Companies Act: How Useful Is The ‘Two Layers Of Subsidiaries’ Rule?
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Companies Act: How Useful Is The ‘Two Layers Of Subsidiaries’ Rule?

A recent notification by the Ministry of Corporate Affairs restricts the ability of certain companies to create multiple layers of subsidiaries. The notification is being seen as the government’s attempt to address opaque fund-raising activities, and intensify the crackdown on black money and shell companies. But the carve-outs that come with this attempt may defeat the purpose, experts told BloombergQuint.

Rules & Carve-Outs

The new rules say that no company can have more than two layers of subsidiaries. Banking companies, systemically important non-banking financial companies, insurance companies and government companies are exempt from this restriction. To calculate the number of layers, the layer that consists of one or more wholly owned subsidiary or subsidiaries will not be taken into account, as per the guidelines.

Additionally, the restriction will not prohibit an Indian company from acquiring a foreign company that has more than two layers of subsidiaries.

Though existing structures – where more than two layers of subsidiaries exist – have been grandfathered, such companies are prohibited from creating additional layers and have to disclose the number of layers beyond two to Registrar of Companies within 150 days.

Possible Impact?

The intent was to eliminate multi-layered structures that siphoned off funds without any visibility to the parent company shareholders but with all these carve-outs, there is hardly any impact, Bharat Vasani, former group general counsel of Tata Sons, told BloombergQuint.

The rules apply only to prospective structures. Since wholly owned subsidiaries are carved out, only partly owned subsidiaries will be regulated. I personally do not see any structuring handicap for companies.
Bharat Vasani, Former Group General Counsel, Tata Group

Sharad Abhyankar, a corporate law partner at law firm Khaitan & Co., agrees. According to him, this kind of regulatory intervention in legitimate business arrangements may not be the best approach to curb illicit funding activities and could act as a drag on business.

The government is already collecting vast amounts of information from regulatory filings and tax returns – it should have been a matter of connecting the dots rather than promulgation of regulations of this nature.
Sharad Abhyankar, Partner, Khaitan & Co.

The new rules paint all companies with the same brush, said Lalit Kumar, a corporate law partner at J Sagar Associates. The assumption is that anyone who has more than two-layers of subsidiaries is doing something wrong, he added.

This belief is incorrect. You can’t have more than two layers for even genuine business reasons now; they could’ve allowed that but asked for more elaborate disclosures. Also, there is no window for a government or shareholders’ approval either.  
Lalit Kumar, Partner, J Sagar Associates

It won’t come as a surprise, therefore, if this regulation hastens the flight of entrepreneurs towards business-friendlier jurisdictions, argued Khaitan’s Abhyankar.

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