What is a subsidiary under section 2(87)?

What is a section 2(87) subsidiary?

Section 2(87) of the Companies Act, 2013 makes a company a subsidiary if the holding company controls the composition of its Board of Directors, or exercises or controls more than one-half of its total voting power, either on its own or together with one or more of its subsidiary companies.

The voting-power words are the current test. The Companies (Amendment) Act, 2017 substituted "total share capital" with "total voting power", effective 7 May 2018. A 2014 reprint that still talks about share capital is not the test you apply now.

When does board control create a subsidiary?

Board control under section 2(87) exists when the holding company can, at its discretion, appoint or remove all or a majority of the directors. Explanation (b) says the composition of a company's Board shall be deemed to be controlled by another company if that other company, by exercise of some power exercisable by it at its discretion, can appoint or remove all or a majority of the directors.

The power has to be exercisable at its discretion. A right that only arises if someone else agrees is not that power. Shareholding is irrelevant to this limb. A shareholder with 20% of the votes is still a holding company of that entity if the articles let it appoint three directors on a board of five, and it can do so without asking anyone.

Explanation (a) then pulls the chain up. A company is a subsidiary of the holding company even if the control in sub-clause (i) or (ii) is exercised by another subsidiary of that holding company. HoldCo owns 60% of A, and A owns 60% of B. B is a subsidiary of A, and B is also a subsidiary of HoldCo. Explanation (c) says "company" includes any body corporate, so the subsidiary in this definition need not be an Indian company.

How many subsidiary layers are allowed?

Most holding companies may have two layers of subsidiaries, and not three. The proviso to section 2(87) says such class of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed. Explanation (d) says a layer, in relation to a holding company, means its subsidiary or subsidiaries.

Rule 2(1) of the Companies (Restriction on number of layers) Rules, 2017 is the prescription. On and from the commencement of those rules, no company, other than a company in sub-rule (2), shall have more than two layers of subsidiaries. One layer which consists of one or more wholly owned subsidiaries shall not be taken into account. The rule does not say that every wholly owned layer is free. It leaves out one such layer.

So HoldCo, then a wholly owned subsidiary, then an operating company, then one more subsidiary, is the shape the proviso allows: the wholly owned layer is the one left out, and two layers remain. A further subsidiary under that last company is a third counted layer. The first proviso to rule 2(1) does not stop the company from acquiring a company incorporated outside India that already has subsidiaries beyond two layers, if the law of that country allows it.

Rule 2(3) says these rules are not in derogation of the proviso to section 186(1). The layer cap does not replace the investment limits in section 186. Both can apply to the same group.

Who is outside the two-layer cap?

Rule 2(2) of the layers rules leaves four classes outside the two-layer cap. The cap does not apply to a banking company as defined in section 5(c) of the Banking Regulation Act, 1949, an insurance company carrying on insurance business under the Insurance Act, 1938 and the Insurance Regulatory and Development Authority Act, 1999, or a government company referred to in section 2(45).

The fourth class is narrower than "any NBFC". Rule 2(2)(b) requires a non-banking financial company as defined in section 45-I(f) of the Reserve Bank of India Act, 1934, registered with the Reserve Bank, and considered as systematically important by the Reserve Bank. The rule uses that phrase. An NBFC that RBI has not treated that way stays inside the two-layer cap.

What about companies already over two layers?

A company that already had more than two layers when the rules began could keep those layers, and could not add one. Rule 2(4) applied to a company, other than an excluded class, that existed on or before commencement and already had more layers than sub-rule (1) allows. It had to file a return in Form CRL-1 with the Registrar within 150 days of publication of the rules in the Official Gazette. After commencement it shall not have any additional layer over the layers existing on that date.

If it later reduces layers, it cannot go back above the reduced number, or above the two layers in sub-rule (1), whichever is more. CRL-1 was that one return for companies already over the cap. It is not an annual form. A company that is inside two layers does not file it to "confirm" the structure.

Rule 2(5) sets the consequence of a contravention. The company and every officer in default shall be punishable with fine which may extend to ₹10,000, and where the contravention continues, with a further fine which may extend to ₹1,000 for every day after the first. Read section 2(87) against rule 2 before you add a company under an existing subsidiary, and track a change to the class list on the MCA updates feed.