Tag: Liquidation of Companies

Internal Reconstruction refers to the process of reorganizing the financial structure of a financially troubled company without dissolving the existing entity or forming a new one. It involves restructuring the company’s capital, liabilities, and assets to improve its financial stability and operational efficiency. This may include reducing share capital, settling debts at a compromise, revaluing assets and liabilities, or altering shareholder rights. The objective is to revive the company by eliminating accumulated losses, reducing debt burden, and strengthening the balance sheet. Internal reconstruction requires approval from shareholders, creditors, and sometimes the National Company Law Tribunal (NCLT) under the Companies Act, 2013. Unlike amalgamation or external reconstruction, the company continues its operations under the same legal identity but with a restructured financial framework.

Objectives of Internal Reconstruction:

• To Wipe Out Accumulated Losses

One of the primary objectives of internal reconstruction is to eliminate accumulated losses from the company’s balance sheet. These losses often prevent a company from declaring dividends and reflect poor financial health. By reducing share capital or adjusting reserves, the losses are written off, making the balance sheet cleaner and more attractive to investors. This process gives the company a fresh start financially, improving its credibility in the eyes of stakeholders and potential financiers.

• To Reorganize Share Capital

Over time, a company may have an overcapitalized or undercapitalized structure. Internal reconstruction helps reorganize this by reducing or consolidating shares, converting preference shares into equity, or altering share values. This adjustment aligns the capital structure with the company’s present financial position. It also ensures better utilization of funds, more realistic share values, and improved returns for shareholders. This ultimately enhances the company’s ability to raise capital and sustain operations more efficiently.

• To Eliminate Fictitious or Overvalued Assets

Companies may carry fictitious or overvalued assets like preliminary expenses, goodwill, or inflated investments on their balance sheets. These non-productive assets distort the true financial position. Internal reconstruction aims to eliminate or adjust the values of such assets, ensuring the balance sheet reflects accurate values. This transparency is crucial for stakeholder trust, effective decision-making, and compliance with accounting standards. Correct asset valuation also improves ratios and financial health indicators used by investors and lenders.

• To Reduce the Burden of Debt and Liabilities

Excessive or unmanageable liabilities can hinder a company’s ability to operate and grow. Internal reconstruction allows the company to renegotiate or restructure its obligations. It can include converting debt into equity, reducing interest rates, or seeking concessions from creditors. These measures help reduce the debt burden, lower interest outflows, and improve liquidity. A leaner liability structure strengthens the company’s long-term viability and provides better cash flow management for future development.

• To Improve Financial Position and Creditworthiness

A company with a weak financial position may struggle to gain credit or attract investment. Internal reconstruction helps improve its balance sheet by eliminating losses, adjusting capital, and removing fictitious assets. This results in a more accurate representation of the company’s net worth. A stronger balance sheet enhances the company’s image in the financial market, increases investor confidence, and makes it easier to raise funds or get better credit terms from banks and institutions.

• To Avoid Liquidation and Continue Business

When a company faces financial distress, liquidation may seem inevitable. However, internal reconstruction provides an alternative that allows the company to continue operating. Through reorganization and adjustments, the company can become viable again without being dissolved. This saves jobs, preserves business relationships, and retains the company’s market presence. It also gives the business a chance to revive, recover from losses, and potentially return to profitability, which benefits all stakeholders in the long run.

• To Protect the Interests of Stakeholders

Internal reconstruction is designed to protect the interests of various stakeholders, including shareholders, creditors, employees, and customers. By restructuring debt and capital, the company becomes more stable and sustainable. Creditors may receive partial payments or equity in exchange for their claims, and shareholders may retain value in their investments. Employees benefit from continued employment, and customers from uninterrupted services. A successful internal reconstruction creates a win-win situation that balances losses while promoting long-term recovery.

Types of Internal Reconstruction:

• Reduction of Share Capital

This involves decreasing the paid-up value or number of shares issued by the company to write off accumulated losses or overvalued assets. It can take forms like reducing the face value of shares, cancelling unpaid share capital, or returning excess capital to shareholders. This process requires approval from shareholders, creditors, and the tribunal as per legal provisions. The goal is to align the capital with the company’s actual financial position and make the balance sheet healthier, paving the way for future profitability and investor confidence.

• Reorganization of Share Capital

Reorganization refers to altering the structure of a company’s existing share capital without reducing its total value. It may involve converting one class of shares into another (e.g., preference to equity), subdividing shares into smaller units, or consolidating them into larger units. This type of reconstruction improves the flexibility and attractiveness of the company’s shareholding pattern. It helps cater to investor preferences, improve market perception, and better reflect the company’s operational scale and prospects.

• Revaluation of Assets and Liabilities

In this type, the company reassesses the book value of its assets and liabilities to reflect their actual market values. Overvalued assets like goodwill or obsolete machinery are written down, while undervalued ones like land may be increased. Liabilities may also be restated, such as provisioning for doubtful debts. This brings transparency, accuracy, and credibility to the balance sheet, making financial statements more reliable for investors, auditors, and lenders. It supports better decision-making and financial planning.

• Alteration of Rights of Stakeholders

Here, the company may alter the rights attached to different classes of shares or renegotiate terms with creditors. For example, preference shareholders may agree to a lower dividend or delayed payment. Creditors may agree to partial settlements or convert their dues into equity. These adjustments require consent and legal approval but help reduce financial stress on the company. It balances the expectations of stakeholders while improving the company’s survival chances and long-term sustainability.

Conditions/Provisions regarding Internal Reconstruction:

• Approval by Shareholders and Creditors

Internal reconstruction requires the formal approval of shareholders through a special resolution passed in a general meeting. In addition, the consent of creditors, debenture holders, and other affected parties is essential, especially when their rights are altered or reduced. This ensures transparency and fairness in the reconstruction process. Without stakeholder consent, the plan cannot proceed legally, as it may negatively impact their financial interests. This step reflects democratic decision-making and protects the rights of those involved in the company’s capital structure.

• Compliance with Section 66 of the Companies Act, 2013

Section 66 of the Companies Act, 2013 governs the reduction of share capital, a key element of internal reconstruction. It mandates that the company must apply to the National Company Law Tribunal (NCLT) for confirmation of the reduction. A detailed scheme, statement of assets and liabilities, and auditor’s certificate must accompany the application. The Tribunal will approve the plan only after ensuring that the interests of creditors and shareholders are safeguarded. Compliance ensures legal validity and protects against future legal disputes or financial misstatements.

• Tribunal’s Sanction and Public Notice

Before implementing internal reconstruction, especially involving capital reduction, companies must obtain the sanction of the National Company Law Tribunal (NCLT). The Tribunal may direct the company to notify the public and creditors through advertisements in newspapers and seek objections. This transparency protects public interest and allows concerned parties to express their views. Only after hearing objections and verifying fairness does the Tribunal approve the scheme. This provision ensures accountability and protects the rights of both existing investors and the public.

• Filing with Registrar of Companies (RoC)

After obtaining Tribunal approval, the company must file the sanctioned reconstruction scheme and any altered documents with the Registrar of Companies (RoC). This includes submitting revised copies of the Memorandum of Association and Articles of Association if they are modified. Filing ensures that the changes become part of the company’s legal records and are accessible to stakeholders and regulatory authorities. It completes the legal formalities and provides legitimacy and transparency to the restructuring process, keeping the company compliant with statutory requirements.

