Author: Treelife

In the start-up ecosystem, equity distribution is a crucial aspect of wealth creation and value generation. With such importance on the valuation aspect, stakeholders are continuously looking for varied structures to define equity distribution of the company. As such, founders must strike a balance between controlling costs and distributing equity. Although equity distribution has no fixed principles, industry practices offer some broad structures that founders can follow. This post answers frequently asked questions about equity dilution, which is one of the most critical aspects of a start-up.

What is dilution of equity?

Equity dilution means the reduction of a shareholder’s percentage of ownership in the company as new shareholders are added. Consider a company as a piece of land where two shareholders or founders share the land. Then you bring on board an advisor and an ESOP pool is also created.,the founders will have to share the same land with them, reducing the founders’ percentage of ownership. When new investors come in, they will have to share the same land too. The same principle applies to a company, as new shareholders come in, the founders’ share in the company gets reduced. The reduction of your space/ percentage of shareholding as a shareholder is termed as dilution of equity.

What is primary sale vs. secondary sale?

This question often comes across that founders are skeptical about giving away their shares when anyone wants a piece of the company. To address this issue, it’s important to understand two primary concepts  – primary and secondary sale.

Primary Sale – Primary sale happens when an investor invests money in a company and seeks new shares to be allotted from the company. In primary investment, everyone gets diluted in proportion to their shareholding unless special conditions are mentioned.

Secondary Sale – Secondary sale, on the other hand, occurs when the investor is looking to buy already existing shares of the founder or any other existing shareholders by paying money directly to them. There is no dilution or change in the share of other parties, except the buyer and seller.

How does it work?

Every company has 100% shares, and the number of shares can be increased based on the ratio to post-investment.

For example, if two founders (founder A and B) hold 5,250 shares each with a 50% controlling interest in the company, and an investor comes in with an investment of $1 million considering the pre-money valuation of $3 million, the number of shares will increase based on the ratio to post-investment. In this case, 25% (1Mn/4Mn). The post-investment round will dilute the holding of the founders, reducing their controlling interest from the original hold.

How much to dilute?

The amount of dilution depends on the stage of the business and other factors. Too much dilution can be a concern for future incoming investors, while too little is concerning to investors as they should have skin in the game. The ultimate goal is to grow the business, so even if the dilution numbers are skewed from the expected dilution, the growth of the business is the primary concern.

Pre-money vs. post-money Valuation

Pre-money valuation is the value of the company before it receives the investment amount, while Post-money valuation is the value of the company after it receives the investment amount. Investors offer equity based on pre-money valuation, but the percentage sought is based on the post-money valuation.

Post Money Valuation = Pre Money Valuation + Investment Amount

In conclusion, understanding equity dilution and the cap table is a pertinent metric of fundraising and talking to investors. We often see founders neglect it due to a lack of clarity of these concepts. A grasp on these concepts enables the founder to have better control of the shareholding.

Corporate finance is a crucial component of any business’s success, as it encompasses the management of a company’s capital structure and funding activities to enhance its value. Corporate finance is closely linked to business decisions that have a financial and monetary impact, serving as a bridge between the capital market and the corporation. In addition to capital investments, corporate finance is involved with cash flow management, accounting, financial statement preparation, and taxation. The ultimate goal of corporate finance is to optimise a company’s value through resource planning and implementation while balancing risk and profitability.

In this article, we will explore the various types of corporate finance and the three pillars that serve as the foundation for this field.

Types of corporate finance

Corporate finance involves numerous techniques to raise capital for a company, which are classified into short-term and long-term financing options.

Short-term corporate finance provides services to a firm for a limited time, usually lasting a few months to a year. This type of financing includes financial lease, trade credit, and accrual accounts.

Long-term corporate finance refers to financial support that is stretched out over a year or more, with minimal interest rates that can be repaid through monthly interest payments. Examples of long-term corporate finance include debentures, bank loans, and flotation.

Three pillars of corporate finance

To understand the fundamentals of corporate finance, it is necessary to understand the three pillars that serve as its foundation.

1. Investments and Capital Budgeting:

This pillar involves planning where to position a company’s long-term capital assets to earn the maximum risk-adjusted returns. This includes determining whether or not to pursue an investment opportunity through rigorous financial analysis. Capital budgeting helps financial decision-makers make educated decisions for projects that involve significant capital expenditures and are expected to last a year or more. Projects of this type may include :

• Investing in new equipment, technology and buildings
• Upgrading and maintaining current technology and equipment
• completing existing building renovation projects
• Increasing their workforce
• Creating new goods
• Developing new markets

2. Capital Financing:

This pillar involves deciding how to finance the capital investments using the company’s stock, debt, or a combination of the two. The value of the ideal blend for the capital structure is kept in mind while making consistent selections. After determining the best financing mix, the principles assist in putting it in place for the long or short term.

3. Dividend and Return of Capital:

This pillar involves determining whether to keep a company’s surplus earnings for future investments and operational needs or to distribute them to shareholders in the form of dividends or share buybacks. The decision must be made with the highest value of the company in mind. Private and public businesses handle dividend choices differently.

FAQ

1. Why is corporate finance important for business?  Corporate finance is important as it helps businesses optimize financial resources, make informed decisions, and maximize shareholder value.

2. How does financial planning and analysis impact corporate finance?  Financial planning and analysis help companies assess their financial health, make informed decisions, and achieve their financial objectives.

3. What is the role of risk management in corporate finance?  Risk management identifies and mitigates potential financial risks, protecting a company’s assets and ensuring stability.

4. How does corporate finance help maximize shareholder value?  Corporate finance strategies optimize financial decisions and resource allocation to generate higher returns for shareholders.

CONCLUSION

Corporate financing is critical in any organization, as it helps to maximise wealth distribution and return production. The three pillars mentioned above form the core of corporate finance. By understanding these pillars and the various types of corporate finance, businesses can make informed decisions to optimize their value through resource planning and implementation while balancing risk and profitability.

In 2021, the global revenue-based financing market size was valued at $901.41 million. This market is expected to grow at a compound annual growth rate of 61.8% from 2020 to 2027. By 2027, it is estimated to touch $42,349.44 million in value.

Revenue-based finance, which is also referred to as royalty-based financing, is an alternative fundraising model to the equity-based venture capital investment or angel investing model.

Instead of offering equity, founders offer investors a percentage of the company’s gross revenues or an opportunity to earn royalties on sales in exchange for funds.

In this blog, we explore the pros and cons of revenue-based finances and how it compares to debt-based and equity-based models.

Revenue-Based Financing: The Basics 

• To qualify for revenue-based financing, companies need to be generating a certain amount of revenue. Hence, this model is not accessible to pre-revenue early-stage startups.
• Companies do not need to give away any equity from their company. Investors offer funds in exchange for a pre-determined percentage (usually between 4 to 10%) of the revenues earned by the company.
• Typically, there is no set maturity since a company’s revenues can vary from quarter to quarter. However, there may be a flexible time frame, which can range from four months to five years.
• The monthly payout to investors is dependent upon the revenue generated. Hence, if revenues dip, the company is not stuck with an unaffordable monthly payment.
• In revenue-based financing, there is always the potential to raise more funds once the initial contract reaches maturity.

Revenue-Based vs. Debt-Financing vs. Equity-Based Funding 

Startups require funding at various stages and may need to access it via diverse models based on their applicability.

