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Alerts:

Regulatory Alert: Restriction on number of layers of subsidiaries

25 September 2017

The Ministry of Corporate Affairs (“MCA”) vide a notification dated September 20, 2017 notified the Companies (Restriction on number of layers) Rules, 2017 to restrict the number of layers of subsidiaries.

The summarised version of these Rules is as follows:

PROVISIONS OF THE RULES:

The provisions of the Rules have been encapsulated in brief below;

  • A company shall have at the most two layers of subsidiaries. However, the exception being that it can have one or more layers which consists of one or more wholly owned subsidiary(ies)
  • There is no restriction on the acquisition of a company incorporated outside India which already has more than two layers of subsidiaries as per the laws of the said foreign country

The above Rules do not affect the current restriction of not having more than two layers of ‘investment’ companies under section 186(1) of the Companies Act, 2013. In other words, this restriction of having not more than two layers of ‘investment’ companies also continues.

EXEMPTION

These Rules are NOT APPLICABLE to the following class of companies:

  • A Banking company
  • A Non-Banking Financial Company (‘NBFC’) registered with the Reserve Bank of India (‘RBI’) and considered as systematically important NBFC by the RBI
  • An Insurance company
  • A Government company

IMPACT ON CURRENT STRUCTURES

  • While a company which currently has more layers of subsidiaries than the limit prescribed, it shall not be allowed to add any further layer of subsidiaries post the commencement of the these Rules, i.e. w.e.f. 21st September 2017.
  • In the event, a company reduces the existing number of layer of subsidiaries post the commencement of these Rules, i.e. 21st September 2017, it shall have to adhere to the provisions of the these Rules and shall not be allowed to add any further layers of subsidiaries (beyond that is permitted).

COMPLIANCE

A company which has number of layers of subsidiaries more than the layers allowed by the above Rule is required to file Form CRL-1 with the Registrar within 150 days from the date of the publication of these Rules in the Official Gazette (i.e. before 17th February 2018).

PENAL PROVISIONS IN CASE OF CONTRAVENTION

In case of contravention, the company and every officer of the company shall be punishable with fine up to 10,000 and in case of a continuing contravention, with a further fine up to 1,000 for every day after the first day of contravention.

BDO COMMENTS

These Rules are in line with action of the Government to keep a check on shell companies. While these Rules grandfathers the existing structures, it also puts a requirement to report the same within 150 days. Further, the Rules allow acquisition of an existing foreign structure with more than two layers of subsidiaries, thereby not creating any impediments in cross border M&A transactions. There could be a situation where the second layer subsidiary has filed for incorporation of a third layer before the commencement of these rules. It is unclear how such incorporation would be dealt with.