Parental control

Foreign companies need to put at least one share of their Indian subsidiaries in other hands

Abhilash Pillai and Kunal Arora explain

One of the most popular routes for investment into India by foreign parties is through a wholly owned subsidiary (WOS).

This article highlights the key provisions of Indian corporate law that apply to such subsidiaries and solutions for the challenges that a foreign parent company is likely to face when investing in India through a WOS.

Laws and regulations

The regulations that apply to a domestic company established under the Companies Act, 1956, apply equally to a WOS set up by a foreign company in India.

Additionally, a foreign parent company must comply with India’s foreign exchange control regulations, including its foreign direct investment (FDI) policy while setting up a WOS. A foreign entity can only set up a WOS in sectors where 100% foreign investment is permitted under the FDI policy.

Shareholding pattern

The term WOS suggests that the entire shareholding of a subsidiary is held by the parent company, however, this is not the case. Under the Companies Act, every private limited company is required to have a minimum of two shareholders, while a public limited company must have a minimum of seven. The information below applies to a WOS that is a private limited company since most foreign companies prefer this structure in India.

Evidently, in instances where the foreign parent company forms a part of a group of companies and the investment can be made through more than one entity, the issues identified in this article would not arise. This is because the principal factor of maintaining more than one shareholder is achieved simply by having more than one entity participating in the shareholding of the WOS.

In instances where there is only one entity making the investment, the issue that arises is that the WOS is required to have at least two shareholders. This results in the situation where the parent company can legally hold all but one share in the subsidiary and needs to identify a way to satisfy the two-shareholder requirement. This is normally addressed by adopting one of two structures.

(1) All but one: This structure requires a parent company to part with at least one share in favour of another owner. In most of the cases, an affiliate of the parent company holds one share of the WOS and the parent company holds the remaining shares. The person or entity holding the minority share enjoys all rights with respect to the share they hold.

If the parent company is a foreign entity and its constitution has the characteristics of a public company incorporated under the Companies Act, additional care is necessary when using the “all but one” structure. The parent company should ensure that the affiliate holding the minority share is an entity incorporated outside India. This is because under section 4(7) of the Companies Act, a subsidiary of a foreign company which has the characteristics of a public company is treated as a public company unless the entire shareholding of the subsidiary is held by entities incorporated outside India. Maintaining the subsidiary’s status as a private company is essential since, under Indian law, a public company faces more restrictions and compliances than a private one.

(2) Nominee: In this structure while the minority share is legally held by a nominee of the parent company, the beneficial ownership of all the shares is with the parent company. So although the nominee is registered as the legal owner of the minority share, the actual ownership of the share and the ancillary rights (excluding the right to vote) would lie with the parent company. The Companies Act permits a person or entity distinct from the registered “legal” owner of the share to be the beneficial owner, subject to certain reporting requirements under the act.

Abhilash Pillai and Kunal Arora are associates at MNK Law Offices in New Delhi.