Holding-Subsidiary Relationship: The Legal & Regulatory Architecture

[Bharat Vasani is Senior Advisor – Corporate Laws and Miloni Mau an Associate in the General Corporate Practice, both at the Mumbai office of Cyril Amarchand Mangaldas.

An earlier version of this post was published on the Cyril Amarchand Mangaldas Blog]

As their businesses grow, companies operate through their subsidiaries for various reasons such as flexibility in operation of different units, expansion in different geographies, and the like. While a subsidiary is an entity over which the parent has control (and, in the case of a wholly owned subsidiary, complete control), the Companies Act, 2013 (“CA 2013”) recognises a subsidiary as a separate legal entity.

In Vodafone International Holdings BV v. Union of India, the Supreme Court held: “A company is a separate legal persona and the fact that all its shares are owned by one person or by the parent company has nothing to do with its separate legal existence. If the owned company is wound up, the liquidator, and not its parent company, would get hold of the assets of the subsidiary. In none of the authorities have the assets of the subsidiary been held to be those of the parent unless it is acting as an agent. Thus, even though a subsidiary may normally comply with the request of a parent company it is not just a puppet of the parent company.”

With the increase in number of subsidiaries and implications of applicable laws in different jurisdictions along with the applicability to the holding company, the corporate governance of subsidiaries becomes an important aspect of overall governance of the company. The CA 2013 and the regulations of the Securities and Exchange Board of India (“SEBI”) prescribe specific requirements around subsidiary governance, statutory aspects of which have been discussed in this post.

Tests to Determine Holding-Subsidiary Relationship

Section 2(87) of CA 2013, which also includes a foreign company, stipulates two tests to determine holding-subsidiary relationship between two companies. According to the provision, a company is a subsidiary of another company if any one of the following conditions is met:

  • A company in which the holding company controls the composition of the board of directors.
  • A company in which the holding company exercises or controls more than one-half of the total voting power.

Subsidiary Governance under the CA 2013

Consolidation of Accounts

Section 129 of the CA 2013 mandates consolidation of financial statements of the subsidiary and associate companies with the holding company. This is a key aspect, as accounting policies and principles of the holding company gets extended to the subsidiaries. This bears a significant implication for companies that are not wholly owned or are associate companies.

The consolidation of accounts shall be carried out according to Schedule III of the CA 2013 (dealing with balance sheet and statement of profit) and the applicable accounting standards, i.e., the Indian Accounting Standards (“Ind AS”) 110 (dealing with consolidated financial statements),  which require a parent company that controls one or more other subsidiaries to present consolidated financial statements. Ind AS 110 establishes “control” as the foundation for consolidation of financial statements and sets out the accounting requirements for the preparation of consolidated financial statements.


A subsidiary company is prohibited under section 19 of CA 2013 from holding shares in its holding company, with certain exceptions being subsidiary holding shares as a legal representative, as a trustee, or in case such shares are held even before it became the subsidiary company. However, in case of the third possibility where subsidiary was already holding shares before it became a subsidiary, then the subsidiary would have no voting rights on such shares.

Treasury Shares

Treasury shares refer to the shares of a company held by itself and are categorized as assets of the company. Such treasury shares generally arise on the merger of subsidiary with a holding company  The proviso to section 232(3)(b) of the CA 2013 prohibits treasury shares and states:

Provided that a transferee company shall not, as a result of the compromise or arrangement, hold any shares in its own name or in the name of any trust whether on its behalf or on behalf of any of its subsidiary or associate companies and any such shares shall be cancelled or extinguished.”

The CA 2013 does not contain any provision for cancelling or extinguishing treasury shares that existed before the notification of the provisions of the legislation. The report of the Company Law Committee of March 2022 recommended a three-year sunset period for all the existing treasury shares in listed entities to not carry voting rights after such period, which recommendation is yet not implemented.

Restriction on Layers of Subsidiaries

The CA 2013 read with the Companies (Restriction on Number of Layers) Rules, 2017 (“Layers Rules”) introducedrestrictions on the number of layers of subsidiaries that came into effect in September 2017. These rules were notified under section 2(87) i.e., definition of “subsidiary company”. The Layers Rules extend the restriction on the number of layers prescribed under section 186 (1) of the CA 2013 to include even the investment companies along with other entities.

The restriction was introduced to prohibit companies from misusing multiple layers of subsidiaries for diversion of funds. Unlike under section 186(1) of the CA 2013, the extent of the Layers Rules is not limited to layers of investment companies, but extends to the operating companies as well resulting, in a wider coverage of restriction on layers of subsidiary companies.

Removal of Directors

It is important to note that the holding company has the power to appoint and remove the entire board of directors of subsidiary company by an ordinary resolution under section 169 of the CA 2013, except if the director is appointed by the National Company Law Tribunal under section 242 of the CA 2013 and an independent director who is re-appointed for the second term who can only be removed by passing a special resolution.

