Proposed Layering restrictions in Companies Law

To check against illicit fund flows, the Ministry of Corporate Affairs is expected to come up with restrictions on the number of subsidiaries a corporate body can have under the companies law. To this effect, the Ministry has floated the draft norms for public consultations.

Need

The Ministry of Corporate Affairs has received many complaints regarding the misuse of multiple layers of companies, where these firms create shell companies for diversion of funds. The proposal is an effort by the ministry to crack down on shell companies that are involved in dubious activities.

Salient Facts

The “layering restriction on investment subsidiaries” provision for a certain class of corporates is already a part of the Companies Act, 2013. But the provision is yet to be implemented. The provision restricting the holding companies from having subsidiaries beyond a prescribed number is contained in clause (87) of section 2 of the Companies Act, 2013. The provision that was incorporated in the Companies Act, 2013 aims to check misuse of multiple layers of subsidiaries for diversion of funds as a measure of minority investor protection.

As per the proposal, a holding company would be permitted to have only up to two layers of subsidiaries excluding one layer of the wholly-owned subsidiary.

Banking Companies, non-banking financial companies, insurance firms, and government companies are exempted from the restrictions.

The ministry of corporate affairs will make amendments to the Companies (Specification of Definition Details) Rules, 2014.

In addition, the ministry has sought explanations from nearly 3 lakh suspected shell companies that are not carrying out business for a long time.The ministry is also preparing a database of shell companies to check illegal activities carried out by this companies.

Implications

The draft rules are proposed to be implemented prospectively. This means the existing holding companies will be required to reduce the existing layers of subsidiaries. Out of the 16 lakh registered companies in the country, around 11 lakh of them are active.

The crack down on shell companies which are used for large-scale money laundering and tax evasion would benefit the economy.