Corporates can have only two layers of subsidiaries under the companies law, with the government putting in place stricter norms as it continues with the clampdown on illicit fund flows.
While the rules would be applied prospectively, companies that already have more than two layers of subsidiaries have to furnish details about them to the government.
Banking and non-banking financial companies, as well as insurance firms and government companies, have been exempted from the restrictions, according to a notification issued by the corporate affairs ministry.
The rules, notified after public consultation, came into effect on September 20. It assumes significance against the backdrop of concerns that shell companies are being floated to act as conduits for illicit funding activities.
The ministry, which is implementing the Companies Act, said the cap of two layers of subsidiaries would not affect a company from acquiring an overseas firm that has "subsidiaries beyond two layers as per the laws of such country".
"...for computing the number of layers under this rule, one layer which consists of one or more wholly-owned subsidiary or subsidiaries shall not be taken into account," it said.
In case of violation of the norms, the company, as well as every officer of that firm who is in default, would face penalties.
The fine would be up to Rs 10,000 and in case of repeated violation, the penalty "may extend to Rs 1,000 for every day after the first during which such contravention continues".
Companies that have more than two layers of subsidiaries should disclose the details to the ministry within 150 days.
This would not be applicable for banking, non-banking financial, insurance and government companies.
Along with the relevant section, the ministry notified the 'Companies (Restriction on a number of layers) Rules, 2017' on September 20.
Layering restriction on investment subsidiaries was incorporated in the Companies Act, 2013 "with a view to check misuse of multiple layers of subsidiaries for diversion of funds/siphoning off funds as a measure of minority investor protection," the ministry had said while issuing the draft rules in June.
Under the companies law, a subsidiary is an entity where the holding company controls the composition of the board of directors, among other criteria.
Earlier this month, the ministry had said that over 1.06 lakh directors would be disqualified for their association with shell companies. The move came after the registration of 2.09 lakh companies that have not been carrying out business activities for a long period were cancelled.