Subsidiary Governance under SEBI (Listing Obligations & Disclosure Requirements) Regulations, 2015 (“LODR Regulations”)

Regulation 24

The LODR Regulations have taken a step forward by explicitly laying down requirements for subsidiary governance. However, regulation 24(7) of the LODR Regulations provides: “Where a listed entity has a listed subsidiary, which is itself a holding company, the provisions of this regulation shall apply to the listed subsidiary in so far as its subsidiaries are concerned.”

Further, emphasis is placed on the governance of a material subsidiary (a subsidiary whose income or net worth exceeds 20% of the consolidated income or net worth of the listed entity and its subsidiaries), which holds significance for investors as well. The LODR Regulations prescribe the following specific requirements with respect to material subsidiaries:

(i) at least one of the independent directors of the listed company is required to be appointed on the board of the material subsidiary;

(ii) the listed company is prohibited from divesting its investments in the material subsidiary resulting in a reduction of its holding to less than fifty percent or resulting in a cessation of control in such material subsidiary without the prior approval of the shareholders by way of a special resolution;

(iii) disposal of more than twenty percent of the assets of the material subsidiary is not permitted without prior approval of the shareholders by way of a special resolution

In terms of other subsidiary companies, the LODR Regulations prescribe the following:

(iv) the audit committee of the listed company is required to review the financial statement of the subsidiaries, especially the investments made by the subsidiaries.

(v) the minutes of the unlisted subsidiary shall be placed at the meeting of the listed entity

(vi) the management of the subsidiary company is required to bring the significant transactions to the attention of the board of directors of the listed company periodically.

Doubts have been expressed if SEBI can legislate by a delegated legislation (LODR) such  extra-territorial provisions. The Supreme Court’s  view, observed in Limited, is that if SEBI can demonstrate the provision that would protect against fraud and secure the interests of investors and the stock market in India with reference to any fraud played against such interest of investors in India, then it can uphold such an extra territorial operation of the law under the ‘India nexus test’ laid down under Article 245 of the Constitution of India read with constitution bench judgment of the Supreme Court in GVK Industries v. Income Tax Officer.

Related Party Transactions (“RPTs”)

Significant amendments have been made to the LODR Regulations with respect to governance of RPTs. There is a paradigm shift in governance, as not only the transactions of the listed company with its related parties but the transaction of the listed company or its subsidiaries with related parties or the listed entity subsidiaries are also considered as RPTs. This implies that the governance of RPTs now extends to transactions where a listed company may or may not be a party.

Further, irrespective of any approval requirements under the LODR Regulations, all transactions with a company and its subsidiaries with the related party of the listed company and any of its subsidiaries are required to be disclosed as part of the half-yearly disclosure in terms of regulation 23(9) of the LODR Regulations. With this disclosure and regulatory requirement, subsidiary governance is required to be complied to a larger extent under the current regime as RPTs are considered on a consolidated basis.

Additionally, it can be argued that the purpose and effect test under regulation 2(1)(zc) of the LODR Regulations should be interpreted keeping in mind the mischief that was sought to be remedied, and the defect that was sought to be cured – where transactions with seemingly unrelated parties (unrelated party introduced as a subterfuge) that would ultimately benefit a related party, were escaping regulatory scrutiny. A literal reading of the purpose and effect test could potentially result in an absurdity, where any and every transaction that ends up benefiting a related party would get covered, even if such a transaction is in the normal course of business operations and creates synergies and economies of scale for the listed entity.

Regulation 30 of the LODR Regulations

Disclosure of material events or information is not restricted to listed entities alone, but also warrants material information of subsidiaries. With recent amendments to the regulation 30 and Schedule III of the LODR Regulations, there is an increase in reporting and regulating disclosures relating to subsidiaries.

Concluding Thoughts

Most industrial houses in India have large number of subsidiaries, but unfortunately there is no robust institutional framework for subsidiary governance. The following fundamental flaws have been observed in the governance of subsidiaries:

(i) Boards of most of the subsidiaries are packed with full-time employees of the parent company resulting in most of the subsidiaries functioning like a department of the parent company.

(ii) Instances are a plenty of large-scale diversion of funds from the parent company to the subsidiary and thereafter to the promoter group companies. This practice forced the Government of India to introduce further restrictions on the transactions between a holding company and the subsidiary company under the provisions of section 186 of the CA 2013. Unfortunately, due to pressures from corporate India, many of the restrictions have been subsequently relaxed.

(iii) Regulatory provisions made by SEBI relating to oversight over the subsidiaries have proved to be inadequate and have not been successful in controlling diversion of the funds to the subsidiary and further. This has led to SEBI amending the RPT provisions of the LODR with effect from April 1, 2022, and April 1, 2023, to rein in abusive RPTs being undertaken at subsidiary levels even when counter parties are not related party.

(iv) For many corporate houses, major accounting frauds at the subsidiary level have proved to be a huge reputational risk issue apart from financial losses. The problem gets further complicated if there are two different sets of audit firms for holding and subsidiary companies.

It is, therefore, incumbent that both the Government of India and SEBI conduct a comprehensive review of the provisions governing transactions between holding and subsidiary companies. India Inc. too must adopt a stronger governance framework to ensure better governance of subsidiaries.

Bharat Vasani & Miloni Mau

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