The status of a subsidiary company is always associated with its parent company. There is no change in the status of a public company whether it is subsidiary or holding company and it always remains a public company However the status of a private company which is a subsidiary of a public company changes the status of such subsidiary company. The law treats such company akin to that of a public company and subjects it to stringent legal compliance with out altering its private status. In other words a private company subsidiary of a public company is a hybrid company which is "private company" for certain purposes and "public company" for certain purposes. The position of an Indian private company which is subsidiary of a foreign public company is quite peculiar and totally different from the status of an Indian private company which is subsidiary of an Indian company. In this article the relevant legal provisions of the Indian Companies Act, 1956 applicable to an Indian private company subsidiary of a foreign company are critically analyzed to examine the legal status of such a private company.
Relevance of the terms "Company" and "Body corporate".
As per Sections 2(10), 2(35) and 2(37) of the Act the terms ‘company’, ‘private company’ and ‘public company’ mean a company as defined in section 3. According to the definition given under section 3, "company" means a company formed and registered under the Act or an existing company. "Private company" has been defined to be a company having a minimum paid up capital of one lakh rupees and which by its articles restricts the right to transfer its shares, limits the number of members to 50, prohibits any invitation to the public to subscribe for any shares or debentures and prohibits any invitation or acceptance of public deposits. "Public company" has been defined to be a company having a minimum paid-up capital of five lakh rupees and which, in the first instance, is not a private company and which in the second instance, is a private company subsidiary of a public company.
Thus the term "company" essentially denotes an organisation registered under the Act either as a "private company" or "public company". A company incorporated out side India is not a company within the meaning of the definition company.
Section 2 (7) which defines the term "body corporate" runs as under:
"body corporate" or "corporation" includes a company incorporated outside India but does not include__
- a corporation sole:
- a co-operative society registered under any law relating to cooperative societies ;and
- any other body corporate (not being a company defined in this Act) which the Central Government may, by notification in the Official Gazette,specify in this behalf"
The term body corporate is wider than the term company because it includes a foreign company. It is important to keep in mind that the term "body corporate" is not equivalent to the term "incorporated company" because every incorporated company is a body corporate but not every body corporate is an incorporated company.1
This distinction is very crucial because the term body corporate used in section 4 (5) of the Act essentially means an incorporated company of foreign origin and not any other bodies corporate.
Relevance of the terms "Holding company" and "Subsidiary company".
Relevant portion of section 4 runs as under
(1). For the purpose of this Act, a company shall, subject to the provisions of sub-section (3), be deemed to be a subsidiary of another if, but only if, ___
(a). that other controls the composition of its Board of Directors: or
(b). that other___
- where the first-mentioned company is any other company, holds more than half in nominal value of its equity share capital ; or
(c). the first-mentioned company is a subsidiary of any company which is that other’s subsidiary.
(4). For the purposes of this Act, a company shall be deemed to be the holding company of another if, but only if, that other is its subsidiary.
(5). In this section, the expression ‘company’ includes any body corporate and the expression ‘equity share capital’ has the same meaning as in sub section (2) of section 85.
(6). In the case of a body corporate which is incorporated in a country out side India, a subsidiary or holding company of the body corporate under the law of such country shall be deemed to be a subsidiary or holding company of the body corporate within the meaning and for the purposes of this Act also, whether the requirements of this section are fulfilled or not.
(7). A private company, being a subsidiary of a body corporate incorporated outside India, which, if incorporated in India, would be a public company within the meaning of this Act, shall be deemed for the purposes of this Act to be a subsidiary of a public company if the entire share capital in that private company is not held by that body corporate whether alone or together with one or more other bodies corporate incorporated outside India". [Emphasis supplied]"
Company is a juristic person with different identity from that of its members. Each and every company is a distinct and separate legal entity. The relation ship of holding and subsidiary, is therefore, essentially a legal fiction. Legal fiction denotes a fact which is, but for the legal fiction, not existing. In other words the purpose of legal fiction is to assume a thing as existing whereas in reality no such thing exist. Thus both holding and subsidiary companies are separate legal entities and they are related to each other by virtue of a legal fiction creating a subsidiary –holding company relationship. The law has to assume such relationship so as to bring both the holding and subsidiary companies under one roof to regulate them.
