Shriyani DattaCounsel
Shivesh AggarwalSenior Associate
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Background
Many businesses benefit from multi-level corporate structures. Conducting businesses through subsidiaries allows for optimised risk allocation, limited credit claims, efficient tax structuring, and centralised management. Such structures are also common in India's infrastructure sector, where regulations often require the execution of government projects through separately incorporated entities. For instance, many bid documents issued by various Indian government authorities for infrastructure projects, like those from the National Highways Authority of India and the Airports Authority of India, typically require the creation of special purpose vehicles (SPV) to execute the awarded projects. Through this requirement, the government gains a streamlined approach to project management through the SPVs.
This SPV structure has also gained prominence amongst potential investors since it helps them avoid the procedural and practical complexities of managing multiple investments and allows them to instead focus solely on the management of the investee company.
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Unintended non-banking financial company/core investment company classification: A potential hurdle
While the core purpose of infrastructure projects is not to generate income from financial assets, adopting parent-subsidiary corporate structures for the above mentioned efficiencies can create an unexpected hurdle. Under Indian regulations, the investee company, i.e., the holding company into which the investment is proposed, may unintentionally get categorised as a non-banking financial company (NBFC) or a core investment company (CIC). NBFCs are companies that primarily undertake financial activities, while CICs are conceptually passive holding companies for financial assets within a group. This classification can trigger additional regulatory requirements from the Reserve Bank of India (RBI), potentially complicating the investment process. Apart from the investee company being required to fulfill a host of periodic regulatory compliances prescribed by the RBI, the transaction may also become subject to prior approval of the RBI (assuming it results in a change in control/minimum shareholding of the investee company). Additionally, under the existing foreign exchange laws, any foreign investment in a CIC and in an investment company not registered as an NBFC with the RBI must be made under the government route, i.e., requiring the prior approval of the relevant government ministry.
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Registration requirements for NBFC and CIC
RBI’s well known ‘50-50 principal business test’ determines whether a company is an NBFC. When a company’s financial assets constitute more than 50% of the total assets and income from financial assets constitutes more than 50% of the gross income, such a company is categorised as NBFC and must register with the RBI (50-50 Test). An RBI clarification from 8 April 1999 specifies that the 50-50 Test is based on the company’s last audited balance sheet, and if the company’s auditors conclude that the thresholds are met, they are required to report this non-compliance directly to the RBI.
As mentioned above, CICs, a subset of NBFCs, carry on the business of investing. In the event a company holds at least 90% of net assets in the form of investment in equity securities and debt or loans in group companies and specifically has investments in equity securities in group companies constituting at least 60% of its net assets (90-60 Criteria), such company is required to be registered as a CIC with the RBI.
An investee company using a parent-subsidiary structure would need to register as an NBFC or a CIC with the RBI, if its direct investments in its group companies (based on the latest financial statements) cause it to exceed the 50-50 Test or 90-60 Criteria.
Further, an entity can be categorised as a CIC if it meets the 90-60 Criteria even though it does not breach the 50-50 Test. A closer look at the financial assets and income of the company would be warranted on a case-by-case basis to determine its CIC status.
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Exemptions and considerations
The RBI exempts certain companies from obtaining registration as a CIC/NBFC, such as:
- a CIC which has an asset size of less than INR 100 crore or has an asset size of more than INR 100 crore (but does not access funds), which is then considered as an ‘unregistered CIC’;
- insurance companies registered with the Insurance Regulatory and Development Authority of India and not accepting public deposits; and
- stock exchanges/brokers registered with the Securities and Exchange Board of India and not accepting public deposits.
Even if the holding company itself does not qualify as a CIC (not meeting the 90-60 Criteria), it might still need to be registered as an NBFC if it triggers the 50-50 Test. However, RBI offers a potential relief route. The holding company can apply to the RBI with a plan to reorganise its business as an ‘unregistered CIC’ within a specific time frame, and therefore, request for exemption from registration with the RBI. This application should, amongst other things, contain:
- an explanation regarding company’s intention not to conduct financial activities (except investments in its group companies),
- the timeline within which it would become a CIC (which may be through potential investments or reduction of other assets that would lead to the company meeting the 90-60 Criteria), and
- the detailed steps proposed to be undertaken to achieve this reorganisation objective.
Importantly, this exemption is only available for companies with potential eligibility as CIC, and not other types of NBFCs.
While the above exemptions are available for investment companies, foreign investors must also consider the foreign exchange laws as these can impact how they structure an investment in companies adopting multi-level corporate structures in India.
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Regulatory ambiguities
The mechanism for assessing NBFC or CIC status has certain ambiguities that pose a few challenges when structuring deals. For instance, the timeframe for registration based on the last audited balance sheet remains unclear. While the RBI prescribes the last audited balance sheet for the 50-50 Test and 90-60 Criteria, it is unclear if the registration is required immediately after the conclusion of the financial year itself (which may vary for each company) or after the auditors’ report. The latter approach may create difficulty given that the auditors are mandated to immediately notify the RBI about the non-compliance. Another prevalent doubt is whether the registration should then ideally get completed before the completion of the audit or if a registration application pending with the RBI would suffice.
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Structuring to demonstrate non-NBFC/CIC intent
Typically, there have been mechanisms through which investment companies can demonstrate that they do not breach the 50-50 Test or the 90-60 Criteria. Particularly, when the nature of the business itself does not contemplate engaging in any business of an NBFC or a CIC, and the resultant structure is being driven by requirements under governmental regulations (tender contracts) or for optimum tax planning. To this end, companies may enter certain service arrangements with their group companies, own a separate non-financial asset (such as a land parcel), etc., apart from holding the securities in their group companies, and also move certain operational agreements from group entities to the holding company.
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Way forward
The RBI should consider creating a specific exemption for corporate structures that are required to be adopted to meet governmental requirements (of course, with restrictions on the business, i.e., it being limited only to the regulatory mandate). This would be akin to how the Ministry of Corporate Affairs has, while calculating the permissible layers of investment companies under Section 186 of the Companies Act, 2013, exempted a subsidiary company established for meeting the requirements under any law.
While the core purpose of infrastructure projects is not to generate income from financial assets, adopting parent-subsidiary corporate structures can create an unexpected hurdle. Under Indian regulations, the investee company may unintentionally get categorised as an NBFC or a CIC.
While exemptions from obtaining registration as NBFC/CIC are available for investment companies, foreign investors must also consider the foreign exchange laws as these can impact how they structure an investment in companies adopting multi-level corporate structures in India.
