Legal Text and Framework for Various Institutional Forms
This section reviews the legal text relating to each of the legal forms being used by microfinance institutions in India, outlines the regulatory framework for those forms and identifies the pros and cons of each form.
As discussed in Section 1, voluntary developmental non-government organizations (generally known as NGOs) are mostly registered under the Societies Registration Act, 1860. Since these organizations were established as voluntary, not-for-profit development organizations their microfinance activities were also established under the same legal umbrella. This sub-section examines the provisions of the Societies Act from the perspective of the practice of microfinance in India.
The Societies Registration Act 1860 states that “a society can be formed for the promotion of literature, science or the fine arts or the diffusion of useful knowledge/political education or for charitable purposes.” Various state governments have amended these purposes from time to time. However, charitable activities continue to form the core of the stated purpose of the act in each of these cases.
Over the century and a half since the enactment of this law, the Act has been subject to too much legal interpretation which has brought relevant clarity to its practical implementation. Thus, in 1891, a High Court judge, Lord McNaughten defined, the legal sense of the term charity to comprise of trust for
(i) relief of poverty
(ii) advancement of education
(iii) advancement of religion
(iv) purposes beneficial to the community or a section of the community.
Lord Camden, in the same judgement in 1891, defined charitable purposes as “a gift to general public houses which extends to poor as well as rich, equally. It may be laid down as universal rule that the law recognises no purpose as charitable unless it is of a public character, that is to say a purpose must, in order to be charitable, be directed to the benefit of the community or a section of the community.”
Considering the public nature of microfinance activities and the widely accepted notion of its being help for the relief of poverty and for benefit to the community, microfinance activities are interpreted by most of civil society as being charitable for the purpose of this act. Under this law, as a pre-requisite, the registered society would, however, need to mention microfinance clearly as an activity it would be taking up as part of its “charity” work – as one of the objectives in its Memorandum of Association.
Once the name of the proposed society and also the draft memorandum and rules and regulations of the society have been decided, the procedure for the registration of the society can be taken up. All the subscribers (minimum seven) should sign each page of the memorandum and the signatures should be witnessed by an Oath Commissioner, Notary Public (Rs3/- notarial stamp duly affixed), Gazetted Officer, Advocate, Chartered Accountant or Magistrate 1st class with their rubber/official stamp and complete address. The persons desirous of forming a society should also become members of the first governing body. AN outsider cannot become member of the governing body in the first instance.
Following papers should be filed with the Registrar of Societies for registration under the Principal Act or corresponding Acts enacted by various state governments:
- covering letter requesting for registration stating in the body of letter various documents annexed to it. It should be signed by all the subscribers to the memorandum or by a person authorized by all of them to sign on their behalf.
- Memorandum of Association in duplicate alongwith a certified copy. It should be neatly typed and pages serially numbered.
- Rules and regulations/Bye-laws in duplicate duly signed.
- Where there is a reference to any particular existing places of worship like Temple, Gurdwara, Church, Masjid or Budhvihar, etc. sufficient documentary proof establishing legal competence and control of applicant society over such places should be filed.
- Affidavit on non-judicial stamp paper of appropriate value sworn by the President or Secretary of the society stating the relationship between the subscribers. The affidavit should be attested by an oath commissioner, Notary Public or Magistrate 1st class.
- Documentary proof such as House Tax receipt, rent receipt in respect of premises shown as registered office of the society or no-objection certificate from the owner of the premises.
Normally a fee of Rs50/- is payable as registration fee of a society and it should accompany the request for registration payable in cash or by Demand Draft. Formalities for registration and requirement of documents may differ slightly from state to state. The applicant may, therefore, contact in advance the Registrar of Societies having jurisdiction.
On receiving the documents mentioned above the Registrar shall satisfy himself about the compliance of the provisions of the Act and correctness of the documents and then certify in his hand that the society is registered under the Principal Act 1860 or other corresponding Acts. Presumption that the society was duly registered under the Act arises not on the Certificate of Registration granted by the Registrar but on the copies of the Rules and Regulations and Memorandum certified under section 19 which constitutes them prima facie evidence of the matters therein contained.
Acceptance of Foreign Contributions
Acceptance of foreign contribution by MFIs registered under the Societies Registration Act 1860 is regulated by the Foreign Contribution (Regulation) Act 1976 (FCRA). This Act defines foreign contribution as donations or delivery of transfer made by any foreign source
a. of any article, not being an article given to any person as a gift for his personal use, if the market value in India of such article, on the date of such gift, does not exceed one thousand rupees;
- of any currency, whether Indian or foreign;
- of any foreign security.
Besides, ‘foreign contribution’ includes contribution (referred to above) received from one or more organization within India whose original source is foreign.
