Dematerialization of Shares in Private Companies

Dematerialization of Shares in Private Companies – Your Compliance Guide

The Indian government has mandated the compulsory dematerialization of physical shares in private companies by September 30, 2024, following an amendment to the Companies (Prospectus and Allotment of Securities) Rules, 2014. This rule, introduced through the Companies (Prospectus and Allotment of Securities) Second Amendment Rules, 2023 (PAS Amendment Rules), applies to all private companies, excluding small companies and government entities. Here’s a comprehensive guide on the procedure for dematerialization of shares:

What is Dematerialization?

Dematerialization is the process of converting paper/physical share certificates into electronic versions. This process is carried out through SEBI-registered depositories such as National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL). These depositories act as custodians of electronic securities, ensuring safety and accessibility.

Key Exemptions

Small private companies and government companies are exempt from this mandate. A small private company is defined as one:

• Whose Paid-up capital of less than ₹4 crore, and
• Whose Turnover of less than ₹40 crore.

Steps for Dematerialization of Shares

1. Amendment of Articles of Association (AoA)

The company’s AoA must be updated to authorize shareholders to hold shares in dematerialized form. Legal assistance may be required to draft and execute this amendment.

2. Appointing Registrar and Transfer Agent (RTA)

Company need to appoint an independent SEBI-registered RTA through a Board Resolution. The RTA serves as the intermediary between the company and depositories.

3. Document Submission to the RTA

Submit the following documents:

Board Resolution, Memorandum of Association (MoA), Articles of Association (AoA), and Certificate of Incorporation (CoI).

Net worth certificate (certified by a Chartered Accountant or Company Secretary).

Authorization letter for signatories.

GST registration certificate or an undertaking if GST registration is not applicable.

Financial statements, audit reports, and a shareholding list with details like distinctive numbers and folio numbers.

Corporate action details, if any, such as further issuance or buyback of shares.

Additional documents as requested by the RTA.

4. Execution of a Tripartite Agreement

A tripartite agreement must be executed between the company, the RTA, and the depository (CDSL or NSDL), with at least one witness from each party.

5. Obtaining an International Securities Identification Number (ISIN)

Company need to apply for an ISIN for each type of share issued. This unique code globally identifies your company’s securities.

6. Opening a Demat Account

Open a Demat account with a Depository Participant (DP), typically a bank or brokerage firm authorized to facilitate dematerialization.

7. Dematerialization of Existing Shares

Shareholders must submit their physical share certificates to the DP to facilitate conversion into electronic form.

8. Dematerialization for Promoters, Directors, and KMPs

Make certain that all directors, promoters, and Key Managerial Personnel (KMPs) own dematerialized shares. For smooth electronic credit, they need to connect their Demat accounts to the business's account.

9. Compliance Reporting

File Form PAS-6 (half-yearly return) with the Ministry of Corporate Affairs (MCA), detailing the dematerialized shareholdings.

Penalties for Non-Compliance

Non-compliance with the dematerialization mandate can result in severe consequences:

1. The company cannot issue or allot new securities, including bonus shares.
2. Shareholders with physical shares cannot sell or subscribe to additional shares.
3. Monetary fines include:
• ₹10,000 plus ₹1,000 per day of continued violation, up to a maximum of ₹2,00,000 for the company.
• ₹50,000 maximum penalty for defaulting officers.

Important Considerations

• No Exemptions for Specific Companies: Apart from small and government companies, all private entities must comply. Section 8 companies, public limited companies, NBFCs, and Indian subsidiaries of foreign entities are also required to dematerialize their securities.
• Role of SEBI-Registered Depositories: Depositories such as NSDL and CDSL ensure the safety and efficiency of electronic securities.

Conclusion

The compulsory dematerialization of shares is a significant step towards transparency and efficiency in India’s corporate ecosystem. Private companies must act promptly to adhere to the September 30, 2024, deadline to avoid penalties and ensure smooth operations. Early compliance can also strengthen corporate governance and investor confidence.

Read More On: The Beginner’s Guide to Dividends