Companies Act 2013 Begining of A New Era

Companies Act 2013:
Beginning of a new era

B | Companies Act 2013
1 Beginning of a new era |
Dear reader,
We are delighted to share with you our new publication
Companies Act 2013: Beginning of a new era.
1he MCA has so lar noLiled and made ellecLive 283 secLions,
ouL ol LoLal ^70 secLions ol Lhe 2013 AcL. 1he MCA has also
issued lnal rules relaLinq Lo 19 chapLers, coverinq mosL ol
Lhe noLiled secLion. 1o address pracLical issues, Lhe MCA has
also amended Schedule ll (reqardinq depreciaLion), proposed/
issued Lhree orders lor removal ol pracLical dillculLies and
issued cerLain Ceneral Circulars Lo provide more clariLy.
1he enacLmenL is a milesLone evenL wiLh larreachinq
consequences. Companies should noL underesLimaLe Lhe
impacL ol new law. 1he MCA has addressed some key pain
areas lor companies; however, implemenLaLion ol Lhe
2013 AcL isn'L sLill a hassle lree process. lmplicaLions and
consequences can be severe, il a company lails Lo Lake
immediaLe sLeps Lo implemenL Lhe 2013 AcL. A case in poinL is
direcLors' and audiLors' reporLinq responsibiliLies wiLh reqard
Lo inLernal lnancial conLrols. 1houqh Lhe reporLinq is needed
aL yearend, inLernal lnancial conLrols should exisL and be
operaLinq ellecLively LhrouqhouL Lhe year. AnoLher example is
Lhe approval required lor relaLed parLy LransacLions or loans
and invesLmenLs. 1here are numerous such issues requirinq
immediaLe acLion lrom companies.
We complimenL Lhe CovernmenL ol lndia, especially Lhe MCA,
lor mainLaininq a hiqhly consulLaLive approach LhrouqhouL
Lhe process ol issuinq Lhe 2013 AcL and in lnalizinq Lhe rules.
NoneLheless, a larqe number ol inLerpreLaLive issues and
concerns conLinue Lo exisL, and many ol Lhose are discussed
in Lhis publicaLion. 1he mosL lundamenLal beinq Lhe numerous
maLLers where iL appears LhaL Lhe lnal rules may noL be in
consonance wiLh Lhe 2013 AcL. Many ol Lhese issues can
be addressed through appropriate changes in the rules,
schedules and qeneral circulars. A lew oLhers may need some
amendmenLs Lo Lhe 2013 AcL. We believe LhaL Lhis is noL Lhe
end ol Lhe road, and herein lies a siqnilcanL opporLuniLy lor
the MCA to continue engaging with constituents as it has been
doinq so in Lhe pasL. UlLimaLely, all ol us would like Lo see a
leqislaLion LhaL is robusL, and sLrikes a sweeL spoL beLween
business realiLy and requlaLory needs.
We expecL LhaL Lhe MCA/lCAl will come ouL wiLh a deLailed
quidance on various issues arisinq lrom Lhe 2013 AcL and
rules. ln Lhe meanwhile, Lhis publicaLion expresses our
LhouqhLs, perspecLives and poinL ol view, on key issues.
However, Lhese should noL be LreaLed as lormal quidance, as
Lhere may be dillerenL views on Lhese maLLers and Lhe lnal
say on Lhese issues will be wiLh Lhe courLs/requlaLors. Also,
any views or opinions expressed in Lhis publicaLion represenL
our |udqmenL aL Lhe Lime ol publicaLion and may be sub|ecL Lo
chanqe, includinq, buL noL limiLed Lo, due Lo lurLher acLions ol
Lhe courLs or requlaLors, wiLhouL noLice. We recommend LhaL
readers seek appropriaLe leqal/prolessional advice reqardinq
any specilc issues LhaL Lhey encounLer.
1he new leqislaLion is very vasL and Lherelore we decided
Lo locus on some key Lopics in respecL ol which Lhe 2013
AcL and rules are noLiled. 1hese Lopics are broadly
caLeqorized inLo lnancial reporLinq, audiL and audiLors,
relaLed parLy LransacLions, loans and invesLmenLs, corporaLe
social responsibiliLy, corporaLe qovernance and merqers,
amalqamaLions and reconsLrucLions. For Lhe purposes ol
Lhis publicaLion, we have decided Lo locus more on chanqes
brouqhL by Lhe lnal rules issued under Lhe 2013 AcL, and
avoid repeaLinq whaL was covered in our earlier publicaLions
and WebcasLs.
1he SLBl, vide Circular daLed 17 April 201^, amended
Clauses 35B and ^9 ol Lhe LisLinq AqreemenL. 1he RC^9,
amonq oLher maLLers, deals wiLh aspecLs such as relaLed
parLy LransacLions, independenL direcLors, AudiL CommiLLee
and viqil mechanism. 1houqh Lhe purpose ol RC^9 is Lo aliqn
Lhe requiremenLs ol Lhe lisLinq aqreemenL wiLh Lhe 2013 AcL,
Lhere are siqnilcanL dillerences, which eiLher impose new
requiremenLs or maLerially alLer Lhose conLained in Lhe 2013
AcL.
1houqh Lhis publicaLion locuses on requiremenLs ol Lhe 2013
AcL in cerLain specilc areas; Lo help lisLed companies beLLer
undersLand applicable lramework, a briel overview ol RC^9 is
qiven aL Lhe relevanL places.
lL is a maLLer ol qreaL |oy Lo enqaqe wiLh you on Lhis hisLoric
chanqe, as we have been doinq so LradiLionally. We hope
you will lnd Lhis publicaLion uselul in havinq a beLLer
undersLandinq ol Lhe new law. We look lorward Lo your
leedback on Lhe publicaLion.
Ernst & Young LLP
2 | Companies Act 2013
Financial Reporting 4
UniIorm hnancial year 4
National Financial Peporting Authority 5
Board report 6
Disclosures required 6
Preparation of board report 6
Disclosures reqardinq median remuneraLion 7
Internal hnancial controls 8
DirecLors' responsibiliLy 8
AudiLors' responsibiliLy 8
Dehnition oI the term 'subsidiary' 12
Consolidated hnancial statements 13
5ubsidiary hnancial statements 17
Abridged hnancial statements 19
Depreciation 20
Declaration and payment oI dividend 23
Utilization oI securities premium 25
Free reserves 2
Debenture redemption reserve 27
Peopening/revision oI accounts 28
Audit and auditors 30
Appointment of auditors 30
Rotation of auditors 32
Eligibility, qualihcations and disqualihcations oI auditors 3
Independence/prohibited services 39
Peporting responsibilities 41
lnLernal lnancial conLrols ^1
Fraud reporLinq ^1
CARO reporLinq ^^
Penalty on auditors 45
Contents
Related parties transactions 46
Identihcation oI related parties 4
DelniLion under Lhe 2013 AcL ^6
DelniLion under RC^9 ^8
DelniLion ol relaLive ^8
Identihcation oI relevant transactions 51
Approval process 52
Disclosure in the board report 0
Transitional requirements 1
Loans and investments 2
Loans Lo direcLors and subsidiaries 62
Loans and invesLmenLs by company 63
Corporate social responsibility

Corporate governance 74
Composition oI the board/ nonexecutive directors 74
Woman director 75
Independent directors 77
Audit Committee 79
Nomination and Pemuneration Committee 80
Vigil mechanism 81
5ubsidiary companies 81
Internal audit 82
Mergers, amalgamation and 84
reconstruction

Clossary 8

UniIorm hnancial year
1he delniLion ol Lerm "lnancial year" is applicable lrom 1 April
201^. lL requires a company Lo adopL a unilorm accounLinq
year endinq 31 March. Companies which are currenLly
lollowinq a dillerenL lnancial year need Lo aliqn wiLh Lhe new
requiremenL wiLhin Lwo years. A proviso Lo Lhe delniLion sLaLes
LhaL a company may apply Lo Lhe NCL1 lor adopLion ol dillerenL
lnancial year, il iL saLisles Lhe lollowinq Lwo criLeria:
Company is a holdinq or subsidiary ol a company
incorporaLed ouLside lndia, and
Company is required Lo lollow a dillerenL lnancial year lor
consolidaLion ol iLs lnancial sLaLemenL ouLside lndia.
1he CenLral CovernmenL has sLill noL consLiLuLed Lhe NCL1 and
many provisions relaLinq LhereLo are noL currenLly noLiled.
Under secLion ^3^ ol Lhe 2013 AcL, cerLain maLLers pendinq
wiLh Lhe Hiqh CourL, DisLricL CourLs or Lhe CLB, as Lhe case may
be, which will be wiLhin Lhe |urisdicLion ol Lhe NCL1, would be
Lranslerred Lo Lhe NCL1 lrom a noLiled daLe. 1ill such Lime, Lhe
courLs and Lhe CLB will conLinue Lo luncLion. ln Lhe absence
ol NCL1, a company may conLacL Lhe MCA Lo seek quidance
wiLh reqard Lo which ol Lhese auLhoriLies Lhey should lle an
applicaLion lor adopLion ol a lnancial year oLher Lhan one
endinq on 31 March.
Financial ReporLinq
Practical issues and perspectives
In accordance with A5 21, A5 23 and A5 27, a parent
company can use hnancial statements oI subsidiaries,
associates and |oint ventures drawn up to a diIIerent
reporting date to prepare CF5 iI it is impractical to have their
hnancial statements prepared up to the same reporting date
as the parent. How is the impracticality provision oI A5 21,
A5 23 and A5 27 impacted by the requirement to have a
uniIorm hnancial year?
SecLion 129(^) ol Lhe 2013 AcL sLaLes LhaL "Lhe provisions
of this Act applicable to the preparation, adoption and
audiL ol Lhe lnancial sLaLemenLs ol a holdinq company will,
mutatis mutandis, apply Lo Lhe CFS." Hence, Lhe requiremenL
concerninq unilorm lnancial year applies Lo boLh separaLe
lnancial sLaLemenLs ol Lhe parenL company as well as CFS ol
Lhe qroup.
A parenL company has unilaLeral conLrol over all iLs subsidiaries.
Hence, iL should normally be able Lo obLain Lheir lnancial
sLaLemenLs lor Lhe same reporLinq daLe as Lhe parenL and
use Lhem in Lhe preparaLion ol CFS. However, Lhis may noL be
pracLical lor all Lhe associaLes/|oinL venLures. For example, an
associaLe/|oinL venLure incorporaLed ouLside lndia may have
non 31 March yearend, eiLher due Lo requiremenL ol local
requlaLions or requiremenL prescribed by oLher siqnilcanL
shareholder. Since Lhe parenL company does noL have unilaLeral
conLrol over Lhese associaLes/|oinL venLures, iL may noL be in a
posiLion Lo require Lhem Lo prepare an addiLional seL ol lnancial
sLaLemenLs lor 31 March yearend lor use in iLs consolidaLion.
Similarly, in case ol lndian associaLes/|oinL venLures, iL is
possible LhaL Lhese companies have 31 March yearend lor Lheir
own sLaLuLory reporLinq. However, Lheir sysLems may noL be
qearedup Lo provide Limely inlormaLion lor use in Lhe parenL's
CFS. For example, due Lo requiremenLs ol lisLinq aqreemenL,
a lisLed parenL needs Lo lnalize iLs CFS wiLhin 60 days ol Lhe
yearend. However, iLs nonlisLed associaLes/|oinL venLures need
much more Lime Lo lnalize Lheir lnancial sLaLemenLs. ln such
cases, maximum six monLhs qap beLween Lhe reporLinq daLes
ol Lhe parenL company and iLs associaLes or |oinLly conLrolled
enLiLies may be permiLLed, provided LhaL companies meeL
criteria prescribed in accounting standards for use of different
period lnancial sLaLemenLs.
National Financial Reporting
Authority
Under Lhe 2013 AcL, Lhe NFRA will replace Lhe NACAS. NFRA
will be a quasi|udicial body and will have responsibiliLy Lo
ensure overall qualiLy ol lnancial reporLinq. ln addiLion Lo
advisinq Lhe CenLral CovernmenL on lormulaLion ol accounLinq
sLandards lor adopLion by companies/class ol companies, Lhe
NFRA will:
Make recommendaLions Lo Lhe CenLral CovernmenL on
lormulaLion and layinq down ol audiLinq policies and
standards for adoption by auditors
MoniLor and enlorce compliance wiLh accounLinq and
audiLinq sLandards in Lhe manner as may be prescribed
Oversee Lhe qualiLy ol service ol prolessionals associaLed
wiLh ensurinq compliance wiLh sLandards, and suqqesL
measures required lor improvemenL in qualiLy and such
oLher relaLed maLLers as may be prescribed, and
Perlorm oLher prescribed luncLions.
1he CenLral CovernmenL has noL yeL consLiLuLed Lhe NFRA.
Also, Lhe lnal rules relaLinq Lo NFRA are noL yeL noLiled.
1he LransiLional provisions in Lhe AccounLs Rules sLaLe LhaL
accounLinq sLandards prescribed under Lhe 1956 AcL will
conLinue Lo be accounLinq sLandards under Lhe 2013 AcL, unLil
accounLinq sLandards are speciled by Lhe CenLral CovernmenL
under Lhe 2013 AcL. 1he LransiLional provisions also sLaLe LhaL
unLil NFRA is consLiLuLed, Lhe NACAS will conLinue advisinq Lhe
CenLral CovernmenL on lormulaLion ol accounLinq sLandards.
1houqh noL menLioned specilcally, iL appears LhaL lor Lhe Lime
beinq, Lhe lCAl will conLinue Lo perlorm iLs exisLinq luncLions,
e.q., Lhose relaLinq Lo lormulaLion ol audiLinq sLandards and
moniLorinq/ enlorcinq compliance boLh wiLh Lhe accounLinq and
audiLinq sLandards.
Board report
Disclosures required
1he 2013 AcL read wiLh Lhe AccounLs Rules require several
disclosures abouL perlormance, risks, eLc. Key disclosures
include:
LxLracL ol Lhe annual reLurn, which covers maLLers such as
indebLedness, shareholdinq paLLern, deLails ol promoLers,
direcLors and KMP and chanqes Lherein, deLails ol board
meeLinqs and aLLendance, remuneraLion ol direcLors and
KMPs and penalLy or punishmenL imposed on Lhe company,
iLs direcLors/ollcers
Financial summary or hiqhliqhLs
Change in the nature of business, if any
DeLails ol direcLors or KMP who were appoinLed or have
resigned during the year
Names ol companies which have become or ceased Lo
be iLs subsidiaries, |oinL venLures or associaLe companies
during the year
DeLails ol siqnilcanL and maLerial orders passed by Lhe
requlaLors or courLs or Lribunals impacLinq Lhe qoinq
concern sLaLus and company's operaLions in luLure
SLaLemenL indicaLinq developmenL and implemenLaLion
ol risk manaqemenL policy lor Lhe company includinq
idenLilcaLion Lherein ol elemenLs ol risk, il any, which, in
Lhe opinion ol Lhe Board, may LhreaLen Lhe exisLence ol Lhe
company
On Lhe lines ol prerevised Clause ^9, RC^9 requires LhaL
as parL ol Lhe direcLors' reporL or as an addiLion LhereLo, a
MD&A reporL should lorm parL ol Lhe Annual ReporL Lo Lhe
shareholders. 1his MD&A should include discussion on Lhe
lollowinq maLLers wiLhin Lhe limiLs seL by Lhe company's
compeLiLive posiLion:
lndusLry sLrucLure and developmenLs
OpporLuniLies and LhreaLs
SeqmenLwise or producLwise perlormance
OuLlook
Risks and concerns
lnLernal conLrol sysLems and Lheir adequacy
Discussion on lnancial perlormance wiLh respecL Lo
operaLional perlormance
MaLerial developmenLs in Human Resources/lndusLrial
RelaLions lronL, includinq number ol people employed
Practical perspectives
Disclosures required under RC^9 are similar Lo Lhose under
Lhe prerevised ^9. However, companies need Lo ensure proper
synchronizaLion ol Lhese disclosures wiLh Lhe new disclosures
under Lhe 2013 AcL.
ln Lhe case ol a lisLed company, Lhe board needs Lo disclose
inlormaLion under Lhe Lhree heads, viz., board reporL, DirecLors'
ResponsibiliLy SLaLemenL and MD&A. A lisLed company may
present MD&A either separately in the annual report or as part
ol Lhe board reporL iLsell. 1houqh inlormaLion requiremenLs
ol Lhe board reporL and MD&A are worded dillerenLly; lrom
pracLical perspecLive, Lhe presenLaLion ol such inlormaLion
is likely Lo siqnilcanLly overlap wiLh each oLher. A lisLed
company may need Lo sLrucLure iLs board reporL and MD&A
carelully so LhaL meaninqlul inlormaLion is presenLed Lo users
wiLhouL duplicaLion, while ensurinq compliance wiLh boLh Lhe
requiremenLs.
Preparation oI board report
1he AccounLs Rules require LhaL Lhe board reporL will be
prepared based on Lhe SFS ol a company. 1his reporL musL
conLain a separaLe secLion wherein a reporL on Lhe perlormance
and lnancial posiLion ol each subsidiary, associaLe and |oinL
venLure company included in Lhe CFS is presenLed.
ln many cases, Lhis disclosure lor each subsidiary, associaLe and
|oinL venLure may become very cumbersome lor companies.
Also, invesLors and analysLs Lypically look aL perlormance
and lnancial posiLion ol Lhe consolidaLed qroup, as aqainsL
each individual enLiLy. 1herelore, qroups will have Lo provide
sLandalone perlormance ol each company lor complyinq wiLh
Lhe 2013 AcL and consolidaLed perlormance lor Lhe benelL ol
invesLors and oLher sLakeholders.
Disclosure regarding median remuneration
SecLion 197 ol Lhe 2013 AcL requires every lisLed company Lo
disclose in Lhe board's reporL Lhe raLio ol Lhe remuneraLion ol
each direcLor Lo Lhe median employee's remuneraLion and such
oLher deLails as may be prescribed. 1he Manaqerial Personnel
Rules clarily how median remuneraLion is measured. 1hey
also require several addiLional disclosures, examples include:
(i) 7 increase in remuneraLion ol each direcLor, CLO, CFO,
Company SecreLary or Manaqer, il any, in Lhe lnancial year,
(ii) 7 increase in Lhe median remuneraLion ol employees in Lhe
lnancial year, (iii) explanaLion on Lhe relaLionship beLween
averaqe increase in remuneraLion and company perlormance,
(iv) comparison ol Lhe remuneraLion ol Lhe KMP aqainsL Lhe
company's perlormance, (v) key parameLers lor any variable
componenL ol remuneraLion availed by direcLors, and (vi) raLio
ol Lhe remuneraLion ol Lhe hiqhesL paid direcLor Lo LhaL ol Lhe
employees who are noL direcLors buL receive remuneraLion in
excess ol Lhe hiqhesL paid direcLor durinq Lhe year.
1hese disclosures are in many respecLs consisLenL wiLh Lhe
disclosures required qlobally. For example, Lhe Dodd Frank AcL
in Lhe US and recenL chanqes in Lhe Company Law in UK require
similar disclosures. lL is believed LhaL Lhese disclosures will
brinq abouL qreaLer accounLabiliLy amonqsL companies. Also,
disclosure reqardinq remuneraLion ol Lhe employees, who are
noL direcLors buL receive remuneraLion in excess ol Lhe hiqhesL
paid direcLor, durinq Lhe year, may brinq Lo locus Lhe real
decision makers.
1he Manaqerial Personnel Rules clarily LhaL median means Lhe
numerical value separaLinq Lhe hiqher hall ol a populaLion lrom
Lhe lower hall and Lhe median ol a lniLe lisL ol numbers may
be lound by arranqinq all Lhe observaLions lrom lowesL value Lo
hiqhesL value and pickinq Lhe middle one. Assuminq a company
has Lhree caLeqories ol employees, i.e., 1150 workers, 550
ollcers and 299 middle and senior manaqemenL. 1he median
remuneraLion would be whaL employee number 1,000 would be
earning, if they were arranged in an ascending or descending
order based on Lheir remuneraLion. ln Lhis case, LhaL happens
Lo be a worker. 1he comparison ol a worker's remuneraLion wiLh
Lhe CLO will relecL a siqnilcanL dispariLy and may noL qive any
meaninqlul inlormaLion Lo Lhe users.
Similar dispariLy may arise in Lhe case ol a company which has
many branches in counLries where remuneraLion is hiqh. ln
such cases, inclusion ol loreiqn salaries wiLh lndian workers Lo
deLermine Lhe median may relecL a disLorLed comparison.
1o qive more meaninqlul inlormaLion Lo users, some companies
may volunLarily disclose caLeqorywise comparison in
addition to the disclosures required as per the Managerial
Personnel Rules. ln Lhe above example, comparison ol median
remuneraLion ol middle and senior manaqemenL wiLh CLO's
salary may provide more meaninqlul inlormaLion.
Disclosure ol KMP remuneraLion and iLs linkaqe Lo company
perlormance can make Lhe board more accounLable and
reassure invesLors LhaL Lhe board is neqoLiaLinq wiLh execuLives
aL "arm's lenqLh." Disclosure ol remuneraLion packaqes also
provides inlormaLion Lo invesLors abouL Lhe incenLives beinq seL
lor execuLives. 1his could assisL Lhem Lo assess Lhe company's
prospecLs and risk prolle, such LhaL Lhe share price more
accuraLely siqnals Lhe markeL's assessmenL ol Lhe sLream ol
expecLed prolLs. 1hus, Lhrouqh improvinq invesLor conldence
and providinq relevanL inlormaLion abouL company prospecLs,
disclosures may enhance ellciency in equiLy markeLs. However,
unlimiLed disclosure would be unlikely Lo deliver neL benelLs;
lor insLance, deLailed revelaLion ol a company's sLraLeqy
may undermine iLs compeLiLive advanLaqe and lonqLerm
perlormance. ln oLher words, Lhe benelLs ol Lransparency need
Lo be balanced aqainsL compliance cosLs and possible adverse
consequences lor a company's commercial posiLion.
EIIective date
ln Lhe 2013 AcL, Lhe board reporL includes many maLLers, which
hiLherLo were noL required in Lhe 1956 AcL. 1hese maLLers
Lo be reporLed may be very onerous and Lime consuminq Lo
prepare. Hence, Lhe applicabiliLy daLe is imporLanL. SecLion 13^
ol Lhe 2013 AcL dealinq wiLh board reporL is applicable lrom 1
April 201^. 1he MCA has clariled LhaL Lhe rules will also apply
lrom 1 April 201^. However, neiLher Lhe 2013 AcL nor Lhe
rules clarily as Lo how Lhis requiremenL should be applied. 1he
lollowinq Lhree views were possible:
(i) 1he new requiremenL applies Lo all board reporLs lor
periods beqinninq on or alLer 1 April 201^.
