Mint Explainer: Loss-making firms' political donations in focus post SC ruling

The Supreme Court has not outrightly banned political contributions by loss-making companies. Instead, it has deemed specific amendments as unconstitutional. (Photo: ANI)
The Supreme Court has not outrightly banned political contributions by loss-making companies. Instead, it has deemed specific amendments as unconstitutional. (Photo: ANI)

Summary

  • Flagging the amendments made to the Companies Act, 2013, as unconstitutional, the SC ruled that it was necessary to make a distinction between loss-making and profit-making companies making political contributions.

New Delhi: The Supreme Court of India's recent verdict on electoral bonds has cast a spotlight on the practice of loss-making companies making political contributions. The court deemed certain amendments to the Companies Act, 2013, and the Finance Act, which facilitated these contributions, as unconstitutional, and flagged concerns regarding the potential misuse of "shell companies" in making political contributions. 

The ruling also highlighted the impact of these amendments on the fairness of elections and how it infringed on the right to privacy of voters, while impeding the right of shareholders of a company to oversee its finances.

Mint delves into the nuances of the Supreme Court's ruling, its impact on the political contributions of loss-making companies, and the broader ramifications on corporate-political party dynamics.

What is a loss-making company?

While there is no clear legal definition, the determination of a loss-making company can be inferred from Schedule III of the Companies Act, 2013. Typically, a company reporting a loss in its profit and loss statement for any reporting period falls under the category of a "loss-making company." This indicates that its operating expenses exceed its revenue.

According to Srisatya Mohanty, principal associate at law firm Aquilaw, "An easier way to identify a loss-making company is to check if the earnings before interest, taxes, depreciation and amortization (Ebitda) is negative for the given financial year."

SC order on loss-making companies

Contrary to speculation, the Supreme Court has not outrightly banned political contributions by loss-making companies. Instead, it has deemed specific amendments to Section 182 of the Companies Act, 2013, which removed the distinction between a profit- and loss-making company, as unconstitutional. The ruling said about the distinction between between loss- and profit-making companies for the purpose of political contributions, "The underlying principle of this distinction is that it is more plausible that loss-making companies will contribute to political parties with a quid pro quo, and not for the purpose of income tax benefits."

Earlier, companies could only donate a certain percentage of their profits to political parties before the amendments, but that was done away with by way of the amendments. Hence, the top court noted, "...the amendment to Section 182 is manifestly arbitrary for not making a distinction between profit-making and loss-making companies for the purposes of political contributions (sic)".

Arjun Rajgopal, partner at Saraf & Partners, explained the implication: "The Supreme Court, through its ruling, has reversed the prior position that permitted all companies, irrespective of their profitability, to contribute to political parties via electoral bonds."

Shareholders' rights

While recognizing the petitioner's arguments concerning potential violation of a shareholder's rights due to non-disclosure of political contributions, the court refrained from explicitly ruling on shareholder rights. But it emphasized the importance of transparency in corporate donations to political parties. The ruling declared that shareholders have a right to oversee a company's finances, including political contributions as it ensures transparency and maintaines trust in corporate governance.

Rajgopal underscores this: "The judgment makes it clear that a shareholder’s right to have oversight of a company’s finances cannot be impeded."

According to Ameet Datta, partner at law firm Saikrishna & Associates, the judgment highlights the necessity for transparency in corporate donations to political parties, ensuring that shareholders are informed of where and how corporate funds are being utilized. "This transparency is crucial for shareholder trust and corporate governance, reinforcing the principle that shareholders deserve a clear understanding of their company's political engagements," he said.

The Alternative: Electoral trusts

The Supreme Court also proposed electoral trusts as an alternative to electoral bonds. Introduced by the United Progressive Alliance II government in 2013, Electoral Trusts allow companies registered under Section 25 of the Companies Act, 1956, to establish trusts for political donations. Individuals and corporate entities can then donate to these trusts under Section 17CA of the Income-Tax Act, 1961.

Prior to the introduction of electoral bonds, electoral trusts were the primary means of political funding. Both schemes aim to facilitate donations to political parties, with electoral bonds emphasizing donor anonymity, while electoral trusts offer greater transparency by mandating disclosure of funding details of political parties to the Election Commission of India.

According to experts, these trusts, comparable to the U.S. political action committees (PACs), offer a structured and transparent mechanism for political funding. Companies can voluntarily contribute to these trusts, which then distribute the funds to political parties.

“The electoral trusts can receive donations from Indian citizens, companies, firms, Hindu Undivided Families (HUF), or associations of persons living in India. Crucially, electoral trusts are required to donate at least 95% of their received contributions within a financial year to the political parties registered under the Representation of the People Act, 1951," explained Nilesh Tribhuvann, managing partner at White & Brief - Advocates & Solicitor. 

He added, "The scheme mandates the disclosure of contributors' PAN numbers (for residents), or passport numbers (for NRIs) at the time of making contributions."

According to the Association for Democratic Reforms (ADR) report for fiscal year 2022-23, five Electoral Trusts disclosed receiving contributions totalling 366.5 crore from both corporations and individuals, with Prudent Electoral Trust emerging as the leading beneficiary that received 363 crore from the 30 corporates/businesses in FY 2022-23.

Among political parties, the BJP received a total of 259.08 crore (70.69%) from electoral trusts, with the maximum amount coming from Prudent ( 256.25 crore), followed by Samaj Electoral Trust Association which donated 1.50 crore, and Paribartan Electoral Trust which donated 50 lakhs ruling party. Four parties (BRS, YSR-Congress, AAP and INC) collectively received a total of 107.40 crore, or 29.31%, of the total contributions received by parties from electoral trusts for FY 2022-23.

The future of corporations and political parties

Experts foresee a significant reshaping of the relationship between companies and political parties post the Supreme Court's ruling. The decision is likely to caution corporations on political funding, emphasizing transparency and accountability. Suhail Nathani, managing partner at Economic Laws Practice, reflects on the potential consequences: “As a consequence of this judgment of Hon'ble SC, inferences will undoubtedly be drawn between contributions made by a company to the party in government & government policy. Whether true or not, such inferences can't be avoided."

Rajgopal of Saraf & Partners, said that the judgment has moved the regime of corporate political contributions back to a process which is transparent and effectively capped. "It isn’t presently clear that political contributions will move back to being made in cash," he adds, with a caveat.

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