According to the MCA notification dated September 10, 2018, amendments to the Companies (Prospectus and Allotment of Securities) Rules, 2014, introduced Rule 9A, which mandates that every unlisted public company must issue securities solely in dematerialised form and ensure the dematerialisation of all its existing securities. This is to be carried out in accordance with the Depositories Act, 1996, and associated regulations. These amendments became effective on October 2, 2018.
Subsequently, an amendment to Section 29 of the Companies Act, 2013, dated July 31, 2019, removed the word “PUBLIC” from the provision, thereby allowing private limited companies to also dematerialise their shares and admit them into recognized depositories such as CDSL and NSDL.
Further, a private company that does not qualify as a small company as of the last day of a financial year ending on or after March 31, 2023, based on its audited financial statements for that year, must comply with the dematerialisation provisions within eighteen months from the closure of that financial year.
On October 27, 2023, the Ministry of Corporate Affairs notified the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023. This amendment introduced a new Rule 9B to the existing Companies (Prospectus and Allotment of Securities) Rules, 2014, making it mandatory for unlisted private companies classified as other than small companies to dematerialise their securities. This article outlines the dematerialisation process and compliance obligations for unlisted private companies and clarifies whether the notification applies to wholly owned subsidiaries and subsidiary companies in India.
Private Unlisted Wholly Owned Subsidiaries and Subsidiary Companies in India
A subsidiary company is defined as one controlled by a parent company, which may exercise either partial or full control. According to Section 2(1)(zm) of the Listing Obligations and Disclosure Requirements (LODR) Regulations and Section 2(87) of the Companies Act, 2013, a subsidiary is a company where the holding company controls the Board composition or exercises control over more than half of the total voting power (under LODR) or share capital (under the Companies Act), individually or together with one or more subsidiaries.
A wholly owned subsidiary is one where the parent company holds 100% ownership of the shares, whereas a subsidiary company may have the parent holding more than 50% but less than 100% of shares.
Dematerialisation of Shares for Private Companies: Process and Benefits
Dematerialisation refers to converting physical securities into electronic form, held in an account with a Depository Participant (DP) within the depository system. This process does not alter ownership but changes the method of holding shares from physical certificates to electronic balances.
Key benefits of dematerialised securities include:
- Enhanced transparency via electronic shareholding records accessible to companies, regulators, and authorities.
- Reduction of legal disputes related to taxation, transfer, inheritance, and gifting of shares.
- Facilitated pledging or collateralization of securities due to digitized ownership.
- Mitigation of risks related to loss, theft, or forgery of physical certificates.
- Fungibility, where dematerialised shares become identical, interchangeable, and lose unique characteristics like certificate numbers.
Dematerialisation for Private Unlisted Subsidiary Companies
Per Rule 9B of the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, every private company that is not classified as a small company must complete dematerialisation of all its shares by September 30, 2024, a deadline now extended to June 30, 2025.
Companies retaining small company status per the Companies Act must comply within 18 months from the end of the financial year in which they lose that status.
All new securities issued by private companies must be in dematerialised form only.
Additionally, private companies undertaking buybacks, issuing bonus shares, or rights issues must ensure the securities held by promoters, directors, and key managerial personnel are dematerialised.
Accordingly, all unlisted private companies, including wholly owned subsidiaries and subsidiary companies in India, are required to comply with the mandatory dematerialisation of securities as stipulated in the latest MCA notification.
Dematerialisation Requirement Also Applies to Private Indian Subsidiaries of Foreign Companies
Unlike the 2018 amendment, which exempted wholly-owned subsidiaries of unlisted public companies from mandatory dematerialisation, the 2023 amendment does not provide such exemptions. Consequently, all private companies, including wholly-owned subsidiaries—whether of Indian or foreign parent companies—must comply with the dematerialisation of both existing and newly issued securities.
The amended Companies (Prospectus and Allotment of Securities) Rules clarify that the conditions outlined in sub-rules (4) to (10) of the 2018 Amendment Rules, originally applicable to unlisted public companies, are now equally applicable to private companies.
