Section 372A(8) of the Companies Act, 1956

This query is : Resolved

udit sharma (Querist)
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02 November 2010 Suppose there are two Companies A Ltd. and B Ltd. B B Ltd. is a wholly owned subsidiary of A Ltd. So when A Ltd. gives a Loan of Rs. 50 Crores to B Ltd., it will be exmpted from the provisions of section 372A of the Companies Act,1956 as per the provisions of section 372A(8) of the CompaniesAct, 1956.

Now, C Ltd. is a wholly owned subsidiary of B Ltd. By virtue of provisions of section 4(1)(c) of the Companies Act, 1956 C Ltd. is deemed to be a wholly owned subsidiary of A Ltd. If A Ltd. prposes to give a Corporate Gaurantee in favour of C Ltd. towards a unsecured laon of Rs.70 Crores taken by C Ltd. from a third party, will it be exempt from the provisions of section 372A ?????????

CA. Aryendra

CA. Aryendra (Expert)
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02 November 2010 Yes it will be subsidiary company of A
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A. Facts of the Case

1. Section 372A inserted in the principal Act by the Companies (Amendment) Act, 1999, lays down restrictions on inter-corporate loans and investments. One of the restrictions is contained in sub-section (3) which provides as below:
“(3) No loan to any body corporate shall be made at a rate of interest lower than the prevailing bank rate, being the standard rate made public under section 49 of the Reserve Bank of India Act, 1934”.
Sub-section (8) of the aforesaid section provides that nothing contained in the section shall apply “to any loan made by a holding company to its wholly owned subsidiary”.
2. A company (Company ‘A’) geographically spread all over India has various subsidiaries operating at various locations. The company holds the entire equity share capital of Company ‘B’. Company ‘B’ in turn holds the entire equity share capital of Company ‘C’. As per the provisions of section 4 of the Act, Company ‘C’ is a subsidiary of company ‘A’ (besides being a subsidiary of Company ‘B’).
B. Queries

3. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether Company ‘C’ can be construed as a wholly owned subsidiary of Company ‘A’ for purposes of section 372A of the Companies Act, 1956.
(b) Whether Company ‘A’ can extend an interest free inter-corporate loan to Company ‘C’.
C. Points Considered by the Committee

4. The Committee notes that the Companies Act, 1956 does not define the expression “wholly owned subsidiary”. The Committee is of the view that in the absence of a specific definition, the above expression would have to be construed in its generic sense.
5. Section 4 of the Companies Act, 1956, defines the holding-subsidiary relationship as follows:
“4.(1) For the purposes 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-
(i) where the first-mentioned company is an existing company in respect of which the holders of preference shares issued before the commencement of this Act have the same voting rights in all respects as the holders of equity shares, exercises or controls more than half of the total voting power of such company;
(ii) 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

Illustration

Company B is a subsidiary of Company A, and Company C is a subsidiary of Company B. Company C is a subsidiary of Company A, by virtue of clause (c) above. If Company D is a subsidiary of Company C, Company D will be a subsidiary of Company B and consequently also of Company A, by virtue of clause (c) above, and so on.”
The Committee notes that as per the above definition, one of the bases for the existence of holding-subsidiary relationship is the holding of more than half in nominal value of the equity share capital of the subsidiary. However, for a company (‘first company’) to be the holding company in relation to another company (‘second company’), it is not necessary that the first company itself should hold the aforesaid percentage of share capital of the second company; the relationship of holding-subsidiary would exist between the first company and the second company even if this percentage of share capital of the second company is held by a subsidiary of the first company. Thus, section 4 recognises both direct holding as well as indirect holding (viz. through a subsidiary) as creating the holding-subsidiary relationship.
6. The Committee is of the view that the issue whether a subsidiary is ‘wholly owned’ should be construed in a manner consistent with the definition of the expression ‘subsidiary’ as given in section 4 of the Companies Act, 1956. Accordingly, the Committee is of the view that where a company (say, Company ‘A’) holds the entire share capital of another company (say Company ‘B’) and such other company holds the entire share capital of yet another company (say Company ‘C’), Company ‘C’ would be construed as being a wholly owned subsidiary of both Company ‘A’ and Company ‘B’.
7. The issue whether or not a company can provide interest-free loan to its wholly owned subsidiary needs to be examined in the context of all the relevant factors, e.g. its memorandum and articles of association, provisions of other statutes (besides the Companies Act) governing the functioning of the company, covenants of contracts with third parties, etc. Accordingly, the Committee is not in a position to express any opinion on the issue raised by the querist at paragraph 3(b) above. However, as far as the provisions of sub-section (3) of section 372A of the Companies Act are concerned, the Committee is of the view that they are not applicable in the instant case.
D. Opinion

8. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 3, seriatim:
(a) Company ‘C’ can be construed as a wholly owned subsidiary of Company ‘A’ for purposes of section 372A of the Companies Act, 1956.
(b) The Committee is not in a position to express any opinion on the issue raised.

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