In order to access foreign contributions, MFIs need to make applications in form FC-8 of FCRA to the Secretary, Ministry of Home Affairs, New Delhi. Once registered with the Ministry of Home Affairs, these organizations have to agree to receive such foreign contribution only through one of the branches of a bank as it may specify in its application for registration. All such registered organizations need to submit, within a period of four months from the closure of financial year, intimation in Form FC 3 (as per the format prescribed in the FCRA), in duplicate, to the Central Government as to the following
- amount of each foreign contribution received by it;
- the source from which the contribution was received; and
- the manner in which it was utilized.
Provided that where such association obtains any foreign contribution through any branch other than the branch of the bank through which it has agreed to receive foreign contribution or fails to give such intimation within the prescribed time or in the prescribed manner, or gives any intimation which is false, the Central Government may, by notification in the Official Gazette, direct that such association shall not, after the date of issue of such notification, accept any foreign contribution without the prior permission of the Government.
All associations receiving foreign contribution are required to maintain separate accounts for such foreign contributions. The accounts must be maintained on a financial year basis from the first day of April each year and every such yearly account must be furnished in duplicate, duly certified by a Chartered Accountant to Secretary, Government of India, Ministry of Home Affairs. All these organizations must also get their accounts audited by a Chartered Accountant. The auditor would must certify and issue the following reports
- Intimation of foreign contribution in form no FC-3
- Balance Sheet as on 31 March of that year
- Statement of receipts and payments account for the year ending 31 March.
The auditor has also to review the records including Form No FC-6 (the articles of accounts) as well as Form No FC-7 (the securities account) as well as certify the receipt and utilization of foreign contributions in kind such as vehicles, medicines, equipment and so on.
Advantages
i simple process of registration;
ii simple record keeping and even simpler regulations;
iii low possibility of interference by the regulator;
iv (largely) exemption from tax due to the overtly charitable nature of operations;
v Appropriate for taking up micro-insurance (as an agency) on behalf of Insurance companies.
Disadvantages
i as a charitable institutional form, in essence inappropriate to the for-profit, financially sustainable strategic goal of microfinance operations;
ii tax-exemption for surpluses can be (and is) challenged on the question of whether provision of microfinance services is a charitable activity;
iii no system of equity investment or ownership, thereby, making it less attractive for commercial investors interested in microfinance;
iv commercial investors generally regard the investments in such entities risky primarily on account of their lack of professionalism and managerial practices and are, therefore, reluctant to commit large volumes of funds to such MFIs;
v In accordance with Section 45S of the RBI Act, 1934, no unincorporated bodies are allowed to accept deposits from the public. Organisations registered under the Societies Registration Act and the Trust Act are considered unincorporated bodies. Therefore, according to the law, they are not even allowed to collect savings from their clients.
vi also vulnerable to the use of ‘usurious interest prevention acts’ of various state governments as the status of microfinance is debatable as a charitable activity. A discussion on the Moneylenders (Prevention of usurious interest rates) Act is annexed with the report in Annex I.
2.Indian Trusts Act, 1882
Some MFIs are registered under the Indian Trust Act, 1882 either as public charitable trusts or as private, determinable trusts with specified beneficiaries/members.
As per Section 6 of the Indian Trust Act 1882, the essential constituents of a trust are
i. three parties – the author, trustees and beneficiary
ii. declaration of a trust
iii. certainty of the subject matter of a trust; and
iv. certainty of objects of the trust.
According to Section 3 of the Act, the person who reposes or declares confidence in another person, in some property for the benefits of the beneficiary, is called the ‘author’ or ‘settlor’ of the trust. The author is the creator of the trust; he gives birth to the trust. Under the Section 7 of the Indian Trust Act 1882, a trust may be created by any person/institution competent to contract. In the context of microfinance institutions, the author of the trust is an individual with the noble intention of providing financial services to the poor. He arranges for funds from various sources and then deploys the funds to the trust for the sake of the beneficiaries.
The same section of the Act defines a trustee as a person who, while holding legal ownership and/or possession of, or dominion over, the subject matter of the trust, is bound to allow the beneficial enjoyment or usufruct of the property to be reaped by another, called the beneficiary. In common parlance however, the word “trustee” is used in a very wide sense so as to include any person who stands in a fiduciary relationship with another, such as the manager, though strictly speaking they are not the trustees. A trustee is liable to indemnify the loss caused to the trust property or sustained by the beneficiary due to breach of trust committed by him, except where the beneficiary has by fraud induced the trustee to commit the breach or where the beneficiary is an adult and of sound mind and has concurred in the breach or has agreed therein with full knowledge of all the facts. In the context of a microfinance institution, the typical trustees consist of the board or the governing body of the institution that takes policy decisions on behalf of the board and, thereby, holds responsibility for the functioning of the trust.
