MCA Limits Layering of Subsidiaries by Companies
The Ministry of Corporate Affairs (‘MCA’) on September 20, 2017 notified the proviso to Section 2(87) of the Companies Act, 2013 (‘Act’) and the Companies (Restriction on the number of layers) Rules, 2017 (‘Layering Rules’). Prior to said notification, the restriction on the numbers of subsidiaries as specified under Section 2(87) of the Act were not in force.
Layering Rules aims to put a restriction on the layering of subsidiaries by certain class or classes of the holding companies. Such rules have been introduced with a view to prevent misuse of multiple layers of subsidiaries and creation of shell companies for diversion and siphoning of funds with a view to protect the interests of minority investors.
The Companies Law Committee (‘CLC’) had recommended the removal of layering restriction as provided under proviso to Section 2(87). However, the Government did not accept the suggestion of the CLC and on June 28, 2017, MCA issued a draft of the rules limiting the number of subsidiaries, seeking comments from stakeholders. It finally climaxed into the Layering Rules effective from September 20, 2017.
Section 2(87) of the (‘Act’) talks about the subsidiary company which means a company in which holding company-
(i) Controls the composition of Board of Directors; or
(ii) Exercises or controls more than 50% of the total share capital either at its own or together with one or more subsidiary companies.
The proviso to section 2(87) provides that certain class or classes of holding companies shall not have layers of subsidiaries as may be prescribed by the Government.
In pursuance of the power conferred by the proviso of Section 2(87) of the Act, the Government introduced the Layering Rules. Under Rule 2 of the Layering Rules, no holding company shall have more than two layers of subsidiaries. However, the restriction of layering under the Layering Rules will not be applicable to the acquisition of companies incorporated outside India with subsidiary beyond two layers. As per proviso 2 of rule 2(1) of the Layering Rules, for computing the number of layers of subsidiaries, one layer comprising of one or more wholly owned subsidiary or subsidiaries will not be taken into account.
Per rule 2(2) of the Layering Rules the following classes of company are exempted from the application of the Layering Rules;-
(i) a ‘Banking Company’ as defined under the Banking Regulation Act, 1949;
(ii) a non-banking financial company as defined under the Reserve Bank of India Act, 1934 and which is registered with the Reserve Bank of India and is considered as systematically important non- banking company by the Reserve Bank of India;
(iii) an insurance company carrying on the business of insurance in accordance with the requirements of Insurance Act, 1938 and Insurance Regulatory Development Authority Act, 1999;
(iv) a government company as defined under the Companies Act.
All the existing companies having more layers of subsidiaries than as permitted under the Layering Rules and which are not exempted from Layering Rules are required to file with the Registrar of Companies, a return in the Form CRL1 disclosing all the relevant details pertaining to such layers of subsidiaries within a period of 150 days from the effective date of these Rules i.e. September 20, 2017.
From the commencement date of Layering Rules, companies cannot be incorporated having layers of subsidiaries more than as permitted under Layering Rules and the companies already in existence as on date of commencement of the Layering Rules with more than the prescribed layers of subsidiaries cannot incorporate any more layers.
If any company contravenes any requirements as prescribed under these Rules, the company and every officer of such company who is in default will be punishable with fine which may extend to Rs. 10,000 and for continuing offenses, with a fine which may extend to Rs. 1,000 for every day after first during which such contravention continues.
However, the restrictions imposed on the layering of subsidiaries as prescribed under Layering Rules are additional to those prescribed under Section 186 of the Act which provides that a company shall not make the investment through more than two layers of ‘Investment Company’.
The introduction of Layering Rules is expected to cause changes in the way companies carry out business in India and structure their business transactions. The ceiling on the number of subsidiaries is expected to keep a check on the multiple layers of the holding company which is used by the holding companies for routing or siphoning of funds and will enable the government authorities to identify the ultimate beneficiaries of the corporate complex structures and thereby preventing money laundering.