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Company Law Update: Restrictions on Number of Layers of Subsidiaries

By Sharanya Ranga and Aditi Rani

The Ministry of Corporate Affairs (MCA) recently notified the Companies (Restrictions on number of layers) Rules, 2017 (Rules) to restrict the number of layers of subsidiaries for specific classes of holding companies. This notification that has come into effect from September 20, 2017 is only the latest (not the last, of course) in the ongoing drive by the Government of India to fight black money, money laundering and corruption.

Section 2(87) of The Companies Act, 2013 (“the Act”) defines the term “subsidiary company” or “subsidiary” as one where the holding company is either controlling the composition of the board of directors or is in control of more than 50% of the total share capital of the subsidiary company.  The proviso to this Section specifies that certain classes of holding companies shall not have layers of subsidiaries beyond the prescribed numbers.

The key highlights of the Rules are as follows:

  1. No company shall be allowed to have more than two layers of subsidiaries except those that have been specifically exempted. Banking companies[1], non-banking financial companies[2], insurance companies[3] and government companies[4] and Indian companies acquiring overseas companies with more than two layers of subsidiaries as per the local laws of such foreign country have been exempted.

  2. For the purpose of computing the number of layers under the Rules, one layer which consists of one or more wholly-owned subsidiary or subsidiaries shall not be taken into account.

  3. The Rules will apply prospectively to existing companies; however companies having more than two layers of subsidiaries have to comply with the following conditions:

  4. File a return in Form CRL-1 within 150 days from September 20, 2017, i.e. by February 17, 2018. The return requires layer-wise details of subsidiary companies along with the percentage of shares held by the holding company in each subsidiary.

  5. Not have any additional layers of subsidiaries over and above the layers existing on September 20, 2017; and

  6. If one or more layers of subsidiaries of a company are reduced after September 20, 2017, then the numbers of layers of subsidiaries of such a company shall not be beyond the number of layers it will have after such reduction or two layers, whichever is more. For example, if a company reduces its layers of subsidiaries, bringing it down from five to three layers of subsidiaries, after the Rules have come into effect, then in such a scenario the company can continue to operate with three layers of subsidiaries even though the Rules restricts it to two.

  7. The Rules also impose a penalty on the company and every officer of the company which is in default will be punishable with fine up to INR 10,000 and in the case of continuing contravention with a further fine up to INR 1,000 per day.

Advaya View:

It is interesting to note that the Rules compliments Section 186(1) of the Act that prohibits companies from making investments through more than two layers of investment companies. This provision has been in place since April 1, 2014.

The debate on restricting the number of layers of subsidiaries has been an ongoing debate for over a decade. In 2005, the Government constituted Expert Committee under the Chairmanship of J.J. Irani had recommended that the company law should not pre-empt or restrict appropriate structures for controlling businesses in India. The rationale was that such onerous restrictions would place Indian companies at a disadvantage vis-à-vis their international counterparts. Rather than restricting the number of layers of subsidiaries and interfering with corporate structuring options for businesses, the Committee proposed mandatory financial disclosures and a strong regulatory framework to usher in transparency. The Companies Law Committee set up by the MCA in their report on the Companies Amendment Bill, 2016 was also of a similar view that layering restrictions will substantially impact the functioning, fundraising and expansion activities of Indian companies, especially at a global level and strongly recommended omitting section 2(87) from the Act. Needless to say, this was not paid heed to as the section and the layering rule have been brought into effect.

The timing of the notification of the Rules is not too much of a surprise as post the demonetisation exercise of the Government last year, there has been a growing crackdown on unaccounted cash transactions, siphoning of funds and money laundering activities. On the corporate landscape itself, we have had overzealous regulatory acts that have led to notifications striking off the names of inactive companies and the disqualification of directors in companies. While there are instances of misuse of multiple layers of subsidiaries, the Rules appear to be a short-sighted approach to control corporate structuring options. While smaller companies with nimble structures may not face too much of an issue, the Rules will impact large conglomerates and multinational corporations who set up multiple subsidiaries for different verticals, businesses and locations. It is advisable for such companies to examine their internal structures and ensure compliance with the Rules at the earliest, in any event, before the filing of the form CRL-1 by February 17, 2018.

[1] As defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);

[2] As defined in clause (f) of Section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934) which is registered with the Reserve Bank of India and considered as systematically important non-banking financial company by the Reserve Bank of India;

[3] Engaged in carrying on the business of insurance in accordance with provisions of the Insurance Act, 1938 (4 of 1938) and the Insurance Regulatory Development Authority Act, 1999 (41 of 1999);

[4] As per the Section 2(45) of the Act;

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