In this article, Neha Verma pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses the question when a company will be considered as an associate company
A Company as defined under Companies Act, 2013, means a Company which is incorporated under the Companies Act, 2013 or under any previous company law. In India, there are several laws and regulations which govern Companies and the mode of their operations. The principal Act which governs all Companies is the Companies Act, 2013 and all rules and regulations made therein including any amendments thereof such as Companies (Amendment) Act, 2017.
There are various types of Companies under the Companies Act, 2013, such as:
- Companies limited by shares
- Companies limited by guarantee
- One Person Company
- Section 8 Company
The Companies limited by shares are further divided into private companies and public companies.
A company must ensure the compliance with all relevant laws and regulations for itself and for its associate companies as well. Every Company having an associate Company is required to consolidate the accounts of such associate companies with its own accounts as per the Companies Act, 2013 and the Indian Accounting Standards provided therein.
Definition of an Associate Company
As per Section 2(6) of the Companies Act, 2013, an Associate Company is defined as follows:
“Associate Company”, in relation to another Company, means a company in which another company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
For the purpose of Section 2(6) of the Companies Act, 2013, explanation provided is as below:
- The expression “significant influence” means control of at least twenty percent of total voting power, or control of or participation in business decisions under an Agreement,
- The expression “joint venture” means a joint Agreement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Therefore, for a Company to be considered as an Associate Company of another company either the company should have significant influence over the other Company or it should be a joint venture company.
Analysis of Associate Company under the Companies Act, 2013
A Company can determine if any other company is its Associate Company based on the following criteria:
- If the Company has significant influence over the other Company; or
- If the other Company is a joint venture Company of the Company
A Company is said to have significant influence over the other Company if:
- the Company controls at least 20% voting power of the other Company; or
- the Company controls the business decisions of the other Company under an Agreement;
- the Company participates in business decisions of the Company under an Agreement
To better understand the concept of “control” as provided in the explanation of “significant influence”, Section 2(27) of the Companies Act 2013 has described the term “control”.
As per this section, the term “control” shall include:
- the right to appoint a majority of the directors; or
- to control the management of a Company; or
- to control the policy decisions of a Company
The aforesaid rights are exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.
As per Companies Act, 2013 a subsidiary company with regard to any other Company means a Company in which holding Company:
- controls the composition of Board of directors of the Company, or
- controls more than one-half of such Company’s total voting power either on its own or together with its one or more subsidiaries.
An Associate Company is a Company which is not a subsidiary as defined above, therefore, an Associate Company and a subsidiary Company are two completely different kinds of Companies.
Analysis of the various provisions of Companies Act, 2013 related to “Associate Company”
Associate Company will be considered as a Related Party
As per Section 2(76) (viii) of the Companies Act, 2013, “related party” with reference to a Company includes “a holding, subsidiary or an associate company of such Company”. According to this section, an associated company is treated as a related party for a company and consequently, the company must abide by Section 188 while dealing with such associate companies.
However, Section 2(76)(viii) does not apply with respect to Section 188 to private companies and also does not apply to an unlisted public company which is licensed to operate by RBI or SEBI or IRDA from the International Financial Services Centre located in an approved multi-services SEZ under SEZ Act.
Associate Company details should be provided in Annual Return
The Companies Act, 2013 requires that every company should mention the details and particulars of its associate companies in its Annual return which is prepared by the Company in the prescribed form as provided in Section 92.
Company needs to prepare Consolidated Financial Statement of its Associate Companies also
As per Section 129(3) of the Companies Act, 2013 as amended by the Companies (Amendment) Act 2017, a Company which has any associated company or companies is required to prepare consolidated financial statement of the company and all its subsidiary and associate Companies in the same form and manner as it prepares its own financial statements. Such consolidated financial statement as prepared by the Company needs to be laid before the shareholders of the Company at its annual general meeting along with its own financial statements. The Company is also required to attach with its financial statement a separate statement containing the salient features of its associate Companies.
Vacation of office of Director if he was appointed as a director by virtue of holding any post in an Associate Company
As per this section, the office of a director becomes vacant in case he was appointed as a director of the Company by virtue of him holding any office or other employment in the holding, subsidiary or associate Company and he no longer holds such office or employment in that Company.
Related Party Transactions with respect to an Associate Company
The consent of the Board of Directors of the Company given by passing a resolution at the meeting of the Board is required before the Company enters into any contract or arrangement with related party with respect to such related party’s appointment to any office or place of profit in the Company, its subsidiary Company or associate Company. Therefore, before any related party is appointed to any office or place of profit even in associate Company of a Company, the Company would be required to obtain the approval of Board for the same.
In the event, the related party is to be appointed to any office or place of profit in the Company or its associate Company for monthly remuneration exceeding Rupees Two lakh fifty thousand per month then the Company needs to take prior approval of its members, by way of passing a resolution at the meeting of shareholders, for entering into such transaction.
Restrictions on non-cash transactions involving directors
This section clearly provides that a Company shall be required to take prior approval by its shareholders in general meeting if the Company wishes to enter into an arrangement by which a director of the company or its holding, subsidiary or associate company or a person connected with him acquires or is to acquire assets for consideration other than cash, from the Company. A resolution in general meeting needs to be passed to give effect to any such transaction.
Prohibition on forward dealings in securities of company by the director or key managerial personnel
Section 194 prohibits the director or key managerial personnel of a Company from forward dealing in securities of its Associate Company.
Associate Company as per Accounting Standards
As per Accounting Standard 28, an “Associate” is defined as an entity over which the investor has significant influence.
“Significant influence”, as per the Indian Accounting Standard 28, means having the power to participate in the financial and operating policy decisions of the investee but does not mean control or joint control of those policies.
As per the Indian Accounting Standard 28, if a Company holds either by itself or through its subsidiaries 20% or more of the voting power of another Company then it is presumed that the Company has significant influence over the other Company unless the Company can clearly demonstrate that this is not the case. Similarly, if a Company either by itself or through its subsidiaries holds less than 20% voting power of any Company then it is presumed that the Company does not have significant influence over the other Company unless such influence can be clearly established.
To determine whether or not a Company has significant influence over the other Company, the following evidence can be relied upon:
- Representation of the Company on the Board of directors of the other Company;
- Participation of the Company in the process of policy making of the other Company;
- Material transactions between such Companies;
- Interchange of managerial personnel between Companies;
- Provision of essential technical information
At the time of accounting of investments of the Company, this standard is used to determine whether a Company has an associate or joint venture company and also to prepare and draw up accounts for the same.
The equity method of accounting is used as per Indian accounting Standard 28 for the accounting of investments in associates. The equity method of accounting is a method of accounting whereby the investment is initially recognized at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investors’ share in the investee’s profit or loss is recognized in the investor’s profit or loss. Therefore, initial recognition and measurement is applied at cost.
In recent times, the concept of “Associate Company” has become all the more important and relevant so that the promoters and/or directors of these Companies operate them in a clear manner and do not roll over and utilize the funds obtained by one company in its associate Companies. The consolidation of financial statements of a Company along with its Associate and subsidiary company ensures that the statutory authorities have a clear view of the dealings undertaken by a Company and to detect any misappropriation of funds.