Status of Subsidiary Private Companies in India – Cross Border Holdings

[The following guest post is contributed by Siddharth Raja, Founding Partner of Samvad Partners. Views are personal, and comments are welcome]The Ministry of Corporate Affairs’ (“MCA”) recent issuance of a notificationproviding for exceptions, modifications and adaptations in the application of the Companies Act, 2013 (the “2013 Companies Act”) to “private companies” has once again revived the debate in India (here, hereand here) on the status of Indian incorporated private companies, especially those that are subsidiaries of foreign bodies corporate. The key issue is this: do such “private companies” retain their incorporation status for all purposes of the 2013 Companies Act; or do they become “public companies” under the 2013 Companies Act?  The issue, thus framed, might appear to present a purely legal debate, or one of semantics.  The need for clarity on which companies fall into the bucket of “private companies” (and, conversely, which don’t and are to be treated as “public companies”) has now come to acquire great significance given the exceptions or exemptions provided to those companies regarded as “private companies”.  For instance, “private companies” do not now need to follow the strict differentiations between equity and preference share capital (and their respective segregated economic and, in particular, voting rights), which has a direct impact on the range, scope, efficacy and enforceability of a wide range of such economic and other rights attaching to investors’ share capital. Upon a review of the applicable legal provisions and the current state of the law, it would be fair to conclusively conclude – it is argued in this post – that a private company subsidiary in India of an overseas body corporate holding company will continue to be a “private company” for purposes of the 2013 Companies Act, and such a private company is not caught-up in those provisions of the 2013 Companies Act deeming it to be a “public company”.  The reasoning is as follows:A)        Under the 2013 Companies Act [proviso to Sec. 2(71))], a “company” which is a subsidiary of a company, not being a private company (emphasis added), is deemed to be a public company for the purposes of that Act, even where such subsidiary company continues to be a private company by its articles. In this post, for ease of reference, this provision is called as the “deeming provision”. In other words, the incorporation status in India of a “company” (which term refers only to those companies incorporated in India under applicable Indian law at the relevant time [Sec. 2(20)]), is irrelevant when it comes to deeming any such Indian private company as an Indian public company on the basis of it being a “subsidiary” of a “company, not being a private company”.This word (“subsidiary”) and this phrase (“company, not being a private company”), as used in this context, are important to analyze, as follows:B)        A “company, not being a private company” must be taken to be a reference only to an Indian company – as the definition of “company” [Sec. 2(20)] and “private company” [Sec. 2(68)] make expressly clear, these provisions and this phrase are restricted in operation under Indian law only to those entities, thus described, as incorporated in India and having the necessary features under Indian law.  The Companies Act, 1956 (the “1956 Companies Act”) [Sec. 3(1)(iv)(c)] had the same provision – a “public company” covers even a private company which is a subsidiary of a company which is not a private company – where the coverage of the term “public company” in the holding – subsidiary matrix did not extend to overseas holding companies.  A fine counter argument in this behalf as to inclusion of “bodies corporate” (i.e., entities incorporated overseas) within the ambit of the holding -subsidiary relationship is dealt with in point # (D) below.C)        The interpretation of the term “subsidiary” used in the above deeming provision, can, therefore, only mean be in reference to an Indian holding company, as the phrase “company, not being a private company” clearly demonstrates.  In other words, the focus shifts from purely an interpretation of just the term “subsidiary”, to an appreciation that the deeming provision only kicks in when the nature or type of the holding company is clear – that holding company must be one which is a “company, not being a private company”.  And, it is manifest that that phrase and the reference to “company” and “private company” therein, covers only Indian incorporated holding companies; thereby, meaning that the deeming provision is only triggered in the Indian subsidiary – holding context, and not in the overseas holding context. This conclusion of mine is further corroborated if one were to examine the legislative background leading up to the 2013 Companies Act. The deeming provision language in the concept paper in 2004 on the draft Companies Bill issued by the MCA stipulated that an Indian company subsidiary of an overseas body corporate incorporated outside India (which would be a public company within the meaning of Indian law, if incorporated in India), shall be a public company.  In other words, the proposal as contained in the concept paper was to do away entirely with the benefit of Sec. 4(7) of the 1956 Companies Act, and include ALL overseas body corporate-held subsidiaries (including wholly owned ones) within the rubric of “public company” in India on such deemed basis.  