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Friday, March 29, 2024
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HomeOpinionNew notification on corporate layering will limit growth and disadvantage Indian companies

New notification on corporate layering will limit growth and disadvantage Indian companies

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The government has chosen to carpet bomb domestic companies in its bid to crack down on money laundering instead of resorting to a surgical strike.

The government’s recent notification limiting the number of subsidiaries a company can have to two, was aimed ostensibly at reducing black money and money laundering. The logic is that “shell” companies are a conduit for money laundering.

Now, new companies cannot have more than two layers of separation between themselves and their holding company.

The government has once again chosen to carpet bomb domestic companies in its bid to crack down on money laundering instead of resorting to a surgical strike. While it is true that subsidiaries can be “shell” companies that are misused for illegal financial gain, corporate layering also has legitimate uses.

In fact, in the Vodafone tax case, the Supreme Court has expressly ruled that a complex transnational corporate layering structure is legitimate. These structures exist in a purely domestic arena also, where a domestic mid-size company may have different subsidiaries for different sectors of operation, which may then set up further subsidiaries, either for tax reasons, or as special purpose vehicles, or to attract investment for particular projects.

This regulation will restrict legitimate activities, making it harder for businesses to attract investment, because new investments often require new entities to be set up as subsidiaries.

The government is cognisant of this difficulty and has tried to address it by excluding exclusively investment companies from this regulation. But unfortunately that is not enough because, in reality, investment doesn’t always come from pure investment companies.

The implications of these restrictions are perhaps even worse at a time when investment and job creation need to be ramped up amid the slowing economy. The regulation excludes overseas companies putting domestic companies at a competitive disadvantage.

The benefit of this regulation is unclear – in particular the arbitrary restriction of not more than two layers — especially since the sort of “shell” companies often used for money laundering are set up not through the kind of corporate layering that is being restricted but through proxies with no working address.

The inter-government Financial Action Tax Force (FATF), and OECD have published reports in the early 2000s on the issue of money laundering, and there have been numerous policy changes internationally on laws governing transparency of the beneficial ownership of companies. However, none of the policy recommendations have included a blanket restriction on corporate layering.

The primary focus on addressing shell companies and misuse of corporate layering is on transnational ownership, specifically excluded from the current rules. Each structure has a risk of misuse, but the recommended policy to address it is codification and unification of rules that increase transparency across jurisdictions. Shell companies being used for illegal activities should be dealt with on a case-by-case basis rather than a blanket restriction, which is not only onerous for businesses but also very difficult to implement because a company does not control or necessarily know the corporate form of its investors.

The Company Law Committee, in 2016, in reviewing the provisions of the Companies Act, 2013, had specifically recommended against restrictions on layering, as such a restriction would have “substantial bearing on the functioning, structuring and the ability of companies to raise funds”. Earlier, in 2005, the Justice Irani report on the same subject had recommended that a law restricting layers of corporate ownership would not be advisable as it would pre-empt the decision as to what structure is appropriate for controlling businesses.

Justice Irani held that such presumptions would make the environment rigid and put Indian companies at a disadvantage vis-à-vis foreign competition, and not facilitate corporate planning. The Parliamentary Standing Committee echoed this position.
The government chose to ignore both national and international opinion in passing this regulation. Indian companies may have to go through mass restructuring. Innovative methodologies, or jugaad, will be necessary for companies to put in place structures for perfectly legitimate economic reasons. Those who fall afoul of the law, either for willful criminality or neglect, face criminal action, heavy fines, and even prison.

But the blame for passing this regulation that was not debated in Parliament and not subjected to the scrutiny of a democratic process does not rest with this government alone. It is the UPA’s Companies Act, 2013, that has enabled this government in this regard. The Act is fundamentally flawed because it allows the executive to amend and implement the law at will, without having to undergo the Parliamentary legislative process. It has also led to substantial unpredictability.

And, like in the case of demonetisation, we might learn too little, too late, as to what effect this has on black money.

Avi Singh is an advocate who specialises in transnational law and serves as the Additional Standing Counsel for the government of NCT of Delhi.

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