Also there should be a third person for whose benefit the confidence is reposed by the author or accepted by the trustee. The author of the trust may himself be the beneficiary or one of the several beneficiaries under the trust. As per Section 9 of the Indian Trust Act, every person capable of holding property may be a beneficiary under trust. The capacity to hold property is the only requisite qualification.
The following types of registration are associated with a private trust:
a Registration under the Indian Trusts Act (for the trust deed only)
b Registration under the Societies Registration Act (when the trust is constituted as a society), as discussed in the Section 2.1.2.
c Registration under the Income Tax Act (though private trusts are generally not required to register under the Income Tax Act as they are not exempted from Income Tax under Section 11, they may seek exemption for that part of their work which is charitable after obtaining registration under the Income Tax Act). Also the Mutually-aided Benefit Trusts (MBTs), a form of private trusts does not need to be registered under this act.
d Registration under the Foreign Contribution (Regulation) Act, 1976 (for becoming eligible to received foreign grants for carrying out their activities); as discussed under the section 2.1.7.
Advantages and Disadvantages of registration under the Indian Trusts Act
The advantages and disadvantages related to MFIs registered under the Societies Act are equally applicable to trusts. However while the IRDA recognizes NGOs registered as societies as a distribution channel for the micro-insurance, there is no such clarity with regard to trusts. Apart from this, private trusts may be even more unsuitable as the tax exemption extended to societies may apply to such trusts only to the extent the Income Tax Department accepts their activities as being charitable.
Advantages:
· simple process of registration;
· simple record keeping and even simpler regulations;
· low possibility of interference by the regulator;
· (largely) exemption from tax due to the overtly charitable nature of operations;
Disadvantages
Ø as a charitable institutional form, in essence inappropriate to the for profit, financially sustainable strategic goal of microfinance operations;
Ø tax-exemption for surpluses can be (and is) challenged on the question of whether provision of microfinance services is a charitable activity;
Ø no system of equity investment or ownership, thereby, making it less attractive for commercial investors interested in microfinance;
Ø commercial investors generally regard the investments in such entities risky primarily on account of their lack of professionalism and managerial practicesand are, therefore, reluctant to commit large volumes of funds to such MFIs;
Ø In accordance with Section 45S of the RBI Act, 1934, no unincorporated bodies are allowed to accept deposits from the public. Organisations registered under the Societies Registration Act and the Trust Act are considered unincorporated bodies. Therefore, according to the law, they are not even allowed to collect savings from their clients.
Ø also vulnerable to the implication under the money lenders (prevention of usurious interest rates) acts of various state governments as the status of microfinance is debatable as a charitable activity. A discussion on the Moneylenders’ (Prevention of usurious interest rates) Act is annexed with the report in Annex I.
An organization given a license under Section 25 of the Companies Act 1956, is allowed to be registered as a company with limited liability without the addition of the words ‘Limited’ or ‘Private Limited’ to its name. It is also eligible for exemption from some of the provisions of the Companies Act, 1956. For companies that are already registered under the Companies Act, 1956, if the Central Government is satisfied that the objects of that company are restricted to the promotion of commerce, science, art, religion, charity or any other useful purpose; and the constitution of such company provides for the application of funds or other income in promoting these objects and prohibits payment of any dividend to its members, then it may allow such company to register under Section 25 of the Companies Act. Henceforth referred to as Section 25 companies.
As stated earlier both a fresh entity or association as well as an existing company is entitled to be registered as Section 25 company provided they follow certain procedure and fulfill requirements as provided in the guidelines. The procedure for the registration as Section 25 for both the above types of organizations is discussed below.
Registration of New Associations
Such associations need to apply to the Regional Director, Company Law Board of the region with a covering letter along with the following documents
i Draft Memorandum and Articles of Association of the proposed company in three copies. The memorandum and articles should be typewritten and then printed after having been approved by the Regional Director. No stamp duty is payable on the Memorandum and Articles of Association of a company to be registered under these provisions.
ii List of names, addresses, description and occupation of the promoters in three copies.
iii List of companies, associations and other institutions in which promoters of the applicant company are directors or hold responsible positions, with description of positions held.
iv List of members of the proposed Board of Directors.
v Declaration in the prescribed format signed by
Ø An advocate of Supreme Court or of the High Court, or
Ø An attorney or pleader entitled to appear before the High Court, or
Ø A Chartered Accountant with a whole time practice in India, or
Ø A Company Secretary with a whole time practice in India,
on a non-judicial stamp paper of appropriate value.
vi Copies of accounts, balance sheet and reports on the working of the association for the last two financial years (for one year only if the association has functioned for less than two years), in triplicate.
vii Statements of assets and liabilities.
viii Sources of income of the proposed company and estimate of annual income and expenditure.
ix A note on the work already being done by the association and work proposed to be done after being registered under Section 25.
x Grounds in brief for making application under Section 25.
xi Declaration (in the prescribed format) signed by each of the applicants.
