Corporate Layering Restrictions in India: A Constitutional Tightrope Walk 

Corporate Layering Restrictions in India: A Constitutional Tightrope Walk 

India’s unique corporate layering restrictions, limiting companies to just two subsidiary layers, face mounting constitutional scrutiny as businesses argue these rules stifle legitimate operations while doing little to prevent actual financial misconduct. 

The Scandal That Changed Corporate India 

The genesis of India’s corporate layering restrictions traces back to the 2001 stock market scandal involving financier Ketan Parekh—an event that shook investor confidence and exposed systemic vulnerabilities in India’s financial architecture. The subsequent Joint Parliamentary Committee (JPC) investigation uncovered how complex networks of subsidiaries had been used to siphon funds through intercorporate loans, creating opaque structures that obscured financial trails and facilitated market manipulation. 

In response, the Ministry of Corporate Affairs (MCA) proposed what would become one of India’s most distinctive corporate regulations: a statutory cap on subsidiary layering for holding companies. The provision, initially introduced in the Companies Bill of 2009 and later incorporated into Section 2(87) of the Companies Act, 2013, allowed the government to prescribe limits on subsidiary layers. On September 20, 2017, the MCA notified the Companies (Restriction on Number of Layers) Rules, 2017, which capped most companies at just two subsidiary layers—a restriction that applies to both Indian and foreign subsidiaries. 

How the Layering Rules Actually Work 

The technical framework of India’s layering restrictions operates through a dual statutory approach. Section 186(1) of the Companies Act restricts companies from making investments through more than two layers of investment companies (those with at least 50% of assets or income from investments). More broadly, the 2017 Rules expand this restriction to include all types of subsidiaries, whether operational or investment-focused. 

Key Provisions and Exemptions: 

• Two-Layer Limit: Companies cannot have more than two layers of subsidiaries, whether directly or indirectly. 

• Wholly-Owned Subsidiary Exception: One layer consisting exclusively of wholly-owned subsidiaries is excluded from this calculation. 

• Exempted Sectors: Banking companies, non-banking financial companies (NBFCs), insurance companies, and government companies are exempt from these restrictions. 

• Grandfathering: Corporate structures existing before September 20, 2017 were permitted to continue, though they cannot add further layers. 

Interestingly, these rules apply to both listed and unlisted companies, as well as public and private entities—a broader application than international counterparts. For instance, Israel imposes similar restrictions only on publicly traded companies, making India’s approach uniquely comprehensive. 

Table: Evolution of India’s Corporate Layering Framework 

Expert Opposition and International Isolation 

What makes India’s layering restrictions particularly contentious is the consistent opposition from expert committees tasked with examining the issue. Both the J.J. Irani Committee (2005) and the Company Law Committee (2016) recommended against structural limitations, favoring instead enhanced disclosure requirements and transparent board processes supervised by regulators. 

The 2016 Company Law Committee specifically warned that such “blanket restrictions might adversely impact legitimate business structuring” and would place Indian companies at a competitive disadvantage internationally. Their recommendations were largely ignored—a Companies Amendment Bill in 2016 that proposed removing the restrictions was referred to the Parliamentary Standing Committee, which reinstated them without explanation. 

This places India in a regulatory outlier position globally. As noted in the analysis, “apart from India, only Israel has imposed such restrictions on the number of layers”. Most jurisdictions address concerns about corporate transparency through beneficial ownership disclosure requirements and consolidated financial reporting rather than structural caps on subsidiary layers. 

The Constitutional Crucible: Proportionality Analysis 

The constitutional validity of India’s layering restrictions hinges on the proportionality test established by the Supreme Court in the landmark K.S. Puttaswamy v. Union of India (2017) case. This test, which has since been applied to various fundamental rights including those under Article 19, consists of four prongs that any state restriction must satisfy: 

1. Legitimate Aim

The state must demonstrate that the restriction pursues a legitimate aim. In the case of layering restrictions, preventing siphoning of funds and enhancing corporate transparency undoubtedly qualify as legitimate state interests. The historical context of financial scandals provides a clear rationale for regulatory intervention. 

2. Rational Connection

There must be a rational connection between the restriction and the legitimate aim. Here, arguments grow more nuanced. While limiting subsidiary layers theoretically simplifies tracing fund flows, critics note that sophisticated financial malfeasance rarely depends on layering depth alone. Many fraudulent structures operate effectively within just two layers, while legitimate global businesses often require more complex structures. 