Sometimes, startup founders may need to opt for a hybrid model, which can have various components. For instance, a founder may go for a mix of debt and revenue-based funding. Hence, it is important to understand the basics of two other popular funding models work:

1. Debt-Financing

In this model, an investor will extend a credit line to the company. The interest and payment tenure will be pre-fixed, akin to a business loan. It comes with certain advantages over a traditional business loan, such as quicker access and a principal amount of higher ticket size.

However, founders will need to offer some form of personal guarantee. For instance, they may use personal assets, such as a house, as collateral. They will need to pay a fixed amount every month. Defaults on payment can come with financial penalties.

2. Equity-Based Funding  

In this model, founders offer an equity stake in the company in exchange for a large chunk of funding. This is a popular model, especially for those startups that require an investment of a higher ticket size and have not started generating any revenue as yet.

Venture capitalists tend to bet on the startup idea and hence, demand some ownership and higher returns in exchange for the risk they are undertaking.

The Growing Relevance of Revenue-Based Financing 

The startup world is seeing a spurt in the adoption of revenue-based financing. There are several reasons for this trend.

One of the key advantages of revenue-based funding is that the risk is lower for founders as compared to equity-based funding, where the stakes are much higher, and investors expect returns to the tune of 10X to 20X. Hence, revenue-based financing is relatively cheaper.

Another key advantage is that the ownership of the business, autonomy, and decision-making stay with the founders. On the other hand, once venture capital investors come into the equation, founders must be ready for higher scrutiny on the running of the business.

In the case of revenue-based financing, investors are satisfied as long as they receive their share of the revenues. They do not occupy board seats or bring in fresh financial demands.

In Conclusion

The revenue-based finance model is applicable to companies that have demonstrated steady growth but require capital for further expansion.

The founders may not wish to part with equity or take a loan. But generating considerable revenue puts them in a position to access this option. Having said that, making the right funding choice is a critical decision for startups, one that must be taken after weighing the pros and cons of all options.

Fundraising contracts play a significant role in the ownership, sustainability, and profitability of the business.  Hence, it is advisable for startups to partner with a legal and financial firm like Treelife, which comes with the expertise to help them make informed decisions. 

In the previous article we had learnt about what the e-commerce ecosystem is and how it functions in India, the Government of India initiatives taken to promote the same and the Foreign Direct Investment (“FDI”) norms for investment in the e-commerce ecosystem in India.

In this article we shall be learning about the laws and regulations applicable, compliances required for an e-commerce startup and the related impact on the economy.

Laws and regulations applicable

i. Information Technology Act, 2000 (“IT Act”) –

The e-commerce is similar to the traditional marketplaces with the only difference of non-availability of flesh and blood to sell things. Through e-commerce also, the sellers have to generate bills, pay taxes, file returns, prepare ledgers, and maintain records which are done online. The IT Act is the primary legislation that governs and regulates the services provided by e-commerce platforms in India. The IT Act governs online conduct and related aspects of e-commerce and recognizes electronically concluded contracts and digital signatures which are essential for facilitating paper less trading. The Act aims at regulating the use of the Internet by providing punishments for publication of obscene information or hacking or destroying or altering the data from devices.

• Indian Contracts Act, 1872 –

Governs the conditions for validity of contracts formed through electronic means; communication and acceptance of proposals; additionally, revocation, and contract formation between consumers, sellers, and intermediaries. Further, the terms of service, privacy policy, and return policies of any online platform must be legally binding agreements. The seller and buyer on an e-commerce platform enter into an electronic contract while the seller provides the good or services to the buyer. For this purpose, it is important to read the Indian Contract Act with the Information Technology Act, 2000.

• Transaction security is one of the most important aspects of e-commerce. It is absolutely essential for any e-commerce business to ensure reliability and security of transactions being conducted over the internet. The most reliable means is through cryptography.  The most popular and useful method of encryption is public-key cryptography; that is, encryption and decryption techniques involve the use of two kinds of keys, public keys and private keys both of which are mathematically linked. One key is used for encryption and the other corresponding key is used for decryption. The IT Act regulates encryption in India.
• Digital Signatures – These are electronically attached signatures that can be annexed to e-contracts by the parties and shall be treated equivalent to physical signatures. Section 3 of the IT Act establishes that a signature could be sent using public-key cryptography. In order to link the identity of the sender with the signature, it is necessary to attach a digital certificate which is issued by a certifying authority that confirms the identity of the sender.

ii. Payment and Settlements Systems Act, 2007

A ‘payment system’ indicates a system that enables payment to be effected between a buyer and a seller. An e-commerce business has to qualify as a payment system and comply with the relevant rules of RBI relating to online payments. Further, it is mandatory for every intermediary that is receiving payments through electronic modes to have a Nodal Account in operation for settling the payments of the merchants on its online e-commerce platform.

iii. Sale of Goods Act, 1930

The Sale of Goods Act, 1930 covers what the sales and shipping policy of the e-commerce business must contain. Additionally, such as the warranties, conditions, and the refund and return conditions.

iv. Consumer Protection Act, 2019 read along with Consumer Protection (E-Commerce) Rules, 2020

In order to protect the interest of the consumers, the central government has enacted the Consumer Protection Act, 2019. Section 94 of the Consumer Protection Act, 2019 provides that for the purposes of preventing unfair trade practices in e-commerce, direct selling and also to protect the interest and rights of consumers, the Central Government may take such measures as required. For the same purpose the Consumer Protection (E-Commerce) Rules, 2020 have been enacted to provide the details of the compliances required by every e-commerce business.

Compliance requirements for E-commerce business in India

i. Indian Contracts Act, 1872 read with Information Technology Act, 2000 – Terms of Service, Privacy Policy and return policies of any e-commerce platform are to be laid out such that they are legally binding agreements.

ii. Information Technology Act, 2000 and rules thereunder – Compliances under Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data Or Information) Rules, 2011 for the policy of privacy and the disclosure of information. Under section 79 of the IT Act certain safe-harbors are available to e-commerce entities functioning as ‘Intermediaries’. Regulations are also applicable to ‘Intermediaries’ relating to the content displayed on the platform, especially pertaining to defamation and obscenity. The Information Technology (Intermediary Guidelines) Rules 2011 lays down stringent liability for e-commerce businesses in India. A digital due diligence is advisable before commencing any e-commerce business. If the end consumers happen to be a European Union resident, General Data Protection Regulations (GDPR) compliance becomes mandatory.

iii. Intellectual Property Issues – the e-commerce business must secure all trademarks in accordance with the Trademarks Act and copyrights intended to be used by it, one must also be mindful to not infringe the trademarks and copyrights of other businesses as well. In the age of such wide use of the internet, e-commerce entities should be aware of various intellectual property infringements that may happen online such as cybersquatting, identity theft, copyright infringement, caching, derivative works, domain name protection, etc.

iv. As per the Reserve Bank of India (“RBI”) notification DPSS.CO.PD.No.1102 /02.14.08/ 2009-10 dated 24 November 2009, it is mandatory for an intermediary which is receiving payments through electronic modes to have a Nodal Account in operation for settling the payments of the merchants on its online e-commerce platform. Further depending on the arrangements for payments for the transactions on the platform, the entity must comply with the relevant rules relating to online payments made by the RBI.

v. Legal Metrology Act, 2009 read with Legal Metrology (Packaged Commodity) Rules, 2011 – The e-commerce platform must display requisite information about the goods displayed on sale, such as, units, dimensions, weight, etc. on the display page of the products itself.

vi. Fixation of prices by arrangements between sellers listed on the platform, exclusive sales agreements, and other practices under the scope of Sections 3 and 4 of the Competition Act, 2002 can be brought under the scrutiny of the Competition Commission of India. The e-commerce business must be mindful of these factors while entering into any arrangements.

vii. Goods and Service Tax Registration – it is mandatory for all e-commerce platforms and sellers/distributors/suppliers who sell through e-commerce to get GST registration in all States where they purport to sell their goods/services.