(ii) lL is applicable Lo all board reporLs lor periods endinq on
or alLer 1 April 201^.
(iii) lL is applicable Lo all board reporLs issued on or alLer 1
April 201^.
Ceneral Circular no 8/201^ issued on ^ April 201^ has
addressed Lhis issue. lL clariles LhaL Lhe Board's reporL in
respecL ol lnancial years, which commenced earlier Lhan 1
April 201^, will be qoverned by Lhe relevanL provisions ol Lhe
1956 AcL (View (i)). A company havinq 31 March yearend
applies Lhe requiremenLs ol Lhe 2013 AcL lor board reporLs
issued wiLh respecL Lo year ended 31 March 2015. A company
havinq any oLher yearend will apply Lhe requiremenLs lrom Lhe
nexL lnancial year onwards. For example, a company havinq
31 December yearend will apply Lhe requiremenLs ol Lhe 2013
AcL lor boards reporLs issued wiLh respecL Lo year ended 31
December 2015. 1ill such daLe, Lhe requiremenLs ol Lhe 1956
AcL will conLinue Lo apply.
Internal hnancial controls
Directors' responsibility
SecLion 13^(5)(e) ol Lhe 2013 AcL requires LhaL in case ol
lisLed companies, DirecLors' ResponsibiliLy SLaLemenL should,
amonq oLher maLLers, sLaLe LhaL direcLors had laid down
inLernal lnancial conLrols and such conLrols are adequaLe and
were operaLinq ellecLively. An explanaLion qiven Lo clause (e) ol
secLion 13^(5) sLaLes as below:
"For Lhe purposes ol Lhis clause, Lhe Lerm 'inLernal
lnancial conLrols' means Lhe policies and procedures
adopLed by Lhe company lor ensurinq Lhe orderly and
ellcienL conducL ol iLs business, includinq adherence
Lo company's policies, Lhe salequardinq ol iLs asseLs,
Lhe prevenLion and deLecLion ol lrauds and errors, Lhe
accuracy and compleLeness ol Lhe accounLinq records, and
Lhe Limely preparaLion ol reliable lnancial inlormaLion."
Hence, Lhe 2013 AcL lays down very wide responsibiliLy
reqardinq inLernal lnancial conLrol reporLinq on Lhe direcLors.
lL includes policies and procedures lor ensurinq orderly
and ellcienL conducL ol business Lhereby coverinq noL
|usL lnancial reporLinq aspecLs, buL also Lhe sLraLeqic and
operaLional aspecLs ol Lhe business and Lhe ellciency wiLh
which Lhose operaLions are carried ouL. For Lhe purpose ol
Lhis publicaLion, inLernal lnancial conLrols relaLed Lo lnancial
reporLinq aspecLs are relerred as "lnancial reporLinq conLrols"
and those related to strategic and operational aspects of the
business are relerred Lo as "business conLrols."
SecLion 13^(3)(p) ol Lhe 2013 AcL sLaLes LhaL in case ol a lisLed
company and every oLher public company havinq such paidup
share capiLal as may be prescribed, Lhe board reporL will include
a sLaLemenL indicaLinq Lhe manner in which lormal annual
evaluaLion has been made by Lhe board ol iLs own perlormance
and LhaL ol iLs commiLLees and individual direcLors. SecLion
13^(3)(q) ol Lhe 2013 AcL enables Lhe CenLral CovernmenL Lo
prescribe addiLional maLLers lor inclusion in Lhe board reporL.
WiLh reqard Lo secLion 13^(3)(p), subrule 8(^) ol Lhe AccounLs
Rules sLaLes as below:
"Lvery lisLed company and every oLher public company
havinq a paid up share capiLal ol LwenLy lve crore rupees
or more calculaLed aL Lhe end ol Lhe precedinq lnancial
year shall include, in the report by its Board of directors,
a sLaLemenL indicaLinq Lhe manner in which lormal
annual evaluaLion has been made by Lhe Board ol iLs own
perlormance and LhaL ol iLs commiLLees and individual
direcLors."
WiLh reqard Lo secLion 13^(3)(q), subrule 8(5) ol Lhe above
rules sLaLes as below:
"ln addiLion Lo Lhe inlormaLion and deLails speciled in sub
rule (^), Lhe reporL ol Lhe Board shall also conLain: ."
One ol Lhe disclosures conLained in Lhe subrule 8(5) is "Lhe
deLails in respecL ol adequacy ol inLernal lnancial conLrols wiLh
relerence Lo Lhe lnancial sLaLemenLs."
RC^9 requires LhaL discussion on "inLernal conLrol sysLems
and Lheir adequacy" is included in Lhe MD&A reporL. Also, Lhe
board has Lo ensure Lhe inLeqriLy ol Lhe company's accounLinq
and lnancial reporLinq sysLems, includinq Lhe independenL
audiL, and LhaL appropriaLe sysLems ol conLrol are in place,
in parLicular, sysLems lor risk manaqemenL, lnancial and
operaLional conLrol, and compliance wiLh Lhe law and relevanL
sLandards.
Auditors' responsibility
SecLion 1^3(3) ol Lhe 2013 AcL sLaLes LhaL Lhe audiLor's reporL,
amonq oLher maLLers, will sLaLe "wheLher Lhe company has
adequaLe inLernal lnancial conLrols sysLem in place and Lhe
operaLinq ellecLiveness ol such conLrols." 1his requiremenL
is applicable Lo all companies, includinq nonlisLed public and
privaLe companies. NeiLher Lhe 2013 AcL nor Lhe AudiL Rules
delne Lhe Lerm "inLernal lnancial conLrols" lor Lhis purpose.
The 2013 Act has already prescribed the directors'
responsibility with respect to internal hnancial controls.
It requires that in case oI listed companies, Directors'
Pesponsibility 5tatement should state that directors had
laid down internal hnancial controls and such controls are
adequate and were operating eIIectively. For this purpose,
"internal hnancial controls" include both hnancial reporting
controls and business controls. In addition, rule 8(5) under
the Accounts Pules requires that the board report should
contain details Ior adequacy oI hnancial reporting controls.
The rules do not reIer to adequacy oI business controls.
Civen the specihc requirement in the 2013 Act, what is the
relevance oI requirement on similar matter prescribed in the
Accounts Pules? How do these two requirements interact
with each other?
One view is LhaL Lhe 2013 AcL requires direcLors' reporLinq
on inLernal lnancial conLrol only in case ol lisLed companies.
ln conLrasL, audiLors are required Lo reporL on Lhe exisLence
and operaLinq ellecLiveness ol inLernal lnancial conLrols in
all companies. 1o bridqe Lhis qap, Lhe AccounLs Rules require
direcLors ol even nonlisLed companies Lo commenL on Lhe
maLLer. Under Lhis arqumenL, Lhe requiremenL reqardinq
direcLors' responsibiliLy will apply as below in Lable 1:
ln Lhis view, Lhere is no conlicL beLween Lhe requiremenLs
ol Lhe 2013 AcL and Lhe AccounLs Rules. Also, Lhe direcLors'
responsibiliLy wiLh reqard Lo reporLinq on inLernal lnancial
conLrols will be in sync wiLh Lhe audiLors' responsibiliLy. ln Lhe
case ol lisLed companies, Lhe direcLors' responsibiliLy will be
based on Lhe wider delniLion ol inLernal lnancial conLrols
(i.e., boLh lnancial reporLinq conLrols and business conLrols);
whereas in Lhe case ol nonlisLed companies, Lhe delniLion ol
inLernal lnancial conLrols is narrowed Lo lnancial reporLinq
conLrols.
1he second view is LhaL Lhe MCA has included Lhis provision in
Lhe AccounLs Rules Lo address siqnilcanL concerns LhaL were
beinq raised abouL Lhe delniLion ol inLernal lnancial conLrols
and Lo brinq Lhe same in line wiLh Lhe qlobal pracLices. Hence,
Lhe inLenLion ol Lhe MCA is Lo resLricL inLernal lnancial conLrol
reporLinq in case ol lisLed companies Lo lnancial reporLinq
conLrols only; iL does noL inLend Lo exLend such reporLinq Lo
nonlisLed companies. ln Lhis view, Lhere are Lwo lall ouLs. 1he
lrsL concern is LhaL in Lryinq Lo narrow Lhe delniLion ol inLernal
lnancial conLrols, Lhe AccounLs Rules have inadverLenLly made
Lhe requiremenL applicable Lo nonlisLed companies. 1he second
concern is LhaL ol Lhe AccounLs Rules overridinq Lhe 2013 AcL.
1he Lhird view is LhaL Lhe direcLors ol boLh lisLed and nonlisLed
companies are required Lo reporL on inLernal lnancial conLrols
perLaininq Lo lnancial sLaLemenLs, i.e., lnancial reporLinq
conLrols only. Under Lhis view, Lhe AccounLs Rules have Lhe
ellecL ol (i) exLendinq Lhe inLernal lnancial conLrol reporLinq
requiremenL Lo nonlisLed companies, and (ii) narrowinq Lhe
delniLion ol "inLernal lnancial conLrol" Lo lnancial reporLinq
conLrols. ln Lhis view, Lhe AccounLs Rules are overridinq Lhe
2013 AcL.
Table 1
Companies Place to include directors' reporting Coverage
LisLed DirecLors' ResponsibiliLy SLaLemenL Adequacy/exisLence and operaLinq ellecLiveness ol inLernal
lnancial conLrols usinq wider delniLion in Lhe 2013 AcL,
i.e., boLh lnancial reporLinq conLrols and business conLrols
NonlisLed Board's reporL Adequacy ol inLernal lnancial conLrols perLaininq Lo
lnancial sLaLemenLs, i.e., only lnancial reporLinq conLrols
lL may be appropriaLe lor Lhe MCA/ lCAl Lo address Lhis issue.
UnLil such quidance or clarilcaLion is provided, our prelerred
view is LhaL Lhe 2013 AcL and Lhe AccounLs Rules should be
read harmoniously so LhaL Lhere is no conlicL. Hence, our
prelerred approach is Lo apply Lhe lrsL view.
The term "internal hnancial controls" is not explained in the
context oI auditors' reporting responsibility. What is the scope
oI auditors' responsibility Ior reporting on internal hnancial
controls?
ln Lhe 2013 AcL, Lhe meaninq ol Lhe Lerm "inLernal lnancial
conLrols" is qiven only in Lhe explanaLion Lo secLion 13^(5)
clause (e). 1he explanaLion beqins wiLh Lhe use ol words "lor
Lhe purposes ol Lhis clause" and assiqns a wider meaninq Lo Lhe
Lerm.
One view is LhaL in Lhe absence ol any oLher delniLion/
explanaLion, Lhe explanaLion Lo clause (e) in secLion 13^(5) is
relevanL lor decidinq Lhe audiLors' reporLinq responsibiliLy as
well. 1his implies LhaL an audiLor needs Lo reporL on inLernal
lnancial conLrols relaLinq noL only Lo Lhe lnancial sLaLemenLs,
buL also oLher maLLers such as policies and procedures
lor ensurinq orderly and ellcienL conducL ol business and
salequardinq ol asseLs, i.e., audiLors' reporLinq includes boLh
lnancial reporLinq conLrols and business conLrols.
1he second view is LhaL belore usinq Lhe explanaLion qiven lor
the purposes of a particular section for interpreting another
secLion, one needs Lo look aL Lhe conLexL. 1he direcLors ol a
company are responsible lor overseeinq all aspecLs relaLinq
Lo luncLioninq ol a company. Hence, wider meaninq ol Lhe
Lerm 'inLernal lnancial conLrols' in Lhe conLexL ol Lheir
responsibiliLy may be somewhaL |usLiled. However, Lhe
audiLors' responsibiliLy is only wiLh reqard Lo reporLinq on
lnancial sLaLemenLs and maLLers connecLed LherewiLh. An
audiLor is Lypically noL expecLed Lo look inLo or commenL on
strategic and operational business decisions, including whether
manaqemenL is runninq business ellcienLly. ln many cases, an
audiLor may noL have sullcienL knowledqe/experLise Lo do so.
Basis Lhis, Lhe proponenLs ol Lhis view suqqesL LhaL Lhe audiLor
is required Lo commenL only abouL adequacy/exisLence and
operaLinq ellecLiveness ol inLernal lnancial conLrols perLaininq
Lo lnancial sLaLemenLs, i.e., lnancial reporLinq conLrols only.
We undersLand LhaL Lhe lCAl is developinq quidance on various
issues arisinq lrom Lhe 2013 AcL, includinq Lhe lramework on
audiLors' responsibiliLy Lo reporL on inLernal lnancial conLrols.
UnLil such quidance or clarilcaLion is provided by Lhe lCAl, our
prelerred approach is Lo apply Lhe second view. We expecL LhaL
Lhe lCAl may clarily Lhe same in due course.
5ubsequent issues concerning internal hnancial control
are discussed assuming that the hrst view is accepted
on this matter. II this is not the case, views on the
subsequent issues may need to be reconsidered.
PeIerence is drawn to subrules 8(4) and 8(5) oI the Accounts
Pules as reproduced above. 5ubrule 8(4) deals with annual
evaluation oI the board, and is applicable to listed and
specihed class oI public companies. 5ubrule 8(5) prescribes
other matters, including comment on internal hnancial
controls, to be included in the board report. 5ubrule 8(5)
starts by stating that "in addition to matters prescribed under
subrule 8(4)." Does it mean that the requirements under sub
rule 8(5) apply only to companies prescribed in the subrule
8(4)?
Subrule 8(5) ol Lhe AccounLs Rules is worded in a conlusinq
manner. One view is LhaL by drawinq relerence, iLs applicabiliLy
is resLricLed only Lo companies menLioned in Lhe subrule 8(^),
i.e., lisLed companies and public companies havinq paidup
share capital of `25 crore or more aL Lhe end ol Lhe precedinq
lnancial year. 1he second view is LhaL subrule 8(^) and 8(5)
are independenL and have been issued in Lhe conLexL ol Lwo
dillerenL secLions, i.e., secLion 13^(3)(p) and secLion 13^(3)
(q), ol Lhe 2013 AcL, respecLively. WhilsL Lhe lrsL secLion relers
Lo "class ol companies"; Lhere is no such relerence in Lhe laLLer.
Also, Lhe subrule 8(5) does noL sLaLe LhaL iLs applicabiliLy is
resLricLed only Lo companies menLioned in Lhe subrule 8(^).
Hence, Lhe requiremenLs covered under Lhe subrule 8(5) apply
Lo all companies, includinq privaLe companies.
We expecL LhaL Lhe MCA/lCAl may provide quidance on various
issues reqardinq inLernal lnancial conLrol reporLinq. UnLil
any quidance or clarilcaLion is provided, our undersLandinq
is LhaL subrule 8(^) and 8(5) are independenL. Hence, our
prelerred approach is Lo apply Lhe second view on Lhis issue,
i.e., requiremenLs covered under subrule 8(5) apply Lo all
companies.
In accordance with section 129(4) oI the 2013 Act, the
requirement concerning preparation, adoption and audit
oI the hnancial statements oI a holding company, mutatis
mutandis, apply to the CF5. Does it mean that directors as
well as auditor oI a parent company are also required to
comment regarding existence and operating eIIectiveness oI
internal hnancial controls in the entire group?
NeiLher secLion 129(^) nor any oLher secLion ol Lhe 2013 AcL
requires Lhe provisions concerninq preparaLion ol Lhe board
reporL ol a parenL company Lo be applied, mutatis mutandis, to
Lhe consolidaLed board reporL. ln lacL, Lhere is no concepL ol a
"consolidaLed board reporL" under Lhe 2013 AcL. RaLher, sub
rule 8 in Lhe AccounLs Rules is clear LhaL board reporL needs Lo
be prepared based on Lhe sLandalone lnancial sLaLemenLs ol a
company. Considerinq Lhis, direcLors ol a parenL company are
noL required Lo commenL reqardinq adequacy/ exisLence and
operaLinq ellecLiveness ol inLernal lnancial conLrols lor Lhe
qroup as a whole.
WiLh reqard Lo audiLors' reporLinq responsibiliLies, Lwo views
seem possible. 1he lrsL view is LhaL secLion 129(^) ol Lhe
2013 AcL deals wiLh issuance ol audiL opinion on Lhe CFS, i.e.,
wheLher CFS presenL Lrue and lair view in accordance wiLh Lhe
applicable accounLinq sLandards. ReporLinq on inLernal lnancial
conLrol is noL Lhe same as issuinq audiL opinion on Lhe CFS.
Hence, audiLors' reporLinq on inLernal lnancial conLrol does noL
apply Lo Lhe CFS.
Accordinq Lo Lhe supporLers ol Lhe second view, secLion 1^3(3)
requires reporLinq on "inLernal lnancial conLrol" Lo be parL ol
Lhe audiLors' reporL. Hence, secLion 129(^) read wiLh secLion
1^3(3) indicaLes LhaL Lhe requiremenLs concerninq audiLors'
reporLinq on inLernal lnancial conLrol are likely Lo apply Lo Lhe
CFS as well.
From our perspecLive, Lhe second view appears Lo be a
more loqical readinq ol Lhe relevanL secLions ol Lhe 2013
AcL. However, Lhe lnal decision resLs wiLh Lhe MCA/ lCAl.
ln providinq quidance, Lhe lCAl may consider providinq
exempLions/ relaxaLions lor immaLerial subsidiaries and
newly acquired subsidiaries included in Lhe CFS, on Lhe lines
ol exempLion available under Lhe SOX AcL. 1he lCAl may also
consider providinq quidance on how Lo deal wiLh associaLes and
|oinLly conLrolled enLiLies accounLed lor usinq Lhe equiLy meLhod
and proporLionaLe consolidaLion, respecLively, in Lhe CFS, where
Lhe parenL may noL have Lhe riqhL/ auLhoriLy Lo evaluaLe Lhe
inLernal lnancial conLrols and/or may lack Lhe access necessary
Lo make such an evaluaLion.
1he audiLor ol a parenL company and Lhe CFS may noL be Lhe
audiLor ol all Lhe subsidiaries, associaLes and |oinL venLures
LhaL are included in Lhe CFS. ln such cases, Lhe parenL company
and iLs audiLor will have Lo puL a sysLem in place whereby
Lhe audiLor ol each ol Lhe componenL includes in Lheir audiL
reporL, Lhe reporLinq on inLernal lnancial conLrols. 1he parenL
company's audiLor can use Lhese audiL reporLs Lo lnalize Lhe
reporLinq on inLernal lnancial conLrols on a consolidaLed basis.
1his is an approach similar Lo whaL is currenLly beinq lollowed
lor issuinq audiL reporL on Lhe CFS.
The Guidance Note on Audit of Consolidated Financial
Statements allows Lhe parenL company audiLor Lo rely upon Lhe
work perlormed by Lhe audiLors ol subsidiaries, associaLes and
|oinL venLures, while issuinq audiL opinion on Lhe CFS. ln such
cases, Lhe audiLors' reporL on CFS may draw aLLenLion Lo Lhe
fact that part of the audit of the group was carried out by other
audiLor(s). 1o avoid any poLenLial issue, iL is suqqesLed LhaL
Lhe lCAl issues similar quidance lor reporLinq by audiLors on
maLLers relaLinq Lo inLernal lnancial conLrols also.
Other key perspectives
1he direcLor's and audiLor's reporLinq concerninq inLernal
lnancial conLrols will be wiLh respecL Lo periods commencinq
lrom 1 April 201^ or alLer. For a company, whose lnancial
year beqins on 1 April 201^, Lhis implies LhaL Lhe sysLem ol
inLernal lnancial conLrols should be in place and be operaLinq
ellecLively lrom 1 April 201^. lL may be noLed LhaL secLions
conLaininq requiremenLs concerninq inLernal lnancial conLrols
were noLiled on 26 March 201^ and Lhe lnal rules were issued
on 27 March/31 March 201^. 1his leaves companies wiLh an
impossible Lask. 1his issue is lurLher complicaLed because an
appropriaLe lramework/quidance reqardinq implemenLaLion ol
inLernal lnancial conLrol sysLem and reporLinq Lhereon is noL
yeL issued.
ln conLrasL Lo Lhe above, when SOX requiremenLs were made
applicable in Lhe US, Lhe SLC had qiven an adequaLe Lime
lor providinq (i) companies an opporLuniLy Lo compleLe Lhe
preparaLory work, and (ii) audiLors an opporLuniLy Lo qear up lor
Lhe new requiremenLs.
lL may be appropriaLe lor Lhe MCA Lo deal wiLh Lhis issue
and provide a LransiLion period ol aLleasL one year lor
companies and audiLors Lo implemenL Lhis requiremenL. From
companies' perspecLive, iL may be noLed LhaL Lhere can be
severe implicaLions and consequences, includinq, modiled/
qualiled reporLinq, il iL is observed alLer Lhe yearend LhaL
eiLher conLrols were noL exisLinq or Lhey were noL operaLinq
ellecLively. 1o avoid such issues, iL is imperaLive LhaL companies
enqaqe wiLh Lheir audiLors/prolessional advisors lor conLrol
LesLinq much belore Lhe yearend. 1his is likely Lo help Lhem in
Lakinq correcLive measures on a Limely basis.
Dehnition oI the term 'subsidiary'
ln accordance wiLh Lhe 2013 AcL, "'Subsidiary company' or
'subsidiary,' in relaLion Lo any oLher company (LhaL is Lo say
Lhe holdinq company), means a company in which Lhe holdinq
company:
(i) ConLrols Lhe composiLion ol Lhe board ol direcLors, or
(ii) Lxercises or conLrols more Lhan onehall ol Lhe LoLal share
capiLal eiLher on iLs own or LoqeLher wiLh one or more ol
iLs subsidiary companies."
