Charitable trusts must not exert corporate control

Three years ago, Ratan Tata, head of the Tata Trusts, ousted Cyrus Mistry as the head of Tata Sons, the holding company of the Tata group. Cyrus Mistry took the matter to the courts. He lost the first legal round but has just won the second legal round in the National Company Law Appellate Tribunal. The Supreme Court will have the final word.

Economic analysts are debating this issue in terms of majority versus minority shareholder rights. The Tata Trusts have the vast majority of shares in Tata Sons, but Mistry’s Pallonji family is also a significant minority shareholder.

This debate misses the elephant in the room. The real question, surely, is why the Tata Trusts, set up for charitable purposes and given tax-exempt status, should be allowed to control one of India’s greatest industrial empires? The Tata Trusts have earned a reputation for excellent social and charitable work. But surely a charitable trust must not be able to misuse its tax-exempt status to control corporations. That makes the trusts look more like tax fiddles than charitable exemplars.

In recognition of this, charitable trusts were prohibited from owning shares in companies several decades ago. However, an exemption was given to a few big trusts including the Tata and Birla trusts. Today the continuance of those exemptions makes no sense.

Anybody setting up a tax-exempt charitable trust today, be it NR Narayana Murthy of Infosys fame or myself, is forbidden to invest the trust’s money in shares. But that privilege continues for the Tatas and Birlas. Whatever the original grounds for exemption to avoid market disruption were, they cannot hold decades later. All tax-exempt trusts should be obliged to sell all share in companies they control, leaving them free to focus on socially useful work alone.

Charitable trusts can argue that there is indeed a case for allowing them to hold equity shares. If trusts invest only in interest-earning securities like bonds, the real value of these will erode over time with inflation, making it difficult to expand or even sustain charitable activities. In the long run, equities give far better returns than bonds or fixed deposits. So, the solution could be to allow charitable trusts to invest a maximum of 30% of their corpus in equities, and the rest in interest-bearing securities.

However, this should be subject to a low ceiling of say 0.5% of the shares in any one corporation. That will ensure that trust holdings in individual companies are too small to be misused for corporate control through the backdoor. Besides, not all socially useful work is charitable. For social reasons, the government forces banks to lend to certain for-profit priority groups — agriculture, small-scale industries, education, and disadvantaged groups like SC/STs. This recognises the fact that many for-profit institutions have social value.

In the last two decades, a new category of investors called social investors has come up, who invest not just for profit but in socially important sectors. Such investment greatly improves the ability of socially important start-ups to expand fast. Institutions dependent on grants alone cannot grow fast or expand their reach. But an enterprise that is profitable enough to attract investors’ money can expand fast and help thousands, even millions of people.

Bandhan Bank is the best example of a small microfinance company that attracted equity infusions from investors, grew fast and is now a highly respected bank that focuses on lending to priority sector. It has helped millions of the deserving needy. India needs to encourage rather than ban trusts from investing in start-ups that can grow into new Bandhans.

So, the ceiling of investing more than 0.5% of equity can be amended for start-ups to a maximum of Rs 5 crore. That will be large enough to make a difference to startups, yet too small for corporate control.

Old trusts like the Tata and Birla trusts can be given five years to gradually reduce their equity stakes to a maximum of 0.5% in any company, subject to an overall equity limit of 30% of the trust corpus. Should the trusts be allowed to invest in mutual funds? Yes, within the 30% ceiling, provided that the mutual funds are not controlled by the same group. For instance, the Birla or Tata Trusts should not be able to invest in the mutual funds run by the financial arms of these groups. That could lead to indirect control of a business empire.

The aim must be to end the misuse of charitable trusts even while permitting them to inject much-needed equity into socially relevant ventures. We can then cheer their social and charitable activities without reservation.

What do you think?