Impact of E-commerce success in India

The E-commerce industry has been directly impacting micro, small & medium enterprises (MSME) in India by providing means of financing, technology and training and has had a favorable cascading effect on other industries as well. The Indian e-commerce ecosystem has been on an upward growth trajectory and is expected to surpass the US to become the second largest e-commerce market in the world by 2034. Technology-enabled innovations like digital payments, hyper-local logistics, analytics driven customer engagement, and digital advertisements will likely support the growth in the sector. The growth in e-commerce will also boost employment, increase revenues from export, increase tax collection, and provide better products and services to customers in the long-term. With a turnover of $50 billion in 2020, India became the eighth-largest market for e-commerce, trailing France and a position ahead of Canada.

The Indian online grocery market is estimated to reach US$ 26.93 billion in 2027 from US$ 3.95 billion in FY21, expanding at a CAGR of 33%. India’s consumer digital economy is expected to become a US$ 1 trillion market by 2030, growing from US$ 537.5 billion in 2020, driven by the strong adoption of online services such as e-commerce and edtech in the country.

According to Grant Thornton, e-commerce in India is expected to be worth US$ 188 billion by 2025.

References: Media Reports, Press releases, IBEF Blog

What is a digital rupee?

The Reserve Bank of India has launched the pilot of its Central Bank Digital Currency (CBDC), which is being categorized as legal tender in a digital form, by the central bank. Popularly recognized as the digital rupee, it is exchangeable at par with existing currencies and will be considered acceptable for payments and a safe store of value. The Reserve Bank announced the launch of the first pilot for retail digital Rupee (symbolized as “e₹-R”) on December 01, 2022.

The pilot is set to cover locations which have been notified by the RBI and are mentioned hereinbelow. The pilot will be available for a closed user group (CUG) comprising participating customers and merchants. The e₹-R shall be in the form of a digital token that represents legal tender. The denominations of this digital token are being touted to be the same as that of the paper currency. Banks shall be responsible for the distribution of the digital currency. Users will be able to transact with e₹-R through a digital wallet offered by the participating banks and stored on mobile phones / devices. The users will be able to transact on a Person to Person (P2P) basis as well as Person to Merchant (P2M) basis too. The Merchants will be having QR codes at the Merchant locations to enable them to accept the e₹-R. The e₹-R would offer features of physical cash like trust, safety and settlement finality. However, as is the case with cash, the digital currency will not earn any interest and may not be subject to conversion to other forms of money, like deposits with banks.

Why is digital currency important for India?

It is safe to state that the most important reason behind launching the digital currency by the RBI is to provide the country with a catalyst to remain in the virtual currency race. The potential that India and its huge populace carries is no secret and with a digital currency the transactions may just end up simplified and multiplied, which shall further and eventually result in the creation of more capital, thus giving a massive push to our economy. Being called the first digital currency of the nation and aimed at creating an additional option to use money and it isn’t very different from the currently-issued banknotes; only that the digital rupee is expected to be transacted digitally and thus facilitate ease of use.

How will you benefit from this?

There are various expected benefits of the digital currency which has been rolled out. Few of the benefits can be listed as:

· With the introduction of blockchain technology in the mainstream, the digital rupee is set to increase efficiency and transparency.

· The use of digital rupee is also set to enable real-time transaction tracking which will further simplify the process of ledger maintenance.

· The payment system is expected to be active 24X7 and for all days over the year. The same shall be available for wholesale and retail customers alike.

· It shall enable the Indian buyers and customers to make online payment of digital currency without the requirement of a middleman.

· It is expected to reduce the intermediaries, and resultantly, the average transaction cost.

· Users will not be required to mandatorily open a bank account to transact in digital money, hence increasing the scope of online payments.

· The benefits of simplified and quick cross border transactions is a major benefit of digital currencies. As the e₹-R is being backed by the RBI, there will not be any threats of volatility

Conclusion

The e₹-R is the RBI’s accepted version of cryptocurrencies, which the central bank has dismissed repeatedly and called a serious challenge to the stability of the financial system of the country. It is aimed at creating an additional option to use money which is not very different from the currently issued banknotes, except for the ease of use. It’s only fair to form more opinions and follow the growth of our very own digital currency once the pilot project rolled by the RBI comes to its conclusion.

Introduction

Dividends are typically paid for a fiscal year when the final accounting are completed and the amount of distributable earnings is known. Dividends for a firm’s fiscal year (referred to as a “final dividend”) are due only if declared by the company at its annual general meeting on the suggestion of the Board of Directors. Dividends are sometimes paid by the Board of Directors between two annual general meetings without being declared at an annual general meeting (this is known as an ‘interim dividend’).

Section 2(35) of the Companies Act of 2013 defines the term “dividend.” Any interim dividend is included in the definition of “Dividend.” It is a broad definition, not a complete one. According to the commonly recognised definition, a “dividend” is a company’s profit that is not retained in the firm and is dispersed to shareholders in proportion to the amount paid-up on the shares owned by them.

Dividend Payout Ratio

The dividend payout ratio is the ratio of the total amount of dividends paid out to shareholders to the company’s net income. It is the percentage of earnings distributed to shareholders in the form of dividends. The sum not given to shareholders is kept by the firm and used to pay down debt or reinvest in core activities. It is sometimes referred to simply as the payout ratio.The dividend payout ratio can be calculated as the yearly dividend per share divided by the earnings per share (EPS), or equivalently, the dividends divided by net income.

The dividend payout ratio is a crucial financial indicator used to assess the long-term viability of a company’s dividend distribution programme. It is the amount of dividends given to shareholders in relation to a company’s total net income.

Key Dividend Dates

1. Date of declaration

This is the day on which the company’s board of directors declares its intention to pay a cash dividend. A corporation may make a payment one quarter but not the next. Even though a corporation has a history of paying dividends, there is no guarantee that they will be paid until the day of declaration. When a firm declares dividends, it incurs a debt on its books. The declaration specifies the amount of the dividend to be paid as well as the record and payment dates.

2. Date of Record (& ex-dividend rate)

The corporation determines which shareholders are entitled to the dividend based on the date of record. Unless the shares are held in street names, a corporation keeps a record of all its shareholders. The term “street-name” refers to the fact that you hold your shares through a brokerage account. In some circumstances, the corporation pays the broker, who then sends the cash dividend into your account. The ex-dividend date is two days before the record date. Investors who possess the stock prior to the ex-dividend date are entitled to the dividend, however investors who purchase the shares on or after the ex-dividend date are not. As a result, the stock’s value falls on the ex-dividend date since it trades without the right to the dividend, and the business’s value falls because the dividend no longer belongs to the firm.

3. Date of payment

It is the day on which you will get your cash dividend. If you own your shares through a brokerage account (also known as a street-name account), the firm pays the broker, who puts the cash dividend into your account.

Conclusion

Some businesses provide dividend-paying stocks, which pay out a percentage of profits in cash to owners on a quarterly basis. If you decide to purchase a dividend-paying stock, keep the aforementioned three dates in mind to guarantee that you receive the cash you are entitled to.

