UNDERWRITING SERVICES PROVIDED BY MERCHANT BANKERS

[Dr. Sanjiv Agarwal]

Meaning of Underwriting 

As per Section 65(116) The Finance Act, 1994, ’underwriter’ means-

 “underwriter” has the meaning assigned to it in clause (f) of rule 2 of the Securities and Exchange Board of India (Underwriters) Rules, 1993.

According to SEBI Rules/Regulations on underwriters, underwriter means a person who engages in the business of underwriting of an issue of securities of a body corporate.

No person can act as underwriter unless he holds a certificate granted by the SEBI under the Securities and Exchange Board of India (Underwriters) Regulations, 1993.

As per Section 65(117) The Finance Act, 1994 ‘underwriting’ means —

“underwriting” has the meaning assigned to it in clause (g) of rule 2 of the Securities and Exchange Board of India (Underwriters) Rules, 1993.

The dictionary meaning of underwriting is —

‘to agree to sell bonds etc., to the public, or to furnish the necessary money for such securities and to buy those which cannot be sold. It is similar to insurance business and involves risk evaluation. Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them.

‘’Underwriting’’ means contract, with or without conditions, to subscribe for stock, shares, bonds or debentures of an industrial concern with a view to the resale of the whole or any part thereof.

P Ramanatha Aiyar’s The Law Lexicon, 3^rd Edition 2005 provides the following meanings-

The word’ underwriting’ in the context of company law, means that a person agrees to take up shares specified in the underwriting agreement  if the public or other persons fail to subscribe for them. CIT v. U.P. State Industrial Development Corpn. , (1997) 4 SCC 701, para : AIR 1997 SC 2214

An underwriting agreement is a contract that the underwriter will either himself purchase or procure purchasers for the shares underwritten by him. Nain Gopal Lahiri v. State of uttar Pradesh, (1965) 35 Com. Cases 30 (SC).

As per Section 65(105)(z), ‘taxable service’  is defined as  under —

 “taxable service  means any service provided or to be provided to any  person, by an underwriter in relation to underwriting in any manner.”

It involves services provided by such agencies to the client for underwriting the amounts on behalf of clients. Service provided by underwriters in relation to underwriting is liable to service tax.

 The underwriters are engaged by the company to avoid risk of devolvement of public issues made by the company. There can be uncertainty regarding full subscription of the issue of securities to the public. Many times, the company does not get full subscription. If the company does not receive 90% of the offered amount of issue of securities, the company is required to refund the money received form the investors / public. To avoid such a situation, the company engages the services of underwriters. The underwriters agree to subscribe the securities in case of under–subscription. They charge the commission to the body corporate. In case of under-subscription, the underwriters subscribe the securities and the company does not have to refund the application money to the investors / public.

SEBI Regulations

Regulation 14 of the SEBI (Underwriters) Regulations, 1993 provides for, inter alia, the amount of commission or brokerage payable to the underwriter. Service Tax is required to be paid by the underwriter at the rate of 10.20% from 10.09.2004 on such commission or brokerage paid to him for the services of underwriting rendered by him. The underwriting commission varies, depending upon the category of underwriter, whether a financial institution or otherwise and also on the amounts devolving on the public and those devolving on the underwriters. However, the maximum underwriting commission applicable is notified by the Banking Department of the Ministry of Finance, though lower rates of underwriting commission can also be negotiated between the underwriter and the service receiver. The minimum and maximum commission varies from 0.5% to 2.5%.

Scope of Service

The service should be provided in relation to underwriting and in any manner.

The words ‘in relation to’ have been held to be equivalent to or synonymous with ‘concerning with’ or ‘pertaining to’ and as words of comprehensiveness which might both have a direct significance as well as indirect significance depending on the context Doypack Systems (P.) Ltd. v. Union of India 1988 -TMI - 35449 – (SUPREME COURT OF INDIA). It can be said that any service which has a direct or indirect connection with a specified service has to be treated as ‘in relation to’ that specified service.

Similarly, ‘in any manner’ would cover the subscription undertaken and procured.

Underwriting Services by Managers

The Department has clarified (in FAQs issued by CBEC) , that if companies which are Lead Managers to issue of shares to the general public also undertake the activity of underwriting of the issues, such Lead Managers would be covered under the category of ‘underwriters’ for levy of service tax. The text of question and its answer is reproduced below:

 “ There are many companies who are lead Managers to issue of shares to the general public. In many cases, these lead managers also undertake the activity of underwriting of the issues. Would such companies also be covered in the category of underwriters ?

 Ans. An underwriter means a person who is engaged in the business of under writing of issue of securities of a body corporate. In case a lead manager, also undertake the activity of underwriting of the issues then such lead managers would be covered under the category of under writers, for levy of Service Tax.”

In view of the above scope, it can be said that if merchant bankers provide underwriting services, such services would be taxed under underwriting services only and not under banking services.

 

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