Transactions are routed through a Sebi-approved intermediary to whom the lender will lend the securities and the borrower will borrow. The lender is paid market-determined charges and such cost is borne by the borrower, apart from other costs, including the intermediary's fees. The crucial point is that though the lender transfers share certificates, efforts are made to ensure that for all practical purposes he continues to enjoy and bear the rewards and risks of ownership of the shares. To that effect, it is ensured that after the stipulated period he gets only securities back, and all bonuses, rights, dividends, etc. also accrue to him. Further, since he will only get securities back, the risks of fluctuations in market priceswill also be on him.

Problems, however, arise since, at least in form, the lender is transferring the securities and the borrower is acquiring them. Though it is easy to create a legal fiction that all corporate benefits on the securities will remain with the lender, issues still remain. Further, while the procedure for implementation of the scheme is laid down, other issues arise under company law, taxation, law of contracts, and so on. Some such issues are considered here. The scheme involves the lender transferring the securities to the intermediary. The borrower then acquires securities from the intermediary. There is no direct link between the borrower and the lender.

What would happen if the intermediary or the borrower fails. Is the lender entitled to get back his original securities, wherever they are lying and thus suffer no loss, or is he only entitled to claim the value of the securities and thus expose himself to lower or no realisation? The answer seems to lie in the law relating to bailment(See Section 148 and subsequent sections of the Indian Contract Act) under which, in case of bailment, the bailor can rightfully claim the property back, wherever it is lying. It is true that the intention of the contract is that the lender should only get the same quality and quantity of securities back. Clause 4(12) of the scheme specifically says that the borrower will not be entitled to discharge his liability in cash and has to give securities only.

However, to be a bailment, the condition should be that when the purpose of bailment is fulfiled, the original property should be returned and one cannot substitute the property. In case of stock-lending, the lender would not get the same securities back, though he would get the same quality and quantity. In the normal course, he may not even know what the intermediary has done with the securities and who the borrower is and what he has done with the securities. In fact, the securities may pass through many more hands. The current holder may not even knowthat the securities were originally lent. It has been held that when a person deposits cash in a bank, he can recover it only as money lent (Ichha Dhanji v. Natha (1888) 13 Bom. 338). This principle can also be applied here.

The lender and the intermediary cannot claim the securities lent back in case of failure and can recover only what the estate of the defaulter distributes. This risk needs to be carefully considered by the lender and the intermediary. Several issues arise under income-tax. Will the lending deemed to be a transfer attracting capital gains? The CBDT has specifically clarified that such stock-lending will not amount to transfer. However, other interesting issues arise. What if the intermediary or borrower defaults and the lender can only recover the market price of the securities? Will capital gains arise if the lender immediately buys the same securities from the market? What will be the tax treatment of the lending charges in the hands of the borrower and the lender? Will the holdingperiod be affected in the hands of the lender so as to shorten his holding period, and thus putting him at a disadvantage as regards short-term capital gains, indexation, and so on.?

Issues will arise under accounting also. How will the lender treat and disclose the transaction in the books of accounts? Should the transaction be not recorded at all since he has merely "lent" the securities?

In that event, will it be necessary to disclose the securities lent by way of a note to accounts? Alternatively, should the lender treat it as a transfer and show the intermediary as a debtor? What will be the accounting treatment by the borrower? If he does not record the transaction, will it not amount to concealed borrowings and leverage? Will such borrowings be counted for purposes of Section 58A of the Companies Act, 1956 or the Reserve Bank of India regulations on acceptances of deposits by non-banking finance companies? Section 49 of the Companies Act, 1956, requires that a company should hold its investments inits own name.

If the lender company says that it has not transferred the securities and continues to hold it, will it not be a violation of that section?

It would be fruitless to attempt to answer all these questions for the reason that in most cases, these are rhetoric questions, and appropriate amendments and clarifications would be needed to resolve these issues.

Nevertheless, these issues need close examination by parties involved.

(The author is a Mumbai-based chartered accountant)