1. Global Market Access: Flipping core business operations outside India provides a wider audience to the startup. This enables the startup to reach out to a global audience as compared to just India. This access is enabled because of the reasons below which act as a catalyst for such access and expansion.
2. Ease of Operations to manage foreign currency transactions: Multi-currency payment gateway management is easier in jurisdictions like Singapore and the USA. This facilitates faster reconciliation, easier payment mechanisms enable the business to grow faster and swifter.
3. Access to global incubator/s, investors, etc: Flipping opens up new funding opportunities for startups. Exposure and access to global incubators, VCs, and accelerators who may be restricted from funding companies abroad. The new company enables startups to pitch and seek funding from such specialized funding players.
4. Flexibility of financing options and structuring: Countries like Singapore/USA have easier and more flexible regulatory frameworks for the functioning of businesses. For eg in terms of granting of ESOPs, faster IP registration mechanisms, and robust judicial procedures. This offers ease of business and malleability in business operations that startups require. Additionally, options like revenue-based financing and line of credit schemes for startups are easily available. This empowers the entrepreneurs to avail of better financing options than diluting equity all the time.
5. Lower tax rates in certain countries: Multiple countries have lower tax rates which turn out to be lucrative for startups. A lower corporate tax rate helps startups to manage cash flows and plan better for resources.

25th August 2022  

Ministry of Corporate Affairs (MCA) vide a notification dated 5^th August 2022 has amended Rule 3 of Companies (Accounts) Rules, 2014, relevant for companies maintaining their accounts and other books and papers in electronic mode. The summary of the amendment is provided as under:

1.    Accounts and other books and papers shall remain accessible in India at all times: Prior to this change, Companies were required to ensure that the accounts and other books and papers are accessible in India so that they can be made available to stakeholders as and when required, however, post this amendment, it shall be maintained at all times. Accordingly, the loss of accessibility even for a brief amount of time will be categorized as a non-compliance and no company can decline access to authorities on the pretext that data is accessible otherwise but not accessible at a particular point in time.

2.    Back-up of Accounts on servers located in India on daily basis: The accounts and other books and papers of the Company maintained electronically, whether in India or outside India shall be backed up on servers physically located in India on daily basis. Earlier, such backup had to be taken on a “periodic basis”, with the provisions being silent on the length of the period.

3.    Details to be provided in case if service provider is located outside India: Sub-rule 6 to Rule 3 has been added stating that in case the service provider of Record keeping through Electronic Mode is located outside India, the company shall intimate the name and address of the person who is in control of such accounts and other Books and Papers in India to the Registrar on an annual basis at the time of filing of financial statement.   

Goods or Services? Understanding the Classification of Computer Software under GST

Introduction:

The classification of computer software as either a good or a service has been a contentious issue for businesses since the service tax regime. However, the Goods and Services Tax (GST) Act has provided some much-needed clarity on the matter.

Classification of Computer Software:

According to the GST Act, computer software is categorized as either “normal software” or “specific software”. Normalized software refers to pre-designed software that is available off-the-shelf in retail outlets. It can be supplied in any medium or storage (such as a CD-ROM or through the use of encryption keys) and is treated as a supply of goods. On the other hand, specific software is customized to the specific requirements of the customer and includes development, design, programming, customization, adaptation, upgradation, enhancement, and implementation of information technology software or permitting the use or enjoyment of any intellectual property right. Hence, it shall be treated as a supply of services.

Conclusion

In conclusion, it can be said that the classification of computer software as either a good or a service depends on whether it is an off-the-shelf product or a customized product. It is important for businesses to understand this classification to determine the appropriate tax treatment for their software-related transactions under the GST Act.

Budget 2022 is here and its focus is on steering the economy over the Amrit Kaal for India for the next 25 years –India at 75 to India at 100. The Hon’ble Finance minister has also introduced various new policies for startups and incentives for investing in them, with the aim to provide a boost to the entrepreneurial spirit in the country. Some key highlights for the startup ecosystem:

1) Capping surcharge on Long term capital gain on unlisted equity to 15% bringing the effective tax rate from ~28% to ~23%.

2) Taxation framework for ‘virtual digital assets’ including Crypto and NFT

3) Introducing section 194R which may bring TDS implications for phantom stock, advisory equity and similar arrangements

4) Extension of 3 year tax holiday u/s 80 IAC for eligible startups and commencement date deferral u/s 115 BAB for lower tax rates

Our awesome team at Treelife has done a focussed analysis on provisions applicable to the stakeholders i.e. Startups, Investors and Founders – check the link below

Introduction

The digital payments ecosystem in India has seen an excellent growth in the past few years. The term “Digital Payments” comprises of different types of systems of online payment which cover transactions done through Real Time Gross Settlement (RTGS), National Electronic Fund Transfer (NEFT), Immediate Payment Service (IMPS), Digital Wallets and Unified Payments Interface (UPI). Of these, Digital Wallets and UPI have amplified their operations in the wake of demonetization in the November of 2016.

Payment systems are not only the lifeline of an economy but are increasingly being recognized as a means of achieving financial inclusion and ensuring that economic benefits reach the bottom of the pyramid.

Regulating the payment and settlement systems in the country enables businesses, companies, and consumers to manage their financial transactions and payments efficiently. Implementing fintech laws and regulations ensures safety and security to financial institutions, providing services and the customers using them.

The term “FinTech” is short for “financial technology” and could apply to any kind of technology that is used to drive a financial transaction or service, offered by any entity. However, in business and regulatory jargon, FinTech has come to mean the technology used by financial service providers that disrupt the traditional way of providing such services. Thus, businesses such as PayTM, PhonePe, RazorPay, MobiKwik, PayU are all classified as fintech businesses.

Key Fintech Offerings

Some of the key services that are offered by FinTech companies broadly fall within the ambit of either Digital Payments or digital lending.

PPI – Prepaid Payment Instruments (“PPIs”) are instruments that facilitate the purchase of goods and services including financial services, remittances etc. against a stored value on such instruments. PPIs may be issued under one of the three categories –

1. Closed system PPIs – They are issued by an entity to a holder to facilitate the purchase of goods and services from the issuer itself. An ideal example of this type of a system would be a brand-specific gift card.
2. Semi – closed system PPIs – These are used for purchase of goods and services, including financial services, remittance facilities, etc., at a group of clearly identified merchant locations or establishments which have a specific contract with the issuer to accept the PPIs as payment instruments. These instruments do not permit cash withdrawal, irrespective of whether they are issued by banks or non-banks.
3. Open system PPIs – These PPIs are issued only by banks and are used at any merchant for purchase of goods and services, including financial services, remittance facilities, etc.

Each of these categories permits a different scope of transactions.

UPI Payments – UPI is a payment platform managed and operated by the National Payments Corporation of India (“NPCI”). The UPI enables real time, instant, mobile based bank to bank payments. It primarily relies on mobile technology and telecom infrastructure to offer easily accessible, low cost facilities to the users. UPI enabled payments constitute majority of the digital payment transactions in India.

Digital Lending – With expanding propels in innovation, technology, and telecommunications foundations, several Non-Banking Financial Institutions (NBFCs) in India have moved to advanced stages of digital platforms for credit items, especially to retail and Small and Medium Enterprises (SME) clients. They have developed intuitive applications and websites to empower end-to-end digital customer journeys. 

