SKP Business Alert
26 September 2017
The MCA notifies restrictions on layers of subsidiaries

Section 2(87) of the Companies Act, 2013 (the Act) defines the meaning of a ‘subsidiary company’. It further empowers the Ministry of Corporate Affairs (MCA) to notify that a specified class or classes of holding companies should not have more than a prescribed number of layers of subsidiaries.
 
In exercise of the said powers under Section 2(87) of the Act, the MCA vide its notification dated 20 September 2017 has notified Companies (Restriction on the number of layers) Rules, 2017 (the Rules) restricting the number of layers of subsidiaries for certain classes of holding companies.
 
The above rules are notified after the MCA issued draft rules for public consultation on 28 June 2017. The restriction seeks to keep a check on the misuse of multiple layers of subsidiaries and curb diversion/syphoning of funds.

Key highlights of the notification
  1. Restriction: No company other than which are exempted shall have more than two layers of subsidiaries. However, one layer represented by a wholly owned subsidiary would not be taken into account for computing the number of layers. Also, the restriction of two layers of subsidiaries shall not affect a company from acquiring an overseas company that has ‘subsidiaries beyond two layers as per the laws of such country’. 
  2. Exempted companies: Banking companies, non-banking financial companies, insurance companies and government companies have been exempted from the said restrictions.
  3. Existing companies: Although the Rules apply prospectively to the existing companies having layers of subsidiaries in excess of layers specified in the Rules, such relaxation is subject to the conditions that:
    • They shall file a return in Form CRL-1 disclosing details specified therein with the MCA.
    • They shall not have any additional layer of subsidiaries after the commencement of the Rules.
    • They shall not increase the number of layers of subsidiaries subsequent to such reduction in the event one or more layers are reduced.
  4. Penalty: In case of contravention of the above, the company, as well as every officer who is in default, shall face a penalty with a fine up to INR 10,000, and in case of repeated violation, the penalty may extend up to INR 1,000 for every day after the first day during which such contravention continues.
SKP's Comments
The proviso to Section 2(87) of the Act empowering the MCA to restrict the layers of subsidiaries was, inter alia, sought to be omitted in the Companies (Amendment) Bill, 2016 following the recommendations made by the Companies Law Committee in its report given during February 2016. However, in view of reports of misuse of multiple layers of companies, where companies create shell companies for diversion of funds or money laundering, the MCA decided to retain the provisions. Accordingly, the MCA has now notified the said Section and Rules made thereunder.

Although the restriction has been made with an objective to keep vigil over layers of companies, it may create challenges for the corporate sector in India. The fact that there is no exemption to corporate actions like merger and acquisition involving layers of subsidiaries could be an issue. However, ignoring one layer of a wholly owned subsidiary is a step towards facilitating business and provides flexibility in structuring special purpose vehicles.
SKP
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