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Impact of changing tax and regulatory landscape in India on Family owned businesses – Part 1

Family run businesses dominate the economic landscape of countries across the globe. In India as well, some of the family businesses over the past few decades have grown exponentially and evolved into multi-national business conglomerates while, on the other hand, there is a vast number of corporates which continue to be promoter owned and driven.

Family businesses which have successfully existed for several decades/ generations generally tend to have a complex web of structures, agreements and arrangements to manage their wealth and often resort to various forms of internal and external business restructurings on their path to growth. However, in recent years, there have been continuous developments in the Indian tax and corporate law regime which have thrown up new structuring challenges particularly for these private sector players.

Over the years, one big concern for regulators has been the multi-layered company structures. Various scams were eye openers where a web of investment companies were used by the promoters for money-laundering and fund diversion. Accordingly, with a view to bring more transparency in shareholding and funding structures, the Companies Act, 2013 (“2013 Act”) introduced restrictions on investing through more than two layers of investment companies with some exemptions e.g. an outbound acquisition where the target has subsidiaries beyond two layers. While introduction of such restrictions is a welcome measure to check diversion of funds and protect interest of minority investors, they may adversely affect genuine business structures where investments are structured in layers for multiple reasons such as fund raising, concentration on sector specific expertise, ease of investor entry and exit.

Such multi-layered structures usually encompass intra-group fund movement through inter-company loans and investments. Section 185 of the 2013 Act, seeks to prohibit flow of funds by way of loan from a Company to any of its directors or specified persons in whom directors are interested, to curb misuse of powers by the directors of the Company and safeguard the interest of various stakeholders. This restriction has been a significant pain point for family-run businesses. Considering the closely held nature of such companies, where usually one or more directors are common, this restriction has become an encumbrance for companies to access capital from their parent company, fellow subsidiaries or associate companies. The Ministry of Corporate Affairs (“MCA”) has introduced exceptions to the above provisions such as loan by a holding company to its wholly owned subsidiary provided such funds are utilised for its principal business activities. However, the 2013 Act or rules thereof do not clarify what activities would constitute ‘principle business activities’, making this a matter of contentious interpretation.

Further, for the purposes of section 185, ‘loan’ includes any loan represented by a book debt. Thus any book debt in books of the company relating to any Director or a company/ firm in which Director is interested will be treated as a loan. This may mean that selling goods or rendering services on a credit basis to directors or any other specified person could also be restricted.

Likewise, Section 186 was introduced in the 2013 Act, which deals with inter-company loans and investments, to restrict granting of loans or extending any guarantee or security in excess of the prescribed thresholds without prior shareholders’ approval by way of a special resolution. Such restrictions which were hitherto applicable only on public companies under the erstwhile Companies Act, 1956, are now applicable even on private companies. This will create hardships for many companies which were largely dependent on debt and other modes of financing from group companies. Further, in case of loans, the lending company is required to charge an interest on the loan at a rate which is not less than the prevailing yield on the Government securities.

Most of these amendments to the Companies Act, 2013 are aimed at enhancing the level of corporate governance, protection of minority shareholders’ interests and to prevent promoters from misusing or diverting the companies’ funds. While some relaxations and exemptions have been introduced by the MCA from time to time in favour of privately held companies to facilitate their business operations, there are some areas on which the businesses require clarifications and further rationalisation of provisions.

The article is authored by Radhika Jain, Partner and co-authored by Surabhi Singhal, Associate Director, Grant Thornton India LLP. Views are personal.

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