic state of affairs of Pakistan at present it would have to be decided whether any economic benefit will accrue to Pakistan by divulging this information by businessmen and investors who have invested in Pakistani companies.

This may lead to flight of capital. It is also important to note that there are many cases where persons controlling the companies are now non-residents in Pakistan for tax purposes whereas these persons are Pakistani shareholders for foreign exchange laws.

It is therefore suggested that this matter be taken up after proper consultation with the Securities & Exchange Commission of Pakistan and the State Bank of Pakistan.

The Finance (Supplementary) Bill 2023: a comment

In simple words, this step is a move towards over regulation of the already documented sector without taking into account that a substantial part of the economy is undocumented.

Preamble

Finance Act, 2022 introduced the definition of beneficial ownership in the Income Tax Ordinance, 2001. Section 181E was also inserted which requires furnishing a statement of beneficial ownership by companies. Through SRO 229(I)/2023 dated February 28, 2023 Chapter XIIIA has been added with respect to the record of beneficial ownership.

(7A) “beneficial owner” means a natural person who –

(a) ultimately owns or controls a Company or association of persons, whether directly or indirectly, through at least twenty five percent shares or voting rights; or

(b) exercise ultimate effective control, through direct or indirect means, over the company or association of persons including control over the finances or decisions or other affairs of the company or association of persons;

Record of beneficial ownership under the Companies Act, 2017

There is a comprehensive scheme for beneficial owner under the corporate law. The term beneficial ownership has been defined as under:

“beneficial ownership of shareholders or officer of a company” means ownership of securities beneficially owned, held or controlled by any officer or substantial shareholder directly or indirectly, either by—

(a) him or her;

(b) the wife or husband of an officer of a company, not being herself or himself an officer of the company;

(c) the minor son or daughter of an officer where “son” includes step-son and “daughter” includes step-daughter; and “minor” means a person under the age of eighteen years;

(d) in case of a company, where such officer or substantial shareholder is a shareholder, but to the extent of his proportionate shareholding in the company: Provided that “control” in relation to securities means the power to exercise a controlling influence over the voting power attached thereto: Provided further that in case the substantial shareholder is a non-natural person, only those securities will be treated beneficially owned by it, which are held in its name.

Explanation.—For the purpose of this Act ``substantial shareholder”, in relation to a company, means a person who has an interest in shares of a company-

(a) the nominal value of which is equal to or more than ten percent of the issued share capital of the company; or

(b) which enables the person to exercise or control the exercise of ten per cent or more of the voting power at a general meeting of the company;

Section 452 of the Companies Act provides for maintenance of Global Register of Beneficial Ownership as under:

(1) Every substantial shareholder or officer of a company incorporated under the Company law, who is citizen of Pakistan within the meaning of the Citizenship Act, 1951 (II of 1951), including dual citizenship holder whether residing in Pakistan or not having shareholding in a foreign company or body corporate shall report to the company his shareholding or any other interest as may be notified by the Commission, on a specified form within thirty days of holding such position or interest.

Explanation. For the purposes of this section the expression “foreign company” means a company or body corporate incorporated or registered in any form, outside Pakistan regardless of the fact that it has a place of business or conducts any business activity or has a liaison office in Pakistan or not.

(7) The Commission shall keep record of the information in the Companies’ Global Register of Beneficial Ownership.

(8) The Commission shall provide the information maintained under sub-section (7) to the Federal Board of Revenue or to any other agency, authority and court.

In these circumstances a separate beneficial ownership register document for tax purposes needs to be examined as both the statutes operate in different manners which may create practical problems.

Relevance & nature in income tax

Though the term beneficial owner has been defined in the Ordinance, the same has not been used in any provision of law except the following two subsections of Section 2:

(2)(5C) “assets move” means the transfer of an offshore asset to an unspecified jurisdiction by or on behalf of a person who owns, possesses, controls or is the beneficial owner of such offshore assets for the purpose of tax evasion; And

(2)(38AB) “offshore evader” means a person who owns, possesses, controls, or is the beneficial owner of an offshore asset and does not declare, or under declares or provides inaccurate particulars of such asset to the Commissioners;

Beneficial ownership may be of two kinds. It may be beneficial ownership of assets or the beneficial ownership of income from any asset or source.

The definition of beneficial ownership as inserted in the Ordinance relates to beneficial ownership of the assets and is not related to beneficial ownership of the income. Under the OECD and UN Model treaties and almost all the taxing statutes of the world, the term ‘beneficial owner’ is used with reference to income as such laws are there to tax income.