Payment Intermediaries/Aggregators and Payment Gateways – Payment intermediaries or aggregators are entities which simplify online sale and purchase transactions primarily on e-business platforms. They facilitate collecting electronic payments from customers and pool them and transfer them to the merchants. Payment Gateways provide technology infrastructure to route or facilitate processing of online payment transactions, without handling any funds.

P2P lending platforms – Peer-to-peer (P2P) lending platforms are online platforms that offer loan facilitation services between lenders registered on the platform and prospective borrowers. Under RBI regulations, P2P lending platforms may be operated by eligible Indian companies registered with the Reserve Bank of India (“RBI”) as NBFC.

Payment Banks – Payment banks are bodies authorized by the RBI to offer fundamental online banking services to their clients. These are allowed to accept small deposits (up to INR 100,000). However, they are not permitted to issue credit cards, give loans or offer any credit products

Laws and Regulations

The RBI is the primary regulator for most Fintech activities in banking, payments and lending. The jurisdiction of other regulators may also get attracted, depending on the nature of the services being offered, including of the Securities and Exchange Board of India (“SEBI”) when dealing in the securities market, the Insurance Regulatory and Development Authority of India (“IRDAI”) for the insurance sector, as well as the Ministry of Electronics and Information Technology (“MEITY”) and the Ministry of Corporate Affairs (“MCA”), as may be applicable.

Regulations governing Digital Payments

PPIs

Regulation

Master Direction on Issuance and Operation of Prepaid Payment Instruments (“Master Direction”) which was issued by the RBI by virtue of Section 18 read with Section 10(2) of the Payment and Settlement Systems Act, 2007 (“PSS Act”). PPIs can be issued as cards, wallets, and any such form / instrument which can be used to access the PPI and to use the amount therein. PPIs in the form of paper vouchers cannot be issued.

Eligibility

1. All entities (both banks and non-banks), regulated by any of the financial sector regulators and seeking approval / authorisation from the RBI under the PSS Act, shall apply to Department of Payment and Settlement Systems (DPSS), RBI, Central Office, Mumbai along with a ‘No Objection Certificate’ from their respective regulator, within 45 days of obtaining such clearance.
2. Non-bank entities applying for authorisation shall be a company incorporated in India and registered under the Companies Act 1956 / Companies Act 2013.
3. The Memorandum of Association (MOA) of the applicant non-bank entity shall cover the proposed activity of operating as a PPI issuer.
4. Banks which comply with the eligibility criteria, including those stipulated by the respective regulatory department of RBI, shall be permitted to issue semi-closed and open system PPIs, after obtaining approval from RBI.
5. Non-bank entities which comply with the eligibility criteria, including those stipulated by the respective regulatory department of RBI, shall be permitted to issue only semi-closed system PPIs, after obtaining authorization from RBI.

Capital and other eligibility requirements

1. All non-bank entities seeking authorisation from RBI under the PSS Act shall have a minimum positive net-worth of Rs. 5 crore as per the latest audited balance sheet at the time of submitting the application. Thereafter, by the end of the third financial year from the date of receiving final authorisation, the entity shall achieve a minimum positive net-worth of Rs. 15 crore which shall be maintained at all times.
2. Newly incorporated non-bank entities which may not have an audited statement of financial accounts shall submit a certificate from their Chartered Accountants regarding the current net-worth along with provisional balance sheet.

Authorisation Process

1. A non-bank entity desirous of setting up payment systems for issuance of PPIs shall apply for authorisation in Form A (available on RBI website) as prescribed under Regulation 3(2) of the Payment and Settlement Systems Regulations, 2008 along with the requisite application fees. The directors of the applicant entity shall submit a declaration in the enclosed format. RBI shall also check ‘fit and proper’ status of the applicant and management by obtaining inputs from other regulators, government departments, etc., as deemed fit. Applications of those entities not meeting the eligibility criteria, or those which are incomplete / not in the prescribed form with all details, shall be returned without refund of the application fees.
2. In addition to the compliance with the applicable guidelines, RBI shall also apply checks, inter-alia, on certain essential aspects like customer service and efficiency, technical and other related requirements, safety and security aspects, etc. before granting in-principle approval to the applicants.
3. Subject to meeting the eligibility criteria and other conditions, the RBI shall issue an ‘in-principle’ approval, which shall be valid for a period of six months. The entity shall submit a satisfactory System Audit Report (SAR) to RBI within these six months, failing which the in-principle approval shall lapse automatically. SAR shall be accompanied by a certificate from the Chartered Accountant regarding compliance with the requirement of minimum positive net-worth of Rs. 5 crore. An entity can seek one-time extension for a maximum period of six months for submission of SAR by making a request in writing, to DPSS, Central Office, RBI, Mumbai, in advance with valid reasons. The RBI reserves the right to decline such a request for extension.
4. Pursuant to receipt of satisfactory SAR and net-worth certificate, the RBI shall grant final Certificate of Authorisation. Entities granted final authorisation shall commence business within six months from the grant of Certificate of Authorisation failing which the authorisation shall lapse automatically.
5. The Certificate of Authorisation shall be valid for five years unless otherwise specified and shall be subject to review including cancellation of Certificate of Authorisation.
6. Any takeover or acquisition of control or change in management of a non-bank entity shall be communicated by way of a letter to the Chief General Manager, DPSS, RBI, Central Office, Mumbai within 15 days with complete details, including ‘Declaration and Undertaking’ by each of the new directors, if any. RBI shall examine the ‘fit and proper’ status of the management and, if required, may place suitable restrictions on such changes.

KYC Requirements

The issuers can issue two types of semi-closed PPIs based on the level of their Know Your Customer (“KYC”) compliance, that is to say, on the level of identification-related information provided by the user. The first type can be issued with minimum or limited KYC. The minimum KYC details include the customer’s mobile number verified through One-Time-Pin (OTP), and a self-declaration of name and a government identification number to authenticate the account.

The amount of funds loaded in this type of an instrument, during any month, cannot exceed ten thousand rupees and the total amount loaded during the whole of financial year cannot exceed one lakh rupees. Only the purchase of goods and services is allowed and bank transfer and interoperability of the instrument is not permissible for PPIs with a limited KYC compliance.

These minimum-detail instruments are mandatorily required to be converted within 18 months into full-KYC compliant, semi-closed PPIs. On the other hand, the full KYC-compliant PPIs, apart from allowing for purchase of goods and services, offer the option of ‘fund transfer back to the source’, bank account transfers as well as transfer to beneficiaries of up to one lakh rupees per month.

Prevention of Money Laundering

The entity operating a digital payment system is required to adhere to the RBI Master Direction on Know Your Customer (KYC), 2016 for customer identification. These Master Directions have provided for a sound framework for the prevention of money-laundering and since the non-bank issuers are essentially in the business of operating a payment system, compliance with Prevention of Money Laundering Act, 2002 and the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 framed thereunder, is necessary.

Additionally, PPI issuers are required to maintain the log of all transactions for a period of ten years. This data shall be made available for scrutiny to RBI or any other agency / agencies as may be advised by RBI. PPI issuers are also required to file Suspicious Transaction Reports (STRs) to the Financial Intelligence Unit (FIU-IND).

Security of Payments

A strong risk management system is necessary for the PPI issuers to meet the challenges of fraud and ensure customer protection. PPI issuers shall put in place adequate information and data security infrastructure and systems for prevention and detection of frauds.

All PPI issuers shall put in place information security policy for the safety and security of the payment systems operated by them, and implement security measures in accordance with this policy to mitigate identified risks. PPI issuers shall review the security measures (a) on on-going basis but at least once a year, (b) after any security incident or breach, and (c) before / after a major change to their infrastructure or procedures.

