Layering Restrictions in Companies Law

Layering restrictions under Indian Companies Law refer to limitations placed on the number of subsidiary companies that a company can establish in a chain of ownership or control. These restrictions aim to prevent the misuse of corporate structures for purposes such as money laundering, tax evasion, diversion of funds, and the concealment of beneficial ownership. By imposing a ceiling on the number of layers of subsidiaries, the law ensures transparency, accountability, and easier regulatory oversight in corporate operations.

Background

The concept of layering restrictions was introduced as part of India’s broader effort to promote corporate transparency and curb the misuse of complex company structures. Before these restrictions were implemented, many companies had created multiple layers of subsidiaries, often spread across jurisdictions, to obscure ownership, shift profits, or manipulate financial statements.
The Companies Act, 2013, under Section 2(87) and relevant rules notified by the Ministry of Corporate Affairs (MCA), laid the foundation for regulating subsidiary structures. Later, the Companies (Restriction on Number of Layers) Rules, 2017 were notified to operationalise these provisions. These rules represent an important component of India’s corporate governance reforms, aligning domestic practices with global standards of transparency and anti-money laundering regulations.

Objective of Layering Restrictions

The primary objectives of introducing layering restrictions are:

• Transparency: To reveal the ultimate beneficial owners of corporate structures and prevent concealment through complex layering.
• Accountability: To ensure clear lines of responsibility in group companies.
• Prevention of misuse: To deter the use of multiple layers for siphoning off funds, round-tripping of capital, and illicit financial activities.
• Ease of regulation: To simplify supervision by regulatory authorities such as the MCA, SEBI, and the Reserve Bank of India (RBI).
• Corporate governance: To promote ethical business practices and prevent the creation of shell entities.

Legal Framework

Section 2(87) of the Companies Act, 2013

Defines a subsidiary company as one in which another company — referred to as the holding company — controls the composition of its board of directors or exercises or controls more than one-half of its total share capital, either directly or indirectly.

Companies (Restriction on Number of Layers) Rules, 2017

The Rules, which came into effect on 20 September 2017, were issued under the powers granted by Section 469 of the Companies Act, 2013. They prescribe the maximum number of subsidiary layers a company may have and the conditions for compliance.

Key Provisions of the 2017 Rules

1. Maximum Number of Layers Permitted

• A company cannot have more than two layers of subsidiaries, whether directly or indirectly.
• This restriction applies to both Indian and foreign subsidiaries, meaning that any subsidiary formed outside India is also counted towards the permitted limit.
• However, one layer of wholly owned subsidiaries (WOS) is exempted from being counted towards the layering limit.

2. Exceptions to the Restriction

Certain companies and situations are exempt from the layering restriction:

• Banking companies, non-banking financial companies (NBFCs), insurance companies, and government companies are exempt, given their operational requirements and regulatory oversight by specialised agencies.
• Acquisition of foreign companies: If an Indian company acquires a foreign company that has subsidiaries beyond the prescribed layers under the law of that foreign country, such a structure is permitted.
• Subsidiaries incorporated before 20 September 2017: Existing corporate structures with more than two layers prior to the introduction of the Rules were permitted to continue, though they are prohibited from adding further layers.

3. Filing and Disclosure Requirements

• Every company with more than two layers of subsidiaries at the commencement of the Rules must file details of such subsidiaries in Form CRL-1 with the Registrar of Companies (ROC) within the prescribed time.
• Companies must also disclose the names and corporate identification numbers (CIN) of all their subsidiaries in annual financial statements.

4. Restriction on Further Layering

• Companies with existing multiple layers are not allowed to create or acquire any additional subsidiary beyond the existing structure.
• If any layer is dissolved or disposed of, it cannot be replaced with a new one if doing so would exceed the permissible limit.

Purpose and Rationale

The rationale behind restricting the number of subsidiary layers lies in combating the risks associated with opaque corporate structures. In the absence of restrictions, companies could:

• Conceal beneficial ownership and ultimate control.
• Divert funds through multiple entities to evade tax or launder money.
• Engage in fraudulent activities by using shell companies.
• Obstruct regulatory oversight and financial transparency.

By limiting the number of layers, regulators can better trace ownership patterns, identify related-party transactions, and monitor the flow of funds across corporate networks.

Implications for Companies

The layering restrictions have several practical implications for Indian corporate groups:

• Simplification of structures: Companies are encouraged to consolidate subsidiaries and eliminate redundant layers.
• Compliance burden: Entities must review and restructure their holdings to ensure conformity with the law.
• Enhanced disclosures: Companies are now required to maintain accurate and transparent records of all subsidiaries.
• Impact on global operations: Multinational enterprises must ensure their Indian operations comply with both domestic and foreign laws relating to corporate layering.

Enforcement and Penalties

The Ministry of Corporate Affairs, through the Registrar of Companies, monitors compliance with the layering restrictions. Any violation of these rules may attract penalties under the Companies Act, 2013, including monetary fines and potential disqualification of officers in default. Moreover, persistent non-compliance can lead to regulatory investigations and restrictions on further expansion.

Advantages of Layering Restrictions

• Enhanced transparency: Simplifies the identification of beneficial owners and related-party transactions.
• Corporate discipline: Discourages formation of shell entities and round-tripping of funds.
• Improved investor confidence: Ensures clearer corporate structures, enhancing credibility in financial markets.
• Ease of supervision: Facilitates monitoring by auditors, regulators, and financial institutions.
• Alignment with global norms: Reflects international best practices on anti-money laundering and beneficial ownership disclosure.

Criticism and Challenges

Despite their advantages, layering restrictions have also faced certain criticisms:

• Operational rigidity: Large conglomerates argue that a two-layer limit restricts legitimate business expansion, particularly in sectors requiring multiple operational subsidiaries.
• International competitiveness: Multinational corporations contend that such limitations may discourage investment by making structuring less flexible than in other jurisdictions.
• Complex global compliance: Cross-border structures involving foreign subsidiaries may face practical challenges in reconciling Indian restrictions with foreign laws.
• Transition burden: Companies with pre-existing complex hierarchies face difficulties in restructuring and ensuring compliance.

Significance and Future Outlook

The layering restrictions represent a significant milestone in India’s journey toward stronger corporate governance and anti-money laundering safeguards. They enhance transparency, discourage the misuse of shell companies, and align Indian corporate regulations with global financial integrity standards.
Going forward, as India continues to attract foreign investment and foster multinational business operations, there may be periodic reviews to strike a balance between transparency requirements and business flexibility. The government and regulators are expected to refine the framework to accommodate legitimate commercial needs without compromising on accountability and ethical corporate practices.