These conditions include:
- Application to Depository and ISIN Issuance:
Every company must apply to a depository, as defined under Section 2 of the Depositories Act, 1996, to obtain an International Securities Identification Number (ISIN) for each class of security and inform all existing security holders about this facility. - Fee Payments and Security Deposits:
Companies must ensure timely payment of admission and annual fees to the depository and the registrar to an issue and share transfer agent, maintain a security deposit covering at least two years of fees, and comply with all applicable SEBI and depository regulations, guidelines, and circulars relating to dematerialisation. - Restrictions on Securities Offers and Buybacks:
Any company defaulting on fee payments is prohibited from offering securities, conducting buybacks, or issuing bonus or rights shares until dues are cleared. - Filing of Half-Yearly Reports:
Unlisted public companies governed by this rule must submit Form PAS-6 to the Registrar of Companies within 60 days of each half-year, certified by a practicing Company Secretary or Chartered Accountant. - Disclosure of Capital Differences:
Companies are required to promptly notify depositories of any discrepancies between issued capital and capital held in dematerialised form. - Investor Grievance Redressal:
Security holders’ grievances should be directed to the Investor Education and Protection Fund Authority, which, after consulting SEBI, may take action against depositories, participants, or share transfer agents.
Compliance Requirements for Wholly-Owned Subsidiaries and Subsidiary Companies
Private companies undertaking dematerialisation must comply with the following:
- Amend their Articles of Association to permit shareholders to hold securities in dematerialised form.
- Appoint a Registrar and Transfer Agent registered with the Securities and Exchange Board of India (SEBI).
- Obtain International Securities Identification Numbers (ISINs) from NSDL or CDSL for each category of security, following prescribed procedures and documentation. Separate ISINs are required for each type of security issued.
Penalty for Non-Compliance
While the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023, do not specify penalties under Section 29 of the Companies Act, 2013 for non-compliance with dematerialisation requirements, general penalties under Section 450 apply. These include a daily fine of Rs. 1,000 for continuing offenses, capped at Rs. 2,00,000, and a fine of Rs. 50,000 on officers in default.
Conclusion
The 2023 amendments to the Companies (Prospectus and Allotment of Securities) Rules mark a significant regulatory shift by mandating the dematerialisation of securities for all unlisted private companies classified as other than small companies, including wholly-owned subsidiaries and subsidiary companies. This move enhances transparency, reduces risks associated with physical share certificates, and aligns private companies with modern securities management standards.
Compliance with these rules requires companies to update their Articles of Association, obtain ISINs for all security types, and engage SEBI-registered registrars and transfer agents. Failure to adhere may attract penalties under the Companies Act, underscoring the importance of timely and accurate compliance.
As these requirements impact a broad spectrum of private companies, it is essential for businesses to stay informed and take proactive steps to ensure adherence, thereby safeguarding shareholder interests and avoiding regulatory complications.
Frequently Asked Questions (FAQs)
Q1. Does the dematerialisation requirement apply to all private companies?
No, only unlisted private companies classified as other than small companies as per the Companies Act, 2013, are required to mandatorily dematerialise their securities.
Q2. Are wholly-owned subsidiaries of foreign companies exempt from dematerialisation?
No, the 2023 amendment removes exemptions for wholly-owned subsidiaries. All such companies must comply with the dematerialisation requirements.
Q3. What is an ISIN and why is it required?
An International Securities Identification Number (ISIN) uniquely identifies each class of securities issued by a company and is mandatory for dematerialisation to facilitate electronic trading and settlement.
Q4. What penalties can companies face for not complying with dematerialisation rules?
Non-compliance may attract penalties under Section 450 of the Companies Act, including daily fines up to Rs. 1,000, subject to a maximum of Rs. 2,00,000, and fines on officers in default.
Q5. Can companies continue to issue physical share certificates?
No, following the amendments, all new issuances of securities by eligible companies must be in dematerialised form only.
Q6. What steps must a company take to comply with the dematerialisation mandate?
Companies need to amend their Articles of Association, appoint a SEBI-registered registrar and transfer agent, obtain ISINs from depositories, and facilitate the dematerialisation of all existing securities.