It may be mentioned in passing that there are striking similarities in this position with that of a discussion recorded by the Companies Act Amendment Committee of 1957 that preceded the insertion of Sec. 4(7) into the 1956 Companies Act, which stated (all emphasis added):“As regards the treatment of private companies, the entire share capital of which is owned by one or more foreign bodies corporate, it is a matter of economic and financial policy for Government to decide, having regard to the position of foreign investments in this country generally, whether or not such private companies should continue, as at present, to remain outside the restrictions imposed on private companies which are subsidiaries of Indian public companies or whether they should henceforth be made subject to these restrictions.  If an alteration of law in this respect is considered desirable, a provision should be inserted in section 4 to the effect that “a private company, which is registered in India and which is a subsidiaryof a foreign public company, shall be deemed to be a subsidiary of a public company for all purposes of this Act” So it seems that, despite the passage of almost fifty years (as in 2000), the Government of India (or, at least, some parts of the Government) was still willing to go by the economic logic of a vastly different, much earlier era, in our nation’s development; and that too a view which, ultimately, came to be rejected by the Government of the day, as evident in Sec. 4(7) of the 1956 Companies Act! However, this proposal as in the concept paper was dropped (and no further discussions on this topic were elicited in the various subsequent committee reports that redrafted the law) and instead, the provision as now enacted simply referenced “a subsidiary of a company, not being a private company” – meaning thereby that the legislative intent, as can be discerned from a plain reading of the statute, is also demonstrated (or underscored) by the way in which the current provision found itself onto the statute books.D)        As a result, it is not surprising to find – and, indeed, on the basis of point #s (B) and (C) above and in order to read the statute harmoniously – that the reference in the definition of “subsidiary” [Sec. 2(87)] to cover the holding relationship even qua an overseas “body corporate” is only for purposes of that clause (and not for the entire 2013 Companies Act), which does not, therefore, extend to the deeming provision; and which this author believes (regardless of whether this is a drafting error or an oversight), to be a restrictive stipulation that needs to be interpreted correctly in context, as regards its applicability to the entire 2013 Companies Act.  This analysis does not even then need to examine the issue as to whether that particular provision in Sec. 2(87) has to be read into the deeming provision, as even the basis for such reading together does not arise, if the scheme separating the deeming provision and 2(87) is properly appreciated in the case of an overseas body corporate holding company.    In other words, since Sec. 2(87) includes a substantive provision that enables the Government to prescribe such class or classes of holding companies that will not have layers of subsidiaries beyond a number they can prescribe (a provision not yet notified to be in force), it is for such prescriptive requirements that the overseas holding – subsidiary relationship falls within the definition of “subsidiary”; not with a view to impinge on the status of the Indian private company subsidiary of such overseas holding body corporate in such cases, which is a deeming requirement entirely in the Indian holding context as properly interpreted in point #s (B) and (C) above. It is pertinent to note that the 1956 Companies Act also had a similar stipulation – that the expression “company” in this section(i.e., Sec. 4) includes any body corporate; although, the 1956 Companies Act did have the benefit of Sec. 4(7).So, to address those who would seek to interpret an incorporation of “body corporate” into the term “company” for purposes of the deeming provision, there is actual legislative force as to why Sec. 2(87) makes such inclusion only for purposes of that clause – and for no other provision of the 2013 Companies Act.  Consequently, there can be no reason not to follow the principle of giving effect to such express words of Sec. 2(87) (especially where no other conflict with other provisions arise); meaning, thereby, that the position of an India incorporated private company subsidiary of an overseas body corporate is untouched by the deeming provision and, as a result, for all consequent purposes of the 2013 Companies Act.The clarification issued by the MCA admittedly affirms this position; but, its analysis is incomplete and does not do full justice to the scheme of the 2013 Companies Act, as explained above.  To the extent its conclusion may be regarded as matching the above analysis, this circular may be considered (although merely persuasive in effect), with reliance being better placed on a proper appreciation of the harmonious working (and proper comprehensive reading of the wording) of the appropriate provisions of the 2013 Companies Act itself lending greater credibility to the conclusion this article makes – to reiterate, that private company subsidiary in India of an overseas body corporate holding company will continue to be a “private company” for purposes of the 2013 Companies Act. – Siddharth Raja

Source: Corporate

Leave a Reply