Article. MCA s deemed clarification on Foreign Subsidiary Status. CS Esha Chakraborty CS Shampita Das

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1 Article MCA s deemed clarification on Foreign Subsidiary Status CS Esha Chakraborty esha@vinodkothari.com CS Shampita Das shampita@vinodkothari.com June 26, 2014 (as updated on August 05, 2016) Check at: Copyright: This document is the property of Vinod Kothari & Company and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This document is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 Continuing with the intent of infusing clarity to somewhat ambiguous drafting of regulations, the Ministry of Corporate Affairs (MCA) on June 26, 2014 came with the major clarification on the deemed public company status of subsidiaries of foreign companies. Considering the consequence arising from the absence of the deeming provision of subsection (7) of Section 4 of the Companies Act, 1956 ( Act, 1956 ) by which the status of all such Indian subsidiaries having foreign holding entities changed; this stance, somehow, does bring some relief to all such entities. But, unsurprisingly, the drafting ineptitude prevails to bring in some new ambiguities in picture! Let us understand through a step by step analysis what was the plausible impact arising from the provisions of Companies Act, 2013 ( Act, 2013 ) and how far this clarification grants relief. Position under the Companies Act, 1956 The erstwhile Act, 1956 laid down the defining clause for deemed public companies under Section 3 (1) (iv)(c), which provisioned that a private company which is a subsidiary of a public company, would also be considered as a public company. However, by virtue of sub-section (7) to Section 4, which defined holding subsidiary relationships, private companies being subsidiaries of foreign body corporate(s) were exempted from the above compulsion of being treated as deemed public company. It was this saving section, which provided that a private company being a subsidiary of a foreign body corporate would not be deemed to be a public company if: (a) the foreign body corporate, if incorporated in India, would have been a private company; and (b) the entire share capital in the Indian subsidiary was held by that foreign body corporate, either alone or together with more foreign bodies corporate. In all other cases, such private companies would grow out of their skin of being a private company and be deemed to the status of a public company. In such scenario, the privileges available with private companies would not be available to them. Enter Companies Act, 2013 With major streamlining of regulatory structures, some most welcoming, a few glaring loopholes have also been brought forth. This exemption granted under Section 4(7) of Act, 1956 has been left out from the Act, 2013, which left us with the obvious interpretation that all private companies, even being subsidiaries of foreign bodies corporate, would now be deemed to be public companies for the purposes of the Act, Let us assimilate the basis of our above interpretation:

3 The proviso clause of Section 2 (71) of the Act, 2013 lays down the concept of deemed public company, stating a company which is a subsidiary of a company, not being a private company, shall be deemed to be public company for the purposes of this Act even where such subsidiary company continues to be a private company in its articles; The definition of subsidiary, here, would derive its meaning from Section 2 (87) which defines subsidiary and wherein, the expression company, i.e, the holding company, includes any body corporate. One can see, the word company used in this context in an expansive sense and would include all bodies corporate and Body Corporate by virtue of its very definition, drawn from Section 2(11) of the Act, 2013, also includes a company incorporated outside India. Hence, for the purpose of defining a subsidiary company in relation to a holding company, company would definitely mean a foreign company as well. In light of the above, Section 2 (87) gives rise to two scenarios The subsidiary company is an Indian company with the holding entity as a foreign company; and The subsidiary company is a foreign company with the holding entity as an Indian company. Here, we need to understand that the relevance of this definition section is that it will apply to the entire Act and the Rules made thereunder. Accordingly, wherever the word subsidiary in relation to a company is used under the Act, the above interpretation would undoubtedly apply. Therefore, in the above two scenarios, this subsidiary could be a subsidiary of a body corporate, being a foreign company. Thus, it can be summed up that a private company, being a subsidiary of a foreign holding company, will be deemed to a public company under the Act, Implications of the deeming status Given this, can we say that a private company which has been deemed to be a public company loses the core values of its constitution viz. (a) minimum paid up capital of Rs. 1 lakh, (b) minimum and maximum number of members (min. 2 and max. 200) and (c) minimum number of two directors? In our view, that will not be the case and such companies will continue to remain private as per its articles of association. A supporting view was held in the landmark judgment of the Supreme Court in Needle Industries (India) Ltd., &Ors. vs. Needle Industries Newey (India)

4 Holding Ltd. & Ors. 1 dated May 7, 1981, wherein it was held that a private company which becomes a deemed public company would continue to retain the three basic characteristics of a private company. Such a deemed public company, therefore, would retain the fabric of its constitution and would not have to give up its statutory status with which it was incorporated. However, by becoming a deemed public company, it still have to comply with the corporate governance norms as applicable to a public company. For instance, constitution of audit committee and nomination and remuneration committee, appointment of internal auditors and Limits on Managerial Remuneration. Finally, clarification from Ministry The significant effects of the deeming provisions on subsidiaries of foreign companies had created quite a ripple in the corporate sector. Companies which were not deemed public companies by virtue of Section 4(7) of the erstwhile Act, suddenly faced with the thoughts of huge compliance burden. Our Ministry with its ardent interest in rendering slow comforts to India Inc. has yet again come up with another Circular 2, meaning to clarify the status of subsidiaries incorporated or to be incorporated by foreign holding companies. But of course, again, with the usual drafting skills, the MCA has left it to one s imagination to decipher its intent. Though the first para of the Circular draws attention to the fact that the deeming provision of Section 4 (7) of Act, 1956 was missing in the Act, 2013; it failed to capture the fact that the exemption from deeming provision under Act, 1956 would still be applicable under the Act, Instead, it goes on to say, such subsidiary company with foreign holding company(s) would continue to act as a private company or public company, as the case may be, without any change in the incorporation status of such company. As explained earlier, there was anyway no ambiguity in the understanding w.r.t. to the incorporation status of a deemed public company and they would have still retained their statutory constitution only. See also our discussion under heading, Implications of the deeming status. Thus, instead of stating the obvious intent of the Circular, as evident from the first para, the Circular completely disconnects in the second para, and moves on to state the obvious! Further, deliberating over the language used, here are few more thoughts to mull over Circular states that an existing company, being a subsidiary of a company incorporated outside India would continue to be a private or public company without any change in the incorporation status. So, apparently, it deems to suggest that subsidiaries of only companies incorporated outside India would be covered by this clarification. However, the language used in the

5 Act, 1956 as well as Act, 2013 covered all bodies corporate and not merely foreign companies. If this is the case, then the stake held by limited liability corporations (LLCs), association of persons and other bodies corporate incorporated outside India, in the Indian subsidiary cannot be considered for determining the exemption status from the deeming provisions. Perhaps, this could create more problems than solving the same. The erstwhile Section 4(7) clearly stated one of the preconditions to avail the exemption clause is that, the entire share capital of the Indian private company should be held by the overseas bodies corporate. In the absence of the said deeming provision or any such exemption clause in the new legislation, are we left to assume that every subsidiary of the foreign company may still avail the exemption on this front? As of now, the Circular, somehow, blatantly overlooks to render any light on this. To read our other articles on The Companies Act, 2013: click here To read our other articles on various subjects: click here