Accounting Treatment of Internal Reconstruction:

Amalgamation is a strategic process in corporate restructuring where two or more companies combine to form a new entity or where one company is absorbed by another. The primary motive behind amalgamation is to achieve synergy, expand operations, eliminate competition, and enhance market reach. In accounting and legal terms, amalgamation is governed by the Companies Act, 2013, and is treated as per the accounting standard AS 14 – Accounting for Amalgamations.

AS 14 classifies amalgamation into two broad categories:

1. Amalgamation in the Nature of Merger

2. Amalgamation in the Nature of Purchase

Each type has distinct accounting treatments, legal conditions, and strategic implications, which are discussed in detail below.

Amalgamation in the Nature of Merger

Amalgamation in the nature of merger is a unification of two or more companies into a single entity, where:

• All the assets, liabilities, and reserves of the transferor company are transferred to the transferee company.

• The shareholders of the transferor company continue to have a proportionate shareholding in the transferee company.

• The business of the transferor company is intended to continue.

This type of amalgamation reflects a genuine pooling of interests where the identity of the combining companies is retained in spirit, if not in form.

Key Characteristics

According to AS 14, an amalgamation is considered to be in the nature of merger if all the following conditions are met:

1. All assets and liabilities of the transferor company become assets and liabilities of the transferee company.

2. Shareholders holding at least 90% of the face value of equity shares in the transferor company become equity shareholders of the transferee company.

3. The consideration is discharged solely by equity shares, except for cash paid for fractional shares.

4. The business of the transferor company is intended to be carried on by the transferee company.

5. No adjustment is made to the book values of assets and liabilities, except to bring uniformity in accounting policies.

Accounting Treatment – Pooling of Interests Method

Under the Pooling of Interests Method, the books of the transferee company reflect:

• Assets and liabilities of the transferor company at existing book values.

• Reserves of the transferor company as they are, and not transferred to the Profit & Loss account.

• No goodwill or capital reserve is recorded.

• The difference in share capital is adjusted against reserves.

This method ensures continuity in financial reporting and is often preferred for strategic mergers between equals.

Example

Let’s consider two companies – A Ltd. and B Ltd.

• A Ltd. and B Ltd. decide to merge and form a single company, A Ltd. (B Ltd. is absorbed).

• All assets and liabilities of B Ltd. are taken over by A Ltd.

• 95% of the shareholders of B Ltd. are issued equity shares in A Ltd.

• No purchase consideration is paid in cash.

• Business of B Ltd. is continued by A Ltd.

Since all five conditions are satisfied, this amalgamation is in the nature of merger.

Amalgamation in the Nature of Purchase

Amalgamation in the nature of purchase refers to a situation where one company acquires another and takes over its assets and liabilities, but the acquisition does not meet the criteria of a merger.

Here, the identity of the transferor company is dissolved, and the shareholders of the transferor company may or may not become shareholders of the transferee company. The business of the transferor company may or may not be continued.

Key Characteristics:

If any one of the five conditions required for a merger is not satisfied, then the amalgamation is treated as a purchase. In such a case:

• The transferee company may selectively take over assets and liabilities.

• Consideration may be paid in cash, shares, debentures, or a combination.

• Shareholders of the transferor company may not receive equity shares in the transferee company.

• The business of the transferor company may be discontinued or modified.

• Adjustments are made to asset values, and reserves are not carried forward.

Accounting Treatment – Purchase Method:

Under the Purchase Method, the transferee company:

• Records assets and liabilities at fair market value (not book value).

• Does not carry over reserves of the transferor company (except statutory reserves).

• Recognizes the difference between the purchase consideration and net assets taken over as goodwill (if consideration > net assets) or capital reserve (if consideration < net assets).

This method reflects a new ownership and often results in changes in financial position due to revaluation.

Example:

Consider another case:

• X Ltd. acquires Y Ltd. by paying ₹50 lakh in cash and taking over only selected assets.

• Only 60% of Y Ltd.’s equity shareholders become shareholders of X Ltd.

• Y Ltd.’s business is discontinued after acquisition.

• Asset values are revalued at the time of acquisition.

This transaction fails to meet the conditions of merger and hence qualifies as an amalgamation in the nature of purchase.

Comparison Between Merger and Purchase

Remuneration of a Liquidator refers to the compensation or fee payable to a liquidator for carrying out the process of winding up a company. This process includes selling the company’s assets, settling liabilities, distributing the surplus (if any) among shareholders, and ensuring all statutory and regulatory obligations are fulfilled. The liquidator plays a critical fiduciary role, and the remuneration structure is designed to reflect the complexity, responsibility, and time involved in managing the liquidation process.

Legal Framework

The remuneration of the liquidator is governed by:

• Companies Act, 2013 (especially Sections 275–365 on winding up),

• Insolvency and Bankruptcy Code (IBC), 2016, and

• Companies (Winding-Up) Rules, 2020.

Under these laws, the amount and manner of payment of remuneration vary depending on whether the liquidation is:

1. Voluntary,

2. Compulsory (by order of NCLT), or

3. Under the IBC (corporate liquidation process).

Who Fixes the Remuneration?

The remuneration is fixed based on the mode of winding up:

1. In Compulsory Winding-Up:

• The National Company Law Tribunal (NCLT) appoints an official liquidator and fixes their remuneration.

• The fee may be fixed as a percentage of the assets realized and distributed or as a fixed sum depending on the complexity and scale of the process.

2. In Voluntary Winding-Up:

• The company in general meeting appoints the liquidator and fixes the remuneration through a special resolution.

• The appointed liquidator cannot change the remuneration unless approved by shareholders.

3. In Liquidation under IBC:

• The Committee of Creditors (CoC) fixes the fee of the liquidator (Resolution Professional acting as liquidator) under Regulation 4 of the IBBI (Liquidation Process) Regulations, 2016.

• The fees may be a fixed monthly remuneration or based on asset realization and distribution.

Modes of Remuneration:

Remuneration may be paid in the following ways:

1. Percentage Basis:

• A percentage of the assets realized or distributed to creditors and shareholders.

• For example, 2% of assets realized and 3% of assets distributed.

2. Fixed Monthly Fee:

Especially under IBC, where CoC fixes a monthly fee for the duration of the liquidation.

3. Success-Based Fee:

In some cases, liquidators may be offered an incentive for completing the process efficiently or achieving higher recoveries.

Remuneration is a Priority Cost:

• Under both the Companies Act and IBC, the liquidator’s remuneration is treated as part of the insolvency resolution and liquidation process costs.

• These costs are accorded highest priority in the waterfall mechanism for distribution (Section 53 of IBC and Rule 190 of Companies Rules).

Reimbursement of Expenses:

In addition to remuneration, a liquidator is entitled to reimbursement of actual expenses incurred during the winding-up, such as:

• Legal and professional fees,

• Advertising costs for notices or auctions,

• Costs of maintaining records and conducting meetings,

• Travel and administrative expenses.

All such expenses must be properly accounted for and supported with evidence.

Remuneration Restrictions:

Certain restrictions and rules ensure fairness and prevent abuse:

• Liquidators cannot increase their own fee or receive additional benefits without approval.

• They cannot accept commissions or gifts from stakeholders.

• Double remuneration for the same work is prohibited.

• The remuneration must be approved and disclosed in the final accounts.