In Pakistan, the term ‘beneficial owner’ has also been used in the definition of foreign assets under Capital Value Tax 2022 levied under Section 8 of the Finance Act, 2022.

In these circumstances, the relevance and purposes of seeking this information are not clear.

Definitions inserted in the Rules

The following definitions have been inserted in the draft rules:

(1) “Chain of ownerships” means all the legal entities and the legal arrangements through which the ownership rights (shareholdings) of a company or AOP are ultimately held by the natural person;

(2) “Contractual association” means the legal tie or contractual tie of two or more legal entities and/or legal arrangements to undertake joint investments and/or joint ventures;

(3) “Direct means” means

(i) exercise of control by natural person including exercise of ultimate control over a company or AOP through direct ownership i.e. without having ownership of intervening legal person or persons between the natural persons and the company or AOP, as the case may be, or

(ii) exercise of control through direct voting rights;

(4) “Indirect means” means exercise of control through means other than the direct means, and includes but not limited to means of control through (i) chain of ownerships, (ii) joint control arrangement, (iii) indirect voting rights, (iv) contractual associations, (v) personal and/or family connections, (“i) senior managerial position;

(5) “Joint control arrangement” means a situation where two or more natural and/or legal persons, each having ownership or voting rights of less than twenty-five percent, but their aggregate ownership or voting rights is twenty-five percent or more in a company or AOP and exercise or may exercise control over that company or AOP for being associates to each other in terms of section 85 of the Income Tax Ordinance, 2001.

(6) “ultimate effective control” means a situation in which ownership or control is ultimately exercised through direct and/or indirect means.

Manner of determination of beneficial ownership:

The purpose of beneficial ownership is to reach the natural person who is the beneficial owner of 25% of a company. The rules have provided eight situations as under:

(l) Direct ownership in a company through shareholding.

Mr A holds 25% shares in X Ltd;

(2) Indirect ownership through shareholding by way of chain of ownerships,

Mr A holds 50% shares in X Ltd which holds 100% shares in Y Ltd;

(3) Ownership through associates by way of joint ownership arrangement.

Mr A and Mr B are associates and they each hold shares equivalent to 12.5% in X Ltd.

(4) Voting Rights: The beneficial owner who exercises ultimate effective control over the company’s direct voting rights.

Mr A is the owner of only 10% shares of X Ltd however his voting rights are more than 25%

(5) Indirect Voting: The beneficial owner who exercises ultimate effective control over the company through indirect voting rights.

Mr A holds 10% shares in X Ltd and also holds 50% of its voting rights. X Ltd holds 50% voting rights in Y Ltd. Thus, Mr A becomes the beneficial owner of X Ltd and Y Ltd.

(6) Contractual Obligation: The beneficial owner who exercises ultimate effective control over the company through contractual associations.

This position envisages control through contractual obligation. However, this position is not in line with the Companies Act, 2017 as no company can be contractually controlled.

(7) Family and Personal Connection: A beneficial owner who exercises ultimate effective control over the company through personal or through family connections with the owners/directors/management of the company.

This provision refers to ultimate control by some not having shareholding and voting right but ultimate control through personal or family connection. This provision will not stand the test of law.

(8) A beneficial owner who exercises ultimate effective control over the company through senior managerial position and/or other indirect means.

Mr B is a Managing Director who exercises control through his position. This position will also not pass the test of law.

83D. The cascading process for recording beneficial ownership information. -

(1) This rule represents a cascading process which entails three tests.

Test 1. (l) Direct ownership, Indirect ownership, Ownership through associates, voting rights and indirect Voting shall collectively represent Test 1.

Test 2. Contractual Obligation, (7) Family and Personal Connection shall collectively represent Test 2 and

Test 3. Management Control shall represent Test 3 of the cascading process.

The 3 Tests of the cascading process shall be applied in succession when a previous test has been applied but has not resulted in the identification of all beneficial owner, i.e., Test 2 shall only be applied in case if there is doubt as to whether a person with controlling ownership interest is a beneficial owner, or where no beneficial owner has been identified as a consequence of application of Test 1.

Similarly, Test 3 shall only be applied in case the information about all beneficial owners are not recorded or captured by application of Test I and Test 2.

Retention of records of beneficial owner(s). -

(1) Every company shall retain the records of all beneficial owners for a period of ten years from the date when the beneficial owners of that company as the case may be, ceased to be the beneficial owner of that company

(2) FBR shall retain the records of beneficial owners of all companies registered with the Board for a period of fifteen years from the date when that company ceases to be registered with FBR.

Copyright Business Recorder, 2023