The Companies Act of 2013 (hereinafter referred to as “the Companies Act”) has made provision for various types of companies. In the Companies Act, among others, a company may be termed as a separate legal entity and is further categorized in various manners, such as, for example, a private company, a public company, a holding company, or a foreign corporation. Depending on the shareholding pattern of the company, the charter documents of the company classifies themselves among one of the abovementioned companies.
In particular, the Companies Act makes special provision for subsidiary company. A subsidiary company is intended as a company over which the wholly owning company has control, and the Companies Act recognizes it as a separate legal entity at conditions that certain parameters are met. The subsidiary company being a separate legal entity enjoys independency in terms of raising its own capital through equity or debt and also provides protection to the extent of its limited liability to the holding company.
In addition, the Company Act along with the Securities and Exchange Board of India (“SEBI”) has made special provision for governance of such subsidiary companies.
At first glance, the Company Act states that the holding company shall have invested in the majority of capital into the subsidiary. Secondly, the Act has laid down a test to determine whether a certain company is subsidiary of the holding company or otherwise. According to the provision, a company is a subsidiary of another company if any one of the following conditions are met:
Furthermore, from a management point of view, the Company Act makes provision for consolidation of financial statement of the subsidiary company with the holding company. The consolidation of accounts shall be done as per the Schedule III of CA 2013 and the applicable accounting standards i.e., Indian Accounting Standards (“Ind AS”) 110, which requires a holding company that controls one or more other subsidiaries to present consolidated financial statements.
Another restriction is applicable to subsidiary companies whereby they are prohibited from holding shares in it’s holding company. However certain exceptions have been granted to the subsidiary company as they are permitted to hold shares as legal representatives and/or , as trustees of the holding company..
Further under the latest amendment, the Company Act prohibits the holding company to hold any shares of the subsidiary its own name or in the name of any trust on account of any change in the nature of its shareholdings as a result of compromise or arrangement made by the subsidiary company . Such shares of the subsidiary company shall be cancelled or extinguished upon such compromise or arrangement.
Further restriction has been laid on the holding company and the subsidiary by way of Companies (Restriction on Number of Layers) Rules, 2017. These Rules place restriction on number of layers of subsidiaries that provides that a company is not allowed to have more than 2 (two) layer of subsidiaries and also includes investment companies along with other entities.
Lastly, the advantage has been placed in the hands of the holding company whereby, the holding company has the power to appoint and remove the entire Board of directors of subsidiary company by way of an ordinary resolution.
A subsidiary is an entity over which a wholly owned entity has control, however it is still categorized as separate legal entity. There are various reasons for setting up of subsidiary companies mainly due to flexibility in operation of different units and expansion in different geographies. On account of the enactment of the new Rules as mentioned above the holding company has now better clarity on the governance of its subsidiary.
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