Remuneration Upon Resignation or Removal:

If a liquidator resigns or is removed before the completion of liquidation:

• They are entitled to remuneration only for the period of service.

• Prorated fees may be calculated based on work done and approvals obtained.

The Liquidator’s Statement of Account is a comprehensive financial report prepared by the liquidator during the winding-up process of a company. It captures all financial transactions from the commencement of liquidation to its completion. This statement ensures accountability, transparency, and statutory compliance, especially under the Companies Act, 2013 and the Insolvency and Bankruptcy Code (IBC), 2016.

Purpose and Importance:

The primary objective of preparing a Liquidator’s Statement of Account is to:

1. Disclose the financial position of the company under liquidation.

2. Track the realization and distribution of assets.

3. Provide transparency to stakeholders including creditors, shareholders, and regulatory authorities.

4. Ensure compliance with the legal and procedural norms under the Companies Act, IBC, and SEBI guidelines (where applicable).

It acts as a key document submitted to the Tribunal (NCLT), Registrar of Companies, and the Insolvency and Bankruptcy Board of India (IBBI) as part of the final reporting in the liquidation process.

Legal Provisions:

Under the Companies (Winding-Up) Rules, 2020, Rule 185 and 186 outline the format and frequency of the Liquidator’s Account.

Under the Insolvency and Bankruptcy Code, 2016, the Liquidator must file periodic and final reports, including statements of receipts and payments, with the Adjudicating Authority (NCLT) and IBBI.

Contents of the Liquidator’s Statement of Account:

A standard Liquidator’s Statement of Account includes the following components:

1. Receipts Section

This section details the total cash and assets received during liquidation, including:

• Opening cash and bank balances.

• Sale proceeds from fixed assets.

• Realization from current assets (stock, receivables, etc.).

• Income from investments.

• Refunds or recoveries from tax authorities.

• Other income (interest, rent, etc.).

2. Payments Section

This section records all expenditures and distributions, such as:

• Insolvency resolution and liquidation process costs.

• Legal and professional fees.

• Payments to secured creditors.

• Workmen’s dues and employee salaries.

• Government dues (taxes, duties, etc.).

• Payments to unsecured creditors.

• Interim dividend or final dividend to shareholders.

• Miscellaneous expenses (postage, printing, rent, utilities).

3. Summary of Assets Realized and Disposed

• Details of each asset realized (description, book value, sale value).

• Details of assets yet to be realized or written off.

• Any shortfall or surplus generated.

4. Statement of Distribution

• Date and amount paid to each category of stakeholder.

• Particulars of dividends declared and paid.

• Unclaimed amounts and transfer to the Corporate Liquidation Account (as mandated by IBBI).

5. Bank Reconciliation Statement

• Cash at bank and on hand.

• Bank account statement attached to ensure reconciliation with liquidation records.

6. Notes and Observations

• Notes regarding any legal proceedings, disputes, or liabilities.

• Explanation for delays or outstanding recoveries.

• Remarks on books and records maintained during liquidation.

Format and Frequency

Frequency of Submission:

• Half-yearly (for voluntary winding-up) or

• Quarterly (as per IBBI regulations for corporate persons)

• Final Statement at the end of the liquidation process

Format:

The format of the statement is prescribed under Form No. 11 and Form No. 12 of the Companies (Winding-Up) Rules and under Form H of IBBI (Liquidation Process) Regulations, 2016.

Audit and Certification

• The statement must be audited by a Chartered Accountant, especially if the liquidation period exceeds one year.

• Certified true copies are submitted to:

  • NCLT (for compulsory winding-up)

  • Registrar of Companies

  • IBBI (for cases under IBC)

Closing the Liquidation Process:

Once the statement is prepared and submitted, and all obligations are met:

1. Final meeting of stakeholders is held (in case of voluntary winding-up).

2. A final report and accounts are submitted to the NCLT/Registrar.

3. On approval, the company is dissolved and struck off from the records.

If unclaimed funds remain, they are deposited into the Corporate Liquidation Account, managed by IBBI, and reported in the Statement.

Participants

Loan Takers: A huge number of organizations want to take a loan from the capital market. Among them, the following are prominent as Govt. organizations, Corporate bodies, Non-profit organizations, Small business, and Local authorities.

Loan Providers: These types of organizations provide loans to my capital market. Others can take the loan from the loan providers such as savings organizations, insurance organizations etc.

Service organizations: Service organizations help to run capital market perfectly. These firms, on one hand, help issuers or underwriters to sell their instruments with high value and in other hand help sellers and buyers to transact easily. These are mainly service organization – invests banks, Brokers, Dealers, Jobbers, Security Exchange Commission, Rating service, Underwriters etc.

Financial intermediaries: Financial intermediaries are media between loan providers and takers. The financial intermediaries are Insurance organizations, Pension funds, Commercial banks, financing companies, Savings organizations, Dealers, Brokers, Jobbers, Non-profit organizations etc.

Regulatory organizations: Regulatory organizations are mainly govt. the authority that monitors and controls this market. It secures both the investors and corporations. It strongly protects forgery in stock market Regulatory organization controls the margin also. The Central bank, on behalf of govt. generally controls the financial activities in a country.

Instruments

Government Securities:

Securities issued by the central government or state governments are referred to as government securities (G-Secs).

A Government security may be issued in one of the following forms, namely:

1. A Government promissory note payable to or to the order of a certain person,
2. A bearer bond payable to bearer
3. A stock
4. A bond held in a ‘bond ledger account,

Bonds:

Bonds are debt instruments that are issued by companies/governments to raise funds for financing their capital requirements. By purchasing a bond, an investor lends money for a fixed period of time at a predetermined interest (coupon) rate. Bonds have a fixed face value, which is the amount to be returned to the investor upon maturity of the bond.

During this period, the investors receive a regular payment of interest, semi-annually or annually, which is calculated as a certain percentage of the face value and known as a ‘coupon payment.’ Bonds can be issued at par, at discount or at premium. A bond, whether issued by a government or a corporation, has a specific maturity date, which can range from a few days to 20-30 years or even more.

Both debentures and bonds mean the same. In Indian parlance, debentures are issued by corporates and bonds by government or semi-government bodies. But now, corporates are also issuing bonds which carry comparatively lower interest rates and preference in repayment at the time of winding up, comparing to debentures.

The government, public sector units and corporates are the dominant issuers in the bond market. Bonds issued by corporates and the Government of India can be traded in the secondary market.

Basically, there are two types of bonds viz.:

1. Government Bonds: Are fixed income debt instruments issued by the government to finance their capital requirements (fiscal deficit) or development projects.
2. Corporate Bonds: Are debt securities issued by public or private corporations that need to raise money for working capital or for capital expenditure needs.

Types of Government Securities:

Following are the types of Government Securities:

1. Promissory Notes:

Promissory Notes are instruments containing the promises of the Government to pay interest at a specified rate. Interests are usually paid half yearly. Interest is payable to the holder only on presentation of the promissory notes. They are transferable by endorsement and delivery.

2. Stock Certificates (Inscribed Stock):

Stock certificate, also known as Inscribed Stock, is a debt held in the form of stock. The owner is given a certificate inserting his name after registering in the books of PDO of RBI. The execution of transfer deed is necessary for its transfer. Since liquidity is affected, these are not much favoured by investors. One will have to wait till maturity to get it encashed.

