Legal Alert on Layering Restrictions October Issue

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The Companies (Restriction on number of layers) Rules, 2017

2017

Introduction

The Ministry of Corporate Affairs (MCA) notified the proviso to section 2(87) of the Companies Act, 2013 (2013 Act) and the Companies (Restriction on number of layers) Rules, 2017 (Rules) on 20 September 2017 vide notifications S.O. 3086 (E) and G.S.R. 1176 (E) respectively (Notifications).

Change in Law

The Notifications impose restrictions on the number of layers of subsidiaries of a holding company. The effect is that a holding company cannot have more than 2 (two) layers of subsidiaries.

Importantly, the Rules clarify that (i) for computing the number of “layers,” a layer consisting of one or more wholly owned subsidiary or subsidiaries (WOS) will not be taken into account and (ii) Indian companies may acquire a foreign company with subsidiaries beyond two layers, as per the laws of such country.

Prior to the Notifications, the only layering restrictions under the 2013 Act were with respect to investment companies (these layering restrictions continue to be applicable).

To dos for new and existing companies

New companies
Companies incorporated after 20 September 2017 (new companies) are subject to the layering restrictions under the Notifications. Therefore, promoters should ensure that new companies are not incorporated with more than 2 (two) layers of subsidiaries.

Existing companies

Companies that were already in existence on 20 September 2017 and have more than two layers of subsidiaries (existing companies) face reporting requirements. Existing companies should file a return in form CRL-1 by 17 February 2018, with the Registrar of Companies (ROC).

The Rules prohibit additional layers of subsidiaries over and over and above the layers existing on 20 September 2017.

Further, in case the number of layers of an existing company is reduced, the company should ensure it does not exceed the number of layers it has after such reduction or the maximum number of layers allowed, whichever is more.

Example 1: Company A had 4 (four) layers of subsidiaries on 20 September 2017. One year later, on 20 September 2018, the number of layers of subsidiaries of Company A is reduced to 3 (three). Company A cannot have more than 3 (three) layers of subsidiaries after 20 September 2018.

Example 2: Company B has 2 (two) layers of subsidiaries on 20 September 2017. One year later, on 20 September 2018, the number of subsidiaries of Company A is reduced to 1 (one). Company B can still have 1 (one) more layer of subsidiaries after 20 September 2018 since the maximum number of layers allowed is 2 (two).

Are you exempted from the layering restrictions?

The following classes of companies are exempted:

  1. A banking company under the Banking Regulations Act, 1949
  2. A systematically important nonbanking financial company under the Reserve Bank of India Act, 1934
  3. An insurance company under the Insurance Regulatory Development Authority Act, 1999
  4. A government company under the Companies Act, 2013

What happens if you do not comply with the layering restrictions?

In case of contravention of any of the provisions of the Rules, the Rules impose a fine on the company and every officer of the company who is in default. The maximum amount of the fine is INR10,000 (rupees ten thousand). Where the contravention is a continuing one, the Rules impose a further fine, up to a maximum of INR1,000 (rupees one thousand) for every day during which the contravention continues.

Implications

As per the MCA, the purpose of the layering restrictions is to combat the use of multiple layers of subsidiaries for money laundering and siphoning off of funds.

However, the layering restrictions may also have an adverse impact. In its 2016 report, the Companies Law Committee highlighted its primary concerns as (i) the negative impact on companies engaged in legitimate businesses through multiple layers of subsidiaries and (ii) the existence of alternate routes through which siphoning off of funds could take place.

Furthermore, the filing requirements may prove to be particularly onerous for companies within the same group (group companies). Group companies would have to closely examine the inter-linking relationships between them and consequently make several overlapping disclosures.