Some of the mandatory requirements to be followed by the private entities to prevent fraudulent transactions are:

1. If the PPI issuer provides the same login for its wallet and its other services, that information regarding the same has to be clearly conveyed to the holder.
2. Restrictions on multiple invalid attempts to log in have to be placed.
3. Every payment transaction has to be authenticated through customer consent and alerts should be sent out for every transaction.
4. Overall, a suitable mechanism has to be put in place for preventing, detecting and restricting occurrence of fraudulent transactions.
5. Increasing norms around customer protection and fraud prevention is going to have the effect of increasing customer confidence in the digital payments, thereby increasing its adoption and increasing business.
6. As per the norms, a ‘cooling period’ for fund transfer is also a requisite whenever a new PPI account is opened, freshly loaded or a new beneficiary is added. In that time, alerts are sent to the customers to review the new additions and prevent erroneous transactions.

Interoperability

The ability of customers to use a set of payment instruments seamlessly with other users within the segment are based on adoption of common standards by all providers of these services so as to make them inter-operable. Accordingly, it has been decided to implement it in phases:

1. In the first phase, PPI Issuers (both bank and non-bank entities) shall make all KYC-compliant PPIs issued in the form of wallets interoperable amongst themselves through Unified Payments Interface (UPI) within 6 months from the date of issue of the Master Direction. With Prepaid Payment Instruments (PPIs) – Guidelines for Interoperability released by the RBI in 2018, an attempt has been made to make the digital wallets operable with each other.
2. In subsequent phases, interoperability shall be enabled between wallets and bank accounts through UPI.
3. PPI Issuers shall ensure adherence to the technical and operational requirements for such interoperability, including those relating to safety and security, risk mitigation, etc.

UPI

UPI was developed by the NPCI and was launched in 2016. It facilitates inter-bank transactions in real-time which are processed either on web or a mobile platform. It also caters to the “Peer to Peer” collect request which can be scheduled and paid as per requirement and convenience.

How is it unique?

• Immediate money transfers through mobile device round the clock 24*7 and 365 days.
• Single mobile application for accessing different bank accounts.
• Single Click 2 Factor Authentication – Aligned with the Regulatory guidelines, yet provides for a very strong feature of seamless single click payment.
• Virtual address of the customer for Pull & Push provides for incremental security with the customer not required to enter the details such as Card no, Account number; IFSC etc.
• Merchant Payment with Single Application or In-App Payments.
• Utility Bill Payments, Over the Counter Payments, Barcode (Scan and Pay) based payments.
• Raising Complaint from Mobile App directly.

NPCI Guidelines

For the functioning of UPI there is a Unified Payment Interface Guidelines by the NPCI. These guidelines are framed under the provisions of the Payment and Settlement of System Act, 2007. These guidelines are binding in nature and hence every member of UPI has to abide by them.

Membership Requirements

The Payment Service Provider/member should be a regulated entity by RBI under Banking Regulations Act 1949 and should be authorized by RBI for providing mobile banking service.

The member should comply with the Procedural Guidelines, certification requirements and efficiency and risk guidelines issued by NPCI from time to time.

Lastly, the bank should be live on Immediate Payment Service (IMPS).

Once the bank-enabled UPI agrees the entity can build their PSP (Payment Service Provider) which is well known as a third-party application. The partnered banks are entirely liable for all the financial and operation liability of these applications.

Other Requirements

The data of clients should be maintained by the banks, and the merchant app shouldn’t have access to it. The payment concerning the responsive data, credentials should by no means reach these merchant apps and only exist in the UPI system of the bank. It imposes accountability on the bank for the proper functioning of the apps and to make sure that the application assists supports all versions of Android and iOS.

These NPCI guidelines also offer freedom to the client for downloading any application as they want. Clients can have two applications in a single device, and no application should obstruct the working of the other while installing, operating or any function done by the application.

The present members can be suspended or terminated anytime from undertaking the functions by NPCI if the member fails to obey any UPI or NPCI product, procedural NPCI guidelines for UPI or any provisions by RBI or NPCI. It can further be terminated if the member’s RTGS account with the RBI is suspended. Moreover, in the case where the member bank is amalgamated or combined with another member bank, the membership is terminated or suspended. At last, if the RBI suspends the consent of the mobile application, then the also merchant stops being a member.

Obligation of PSP

Considering the sensitivity of these transactions, NPCI obligates the Third Party Application Provider (TPAP) as well as the PSPs certain requirements to be fulfilled to enable such transactions. Before initiating operations, the TPAP is mandated to seek a written permission from the NPCI and is required to give the names of the participating banks. The responsibility of the participating banks is immense as they are primarily responsible for providing security against any kind of breach of customer data that could happen through the third party apps. As the responsibility for storing payment sensitive data of the customers is with the PSP, they must perform an audit on the TPAP’s infrastructure to ensure that the integrity of such data is maintained and that the functioning of the app is secure. Along with the TPAP, the PSPs are also responsible for addressing the complaints of the consumers.

PSP should conduct due diligence on the potential technology service provider before selecting and entering into any form of outsourcing relationships. A bank should conduct an in-depth assessment of the third party’s ability to perform the said activities in compliance with all applicable laws and regulations and in a safe and sound manner. The PSP should consider the following during due diligence: a) Legal and Regulatory Compliance b) Financial Condition c) Business Experience and Reputation d) Qualifications, Backgrounds, and Reputations of Company Principals e) Risk Management f) Information Security g) Incident-Reporting and Management Programs h) Business Continuity Program.

Obligations of TPAP

The obligation on the third parties is to store only that customer data to which the customers have given their consent. A record of details like customer’s name, mobile number, gender, email id etc. can only be in an encrypted format and all the information exchange between the third party and the bank is to be done through a secure channel. As a caveat, it has also been provided that the third party shall not share the details of individual transactions with any other third party, including their holding company or subsidiary and the Indian Government or Intelligence without the prior consent of the PSP and NPCI.

Payment Gateways and Payment Aggregators

The RBI vide its Circular dated March 17, 2020, has issued the ‘Guidelines on Regulation of Payment Aggregators and Payment Gateways’ (the “Guidelines“) through which, the RBI has decided to (a) regulate in entirety, the activities of payment aggregators; and (b) provide baseline technology-related recommendations to payment gateways.

PAs are entities that facilitate e-commerce sites and merchants to accept various payment instruments from the customers for completion of their payment obligations without the need for merchants to create a separate payment integration system of their own. PAs facilitate merchants to connect with acquirers. In the process, they receive payments from customers, pool and transfer them on to the merchants after a time period.

PGs are entities that provide technology infrastructure to route and facilitate processing of an online payment transaction without any involvement in handling of funds.

Applicability

The Guidelines have been issued to regulate in entirety the activities of payment aggregators. In this regard, the RBI has also mandated payment aggregators to adopt the technology-related recommendations provided in the Guidelines. While the RBI has clarified that the domestic leg of import and export related payments facilitated by payment aggregators shall also be governed by these Guidelines, these Guidelines will not regulate Cash on Delivery (COD) payments.

The RBI, as a measure of good practice, has stated that PGs may adhere to the baseline technology-related recommendations provided in the Guidelines.

Authorization

The Guidelines provide that any entity seeking to make an application for authorization must be a company incorporated in India under the Companies Act 1956/ 2013 and shall ensure that the business activity of operating as a PA is covered under the scope of its memorandum of association.

