The blog focuses on MLM schemes - their benefits, rules and regulation governing these schemes and how some white caller criminals are running Pyramid schemes in the garb of being MLM Schemes or Direct Selling schemes.
The ultimate aim of the write up is to educate the masses on how to distinguish a genuine MLM Scheme from fake ones. Thus,to protect the gullible citizens from being victims of such fraudulent schemes.
Multi-level Marketing (MLM): Sales in multi-level marketing are made in a variety of ways, including single or party presentations, but also through online stores and catalogs. Income earned through MLM is commission on sales, and the sales made by other business partners the distributor recruits into the company.
Sometimes, direct sales are called MLM or network marketing. However, these terms are not interchangeable. While MLM and Network Marketing are a form of direct sales, not all direct sales systems involve MLM. For example, in single-level marketing, the sales representative is only paid commission on the sales he/ she makes personally. In this case, there is no recruitment of other sales team members.
Since, many MLM schemes, employ Direct selling model too, we shall read about them in detail too, for better conceptual clarity.
What are Direct Selling Schemes?
Direct Selling Guidelines, 2016 were issued by MCA - as guiding principles for State Governments to consider regulating the business of Multi-Level Marketing (MLM) and Direct Selling and to strengthen the existing regulatory mechanism on MLM and Direct Selling, for preventing fraud and protecting the legitimate rights and interests of consumers.
Clause 1 (6) defines Direct Selling as:
“Direct Selling” means marketing, distribution and sale of goods or providing of services as a part of network of Direct Selling other than under a pyramid scheme. Provided that such sale of goods or services occurs otherwise than through a “permanent retail location” to the consumers, generally in their houses or at their workplace or through explanation and demonstration of such goods and services at a particular place.
Direct Selling Schemes Simplified:
In Direct Selling Schemes products are sold directly to the consumer in a non-retail environment. For example, sale occurs at home, online or at other non-store locations.
The system eliminates middlemen involved in product distribution, such as the regional distribution center and wholesaler. Instead the product follows the following route:
Manufacturer --- >Direct Sales Company --->Distributor or Representative --- >Consumer
As expected, the products sold through direct sales are usually not found in typical retail locations, which means finding a Distributor or Representative is the only method to buy their products or services.
Benefits of MLM / Direct Selling Schemes:
As discussed above, the MLM schemes employing Direct Selling scheme system eliminate middlemen involved in product distribution, such as the regional distribution center and wholesaler.
Instead the product follows the following route:
Manufacturer --- >Direct Sales Company --->Distributor or Representative --- >Consumer
The elimination of middlemen leads to savings which in turn are given to Distributor or Representatives as commission for sales.
Normally, manufacturers advertise for their products, which leads to higher sales and thus higher revenues. However, higher expenditure in advertisement does not necessarily guarantee higher sales. Thus, possibility of losses at least in initial stages.
However, in direct selling schemes commissions are paid to Distributors for their effort made in selling the product. In other words, commissions are to be paid only when distributor becomes successful in selling the product/ service. Thus, the amount of risk involved is substantially lesser.
Though, the advertisement model vs direct selling model comparison involves several other parameters like sales frequency, capital cost, cost of borrowing in setting up business etc. However, in laymen terms, the above paragraph explains the preference for direct selling schemes by several manufacturers.
How to Identify Genuine vs fraudulent Ones?
Some of the Acts relevant to these schemes include:
Guidelines relevant to these schemes include:
Direct Selling Guidelines of Ministry of Consumer Affairs, 2016
A genuine Direct Selling Scheme shall comply with all the laws of the land and possibly all the guidelines too, to evade any suspicion of being seen as fraudulent.
Prize Chit & Money Circulation Schemes (Banning) Act, 1978:
Any promise to pay money based on enrolment of members into the scheme, brings the scheme under the ambit of Prize Chit and Money Circulation Schemes. Hence, any genuine scheme shall not pay money for bringing members into the scheme.
In real life scenario, this is lithmus test for any MLM or Direct Selling scheme. If any scheme offers money for bringing members into the scheme, it’s a fraudulent one.
