Introduction

The Ministry of Corporate Affairs (hereinafter referred to as the “MCA”), vide notification No. G.S.R 1176(E) dated September 20, 2017, has notified the Companies (Restriction on number of layers) Rules, 2017 (hereinafter referred to as the “Rules”). The Rules state that no company, other than which are exempted, shall have more than two layers of subsidiaries. The restriction on companies to have more than two layers of subsidiaries is mandated to primarily check the misuse of multiple layers of subsidiaries and curb diversion/syphoning of funds.

Computation of layers

In computing the number of layers, one layer which consists of one or more wholly-owned subsidiary or subsidiaries shall not be taken into account. It means that if a holding company has a wholly owned subsidiary, then such subsidiary can in turn have two step-down subsidiaries or layers of subsidiaries. However, subsidiaries of the wholly owned subsidiary cannot have any subsidiary. For example, “A” is a holding company which has a wholly owned subsidiary “B”. “B” can have two step-down subsidiaries, “C” and “D”. However, “D” cannot have any subsidiary.

Exemptions

The restriction of two layers of subsidiaries shall not affect a company from acquiring a company incorporated outside India with subsidiaries beyond two layers as per the laws of such country.

Further, the following classes of companies are exempted from such restriction:

  • Banking companies
  • Non-banking financial companies
  • Insurance companies
  • Government companies

Existing companies

The Rules apply prospectively to the existing companies which have more than 2 layers of subsidiaries as on September 20, 2017. However, such companies have to ensure the following:

  1. Filing of a return in Form CRL-1 disclosing details specified therein with the Registrar of Companies, within 150 days of commencement of the Rules.
  2. Prohibition to have any additional layer of subsidiaries after the commencement of the Rules.
  3. In case one or more layers are reduced by such companies subsequent to the commencement of Rules, then such companies shall not have the number of layers beyond the number of layers it has after such reduction or 2 layers as allowed, whichever is more.

Penalty

If a company contravenes any provision of the Rules, then such company and every officer of the company who is in default, shall be punishable with a fine which may extend to INR 10,000.  In case of continuing contravention, the penalty may extend up to INR 1,000 for every day after the first day during which such contravention continues.

Conclusion

The restriction on layers of subsidiaries will keep a vigil on usage of multiple layers of holding-subsidiary structures for purposes of siphoning off or routing of funds. The Rules will also allow concerned authorities to identify which are the ultimate beneficiaries in a complex corporate structures. However, such restriction may create an issue for companies which seek to undertake merger and acquisition involving layer of subsidiaries.