Multi-layered companies have become a matter of concern for regulators and investors. The Harshad Mehta and Satyam scams and the 2G spectrum controversy were eye-openers in which a web of companies were the investment vehicles.

Now, the Companies Bill lays down restrictions on investing through more than two layers of investment companies. The Bill provides for exceptions such as an outbound acquisition where the target has subsidiaries beyond two layers, or there are more than two investment companies under statutory requirements.

The new provision will bring transparency in shareholding and funding structures. However, there is another side to the story — multi-tier investment companies created for multiple reasons such as fund-raising, concentration of sector-specific expertise, and ease of management and exit. These genuine corporate structures and business transactions too would be covered by the proposal, and this may curb the ability of companies to organise efficiently.

Also, this could hurt many multi-sector groups/ conglomerates in which investments are usually structured in layers. This could particularly debilitate real estate companies and infrastructure firms, which operate across sectors and usually have more than one subsidiary for doing business in India and abroad.

Also, when not structured efficiently, it could erode the flexibility of private equity investors to invest and hive off at any level. For instance, a PE investor desirous of investing in a specific sector may prefer to enter at the sector hold company level or operating company level, rather than industry hold company. For corporates, this could mean an additional hurdle in raising funds, and they may have to revisit their investment strategies.

Even when a strategic joint venture partner is sought by conglomerates for a particular investment, a multi-tier structure enables the separation of such investment. The new imposition could also necessitate structuring such transactions to abide by law as well as comply with the commercial terms agreed upon.

One critical point is that there are existing multi-layered structures (in contradiction to the restrictions under Companies Bill) — would such structures need a revision, or would there be an exception through grandfathering provisions?

Any revision of structures should be carefully thought through, not only for compliance but also the resulting tax implications.

On closer look, there is flexibility if the investment is by a non-investment company, as the proposal does not seem to cover that aspect. “Investment company” is defined as one whose “principal business” is acquisition of shares, debentures or other securities. However, the term “principal business” has not been defined. Clarity is needed to ensure compliance and efficient structuring of investments.

The Bill seeks to address the abuse of multi-tiered investment structures and enhance transparency, besides marching towards a more investor-friendly India Inc. Whether genuine business structures will be able to step up to the change still remains uncertain.

Deepa Dalal, Associate Director — Transaction Tax, contributed to the article

The author is Transaction Tax Leader, EY

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