3. Bearer Bonds:

A bearer bond is an instrument issued by government, certifying that the bearer is entitled to a specified amount on the specified date. Bearer bonds are transferable by mere delivery. Interest Coupons are attached to these bonds. When the periodical interest falls due, the holder clips off the relevant coupon and presents it to the concerned authority for payment of interest.

4. Dated Securities:

They are long term Government securities or bonds with fixed maturity and fixed coupon rates paid on the face value. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 12.60% GOI BOND 2018 is a Central Government security maturing in 2018, which was issued on 23.11.1998 bearing security coupon 400095 with a coupon of 12.06 % payable half yearly. At present, there are Central Government dated securities with tenure up to 30 years in the market. Dated securities are sold through auctions. They are issued and redeemed at par.

5. Zero Coupon Bonds:

These bonds are issued at discount to face value and to be redeemed at par. As the name suggests there is no coupon/interest payments. These bonds were first issued by the GOI in 1994 and were followed by two subsequent issues in 1995 and 1996 respectively.

6. Partly Paid Stock:

This is a stock where payment of principal amount is made in installments over a given time frame. It meets the needs of investors with regular flow of funds and the needs of Government when it does not need funds immediately. The first issue of such stock of eight year maturity was made on November 15, 1994 for Rs. 2000 crore. Such stocks have been issued a few more times thereafter.

7. Floating Rate Bonds:

These are bonds with variable interest rate, which will be reset at regular intervals (six months). There may be a cap and a floor rate attached, thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995.

8. Bonds with Call/Put Option:

These are Govt. bonds with the features of options where the Govt. (issuer) has the option to call (buy) back or the investor can have the option to sell the bond (Put option) to the issuer. First time in the history of Government Securities market RBI issued a bond with call and put option in 2001-02. This bond was due for redemption in 2012 and carried a coupon of 6.72%. However the bond had call and put option after five years i.e. in the year 2007. In other words, it means that holder of bond could sell back (put option) bond to Government in 2007 or Government could buy back (call option) bond from holder in 2007.

9. Capital Indexed Bonds:

These are bonds where interest rate is a fixed percentage over the wholesale price index. The principal redemption is linked to an index of inflation (here wholesale price index). These provide investors with an effective hedge against inflation. These bonds were floated on December, 1997 on an on tap basis. They were of five-year maturity with a coupon rate of 6 per cent over the wholesale price index.

10. Fixed Rate Bond:

Normally government securities are issued as fixed rate bonds. In this type of bonds the coupon rate is fixed at the time of issue and remains fixed till redemption.

Gold bonds, National Defence bonds, Special Purpose Securities, Rural Development bonds, Relief bonds, Treasury bill etc. are other types of Government securities.

The major investors in G-Secs are banks, life insurance companies, general insurance companies, pension funds and EPFO. Other investors include primary dealer’s mutual funds, foreign institutional investors, high net-worth individuals and retail individual investors.

Most of the secondary market trading in government bonds happens on OTC (Over the Counter), the Negotiated Dealing System and the wholesale debt-market (WDM) segment of the National Stock Exchange.

Debentures:

Debenture is an instrument under seal evidencing debt. The essence of debenture is admission of indebtedness. It is a debt instrument issued by a company with a promise to pay interest and repay the principal on maturity. Debenture holders are creditors of the company. Sec 2 (12) of the Companies Act, 1956 states that debenture includes debenture stock, bonds and other securities of a company. It is customary to appoint a trustee, usually an investment bank- to protect the interests of the debenture holders. This is necessary as debenture deed would specify the rights of the debenture holders and the obligations of the company.

Types of Debentures:

1. Secured Debentures:

Debentures which create a charge on the property of the company is a secured debenture. The charge may be floating or fixed. The floating charge is not attached to any particular asset of the company. But when the company goes into liquidation the charge becomes fixed. Fixed charge debentures are those where specific asset or group of assets is pledged as security. The details of these charges are to be mentioned in the trust deed.

2. Unsecured Debentures:

These are not protected through any charge by any property or assets of the company. They are also known as naked debentures. Well established and credit worthy companies can issue such shares.

3. Bearer Debentures:

Bearer debentures are payable to bearer and are transferable by mere delivery. Interest coupons are attached to the certificate or bond. As interest date approaches, the appropriate coupon is ‘clipped off by the holder of the bond and deposited in his bank for collection. The bank may forward it to the fiscal agent of the company and proceeds are collected. Such bonds are negotiable by delivery.

4. Registered Debentures:

In the case of registered debentures the name and address of the holder and date of registration are entered in a book kept by the company. The holder of such a debenture bond has nothing to do except to wait for interest payment which is automatically sent him on every payment date.

When such debentures are registered as to principals only, coupons are attached. The holder must detach the coupons for interest payment and collect them as in the case of bearer bonds.

5. Redeemable Debentures:

When the debentures are redeemable, the company has the right to call them before maturity. The debentures can be paid off before maturity, if the company can afford to do so. Redemption can also be brought about by issuing other securities less costly to the company in the place of the old ones.

6. Convertible Debentures:

When an option is given to convert debentures in to equity shares after a specific period, they are called as convertible debentures.

7. Non-Convertible Debentures With Detachable Equity Warrants:

The holders of such debentures can buy a specified number of shares from the company at a predetermined price. The option can be exercised only after a specified period.

Preference Shares:

The Companies Act (Sec, 85), 1956 describes preference shares as those which Carry a preferential right to payment of dividend during the life time of the company and Carry a preferential right for repayment of capital in the event of winding up of the company.

Preference shares have the features of equity capital and features of fixed income like debentures. They are paid a fixed dividend before any dividend is declared to the equity holders.

Types of Preference Shares:

1. Redeemable Preference Shares:

These shares are redeemed after a given period.

Such shares can be repaid by the company on certain conditions, viz.;

1. The shares must be fully paid up.
2. It must be redeemed either out of profit or out of reserve fund for the purpose.
3. The premium must be paid if any.

A company may opt for redeemable preference shares to avoid fixed liability of payment, increase the earnings of equity shares, to make the capital structure simple or such other reasons.

2. Irredeemable Preference Shares:

These shares are not redeemable except on the liquidation of the company.

3. Convertible Preference Shares:

Such shares can be converted to equity shares at the option of the holder. Hence, these shares are also known as quasi equity shares. Conversion of preference shares in to bonds or debentures is permitted if company wishes. The conversion feature makes preference shares more acceptable to investors. Even though the market for preference shares is not good at a point of time, the convertibility will make it attractive.

4. Participating Preference Shares:

These kinds of shares are entitled to get regular dividend at fixed rate. Moreover, they have a right for surplus of the company beyond a certain limit.

5. Cumulative Preference Shares:

The dividend payable for such shares is fixed at 10%. The dividend not paid in a particular year can be cumulated for the next year in this case.

6. Preference Shares with Warrants:

This instrument has certain number of warrants. The holder of such warrants can apply for equity shares at premium. The application should be made between the third and fifth year from the date of allotment.

7. Fully Convertible Cumulative Preference Shares:

Part of such shares, are automatically converted into equity shares on the date of allotment. The rest of the shares will be redeemed at par or converted in to equity after a lock in period at the option of the investors.

Securities:

‘Securities’ is a general term for a stock exchange investment.