As per Section 3 of Prize Chit and Money Circulation (Banning) Schemes Act, even enrolment as members or participation therein is a legally punishable offence. Hence, you should remain away from such schemes offering money for bringing others into it.
Banning of Unregulated Deposits Schemes Act, 2019:
By virtue of Section 6 - Certain scheme to be Unregulated Deposit Scheme:
“A prize chit or a money circulation scheme banned under the provisions of the Prize Chits and Money Circulation Scheme (Banning) Act, 1978 shall be deemed to be an Unregulated Deposit Scheme under this Act”.
A prize chit or money circulation scheme comes under it’s ambit. So, a genuine MLM or Direct Selling Scheme shall follow all the conditions stipulated in Prize Chit and Money Circulation (Banning) Scheme, to escape legal liability of BUDS Act.
Drugs & Magic Remedies (Objectionable Advertisement) Act, 1954:
If the MLM or Direct Selling Entity is dealing with “drugs”, which as per the act has been defined as:
Then, the MLM or Direct Selling Entity shall:
- Not take any part in the publication of any advertisement referring to any such drug in terms which suggest or are calculated to lead to the use of that drug for:
(a) the procurement of miscarriage in women or prevention of conception in women; or
(b) the maintenance or improvement of the capacity of human beings for sexual pleasure; or
(c) the correction of menstrual disorder in women
(Section 3: Prohibition of advertisement of certain drugs for treatment of certain diseases and disorders)
Not take any part in the publication of any advertisement relating to such drug if the advertisement contains any matters which:
(a) directly or indirectly gives a false impression regarding the true character of the drug; or
(b) makes a false claim for the drug; or
(c) is otherwise false or misleading in any material particular.
(Section 4: Prohibition of misleading advertisements relating to drugs)
Section 2 (d) defines – “Taking any part in the publication of any advertisement”, as:
Section 2 (a) defines – “Advertisement” as:
Any notice, circular, label, wrapper or other document, and any announcement made orally or by any means of producing or transmitting light, sound or smoke.
Indian Panel Code:
Any genuine MLM or Direct Selling Entity shall not use false, misleading, fraudulent statements/ information for its operations. For example, it shall:
Section 406 IPC: Punishment for criminal breach of trust:
Whoever commits criminal breach of trust shall be punished with imprisonment of either description for a term which may extend to three years, or with fine, or with both.
- Entrusting any person with property or with any dominion over property;
- The person entrusted
(a) dishonestly misappropriating or converting to his own use that property, or
(b) dishonestly using or disposing of that property or willfully suffering any other person so to do in violation -
(i) of any direction of law prescribing the mode in which such trust is to be discharged, or
(ii) of any legal contract made touching the discharge of such trust.
To bring home the offence under section 406 of the Indian Penal Code, 1860, the ingredients of entrustment with property, having domain over it, and the same having been misappropriated or converted to his own use by the accused person, are required to be proved.
Section 420 IPC: Cheating and dishonestly inducing delivery of property:
Whoever cheats and thereby dishonestly induces the person deceived to deliver any property to any person, or to make, alter or destroy the whole or any part of a valuable security, or anything which is signed or sealed, and which is capable of being converted into a valuable security, shall be punished with imprisonment of either description for a term which may extend to seven years, and shall also be liable to fine.
Evidence: For a person to be convicted under section 420 of the Indian Penal Code, 1860, it has to be established not only that he has cheated someone but also that by doing so, he has dishonestly induced the person who was cheated to deliver any property etc.
Information Technology Act, 2000:
An Act to provide legal recognition for transactions carried out by means of electronic data interchange and other means of electronic communication, commonly referred to as "electronic commerce", which involve the use of alternatives to paper-based methods of communication and storage of information, to facilitate electronic filing of documents with the Government agencies and further to amend the Indian Penal Code, the Indian Evidence Act, 1872, the Bankers' Books Evidence Act, 1891 and the Reserve Bank of India Act, 1934 and for matters connected therewith or incidental thereto.
This Section becomes relevant when the MLM or Direct Selling Entity impersonates another legal entity. E.g., Company impersonating another company.
