These curbs also far exceed the existing method of dealing with group structures, which are generally considered acceptable. The checks and balances currently employed by the law is through lifting the corporate veil, which is possible only in exceptional circumstances, and with the existence of specific grounds that have been established by case law. At a broader level, even the landmark case of Adams v. Cape Industries plc,  Ch. 433, generally recognizes the utility of these structures and does not proscribe them at the outset. Even when it comes to issues of round-tripping of investments and abusive related-party transactions, it is more advantageous to deal with them through existing (or proposed) governance structures such as an independent board or audit committee, obtaining independent shareholder approval, requiring a transfer pricing report by an external gatekeeper, and the like. These principles-based approaches ensure that while genuine transactions are allowed, the abusive ones are reined in. The Bill, however, deals with both genuine and abusive transactions alike, and paints them with the same brush by restricting them. The saving grace, however, is that these are default provisions, and are capable of being moderated by Central Government through rules, and it is hoped that the rule-making process would consider some of these commercial realities and ensure the required flexibility.
Companies Bill, 2011: Layering of Subsidiaries
It is quite common for companies to be structured in the form of groups. Apart from various operational advantages of separating businesses into distinct entities, it also has the effect of enabling promoters to maintain control over separate aspects of the business. Group structures are prominent in countries where shareholding is concentrated, and the corporate structures in many Asian jurisdictions typify group holdings. Group structures also have certain incidental effects: the possibility of limiting liability to separate entities that may be thinly capitalized so as to adversely affect the interests of third parties dealing with such entities (especially its unsecured creditors such as tortious creditors) and also provide greater scope for related-party transactions that may not be on arm’s length basis thereby enabling promoters to extract greater value from the company to the detriment of the minority shareholders. These are usually addressed by different principles of law: lifting of the corporate veil in order to deal with the unintended consequences of limited liability, and stricter controls on related-party transactions. The Companies Bill, 2011 goes to the extreme of imposing severe restrictions of the ability of companies to operate as groups.
First, the Bill confers powers on the Central Government to prescribe the number of layers of subsidiaries that a specific class of company may have. Second, in terms of making investments, clause 186 of the Bill states that a company cannot make investments through more than two layers of investment companies. An “investment company” is defined as “a company whose principal business is the acquisition of shares, debentures or other securities”. Of course, the Central Government may make exceptions to this rule. Moreover, investments in subsidiaries outside India are excluded from this limit so long as multiple layers of subsidiaries are permitted in the relevant jurisdictions where the subsidiaries are located.
Although there can be no argument against the need for controlling the use of group company structures as they can be subject to abuses, the present proposal for limiting its use altogether goes too far. It is unusual for jurisdictions to impose such absolute curbs on the use of investment vehicles, and this provision in the Bill appears to be somewhat unique even in the international context. This seems to have emanated again from specific episodes witnessed in the past, in this case the stock market scam involving the use of investment vehicles for routing funds back and forth from companies and their promoters, which was the subject matter of a Joint Parliamentary Committee report nearly a decade ago. Again, the severity of these restrictions is arguably a result of individual experiences in specific cases, and a need for legislative reaction to plug gaps identified through those. However, the downside of such legislative approach is that with a view to ensnaring specific abuses it also has the effect of capturing genuine business transactions and corporate structures within its scope thereby curbing the ability of companies to organize themselves more efficiently. This provision, if implemented, is likely to affect investments and acquisitions using layers of subsidiaries, which may otherwise be optimal from various perspectives, including taxation. Although existing corporate group structures are likely to be grandfathered as clause 186 is likely to be implemented only prospectively, it would affect any further changes to existing structure and to the creation of new structures.
Nice Article Mr. Umakanth.
A suggestion for recommending commercial issues involved or providing reasonable excepts for such structures to the government. The same can be brought forth in Budget session while proposing the Bill.