Securities Contract (Regulation) Act, 1956 defines securities as to include:

1. Shares, Scripts, Stocks, Bonds, Debentures.
2. Government Securities.
3. Such other instruments as may be declared by the Central government to be securities.
4. Rights or interests in securities
5. Derivatives
6. Securitized instruments

Equity Shares:

Equity Shares are the ordinary shares of a limited company. It is an instrument, a contract, which guarantees a residual interest in the assets of an enterprise after deducting all its liabilities- including dividends on preference shares. Equity shares constitute the ownership capital of a company. Equity holders are the legal owners of a company.

Capital Expenditure

Capital expenditure is the expenditure incurred to acquire fixed assets, capital leases, office equipment, computer equipment, software development, purchase of tangible and intangible assets, and such kind of any value addition in business with the purpose to enhance the income. However, to decide nature of the capital expenditure, we need to pay attention on:

• The expenditure, which benefit cannot be consumed or utilized in the same accounting period, should be treated as capital expenditure.
• Expenditure incurred to acquire Fixed Assets for the company.
• Expenditure incurred to acquire fixed assets, erection and installation charges, transportation of assets charges, and travelling expenses directly relates to the purchase fixed assets, are covered under capital expenditure.
• Capital addition to any fixed assets, which increases the life or efficiency of those assets for example, an addition to building.

Revenue Expenditure

Revenue expenditure is the expenditure incurred on the fixed assets for the ‘maintenance’ instead of increasing the earning capacity of the assets. Examples of some of the important revenue expenditures are as follows:

• Wages/Salary
• Freight inward & outward
• Administrative Expenditure
• Selling and distribution Expenditure
• Assets purchased for resale purpose
• Repairs and renewal expenditure which are necessary to keep Fixed Assets in good running and efficient conditions

Revenue Expenditure Treated as Capital Expenditure

Following are the list of important revenue expenditures, but under certain circumstances, they are treated as a capital expenditure:

• Raw Material and Consumables: If those are used in making any fixed assets.
• Cartage and Freight: If those are incurred to bring Fixed Assets.
• Repairs & Renewals: If incurred to enhance life of the assets or efficiency of the assets.
• Preliminary Expenditures: Expenditure incurred during the formation of a business should be treated as capital expenditure.
• Interest on Capital: If paid for the construction work before the commencement of production or business.
• Development Expenditure: In some businesses, long period of development and heavy amount of investment are required before starting the production especially in a Tea or Rubber plantation. Usually, these expenditures should be treated as the capital expenditure.
• Wages: If paid to build up assets or for the erection and installation of Plant and Machinery.

A transaction refers to the exchange of an asset and discharge of liabilities for consideration in terms of money. However, these transactions are of two types, viz. Capital transactions and Revenue transactions.

the accounting profit for a period the concept of capital and revenue is of utmost importance. The bifurcation of the transactions between capital and revenue is also necessary for the recognition of business assets at the end of the accounting or financial year.

Important Terms

1. Capital Transactions

Capital transactions are transactions that have a long-term effect on the business. It means that the effect of these transactions extends to a period of more than one year.

2. Revenue Transactions

Revenue transactions are transactions that have a short-term effect on the business. Usually, the effect of these transactions is only for a period of one year.

3. Capital Expenditure

Capital expenditure is the expenditure that a business incurs on the purchase, alteration or the improvement of fixed assets. For example, the purchase of furniture for office use is a capital expenditure. The following costs are included in the capital expenditure:

1. Delivery charges of fixed assets
2. Installation expenses of fixed assets
3. Alteration or improvement expenses of fixed assets
4. Legal costs of purchasing a fixed asset
5. Demolition costs of fixed assets
6. Architects fee

   4. Revenue Expenditure

The expenditure incurred in the running or the management of the business is known as the revenue expenditure. For example, the cost of the repairs of machinery is a revenue expenditure.

We need to show the Capital expenditure on the Assets side of the Balance Sheet while we show the Revenue expenditure on the debit side of the Trading and Profit and Loss Account.

5. Revenue Receipts

The revenue receipt is the amount received by a business against the revenue incomes.

6. Capital Receipts

It is the amount which is received against the capital income by a business.

7. Capital Profits

Capital profit refers to the profit that is earned on the sale of fixed assets.

8. Revenue Profits

Revenue profit is the profit which a business earns during the ordinary course of business.

9. Capital Loss

It is the amount of loss that a business incurs on the sale of fixed assets.

10. Revenue Loss

It is the amount of loss that a business incurs during the ordinary course of business.

Rules for Determination of Capital Expenditure

The following expenses are termed as Capital expenditure:

1. Any expenditure on the purchase of fixed assets or long-term assets for use in business in order to earn profits is capital expenditure. However, expenditure on fixed assets purchased for resale does not amount to capital expenditure.
2. Any expenditure on the improvement or alteration in the present condition of a fixed asset to bring it to the working condition is a capital expenditure and thus we need to add it to the cost of the asset.
3. Any expenditure of any sort which increases the earning capacity of the business is also capital expenditure.
4. Preliminary expenses incurred before the commencement of business are also capital expenditure.

Rules for Determination of Revenue Expenditure

The following expenses are termed as the revenue expenditure:

1. Any expenditure for the day-to-day conduct of the business is revenue expenditure. The benefits of these expenses last only for the period of one year.
2. Any expenditure on the consumable items and on goods and services.
3. Any expenditure on the maintenance of fixed assets such as repairs and renewals.

Deferred Revenue Expenditure

Deferred revenue expenditure refers to the expenditure which is revenue in nature but involves a lump sum amount and the benefits that extend for a period of more than one year. We need to write off these expenses over a period of 3 to 5 years. On the other hand, the balance which is not written off is carried forward and shown on the Assets side of the Balance Sheet. Heavy advertisement expenditure is a good example of such expenditure.

The following are the types of capital and revenue items in accounting:

1. Capital Receipts
2. Revenue Receipts
3. Capital Profits
4. Revenue Profits
5. Capital Losses
6. Revenue Losses

(A) Capital Receipts:

Capital Receipts is the amount received in the form of additional Capital (by issuing shares) loans or by the sale proceeds of any fixed assets. Capital Receipts are shown in Balance Sheet.

(B) Revenue Receipts:

Revenue Receipts are the amount received in the ordinary course of a business. It is the incomes earned from selling merchandise, or in the form of discount, commission, interest, transfer fees etc. Income received by selling waste paper, packing cases etc. is also a revenue receipt. Revenue Re­ceipts are shown in the Profit and Loss Account.

(C) Capital Profit:

Capital profits are earned as a result of selling some fixed assets or in connection with raising capital for the firm. For example a land purchased by a business for Rs 2, 00,000 is sold for Rs. 2, 50,000. Rs 50,000 are a profit of capital nature. Another example, suppose a company issues its shares of the face value of Rs 100 for Rs 110 each, i.e. issue of shares at premium, the premium on shares i.e. Rs 10 is capital profit. Such profits are (a) transferred to Capital Account or (b) transferred to Capital Reserve Account. This amount is utilised for meeting Capital losses. Capital Reserve ap­pears in the Balance Sheet as a liability.

(D) Revenue Profits:

evenue Profits are earned in the ordinary course of business. Revenue profits appear in the Profit and Loss Account. For example, profit from sale of goods, income from investments, discount received, Interest Earned etc.

(E) Capital Losses:

Capital losses occur when selling fixed assets or raising share capital. A building purchased for Rs 2, 00,000 is sold for Rs 1, 50,000. Rs 50,000 are a capital loss. Shares of the face value of Rs 100 issued at Rs 95, i.e. discount of Rs 5. The amount of discount is a capital loss.