3. Least Restrictive Alternative

The restriction must be the least intrusive measure among alternatives that could achieve the same objective. This represents the most vulnerable point in the government’s case. Both expert committees recommended disclosure-based approaches as equally effective but less restrictive alternatives. Enhanced reporting requirements, consolidated financial statements (already mandated under Section 129 of the Companies Act), and stricter beneficial ownership disclosure could potentially achieve transparency goals without structural limitations. 

4. Balancing of Interests

Finally, the restriction must strike an appropriate balance between individual rights and public interest. The Supreme Court’s application of this test in cases like Akshay N Patel v. Reserve Bank of India demonstrates the careful weighing required, particularly when restrictions impact economic rights. 

Table: The Four-Pronged Proportionality Test Applied to Layering Restrictions 

Practical Implications for Indian Business 

Beyond constitutional theory, the layering restrictions create tangible business challenges. Indian companies engaged in cross-border mergers and acquisitions face particular difficulties when acquiring foreign entities with existing multi-layered structures permitted under their home jurisdictions. While the rules contain an exception for such acquisitions, the requirement that Indian companies cannot add further layers creates ongoing operational constraints. 

The restrictions also impact legitimate business structuring for operational efficiency, risk segregation, and regulatory compliance across jurisdictions. Different business units often require separate legal entities for liability protection, tax optimization, or regulatory licensing—needs that can legitimately necessitate more than two subsidiary layers. 

Notably, the rules have not eliminated corporate misconduct. As noted in analysis of subsidiary governance, “instances are a plenty of large-scale diversion of funds from the parent company to the subsidiary and thereafter to the promoter group companies”. This empirical reality undermines the efficacy argument for structural restrictions. 

Global Context and Competitive Implications 

In an increasingly interconnected global economy, regulatory divergence carries competitive consequences. Multinational corporations evaluating investment locations consider regulatory flexibility alongside traditional factors like labor costs and infrastructure. India’s unique layering restrictions create additional compliance complexity for global enterprises compared to jurisdictions favoring disclosure-based transparency regimes. 

This regulatory exceptionalism may inadvertently disadvantage Indian companies competing internationally. Their foreign competitors can employ more nuanced corporate structures tailored to operational needs, while Indian companies face rigid layering constraints regardless of legitimate business requirements. 

The Path Forward: Constitutional Challenges and Regulatory Reform 

While no direct constitutional challenge to the layering restrictions has reached adjudication, the legal framework established in Puttaswamy and subsequent cases like the Electoral Bonds judgment provides a clear roadmap for potential litigation. A constitutional challenge would likely focus on the third prong of proportionality—whether disclosure-based alternatives could achieve transparency goals with less restriction on the fundamental right to conduct business under Article 19(1)(g). 

The government’s defense would need to demonstrate why structural limitations were necessary despite expert recommendations favoring disclosure regimes. The absence of published rationale for selecting a two-layer cap (rather than three or four) and the rejection of expert committee recommendations without explanation weakens the government’s position on the “least restrictive means” analysis. 

A more sustainable regulatory approach might combine enhanced disclosure requirements with the existing mandate for consolidated financial statements. The consolidation requirement under Section 129 of the Companies Act, coupled with Indian Accounting Standards (Ind AS) 110, already provides transparency by requiring holding companies to present consolidated financial statements encompassing all subsidiaries they control. Additional beneficial ownership disclosure and transaction reporting could address concerns about fund diversion without imposing absolute structural limitations. 

Conclusion: Between Transparency and Flexibility 

India’s corporate layering restrictions represent a distinctive approach to corporate governance—one born from legitimate concerns about financial malfeasance but potentially flawed in its constitutional foundations and practical efficacy. The restrictions sit at the intersection of competing values: transparency versus flexibility, prevention of misconduct versus facilitation of legitimate business, and state regulatory power versus fundamental economic freedoms. 

As global business structures grow increasingly complex and cross-border operations become the norm rather than the exception, regulatory frameworks must balance these competing interests with precision. The proportionality test established in India’s constitutional jurisprudence offers a disciplined methodology for this balancing act—one that current layering restrictions may struggle to satisfy. 

Whether through constitutional litigation or regulatory reform, India’s approach to corporate structuring appears destined for reconsideration. The fundamental question remains: can the legitimate goal of corporate transparency be achieved through means less restrictive than arbitrary numerical caps on subsidiary layers? Both constitutional principles and practical business realities suggest affirmative alternatives exist, waiting to be implemented in India’s ongoing evolution toward mature corporate governance.