India’s New Limit on Subsidiaries Poses Compliance Challenges

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By Siri Bulusu

A new India rule prohibiting investments and corporate structuring from exceeding two layers of subsidiaries will make aggressive tax planning “difficult,” according to tax practitioners.

The new rule aims to prevent the misuse of complex corporate structuring through prohibiting companies from having more than two layers of subsidiaries to evade taxes. It also prohibits investors from investing through more than two layers of investment companies.

But practitioners warn that this will complicate other genuine reasons for creating subsidiaries. “The aim of the government is to achieve simplicity and uncover any hidden agenda, but it may pose an impediment, especially for companies fundraising or separating business in a supply chain,” Ravi Mehta, transaction tax partner at Grant Thornton India LLP, told Bloomberg Tax Oct. 12.

The new rule was first introduced in the Companies Act, 2013, but corporate lobby groups feared the restrictions would be impractical and hinder a company’s ability to raise funds, practitioners said. Reports of shell companies and money laundering, however, caused the government to retain the restriction, which took effect Sept. 20. India’s Ministry of Corporate Affairs issued notification of the rule Sept. 20.

Banking companies, systematically important non-banking financial companies, insurance companies and government companies are exempt from the restriction.

‘Complex Web’ of Companies

“Over the last several decades, the government has found fraud and other scams where there is a complex web of companies where money is being rotated around,” Abhishek Goenka, tax partner at PricewaterhouseCoopers Private Ltd., told Bloomberg Tax Oct. 12.

Goenka said the scams included tax fraud and investment in shares to move money from one company to another, resulting in India’s tax laws targeting different types of investments. But while tax law has tightened, it’s done little to prevent this rotation of money through complex corporate structures.

“This is targeted at scams involving complex webs of companies, and the way to prevent that is to legislate that companies can only have a certain number of companies—it’s important to nip it in the bud,” Goenka said.

Under the new rules:

  •  A company may acquire a company incorporated outside India with subsidiaries beyond two layers, if it’s in accordance with the laws of that country.
  •  When computing the number of corporate layers, one layer which consists of one or more wholly owned subsidiaries shall not be taken into account.
  •  Existing companies having more than two layers as of Sept. 20, 2017, must file a specific form with the Registrar of Companies within 150 days of Sept. 20, 2017.

Failure to comply with the rules could result in a fine of up to 10,000 rupees ($154) upon each officer of the company, with a further fine of up to 1,000 rupees per day of non-compliance.

‘A Lot More Compliance Requirements’

Mehta said companies use multiple layers to achieve a variety of genuine business motives, like creating an entity to capture overall value or separating business functions to attract specific investors.

“The main government motive was to bring simplicity and avoid aggressive tax planning, but it will create complexity and overall create a lot more compliance requirements,” Mehta said.

Developed economies lack a restriction on the number of subsidiaries because those economies have a matured system to monitor companies and crack down on fraud, Mehta said, adding that countries considered tax havens lack such restrictions.

To contact the reporter on this story: Siri Bulusu in New Delhi at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

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