Capital Loss is not shown in the Profit and Loss Account. They are shown in the asset side of Balance Sheet. When Capital Profit arises, Capital losses are gradually written off against them. If capital losses are huge, it is common to spread them over a number of years and a proportionate amount is charged to Profit and Loss Account every year.

Balance amount is shown in the Balance Sheet as an asset and it is written off in future years. If the loss is manageable, they are debited to Profit and Loss Account of the same year.

(F) Revenue Losses:

Revenue losses arise during the normal course of business. For instance, sale of goods, loss may incur. Such losses are debited in the Profit and Loss Account.

Goodwill is an intangible asset representing the value of a business’s reputation, brand image, customer loyalty, efficient management, favourable location, and other advantages that enable it to earn higher profits compared to other firms in the same industry.

Unlike tangible assets such as buildings, machinery, or stock, goodwill cannot be physically seen or touched, but it significantly contributes to the earning potential of the business. It reflects the premium value that an acquiring company is willing to pay over and above the fair market value of the net assets of the acquired business.

In accounting terms, goodwill is recognised when a business is purchased for a price higher than the value of its net assets. The difference between the purchase price and the net asset value is recorded as goodwill in the books of the buyer.

Example:

If the net assets of a business are worth ₹50,00,000 and it is purchased for ₹60,00,000, the excess ₹10,00,000 is goodwill.

Goodwill can be:

• Purchased Goodwill: Arises when paid for during the acquisition.

• Self-generated Goodwill: Arises due to the firm’s efforts over time but is usually not recorded in the books as per accounting standards.

Circumstances When Goodwill is Valued:

Valuation of goodwill becomes necessary under several business situations, particularly when ownership or profit-sharing arrangements change. The key circumstances are:

• Sale of Business

When a business is sold as a going concern, the purchase price often includes an amount for goodwill. The buyer is willing to pay for the benefits of an established reputation, customer base, and other advantages that will generate profits in the future. In such cases, goodwill is valued to determine the total consideration.

• Admission of a New Partner

When a new partner joins a partnership firm, they get the right to share in the future profits of the business. Since the existing partners have worked to build the firm’s reputation and profit potential, the incoming partner usually compensates them for their share of the goodwill. The valuation ensures fairness in determining the amount payable.

• Retirement or Death of a Partner

When a partner retires or dies, they are entitled to receive their share of the goodwill, as they helped build the business’s reputation. Valuation ensures the outgoing partner (or their legal heirs) is fairly compensated for their contribution.

• Amalgamation of Companies

When two companies merge, the valuation of goodwill helps in deciding the share exchange ratio or purchase consideration. This ensures both sets of shareholders are treated fairly based on the relative worth of their companies, including intangible assets like goodwill.

• Change in Profit-Sharing Ratio

If partners in a firm decide to change their existing profit-sharing arrangement, the partner gaining a higher share compensates the partner losing a share of profits. Goodwill valuation helps determine this compensation amount.

• Conversion of a Partnership into a Company

When a partnership is converted into a company, goodwill is valued to determine the consideration payable to the partners, especially when the business is transferred as a going concern.

• Court Cases or Tax Purposes

In legal disputes, divorce settlements, inheritance cases, or tax assessments, goodwill valuation may be required to determine the fair market value of a business.

• Liquidation

Even during liquidation, goodwill may have a residual value if the brand name, customer contracts, or other intangible advantages can be sold separately.

Factors Affecting the Valuation of Goodwill:

The value of goodwill is not fixed—it varies depending on several qualitative and quantitative factors. These include:

• Nature of Business

The type of business has a major influence on goodwill. A business with stable demand, essential products, and a long-term customer base (e.g., FMCG, healthcare) will generally have higher goodwill compared to one operating in a volatile or seasonal market.

• Location of Business

A business located in a prime area with high footfall (e.g., near markets, busy streets, or transportation hubs) can attract more customers without significant advertising. Such businesses have higher goodwill because their location provides a competitive advantage.

• Reputation of the Business

A well-established reputation for quality, service, and reliability increases customer trust and loyalty, resulting in repeat business and higher goodwill. Negative publicity or poor customer service can reduce goodwill.

• Efficiency of Management

A capable and experienced management team improves productivity, reduces costs, and maintains consistent quality—factors that enhance profitability and goodwill. Poor management decisions, on the other hand, can damage goodwill quickly.

• Quality of Products or Services

High-quality products and services ensure customer satisfaction and retention, leading to strong word-of-mouth promotion and higher goodwill. Businesses known for substandard products may have low or even negative goodwill.

• Market Conditions

Favourable industry trends, low competition, and economic stability enhance goodwill, while recession, intense competition, or market saturation can reduce it.

• Access to Resources

Easy access to skilled labour, raw materials, finance, and advanced technology can increase a firm’s efficiency and profitability, thereby boosting goodwill.

• Risk Involved

Businesses with lower business risk (e.g., stable cash flows, diversified products) command higher goodwill. High-risk ventures (e.g., speculative trading) have lower goodwill valuations.

• Long-Term Contracts and Relationships

Securing long-term contracts with key customers or suppliers provides revenue stability and increases goodwill.

• Brand Value and Intellectual Property

Well-known trademarks, patents, and copyrights add to goodwill because they provide a unique competitive advantage.

• Monopoly or Favourable Agreements

Legal monopolies or government concessions can significantly enhance goodwill since they reduce competition and guarantee revenue streams.

• Synergy Benefits in Mergers

In the case of amalgamation or acquisition, expected cost savings, market expansion, or combined operational efficiency can increase the goodwill valuation.

Importance of Valuation of Goodwill:

The process of valuing goodwill is essential for:

• Ensuring fairness in partner compensation.

• Determining the correct purchase consideration in mergers/acquisitions.

• Presenting an accurate financial position in legal cases.

• Facilitating negotiations during business sale.

• Ensuring compliance with accounting standards (AS 26 in India, IFRS 3 globally).

Methods of Valuation of Goodwill:

The value of goodwill can be determined using various methods, depending on the nature of the business, purpose of valuation, and availability of data. The main methods are:

1. Average Profit Method

Goodwill is valued by multiplying the average maintainable profits by a certain number of years’ purchase.

• Formula:

Goodwill = Average Profit × Number of Years’ Purchase

• Steps:

  1. Determine past profits.

  2. Adjust for abnormal items.

  3. Calculate average profit.

  4. Multiply by agreed years’ purchase (e.g., 3, 4, or 5 years).

• Types:

  • Simple Average Profit Method – Uses arithmetic average.

  • Weighted Average Profit Method – Gives higher weight to recent profits to reflect current earning capacity.

2. Super Profit Method

Goodwill is calculated based on the “super profits” — the excess of average profit over the normal profit (which is based on the normal rate of return).

• Formula:

Goodwill = Super Profit × Number of Years’ Purchase

Where:

Super Profit = Average Profit − Normal Profit

Normal Profit = Capital Employed × Normal Rate of Return (NRR)

• Features:

  • Highlights the business’s earning capacity above industry standards.

  • Suitable when profits are higher than normal industry returns.