Section 4 of the Act which defines the terms "holding company" and "subsidiary company" is a legal fiction created by the Act. Further this legal fiction contains sub-fictions within it. The interpretation of a legal fiction has been beautifully explained by the Supreme Court. Justice S.R.Das J observed that "when legal fiction is created, for what purpose, one is led to ask at once, is it so created".2 Once the purpose is ascertained full effect must be given to the statutory fiction and it should be carried to its logical conclusion3. The overall impact is that the fiction created by this section is applicable to the entire Act. In other words wherever the term subsidiary is used in the Act the effect of section 4 has to be given.
Mode of creation of a subsidiary company.
Section 4 of the Act prescribes three conditions under which a company becomes a subsidiary of another company. A company shall be deemed to be a subsidiary of another if, but only if, (1) the other controls the composition of its Board of Directors, (2) the other company holds more than half of its equity capital and (3) the controlling company, as above said, is a subsidiary of another company.
In other words to be a holding company, a company has to either control the Board of directors or hold more than half of the equity capital of the other company. The above two methods of control need not be exercised by the holding company by itself and the control can be exercised through a subsidiary company also. It is pertinent to point out here that the Indian Law does not require the holding company to be a member of the subsidiary company. All that the Indian law requires is the actual control of the subsidiary company by a holding company in any one or both methods i.e. Board control or Share control.
As far as foreign companies are concerned, the law states that, in the case of a body corporate which is incorporated in a country outside India, a subsidiary or holding company of the body corporate under the law of such country shall be deemed to be a subsidiary or holding company of the body corporate within the meaning and for the purposes of this Act also, whether the requirements of this section are fulfilled or not.
Thus if a foreign company is a holding company of another company as per the laws of the country of that company, for the purposes of the Act, it will be treated in the same manner in India also even though the holding company may not be satisfying the two methods of controlling the subsidiary company. It is to be noted here that the holding and subsidiary relationship is inter se the two foreign companies only. In other words if A is the holding company of B in a foreign country, in India also A will be treated as the holding company of B.
Meaning of the term "body corporate" used in Section 4.
The term body corporate includes companies incorporated outside India. Sub-section (5) of section 4 includes, for the purpose of the section, any body corporate in the definition of company. The moot question is whether the term "any body corporate" include other non-corporate entities also, say partnership firms, association of persons etc., The answer to this question can be found if we ask another pertinent question i.e. what for section 4 is enacted?
Section 4 of the Act seeks to create a holding-subsidiary relationship between two companies. A company cannot be a holding or subsidiary company of another non-corporate entity. Thus essentially there has to be incorporated companies to create the holding-subsidiary relationship between them. Therefore, it can be concluded that, the term any body corporate essentially refers to a company incorporated outside India. Any meaning other than this will not be in conformity with the provisions of section 4.
Subsidiary of foreign company.
A company incorporated in India can become a subsidiary of a company incorporated outside India in any one of the three ways provided for in sub-section (1) of section 4. In other words Indian company shall be a subsidiary of a foreign company if
- Indian company’s Board of Directors are controlled by the foreign company; or
- More than half of the equity share capital of the Indian company is held by the foreign company.
- The foreign company is a subsidiary of another foreign company.
For example (1) A (Fco) appoints majority or all of the Board of directors of B (Ico). (2) A holds more than 50% of the equity share capital of B. (3) A is the subsidiary of another Fco C. Then B is a subsidiary of C also.
Effect of sub-section (7) of section 4.
Under Indian law a private company subsidiary of a public company is treated as a public company and made subject to all stringent legal compliance applicable to a public company. However, by virtue of sub- section (7) of section 4 of the Act, in the case of a private company which is a subsidiary of a foreign public company a different treatment is given whereby under certain conditions such subsidiary is treated as a private company.
Indian private company, which is a subsidiary of a foreign company, shall be treated as a private company under two circumstances. When the foreign holding company if incorporated in India would not have been a public company under the Act i.e such a foreign company could have been incorporated only as a private company. This situation involves two private companies as both holding and subsidiary companies are private companies.
