Govt could impose cap on step-down subsidiaries

The government is looking at limiting the creation of step-down subsidiaries? subsidiaries of subsidiaries?by companies having foreign investments in them. The need to impose such a limit is being felt because with every step-down subsidiary, the relationship between the parent company and the subsidiary gets blurred and meaningful assessment of the FDI component in such companies becomes difficult.

?The ultimate step-down subsidiary may not be actually capitalised in real terms and thus, will defeat the purpose of providing the safeguard of capitalisation,? a senior official in the department of industrial policy and promotion (DIPP) told FE. The DIPP?s move, however, is at odds with the extant Companies Act as well as the Companies Bill 2009 pending before the Parliament. Both the Act and the Bill do not propose any restrictions on subsidiaries having subsi- diaries or on the number of subsidiaries or investment companies that corporate groups can float.

The DIPP feels that there is a need to curb subsidiaries of subsidiaries in the backdrop of the global recession that the world is recovering from, which made tracking foreign capital entering the country all the more important. However, it does not have any problem with companies setting up any number of direct subsidiaries under a single parent company.

Company law experts have a different view. ?In a globalised world, corporates need flexibility to access outside capital and structure different transactions. Any curbs on such flexibility would affect the global competitiveness of Indian companies, as the largest economies in the world are free from such curbs,? said Preeti Malhotra, former president, Institute of Company Secretaries of India.

The issue came up at a recent FIPB meeting which it took up the case of Morgan Stanley India for making downstream investment in a subsidiary through another subsidiary. The board deferred the proposal since FDI policy on downstream investments was open to interpretation and should be finetuned properly. The board has since asked the DIPP to issue a clarification in this regard.

DIPP?s clarification will hold true for all companies going in for such investments and will set a precedent. The department may limit the approval to only one step-down subsidiary.

The FIPB was of the view that the interpretation for justifying its downstream investments by Morgan Stanley was legalistic in nature. ?If we go by that interpretation, there is no requirement of capitalisation norms at any level of step-down subsidiary. It is very important to understand the architecture of the financial market. It is important to see till what level of subsidiary we can allow downstream investments,? an official handling the case said.