Sections of the Companies Act, 2013 which deal with Restriction on Layers of Companies

The Companies Act, 2013 (New Act) came into force on 12th September, 2013 intending to ease business, streamline the compliance process and resolve various issues faced under Companies Act, 1956 (the ‘Old Act’). In the New Act, many sections from the Old Act were amended among which one Section 372A which dealt with Inter Corporate Loan, Investment, Guarantee, and Security was also amended in the concept of ‘Loan and Investment by Company’ under Section 186 of the New Act.

Provision to check diversion of funds and siphoning off funds:

To check misuse of multiple layers of subsidiaries for diversion of funds and siphoning off funds, the New Act-

(a) Requires that no investment can be made through more than two layers of investment company; and [See Section 186(1) of the New Act]

(b) Prohibit prescribed holding companies from having layers of subsidiaries beyond prescribed numbers. [See Proviso to Section 2(87) of the New Act]

Therefore, the following are two sections of the New Act which deal with restriction on layers of companies-

  • Proviso to Section 2 (87): such class or classes of holding companies shall not have layers of subsidiaries beyond such numbers as may be prescribed. [See Companies (Restriction on Number of Layers) Rules, 2017.
  • Section 186 (1) [Loan and Investment by Company]: a company shall unless otherwise prescribed, make investment through not more than two layers of investment companies.

Section 186 (1) [Loan and investment by company].

Section 186(1) of New Act was introduced w.e.f. 01.04.2014 which provides that investments not to be made through more than two layers of investment companies. The same was not required Section 372A of the erstwhile Companies Act, 1956 i.e. Old Act.

186(1): Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed, make investment through not more than two layers of investment companies.

Provided that the provisions of this section shall NOT affect in the following cases:

(i) If a Company acquires any Company which is incorporated outside India and such Company has Investment Subsidiary beyond two layers as per the law of such country.

(ii) A subsidiary Company from having any investment subsidiary for the purpose of meeting the requirement under any law or under any rule or regulation framed under any law for the time being in force.

The Section 186(1) of the New Act is applicable on all companies except the situation prescribed under the proviso to that section. It is clear that restriction of the investment is only through more than 2 layers of investment companies. Therefore, the definition of the investment company has been provided in Explanation (a) of Section 186 of the New Act as under:

‘Investment Company’ means a Company whose principal business is acquisition or purchase of shares, debentures and other securities.

However, it is to be noted that there is no definition of ‘layer’ under section 186 of the Companies Act, 2013. [But you can see the definition provided in Explanation (d) to Section 2(87) of the Companies Act, 2013 which comes into effect w.e.f. 01.04.2014]

Resultant, Section 186 (1) of the New Act prescribes that a company is prohibited from making investments through more than 2 (two) layers of investment companies. The proviso to Section 186(1) exempts the following companies from the restriction:

(i) companies acquiring foreign companies with 2 (two) or more layers of subsidiaries;

(ii) subsidiary companies having investment subsidiaries for the purpose of meeting the requirements under law.

Modifications to Companies Act, 2013 vide Companies (Amendment) Act, 2017 w.e.f. 07.05.2018.

To address the concerns raised in the New Act, the Government of India enacted the Companies (Amendment) Act, 2017 (‘the 2017 Act’) which received the President’s assent on 1st January 2018 and was notified in the Official Gazette on 7th May 2018. The key amendments that were brought about under the 2017 Act were the changes to Sections 185 and 186 of the 2013 Act, which deals with loans to directors and loan and investment by Company.

By the said amendment the definition of the “Investment Company” has been expanded by insertion of the following, in the explanation in clause (a), after the words “other securities” namely:-

“and company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty percent of its total assets, or if its income derived from investment business constitutes not less than fifty percent as a proportion of its gross income.”