The other circumstance is when the foreign holding company, if incorporated in India would have been a public company under the Act and the entire equity share capital of the subsidiary is held by such foreign company either alone or together with one or more bodies corporate incorporated outside India. Otherwise such Indian subsidiary shall be treated as a private company subsidiary of a public company. Under this situation the holding company is a public company and the subsidiary is a private company.
Let us critically analyze the provisions of sub-section (7) by breaking it into various limbs.
i. A private company
ii. Being a subsidiary of a body corporate incorporated outside India
iv. If incorporated in India
v. Would be a public company within the meaning of this Act,
vi. Shall be deemed for the purposes of this Act to be a subsidiary of a public company
vii. If the entire share capital in that private company is not held
viii. By that body corporate
xi. Whether alone or together with one or more other bodies corporate incorporated outside India.
The first two limbs are connected with fourth and fifth limbs by the third limb. These five limbs explain the factual relation ship between the Indian private company which is the subsidiary of a foreign public company. It considers the Indian private company as a subsidiary of the foreign company in the first place and further stipulates that such foreign company if incorporated in India would have been a public company i.e. within the meaning of section 3(1)(iv) of the Act. This is the first condition relating to the status of the foreign holding company. Sixth limb states what the treatment will be accorded to the private company if the conditions of seventh, eighth and ninth limbs are not met with by such foreign company. These limbs provide the second condition that such foreign company should hold the entire equity share capital of the private company either alone or together with one or more foreign bodies corporate. If all these conditions are met by the foreign holding company the Indian private company will be treated as a private company.
Holding entire share capital of a Wholly Owned Subsidiary
A pertinent question, in relation to holding the entire share capital of the subsidiary (in the case of a wholly owned subsidiary), that arises is whether all the shares to be registered in the name of the foreign holding company? In other words in a wholly owned subsidiary of a foreign public company can Indian individuals hold shares in trust?
Answer to this question lies in section 49 of the Act which governs the manner in which investment to be made by a company in the shares of another company. In a wholly owned subsidiary there is only one shareholder i.e.the holding company. However to transact business and to convene Board and company meetings at least two individuals are required. The general practice, in pursuant to section 49(3), is that the holding company makes at least one Individual to hold a share in trust on behalf of it and such a share is registered in the name of the individual. The individual and the holding company file appropriate declarations with the ROC in compliance with section 187-D (1) and (2) of the Act.
Section 3 (i) of the Act defines "a compay" to be incorporated in India. Again, the definition of "body corporate" in section 2 (7) of the Act includes a foreign company. A body corporate, for the limited purposes of section 4 (5), is included in the definition of "a company". For the purposes of section 4 (5) and (7) a body corporate could only be a company incorporated outside India. Though a body corporate is not a company for the purposes of Section 49, the foreign holding company being a body corporate, b y virtue of legal fiction created by section 4(5), becomes a company for the purposes of section 49 of the Act also. In view of this the shares held by the individual in trust for the holding company in the subsidiary shall be treated as the share holding of the holding company.
Section 49 of the Act has to be read in conjunction with section 4 of the Act. Though the term "a company", in section 49 of the Act, does not include a body corporate expressly, section 4 of the act includes the same expressly. The effect of section 49 is obvious on section 4 as a holding company holds the entire shares of the subsidiary (WOS) company. Further Section 4(7) deals with the manner of share holding of a holding company in its subsidiary company and section 49 deals with different situations in which a company is deemed to hold shares of another company in its own name. Thus the provisions of these two sections cannot be read in isolation.
Crucial test that decides the issue is share holding
Sub-section (7) is thus, primarily, concerned with subsidiary within the meaning of sub-section (1)(b)(ii) of section 4 of the Act. The criteria are the direct shareholding by the foreign company either full or in part in the subsidiary. If the Act intended to cover the foreign public company holding shares through one of its subsidiaries the word "through" would have been employed instead of the words " together with". There is no ambiguity in the language employed by the legislature. The intention to cover only such foreign public companies which have direct investment in Indian private companies is very clear. If the foreign company, to which the relationship of subsidiary has to be determined, is not holding any shares in the Indian Company such foreign company is out of the purview of sub-section (7).