1he dralL rules sLaLed LhaL lor Lhe above purpose, LoLal
share capiLal includes boLh paidup equiLy share capiLal and
prelerence share capiLal. 1his resulLed in a very unique siLuaLion
whereby a lender providinq lnance Lo a company in Lhe lorm ol
redeemable prelerence shares would LreaL Lhe borrower as iLs
subsidiary, il Lhe prelerence shares worked ouL Lo be more Lhan
507 ol Lhe LoLal share capiLal.
ln Lhe DelniLion Rules, Lhe delniLion ol LoLal share capiLal is
chanqed. 1he DelniLion Rules sLaLe LhaL lor Lhe purposes ol
delniLion ol subsidiary and associaLe company, "LoLal share
capiLal" comprises paidup equiLy share capiLal and converLible
prelerence share capiLal. ln our view, a converLible prelerence
share includes boLh opLionally as well as compulsorily
converLible prelerence shares. However, prelerence shares
wiLh no opLion ol conversion inLo equiLy capiLal will noL be
considered lor deLermininq il a company is a subsidiary/
associaLe company. Also, insLrumenLs, such as, converLible
warranLs or opLions and converLible debenLures, are noL
considered lor deLermininq il a company is a subsidiary/
associaLe company.
UndoubLedly, Lhe DelniLion Rules represenL an improvemenL
visvis Lhe dralL rules. However, iL leaves scope lor siqnilcanL
sLrucLurinq. Consider Lhe lollowinq Lwo examples:
(i) For requlaLory and oLher purposes, company A does noL
wanL Lo presenL a loss makinq enLiLy (company B) as iLs
subsidiary. Company B may issue converLible debenLures
Lo company A. 1he converLible debenLures qive iL
Lremendous powers, buL unlike prelerence shares are noL
considered lor deLerminaLion ol subsidiary.
1houqh company A is compleLely lundinq and possibly in
conLrol ol company B, iL would noL be LreaLinq company B,
as iLs subsidiary.
(ii) Consider anoLher scenario, company C desires Lo presenL
a huqely prolL makinq company D as iLs subsidiary,
Lhouqh iL may noL have any board conLrol. Company
D plans Lo qeL siqnilcanL equiLy invesLmenL lrom an
invesLor J whereby J will own Lhe enLire equiLy capiLal
ol D, and also conLrol Lhe board ol D. Company D issues
new equiLy shares Lo J and J also acquires Lhe exisLinq
equiLy capiLal ol D lrom Lhe markeL. Also, D issues Lo C,
opLionally converLible redeemable prelerence shares
(exceedinq Lhe 507 Lhreshold), where conversion riqhL
is nonsubsLanLive, deeply ouL ol Lhe money and in
pracLical Lerms may never qeL exercised. ln Lhis case, J in
subsLance conLrols D. However, based on Lhe delniLion,
iL may be possible Lo arque LhaL boLh J and C conLrol D.
WhilsL AS 21 recoqnizes LhaL a subsidiary may have Lwo
parenL companies; however, iL is may noL relecL Lrue
economic subsLance ol Lhe arranqemenL.
Is the dehnition oI the term "subsidiary company" under the
2013 Act in sync with the dehnition under A5 21? II this is
not the case, which dehnition should be used Ior preparing
CF5?
AS 21 read wiLh AS 23 is clear LhaL poLenLial equiLy shares ol
Lhe invesLee are noL considered lor deLermininq voLinq power.
Also, conLrol under AS 21 is based on voLinq power, as aqainsL
LoLal share capiLal ownership under Lhe 2013 AcL. Hence, Lhe
delniLion ol Lhe Lerm "subsidiary company" under Lhe 2013
AcL is dillerenL lrom LhaL under AS 21.
(iii) One view is LhaL Lhe AccounLs Rules, amonq oLher
maLLers, sLaLe LhaL consolidaLion ol lnancial sLaLemenLs
will be made in accordance wiLh Lhe applicable accounLinq
sLandards. 1hus, lor preparinq CFS, delniLion qiven under
AS 21 is relevanL. For leqal and requlaLory purposes,
delniLion ol subsidiary as per Lhe 2013 AcL should be
used.
However, Lhere are oLhers who do noL appear Lo be convinced
wiLh Lhe view expressed in Lhe previous paraqraph. 1hey poinL
ouL LhaL iL is a well seLLled posiLion in lndia LhaL in case ol
conlicLinq requiremenLs beLween Lhe sLaLuLe and accounLinq
sLandards, Lhe law will prevail. 1hey lurLher arque LhaL Lhe
lnal rule requires Lhe use ol accounLinq sLandards (AS 21) lor
preparinq CFS buL is noL relevanL lor idenLilyinq Lhe subsidiaries
LhaL will be included in Lhe CFS. For idenLilyinq Lhe subsidiaries,
delniLion under Lhe 2013 AcL should be used.
1his is an area where MCA/lCAl needs Lo provide quidance.
UnLil such quidance or clarilcaLion is provided or AS 21 is
revised, our prelerred view is LhaL idenLilcaLion ol subsidiaries
lor consolidaLion should be based on Lhe economic subsLance;
raLher Lhan, mere leqal lorm. ll delniLion qiven in Lhe 2013
AcL is used Lo idenLily subsidiaries lor CFS, one may endup
consolidaLinq companies where Lhe reporLinq company has
provided loan in Lhe lorm ol converLible prelerence shares
LhaL do noL have any voLinq power. Hence, our prelerence is Lo
apply Lhe lrsL view. Under Lhis view, a company applies AS 21
delniLion Lo idenLily subsidiaries Lo be consolidaLed. For leqal
and requlaLory purposes, delniLion ol subsidiary as per Lhe
2013 AcL should be used.
Consolidated hnancial statements
SecLion 129(3) ol Lhe 2013 AcL requires LhaL a company havinq
one or more subsidiaries will, in addiLion Lo separaLe lnancial
sLaLemenLs, prepare CFS. Hence, Lhe 2013 AcL requires all
companies, includinq nonlisLed and privaLe companies, havinq
subsidiaries Lo prepare CFS.
1he 2013 AcL also provides Lhe below:
CFS will be prepared in Lhe same lorm and manner as SFS
ol Lhe parenL company.
1he CenLral CovernmenL may provide lor Lhe consolidaLion
ol accounLs ol companies in such manner as may be
prescribed.
1he requiremenLs concerninq preparaLion, adopLion and
audiL ol lnancial sLaLemenLs will, mutatis mutandis, apply
Lo CFS.
An explanaLion Lo secLion dealinq wiLh preparaLion ol CFS
sLaLes LhaL "lor Lhe purposes ol Lhis subsecLion, Lhe word
subsidiary includes associaLe company and |oinL venLure."
While Lhere is no chanqe in secLion 129(3), rule 6 under
the AccounLs Rules deals wiLh Lhe "Manner ol consolidaLion
ol accounLs." lL sLaLes LhaL Lhe consolidaLion ol lnancial
sLaLemenLs ol a company will be done in accordance wiLh Lhe
provisions ol Schedule lll Lo Lhe 2013 AcL and Lhe applicable
accounLinq sLandards. 1he proviso Lo Lhis rule sLaLes as below:
"Provided LhaL in case ol a company covered under sub
secLion (3) ol secLion 129 which is noL required Lo prepare
consolidaLed lnancial sLaLemenLs under Lhe AccounLinq
SLandards, iL shall be sullcienL il Lhe company complies
wiLh provisions on consolidaLed lnancial sLaLemenLs
provided in Schedule lll ol Lhe AcL."
Civen below is an overview ol key requiremenLs under Lhe
Schedule lll concerninq CFS:
Where a company is required Lo prepare CFS, iL will mutatis
mutandis lollow Lhe requiremenLs ol Lhis Schedule as
applicable Lo a company in Lhe preparaLion ol balance
sheeL and sLaLemenL ol prolL and loss.
ln CFS, Lhe lollowinq will be disclosed by way ol addiLional
inlormaLion:
(i) ln respecL ol each subsidiary, associaLe and |oinL
venLure, 7 ol neL asseLs as 7 ol consolidaLed neL
asseLs.
(ii) ln respecL ol each subsidiary, associaLe and |oinL
venLure, 7 share in prolL or loss as 7 ol consolidaLed
prolL or loss. Disclosures aL (i) and (ii) are lurLher
subcaLeqorized inLo lndian and loreiqn subsidiaries,
associaLes and |oinL venLures.
(iii) For minoriLy inLeresL in all subsidiaries, 7 ol neL asseLs
and 7 share in prolL or loss as 7 ol consolidaLed neL
asseLs and consolidaLed prolL or loss, separaLely.
All subsidiaries, associaLes and |oinL venLures (boLh lndian
or loreiqn) will be covered under CFS.
A company will disclose lisL ol subsidiaries, associaLes or
|oinL venLures which have noL been consolidaLed alonq wiLh
Lhe reasons ol nonconsolidaLion.
A5 21 does not mandate a company to present CF5. Pather,
it merely states that iI a company presents CF5 Ior complying
with the requirements oI any statute or otherwise, it should
prepare and present CFS in accordance with AS 21. Keeping
this in view and proviso to the rule , can a company having
subsidiary take a view that it need not prepare CF5?
1his quesLion is noL relevanL Lo lisLed companies, since Lhe
lisLinq aqreemenL requires lisLed companies wiLh subsidiaries
Lo prepare CFS. 1his quesLion is Lherelore relevanL lrom Lhe
perspecLive ol a nonlisLed company.
Some arque LhaL because neiLher AS 21 nor Schedule lll
mandaLes preparaLion ol CFS, Lhe AccounLs Rules have Lhe
ellecL ol noL requirinq a CFS. lnsLead, a company should
presenL sLaLemenL conLaininq inlormaLion, such as share in
prolL/loss and neL asseLs ol each subsidiary, associaLe and |oinL
venLures, as addiLional inlormaLion in Lhe Annual ReporL. ln
Lhis view, Lhe AccounLs Rules would override Lhe 2013 AcL. ll
iL was indeed Lhe inLenLion noL Lo require CFS, Lhen iL appears
inconsisLenL wiLh Lhe requiremenL Lo presenL a sLaLemenL
conLaininq inlormaLion such as share in prolL/loss and neL
asseLs ol each ol Lhe componenL in Lhe qroup.
OLhers arque LhaL Lhe requiremenL Lo prepare CFS is arisinq
lrom Lhe 2013 AcL and Lhe AccounLs Rules/ accounLinq
sLandards cannoL override/ chanqe LhaL requiremenL. 1o
supporL Lhis view, iL is also beinq arqued LhaL Lhe AccounLs
Rules reler Lo AS 21 lor Lhe requiremenL concerninq
preparaLion ol CFS and AS 21, in Lurn, relers Lo Lhe qoverninq
law which happens Lo be Lhe 2013 AcL. Hence, Lhe AccounLs
Rules/ AS 21 also mandaLe preparaLion ol CFS. Accordinq
Lo Lhe supporLers ol Lhis view, Lhe proviso qiven in Lhe
AccounLs Rules deals wiLh specilc exempLions in AS 21 lrom
consolidaLinq cerLain subsidiaries which operaLe under severe
lonqLerm resLricLions or are acquired and held exclusively wiLh
a view Lo iLs subsequenL disposal in Lhe near luLure. ll Lhis was
indeed Lhe inLenLion, Lhen Lhe proviso appears Lo be poorly
dralLed, because Lhe exempLion should noL have been lor
preparinq CFS, buL lor excludinq cerLain subsidiaries in Lhe CFS.
ln our view, Lhis is an area where Lhe MCA/ lCAl need Lo provide
quidance/ clarilcaLion. UnLil such quidance/ clarilcaLions
are provided, our prelerred approach is Lo read Lhe "proviso"
menLioned above in a manner LhaL Lhe AccounLs Rules do noL
override Lhe 2013 AcL. Hence, our prelerence is Lo apply Lhe
second view, i.e., all companies (lisLed and nonlisLed) havinq
one or more subsidiary need Lo prepare CFS.
The subsequent issues are discussed on the assumption
that our preIerred view, i.e., all companies having one or
more subsidiary need to prepare CF5, is hnally accepted.
II this is not the case, views on subsequent issues may
need to be reconsidered
IFP5 exempts nonlisted intermediate holding companies
Irom preparing CF5 iI certain conditions are Iulhlled. Is
there any such exemption under the 2013 Act read with the
Accounts Pules?
ALLenLion is inviLed Lo discussion on Lhe previous issue
reqardinq need Lo prepare CFS. As menLioned earlier, our
prelerred view is LhaL all companies havinq one or more
subsidiary need Lo prepare CFS. Under Lhis view, Lhere is no
exempLion lor nonlisLed inLermediaLe holdinq companies
lrom preparinq CFS. Hence, all companies havinq one or more
subsidiaries need Lo prepare CFS.
Currently, the listing agreement permits companies to
prepare and submit consolidated hnancial results/hnancial
statements in compliance with IFP5 as issued by the IA5B.
For a company taking this option, there is no requirement to
prepare CFS under Indian GAAP. Will this position continue
under the 2013 Act?
ALLenLion is inviLed Lo discussion on Lhe earlier issue reqardinq
Lhe requiremenL Lo prepare CFS. As menLioned earlier, our
prelerred view is LhaL CFS is required lor all companies havinq
one or more subsidiary. 1he AccounLs Rules are clear LhaL
consolidaLion ol lnancial sLaLemenLs will be done in accordance
wiLh Lhe provisions ol Schedule lll Lo Lhe 2013 AcL and Lhe
applicable accounLinq sLandards. Hence, companies will have Lo
mandaLorily prepare lndian CAAP CFS, and may choose eiLher
Lo conLinue preparinq lFRS CFS as addiLional inlormaLion or
disconLinue preparinq Lhem.
1he lCAl has recenLly proposed a new roadmap lor
implemenLaLion ol lndAS in lndia and submiLLed iL Lo Lhe
MCA lor iLs consideraLion. ln accordance wiLh Lhe roadmap,
companies meeLinq Lhe criLeria below will prepare Lheir CFS in
accordance wiLh lndAS lrom accounLinq period beqinninq on or
alLer 1 April 2016. ComparaLives lor Lhe year endinq 31 March
2016 will also be in accordance wiLh lndAS.
Companies whose equiLy and/or debL securiLies are lisLed
or are in Lhe process ol lisLinq on any sLock exchanqe in
lndia or ouLside lndia
Companies oLher Lhan Lhose covered in (a) above, havinq
net worth of `500 crore or more
Holdinq, subsidiary, |oinL venLure or associaLe companies
ol companies covered under (a) or (b) above
We recommend LhaL Lhe MCA should reexamine Lhis issue
and allow companies Lo volunLarily prepare CFS under lASB
lFRS insLead ol lndian CAAP. More Lhan 100 counLries around
Lhe world use lFRS, which is now ellecLively a qold sLandard.
1herelore, iL may be inappropriaLe Lo noL accepL lFRS CFS. We
also recommend LhaL when lndAS are noLiled lor preparinq
CFS, Lhey should be noLiled wiLh no or very lew chanqes lrom
Lhe lASB lFRS.
An explanation to section 129(3) oI the 2013 Act states that
"Ior the purpose oI this subsection, the word subsidiary
includes associate company and |oint venture." The meaning
oI this explanation is not clear. Does it mean that a company
will need to prepare CF5 even iI it does not have any
subsidiary but has an associate or |oint venture?
1he lollowinq Lwo views seem possible on Lhis maLLer:
One view is LhaL under Lhe noLiled AS, Lhe applicaLion ol
equiLy meLhod/proporLionaLe consolidaLion Lo associaLe/
|oinL venLures is required only when a company has
subsidiaries and prepares CFS. Moreover, Lhe AccounLs
Rules clarily LhaL CFS need Lo be prepared as per
applicable accounLinq sLandards. Hence, Lhe proponenLs
ol Lhis view arque LhaL LhaL a company is noL required Lo
prepare CFS il iL does noL have a subsidiary buL has an
associaLe or a |oinL venLure.
1he second view is LhaL Lhe above explanaLion requires
associaLes/|oinL venLures Lo be LreaLed aL par wiLh
subsidiary lor decidinq wheLher CFS needs Lo be prepared.
Moreover, Lhe 2013 AcL decides Lhe need Lo prepare CFS
and Lhe AccounLs Rules are relevanL only lor Lhe manner ol
consolidaLinq enLiLies idenLiled as subsidiaries, associaLes
and |oinL venLures. Hence, CFS is prepared when Lhe
company has an associaLe or |oinL venLure, even Lhouqh
iL does noL have any subsidiary. 1he associaLe and |oinL
venLure are accounLed lor usinq Lhe equiLy/proporLionaLe
consolidaLion meLhod in Lhe CFS.
We undersLand LhaL Lhe MCA/lCAl may provide an appropriaLe
quidance on Lhis issue in Lhe due course. UnLil such quidance is
provided, lrom our perspecLive, Lhe second view appears Lo be
more loqical readinq ol Lhe explanaLion. Hence, our prelerence
is Lo apply Lhe second view.
5ection 129(4) read with 5chedule III to the 2013 Act
suggests that disclosure requirements oI 5chedule III mutatis
mutandis apply in the preparation oI CF5. In contrast,
explanation to paragraph oI A5 21 exempts disclosure oI
statutory inIormation in the CF5. Will this exemption continue
under the 2013 Act?
A company will need Lo qive all disclosures required by
Schedule lll Lo Lhe 2013 AcL, includinq sLaLuLory inlormaLion,
in Lhe CFS. 1o supporL Lhis view, iL may be arqued LhaL AS
21 (explanaLion Lo paraqraph 6) had qiven exempLion lrom
disclosure ol sLaLuLory inlormaLion because Lhe 1956 AcL did
noL require CFS. WiLh Lhe enacLmenL ol Lhe 2013 AcL, Lhis
posiLion has chanqed. Also, Lhe exempLion in AS 21 is opLional
and Lherelore Lhis should noL be seen as a conlicL beLween AS
21 and Schedule lll. ln oLher words, Lhe sLaLuLory inlormaLion
required by Schedule lll lor SFS will also apply Lo CFS.
1he disclosures qiven in Lhe CFS will include inlormaLion
lor parenL, all subsidiaries (includinq loreiqn subsidiaries)
and proporLionaLe share lor |oinL venLures. For associaLes
accounLed lor usinq equiLy meLhod, disclosures will noL apply.
1his ensures consisLency wiLh Lhe manner in which invesLmenLs
in subsidiaries, |oinL venLures and associaLes are LreaLed in CFS.
Some pracLical challenqes are likely Lo arise in implemenLinq
Lhe above requiremenL. For example,
lL is noL clear as Lo how a company will qive disclosures
such as imporL, exporL, earninqs and expendiLure in loreiqn
currency, lor loreiqn subsidiaries and |oinL venLures. LeL
us assume LhaL an lndian company has US subsidiary LhaL
buys and sells qoods in USD. From CFS perspecLive, should
Lhe purchase/sale in US be LreaLed as imporL/exporL ol
qoods? Should such purchase/sale be presenLed as loreiqn
currency earninq/expendiLure?
How should a company deal wiLh inLraqroup loreiqn
currency denominaLed LransacLions which may qeL
eliminaLed on consolidaLion? LeL us assume LhaL Lhere
are sale/purchase LransacLions beLween Lhe lndian parenL
and iLs overseas subsidiaries, which qeL eliminaLed on
consolidaLion. Will Lhese LransacLions require disclosure as
exporL/imporL in Lhe CFS?
lCAl should provide appropriaLe quidance on such pracLical
issues. UnLil such quidance is provided, dillerinq views are
possible. One view is LhaL Lhe MCA has mandaLed Lhese
disclosures Lo presenL inlormaLion reqardinq imporLs/exporLs
made and loreiqn currency earned/spenL by lndian companies.
1o meeL disclosure ob|ecLive, CFS should conLain disclosures
such as imporL, exporL, earninqs and expendiLure in loreiqn
currency lor Lhe parenL plus lndian subsidiaries (1007 share)
and lndian |oinL venLures (proporLionaLe share). 1hese
disclosures may be omiLLed lor loreiqn subsidiaries and |oinL
venLures. Since disclosures lor loreiqn operaLions are noL beinq
qiven, Lhere may noL be any inLraqroup eliminaLion.
1he second view is LhaL Schedule lll has mandaLed specilc
disclosures and one should look aL disclosures required and
ensure compliance. Hence, lor each subsidiary and |oinL
venLure, imporL, exporL, earninqs and expendiLure in loreiqn
currency is idenLiled based on iLs domicile counLry and
reporLinq currency. 1o illusLraLe, lor a US subsidiary havinq USD
reporLinq currency, any sale and purchase ouLside US is LreaLed
as exporL and imporL, respecLively. Similarly, any income/
expendiLure in nonUSD currency is loreiqn currency income/
expendiLure. Under Lhis view, inLraqroup LransacLions may
eiLher be eliminaLed or included in boLh imporL and exporL.
ln Lhe absence ol specilc quidance/clarilcaLion, we believe LhaL
lrsL view is Lhe prelerred approach. 1o explain Lhe approach
adopLed, we recommend LhaL an appropriaLe noLe is qiven in
Lhe lnancial sLaLemenLs.
Assume that the 2013 Act requires even nonlisted and
private groups to prepare CF5. Under this assumption, the
Iollowing two issues need to be considered:
The date Irom which the requirement concerning
preparation oI CF5 will apply. Particularly, is it mandatory
Ior nonlisted/private groups to prepare CF5 Ior the year
ended 31 March 2014?
Whether the comparative numbers need to be given in
the hrst set oI CF5 presented by an existing group?
Basis Lhe Ceneral Circular no. 8/201^ daLed ^ April
201^, nonlisLed/privaLe qroups need Lo prepare CFS lrom
lnancial years beqinninq on or alLer 1 April 201^.
Reqardinq Lhe second issue, Schedule lll sLaLes LhaL excepL
lor Lhe lrsL lnancial sLaLemenLs prepared by a company
alLer incorporaLion, presenLaLion ol comparaLive amounLs
is mandaLory. ln conLrasL, LransiLional provisions Lo AS 21
exempL presenLaLion ol comparaLive numbers in Lhe lrsL
seL ol CFS prepared even by an exisLinq qroup.
One may arque LhaL Lhere is no conlicL beLween
LransiLional provisions ol AS 21 and Schedule lll. RaLher,
AS 21 qives an exempLion which is noL allowed under Lhe
Schedule lll. Hence, presenLaLion ol comparaLive numbers
is mandaLory in Lhe lrsL seL ol CFS prepared by an exisLinq
company.
5ubsidiary hnancial statements
A proviso Lo secLion 136(1) ol Lhe 2013 AcL requires every
company havinq one or more subsidiaries Lo:
Place separate audited accounts in respect of each of its
subsidiary on its website, if any
Provide a copy ol separaLe audiLed lnancial sLaLemenLs in
respecL ol each ol iLs subsidiary, Lo a shareholder who asks
lor iL.
1he lisLinq aqreemenL requires all lisLed companies Lo mainLain
a luncLional websiLe conLaininq basic inlormaLion abouL Lhe
company, includinq lnancial inlormaLion. 1he 2013 AcL does
noL mandaLe nonlisLed companies Lo have Lheir websiLe.