Section 66D: Punishment for cheating by personation by using computer resource:
Whoever, by means of any communication device or computer resource cheats by personation, shall be punished with imprisonment of either description for a term which may extend to three years and shall also be liable to fine which may extend to one lakh rupees.
Direct Selling Guidelines, 2016:
An Inter Ministerial Committee was constituted by the Government to look into matters concerning the direct selling industry consisting of representatives from Ministry of Finance, the Department of Industrial Policy and Promotion, Department of Legal Affairs, Department of Information Technology and Ministry of Corporate Affairs, besides representatives of State Governments of Delhi, Andhra Pradesh and Kerala. Consultations with stakeholders were also held.
Based on the deliberations of the Inter Ministerial Committee and consultation with Stakeholders, the model guidelines on direct selling have been formulated. State Governments/ UTs may kindly take necessary action to implement the same. It is envisaged in the guidelines that the State Governments will set up a mechanism to monitor/ supervise the activities of Direct Sellers, Direct Selling Entity regarding compliance of the guidelines for Direct Selling.
Any direct selling entity conducting direct selling activities shall submit an undertaking to the Department of Consumer Affairs within 90 days, stating that it is in compliance of with these guidelines and shall also provide details of its incorporation.
Advisory to State Governments / Union Territories:
Model Framework for Guidelines on Direct Selling:
These guidelines, may be called the Direct Selling Guidelines 2016.These are issued as guiding principles for State Governments to consider regulating the business of Multi-Level Marketing (MLM) and “Direct Selling” and strengthen the existing regulatory mechanism on MLM and Direct Selling, for preventing fraud and protecting the legitimate rights and interests of consumers.
Though, the guidelines are very comprehensive in nature but they lack legal tooth. The punitive provisions for breach of guidelines have not been provided for.
State Governments/ UTs have been tasked to take necessary action to implement the same. As such, several state have failed to come up with relevant Acts up-to now. These guidelines continue to serve only as moral compass and lack effective remedy for violation. Hence, these guidelines have not been discussed in detail. However, relevant links has been shared for use as and when required.
Direct Selling Guidelines: https://consumeraffairs.nic.in/sites/default/files/file-uploads/direct-selling/Direct Selling Guidelines Final _0.pdf
Updated List of MLM/ Direct Selling Entities: https://consumerhelpline.gov.in/directsellingentities/data-history.php
Sample returns filed by Amway India Enterprises Private Limited: https://consumerhelpline.gov.in/directsellingentities/data-details.php?cid=ODg2MjEyMjE3
Income Tax Compliances:
A proper MLM or DSE shall comply with the provisions of Income Tax Act, including:
Goods & Services Tax Act Compliances:
Similarly, a genuine entity complies with the provisions of GST Act.
In the GST regime, any regular business has to file two monthly returns and one annual return. This amounts to 26 returns in a year. Any business whose turnover is less then Rs. 20 lakh is not required to register under GST and pay any taxes. However, this is subject to inter-state and e-commerce business. It means that if the business entity is doing inter-state business or selling online through e-commerce operator, the threshold of Rs. 20 lakh will not available and the entity must have to register under GST.
However once the entity is registered under GST, it is required to file GST return irrespective of the turnover. In fact, if the turnover is zero, that means the entity has not done any business, still it will have to file NIL Return under GST.
Here are some of the returns details:
Quarterly GST Return:
Annual Turnover up to Rs 1.5 crore can opt for quarterly filing
|Oct-Dec 2019||31st January 2020|
|Jan- Mar 2020||30th April 2020|
Monthly GST Return:
Annual Turnover of more than Rs 1.5 crore must file monthly:
|December 2019||11th January 2020|
|January 2020||11th February 2020|
|February 2020||11th March 202|
Invoicing Under GST:
As a GST registered dealer, the entity is required to provide GST Invoices, also known as bills to the clients. A tax invoice is generally issued to charge the tax and pass on the input tax credit. A GST invoice must have the following mandatory fields:
If the recipient is not registered and the value is more than Rs.50,000 then the invoice should carry:
i. name and address of the recipient,
ii. address of delivery,
iii. state name and state code
Company Act, 2013:
If the entity is a Company, it must comply with the provisions of Companies Act, 2013 along with other laws governing them. Following are the compliance required for a Company under Companies Act 2013. The list is inclusive rather than being exhaustive.