The share holding pattern is the test applied by the Act, in case the holding company is a public company, to determine the status of subsidiary. The provisions of section 4 (7) of the Act are applicable only to such foreign holding company which actually holds shares in the subsidiary either alone or together with other foreign bodies corporate. The crucial point is that unless the holding company holds any share in the subsidiary no reference to such a holding company to be made while applying the provisions of subsection 7 of section 4 of the Act.
In a case of single holding i.e one holding company and one subsidiary company the impact of subsection (7) is quite simple. If the holding company is a private company sub-section (7) will have no application. If the holding company is a public company, if the entire equity share capital is not held by the holding company either alone or together with other bodies corporate the subsidiary will be treated as a private company subsidiary of a public company.
To illustrate this with the earlier example, if A is a private foreign company holding more than 50% or the entire equity sharecapital of the Indian private company B, B becomes a subsidiary of A. As A is a private company Sub-section (7) is not applicable and B remains a private company.
Suppose A is a public company. If A holds the entire sharecapital of B either alone or together with other bodies corporate, B will be treated as a private company. If even a single share is held by an Indian (individual or company) in company B, it will be treated as a private company subsidiary of a public company.
In other words sub-section (7) will have its impact only when the holding company is a public company.
It is only in the event of chain holding where there are subsidiaries and sub-subsidiaries involving public and private companies the real impact of sub-section (7) is felt. It becomes a daunting task to interpret and apply the law enunciated in sub-section (7) of section 4 of the Act as chain-holding involves lot of combinations.
Now let us suppose, in the earlier example, that A is a private company and subsidiary of C which is a public company and C is not holding any share in B. There can be two situations. Situation I. A holds the entire share capital of B.
Situation II.A holds 60% of the equity share capital of B and rest of the shares is held by Indian public company D.
If C also holds share in B there can be two situations.
Situation III. A holds 90% and C holds 10% of the equity share capital of B.
Situation IV: A holds 40%, C holds 20% of the equity share capital of B and rest of the share capital is held by D.
What is the position of B in all these situations?
In situation I and II since C is not at all holding any shares in B, provisions of sub-section (7) are not applicable and B will be treated as a private company. In situation III C holds 10% and A holds 90% of the equity share capital of B. Here C is holding the entire equity share capital of B together with A. Provisions of sub-section (7) are applicable and B will be treated as a private company. In situation IV C together with A holds only 60% of the equity share capital of B. Here also provisions of sub-section (7) are applicable and B will be treated as a private company subsidiary of a public company.
What is the implication when a private company becomes a subsidiary of a public company under section 4(7) of the Act?
The expression private company subsidiary of a public company used in various places in the Companies Act, 1956 (the Act) has wider application so as to bring a private company which is a subsidiary of a foreign public company into its scope. As has been discussed, a private company incorporated in India though becomes a subsidiary of a foreign public company in any one of the ways mentioned under section 4(1) of the Act, it is only such private company which becomes a subsidiary of a foreign public company under section 4(1)(b)(ii) is considered for the expression "private company subsidiary of a public company", for the purposes of the Act, by sub-section (7) of section 4 of the Act. When a private company becomes a subsidiary of a public company within the meaning of section 4(7) it shall remain as a subsidiary of a public company for all purposes of the Act.
Investment planning through a subsidiary is a global phenomenon. The legislature also recognises this and it has aptly enacted sub-section (7) of section 4 of the Act by bringing subsidiary having Indian investment (whatsoever is the extent) into the fold of public company. However investors are free to adopt the chain-holding method to come out of this by channalising the investment through a wholly owned off shore subsidiary.
1 Madras central Urban Bank vs Corporation of Madras (1932) 2 Comp.Cases 328.
2 State of Travancore-Cochin vs Shunmugavilas Cashewnut Factory AIR 1953 SC 333.
3 American Home Products Corporation vs Mac Laboratories AIR 1986 SC 137.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.