EXCEPTION TO HOLDING & SUBSIDIARY COMPANIES

 

Subsidiary company: Section 2(87)

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) Exercises 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. 

Exercises means holding the shares of subsidiary company directly. 

Controls means holding the shares of subsidiary company by another subsidiary company. 

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; 

Ex:- Ekagrata ltd.(Holding company)                        Gyana ltd.(subsidiary company) 
Board of Directors: - H1, H2, H3, H4.                                       S1, S2, S3, S4, S5, S6, S7, S8

1. Ekagrata ltd has the right to remove or appoint 4 Directors of Gyana ltd.= wrong

2. Ekagrata ltd has the right to remove or appoint 5 Directors of Gyana ltd. = correct

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

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

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- 

1. 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) 
2. 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.

So the above provisos means :- 

1) A holding company cannot have more than 2 layers of subsidiary companies either by control or by exercise over them.

Ex:- H Ltd holds shares 53% of equity shares in S1 Ltd. S1 control the power to remove majority of directors in S2 ltd. S1 and S2 holds 70% share in S3 ltd. So Hltd is holding company of only S1 and S2 ltd, not of S3.

Exception of holding subsidiary companies, when a holding co can have more than 2 layers.

1. When holding company holds 100% share in any company it's known as wholly owned subsidiary company. In that case it can have more than 2 layers as shown in above diagram.

2. If the holding company have a subsidiary company which is a foreign company and through that foreign company it holds more than 2 layers of subsidiaries in the foreign country if the law allow so.

3. If there is already more than two layer in the previous companies act then it should also exist in the current companies act.

But once  you decreased the no of layers in the 3rd case then  you can't increase it anymore.

Vide Notification 27th Dec 2013, MCA  clarifies that the shares held by a company or power exercisable by it in another company in a fiduciary capacity shall not be counted for the purpose of determining holding subsidiary relationship.