Subsidiaries Unshelled
Pursuing the mission of cracking down on shell companies and curbing money laundering, on September 20, 2017, the Government of India - Ministry of Corporate Affairs policy division - has notified the 'Companies (Restriction on number of layers) Rules, 2017' which restricts the number of subsidiaries for holding companies. The move will bring in major ramifications in Indian corporate structures. No company is permitted to have more than two layers of subsidiaries in India, with an exception of one layer of wholly-owned subsidiary/ies.
This new restriction applies to all companies - listed or unlisted, operating or non-operating - except specified companies such as banking companies, non-banking financial services, insurance companies and government companies.
As a relief to existing corporate structures, this rule has been made applicable on a progressive basis, but further expansion of structure in contravention to this rule (including reducing an existing grandfathered layer of subsidiaries) is not allowed. Foreign acquisitions have been given a leeway; but, more importantly, this rule has no exceptions for India-level acquisitions.
With effect from September 20, 2017, an existing Indian conglomerate (which has more than two layers of subsidiaries - as contemplated in the rule) cannot create or acquire another layer of company in India; else it results in violation. Making an acquisition (via plain vanilla share purchase or merger or other corporate restructuring) must now meet the test of the layer of subsidiaries rule, which can prove to be a challenge. Although existing structures are grandfathered, the new acquirer of such structures may need to adhere to this two-layer requirement, thereby calling for some pre-acquisition restructuring.
Even in an overseas acquisition scenario, if there are Indian companies in the acquired group which need to be brought under the India structure of the acquirer, this rule will have a bearing. Interestingly, there already exists a rule which restricts having pure investment companies in a given structure, but this new rule further propels the restriction to all subsidiaries. Clearly, the intention of the government is to track down misuse of layers on subsidiaries (as mentioned in a public notice in June 2017).
Having said that, giving no leeway to set up or acquire operating companies say by listed companies, which are governed and monitored regularly by SEBI, could be a possible road block. At times, layers of subsidiaries are looked at for value capturing, coupled with strategic reasons such as diversification of risk (say in real estate or infrastructure sector), protecting interests of multiple investors (PE or VC), leveraging, bringing strategic partner for a part of business, etc.
With these new rules, it is essential that companies identify and strategically streamline their structure to plan acquisitions. Some questions remain unanswered though: what happens to acquisitions agreed upon before September 20? What happens to corporate restructuring pending with the National Company Law Tribunal? Will there be a mechanism to seek permission from the Company Law Board for exceptions? As a fall out of this rule, all the companies (barring exceptions) have to disclose their existing layer of structures to the government by February 17, 2018.
This could facilitate the identification of complex structures in India and, where required, undertaking necessary actions to crack down on shell companies. Despite the challenges it poses, the new rule should go a long way in delivering what can be called as a swachh corporate structure for India Inc and provide a more transparent operating environment.