1he 2013 AcL requires a lisLed company Lo place iLs lnancial
sLaLemenLs, includinq CFS, il any, and all oLher documenLs
required Lo be aLLached LhereLo, on iLs websiLe. LisLed
companies are also required Lo place lnancial sLaLemenLs ol
Lheir subsidiaries on Lhe websiLe. For nonlisLed companies,
Lhe 2013 AcL only requires lnancial sLaLemenLs ol subsidiaries
Lo be hosLed on Lhe websiLe, il Lhey have one. lnLeresLinqly, iL
does noL mandaLe nonlisLed companies Lo place Lheir own SFS
or CFS on Lhe websiLe, even il Lhey have one. However, many
companies may choose Lo do so volunLarily.
1he discussion below explains key issues relaLinq Lo loreiqn
subsidiary's lnancial sLaLemenLs. 1houqh Lhese discussions
reler Lo Lhese lnancial sLaLemenLs lor hosLinq on Lhe websiLe,
Lhey equally apply when Lhey are noL hosLed on websiLe. For
example, in Lhe case ol a nonlisLed company, iL may noL have a
websiLe and hence would noL be required Lo hosL Lhe lnancial
sLaLemenLs ol loreiqn subsidiaries on Lhe websiLe. NoneLheless,
Lhe discussions below would sLill be relevanL as Lhese lnancial
sLaLemenLs are required Lo be made available Lo shareholders
on requesL.
Are hnancial statements oI Ioreign subsidiaries, Ior placing on
the website, needed to be prepared in accordance with Indian
CAAP, i.e., notihed accounting standards and 5chedule III? Cr
will it be suIhcient compliance iI a company uses the hnancial
statements prepared as per local GAAP for this purpose.
NeiLher Lhe 2013 AcL nor Lhe lnal AccounLs Rules provide
any quidance on Lhis maLLer. ln Lhe absence ol quidance, one
possible view is LhaL iL is accepLable Lo hosL loreiqn subsidiaries'
local CAAP lnancial sLaLemenLs on Lhe websiLe. 1he proponenLs
ol Lhis view make Lhe lollowinq arqumenLs:
RequiremenL Lo hosL subsidiaries' lnancial sLaLemenLs on
Lhe websiLe is qiven in a proviso Lo secLion 136(1). SecLion
129, which deals wiLh preparaLion ol lnancial sLaLemenLs
as per noLiled accounLinq sLandards and Schedule lll, is
noL applicable Lo loreiqn companies.
SecLion 2(^0) ol Lhe 2013 AcL delnes Lhe Lerm "lnancial
sLaLemenLs." lL prescribes minimum componenLs ol
lnancial sLaLemenLs; however, iL does noL require wheLher
Lhese lnancial sLaLemenLs should be prepared as per
lndian CAAP or any oLher CAAP.
1he counLer view is LhaL lnancial sLaLemenLs ol loreiqn
subsidiaries Lo be hosLed on Lhe parenL company's websiLe need
Lo be prepared as per lndian CAAP. 1he proponenLs ol Lhis view
make Lhe lollowinq arqumenLs:
ALLenLion is drawn Lo Lhe lourLh proviso Lo secLion 137(1).
lL requires lnancial sLaLemenLs ol loreiqn subsidiaries Lo
be lled wiLh Lhe RoC. 1his seems Lo suqqesL LhaL Lhese
lnancial sLaLemenLs are sub|ecL Lo cerLain requiremenLs
ol lndian requlaLion and, Lherelore, should be prepared in
accordance wiLh Lhe requiremenLs ol Lhe 2013 AcL.
SecLion 2(^0) only delnes Lhe minimum componenLs
ol lnancial sLaLemenLs. lL does noL prescribe as Lo how
Lhese lnancial sLaLemenLs should be prepared. SecLion
129, which requires lnancial sLaLemenLs Lo be prepared
in accordance wiLh lndian CAAP, is relevanL lor preparinq
all lnancial sLaLemenLs required Lo be prepared under Lhe
2013 AcL.
lCAl should provide quidance on Lhis issue. UnLil such quidance
is provided, our prelerred view is LhaL iL is accepLable Lo hosL
loreiqn subsidiaries' local CAAP lnancial sLaLemenLs on Lhe
websiLe.
Whether the hnancial statements oI Ioreign subsidiaries
need to be translated into English Ior hosting on its website/
giving them to shareholders? Let us assume that an Indian
parent company has a Chinese subsidiary which has prepared
its hnancial statements in the Chinese language. Would a
Chinese version oI the hnancial statements suIhce Ior hosting
on the website or the Indian parent will need to host an
English version?
No specilc quidance under Lhe 2013 AcL is available on
Lhis maLLer. 1here is noLhinq specilc in Lhe 2013 AcL which
prohibiLs a nonLnqlish version. However, a nonLnqlish
version may noL serve any uselul purpose. Also, Lhe lnancial
sLaLemenLs ol loreiqn subsidiaries need Lo be lled wiLh Lhe
RoC. 1here are oLher provisions in Lhe 2013 AcL, e.q., secLion
380 and 381, which require cerLiled Lnqlish LranslaLion belore
llinq Lhe documenLs wiLh Lhe RoC. One may arque LhaL Lhe
same analoqy would apply. Considerinq Lhis and Lo meeL Lhe
requiremenL in spiriL, a company may have Lo LranslaLe lnancial
sLaLemenLs in Lnqlish belore hosLinq Lhem on iLs websiLe.
CurrenLly also, companies are lollowinq similar pracLices.
5ome Ioreign |urisdictions do not require an audit oI hnancial
statements. Is it compulsory to have hnancial statements oI a
Ioreign subsidiary audited under the 2013 Act?
1he 2013 AcL is clear. Companies wiLh one or more subsidiaries
need Lo place audiLed lnancial sLaLemenLs ol each subsidiary
on Lheir websiLe, il Lhey have one. lL also requires companies
Lo provide a copy ol audiLed lnancial sLaLemenLs ol each
subsidiary Lo shareholders on Lheir requesL. 1he lanquaqe used
suqqesLs LhaL iL is mandaLory lor a company Lo have lnancial
sLaLemenLs ol all iLs subsidiaries audiLed lor Lhis purpose, even
il Lhere is no oLher requiremenL Lo have a loreiqn subsidiary
lnancial sLaLemenLs audiLed.
Are hnancial statements oI Ioreign subsidiaries to be audited
by an Indian auditor or Ioreign auditor?
NeiLher Lhe 2013 AcL nor Lhe AccounLs Rules nor AudiL Rules
conLain an expliciL requiremenL lor audiL ol loreiqn subsidiaries
by an lndian audiLor. ln Lhe absence ol any specilc requiremenL,
one may arque LhaL iL is accepLable il lnancial sLaLemenLs ol
foreign subsidiaries prepared in accordance with their local
CAAP are audiLed by a loreiqn audiLor. 1o supporL Lhis view,
iL may also be arqued LhaL loreiqn audiLor has comparaLively
beLLer knowledqe abouL local CAAP ol loreiqn subsidiary
and laws/requlaLions impacLinq lnancial sLaLemenLs in Lhe
respecLive |urisdicLion. Hence, Lhe loreiqn audiLor will be beLLer
equipped Lo audiL local CAAP lnancial sLaLemenLs ol loreiqn
subsidiaries.
5ubsequent issues are discussed based on the view
that hnancial statements oI Ioreign subsidiaries Ior
hosting on the website need not be prepared under
Indian CAAP. II this is not the case, views on the
subsequent issues may need to be reconsidered.
It may also be noted that even iI Ioreign
subsidiaries' hnancial statements are not prepared
under Indian CAAP Ior hosting on the website, they
may still have to be converted to Indian CAAP Ior
the purposes of preparing CFS.
However, Lhe counLer arqumenL is LhaL lnancial sLaLemenLs
will be LreaLed as "audiLed" only il Lhe audiL is carried ouL in
accordance wiLh Lhe requiremenLs ol Lhe 2013 AcL. Hence,
Lhere is a requiremenL Lo qeL lnancial sLaLemenLs ol each
loreiqn subsidiary audiLed in accordance wiLh Lhe requiremenLs
ol Lhe 2013 AcL.
lCAl should provide quidance on Lhis issue. UnLil such quidance
is provided, our prelerred view is LhaL iL is accepLable il lnancial
sLaLemenLs ol loreiqn subsidiaries prepared in accordance wiLh
Lheir local CAAP are audiLed by a loreiqn audiLor.
In accordance with the hrst proviso to section 129(3), a
company needs to attach along with its hnancial statements,
a separate statement containing the salient features of the
hnancial statements oI its subsidiaries in such Iorm as may be
prescribed. In this context, Form ACC1 requires companies
to present the statement containing inIormation, such as,
share capital, reserves & surplus, total assets, total liabilities,
investments, turnover, proht beIore taxation, provision Ior
taxation and proht aIter taxation, Ior each subsidiary. For
Ioreign subsidiaries, should this inIormation be prepared
in accordance with Indian GAAP or the local GAAP of the
subsidiary?
ALLenLion is inviLed Lo our earlier discussions on wheLher Lhe
lnancial sLaLemenLs ol loreiqn subsidiaries need Lo be prepared
in accordance wiLh lndian CAAP. Similar arqumenLs may apply
here as well, excepL LhaL Lhis requiremenL is conLained in
secLion 129 and noL secLion 136.
One view is LhaL sLaLemenL conLaininq salienL leaLures should
be prepared based on Lhe local CAAP lnancial sLaLemenLs
ol all subsidiaries. Under Lhis view, salienL leaLures ol lndian
subsidiaries are prepared usinq lndian CAAP lnancial
sLaLemenLs and Lhose ol loreiqn subsidiaries are prepared usinq
Lheir local CAAP lnancial sLaLemenLs.
1he second view is LhaL mosL ol Lhe inlormaLion required
in Form AOC1 is basic lnancial inlormaLion. For loreiqn
subsidiaries also, such inlormaLion under lndian CAAP is readily
available lrom Lheir reporLinq packaqes used lor consolidaLion
purposes. Hence, Lhe sLaLemenL conLaininq salienL leaLures
lor all subsidiaries (includinq loreiqn subsidiaries) should be
prepared based on lndian CAAP numbers.
Our prelerred approach is Lo apply Lhe second view on Lhis
maLLer.
Abridged hnancial statements
Like Lhe 1956 AcL, Lhe 2013 AcL also allows lisLed companies
Lo circulaLe AFS. 1he AccounLs Rules conLain a lormaL (Form
AOC3) lor presenLaLion ol AFS, which is similar Lo Lhe lormaL
prescribed under Lhe 1956 AcL. AddiLionally, Lhe AccounLs
Rules conLain Lhe lollowinq clarilcaLion:
"Where a company is required Lo prepare consolidaLed
lnancial sLaLemenLs i.e. consolidaLed balance sheeL
and consolidaLed sLaLemenL ol prolL and loss, Lhe
company shall mutatis mutandis lollow Lhe requiremenLs
ol Schedule lll ol Lhe AcL, as applicable Lo a company
in Lhe preparaLion ol balance sheeL and sLaLemenL ol
prolL and loss. ln addiLion, Lhe consolidaLed lnancial
sLaLemenLs shall disclose Lhe inlormaLion as per Lhe
requiremenLs speciled in Lhe applicable AccounLinq
SLandards includinq Lhe iLems speciled aL Serial numbers
(1) and (2) under Lhe headinq 'qeneral insLrucLions lor
Lhe preparaLion ol consolidaLed lnancial sLaLemenLs'
conLained in Lhe said Schedule."
From Lhe above, iL appears LhaL Lhe preparaLion and circulaLion
ol abridqed CFS is noL allowed. 1hus, AFS will be allowed only
in Lhe case ol separaLe lnancial sLaLemenLs. 1his also ensures
consisLency wiLh clause 32 ol Lhe lisLinq aqreemenL.
Depreciation
Amendments in Schedule II to the 2013 Act
Minimum vs. indicative rates
ln Schedule ll oriqinally noLiled, all companies were divided inLo
Lhree classes.
(i) Class l basically included companies which may evenLually
apply lndAS. 1hese companies were permiLLed Lo adopL
a uselul lile or residual value, oLher Lhan Lhose prescribed
under Lhe schedule, lor Lheir asseLs, provided Lhey
disclose |usLilcaLion lor Lhe same.
(ii) Class ll covered companies or asseLs where uselul
lives or residual value are prescribed by a requlaLory
auLhoriLy consLiLuLed under an acL ol Lhe ParliamenL
or by Lhe CenLral CovernmenL. 1hese companies will
use depreciaLion raLes/uselul lives and residual values
prescribed by Lhe relevanL auLhoriLy.
(iii) Class lll covered all oLher companies. For Lhese
companies, Lhe uselul lile ol an asseL will noL be lonqer
Lhan Lhe uselul lile and Lhe residual value will noL be
hiqher Lhan LhaL prescribed in Schedule ll.
PursuanL Lo a recenL amendmenL Lo Schedule ll, disLincLion
beLween class (i) and class (iii) has been removed. RaLher, Lhe
provision now reads as under:
"(i) 1he uselul lile ol an asseL shall noL be lonqer Lhan
Lhe uselul lile speciled in ParL 'C' and Lhe residual value
ol an asseL shall noL be more Lhan lve per cenL ol Lhe
oriqinal cosL ol Lhe asseL:
Provided LhaL where a company uses a uselul lile or
residual value ol Lhe asseL which is dillerenL lrom Lhe
above limiLs, |usLilcaLion lor Lhe dillerence shall be
disclosed in iLs lnancial sLaLemenL."
From Lhe use ol word "dillerenL", iL seems clear LhaL boLh
hiqher and lower uselul lile and residual value are allowed.
However, a company needs Lo disclose |usLilcaLion lor usinq
hiqher/lower lile and/or residual value. Such disclosure will lorm
parL ol Lhe lnancial sLaLemenLs.
Continuous process plant
Under Schedule ll as oriqinally noLiled, uselul lile ol Lhe CPP,
for which there is no special depreciation rate otherwise
prescribed, was 8 years. 1his was a ma|or concern lor cerLain
companies usinq CPP as Lhey would have been required Lo
wriLeoll Lheir enLire planL over 8 years. 1he amendmenL Lo
Schedule ll has resolved Lhe issue as uselul lile ol Lhe CPP
has now been increased Lo 25 years. Moreover, Lhe impacL ol
amendmenL as explained in Lhe precedinq paraqraph is LhaL a
company can depreciaLe iLs CPP over a period shorLer or lonqer
Lhan 25 years, wiLh proper |usLilcaLion.
BOT assets
ln accordance wiLh amendmenL made Lo Schedule XlV Lo Lhe
1956 AcL in April 2012, a company was allowed Lo use revenue
based amorLizaLion lor inLanqible asseLs (Loll roads) creaLed
under BO1, BOO1 or any oLher lorm ol PPP rouLe (collecLively,
relerred Lo as "BO1 asseLs"). Since Schedule ll as oriqinally
noLiled did noL conLain a similar provision, an issue had arisen
wheLher revenue based amorLizaLion will be allowed qoinq
lorward.
1he recenL amendmenL Lo Schedule ll has addressed Lhis
concern. ln accordance wiLh Lhe amendmenL, a company
may use revenue based amorLizaLion lor BO1 asseLs. For
amorLizaLion ol oLher inLanqible asseLs, AS 26 needs Lo be
applied.
Double/ triple shiIt working
Under Schedule ll, no separaLe raLes/ lives are prescribed lor
exLra shilL workinq. RaLher, iL sLaLes LhaL lor Lhe period ol Lime,
an asset is used in double shift depreciation will increase by
507 and by 1007 in case ol Lriple shilL workinq.
LeL us assume LhaL a company has purchased one planL and
machinery Lhree years prior Lo Lhe commencemenL ol Lhe
2013 AcL. Under Schedule XlV, sinqle, double and Lriple shilL
depreciaLion raLes applicable Lo Lhe asseL are ^.757, 7.^27 and
10.3^7, respecLively. Under Schedule ll, iLs lile is 15 years. For
all Lhree years, Lhe company has used Lhe asseL on a Lriple shilL
basis and Lherelore, depreciaLed 31.027 ol iLs cosL over Lhree
years. For simpliciLy, residual value is iqnored.
On LransiLion Lo Schedule ll, Lhe asseL has remaininq Schedule
ll lile ol 12 years, i.e., 15 years 3 years. 1he manaqemenL
has esLimaLed LhaL on sinqle shilL basis, remaininq AS 6 lile is
also 12 years. 1he company will depreciaLe carryinq amounL ol
Lhe asseL over 12 years on a sLraiqhLline basis. ll Lhe company
uses the asset on triple shift basis during any subsequent year,
depreciaLion so compuLed will be increased by 1007. ln case ol
double shilL, depreciaLion will be increased by 507.
Transitional provisions
WiLh reqard Lo Lhe ad|usLmenL ol impacL arisinq on Lhe lrsL
Lime applicaLion, Lhe LransiLional provisions Lo Schedule ll sLaLe
as below:
"From Lhe daLe Schedule ll comes inLo ellecL, Lhe carryinq
amounL ol Lhe asseL as on LhaL daLe:
a) Will be depreciaLed over Lhe remaininq uselul lile ol
Lhe asseL as per Lhis Schedule,
b) AlLer reLaininq Lhe residual value, will be recoqnised
in the opening balance of retained earnings where
Lhe remaininq uselul lile ol an asseL is nil."
Proviso in the latest amendment to 5chedule II states that iI a
company uses a useIul liIe or residual value oI the asset which
is diIIerent Irom limit given in the 5chedule II, |ustihcation
Ior the diIIerence is disclosed in its hnancial statements.
How is this proviso applied iI notihed accounting standards,
particularly, A5 is also to be complied with?
AS 6 sLaLes LhaL depreciaLion raLes prescribed under Lhe sLaLuLe
are minimum. ll manaqemenL's esLimaLe ol Lhe uselul lile ol
an asseL is shorLer Lhan LhaL envisaqed under Lhe sLaLuLe,
depreciaLion is compuLed by applyinq Lhe hiqher raLe. 1he
inLeracLion ol Lhe above proviso and AS 6 is explained wiLh
simple examples:
(i) 1he manaqemenL has esLimaLed Lhe uselul lile ol an asseL
Lo be 10 years. 1he lile envisaqed under Lhe Schedule ll
is 12 years. ln Lhis case, AS 6 requires Lhe company Lo
depreciaLe Lhe asseL usinq 10 year lile only. ln addiLion,
Schedule ll requires disclosure ol |usLilcaLion lor usinq
Lhe lower lile. 1he company cannoL use 12 year lile lor
depreciaLion.
(ii) 1he manaqemenL has esLimaLed Lhe uselul lile ol an asseL
Lo be 12 years. 1he lile envisaqed under Lhe Schedule ll
is 10 years. ln Lhis case, Lhe company has an opLion Lo
depreciate the asset using either 10 year life prescribed in
Lhe Schedule ll or Lhe esLimaLed uselul lile, i.e., 12 years.
ll Lhe company depreciaLes Lhe asseL over Lhe 12 years, iL
needs Lo disclose |usLilcaLion lor usinq Lhe hiqher lile. 1he
company should apply Lhe opLion selecLed consisLenLly.
(iii) Similar posiLion will apply lor Lhe residual value. 1he
manaqemenL has esLimaLed LhaL AS 6 lile ol an asseL
and lile envisaqed in Lhe Schedule ll is 10 years. 1he
esLimaLed AS 6 residual value ol Lhe asseL is nil. 1he
residual value envisaqed under Lhe Schedule ll is 57. ln
Lhis case, AS 6 depreciaLion is Lhe minimum Lhreshold.
1he company cannoL use 57 residual value. ln addiLion,
Schedule ll requires disclosure ol |usLilcaLion lor usinq a
lower residual value.
(iv) AlLernaLively, leL us assume LhaL Lhe manaqemenL has
esLimaLed AS 6 residual value ol Lhe asseL Lo be 107
ol Lhe oriqinal cosL, as aqainsL 57 value envisaqed
in Lhe Schedule ll. ln Lhis case, Lhe company has an
opLion Lo depreciaLe Lhe asseL usinq eiLher 57 residual
value prescribed in Lhe Schedule ll or Lhe esLimaLed
AS 6 residual value, i.e., 107 ol Lhe oriqinal cosL. ll Lhe
company depreciaLes Lhe asseL usinq 107 esLimaLed
residual value, iL needs Lo disclose |usLilcaLion lor usinq
Lhe hiqher residual value. 1he company should apply Lhe
opLion selecLed consisLenLly.
Whether the amendment regarding BCT assets allows
revenue based amortization only Ior toll roads? Cr can a
company apply revenue based amortization to other type oI
intangible assets created under the BCT model?
1he amendmenL in Schedule ll reads as lollows "For inLanqible
asseLs, Lhe provisions ol Lhe accounLinq sLandards applicable
lor Lhe Lime beinq in lorce shall apply excepL in case ol
inLanqible asseLs (1oll roads) creaLed under BO1, BOO1 or any
oLher lorm ol public privaLe parLnership rouLe in case ol road
pro|ecLs." 1he amendmenL clearly suqqesLs LhaL revenue based
amorLizaLion applies Lo Loll roads. 1he same meLhod cannoL be
used lor oLher inLanqible asseLs even il Lhey are creaLed under
PPP schemes, such as airporL inlrasLrucLure.
5chedule II clarihes that the useIul liIe is given Ior whole oI
the asset. II the cost oI a part oI the asset is signihcant to
total cost of the asset and useful life of that part is different
Irom the useIul liIe oI the remaining asset, useIul liIe oI that
signihcant part will be determined separately. This implies
that component accounting is mandatory under 5chedule
II. How does component accounting interact with AS 6
requirements and the amendment in the 5chedule II, which
allows higher or lower useIul liIe, sub|ect to appropriate
|ustihcation being provided?
ComponenL accounLinq requires a company Lo idenLily and
depreciaLe siqnilcanL componenLs wiLh dillerenL uselul lives
separaLely. 1he applicaLion ol componenL accounLinq is likely Lo
cause siqnilcanL chanqe in Lhe measuremenL ol depreciaLion
and accounLinq lor replacemenL cosLs. CurrenLly, companies
need Lo expense replacemenL cosLs in Lhe year ol incurrence.
Under componenL accounLinq, companies will capiLalize Lhese
cosLs as a separaLe componenL ol Lhe asseL, wiLh consequenL
expensinq ol neL carryinq value ol Lhe replaced parL.