Therefore, the definition of the ‘Investment Company’ in explanation (a) of Section 186 of the New Act are as under:

‘Investment Company’ means a Company whose principal business is acquisition or purchase of shares,  debentures and other securities and company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty percent of its total assets, or if its income derived from investment business constitutes not less than fifty percent as a proportion of its gross income.

Exemption:

In case of Government Companies, Section 186 shall not apply to-

(A) a Government Company engaged in defence production;

(b) a Government Company, other than a listed company, in case such company obtains approval of the Ministry or Department of the Central Government which is administratively in charge of the company, or, as the case may be, the State Government before making any loan or giving any guarantee or providing any security or making any investment under the section- Notification No. GSR 463(E), dated 05.06.2015.

In case of unlisted public company which is licensed to operate by RBI or SEBI or IRDA from the International Financial Service Centre located in an approved multi services SEZ set-up under the SEZ Act, sub-section (1) of Section 186, shall not apply- Notification No. GSR 9(E), dated 04.01.2017.

In case of private company which is licensed to operate by RBI or SEBI or IRDA from the International Financial Service Centre located in an approved multi services SEZ set-up under the SEZ Act, sub-section (1) of Section 186, shall not apply- Notification No. GSR 9(E), dated 04.01.2017.

Proviso to Section 2 (87) of the Companies Act, 2013 w.e.f. 20.09.2017.

Section 2(87) of New Act was introduced w.e.f. 12.09.2013 except the proviso and Explanation (d). The Explanation (d) was enforced w.e.f. 01.04.2014. the proviso was enforced later on w.e.f. 20.09.2017 vide Notification No. S.O. 3086(E) dated 20th September 2017. Section 2(87) which were introduced in the New Act was as under: –

2(87): “Subsidiary Company” or “Subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company-

(i) Controls the composition of the Board of Directors; or

(ii) Exercise or controls more than one half of the total voting power [substituted for total share capital w.e.f 07.05.2018] either as its own or together with one or more of its subsidiary companies;

Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.

Explanation- for the purpose of this clause-

(a) A company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;

(b) The composition of a company’s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it as its discretion can appoint or remove all or a majority of the directors;

(c) The expression “company” includes any body corporate.

(d) “layer” in relation to a holding company means its subsidiary or subsidiaries.

Section 2(87) of the New Act deals with the definition of “Subsidiary Company” or “Subsidiary” and proviso of this Section prohibit prescribed holding companies from having layers of subsidiaries beyond prescribed numbers. ‘layer’ in relation to a Holding Company means its Subsidiary or Subsidiaries.

New Rule the Companies (Restriction on Number of Layers) Rules, 2017 w.e.f. 20.09.2017 pursuant to Section 2(87).

The Ministry of Corporate Affairs notified the Companies (Restriction on Number of Layers) Rules, 2017 (the “Rules”) on September 20, 2017. The Rules have been issued pursuant to Section 2 (87) of the New Act, which provides the Central Government the power to cap the number of layers of subsidiaries that a company may have. The Rules clarify that they are not in derogation of the exceptions to Section 186 (1) of the Act.

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. On and from the date of commencement of these rules, no company, other than a company belonging to a specified class, shall have more than two layers of subsidiaries:

Remarks: The word “layer”, referred to in Section 2(87) of the New Act, means subsidiary or subsidiaries of the holding company. The same word has also been used in Section 186 (1) of the New Act. Given the intent of the section, ‘layer’ refers to vertical limit. For computing the number of layers under this rule, one layer which consists of one or more wholly owned subsidiary or subsidiaries shall not be taken into account.

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Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the authors whatsoever and the content is to be used strictly for educative purposes only.

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One Comment

  1. Brajesh Kumar says:

    Please clarify:

    ABC Limited has its subsidiary (51%) BCD Limited and also BCD Limited has its subsidiary (51%) CDE Limited. Now CDE Limited has its wholly Owned Subsidiary PQR Limited.

    Above mentioned Companies is not Investment Company.

    Whether these layers are permissible under the Companies ACT, 2013 as on current date?

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