3. Capitalization Method

This method converts maintainable profits into total capital value, then deducts the actual capital employed to get goodwill.

a) Capitalization of Average Profits

• Formula:

Goodwill = [Average Profit × 100 / NRR] − Capital Employed

• Indicates how much more the business is worth compared to its actual capital invested.

b) Capitalization of Super Profits

• Formula:

Goodwill = [Super Profit × 100] / NRR​

• Focuses purely on capitalizing the extra profit above the normal level.

4. Annuity Method

Super profits are treated as an annuity receivable for a certain period, and goodwill is calculated as the present value of that annuity.

• Formula:

Goodwill = Super Profit × Present Value of ₹1 for n years at i%

• Use: Reflects the time value of money, making it suitable when super profits are expected only for a limited period.

5. Market Value Method

Used for companies whose shares are actively traded in the stock market. Goodwill is indirectly reflected in the market value of shares above their book value.

• Formula:

Goodwill = (Market Value per Share − Net Asset Value per Share) × Number of Shares

• Use: Common for valuing goodwill in publicly listed companies.

6. Purchase Consideration Method (Residual Method)

Goodwill is the difference between the purchase consideration paid for acquiring a business and the net assets acquired.

• Formula:

Goodwill = Purchase Consideration − Net Assets Acquired

• Use: Applicable in mergers, acquisitions, and business takeovers.

7. Rule of Thumb Method

Goodwill is valued as a fixed proportion (e.g., 1 year’s purchase) of turnover, gross profit, or some other financial measure.

• Use: Quick, but not precise; often used in small business sales (e.g., retail shops).

Holding Company is an entity that has control over one or more companies, known as subsidiaries. Control is typically exercised by owning more than 50% of the subsidiary’s equity share capital or by having the power to appoint or remove a majority of its directors. The holding–subsidiary structure allows the parent entity to influence strategic decisions, manage resources, and oversee operations without being directly involved in day-to-day activities.

Under the Companies Act, 2013, the definition is provided in Section 2(46). A holding company may be incorporated in India or abroad. It must comply with specific legal provisions relating to subsidiary relationships, financial reporting, corporate governance, and restrictions on layers of subsidiaries. This structure is often used for group companies, diversification, risk management, and regulatory benefits, while enabling centralized control over multiple business entities.

Types of Holding Companies

1. Pure

A holding company is described as pure if it was formed for the sole purpose of owning stock in other companies. Essentially, the company does not participate in any other business other than controlling one or more firms.

2. Mixed

A mixed holding company not only controls another firm but also engages in its own operations. It’s also known as a holding-operating company.

Holding companies that take part in completely unrelated lines of business from their subsidiaries are referred to as conglomerates.

3. Immediate

An immediate holding company is one that retains voting stock or control of another company, in spite of the fact that the company itself is already controlled by another entity. Put simply, it’s a type of holding company that is already a subsidiary of another.

4. Intermediate

An intermediate holding is a firm that is both a holding company of another entity and a subsidiary of a larger corporation. An intermediate holding firm might be exempted from publishing financial records as a holding company of the smaller group.

Benefits of a Holding Company

1. Greater control for a smaller investment

It gives the holding company owner a controlling interest in another without having to invest much. When the parent company purchases 51% or more of the subsidiary, it automatically gains control of the acquired firm. By not purchasing 100% of each subsidiary, a small business owner gains control of multiple entities using a very small investment.

2. Independent entities

If a holding company exercises control over several companies, each of the subsidiaries is considered an independent legal entity. It means that if one of the subsidiaries were to face a lawsuit, the plaintiffs have no right to claim the assets of the other subsidiaries. In fact, if the subsidiary being sued acted independently, then it’s highly unlikely that the parent company will be held liable.

3. Management continuity

Whenever a parent company acquires other subsidiaries, it almost always retains the management. It is an important factor for many owners of subsidiaries-to-be who are deciding whether to agree to the acquisition or not. The holding firm can choose not to be involved in the activities of the subsidiary except when it comes to strategic decisions and monitoring the subsidiary’s performance.

It means that the managers of the subsidiary firm retain their previous roles and continue conducting business as usual. On the other hand, the holding company owner benefits financially without necessarily adding to his management duties.

4. Tax effects

Holding companies that own 80% or more of every subsidiary can reap tax benefits by filing consolidated tax returns. A consolidated tax return is one that combines the financial records of all the acquired firms together with that of the parent company. In such a case, should one of subsidiary encounter losses, they will be offset by the profits of the other subsidiaries. In addition, the net effect of filing a consolidated return is a reduced tax liability.

Functions of a Holding Company

Successful entrepreneurs with multiple small businesses are typically concerned with limiting liability, streamlining management and retaining ownership control over each entity. Using a holding company can sometimes be the solution to all three concerns. The company works as an umbrella to give you centralized control over your endeavors while maintaining the liability firewall between each business.

1. Parent Company

A holding company is a corporation or limited liability company that holds a controlling ownership interest in other companies or the assets that those companies use. Typically, a holding company simply holds equity interests or assets, rather than actively engaging in business, such as selling goods or services. Another name for a holding company is a parent, and the companies under it are called operating companies or subsidiaries.

2. Centralized Control

Entrepreneurs who want to open multiple small businesses can use a holding company to centralize control. The entrepreneur can set up the holding company and designate himself as the sole owner. Each business can be set up separately with the holding company as the owner. In this way, the holding company is the central repository of the equity interests in those companies, and the entrepreneur can select executive management for each company while retaining the ability to direct each entity.

3. Limiting Investment

Using a holding company also enables you to raise money and create partnerships for each individual entity without losing overarching control of the business conglomerate. An equity investor can invest in one of the companies under the holding company without interfering with any of the others. If you had simply created a single company with multiple divisions or projects, an investor would take an interest in your whole business empire instead of just a single project that is set up as its own business.

4. Limiting Liability

One of the best uses of a holding company for small-business owners is to further limit liability. Creditors of a corporation or an LLC can go after anything that the entity owns. If you’re in a high-risk business, you can use a holding company to own all of the assets that your business needs to operate, such as real property, vehicles and equipment. The holding company leases those assets to the operating company, so if the operating company gets sued, it owns very little that can be used to satisfy a judgment. The operating company can easily be closed and declared bankrupt, and you can set up another business that leases the exact same assets from the holding company.

5. Considerations

Creating an interlocking ownership structure for multiple small businesses using a holding company is a sophisticated endeavor with significant tax consequences that are tied to your legal structure choices and tax elections. For example, special personal holding company tax rules apply to corporations but not necessarily LLCs that are used as holding companies. Consult with qualified legal and tax professionals before setting up your businesses.

Holding Companies Legal Requirements under Companies Act, 2013:

The Companies Act, 2013 lays down the following legal requirements:

1. Definition (Section 2(46)): A holding company includes any body corporate controlling a subsidiary.

2. Restriction on Layers (Section 2(87) & Rules): A holding company cannot have more than two layers of subsidiaries, except in certain cases (e.g., foreign subsidiaries).

3. Consolidated Financial Statements (Section 129): Must prepare and present consolidated accounts for itself and all subsidiaries.

4. Disclosure in Accounts: Details of subsidiaries’ performance must be disclosed in the Board’s Report.

5. Restriction on Loans & Investments (Section 186): Compliance required for inter-corporate loans, guarantees, and investments.

6. Related Party Transactions (Section 188): Deals with subsidiaries are treated as related party transactions, requiring approvals.