1he applicaLion ol componenL accounLinq, includinq iLs
inLeracLion wiLh Schedule ll raLes and AS 6 requiremenLs, is
likely Lo vary dependinq on wheLher a company LreaLs uselul
lile qiven in Lhe Schedule ll as maximum lile ol Lhe asseL
(includinq iLs componenLs) or iL is LreaLed as indicaLive lile only.
ParLicular, aLLenLion is inviLed Lo earlier discussions reqardinq
inLeracLion beLween AS 6 and Lhe proviso added Lhrouqh Lhe
recenL amendmenL Lo Schedule ll. LeL us assume LhaL Lhe
uselul lile ol an asseL as envisaqed under Lhe Schedule ll is 10
years. 1he manaqemenL has also esLimaLed LhaL Lhe uselul
lile ol Lhe principal asseL is 10 years. ll a componenL ol Lhe
asseL has uselul lile ol 8 years, AS 6 requires Lhe company Lo
depreciaLe Lhe componenL usinq 8 year lile only. However, il
Lhe componenL has 12 year lile, Lhe company has an opLion Lo
eiLher depreciaLe Lhe componenL usinq eiLher 10 year lile as
prescribed in Lhe Schedule ll or over iLs esLimaLed uselul lile ol
12 years, wiLh appropriaLe |usLilcaLion. 1he company should
apply Lhe opLion selecLed consisLenLly.
Is component accounting required to be done retrospectively
or prospectively?
ComponenL accounLinq is required Lo be done lor Lhe enLire
block ol asseLs as aL 1 April 1 201^. lL cannoL be resLricLed Lo
only new asseLs acquired alLer 1 April 201^.
How do transitional provisions in 5chedule II apply to
component accounting?
AS 10 qives companies an opLion Lo lollow Lhe componenL
accounLinq; iL does noL mandaLe Lhe same. ln conLrasL,
componenL accounLinq is mandaLory under Lhe Schedule ll.
Considerinq Lhis, we believe LhaL Lhe LransiLional provisions
ol Schedule ll can be used Lo ad|usL Lhe impacL ol componenL
accounLinq. ll a componenL has zero remaininq uselul lile on
Lhe daLe ol Schedule ll becominq ellecLive, i.e., 1 April 201^,
iLs carryinq amounL, alLer reLaininq any residual value, will
be charqed Lo Lhe openinq balance ol reLained earninqs. 1he
carryinq amounL ol oLher componenLs, i.e., componenLs whose
remaininq uselul lile is noL nil on 1 April 201^, is depreciaLed
over Lheir remaininq uselul lile. 1he LransiLional provisions
relaLinq Lo Lhe principal asseL minus Lhe componenLs are
discussed elsewhere in Lhis publicaLion.
In case oI revaluation oI hxed assets, companies are currently
allowed to transIer an amount equivalent to the additional
depreciation on account oI the upward revaluation oI hxed
assets Irom the revaluation reserve to P&L. Hence, any
upward revaluation oI hxed assets does not impact P&L. Will
the same position continue under the 2013 Act also? II not,
how can a company utilize revaluation reserve going Iorward?
Under Lhe 1956 AcL, depreciaLion was Lo be provided on Lhe
oriqinal cosL ol an asseL. Considerinq Lhis, Lhe lCAl Guidance
Note on Treatment of Reserve Created on Revaluation of
Fixed Assets allowed an amounL equivalenL Lo Lhe addiLional
depreciaLion on accounL ol Lhe upward revaluaLion ol lxed
asseLs Lo be Lranslerred lrom Lhe revaluaLion reserve Lo Lhe
P&L.
ln conLrasL, schedule ll Lo Lhe 2013 AcL requires depreciaLion
Lo be provided on hisLorical cosL or Lhe amounL subsLiLuLed
lor Lhe hisLorical cosL. ln Schedule ll as oriqinally noLiled, Lhis
requiremenL was conLained aL Lwo places, viz., ParL A and noLes
in ParL C. PursuanL Lo recenL amendmenL in Schedule ll, Lhe
concerned noLe lrom parL C has been deleLed. However, Lhere
is no change in Part A and it still requires depreciation to be
provided on hisLorical cosL or Lhe amounL subsLiLuLed lor Lhe
hisLorical cosL. 1herelore, in case ol revaluaLion, a company
needs Lo charqe depreciaLion based on Lhe revalued amounL.
ConsequenLly, Lhe lCAl Cuidance NoLe, which allows an amounL
equivalenL Lo Lhe addiLional depreciaLion on accounL ol upward
revaluaLion Lo be recouped lrom Lhe revaluaLion reserve, may
noL apply. Charqinq lull depreciaLion based on Lhe revalued
amounL is expecLed Lo have siqnilcanL neqaLive impacL on Lhe
P&L.
AS 10 allows amounL sLandinq Lo Lhe crediL ol revaluaLion
reserve Lo be Lranslerred direcLly Lo Lhe qeneral reserve on
reLiremenL or disposal ol revalued asseL. A company may
Lransler Lhe whole ol Lhe reserve when Lhe asseL is sold or
disposed ol. AlLernaLively, iL may Lransler proporLionaLe amounL
as Lhe asseL is depreciaLed.
5chedule II to the 2013 Act is applicable Irom 1 April 2014.
Pelated rules, iI any, also apply Irom the same date. It may be
noted that the requirements oI 5chedule II are relevant not
only Ior preparing hnancial statements, but also Ior purposes
such as declaration oI dividend. Civen this background, is
5chedule II applicable to hnancial years beginning on or
aIter 1 April 2014 or it also needs to be applied to hnancial
statements Ior earlier periods iI they are authorized Ior
issuance post 1 April 2014?
Schedule ll is applicable lrom 1 April 201^. As already
menLioned, Schedule ll conLains depreciaLion raLes in Lhe
conLexL ol SecLion 123 dealinq wiLh "DeclaraLion and paymenL
ol dividend" and companies use Lhe same raLe lor Lhe
preparaLion ol lnancial sLaLemenLs as well. SecLion 123, which
is ellecLive lrom 1 April 201^, amonq oLher maLLers, states
LhaL a company cannoL declare dividend lor any lnancial year
excepL ouL ol (i) prolL lor Lhe year arrived aL alLer providinq lor
depreciaLion in accordance wiLh Schedule ll, or (ii) .
Considerinq Lhe above, one view is LhaL lor declarinq any
dividend alLer 1 April 201^, a company needs Lo deLermine
prolL in accordance wiLh SecLion 123. 1his is irrespecLive ol
Lhe lnancial yearend ol a company. Hence, a company uses
Schedule ll principles and raLes lor charqinq depreciaLion in all
lnancial sLaLemenLs lnalized on or alLer 1 April 201^, even il
Lhese lnancial sLaLemenLs relaLe Lo earlier periods.
1he second view is LhaL based on Lhe Ceneral Circular 8/201^,
depreciaLion raLes and principles prescribed in Schedule ll are
relevanL only lor Lhe lnancial years commencinq on or alLer 1
April 201^. 1he lanquaqe used in Lhe Ceneral Circular 8/201^,
includinq relerence Lo depreciaLion raLes in iLs lrsL paraqraph,
seems Lo suqqesL LhaL second view should be applied. For
lnancial years beqinninq prior Lo 1 April 201^, depreciaLion
raLes prescribed under Lhe Schedule XlV Lo Lhe 1956 AcL will
conLinue Lo be used.
ln our view, second view is Lhe prelerred approach lor
charqinq depreciaLion in Lhe lnancial sLaLemenLs. For dividend
declaration related issues, reference is drawn to discussion
under Lhe secLion "DeclaraLion and paymenL ol dividend."
How do the transitional provisions apply in diIIerent
situations? In situation 1, earlier 5chedule XIV and now
5chedule II provide a useIul liIe, which is much higher than
A5 useIul liIe. In situation 2, earlier 5chedule XIV and now
5chedule II provide a useIul liIe, which is much shorter than
AS 6 useful life.
ln siLuaLion 1, Lhe company lollows AS 6 uselul lile under Lhe
1956 as well as Lhe 2013 AcL. ln oLher words, sLaLus quo is
mainLained and Lhere is no chanqe in depreciaLion. Hence, Lhe
LransiLional provisions become irrelevanL. ln siLuaLion 2, when
Lhe company chanqes lrom Schedule XlV Lo Schedule ll uselul
lile, Lhe LransiLional provisions would apply. For example, leL's
assume Lhe uselul lile ol an asseL under Schedule XlV, Schedule
ll and AS 6 is 12, 8 and 16 years respecLively. 1he company
chanqes Lhe uselul lile lrom 12 Lo 8 years and Lhe asseL has
already compleLed 8 years ol uselul lile, i.e., iLs remaininq
uselul lile on Lhe LransiLion daLe is nil. ln Lhis case, Lhe
LransiLional provisions would apply and Lhe company will ad|usL
Lhe carryinq amounL ol Lhe asseL as on LhaL daLe, alLer reLaininq
residual value, in Lhe openinq balance ol reLained earninqs. ll,
on Lhe oLher hand, Lhe company chanqes Lhe uselul lile lrom
12 years Lo 16 years, Lhe company will depreciaLe Lhe carryinq
amounL ol Lhe asseL as on 1 April 201^ prospecLively over Lhe
remaininq uselul lile ol Lhe asseL. 1his LreaLmenL is required
boLh under Lhe LransiLional provisions Lo Schedule ll and AS 6.
Let us assume that a company has ad|usted WDV oI an asset
to retained earnings in accordance with the transitional
provisions given in 5chedule II? 5hould such ad|ustment be
net oI related tax beneht?
ALLenLion is inviLed Lo Lhe lCAl announcemenL LiLled, "Tax effect
of expenses/income adjusted directly against the reserves and/
or Securities Premium Account. 1he AnnouncemenL, amonq
oLher maLLers, sLaLes as below:
". Any expense charqed direcLly Lo reserves and/
or SecuriLies Premium AccounL should be neL ol Lax
benelLs expecLed Lo arise lrom Lhe admissibiliLy ol such
expenses lor Lax purposes. Similarly, any income crediLed
direcLly Lo a reserve accounL or a similar accounL should
be neL ol iLs Lax ellecL."
Considerinq Lhe above, iL seems clear LhaL amounL ad|usLed Lo
reserves should be neL ol Lax benelL, il any.
Declaration and payment oI
dividend
1he 2013 AcL sLaLes LhaL a company will noL declare/pay
dividend lor any lnancial year excepL:
OuL ol prolLs ol Lhe company lor LhaL year alLer
depreciation
OuL ol accumulaLed prolLs lor any previous lnancial
year(s) arrived aL alLer providinq lor depreciaLion
OuL ol boLh
OuL ol money provided by CenLral CovernmenL/sLaLe
qovernmenL lor paymenL ol dividend in pursuance ol any
quaranLee qiven by Lhem.
1he 2013 AcL conLains Lhe lollowinq provisions lor inLerim
dividend:
lnLerim dividend may be declared durinq any lnancial
year ouL ol Lhe surplus in Lhe P&L and ouL ol prolLs ol Lhe
lnancial year in which inLerim dividend is souqhL Lo be
declared.
ll a company has incurred loss durinq Lhe currenL lnancial
year up Lo Lhe end ol Lhe quarLer immediaLely precedinq
Lhe daLe ol declaraLion ol inLerim dividend, such inLerim
dividend will noL be declared aL a raLe hiqher Lhan Lhe
averaqe dividends declared by Lhe company durinq Lhe
immediaLely precedinq Lhree lnancial years.
WhilsL Lhe 2013 AcL does noL mandaLorily require a speciled
percenLaqe ol prolLs Lo be Lranslerred Lo reserves, iL conLains
specilc condiLions lor declaraLion ol dividend ouL ol reserves.
1he Dividend Rules sLaLe LhaL "in Lhe evenL ol adequacy or
absence ol prolLs in any year, a company may declare dividend
out of surplus sub|ecL Lo Lhe lullllmenL ol Lhe prescribed
condiLions" (emphasis added). 1he Dividend Rules prescribe Lhe
lollowinq condiLions in Lhis reqard:
(i) RaLe ol dividend declared will noL exceed Lhe averaqe ol
Lhe raLes aL which dividend was declared by iL in 3 years
immediaLely precedinq LhaL year. However, Lhis resLricLion
does noL apply Lo a company, which has noL declared any
dividend in each ol Lhe Lhree precedinq lnancial years.
(ii) 1oLal amounL Lo be drawn lrom accumulaLed prolLs will
noL exceed an amounL equal Lo 1/10Lh ol Lhe sum ol iLs
paidup share capiLal and lree reserves.
(iii) 1he amounL so drawn will lrsL be uLilized Lo seL oll losses
incurred in Lhe lnancial year belore any dividend in
respecL ol prelerence or equiLy shares is declared.
2^ | Companies Act 2013
(iv) 1he balance ol reserves alLer such wiLhdrawal will noL lall
below 157 ol iLs paid up share capiLal.
(v) No company will declare dividend unless carried over
previous losses and depreciaLion noL provided in previous
year are seL oll aqainsL prolL ol Lhe company ol Lhe
currenL year. 1he loss or depreciaLion, whichever is
less, in previous years is seL oll aqainsL Lhe prolL ol Lhe
company lor Lhe year lor which dividend is declared or
paid.
From Lhe lrsL condiLion, iL appears LhaL a company havinq
hisLory ol dividend can declare maximum dividend upLo pasL
Lhree years' averaqe. However, Lhere is no limiLaLion lor
companies noL havinq dividend payouL hisLory.
Under the 195 Act, the rules relating to dividend declaration
out oI reserves applied to declaring oI dividends out oI
reserves but did not apply Ior declaring dividend out oI
accumulated past years' proht lying in the P&L surplus. The
Dividend Pules issued under the 2013 Act indicate that
restrictions under the rules may apply even Ior declaring
dividend out oI opening P&L surplus. Does it mean that
a company can no longer Ireely declare dividend Irom
accumulated past year prohts lying in the P&L surplus?
1here seems Lo be some conlusion on Lhis maLLer. WhilsL Lhe
2013 AcL allows declarinq boLh inLerim and lnal dividend ouL
ol previous years' accumulaLed prolL, Lhe lanquaqe used in Lhe
Dividend Rules indicaLe LhaL such declaraLion will be sub|ecL Lo
condiLions laid down in Lhe Dividend Rules.
One view is LhaL Lhe 2013 AcL allows lree disLribuLion ol
dividend ouL ol pasL year accumulaLed prolLs and Lhe Dividend
Rules cannoL override Lhis posiLion. Hence, Lhe resLricLions
prescribed in Lhe Dividend Rules do noL impacL declaraLion ol
dividend ouL ol accumulaLed P&L surplus balance.
1he second view is LhaL Lhe 2013 AcL and Dividend Rules
should be read harmoniously. 1he Dividend Rules do noL
override/ chanqe Lhe provision ol Lhe 2013 AcL; raLher, Lhey
only prescribe Lopup condiLion. Moreover, in Lhe 2013 AcL, Lhe
delniLion ol Lhe Lerm "lree reserves," includes previous years'
accumulaLed prolL. Hence, qoinq lorward, companies will need
Lo comply wiLh Lhe Dividend Rules lor declarinq dividend lrom
previous years' accumulaLed prolLs.
We believe LhaL Lhe MCA did noL inLend Lo make requiremenLs
concerninq declaraLion ol dividend ouL ol surplus sLricLer under
Lhe 2013 AcL visvis Lhose under Lhe 1956 AcL. 1he lanquaqe
used in secLion 123 suqqesLs Lhis. Hence, view 1 appears
Lo be prelerred approach. However, one may noL rule ouL
possibiliLy ol dillerenL view. 1o avoid any poLenLial challenqes,
Lhe MCA should provide clarilcaLion on Lhis maLLer. UnLil such
clarilcaLion is provided, we suqqesL LhaL a company proposinq
Lo declare dividend ouL ol P&L surplus balance consulLs Lhe
leqal prolessionals.
Unlike the 195 Act, the 2013 Act does not contain provision
Ior ad|ustment oI past losses beIore declaring dividend Irom
the current year proht. Does it mean that a company may
declare dividend Irom current year proht without ad|usting
past losses?
WhilsL Lhe 2013 AcL does noL conLain provision requirinq
ad|usLmenL ol pasL losses/depreciaLion belore declarinq
dividend lrom Lhe currenL year prolL, similar provision is
conLained in Lhe lnal Dividend Rules. 1he rule reads as below:
"No company shall declare dividend unless carried over
previous losses and depreciaLion noL provided in previous
year are seL oll aqainsL prolL ol Lhe company ol Lhe
currenL year. 1he loss or depreciaLion, whichever is less, in
previous years is seL oll aqainsL Lhe prolL ol Lhe company
lor Lhe year lor which dividend is declared or paid."
1he above paraqraph should be Lypically appearinq as an
independenL rule. However, currenLly, iL is mixed wiLh Lhe
declaraLion ol dividend ouL ol reserve requiremenLs.
How does the option given in the 5chedule II to use higher
useIul liIe interact with the dividend related provisions oI
the 2013 Act? Assuming that an asset has A5 useIul liIe
which is much longer than the liIe prescribed in 5chedule II. In
accordance with the proviso recently added in the 5chedule II,
a company elects to depreciate the asset over its A5 useIul
liIe. For the purposes oI calculating proht Ior declaration
oI dividend, is the company required to charge additional
depreciation to comply with 5chedule II liIe?
SecLion 123(1) and (2) ol Lhe 2013 AcL require LhaL lor Lhe
purpose ol declarinq dividend, prolL should be calculaLed
in accordance wiLh Lhe provisions ol Schedule ll. Since Lhe
Schedule ll iLsell allows Lhe company Lo charqe depreciaLion
based on AS 6 uselul lile, we believe LhaL Lhere is no need Lo
charqe addiLional depreciaLion Lo comply wiLh Schedule ll lile
lor Lhe purpose ol calculaLinq prolL lor declaraLion ol dividend.
Section 123 of the 2013 Act dealing with declaration of
dividend is applicable Irom 1 April 2014. The Dividend
Pules also apply Irom the same date. Does it mean that
dividend declared on or aIter 1 April 2014 is governed by the
requirements oI the 2013 Act? Alternatively, can a company
take a view that Ceneral Circular No 8/2014 applies and
thereIore the 2013 Act will apply Ior declaring dividend in
respect oI hnancial years beginning on or aIter 1 April 2014?
Ceneral Circular 8/201^ is relevanL only lor preparaLion
ol lnancial sLaLemenLs, board reporL and audiLors' reporL.
DeclaraLion ol dividend does noL lall under any ol Lhe Lhree
iLems. Hence, Lhe Ceneral Circular is noL relevanL in Lhis case.
SecLion 123 ol Lhe 2013 AcL applies Lo dividends declared
on or alLer 1 April 201^. Hence, iL may be arqued LhaL any
dividend declared by a company on or alLer 1 April 201^ is
qoverned by Lhe requiremenLs ol Lhe 2013 AcL. 1he accepLance
ol Lhis view, amonq oLher maLLers, implies LhaL a company
declarinq dividend on or alLer 1 April 201^ will noL be required
Lo Lransler any prolLs Lo reserves.
WhilsL Lhe above view seems appropriaLe lrom dividend
disLribuLion perspecLive; Lhere is conlusion reqardinq iLs
inLeracLion wiLh provision relaLed Lo lnancial sLaLemenLs.
SecLion 123 also requires LhaL even prolL lor Lhe concerned
year should be deLermined as per Lhe 2013 AcL. However, Lhis
may noL be permiLLed under Ceneral Circular 8/201^ which
sLaLes LhaL lnancial sLaLemenLs lor lnancial year beqinninq
earlier Lhan 1 April 201^ are prepared as per Lhe requiremenLs
ol Lhe 1956 AcL. Please reler "DepreciaLion" secLion ol Lhe
publication for discussion on the issue related to charging
ol depreciaLion in Lhe lnancial sLaLemenLs lor lnancial year
beqinninq prior Lo 1 April 201^ and iLs inLeracLion wiLh dividend
declaraLion requiremenLs.
1he MCA/lCAl should provide appropriaLe quidance on Lhis
maLLer. UnLil such quidance is provided, a company may need Lo
consulL iLs leqal prolessionals on how Lo deal wiLh Lhis issue.
Utilization of securities premium
Under Lhe 2013 AcL, companies covered under Lhe prescribed
class will noL be allowed Lo use Lhe securiLies premium lor Lhe
lollowinq key purposes:
(i) lssue ol lully paid prelerence shares as bonus shares
(ii) WriLinq oll preliminary expenses ol Lhe company
(iii) Writing off debentures and preference share issue
expenses
(iv) Providinq lor premium payable on redempLion ol
prelerence shares/debenLures
lL is undersLood LhaL Lhe CenLral CovernmenL inLroduced Lhese
resLricLion over Lhe use ol securiLies premium Lo aliqn Lhe
accounLinq requiremenL wiLh lndAS. Since lndAS are currenLly
noL noLiled, Lhe rules do noL delne companies which will be
covered under Lhe prescribed class. 1his implies LhaL currenLly,
Lhere will be no company covered under Lhe prescribed class
and Lhe above resLricLions will noL apply.
lL may be noLed LhaL Lhe lCAl has recenLly proposed a new
roadmap lor implemenLaLion ol lndAS in lndia and submiLLed
iL Lo Lhe MCA lor iLs consideraLion. 1he roadmap recommends
preparaLion ol lndAS accounLs only aL Lhe CFS level. lL seems
LhaL even companies, which are covered under Lhe eliqibiliLy
criLeria lor preparaLion ol lndAS CFS, will conLinue preparinq
SFS in accordance wiLh lndian CAAP. A perusal ol Lhe secLion
indicaLes LhaL lor Lhese companies, resLricLions on uLilizaLion
ol securiLies may apply in boLh Lhe lndian CAAP SFS and lnd
AS CFS. We believe LhaL Lhe MCA may lurLher clarily while
prescribinq companies Lo whom lndAS and Lhe resLricLions on
uLilizaLion ol securiLies premium will apply.
Free reserves
ln accordance wiLh Lhe 2013 AcL, Lhe Lerm "lree reserves"
means "such reserves which, as per Lhe laLesL audiLed balance
sheeL ol a company, are available lor disLribuLion as dividend:
Provided LhaL
Any amounL represenLinq unrealized qains, noLional qains
or revaluaLion ol asseLs, wheLher shown as a reserve or
otherwise, or
Any chanqe in carryinq amounL ol an asseL or ol a
liabiliLy recoqnized in equiLy, includinq surplus in P&L on
measuremenL ol Lhe asseL or Lhe liabiliLy aL lair value,
Shall noL be LreaLed as lree reserves."