Banks, however, provide PA services as part of their normal banking relationship and do not therefore require a separate authorisation from RBI. Non-bank PAs shall require authorisation from RBI under the PSS Act.

E-commerce marketplaces providing PA services shall not continue this activity beyond the deadline prescribed i.e. June 30, 2021. If they desire to pursue this activity, it shall be separated from the marketplace business and they shall apply for authorisation.

PGs shall be considered as ‘technology providers’ or ‘outsourcing partners’ of banks or nonbanks, as the case may be. In case of a bank PG, the guidelines issued by Reserve Bank of India, Department of Regulation (DoR) vide Managing Risks and Code of Conduct in Outsourcing of Financial Services by banks and other follow up circular(s) shall also be applicable.

Networth Requirements

PAs existing as on March 17, 2020 are required to achieve a net-worth of INR 15 crore by March 31, 2021, and a net-worth of INR 25 crore on or before March 31, 2023, which must be maintained at all times thereafter.

New PAs need to have a minimum net-worth of INR 15 crore at the time of application for authorisation and a net-worth of INR 25 crore by the end of third financial year of grant of authorization, which must be maintained at all times thereafter.

Non-bank PAs are required to annually submit a certificate to the RBI evidencing compliance with the applicable net-worth requirement.

Lastly, the Guidelines require that the net-worth consist only of paid-up equity capital, preference shares that are compulsorily convertible to equity (“CCPS“), free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of assets but not reserves created by revaluation of assets adjusted for accumulated loss balance, book value of intangible assets and deferred revenue expenditure, if any. In this regard, the CCPS can be either non-cumulative or cumulative and the shareholder agreements should specifically prohibit any withdrawal of this preference capital at any time.

PAs shall submit a certificate in the specified format from their Chartered Accountants to evidence compliance with the applicable net-worth requirement while submitting the application for authorisation. Newly incorporated non-bank entities which may not have an audited statement of financial accounts shall submit a certificate in the enclosed format from their Chartered Accountants regarding the current net-worth along with provisional balance sheet.

Governance

The Guidelines provide a comprehensive governance framework for PA, key elements of which have been summarised below:

1. PA should be professionally managed. To this extent, promoters of the PAs entity shall need to satisfy the fit and proper criteria prescribed by the RBI. RBI shall also check the ‘fit and proper’ status of the applicant entity and management by obtaining inputs from other regulators, government departments, etc., as deemed fit.
2. Any takeover or acquisition of control or change in management of a non-bank PA shall need to be promptly communicated to the RBI, in order to ensure compliance with the fit and proper criteria of the management.
3. PAs will now have to enter into direct agreements with all merchants, acquiring banks and other stakeholders, which will need to delineate the roles and responsibilities of the involved parties in sorting/ handling complaints, refund/ failed transactions, return policy, customer grievance redressal (including turnaround period), dispute resolution mechanism and reconciliation etc.
4. PAs will need to have a Board approved policy for disposal of complaints/ dispute resolution mechanism/ timelines for processing refunds etc. as per the RBI instructions on Turn Around Time for resolution of failed transactions.
5. PAs are required to appoint a nodal officer responsible for regulatory and customer grievance handling functions.
6. Non-bank PAs shall maintain the amount collected by them in an escrow account with any scheduled commercial bank. An additional escrow account may be maintained with a different scheduled commercial bank at the discretion of the PA. For the purpose of maintenance of escrow account, operations of PAs shall be deemed to be ‘designated payment systems’ under Section 23A of the PSS Act.
7. Amounts deducted from the customer’s account shall be remitted to the escrow account maintaining bank on Tp+0 / Tp+1 basis. The same rules shall apply to the non-bank entities where wallets are used as a payment instrument.
8. Final settlement with the merchant by the PA shall be effected as under:

• Where PA is responsible for delivery of goods / services the payment to the merchant shall be not later than on Ts + 1 basis.
• Where merchant is responsible for delivery, the payment to the merchant shall be not later than on Td + 1 basis.
• Where the agreement with the merchant provides for keeping the amount by the PA till expiry of refund period, the payment to the merchant shall be not later than on Tr + 1 basis.

9. All credits for reversed and refund transactions shall be routed back through the same escrow account, unless the merchant is responsible for managing refunds under the merchant agreement and the customer is aware of this arrangement. The Guidelines list out the permissible credits into and debits from the escrow account. No interest shall be payable by the bank on balances maintained in the escrow account, except under certain circumstances outlined in the Guidelines. Importantly, the escrow account cannot be operated for ‘cash-on-delivery’ transactions, and settlement of funds with merchants must not be co-mingled with other business, if any, handled by the payment aggregator.
10. All Pas shall submit certificate signed by the auditor, to the regional office of the RBI, where the registered office of the PA is situated, certifying that they have been maintaining the balance in the escrow account in compliance with the Guidelines.

Applicability of KYC/ AML/ CFT provisions

The KYC, anti-money laundering (AML)/ combating financing of terrorism (CFT) guidelines issued by RBI shall apply to all entities, along with Prevention of Money Laundering Act, 2002 and Rules framed thereunder.

Security, fraud prevention and risk management framework

All PAs are required to put in place adequate information and data security infrastructure and systems for prevention and detection of frauds, which must be aligned with its Board approved information security policy for safety and security of the payment systems operated by them. To this extent, PAs are required to comply with data storage requirements as applicable to payment system operators, which also includes obligations pertaining to data sovereignty.

PAs have additionally been directed not to store any customer card credentials within their database or server, which can be accessed by the merchant.

PGs

PGs have been considered as ‘technology providers’ or ‘outsourcing partners’ of banks and non-banks, as the case may be and have been advised to adopt the baseline technology-related recommendation provided in the Guidelines. To this extent, PGs may desire to adhere to the prescribed minimum standards in order to remain at power with similar IT and security standards adopted by non-bank PAs and other stakeholders in the digital payment ecosystem.

Bank PGs are further subject to RBI Guidelines on ‘Managing Risks and Code of Conduct in Outsourcing of Financial Services by banks.

Recent years have witnessed a massive drift in the financial sector. Indian customers are embracing digital means of transactions and moving away from traditional banking methods. The integration of technology and banking services has changed the banking landscape, making transactions quicker, cheaper and more customer-oriented. One of the latest buzz words in the fintech sector is ‘Neo Banks’

What is Neo-banking?

Neo banks are like digital banks, with an entirely online presence. These are fintech firms that leverage technology and artificial intelligence (AI) to provide personalised services to their customers. They provide complete digital banking experience through mobile applications.

How do they operate?

Neo-banks can be classified under 3 different categories depending on their style of operations –

1. The first type features those non-licensed fintech companies that have partnered with a traditional bank. Usually, these banks have outdated infrastructure and legacy systems. Neo-banks put a layer of its digital services and products over these legacy systems to make banking services flexible, accessible and scalable.
2. The second type is when a traditional bank launches its digital-only initiative in the form of neo-banks.
3. The third type is the neo-bank that has its own digital banking licenses. However, these type of neo-banks exist only in those countries that permit stand-alone digital entities. (Currently, RBI does not provide banking license to any entity which does not have a physical presence)

How are Neo-banks regulated?

