Friday, June 27, 2014

Guest Post: MCA’s ‘Deemed’ Clarification on Foreign Subsidiary Status

[The following post builds upon two previous posts, here and here.

In this, Esha Chakraborty and Shampita Das of Vinod Kothari & Co. raise some further concerns regarding the recent clarification issued by the Ministry of Corporate Affairs. The authors may be contacted at and respectively.]

Continuing with the intent of infusing clarity to somewhat ambiguous drafting of regulations, the Ministry of Corporate Affairs (MCA) on June 26, 2014 came out with a major clarification on the deemed public company status of subsidiaries of foreign companies.

Considering the consequences arising from the absence of the deeming provision of sub-section (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, some drafting ineffectiveness prevails to bring in some new ambiguities into the picture!

Let us understand through a step by step analysis as to 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 provided 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 omitted 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, 2013.

Let us assimilate the basis of our above interpretation:

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, 2013.


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) Holding Ltd. & Ors. 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, appointment of independent directors, constitution of audit committee and nomination and remuneration committee, appointment of internal auditors, rotation of directors 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, were suddenly faced with the prospect of huge compliance burden.

The MCA has yet again come up with another Circular, meaning to clarify the status of subsidiaries incorporated or to be incorporated by foreign holding companies. But of course, again, due to some ambiguities in the drafting strucutre and language, 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, 2013.

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 with respect to the incorporation status of a ‘deemed public company’ and they would have still retained their statutory constitution. 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 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 fails to render any light on these matters.

- Esha Chakraborty and Shampita Das

1 comment:

vswami said...


The “some further concerns raised herein” may have to be read together with the observations / concerns raised
In the previous article titled,-
MCA Clarifies on Status of Private Subsidiary of a Foreign Company
As indicated/implied in the comment on the latter, the new provisions of the 2013 Act, rwt the MCA clarification might have irresolute implications for taxation of such companies now on.
For an appreciation of the angle in one’s mind, it needs to be noted:
a) In the new corporate law, section 43A of the erstwhile law has been deleted; and in place, the corresponding provisions incorporated are as revamped and freshly drafted/structured.
b) In the 1961 IT Act (as amended from time to time), the related provisions , -refer section 2 (18), (besides section 104, 108 , later deleted) are those as drafted and enacted having regard to the erstwhile company law.
To one’s information (subject to correction if anyone else’s is different), there is no clue whether, and when, the IT Act would be amended so as to bring it in line/alignment with the new company law. There is no gainsaying that, by necessary inference, till then, the legal position for taxation of such companies would, it seems certain, remain muddled and be in limbo.
Should the foregoing observations be regarded to be not without substance or merit, then to simply say, - over to the concerned ministries / empowered authorities for being looked into, on a war footing.
Open / subject to differing viewpoints, if any, of both company law and (cum!) tax experts.