1he delniLion ol Lhe Lerm "lree reserves" appears Lo be
based on Lhe principle LhaL a company should noL include
unrealized qains; buL unrealized losses are included lor
compuLinq lree reserves.
One common example ol reserve which may Lypically
qeL excluded is revaluaLion reserve creaLed on upward
revaluaLion ol lxed asseLs. Similarly, a company, which is
applyinq hedqe accounLinq principles ol AS 30, will exclude
hedqinq reserve lrom Lhe "lree reserves" il Lhe hedqinq
reserve has a posiLive (crediL) balance. ll Lhe hedqinq
reserve has a neqaLive (debiL) balance, iL will be deducLed
lrom lree reserves. An issue is likely Lo arise when Lhe
aqqreqaLe hedqinq reserve is posiLive, buL iL includes iLems
wiLh neqaLive and posiLive balances. ln Lhis case, should
Lhe company exclude only neL posiLive amounL lrom Lhe
hedqinq reserve? Or should iL include losses and exclude
prolLs aL each individual insLrumenL level? No clear
quidance is available on Lhis issue. ln Lhe absence ol clear
quidance, iL appears LhaL a company may elecL Lo lollow
eiLher approach on Lhis maLLer.
1he manner in which Lhe Lerm "lree reserves" is delned,
parLicularly iLs proviso (a), suqqesLs LhaL unrealized qains,
wheLher shown as reserves or crediLed Lo P&L, are noL
lree reserves. 1hus, il a company has recoqnized loreiqn
exchanqe qains on LranslaLion ol receivable, payables or
loans in accordance wiLh AS11 or recoqnized markLo
markeL qains on derivaLive conLracLs in accordance wiLh
AS30, such qains are noL LreaLed as lree reserves. A
company includes Lhese amounLs in lree reserves upon
realizaLion, e.q., when receivable is realized or derivaLive
is seLLled. lnLeresLinqly, any unrealized losses on Lhe same
will be LreaLed as a reducLion ol Lhe lree reserves.
1he applicaLion ol Lhis principle is likely Lo creaLe some
pracLical challenqes. 1rackinq Lhe unrealized qains and iLs
subsequenL realizaLion on an individual iLem basis will be a
very cumbersome exercise.
lL may be noLed LhaL Lhe Lerm 'lree reserves' do noL include
securiLies premium. However Lhe Lerm 'neL worLh' will
include securiLies premium. lL is imporLanL Lo undersLand
Lhese lne nuances because Lhese Lerms are lrequenLly
used in Lhe 2013 AcL; lor example, wiLh respecL Lo limiLs on
loans and invesLmenLs.
Debenture redemption reserve
SecLion 71(^) ol Lhe 2013 AcL requires LhaL where debenLures
are issued by a company under Lhis secLion, Lhe company
will creaLe a DRR accounL ouL ol Lhe prolLs ol Lhe company
available lor paymenL ol dividend and Lhe amounL crediLed Lo
such accounL will noL be uLilised by Lhe company excepL lor Lhe
redempLion ol debenLures.
1he SCD Rules conLain Lhe lollowinq provision reqardinq
creaLion ol DRR:
DRR is creaLed ouL ol Lhe prolLs ol Lhe company available
lor paymenL ol dividend.
1he company needs Lo creaLe DRR equivalenL Lo aLleasL
507 ol Lhe amounL raised Lhrouqh Lhe debenLure issue
belore debenLure redempLion commences.
Lvery company required Lo creaLe DRR needs Lo invesL/
deposiL a sum, which will noL be less Lhan 157 ol Lhe
amounL ol debenLures maLurinq durinq Lhe lollowinq year,
in speciled deposiLs/securiLies.
ln case ol parLly converLible debenLures, DRR will be
creaLed in respecL ol nonconverLible porLion ol debenLure
issue.
1he amounL crediLed Lo DRR will noL be uLilised by Lhe
company oLher Lhan lor Lhe purpose ol redempLion ol
debenLures.
SecLion 2(30) ol Lhe 2013 AcL delnes debenLure as
"debenLure" includes "debenLure sLock, bonds or any other
instrument of a company evidencing a debt, whether
consLiLuLinq a charqe on Lhe asseLs ol Lhe company or noL"
(emphasis added). SecLion 2(12) ol Lhe 1956 AcL delned
debenLure as "debenLure" includes "debenLure sLock, bonds
and any other securities of a company, whether constituting a
charqe on Lhe asseLs ol Lhe company or noL" (emphasis added).
1here seems Lo be an arqumenL LhaL Lhe word "insLrumenL"
used in Lhe 2013 AcL has a wider meaninq Lhan Lhe word
"securiLy" used in Lhe 1956 AcL. 1hus, Lhe delniLion under Lhe
2013 AcL may include several insLrumenLs, e.q., commercial
paper and promissory noLe evidencinq debL, as debenLure,
beyond our normal undersLandinq ol a debenLure. 1his is
particularly onerous, if one considers it together with the
requiremenL Lo creaLe a DRR on all such insLrumenLs.
Table 2: Minimum DPP required Ior debentures
Class oI company
195 Act
2013 Act
Public issue Private placement
All lndia Financial lnsLiLuLions requlaLed by Reserve
Bank ol lndia and Bankinq Companies
Nil Nil 507
NBFCs and oLher lnancial insLiLuLions 257 Nil 507
OLher companies includinq manulacLurinq and
inlrasLrucLure companies
257 257 507
NonlisLed companies NA 257 507
Under Lhe 1956 AcL, Lhreshold lor minimum DRR varied dependinq on Lhe class ol companies. 1hese Lhresholds were lower Lhan
Lhose prescribed under Lhe 2013 AcL. 1able 2 describes minimum DRR required lor debenLures.
The applicability oI the 2013 Act requires higher DPP to be
created visvis that required under the 195 Act. How does
it impact the creation oI DPP Ior debentures issued prior to
the commencement oI the 2013 Act?
1he lanquaqe used in secLion 71(^) suqqesLs LhaL iL deals only
wiLh creaLion ol DRR lor debenLures issued under secLion
71, i.e., any new debenLure issued on or alLer 1 April 201^.
For debenLures issued belore 1 April 201^, Lhe requiremenLs
ol Lhe 1956 AcL conLinues Lo apply. LeL us assume LhaL a
manulacLurinq company has issued Lwo Lranches ol non
converLible debenLures. 1he lrsL Lranche was issued on
28 March 201^ and Lhe nexL Lranche on ^ April 201^. 1he
creaLion ol DRR on Lhe lrsL Lranche is qoverned by Lhe 1956
AcL and Lhe company needs Lo creaLe a minimum DRR ol 257.
1he creaLion ol DRR on Lhe second Lranche is qoverned by Lhe
2013 AcL and Lhe company needs Lo creaLe minimum DRR ol
507 on Lhe second Lranche.
The 5CD Pules state that in case oI partly convertible
debentures, DPP will be created in respect oI nonconvertible
portion oI debenture issue. However, there is no such clarity
Ior FCDs. Does it mean that minimum 507 DPP needs to be
created on the amounts raised through issuance oI FCDs?
1he loqical answer is LhaL no DRR is required Lo be creaLed.
However, in Lhe absence ol any exempLion under Lhe 2013
AcL/SCD lrom creaLion ol DRR lor FCDs, some arque LhaL a
minimum 507 DRR needs Lo be creaLed on Lhe enLire amounL
ol FCD. However, Lhe accepLance ol Lhis arqumenL may qive
ouLraqeous resulLs. LeL us assume LhaL a company has issued
parLly converLible debenLures, where 997 ol Lhe debenLures
have conversion opLion. ln Lhis case, DRR needs Lo be creaLed
only lor 17 nonconverLible porLion. However, il all Lhe
debenLures were havinq conversion opLion, Lhe company will
need Lo creaLe a minimum 507 DRR. 1his obviously cannoL be
Lhe inLenLion ol Lhe law. 1he MCA should provide clarilcaLion
on Lhis maLLer.
Peopening/revision oI accounts
1he 2013 AcL conLains separaLe provisions relaLinq Lo:
Reopeninq ol accounLs on Lhe courL/Lribunal's order
VolunLary revision ol lnancial sLaLemenLs or board's reporL
Re-opening of accounts on the court/tribunals order
On an applicaLion made by Lhe CenLral CovernmenL, Lhe
lncomeLax auLhoriLies, Lhe SLBl, any oLher sLaLuLory/requlaLory
body or any person concerned, Lhe Lribunal/courL may pass an
order Lo Lhe ellecL LhaL:
(i) 1he relevanL earlier accounLs were prepared in a
lraudulenL manner, or
(ii) 1he allairs ol Lhe company were mismanaqed durinq
Lhe relevanL period, casLinq a doubL on Lhe reliabiliLy ol
lnancial sLaLemenLs
ll Lhe Lribunal/courL issues Lhe above order, a company will
need Lo reopen iLs books ol accounL and recasL iLs lnancial
sLaLemenLs.
Voluntary revision of hnancial statements or board's report
ll iL appears Lo direcLors LhaL lnancial sLaLemenLs/board's
reporL do noL comply wiLh Lhe relevanL requiremenLs ol Lhe
2013 AcL, Lhe company may revise lnancial sLaLemenLs/board
reporL in respecL ol any ol Lhe Lhree precedinq lnancial years.
For revision, a company will need Lo obLain prior approval ol Lhe
Lribunal.
1he 1ribunal, belore passinq Lhe order lor revision, will
qive noLice Lo Lhe CenLral CovernmenL and Lhe lncomeLax
auLhoriLies and consider Lheir represenLaLions, il any.
DeLailed reasons lor revision ol such lnancial sLaLemenL/
board's reporL will be disclosed in Lhe board's reporL lor Lhe
relevanL lnancial year in which such revision is beinq made.
1he provisions ol Lhe 2013 AcL concerninq reopeninq/revision
ol accounLs are yeL Lo be noLiled. 1he MCA has issued Lhe dralL
rules concerninq Lhese provisions. However, Lhe lnal rules on
Lhis sub|ecL are sLill awaiLed. 1he daLe lrom which Lhe provisions
ol Lhe 2013 AcL concerninq reopeninq/revision ol accounLs
apply is unknown.
Reopeninq ol accounLs wheLher volunLarily or mandaLorily is
noL an easy process. 1he dralL rules had prescribed several
onerous sLeps which need Lo be compleLed lor revision. Also,
Lhere are cerLain issues which are noL clear. Civen below is an
overview ol key aspecLs which may need Lo be considered:
ll Lhe presenL audiLor is dillerenL lrom Lhe audiLor who
audiLed oriqinal lnancial sLaLemenLs, Lhe currenL audiLor
is required Lo audiL and reporL on Lhe revised lnancial
sLaLemenLs. However, belore such revision, Lhe views ol Lhe
oriqinal audiLor also need Lo be obLained and considered.
Belore Lhe board approves any revision ol lnancial
sLaLemenLs or board reporL, Lhe proposed revision is Lo be
presented to the directors who authenticated the original
lnancial sLaLemenLs/board reporL. DissenL and dissenL
voLe, il any, aL Lhe board meeLinq, on such revision should
be recorded wiLh reasons in Lhe minuLes ol Lhe board
meeLinq.
ll a company revises iLs lnancial sLaLemenLs lor a period
earlier Lhan Lhe immediaLely precedinq lnancial year, iL is
mandaLory Lo revise lnancial sLaLemenLs lor all subsequenL
periods. However, iL is noL clear wheLher Lhe revision ol
SFS will also Lriqqer Lhe revision ol CFS.
Many merqer, amalqamaLion and reconsLrucLion schemes
approved by Lhe courL conLain an appoinLed daLe which is
earlier Lhan Lhe beqinninq ol Lhe currenL lnancial year. lL
is noL clear wheLher a company will be required/allowed Lo
revise iLs lnancial sLaLemenLs lor earlier periods Lo qive
ellecL Lo Lhe courL scheme lrom Lhe appoinLed daLe.
ln case ol a volunLary chanqe in accounLinq policy, error
and reclassilcaLion, lndAS requires LhaL comparaLive
amounL appearinq in Lhe currenL period lnancial
sLaLemenLs should be resLaLed. One may arque LhaL Lhis
LanLamounLs Lo volunLary revision ol lnancial sLaLemenLs
lor earlier periods. While Lhe 2013 AcL allows revision ol
previous period lnancial sLaLemenLs Lo correcL an error,
iL is noL clear wheLher a company is also allowed Lo revise
lnancial sLaLemenLs in oLher cases, say, Lo apply chanqe in
accounLinq policy wiLh reLrospecLive ellecL.
We expecL LhaL Lhe MCA may clarily Lhese issues in Lhe lnal
rules.
Appointment of auditors
Civen below is an overview ol key chanqes inLroduced by Lhe
AudiL Rules, concerninq audiLor appoinLmenL visvis Lhe dralL
rules:
Like Lhe dralL rules, Lhe AudiL rules also require Lhe AudiL
CommiLLee Lo recommend audiLors lor appoinLmenL.
The draft rules required that if the board does not agree
wiLh Lhe AudiL CommiLLee recommendaLion and decides
Lo evenLually propose iLs own nominee aL Lhe ACM, Lhe
board will explain Lhe reasons lor noL accepLinq Lhe AudiL
CommiLLee recommendaLion in Lhe board reporL. lL was
expecLed LhaL Lo avoid such disclosures, Lhere will be
pressure on Lhe board Lo accepL Lhe AudiL CommiLLee
recommendaLion.
ln Lhe AudiL Rules, Lhe lanquaqe has chanqed and
it is stated that the board will record reasons for its
disaqreemenL wiLh Lhe AudiL CommiLLee and send iLs own
recommendaLion Lo Lhe ACM. 1houqh Lhe AudiL Rules
do noL specilcally require disclosure in Lhe board reporL,
secLion 177(8) ol Lhe 2013 AcL requires LhaL il Lhe board
has noL accepLed any recommendaLion ol Lhe AudiL
CommiLLee, Lhe same will be disclosed in Lhe board reporL
wiLh reasons. Hence, Lhe posiLion as menLioned in Lhe dralL
rules will conLinue.
1he dralL rules required LhaL belore recommendinq
Audit and auditors
appoinLmenL, Lhe AudiL CommiLLee or Lhe Board, as Lhe
case may be, will consider Lhe compleLed and pendinq
proceedinqs aqainsL Lhe proposed audiLor belore Lhe lCAl
or Lhe NFRA or 1ribunal or any CourL ol law. Hence, one
inLerpreLaLion was LhaL Lhe board/AudiL CommiLLee need
Lo consider any compleLed/pendinq proceedinqs, includinq
maLLers noL relaLed Lo prolessional conducL, aqainsL Lhe
audiLor.
ln Lhe AudiL Rules, iL has been clariled LhaL Lhe AudiL
CommiLLee or Lhe Board, as Lhe case may be, needs Lo
consider only order or pending proceeding relating to
prolessional maLLers ol conducL aqainsL Lhe proposed
audiLor. ln our view, Lhis chanqe represenLs a siqnilcanL
improvemenL visvis Lhe dralL rules.
1o help Lhe audiL commiLLee/board evaluaLe pendinq
proceedinqs aqainsL Lhe proposed audiLor, Lhe AudiL Rules
require Lhe proposed audiLor Lo submiL a lisL ol proceedinqs
aqainsL Lhe audiLor or audiL lrm or any parLner ol Lhe lrm
wiLh respecL Lo prolessional maLLers ol conducL.
Under Lhe 2013 AcL, an audiLor is appoinLed lor a Lerm
ol 5 years. However, Lhe appoinLmenL needs Lo be raLiled
each year aL Lhe ACM. 1he AudiL Rules clarily LhaL "il
Lhe appoinLmenL is noL raLiled by Lhe members ol Lhe
company, Lhe board ol direcLors shall appoinL anoLher
individual or lrm as iLs audiLor or audiLors alLer lollowinq
Lhe procedure laid down in Lhis behall under Lhe AcL."
In accordance with the Audit Pules, the board/audit
committee need to consider order/pending proceeding
relating to matters of professional conduct against the
proposed auditor. Does it mean that the board/audit
committee cannot recommend such person for appointment
as auditor?
ALLenLion is drawn Lo secLion 1^1 ol Lhe 2013 AcL dealinq wiLh
eliqibiliLy, qualilcaLions and disqualilcaLions ol Lhe audiLor.
lLs clause (3)(h) sLaLes LhaL a person, who has been convicLed
by a courL ol an ollence involvinq lraud and a period ol Len
years has noL elapsed lrom Lhe daLe ol such convicLion, is
noL eliqible lor appoinLmenL as audiLor. 1he secLion does noL
reler Lo "order/pendinq proceedinq relaLinq Lo maLLers ol
prolessional conducL" as a criLerion lor disqualilcaLion. ln
oLher words, disqualilcaLion is Lriqqered only on conclusion ol
Lhe proceedinqs and il Lhe person is convicLed lor an ollence
involvinq lraud, and noL belore such convicLion.
Hence, mere order/pendinq proceedinqs aqainsL Lhe proposed
audiLor do noL necessarily disqualily Lhe person lrom beinq
appoinLed as audiLor. 1he board/audiL commiLLee, upon
consideraLion ol Lhe maLLers, may sLill decide Lo recommend Lhe
person/lrm lor appoinLmenL as audiLor.
We believe LhaL Lhe punishmenL accorded Lo Lhe audiLor by Lhe
lCAl/CourL/CompeLenL AuLhoriLy should, in iLsell, be considered
sullcienL remedy lor Lhe wronqlul acL or omission and should
noL lead Lo addiLional punishmenL ol nonappoinLmenL as
audiLor.
The Audit Rules state that if the appointment of auditor is
not ratihed by the members, the board will appoint another
individual/hrm as its auditor(s) aIter Iollowing the procedure
laid down in the 2013 Act. In the case oI nonratihcation,
will the board be required to Iollow the procedures only Ior
appointment of auditor or will it follow the procedures relating
to removal as well as appointment oI auditor?
From a perusal ol Lhe explanaLion qiven in Lhe AudiL Rules, Lwo
views seem possible. 1he lrsL view is LhaL il Lhe appoinLmenL
ol audiLor is noL raLiled aL Lhe ACM, Lhe board needs Lo lollow
only Lhe procedure reqardinq appoinLmenL ol audiLor lor
appoinLinq a new audiLor. 1he conLrary view is LhaL Lhe board
should lollow boLh Lhe procedures, viz., procedures relaLinq
Lo removal ol audiLor as well as appoinLmenL ol new audiLor.
ParLicularly, Lhe procedure lor removal ol audiLor will require
Lhe CenLral CovernmenL approval and special resoluLion aL Lhe
qeneral meeLinq, since Lhe audiLor has been removed belore
compleLion ol a lve year Lerm.
1he MCA should provide clariLy on Lhis maLLer. UnLil such
quidance or clarilcaLion is provided, our prelerred view is LhaL
Lhe board should lollow boLh Lhe procedures, viz., procedures
relaLinq Lo removal ol audiLor as well as appoinLmenL ol new
audiLor.
Assume that a person/hrm, previously appointed as auditor,
incurs any oI the disqualiIying conditions mentioned in the
2013 Act. In such a case, what is the procedure to be Iollowed
Ior appointment oI new auditor? Is the company also required
to Iollow the procedures relating to removal oI auditor as
prescribed in the 2013 Act?
SecLion 1^1(^) ol Lhe 2013 AcL sLaLes as below:
"Where a person appoinLed as an audiLor ol a company
incurs any ol Lhe disqualilcaLions menLioned in sub
secLion (3) alLer his appoinLmenL, he shall vacaLe
his ollce as such audiLor and such vacaLion shall be
deemed Lo be a casual vacancy in Lhe ollce ol Lhe
audiLor."
SecLion 139(8) ol Lhe AcL sLaLes as below:
"Any casual vacancy in Lhe ollce ol an audiLor shall:
(i) ln Lhe case ol a company oLher Lhan a company
whose accounts are subject to audit by an auditor
appoinLed by Lhe CompLroller and AudiLorCeneral
ol lndia, be llled by Lhe Board ol DirecLors wiLhin
LhirLy days, buL il such casual vacancy is as a resulL
ol Lhe resiqnaLion ol an audiLor, such appoinLmenL
shall also be approved by Lhe company aL a
qeneral meeLinq convened wiLhin Lhree monLhs
ol Lhe recommendaLion ol Lhe Board and he
shall hold Lhe ollce Lill Lhe conclusion ol Lhe nexL
annual qeneral meeLinq ."
We believe LhaL a company is noL required Lo lollow Lhe
procedures relaLinq Lo removal ol audiLor in cases where
an audiLor has Lo vacaLe iLs ollce due Lo incurrence ol any
disqualilyinq condiLion under Lhe 2013 AcL. Such vacaLion is
LreaLed as casual vacancy which can be llled by Lhe board ol
direcLors wiLhin 30 days. lL may be noLed LhaL Lhe audiLor so
appoinLed holds ollce only Lill Lhe conclusion ol Lhe nexL ACM.
Sub|ecL Lo compliance wiLh oLher requiremenLs ol Lhe 2013
AcL, Lhe ACM can reappoinL Lhe same audiLor lor a block ol lve
years.
Rotation of auditors
ln accordance wiLh Lhe 2013 AcL, lisLed companies and
companies belonqinq Lo Lhe prescribed class cannoL appoinL
or reappoinL Lhe audiLor lor: (a) More Lhan Lwo Lerms ol lve
consecuLive years, il Lhe audiLor is an audiL lrm; (b) More
Lhan one Lerm ol lve consecuLive years il Lhe audiLor is an
individual. Under Lhe dralL rules, Lhe prescribed class included
all companies excludinq oneperson companies and small
companies. 1his is chanqed in Lhe AudiL Rules. Under Lhe
AudiL Rules, audiLor roLaLion applies Lo Lhe lollowinq classes
ol companies excludinq one person companies and small
companies:
All lisLed companies
All nonlisLed public companies havinq eiLher (i) paidup
share capital of `10 crore or more, or (ii) public borrowinqs
lrom lnancial insLiLuLions, banks or public deposiLs ol `50
crores or more
All privaLe limiLed companies havinq eiLher (i) paidup
share capital of `20 crore or more, or (ii) public borrowinqs
lrom lnancial insLiLuLions, banks or public deposiLs ol `50
crores or more
1he audiLor, who has compleLed his Lerm, will noL be eliqible lor
reappoinLmenL as audiLor in Lhe same company lor lve years
lrom compleLion ol Lhe Lerm. 1he same resLricLion applies Lo Lhe
audiL lrm which has common parLner(s) wiLh Lhe ouLqoinq audiL
lrm aL Lhe Lime ol appoinLmenL.
lncominq audiLor/audiL lrm is also noL eliqible lor appoinLmenL
il Lhey are parL ol Lhe same neLwork as Lhe ouLqoinq audiLor.
ln simple words, Lhe audiLor has Lo be roLaLed ouLside Lhe
neLwork lrm and noL wiLhin Lhe neLwork lrm. 1he Lerm "same
neLwork" has been explained Lo include Lhe lrms operaLinq or
luncLioninq, hiLherLo or in luLure, under Lhe same brand name,
Lrade name or common conLrol.
ll a parLner in Lhe ouLqoinq audiL lrm, who is in charqe ol Lhe
lrm and also cerLiles lnancial sLaLemenLs ol Lhe company,
reLires lrom Lhe said lrm and |oins anoLher lrm ol charLered
accounLanLs, such oLher lrm will also noL be eliqible Lo be
appoinLed as audiLor lor a period ol lve years.
