Sum of too many corporate parts?

Girish Vanvari | Updated on February 03, 2013

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The limit on layers of subsidiaries should ideally apply only to companies that raise funds from the public. It would be unfair to impose this on closely held/ privately run enterprises.

Companies Bill 2012 is just two steps from becoming law — that is, approval from the Rajya Sabha, followed by Presidential assent. The Bill is hailed as progressive and in tune with changing ground realities in the corporate world. However, some of the provisions are seen restrictive for corporate restructuring.

Clause 2(87) proposes that the Government will prescribe the class of holding companies that cannot have layers of subsidiary companies beyond a prescribed number. Through a separate notification, the Government may decide the kind of companies that cannot have more than the prescribed layers of subsidiaries.

The genesis of this provision was in the Standing Committee Report on Companies Bill, 2009, which discussed that multilayer subsidiaries have become a major source for diversion of funds and, in the process, minority interest is subverted. It is true that in many cases subsidiaries are effectively deployed as a mechanism to divert funds to related parties with no accountability towards minority shareholders. Eventually, if the Government decides to prescribe the class of companies for the limitation, then ideally it should apply only to companies that raise money from the public. It would be unfair to apply it to closely held/ privately-run enterprises.

It must be noted that often multilayer structures are deployed to meet specific commercial needs of projects. These include catering to the complexity of specific businesses, investment in joint ventures, entry into new business, flexibility over the level at which a third-party investor can enter the infrastructure sector, regional businesses, decentralised/ focused management of specific business verticals and segregation of business in diversified business conglomerates. Before framing the rules, the Government should consult various stakeholders to avert any adverse impact on industry.

Clause 13 of the Bill provides that when funds raised through initial public offer are used for some other purpose, dissenting shareholders should be given an exit opportunity. This partially addresses the problem of fund diversion by giving minority shareholders an exit option.

Similarly, Clause 186 provides that a company cannot invest through more than two layers of investment companies. An ‘investment company’ has been defined as one whose principal business is acquisition of shares, debentures and securities. However, the provision will not apply when an Indian concern acquires a foreign company through multiple layers of investment companies.

It is apparent that the limit on the number of investment companies is an anti-abuse provision targeting structures used to re-route funds towards operating companies or stock market investment and so on.

Traditionally, multiple investment companies are floated for reasons ranging from funding and cross-funding to leveraging, aligning stakes within families, using the investment companies to promote other ventures, running private businesses and so on. There is no clarity on the grandfathering of structures set up prior to enacting the Bill and, therefore, holding companies should revisit their structures to avoid being caught unawares. However, there is no threshold prescribed for investment and the clause may apply regardless of the size or quantum of investment. For example, if a company owns 5 per cent equity in an investment company purely as financial investment and is not a promoter of the company, and if such other company has one more layer of an investment subsidiary then such investment could run afoul of the clause.

Nonetheless, on a positive note, the clause will not impact operating-cum-investment companies, where any investment is primarily meant to augment the operating businesses. Therefore genuine cases where investment is structured through such layers (subject to the limit on subsidiaries) would not be impacted.

Girish Vanvari is Partner and Co-head of Tax, KPMG in India

Alok Mundra Director KPMG in India contributed to the article.

Published on February 03, 2013

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