NBFC/CIC classification issue

What is an NBFC?

A Non-Banking Financial Company (NBFC) is an entity incorporated under the Companies Act that primarily engages in financial activities such as lending, investing in shares, bonds, debentures, or other securities. Unlike traditional businesses, NBFCs do not focus on agriculture, industrial production, trading in goods, or real estate development.

To determine whether a company qualifies as an NBFC, the Reserve Bank of India (RBI) applies the ‘50-50 Principal Business Test’, which requires that:

1. Financial assets make up more than 50% of the company’s total assets, and

2. Income generated from these financial assets constitutes more than 50% of the gross income.

If both conditions are satisfied, the company is classified as an NBFC and must obtain registration with the RBI.

NBFCs are also subject to several compliance requirements such as capital adequacy norms, provisioning, corporate governance rules, KYC obligations, and fair practice codes.

What are CICs?

A Core Investment Company (CIC) is a specialized form of NBFC whose primary function is to hold investments in its group companies. According to RBI’s definition, a company is categorized as a CIC if it meets the following conditions:

• Possesses an asset size of ₹100 crore or more.

• Holds at least 90% of net assets in investments such as equity, preference shares, bonds, debentures, debt, or loans to group companies.

• Out of this 90%, a minimum of 60% must consist of equity investments in group companies (including compulsorily convertible instruments) and specified Infrastructure Investment Trust (InvIT) units as a sponsor.

• Does not engage in trading these investments, except in cases of block sales for dilution or disinvestment.

• Conducts no other financial activity, except limited permitted activities such as investing in bank deposits, money market instruments, or providing loans/guarantees to group entities.

• Accepts public funds.

The above framework is prescribed under the Master Direction for Core Investment Companies (Reserve Bank) Directions, 2016.

CICs that meet these conditions must be registered with the RBI. However, CICs with asset sizes below ₹100 crore, or larger CICs that do not accept public funds, are exempt from registration but face restrictions on certain activities like public deposit acceptance.

The Core Issue

India’s infrastructure sector frequently employs multi-layered corporate structures, often using special purpose vehicles (SPVs) mandated by government contracts to implement large projects. These structures allow efficient risk allocation, smooth project execution, and focused investment management.

However, such structures often face unintended regulatory challenges. Entities created for infrastructure holdings or investments are frequently classified as NBFCs or CICs under the RBI framework—even though their primary objective is not financial intermediation, but rather operational efficiency.

This classification forces such entities to comply with complex RBI regulations, similar to financial institutions, despite not being engaged in conventional lending or investment activities. As a result, infrastructure holding companies face compliance burdens that increase operational challenges and costs, raising concerns among investors.

This recurring issue has triggered ongoing debates about whether regulatory relaxation is warranted for such entities.

Applicable Regulations

The regulatory framework for NBFCs and CICs stems from Chapter III-B of the RBI Act, 1934, along with RBI’s Master Directions. Key requirements include:

• Registration Requirements – Companies meeting NBFC or CIC criteria must be registered with the RBI.

• Foreign Direct Investment (FDI) – Any FDI in a CIC or unregistered investment company not classified as an NBFC requires government approval.

• Capital Adequacy & Governance – Entities must comply with capital adequacy norms, exposure limits, and governance standards.

• Layering Restrictions – Only two layers of CICs are permitted within a group.

• Limits on Non-Financial Assets – CICs cannot hold non-financial assets outside the group beyond 10% of net assets, except essential fixed assets.

Despite these provisions, several ambiguities persist:

• Timing of Registration – It is unclear whether the registration requirement arises immediately after the financial year closes or only after audited accounts are finalized.

• Pending Applications – There is uncertainty about whether a pending registration application provides protection from non-compliance.

• Overlap in Definitions – Since a CIC is a subset of an NBFC, companies must balance both the 50:50 Principal Business Test for NBFCs and the 90:60 investment ratio for CICs, leading to varied interpretations.

These ambiguities complicate compliance for infrastructure-focused entities, many of which primarily oversee operations rather than conduct financial activities. Such regulatory uncertainty raises investment risks and can deter much-needed capital inflows into India’s infrastructure and allied sectors.

Conclusion

The classification of infrastructure holding and investment entities as NBFCs or CICs has become a recurring legal and regulatory issue. While RBI regulations aim to maintain systemic stability, their application to companies not engaged in typical financial intermediation creates unnecessary burdens.

Clearer regulatory guidance, or exemptions tailored for infrastructure-focused entities, would reduce compliance hurdles, encourage smoother project execution, and improve investor confidence in India’s infrastructure sector.

This content is originally posted on: https://www.maheshwariandco.com/
Source: https://www.maheshwariandco.com/blog/nbfc-cic-classification-issue/