Transitional requirements
Like Lhe dralL rules, Lhe AudiL Rules are clear LhaL holdinq ol
Lhe ollce by Lhe audiLor prior Lo Lhe commencemenL ol Lhe
2013 AcL will be included Lo deLermine Lhe Lime ol roLaLion. ln
oLher words, roLaLion applies reLrospecLively. ln deLermininq
Lhe Lime ol roLaLion, service period also includes period served
by neLwork lrms. For example, lrm A audiLed ClienL X lor Lhe
lrsL lour years. 1herealLer, iL moved Lo lrm B which is Lhe lrm
under Lhe same neLwork. Hence, service period compleLed
by lrm A and lrm B will be included Lo deLermine Lhe Lime ol
roLaLion.
EIIective date
SecLion 139 (2) ol Lhe 2013 AcL dealinq wiLh audiLor roLaLion
is applicable lrom 1 April 201^. 1he AudiL Rules also apply
lrom Lhe same daLe. One ol Lhe provisos Lo secLion 139(2)
ol Lhe 2013 AcL sLaLes LhaL exisLinq companies, which are
covered under audiLor roLaLion requiremenL, should comply
wiLh Lhose requiremenLs wiLhin Lhree years lrom Lhe daLe ol
commencemenL ol Lhe 2013 AcL. SecLion 1(3) ol Lhe 2013 AcL
sLaLes LhaL dillerenL daLes may be appoinLed lor brinqinq inLo
lorce dillerenL provisions ol Lhe 2013 AcL and any relerence
in any provision Lo Lhe commencemenL ol Lhe 2013 AcL will
be consLrued as a relerence Lo Lhe cominq inLo lorce ol LhaL
provision. Hence Lhe Lhree year period in Lhis reqard sLarLs lrom
1 April 201^. lllusLraLion 2 qiven in paraqraph 6(3) ol Lhe AudiL
Rules also conlrm Lhis poinL. One headinq in Lhe illusLraLion
indicaLes LhaL Lhree years counLdown sLarLs lrom Lhe ACM held
alLer Lhe commencemenL ol secLion 139(2), i.e., lrom Lhe lrsL
ACM held on or alLer 1 April 201^.
WhilsL audiLor roLaLion improves independence, iL also increases
audiL cosL, imposes excessive burden on companies, increases
Lhe risk LhaL new audiLors may noL be able Lo deLecL errors and
lrauds, and does liLLle Lo enhance Lhe audiL qualiLy. Clobally,
in counLries where audiLor roLaLion is mandaLed, e.q., lLaly,
NeLherlands and Brazil, iL is applicable eiLher only Lo lisLed
entities, or to listed entities and public interest entities, such as,
banks and insurance companies. ln none ol Lhese qeoqraphies,
audiLor roLaLion is applicable Lo privaLe companies or Lo non
lisLed public companies. 1he MCA has qenerally been very
consideraLe in addressinq pracLical challenqes. We believe
LhaL iL will lollow a similar approach in relaxinq Lhe roLaLion
requiremenLs in Lhe AudiL Rules by usinq Lhe removal ol
dillculLies secLion and address Lhe qenuine issues laced by Lhe
indusLry and audiL prolession.
For deciding auditor rotation, will paid up share capital include
nonconvertible preIerence shares also?
For audiLor roLaLion, paidup share capiLal includes paidup
equiLy share capiLal and paidup prelerence share capiLal,
wheLher converLible or noL. Also, iL appears LhaL paidup share
capiLal includes only amounL received Loward lace value ol
shares. AmounL received Loward securiLies premium is noL
included in Lhe paidup share capiLal. Also, Lhe share applicaLion
money pendinq alloLmenL is noL included in Lhe paidup share
capiLal. Please also reler discussion on similar issue under Lhe
head "Woman direcLor."
Under section 2(71) oI the 2013 Act, a private company is
deemed to be a public company iI it is subsidiary oI another
company, which is not a private company. In simple terms,
a private company, which is a subsidiary oI public company,
is deemed a public company. For auditor rotation, whether a
deemed public company is governed by the criteria applicable
to a private company or public company?
1he proviso Lo secLion 2(71) sLaLes LhaL "a company which is a
subsidiary ol a company, noL beinq a privaLe company, shall be
deemed Lo be public company lor Lhe purposes ol Lhis AcL." 1he
lanquaqe used indicaLes LhaL a company deemed Lo be a public
company is LreaLed aL par wiLh Lhe public company lor applyinq
all Lhe requiremenLs ol Lhe 2013 AcL. Hence, in Lhe qiven case,
Lhe criLeria applicable Lo a public company are relevanL.
Whether an Indian private company, which is subsidiary oI a
Ioreign public company, also needs to apply the criteria Ior
auditor rotation as applicable to a public company?
SecLion 2(20) ol Lhe 2013 AcL delnes Lhe Lerm "company" Lo
mean "a company incorporaLed under Lhe Companies AcL 2013
or any previous company law." Accordinqly, a company, which is
incorporaLed under Lhe relevanL leqislaLion ol a loreiqn counLry,
will noL qualily as a "company" under Lhe 2013 AcL
1he proviso Lo secLion 2(71) sLaLes LhaL "a company which is a
subsidiary ol a company, noL beinq a privaLe company, shall be
deemed Lo be public company lor Lhe purposes ol Lhis AcL."
Under Lhe 1956 AcL, Lhe issue reqardinq companies
incorporaLed ouLside lndia is dealL wiLh under Lhe secLion ^(7).
1he secLion read as below:
"A privaLe company, beinq a subsidiary ol a body
corporaLe incorporaLed ouLside lndia, which, il
incorporaLed in lndia, would be a public company
wiLhin Lhe meaninq ol Lhis AcL, shall be deemed lor
the purposes of this Act to be a subsidiary of a public
company il Lhe enLire share capiLal in LhaL privaLe
company is noL held by LhaL body corporaLe wheLher
alone or LoqeLher wiLh one or more oLher bodies
corporaLe incorporaLed ouLside lndia."
A similar provision does noL exisL under Lhe 2013 AcL. 1his
has resulLed in an ambiquous posiLion wiLh reqard Lo privaLe
companies which are subsidiaries ol loreiqn public companies.
One may arque LhaL a "loreiqn company" is noL a "company"
under Lhe 2013 AcL. Hence, Lhe proviso Lo secLion 2(71)
is noL Lriqqered. Under Lhis view, a privaLe company, which
is subsidiary ol loreiqn company, will always be a privaLe
company.
ApparenLly, Lhe concepL enshrined in secLion ^(7) ol Lhe 1956
is noL conLained in Lhe 2013 AcL. Hence, iL seems more loqical
LhaL under Lhe 2013 AcL, a privaLe company is deemed a
public company only when iL is a subsidiary ol an lndian public
company. 1his issue impacLs noL only Lhe audiLor roLaLion
criLeria, buL also applicabiliLy ol many oLher key provisions ol
Lhe 2013 AcL, e.q., requiremenLs concerninq Woman DirecLor,
lndependenL DirecLors, AudiL CommiLLee and NominaLion &
RemuneraLion CommiLLee. Considerinq wider implicaLions, iL
may be appropriaLe lor Lhe MCA Lo clarily Lhe posiLion.
What is the relevant date Ior assessing whether a company
meets the criteria Ior auditor rotation? What happens iI there
is any change in the threshold Irom yeartoyear?
5cenario 1: Assume that a private company (ABC) had paid up
share capital of `20 crore or more on 1 April 2014. It needs
to rotate its existing auditor who has completed more than 10
years oI service within the next 3 years. During the hnancial
year 20151, ABC reduces its paidup share capital to below
`20 crore. ABC does not have borrowings exceeding `50
crore. Is ABC still required to rotate its existing auditors?
5cenario 2: A private company (XYZ) did not meet any criteria
Ior auditor rotation on 1 April 2014. It, thereIore, appointed
its existing auditor who has completed more than 10 years
oI service Ior another hve yearterm. During the hnancial
year 20151, XYZ increased its paidup share capital to
above `20 crore. Hence, it now meets the auditor rotation
thresholds. Will such requirement apply prospectively or
retrospectively to XYZ?
NeiLher Lhe 2013 AcL nor Lhe AudiL Rules provide any quidance
on approach to be followed if there is a change in the threshold
over Lhe period. 1herelore, mulLiple views may be possible/
accepLable. lL is expecLed LhaL Lhe lCAl/ MCA may provide
quidance on Lhese issues. UnLil such quidance is provided,
possible views and our prelerred approach on Lhese issues are
explained below.
RoLaLion requiremenLs ol Lhe 2013 AcL, read wiLh Lhe AudiL
Rules, apply lrom 1 April 201^. Hence, on Lhe said daLe, a
company needs Lo assess wheLher iL meeLs Lhe prescribed
criLeria. ll so, iL needs Lo prepare iLsell lor Lhe roLaLion as per
Lhe principles explained in Lhe AudiL Rules. For example, il an
audiL lrm has already compleLed 7 or more years ol service, Lhe
company will need Lo roLaLe iLs exisLinq audiLors wiLhin Lhe nexL
3 years.
ln scenario 1, ABC meeLs Lhe roLaLion criLeria aL 1 April, 201^,
buL durinq Lhe LransiLion period ol 3 years lips ouL ol Lhe
roLaLion criLeria. One view is LhaL Lhe roLaLion criLerion is LesLed
aL 1 April 201^, and on LhaL basis, ABC's exisLinq audiLor can
serve as audiLor lor no lonqer Lhan 3 years. 1he second view is
LhaL since ABC is no lonqer a covered company, iL has an opLion
ol eiLher conLinuinq wiLh iLs exisLinq audiLors beyond Lhree
years or appoinLinq new audiLors volunLarily. Since neiLher Lhe
2013 AcL nor Lhe AudiL Rules provide any specilc quidance on
Lhis aspecL, our prelerence is Loward Lhe second view, viz., ABC
seems Lo have a choice in Lhis maLLer.
ln scenario 2, Lhouqh Lhe 2013 AcL or AudiL Rules do noL
provide any specilc quidance, Lhe wordinq used suqqesLs LhaL
Lhe requiremenL applies reLrospecLively and Lhe earlier service
period, i.e., Lhe period when XYZ did noL meeL Lhe prescribed
criLeria, will also be included in Lhe 10 year limiL.
lL appears LhaL Lhe 3 year LransiLion period is applicable only on
lrsL Lime applicabiliLy ol roLaLion requiremenLs aL 1 April 201^.
lL does noL apply in cases where Lhe prescribed Lhreshold is meL
aL a subsequenL daLe. ln such cases, XYZ will need Lo roLaLe Lhe
audiL lrm aL Lhe Lime ol nexL appoinLmenL/reappoinLmenL il
Lhe 10 year service has already been compleLed by Lhe audiL
lrm.
How do the rotation requirements apply in cases where a
company goes through amalgamation/merger/demerger, etc.?
Let us say that ABC Limited is merging into DEF Limited and
DEF is the surviving company. Assume ABC and DEF have
diIIerent audit hrms and that there was no break in service.
1houqh no specilc quidance is available on Lhis parLicular
maLLer, iL appears LhaL roLaLion requiremenLs will be decided
based on Lhe Lransleree/survivinq company. 1his is irrespecLive
ol Lhe size ol Lhe Lwo companies and Lhe name ol Lhe survivinq
company which may or may noL have chanqed. Hence, il DLF
is Lhe survivinq company and ABC's audiLors are appoinLed
as audiLor ol Lhe merqed company, Lhey can be appoinLed lor
Lwo lve year Lerms. On Lhe oLher hand, il DLF is Lhe survivinq
company and iLs audiLors conLinue Lo be Lhe audiLor ol Lhe
merqed company, Lhe period since Lheir oriqinal appoinLmenL
as audiLor ol DLF will be included lor deLermininq Lhe audiLor
roLaLion period.
Will any change in the management/business oI a company
have impact on the auditor rotation period? Let us assume
that at 1 April 2014, an audit hrm is the auditor oI MNC
Limited (listed company) Ior past 15 years. Four years back,
the controlling shareholder oI MNC sold its stake to an
independent third party. Pursuant to this, the management
oI MNC changed completely. In this case, can a view be taken
that the 10 year period should start Irom the date oI change
in the management and not Irom the date on which the hrm
was originally appointed as auditor oI MNC?
AudiLor roLaLion requiremenLs apply visvis Lhe company and
noL iLs manaqemenL/conLrollinq shareholder/business. Hence,
any chanqe in Lhe manaqemenL ol MNO does noL impacL Lhe
audiLor roLaLion period. ln Lhis example, since Lhe audiL lrm has
already compleLed 10 years ol service Lo MNO, iL needs Lo be
roLaLed ouL wiLhin Lhree years LransiLional period.
How do the rotation requirements apply to a company
having, say, calendar yearend or June Yearend? Assume
two scenarios (i) company will Iollow 31 March yearend in
two years, and (ii) it will get exemption to continue with its
existing calendar or June yearend.
AppoinLmenL/reappoinLmenL ol audiLor Lake place aL Lhe ACM
and are valid unLil Lhe conclusion ol Lhe nexL ACM irrespecLive
ol Lhe year end. 1hree/lve years, as relevanL, will be counLed
lrom ACM Lo ACM.
An explanation in the Audit Pules states that "iI a partner,
who is in charge oI an audit hrm and also certihes the
hnancial statements oI the company, retires Irom the said
hrm and |oins another hrm oI chartered accountants, such
other hrm shall also be ineligible to be appointed Ior a period
oI hve years." What is meant by the terms 'person in charge
oI audit hrm' and 'retires'?
1he meaninq ol Lhe phrase 'in charqe ol Lhe audiL lrm' is noL
clear. ln a mulLidisciplinary, mulLilocaLional lrm, iL is noL
clear wheLher Lhe Chiel LxecuLive Ollcer (CLO), Head ol Lhe
AudiL PracLice, parLner incharqe ol Lhe local ollce or Lhe audiL
parLner who is in charqe ol Lhe enqaqemenL, will be considered
as 'in charqe ol Lhe audiL lrm.' 1he lCAl/MCA need Lo provide
quidance on Lhis aspecL.
1he Lerm 'reLires lrom Lhe said lrm', should in our view noL
be read liLerally as someone leavinq Lhe lrm on reachinq his
or her reLiremenL aqe. RaLher, iL should be read more broadly
as someone leavinq Lhe lrm, irrespecLive ol Lhe reason lor
leavinq.
In case oI banking and insurance companies, the rotation
requirements prescribed by PBI/IPDA are diIIerent Irom
those prescribed under the 2013 Act. Particularly, the PBI
and IPDA require two years cooling oII period, instead oI 5
years cooling oII period required under the 2013 Act. This
may raise a potential issue as to how PBI/IPDA requirements
will work visvis auditor rotation requirements under 2013
Act?
lL may be noLed LhaL Lhe requiremenLs ol Lhe 2013 AcL apply
Lo insurance companies and bankinq companies, excepL Lo Lhe
exLenL Lhese provisions are inconsisLenL wiLh Lhe requiremenLs
ol Lhe lnsurance AcL 1938/Lhe lRDA AcL 1999 and Lhe Bankinq
RequlaLion AcL, 19^9, respecLively. 1hese AcLs do noL conLain
specilc requiremenLs reqardinq audiLor roLaLion. RaLher, Lhe
Bankinq RequlaLion AcL specilcally relers Lo audiL by a person
duly qualiled under Lhe Companies AcL. Since, under Lhe 2013
AcL, coolinq oll period ol less Lhan 5 years does noL meeL
eliqibiliLy requiremenL, a poLenLial issue may arise lor bankinq
and insurance companies.
Under Lhe 2013 AcL, an audiL lrm is appoinLed lor Lwo 5 year
Lerms, which is Lhen lollowed by a 5 year coolinq oll period. ln
Lhe case ol RBl, an audiLor is appoinLed lor ^ years, lollowed
by a Lwo year coolinq oll period. 1hus, one may also raise an
issue ol wheLher a 5 year coolinq oll period is relevanL in Lhe
case ol a bank. Similar concern is also relevanL in Lhe case ol an
insurance company. We suqqesL LhaL Lhe MCA, Lhe RBl and Lhe
lRDA should provide an appropriaLe clarilcaLion on Lhe same.
In accordance with the Audit Pules, a break in the term Ior
a continuous period oI hve years is considered as Iulhlling
the requirement oI rotation. In other words, an audit hrm
becomes eligible Ior Iresh appointment only iI there has
been a break in the audit service Ior a continuous period oI
hve years. Is this requirement applicable prospectively or
retrospectively?
Let us assume that a company has changed its auditor two
yearsback. BeIore the change, the audit hrm had audited
the company Ior a continuous period oI more than 10 years.
From the current hnancial year onward, the company desires
to appoint the same audit hrm as its auditor. In this case, will
the previous period oI service be also included to decide the
auditor rotation period?
Consider second example. An audit hrm had previously
audited a company Ior hve continuous years. AIter this, there
was a break in the service oI the audit hrm Ior 3 years. The
same audit hrm was appointed auditor again and is auditing
the company Ior past 3 years. In this case, to decide auditor
rotation period is there a requirement to consider earlier
service period also? Cr will it be suIhcient compliance iI the
auditor rotation period is decided only based on the current
history, ignoring hve year audit services perIormed in the
earlier past?
LxplanaLion ll Lo paraqraph 6(3) ol Lhe AudiL Rules sLaLes as
below:
"For Lhe purpose ol roLaLion ol audiLors:
a) A break in Lhe Lerm lor a conLinuous period ol
lve years shall be considered as lullllinq Lhe
requiremenL ol roLaLion."
ALLenLion is inviLed Lo illusLraLion 2 qiven in paraqraph 6(3)
ol Lhe AudiL Rules. 1he illusLraLion explains Lhe applicaLion
ol LransiLional provision perLaininq Lo roLaLion in Lhe case ol
an audiL lrm. 1he illusLraLion, amonq oLher maLLers, qives
(i) number ol consecuLive years lor which an audiL lrm has
been luncLioninq as audiLor in Lhe company, and (ii) maximum
number ol consecuLive years lor which Lhe lrm may be
appoinLed in Lhe same company (includinq LransiLional period).
1he noLe 2 Lo Lhe illusLraLion sLaLes LhaL "consecuLive years
shall mean all Lhe precedinq lnancial years lor which Lhe lrm
has been Lhe audiLor unLil Lhere has been a break by lve years
or more."
Hence, iL is clear LhaL Lhe requiremenL concerninq break in Lhe
Lerm lor minimum lve years applies reLrospecLively. Hence,
in Lhe example 1, il Lhe company appoinLs old audiL lrm as iLs
audiLor aL Lhis sLaqe, Lhe lrm can conLinue Lo be iLs audiLor lor
only LransiLional period ol 3 years. ln Lhe example 2, Lhe audiL
lrm has hisLorically audiLed Lhe company lor 8 years (5 years
+ 3 years). 1houqh Lhere was 3year break in Lhe service, iL
does noL saLisly qualilyinq condiLion lor Lhe lresh appoinLmenL.
Hence, Lhe audiL lrm may conLinue renderinq audiL services
only lor LransiLional period ol 3 years.
Eligibility, qualihcations and
disqualihcations oI auditors
Financial interest and indebtedness,
guarantee or security
A person is noL eliqible lor appoinLmenL as audiLor il he himsell,
his relaLive or parLner:
Holds any securiLy or inLeresL in a company, or iLs
subsidiary, holdinq or associaLe company or subsidiary ol
such holdinq company.
However, Lhe relaLive is allowed Lo hold securiLy or inLeresL
in Lhe company havinq lace value noL exceedinq `1 lac. 1he
AudiL Rules sLaLe LhaL il any securiLy or inLeresL is acquired
by a relaLive above Lhe prescribed Lhreshold, correcLive
acLion needs Lo be Laken wiLhin 60 days ol such acquisiLion
or inLeresL.
ls indebLed Lo Lhe company, iLs subsidiary, holdinq or
associaLe company or subsidiary ol such holdinq company,
in excess ol `5 lac.
Has qiven any quaranLee or provided any securiLy in
connection with indebtedness of any third person to the
company, or iLs subsidiary, holdinq or associaLe company
or subsidiary ol such holdinq company, in excess ol `1 lac.
From Lhe wordinq used, iL is noL clear wheLher Lhe `1
lac/`5 lac limiL applies separaLely Lo each relaLive or
collecLively Lo all covered persons, includinq audiLor
(il allowed), all his relaLives and parLner. Also, iL is noL clear
wheLher Lhe limiL will apply separaLely lor Lhe company, iLs
each subsidiary, holdinq company, eLc., or collecLively Lo all
Lhese companies.
We suqqesL LhaL Lhe MCA/ lCAl may clarily Lhis issue. ln Lhe
absence ol any quidance/clarilcaLion, Lhe wordinq used
indicaLes LhaL limiLs apply person/relaLivewise; however,
limiLs includes LhaL person's indebLedness, eLc., Lo Lhe
company, iLs subsidiary, holdinq or associaLe company
or subsidiary ol such holdinq company. Lxample below
explains Lhis principle in Lhe conLexL indebLedness ol an
audiLor's relaLive.
Assume LhaL an audiLor has 10 relaLives. ln Lhis case, `5
lac indebLedness limiL will apply separaLely Lo each relaLive.
However, while evaluaLinq wheLher a relaLive breaches Lhe
limiL, iLs indebLedness Lo Lhe company, iLs subsidiary, iLs
holdinq or associaLe company or subsidiary ol such holdinq
company is combined.
