Layering of Subsidiaries: The Phoenix Rises Again?

[The following guest post is contributed by Siddharth Raja, Senior Partner &
National Executive Director, Argus Partners, Solicitors & Advocates.  Monica
and Divya Mirlay,
Associates of the Firm, assisted in the preparation of the “Note on Objections”
referred to below.  Views are personal
and do not reflect or incorporate the views or positions of the Firm. Comments
are welcome.]
On 28 June 2017,
the Ministry of Corporate Affairs (“MCA”)
issued Public
Notice No. 3/3/2017-CL-I
, containing a draft notification proposing
amendments – chiefly, the insertion of Rule 5 (the “Proposed Amendments”) – to the Companies (Specification of
Definitions Details) Rules, 2014 (the “Rules”). 
The Proposed
Amendments restrict the prescribed class or classes of holding companies from
having subsidiaries beyond two layers.  In
other words, as the Public Notice states, “[b]ased on suggestions received, the
[MCA] is considering commencing” the proviso
to Section 2(87) of the Companies Act, 2013 (the “Companies Act”).  The Public
Notice, which also contains a background or explanatory note, invites
suggestions and comments on the Proposed Amendments from stakeholders. 
The authors of
this post have prepared and submitted to the MCA a detailed note of their
objections to the Proposed Amendments. 
This post is a summary of their “Note on Objections”.  The issue of the layering of subsidiaries had
first caught critical attention at the time such a restriction was first
suggested in the Companies Bill, 2011 (here).
The thrust of the
objections to the Proposed Amendments in their entirety is a principled one. In
other words, the proposed amendments ought not to be implemented in full as, at
the very threshold, we believe they are destructive of the ability of companies
to structure their affairs entirely from a commercial perspective, while still
maintaining their compliance with anti-abuse, prevention of the siphoning-off of
funds or money laundering objectives or other legal provisions.  We believe that the Proposed Amendments are
neither salutary nor necessary to achieve the MCA’s principal objective stated
in paragraph 4 of the “Background / Explanatory Note” accompanying the Public
Notice: namely, the creation of shell companies for the diversion of funds or
money laundering.
In 2005, the J Irani
Committee Report
on a proposed new companies’ legislation for India
strongly opposed the move to have any restrictions on the number of
subsidiaries that a holding company may have.  This opposition was
principally founded on two threads of analysis: firstly, as the Irani Committee
Report itself very succinctly states, in paragraph 8.1 of its Report (emphasis
The Companies Act should not pre-empt the
decision as to what structure is appropriate for controlling businesses. 
Such prescriptions will make the environment rigid and put
Indian companies at a disadvantage
vis-a-vis their competitors
internationally. Such restrictions would also not facilitate sound
corporate planning
, formation of joint ventures, international
operations or restructuring of companies
Secondly, while
recognising the need to control the misuse of funds through multiple layers of
subsidiaries, the Irani Committee had also opined in paragraph 8.3 of its report
that “the phenomenon of siphoning off
funds may not be caused solely on account of holding-subsidiary structure