7. Annual Return (Section 92): Must include details of subsidiaries, associates, and joint ventures.

8. Audit Requirements: Subsidiaries’ accounts must be audited and considered in consolidated reports.

Subsidiary Company is an entity that is controlled by another company, known as the holding company. Control is generally established when the holding company owns more than 50% of the subsidiary’s equity share capital or has the power to appoint or remove a majority of its directors. This control can be direct or indirect, including through another subsidiary (step-down subsidiary). The relationship allows the holding company to influence key decisions and policies of the subsidiary without necessarily being involved in its daily operations.

Under the Companies Act, 2013 (Section 2(87)), subsidiaries are subject to specific legal requirements relating to structure, reporting, and compliance. A company cannot have more than two layers of subsidiaries, except in certain permitted cases, such as foreign subsidiaries with overseas holdings. Subsidiaries must prepare their own financial statements, which are then consolidated into the holding company’s accounts. This structure is widely used for business expansion, risk segregation, and managing diverse operations under a single corporate group.

Types of Subsidiary Company

1. Partly Owned

The parent company owns 50% or more but less than 100% shares in the holding company. Such a subsidiary is partly owned. Here parent company does not get full control over the subsidiary company.

2. Wholly Owned

The parent company holds 100% shares & controls in the subsidiary company. Though, A wholly-owned subsidiary company is not a merger.

A holding company can have more than one subsidiary company. But a subsidiary company can have one and only one holding company. However, a subsidiary can have a subsidiary or more of its own.

The parent company can be larger or smaller than the subsidiary. It need not be more powerful than the subsidiary. The size of the firm or employees does not decide the relationship. The only control over ownership is the key factor.

Also, the location or type of business of both companies does not matter.  They may or may not be in the same location or same business line.

Structure of Subsidiary Company

1. Formation

The parent company has to register with the state registrar of the state in which the company operates. The ownership & stake details are to be defined during this process.

2. Operation

Normally, the parent company just oversees the operations of the subsidiary company. However, in certain cases, the parent company may supervise day to day operations of a subsidiary company.

Subsidiaries are separate legal entities. They have their own concerns regarding the handling of taxation, regulations & liabilities. Subsidiary companies can sue & be sued separate from the parent company. the obligations of a subsidiary may or may not be obligations of the parent company. One of these companies can be undergoing legal proceedings, bankruptcy, tax delinquency or be under investigation without affecting other companies directly. though affecting public image is altogether an intangible thing.

How Does a Subsidiary Work?

Subsidiaries are common in some industries, particularly real estate. A company that owns real estate and has several properties with apartments for rent may form an overall holding company, with each property as a subsidiary. The rationale for doing this is to protect the assets of the various properties from each other’s liabilities. For example, if Company A owns Companies B, C, and D (each a property) and Company D is sued, the other companies can not be held liable for the actions of Company D.

A subsidiary is formed by registering with the state in which the company operates. The ownership of the subsidiary and the type of corporate entity such as a limited liability company (LLC) are spelled out in the registration.

How Are Subsidiaries Accounted For?

From an accounting standpoint, a subsidiary is a separate company, so it keeps its own financial records and bank accounts and track its assets and liabilities. Any transactions between the parent company and the subsidiary must be recorded.

A subsidiary may also be its own separate entity for taxation purposes. Each subsidiary has its own employer identification number and may pay its own taxes, according to its business type.

However, many public companies file consolidated financial statements, including the balance sheet and income statement, showing the parent and all subsidiaries combined. And if a parent company owns 80% or more of shares and voting rights for its subsidiaries, it can submit a consolidated income tax return that can take advantage of offsetting the profits of one subsidiary with losses from another. Each subsidiary must consent to being included in this consolidated tax return by filing IRS Form 1122.

Holding Company vs. Parent Company

Most holding companies’ sole purpose is to hold ownership of subsidiaries. If that’s the case, the company is referred to as a “pure” holding company. If it also conducts business operations of its own, it’s called a “mixed holding company.5 One example of a pure holding company is publicly traded Alphabet Inc., whose purpose is to hold Google and other, lesser-known subsidiaries like Calico and Life Sciences.6 YouTube is, in turn, a subsidiary of Google.

Subsidiary vs. Branch or Division

You may have seen the terms “branch” or “division” used as synonyms for “subsidiary,” but they are not one and the same. A subsidiary is a separate legal entity, while a branch or division is a part of a company that is not considered to be a separate entity.

A branch is usually defined as a separate location within the company, like the Pittsburgh branch of a company whose headquarters is in New York. A division is part of a company that performs a specific activity, such as the wealth management division of a larger financial services company.

Subsidiary Companies Legal Requirements under Companies Act, 2013:

• Definition (Section 2(87))

A subsidiary company is one in which another company (holding company) controls more than 50% of the total share capital or has the right to control the composition of its board of directors. This control may be direct or through another subsidiary. The definition also includes step-down subsidiaries. The Companies (Restriction on Number of Layers) Rules, 2017 limit the number of subsidiary layers, ensuring transparency. This definition is crucial for determining compliance obligations, reporting requirements, and corporate governance rules applicable to both the holding and subsidiary.

• Restriction on Layers

Under the Companies (Restriction on Number of Layers) Rules, 2017, a company cannot have more than two layers of subsidiaries. This restriction is aimed at preventing complex corporate structures that could hide ownership and financial transactions. Exceptions are allowed if the subsidiary is a foreign company with subsidiaries outside India. The rule promotes corporate transparency, facilitates regulatory oversight, and ensures that ownership structures remain simple, making it easier for stakeholders and regulators to trace control and financial relationships within the corporate group.

• Financial Statement Requirements (Section 129)

A subsidiary must prepare its own standalone financial statements as per Schedule III and applicable accounting standards. The holding company is required to consolidate these statements into consolidated financial statements (CFS). This ensures a complete financial picture of the group as a whole. The subsidiary must share its financial data promptly with the holding company for consolidation. The board of the holding company is responsible for ensuring accuracy and compliance with Indian Accounting Standards (Ind AS) or other applicable accounting rules.

• Disclosure in Board’s Report

A subsidiary’s performance, major decisions, and overall contribution to the group must be disclosed in the holding company’s Board’s Report. This includes financial highlights, operations, and any significant events affecting the subsidiary. Such disclosures enable shareholders and investors to assess the subsidiary’s role and performance within the group structure. The requirement improves transparency, accountability, and trust among stakeholders by giving them access to vital subsidiary-related information as part of the holding company’s annual reporting obligations under the Companies Act, 2013.

• Audit Requirements

Every subsidiary company must get its financial statements audited annually by a statutory auditor appointed under the provisions of the Companies Act. The audit ensures the accuracy, fairness, and compliance of accounts with legal and accounting standards. The audited financials are then shared with the holding company for consolidation. For certain classes of companies, internal audit may also be mandatory. The audit process enhances stakeholder confidence, ensures regulatory compliance, and safeguards against financial irregularities within the subsidiary company’s operations.

• Related Party Transactions (Section 188)

Transactions between a holding company and its subsidiary are considered related party transactions. These include the sale or purchase of goods, services, property, or any other arrangements. Such transactions require prior board approval, and in some cases, shareholders’ approval, especially if they exceed prescribed limits. The purpose is to prevent conflict of interest and ensure fairness in dealings between related entities. Proper disclosure of these transactions in financial statements is mandatory to promote transparency and protect minority shareholders’ interests.