The Indian regulatory regime does not allow for the grant of virtual banking licenses. RBI (through its 2015 circular) has mandated the requirement for digital banking service providers to have some physical presence. As a result, neo-banks can provide banking related services only by partnering with licensed banking institutions and non-banking financial companies. RBI has also issued circulars in 2006 and 2010 which deal with outsourcing of financial services by banks and use of business correspondents by banks, which are relevant for neo-banks

In addition to these, since neo-banks are in possession of users’ personal data, they need to comply with India’s Information Technology Act & Rules.

Regulations:

1. Neo banks must be constantly monitored and evaluated by their partner banks.
2. The Reserve Bank of India reserves the right to monitor and track neo bank features and processes.
3. The Reserve Bank of India has complete access to a neo bank’s records of transactions and accounts.
4. The KYC regulations as followed by traditional banks when opening an account must be followed by neo banks.
5. Neo banks should be able to address grievances on time just as their traditional partner banks are obligated to do.
6. Payment/ Settlement: Like their partner banks, Neo banks must adhere to the provisions of Payment and Settlement Systems Act of 2007.

Why Neo-Banking?

While the earlier generations might be satisfied with the traditional banking system, the tech-savvy new generations are an impatient lot and want things done at the click of a button. Some of the key benefits associated with neo-banks are:

1.  Hassle free account opening: Since neo banks do not have a physical presence, opening up an account can be managed online / over an app within a few minutes by performing a couple of simple steps.
2. International transactions: Traditional banks do not always issue a card with which we can transact internationally. We might have to request for this facility / request for an upgrade. However, with neo banks you can execute international transactions or transact while you’re abroad, seamlessly.
3. User friendly interface: Neo banking is all about being a customer friendly facility which is easy to understand & operate and easily accessible. While in traditional banking you might spend time reaching out to customer support executives, in neo-banking you can simply contact the neo-bank representative through digital mediums. The issues are resolved much faster and require fewer efforts from the user.
4. Cost effective: Since there’s no physical infrastructure involved, the transaction costs are a fraction of those charged by the traditional banks, thereby offering cheaper banking solutions
5. Holistic view of your finances: Neo banks provide you with expense reports, investment data,  to give you insights into your spending patterns and help track and budget your spending.
6. Value added services: Neo-banks do not restrict themselves to just enabling faster banking transactions. By leveraging technology, the neo banks have started offering commission-free mutual funds, expense management tools, instant loans, and other financial planning mechanisms with a customer-centric focus. Chatbots and AI are making it possible to analyse customer patterns, credit history, and other data to create realistic data models for recommending financial services based on customers’ lifestyle choices.

These neo banks are creating specialised offerings that concentrate on the under-served demands of blue-collar employees and MSMEs, which is the path forward and a much needed impetus in the current situation.

How safe is Neo-banking?

Security is the number one concerning factor when it comes to digital transactions. Neo bank application implements 2FA (2-factor authorization), Biometric verification, RBAC (Role-Based Access Control), encryption technology along with other security measures to protect customer data. The applications are built to ensure compliance with anti-money laundering laws, complete privacy of customers and to prevent malware attacks.

Which are the Neo-banks in India?

InstantPay, Niyo, Open, Fi Money and RazorpayX are some of the major players in this segment.

There are more than 12 neo banks in India currently, and few more are in the process of entering the market.

Growth Prospects:

• The global neo banking market size was valued at USD 66.82 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 54.8% from 2023 to 2030.
• In India, Transaction value is expected to show an annual growth rate (CAGR 2023-2027) of 17.77% resulting in a projected total amount of USD131.80bn by 2027
• The average transaction value per user in the Neobanking segment amounts to USD 4.97k in 2023.

• Introduction

CARO 2020 is a new format for the issue of audit reports (attachment to the primary report) in case of statutory audits of eligible companies under the Companies Act, 2013. CARO 2020 has included additional reporting requirements after consultations with the National Financial Reporting Authority (an independent regulatory body for regulating the audit and accounting profession in India) as compared to CARO 2016.

The primary aim of CARO is to enhance the overall quality of reporting and disclosure of overall material matters of the Company by the company auditors.

• Effective date

CARO, 2020 is applicable for the Financial years commencing on or after 1st April 2020.

(earlier it was applicable from 1st April 2019)

• Applicability

There are no changes proposed in the applicability section of CARO, 2020. It applies to all companies (including exceptions) as per the previous CARO, 2016. We have listed down below the category of such companies to have a ready reference.

CARO, 2020 applies to all companies including foreign companies, except:

• Banking company;
• Insurance company;
• Company licensed to operate under Section 8 of Co. Act, 2013;
• Small Company;
• Private Limited Company, not being a subsidiary or holding of public company, having:
  • Paid up capital and Reserves & surplus not more than 1 Crore as on balance sheet date;
  • Borrowing not exceeding 1 Crore from bank/financial institution at any point of time during financial year;
  • Revenue not exceeding 10 Crore during financial year as per the financial statements
• Comparative Clauses

There are in total 21 clauses in CARO 2020 as compared to the existing CARO 2016 that has 16 clauses.

• Key Changes/ Highlights between CARO, 2020 and CARO, 2016

Let’s analyze the proposed changes clause-wise between CARO 2020 and CARO 2016.

An income statement helps business owners decide whether they can generate profit by increasing revenues, by decreasing costs, or both. It also shows the effectiveness of the strategies that the business set at the beginning of a financial period. The business owners can refer to this document to see if the strategies have paid off and they can come with the best solutions to yield more profit.

What is an Income Statement

An income statement is a financial statement that shows you the company’s income and expenditures. It also shows whether a company is making profit or loss for a given period. The income statement, along with balance sheet and cash flow statement, helps you understand the financial health of your business.

The income statement is also known as a profit and loss statement, statement of operation, statement of financial result or income, or earnings statement.

Components of an Income Statement

While all financial data helps paint a picture of a company’s financial health, an income statement is one of the most important documents a company’s leadership team and individual investors can review, because it includes a detailed breakdown of income and expenses over the course of a reporting period. This includes:

• Revenue: The amount of money a business takes in during a reporting period
• Expenses: The amount of money a business spends during a reporting period
• Income before taxes: All revenue less expenses but before taxes
• Net income: Income before taxes less taxes
• Earnings per share (EPS): Division of net income by the total number of outstanding shares

Above categories may be further divided into individual line items, depending on a company’s policy and the granularity of its income statement.

Analysis of an Income Statement

There are two methods commonly used to read and analyze an organization’s financial documents: vertical analysis and horizontal analysis. The difference between the two is in the way a statement is read and the comparisons you can make from each type of analysis.

Upright Analysis It refers to the method of financial analysis where each line item is listed even as a percentage of a base figure. In short, it’s the process of reading down a single column of data in a financial statement, determining how individual line items relate to each other (e.g., showing the relative size of different expenses, as line items may be listed as a percentage of operating expenses). This type of analysis makes it simple to compare financial statements across periods and industries, and between companies, because you can see relative proportions. It also helps you analyze whether performance metrics are improving.

Parallel Analysis It reviews and compares changes in the amounts in a company’s financial statements over multiple reporting periods. It’s frequently used in absolute comparisons, but can be used as percentages, too. Horizontal analysis makes financial data and reporting consistent along with growth comparison to it’s competitors.

Conclusion

In conjunction with the cash flow statement, balance sheet, and annual report, income statements help company leaders, analysts, and investors understand the full picture of a business’s operational results so they can determine its value and efficiency and, ideally, predict its future trajectory. Financial analysis of an income statement can reveal that the costs of goods sold are falling, or that sales have been improving, while return on equity is rising. Income statements are also carefully reviewed when a business wants to cut spending or determine strategies for growth.

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