What is Dematerialisation of Shares?

Dematerialisation refers to the process of converting physical share certificates into electronic form, held in a Demat (dematerialised) account with a registered Depository Participant (DP). This transformation has revolutionized the way securities are held and traded, replacing the traditional paper-based ownership system with a secure, efficient, and transparent digital mechanism.
Previously, shareholders received physical share certificates as proof of ownership. These certificates were prone to risks such as loss, theft, forgery, or damage, often resulting in disputes and delays in transferring ownership. The conventional system was also time-consuming and heavily reliant on paperwork, involving physical signatures, postal delays, and manual verification.
To address these inefficiencies, India adopted the dematerialised securities system, legally backed by the Depositories Act, 1996, and regulated by SEBI. With depositories like NSDL and CDSL, investors now hold shares electronically in Demat accounts, akin to holding money in a bank account, ensuring faster, safer, and more transparent transactions.
Dematerialisation has become a cornerstone of modern capital markets, mandated for listed companies and increasingly for certain classes of unlisted private and public companies.

Legal Framework and Rules Pertaining to Dematerialisation

The Ministry of Corporate Affairs (MCA) introduced Rule 9B under the Companies (Prospectus and Allotment of Securities) Rules, 2014, mandating dematerialisation for certain private companies to enhance transparency and accountability. The key provisions are:
1. Mandatory for Non-Small Private Companies: Private companies, excluding those classified as small companies (i.e., with paid-up capital less than ₹4 crore and turnover less than ₹40 crore), must:
 Issue securities only in dematerialised form, and
 Facilitate dematerialisation of all existing securities, in compliance with the Depositories Act, 1996, and relevant SEBI regulations.
2. Applicability and Timeline: This rule applies to any private company that is not a small company as on the last day of any financial year ending on or after March 31, 2023.
Such companies must comply within 18 months from the end of that financial year.
Producer companies under this category have a longer compliance period of 5 years.

Recent Developments on Dematerialisation Deadlines

1. Extension of Compliance Deadline: The MCA has extended the deadline for private companies to complete dematerialisation of shares from September 30, 2024, to June 30, 2025. This extension applies to all private companies except:
 Small companies
 Government companies
Exceptions to Small Company Exemption: Certain categories must comply by June 30, 2025, irrespective of size, including RBI-registered NBFCs, holding and subsidiary companies, Section 8 companies, companies under special Acts, and Indian subsidiaries of foreign firms.
2. SEBI Guidelines for Alternative Investment Funds (AIFs): Companies that have raised capital from AIFs must comply with dematerialisation rules irrespective of their classification as small companies.
 From July 1, 2025, all new investments made by AIFs must be in dematerialised form.
 Existing investments are exempt unless:
a) The investee company falls under MCA’s Rule 9B, or
b) The AIF (alone or jointly with other SEBI-registered entities) exercises control over the investee company.
In these cases, dematerialisation must be completed by October 31, 2025 (extended from January 30, 2025).

Guidelines for Dematerialisation of Shares by Private Companies

To comply with dematerialisation requirements, private companies must follow these steps:
1. Amend the AoA to permit shareholders to hold shares electronically instead of physical certificates.
2. Appoint a SEBI-registered RTA to act as an intermediary between the company and depositories such as CDSL or NSDL.
3. Obtain an ISIN for each category of shares (e.g., common, preferred). ISIN is a unique global identifier for securities.
4. Open a Demat account with a Depository Participant (DP), typically a bank or brokerage firm, authorized to facilitate electronic shareholding.
5. Facilitate shareholders in converting physical share certificates into electronic form by submitting them to the DP.
6. Ensure that all promoters, directors, and KMP hold their shares in dematerialised form before issuing new securities. Their Demat accounts should be linked to the company.
7. Submit half-yearly returns (PAS 6) to the Ministry of Corporate Affairs, reporting on the status of dematerialised shares.

Consequences and Penalties for Non-Compliance

Though Section 29 of the Companies Act and Rule 9B does not specify direct penalties for non-compliance, general penalties under Section 450 of the Companies Act may apply:
 The company will be barred from issuing or allotting any securities, including bonus shares, and from conducting any buyback of shares or securities.
 Shareholders who have not dematerialised their holdings will be unable to sell shares or subscribe to new issues.
 The company may face a penalty starting at ₹10,000, plus an additional ₹1,000 per day of continued default, up to a maximum of ₹2,00,000.
 Every officer responsible for the default may also be fined up to ₹50,000.

Conclusion

Dematerialisation has revolutionized shareholding in India by replacing physical certificates with secure electronic records, enhancing efficiency and transparency in securities transactions. With the MCA’s expanded mandate requiring most private companies to dematerialise their shares, compliance is crucial to avoid penalties and operational restrictions such as the inability to issue new securities or allow shareholders to trade shares. Companies must promptly amend their Articles of Association, appoint authorized intermediaries, and facilitate the conversion process to meet the extended deadlines. Embracing dematerialisation not only ensures legal compliance but also strengthens corporate governance and investor confidence in today’s digital capital markets.