All companies registered in India like private limited company, One Person Company, limited company, and section 8 company must file MCA annual return and Income Tax return each year. Before filing annual return, the company must conduct an Annual General Meeting at the end of each financial year.
Annual General Meeting:
For newly incorporated Companies, the Annual General Meeting should be held within 18 months from date of incorporation or 9 months from the date of closing of financial year, whichever is earlier. Subsequent Annual General Meetings should be held within 6 months from the end of that financial year. In India, normally the financial year starts on April 1st and ends on 31st March.
Company Annual Filing:
Every Company registered under Companies Act is required to file their returns with the Registrar of Companies annually. Company Annual Filings refers to the filing of
- Audited Annual Financial Accounts of the Company along with
- Directors Report and
- Annual Return of Company
with the Registrar of Companies. These yearly filings are mandatory for every registered Company whether the Company carries on business or not.
Annual Financial Accounts:
The financial statement after being duly adopted should be filed along with the Board’s Report in Form AOC-4 within 30 days of the Annual General Meeting (AGM).
Annual Return under Companies Act is an yearly Return containing the general particulars of company on the close of the financial year such as details of its registered office, business activities, particulars of its holding, subsidiary companies, shares, debentures and other securities and shareholding pattern, members and debenture-holders along with changes therein, promoters, directors, key managerial personnel along with changes therein, meetings of members or a class thereof, Board and its various committees along with attendance details, remuneration of directors and key managerial personnel, penalty or punishment imposed on the company, matters relating to certification of compliances, disclosures etc.
Annual Return in Form MGT-7 has to be filed within 60 days of the Annual General Meeting (AGM).
Income Tax Returns:
As per the Income Tax Act, every company is required to close its financial year on 31st March every year and file returns with the Income Tax Department.
Every Company is required to file Income Tax Returns every year mandatorily whether they do business or not. If the annual turnover of a business is more than Rs.100 lakhs, the accounts have to be audited by a qualified Chartered Accountant as required under the Income Tax Act as well.
In addition to MCA annual return, companies must also file income tax return irrespective of income, profit or loss. Hence, even dormant companies with no transactions are required to file income tax return each year. Private limited companies, limited companies and one person companies would be required to file Form ITR - 6. The due date for filing income tax return for a company is on or before the 30th of September.
Commencement of Business Certificate:
Companies registered in India after November 2018 and having a share capital are required to obtain commencement of business certificate before commencing any business or exercising any borrowing powers. The commencement of business certificate must be obtained within 180 days of incorporation of the company. Failure to obtain commencement of business certificate will lead to a penalty of Rs.50,000 for the company and a penalty of Rs.1000 per day for the Directors for each day of default.
All companies registered in India must appoint a statutory Auditor within 30 days of incorporation. Failure to appoint an Auditor will lead to a penalty of Rs.300 per month and the company would not be allowed to commence business.
Companies registered before 31st December 2017 are required to file eForm ACTIVE (Active Company Tagging Identities and Verification) – INC22A on or before 25th April 2019. Failure to file e-Form Active will lead to a penalty of Rs.10,000.
Form DPT-3 filing must be made by all companies other than a Government company on or before 22nd April 2019. Hence, all private limited company, OPC, limited company or Section 8 Company would be required to file Form DPT-3 one-time.
DIN eKYC or DIR-3 eKYC form must be filed for all the Directors of the company. In DIR-3 eKYC filing, the Director must provide and verify a unique personal mobile number and personal email address. Failure to file DIN eKYC attract a penalty of Rs.5000 per DIN.
MLM and Direct Selling business are perfectly legal in India, albeit they comply with the laws of the land. Investors are advised to check for regulatory compliance of the MLM or Direct selling entity before investing their hard earned money.
The flags of a fraudulent MLM, Direct Selling schemes have been discussed in detail. Hopefully, it will serve as ready-made checklist for verifying the true credentials of MLM schemes. In case, the entity is not complying with the Acts/ guidelines, consider walking away, irrespective of the returns or commission being promised.
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(#Note: The Compliances keep on changing from time to time.)