and went on to observe (emphasis added): 
instances of misuse of the holding-subsidiary structure should not result in
doing away with this very important business model
[namely, the holding-subsidiary structure] for investment and corporate planning.
 Instead of prohibiting formation of subsidiaries, there should be
adequate disclosure obligations as to utilisation of the funds raised or loans
and advances given by the coming to other entities.
  Strict disclosure and compliance norms
in respect of holding and subsidiary company structures should be provided for.
Indeed, the Companies Act has proper and
strict disclosure requirements as suggested in the Irani Committee Report,
including the mandatory consolidation of financial statements.  All such
existing provisions address the concerns (principally, the diversion of funds)
attendant to the purported lack of transparency in the holding-subsidiary
structure.  Directed by the need for financial transparency and to root
out misuse, the Companies Act has stringent requirements with respect to
disclosures and related party transactions to snuff out any such potential
Even assuming, for
a moment, that the situation of the Indian economy in general, and the corporate
world in India in particular, is vastly different from what existed when the
Irani Committee submitted its report, despite the passage of time and drastic
changes in circumstances, two subsequent learned and distinguished official committees
of experts have underscored and endorsed (or, in any event, not entirely gone
against) the views and approaches of the Irani Committee on this issue of the
layering of subsidiaries under a holding company structure.
The Companies Law
Committee Report of February 2016 (the “CLC
”) that formed the basis of the Companies Amendment Bill, 2016,
presently pending before Parliament, was especially clear in reiterating the
objection to having any stipulation as to such layers; so much so, that the
Companies Amendment Bill, 2016 based on the CLC Report, expressly and
specifically suggests the removal of the proviso
to Section 2(87) of the Companies Act.  Paragraph 1.24 of the CLC Report
states as follows (emphasis added):
The Committee noted that this provision [Section 186(1)] was included to address practices of
creating subsidiaries aimed at making it difficult to trace the source of funds
and their ultimate use, and reduce the usage of multiple layers of structuring
for siphoning off of funds and that the same was incorporated in the
Act] in the wake of various scams in the
country……..The Committee, therefore, felt that while
the proviso to Section 2(87) has not yet been notified, it was likely to have a
substantial bearing on the functioning, structuring and the ability of
companies to raise funds when so notified and hence recommended that the
proviso be omitted
On merits, Section
186(1) of the Companies Act already effectively restricts the layering of
subsidiaries, in particular investment companies, so as to prevent the
siphoning-off of funds through such multiple layers – thereby making it clear
that the introduction of genuine, operational subsidiaries, which are not
principally mere investment vehicles, is a permitted exercise of corporate investment
structuring between holding companies and as many layers of operating
subsidiary companies as may be commercially justified.  That latter
structuring is, on a reading of the scheme of the Companies Act, entirely legal
and ought not to be subject to the unnecessary restrictions currently
It is, therefore,
clear that the CLC Report was mindful of the issue of abuse and siphoning-off
of funds, but agreed with the Irani Committee so strongly that they recommended
the very omission of the enabling power to make rules in that behalf contained
in Section 2(87) proviso.  
In these
circumstances, we argue that while the Companies Amendment Bill, 2016 which contains
the suggested omission of the proviso
to Section 2(87) is pending in Parliament, this attempt to enforce such proviso by these Proposed Amendments to
the Rules, would be tantamount to flying in the face of legislative wisdom, should
the omission of the proviso be passed
by Parliament.   The Companies
Amendment Bill, 2016, however, appears to be floundering in Parliament and may
well have been put into cold storage, as a result of a change in the MCA’s mind,
as the current proposal seems to suggest. 
At the very least it appears that the MCA is less than enthusiastic in
moving ahead with that amendment bill in its current form.
That said, the
Companies Amendment Bill 2016 would need to change if this proposal from the
MCA comes through and it insists on it. Otherwise, any “commencement” of the
said proviso in the interregnum (such
as currently proposed) may lead to the anomalous position that some companies
would have been impacted by the proscription on having more than the permitted
layers of subsidiaries, while those who acted in a situation without, or in the
absence, of such a proscription would not be under any such disadvantage. It
would potentially lead to a situation where two equal and similarly situated
holding companies would be placed under dissimilar legal requirements leading
to the infringement of the equality of treatment among them.  Any such
position, apart from being potentially legally untenable, would also be
patently disingenuous and disadvantageous to some companies merely because they
had acted at a time when the rules may have proscribed such layering of
Even assuming that
the Companies Amendment Bill, 2016 is amended in Parliament to omit the
deletion of the proviso to Section
2(87), the very making of the Proposed Amendments, would run contrary to
learned and well-held opinion that such a restriction is not warranted in law
as well as in genuine, legally compliant commercial practice, given business
Even the
Parliamentary Standing Committee Report on the Companies Bill, 2011 (that
eventually became the Companies Act) reveals that while stakeholders
(primarily, the MCA) had represented the need for a restriction on layering of
subsidiaries on the basis of prevention of abuse, other stakeholders had
emphasised that imposing such restrictions could be construed as restrictive of
the conduct of business, a point elegantly stated by the Irani Committee, as
noted above.  The Parliamentary Standing Committee’s proposal to introduce
a register of beneficial owners of a company to address the need to know the
ultimate beneficial owners in complex corporate structures is all the more
reason that all such considered opinions from the various committees recommend
not having such layering restrictions in place.
The Proposed
Amendments are both untenable as well as improperly timed. Improperly timed because
assuming there is a felt need for such layering restrictions to be in place,
the proper approach would have been first to seek the continuing retention of
the proviso to Section 2(87)).  The stand of the MCA appears untenable because
to seek the introduction of these Proposed Amendments to the Rules not only
goes against the grain of the various committees that have examined this matter
threadbare, it also exposes companies to the very real possibility of prejudice
if the layering restrictions were subsequently to be entirely done away with by
Parliament.  It is however clear that the
MCA’s approach seems to be in line with the apparent push from the Government
to crack down on shell companies; it remains to be seen whether the MCA’s view
will prevail and the Companies Amendment Bill, 2016 changed to accommodate the
MCA’s and, indeed, the Government of India’s perceived perspective on this
While the
objective of preventing abuse and siphoning-off continues to be capable of
being achieved through other provisions that have more than ample strength and
teeth in law and in practice, the other very real and stated objective of
Government to promote Indian industry, including the “Make In India” programme,
ought not to suffer by such unnecessary and unwarranted restrictions, which in
our view, fetters Indian companies to their detriment and that of the Indian
economy, including as regards overseas entities who may not be subject to any
such restrictive layering stipulations. 
That last aspect is a moot and important issue, requiring further
analysis: would any such restriction on the layering of subsidiaries apply to
overseas holding companies on a proper interpretation of the (existing and
proposed) definitions of “holding company” and “subsidiary”?  This interpretational aspect is made all the
more nuanced because the Companies Amendment Bill, 2016 proposes to clarify
that for the purposes of the definition of “holding company” the expression
company includes anybody corporate.
– Siddharth Raja (assisted
by Monica Umesh and Divya Mirlay)

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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