Computing Materiality of subsidiary with Negative Net Worth under Regulation 16 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015:
In terms of Regulation 16(1)(c) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”), a “material subsidiary” means a subsidiary, whose turnover or net worth exceeds ten percent of the consolidated turnover or net worth respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year.
1. Manner of evaluation of Negative Net worth:
Determine if the subsidiary’s standalone financial position has a material impact (positive or negative) that alters the consolidated net worth by more than 10%. Regulation 16(1)(c) states that a subsidiary is material if its income or net worth exceeds 10% of the consolidated income or net worth respectively, in the immediately preceding accounting year.
The standard calculation formula to identify materiality is:
(a) Compute the consolidated Net worth
(b) Compute 10% of the consolidated Net worth
(c) Compute the Subsidiaries Net worth
(d) Compare (b) & (c)
(e) If (c) > (b), then it is a material subsidiary
Scenario A: Positive Subsidiary Net Worth, Negative Consolidated Net Worth
(a) Consolidated Net Worth: minus ₹400 Crores
(b) 10% of the consolidated Net worth is minus ₹40 Crores
(c) Subsidiary Net Worth: plus ₹50 Crores
(d) Plus ₹50 Crores > minus ₹40 Crores; (c) > (b)
(e) Result: Material Subsidiary.
The positive net worth of the subsidiary significantly reduced the group’s overall negative net worth pool by more than 10%.
Scenario B: Negative Subsidiary Net Worth, Positive Consolidated Net Worth
(a) Consolidated Net Worth: plus ₹400 Crores
(b) 10% of the consolidated Net worth is plus ₹40 Crores
(c) Subsidiary Net Worth: minus ₹50 Crores
(d) Minus ₹50 Crores (c)
(e) Result: Not a Material Subsidiary.
Scenario C: Both Subsidiary and Consolidated Net Worth are Negative
(a) Consolidated Net Worth: minus ₹400 Crores
(b) 10% of the consolidated Net worth is minus ₹40 Crores
(c) Subsidiary Net Worth: minus ₹50 Crores
(d) Minus ₹50 Crores (c)
(e) Result: Not a Material Subsidiary.
2. Rule for interpretation of statue
Unlike Regulation 30(4)(c)(3) which specifically mentions that “five percent of the average of absolute value of profit or loss after tax, as per the last three audited consolidated financial statements of the listed entity” there is no specific mention in Regulation 16, in the absence of specific mention it is not appropriate to interpret the Regulation in a particular manner based on logical reasoning.
Regulation literally does not allow you to change the actual mathematical value (the positive or negative sign) and use the absolute value for calculating a material subsidiary.
According to the Plain Meaning Rule for interpretation of statue, if a law’s text is crystal clear, explicit, and does not cause an absurd result, one must enforce it exactly as written—even if it seems unfair or poorly targeted. We cannot invent a “better purpose” to override plain wording.
According to the Golden Rule of Interpretation, one should stick to the literal text unless it yields a completely absurd, unjust, or impossible result. If it does, it is legally permitted to modify or “do violence” to the literal language to rescue the law’s actual purpose.
3. Formulate a policy for determining ‘material’ subsidiary.
Experts believe that using actual mathematical values when net worth is negative leads to algebraic absurdities that completely defeat the purpose of investor protection under SEBI (LODR) Regulations.
Certain corporates misinterpret the provision based on experts’ interpretation of the Regulation to use absolute terms (ignoring the negative mathematical signs) when dealing with negative net worth, to assess the true impact on the consolidated group because they believe following strict algebraic rules creates absurd results,
Further Explanation to Regulation 16(1)(c) states that the listed entity shall formulate a policy for determining ‘material’ subsidiary.
If you want to evaluate materiality based on absolute values then Review Your Board Policy to ensure that your company’s Board-approved “Policy for Determining Material Subsidiaries” clearly addresses the use of absolute numbers for negative financial parameters.
Do not rely on net worth alone. Even if net worth calculations are distorted, if the subsidiary’s income exceeds 10% of the consolidated income, it automatically qualifies as a material
*****
– N P Mathi Lingan, B.Com, MCA, MBA(Fin), FCA, ACS, CMA(Fin)
Author Bio