Under Lhe 2013 AcL, a person may become ineliqible lor
beinq appoinLed as audiLor ol Lhe company, noL only based
on his/her own LransacLion buL also LransacLions enLered
by a "relaLive." Since Lhe delniLion ol "relaLive" is noL
resLricLed Lo lnancially dependenL relaLive, Lhe audiLor
may noL be able Lo conLrol Lheir acLions. Lven il any ol
Lhese relaLives inadverLenLly enLer inLo a disqualilyinq
LransacLion, Lhe audiLor may have Lo vacaLe his ollce
immediaLely. ln rare cases, an esLranqed relaLive may
invesL in shares ol a company in a manner LhaL will render
Lhe audiLor |obless. 1his is likely Lo creaLe siqnilcanL
inconvenience boLh lor Lhe company and audiLor. 1o avoid
such issues, we suqqesL LhaL Lhe Lerm "relaLive" should be
redelned by Lhe MCA as "lnancially dependenL individual"
by usinq Lhe removal ol dillculLies secLion.
Business relationship
Under Lhe 2013 AcL, a person or an audiL lrm are noL eliqible
lor appoinLmenL as audiLor, il iL, direcLly or indirecLly, has
business relaLionship wiLh Lhe company, iLs subsidiary, iLs
holdinq, or associaLe company or subsidiary ol such holdinq
company or associaLe company. 1he dralL rules explained Lhe
Lerm "Business relaLionship" Lo mean any LransacLion enLered
inLo lor a commercial purpose excepL prolessional services
permiLLed Lo be rendered by an audiLor.
Hence, Lhere was a concern LhaL an audiLor cannoL purchase/
avail qoods/services lrom Lhe audiLee company, iLs subsidiary,
iLs holdinq, or associaLe company or subsidiary ol such holdinq
company or associaLe company. 1his was likely Lo pose serious
pracLical problems noL only Lo Lhe audiLors buL also Lo Lhe
companies Lhey audiL. For example, an audiLor ol a hospiLal
would noL have been able Lo avail services ol LhaL hospiLal even
il Lhe hospiLal charqed Lhe same price as iL would have Lo any
oLher paLienL, and iL would noL have maLLered il LhaL was Lhe
only hospiLal available Lo Lhe audiLor.
ln Lhe AudiL Rules, exempLion reqardinq prolessional services
permiLLed Lo be rendered by an audiLor has been reLained. 1o
address Lhe above concern, Lhe AudiL Rules addiLionally allow
parLies Lo enLer inLo commercial LransacLions LhaL are in Lhe
ordinary course ol business ol Lhe company aL arm's lenqLh
price, e.q., sale ol producLs/services Lo audiLor as cusLomers in
Lhe ordinary course ol business, by companies enqaqed in Lhe
business ol LelecommunicaLions, airlines, hospiLals, hoLels and
such oLher similar businesses.
UndoubLedly, Lhe chanqe made in Lhe AudiL Rules is a reliel
lor companies and Lheir audiLors. However, iL may noL
address all issues which are likely Lo arise. For example,
some may reler Lo examples qiven in Lhe relevanL clause
and sLaLe LhaL Lhey locus primarily on services beinq
rendered Lo Lhe public aL larqe. Hence, iL is noL clear
wheLher similar exempLion also applies Lo LransacLions
involvinq sale ol producLs, say, an audiLor purchasinq a
consumer producL or real esLaLe lrom Lhe company.
1he oLher perspecLive on Lhis issue is LhaL one need
noL locus Loo much on Lhe examples. RaLher, iL is more
imporLanL Lo undersLand Lhe underlyinq principle, which
refers to aspects such as ordinary course of business and
aL arm's lenqLh price. Considerinq Lhis, Lhe deLerminaLion
ol wheLher a LransacLion impacLs audiLor appoinLmenL or
noL will be a maLLer ol |udqmenL and needs Lo be decided
on caseLocase basis. Civen below are some indicaLive
examples which an audiLor/companies may consider in Lhis
reqard:
(i) ll a LransacLion saLisles a basic need ol Lhe audiLors'
business, say, ollce supplies or recruiLmenL services,
one may arque LhaL Lhe audiLor is acLinq akin Lo a
"cusLomer." ll Lhe audiLor/audiL lrm has a qeneral
paLLern ol makinq similar purchases, Lhis may be
anoLher indicaLor LhaL Lhe producL or service is
used rouLinely and Lhus is in Lhe "ordinary course ol
business" lrom Lhe audiLors' perspecLive. However,
a producL or service used inlrequenLly may require
lurLher evaluaLion.
(ii) ll Lhe audiL clienL (or iLs subsidiary, or iLs holdinq or
associaLe company or subsidiary ol such holdinq
company or subsidiary ol associaLe company) is in
Lhe business ol sellinq such producL or providinq such
service, and sells such producL or service cusLomarily
and olLen, Lhen iL may be concluded LhaL Lhe
LransacLion is in "ordinary course ol business" lrom
Lheir perspecLive. ll Lhis is noL Lhe case, Lhe maLLer is
likely Lo require lurLher evaluaLion.
(iii) An addiLional consideraLion is wheLher Lhe Lerms
and conditions of the transaction are standard or the
same as Lhose ol oLher similarly siLuaLed cusLomers
ol Lhe audiL clienL (or iLs subsidiary, or iLs holdinq
or associaLe company or subsidiary ol such holdinq
company or subsidiary ol associaLe company), or il
Lhere is anyLhinq unusual abouL Lhe price, paymenL
arranqemenLs, oLher Lhan normal, LradiLional
commercial Lerms.
lL may be noLed LhaL il Lhe audiL clienL provides
usual crediL period and Lhe same period is qiven Lo
audiLor also, iL may noL breach Lhe "ordinary course
ol business" condiLion. However, Lhere is anoLher
criterion related to indebtedness beyond prescribed
limiL which may poLenLially Lriqqer disqualilcaLion.
lL may be emphasized LhaL Lhese examples are only
indicaLive and one needs Lo consider specilc lacLs
and circumsLances Lo decide wheLher disqualilcaLion
may qeL Lriqqered.
WhilsL Lhe 2013 AcL uses Lhe word "direcLly or indirecLly,"
iLs meaninq in Lhe conLexL ol business relaLionship is noL
explained. One view is LhaL an analoqy may be drawn
lrom explanaLion qiven in secLion 1^^ ol Lhe 2013 AcL.
ln secLion 1^^, Lhis Lerm has been explained Lo include
"renderinq ol services by Lhe lrm iLsell or Lhrouqh any ol
its partners or through its parent, subsidiary or associate
enLiLy or Lhrouqh any oLher enLiLy in which Lhe lrm or any
parLner ol Lhe lrm has siqnilcance inluence or conLrol, or
whose name or Lrade mark or brand is used by Lhe lrm or
any ol iLs parLners". Under Lhis view, audiLor independence
for business relationship is not only restricted to the audit
lrm, buL may also exLend Lo all iLs allliaLed enLiLies.
1he counLer view is LhaL explanaLion qiven in secLion 1^^
is relevanL only lor LhaL secLion. ln Lhe conLexL ol business
relaLionship, "direcLly or indirecLly" means Lhe covered
person acLinq eiLher direcLly or Lhrouqh Lheir aqenLs.
Hence, Lhe LransacLions ol allliaLed enLiLies, which are
oLherwise noL covered and are acLinq in Lheir own capaciLy,
does noL impacL Lhe audiLor independence.
1he MCA/lCAl may clarily Lhis issue. UnLil such quidance
or clarilcaLion is provided, Lhere seems Lo be an arqumenL
lor usinq analoqy ol secLion 1^^. Hence, view 1 is our
prelerred approach.
Limit on maximum number oI audits
ln accordance wiLh Lhe 2013 AcL, a person or a parLner ol
a lrm will noL be eliqible lor appoinLmenL, il such persons
or parLner aL Lhe daLe ol appoinLmenL/reappoinLmenL holds
appoinLmenL as audiLor ol more Lhan 20 companies. PrivaLe
companies are also included in Lhe maximum limiL ol 20
companies.
Under Lhe 1956 AcL read wiLh Lhe lCAl rules, a person/parLner
cannoL audiL more Lhan 30 companies, includinq privaLe
companies, per year. OuL ol Lhis, maximum 20 companies
can be public companies. 1he 2013 AcL has reduced Lhe
maximum limiL Lo 20 companies (includinq privaLe companies)
wiLh immediaLe ellecL lrom 1 April 201^. 1he audiLors/audiL
lrms wiLh more Lhan 20 audiLs (individually/per parLner) sLand
disqualiled lrom beinq appoinLed/reappoinLed as audiLor ol
excess companies. 1his is likely Lo resulL in casual vacancy in
Lhe ollce ol Lhe audiLor, requirinq companies Lo search lor a
replacemenL audiLor immediaLely. ln cerLain cases, iL may be
dillculL Lo lnd a suiLable audiLor in a very shorL period ol Lime.
We recommend LhaL Lhe MCA may address Lhis issue Lhouqh
Lhe order lor removal ol dillculLies.
We believe LhaL lrom an audiL lrm perspecLive, Lhe above limiL
will apply on a qlobal basis and noL per parLner. 1o illusLraLe,
leL us assume LhaL an audiL lrm has 5 parLners. lL can accepL
appoinLmenL as audiLor ol maximum 100 companies. However,
iL is noL Lhe case LhaL each parLner should audiL a maximum ol
20 companies. 1haL limiL can be exceeded, sub|ecL Lo an overall
limiL ol 100 companies lor Lhe lrm. WhilsL Lhis view is clear
lrom readinq ol Lhe secLion; Lo avoid dillerinq pracLices, lCAl
may conlrm Lhis.
Conviction by the Court
ln accordance wiLh Lhe 2013 AcL, a person is noL eliqible lor
appoinLmenL as audiLor, il LhaL person has been convicLed by a
courL ol an ollence involvinq lraud and period ol Len years has
noL elapsed since such convicLion.
A proviso Lo secLion 1^1(1) sLaLes LhaL a lrm whose ma|oriLy
ol parLners pracLisinq in lndia are qualiled lor appoinLmenL as
audiLor may be appoinLed by iLs lrm name Lo be audiLor ol a
company.
A collecLive readinq ol Lhe Lwo clauses suqqesL LhaL il a parLner
in a parLnership lrm (includinq limiLed liabiliLy parLnership),
proposed Lo be appoinLed as audiLor, is convicLed ol lraud, iL
may noL render Lhe enLire lrm ineliqible lor appoinLmenL as
audiLor. However, Lhis is sub|ecL Lo a condiLion, viz., ma|oriLy
ol parLners pracLisinq in lndia are qualiled lor appoinLmenL as
audiLor.
Independence/prohibited services
Under Lhe 2013 AcL, an audiLor is allowed Lo provide only such
nonaudiL services Lo Lhe company as are approved by iLs board
or audiL commiLLee. However, Lhe audiLor is noL allowed Lo
render Lhe lollowinq services eiLher direcLly or indirecLly Lo Lhe
company, iLs holdinq or subsidiary company:
AccounLinq and book keepinq services
lnLernal audiL
Desiqn and implemenLaLion ol any lnancial inlormaLion
sysLem
AcLuarial services
lnvesLmenL advisory services
lnvesLmenL bankinq services
Renderinq ol ouLsourced lnancial services
ManaqemenL services
Any oLher kind ol services as may be prescribed
From an audiL lrm's perspecLive, Lhe Lerm 'direcLly or indirecLly'
includes renderinq ol services by Lhe lrm iLsell or Lhrouqh any
of its partners or through its parent, subsidiary or associate
enLiLy or Lhrouqh any oLher enLiLy in which Lhe lrm or any
parLner ol Lhe lrm has siqnilcance inluence or conLrol, or
whose name or Lrade mark or brand is used by Lhe lrm or any
ol iLs parLners.
ll an audiLor has been renderinq nonaudiL services Lo a
company on or belore Lhe commencemenL ol Lhe 2013 AcL, Lhe
audiLor will need Lo comply wiLh Lhe above resLricLions belore
Lhe end ol Lhe lrsL lnancial year. 1his implies LhaL:
For exisLinq services, an audiLor is required Lo comply wiLh
Lhe above requiremenLs on or belore 31 March 2015.
All enqaqemenLs wiLh an audiL clienL or iLs parenL or
subsidiary company lor any prohibiLed service need Lo be
compleLed/LerminaLed by 31 March 2015.
An auditor is not allowed to enter into any new
enqaqemenL wiLh an audiL clienL or iLs parenL or subsidiary
company lor any prohibiLed services on or alLer 1 April
201^.
ln cerLain cases, Lhe independence requiremenLs ol Lhe 2013
AcL are sLricLer Lhan Lhose currenLly applicable. 1o illusLraLe,
under Lhe lLSBA code, an audiLor is prohibiLed/resLricLed lrom
renderinq nonaudiL services Lo Lhe parenL ol iLs nonSLC lisLed
audiL clienL, only il Lhe audiL clienL is maLerial Lo Lhe parenL. ln
case ol nonlisLed nonSLC audiL clienL, Lhere is no resLricLion
on renderinq nonaudiL services Lo Lhe parenL il Lhe parenL
is also a nonlisLed enLiLy. Under Lhe 2013 AcL, resLricLion/
prohibiLion will apply in all Lhese cases. 1his requires companies
as well audiLors Lo consider various nonaudiL services beinq
rendered Lo a company, iLs holdinq or subsidiary company. ll iL
is deLermined LhaL cerLain services are noL permiLLed, Lhe same
needs Lo be compleLed/LerminaLed by 31 March 2015.
Management services
Under Lhe 2013 AcL, an audiLor is noL allowed Lo render,
amonq oLher services, "manaqemenL service" Lo Lhe company,
iLs holdinq or subsidiary company. However, Lhis Lerm is noL
delned eiLher in Lhe 2013 AcL or in Lhe AudiL Rules. ln Lhe
absence ol clear delniLion, one may arque LhaL quidance can
be Laken lrom Lhe lLSBA Code. 1he lLSBA code provides Lhe
lollowinq quidance on "manaqemenL responsibiliLies":
"290.162 ManaqemenL ol an enLiLy perlorms many
acLiviLies in manaqinq Lhe enLiLy in Lhe besL inLeresLs ol
sLakeholders ol Lhe enLiLy. lL is noL possible Lo specily
every acLiviLy LhaL is a manaqemenL responsibiliLy.
However, manaqemenL responsibiliLies involve leadinq
and direcLinq an enLiLy, includinq makinq siqnilcanL
decisions reqardinq Lhe acquisiLion, deploymenL and
conLrol ol human, lnancial, physical and inLanqible
resources.
290.163 WheLher an acLiviLy is a manaqemenL
responsibiliLy depends on Lhe circumsLances and
requires Lhe exercise ol |udqmenL. Lxamples ol acLiviLies
LhaL would qenerally be considered a manaqemenL
responsibiliLy include:
a) SeLLinq policies and sLraLeqic direcLion
b) DirecLinq and Lakinq responsibiliLy lor Lhe acLions ol
Lhe enLiLy's employees
c) AuLhorizinq LransacLions
d) Decidinq which recommendaLions ol Lhe lrm or oLher
Lhird parLies Lo implemenL
e) 1akinq responsibiliLy lor Lhe preparaLion and lair
presenLaLion ol Lhe lnancial sLaLemenLs in accordance
wiLh Lhe applicable lnancial reporLinq lramework, and
l) 1akinq responsibiliLy lor desiqninq, implemenLinq and
mainLaininq inLernal conLrol."
Since Lhe delniLion ol "manaqemenL service" is noL clear and
may be sub|ecL Lo varyinq inLerpreLaLions, lCAl should provide
quidance. ln Lhe meanwhile, audiLors should Lake precauLion
noL Lo provide any services which enLail manaqemenL
responsibiliLies as discussed in Lhe lLSBA code.
Peporting responsibilities
Internal hnancial controls
ReporLinq responsibiliLies ol Lhe audiLor concerninq "inLernal
lnancial conLrol" boLh wiLh respecL Lo SFS and CFS are
discussed elsewhere in Lhis publicaLion.
Fraud reporting
1he 2013 AcL requires LhaL il an audiLor, in Lhe course Lhe
perlormance ol his duLies as audiLor, has reasons Lo believe
LhaL an ollence involvinq lraud is beinq or has been commiLLed
aqainsL Lhe company by iLs ollcers or employees, he will
immediaLely reporL Lhe maLLer Lo Lhe CenLral CovernmenL
wiLhin Lhe prescribed Lime and manner. Under Lhe dralL rules,
reporLinq Lo Lhe CenLral CovernmenL was required only lor
maLerial lrauds. MaLerial lrauds were delned as (a) lraud(s)
happeninq lrequenLly, or (b) lraud(s) where Lhe amounL
involved or likely Lo be involved is noL less Lhan 57 ol neL prolL
or 27 ol Lurnover ol Lhe company lor Lhe precedinq lnancial
year. For immaLerial lrauds, Lhe audiLor was required Lo reporL
only Lo Lhe AudiL CommiLLee/Board.
ln Lhe AudiL Rules, disLincLion beLween maLerial and immaLerial
lrauds has been removed. 1he audiLor is required Lo reporL all
lrauds Lo Lhe CenLral CovernmenL irrespecLive ol maLerialiLy.
1he AudiL Rules sLaLe LhaL il an audiLor has sullcienL reason
Lo believe LhaL an ollence involvinq lraud, is beinq or has been
commiLLed aqainsL Lhe company by ollcers or employees ol
Lhe company, Lhe audiLor will reporL Lhe maLLer Lo Lhe CenLral
CovernmenL immediaLely buL noL laLer Lhan sixLy days ol his
knowledqe. 1he AudiL Rules prescribe Lhe lollowinq procedure
lor lraud reporLinq:
(i) The auditor will forward his report to the board or the
AudiL CommiLLee, as Lhe case may be, immediaLely alLer
a lraud comes Lo his knowledqe, seekinq Lheir reply or
observaLions wiLhin ^5 days.
(ii) On receipL ol reply/observaLions, Lhe audiLor will lorward
his reporL, reply received and his commenLs on Lhe reply
Lo Lhe CenLral CovernmenL wiLhin 15 days.
(iii) ll Lhe audiLor lails Lo qeL any reply/observaLions wiLhin ^5
days, he will lorward his reporL Lo Lhe CenLral CovernmenL
alonqwiLh a noLe explaininq Lhe lacL.
1he provision will also apply, mutatis mutandis, to a cost auditor
and a secreLarial audiLor.
Noncompliance wiLh Lhis requiremenL knowinqly and willully is
punishable wiLh a lne ol minimum `1 lac which may exLend Lo
`25 lac.
1o reporL Lhe lraud relaLed maLLers Lo Lhe CenLral CovernmenL,
Lhe AudiL Rules have prescribed Form AD1^. 1he lorm requires
LhaL Lhe reporL on lraud, wiLh lorm AD1^, is Lo be qiven in a
sealed cover Lo Lhe SecreLary, MinisLry ol CorporaLe Allairs.
The procedure prescribed for fraud reporting is a step in the
riqhL direcLion. Since Lhe audiLor will obLain Lhe views ol Lhe
Board/AudiL CommiLLee belore reporLinq a maLLer Lo Lhe CenLral
CovernmenL, iL may help in avoidinq/minimizinq siLuaLions
where Lhe audiLor reporLs maLLers Lo Lhe CenLral CovernmenL
purely based on alleqaLions and wiLhouL proper evaluaLion.
We believe LhaL Lhe maLerialiLy Lhreshold lor lraud reporLinq is
needed. ln Lhe absence ol such Lhreshold, an audiLor may need
Lo reporL even Lrivial maLLers ol lraud/poLenLial lraud Lo Lhe
CovernmenL. 1his may impose siqnilcanL addiLional cosL and
burden on all parLies, viz., Lhe company (includinq iLs board/
AudiL CommiLLee), audiLor and Lhe CenLral CovernmenL and yeL
achieve noLhinq.
^2 | Companies Act 2013
Both the 2013 Act and the Audit Pules require an auditor to
report "Irauds being committed" to the Central Covernment.
The Iollowing key issues need to be considered regarding this:
a) Is an auditor also required to report suspected Irauds to
the Central Covernment?
b) II response to (a) is yes, at what stage an auditor should
report matter to the Central Covernment? Consider
that under the vigil mechanism, an employee has raised
complaint about a potential Iraud being committed by an
oIhcer oI the company. The company is in the process oI
collecting necessary data and veriIying the complaint.
It is expected that the management/Audit Committee
need approximately three months to veriIy the accuracy
or otherwise oI the complaint. Is the auditor required to
report the matter to the Central government, without
waiting Ior the outcome oI the inquiry?
c) Is the auditor also required to report those matters oI
suspected Irauds to the Central Covernment where
the management/Audit Committee have ultimately
concluded that no Iraud is involved?
a) For lraud reporLinq, Lhe use ol Lhe phrase "is beinq
commiLLed" is noL clear. However, a readinq ol Lhe 2013
AcL and relaLed Lhe AudiL Rules indicaLe LhaL iL is noL
necessary lor a lraud Lo be lnally concluded Lo Lriqqer an
audiLor's reporLinq Lo Lhe CenLral CovernmenL. RaLher,
an audiLor may also need Lo reporL maLLers ol suspecLed
lrauds Lo Lhe CenLral CovernmenL. Please reler response Lo
issue (b) reqardinq Lhe sLaqe aL which an audiLor may need
Lo reporL suspecLed lrauds.
b) One view is LhaL Lhe AudiL Rules require an audiLor Lo
report on all cases of suspected fraud to the Central
CovernmenL wiLhin 60 days. Hence, as soon as, an
audiLor becomes aware ol any complainL abouL a poLenLial
lraud, Lhe audiLor will reporL Lhe maLLer Lo Lhe CenLral
CovernmenL wiLhin 60 days by adopLinq Lhe procedure
prescribed. Hence, audiLor should noL waiL lor compleLion
ol inquiry beinq conducLed by Lhe manaqemenL/AudiL
CommiLLee.
1he second view is LhaL based on wordinq used in rules,
reporLinq Lo Lhe CenLral CovernmenL is Lriqqered only
once "an audiLor has sufhcient reason to believe that an
ollence involvinq lraud is beinq or has been commiLLed."
Hence, mere complainL by an employee/oLhers may noL
be sullcienL reason Lo Lriqqer reporLinq Lo Lhe CenLral
CovernmenL. Also, reporLinq Lo Lhe CenLral CovernmenL
aL a preliminary sLaqe wiLhouL proper evaluaLion is noL
consisLenL eiLher wiLh Lhe public's expecLaLions or wiLh
companies' undersLandinq ol an audiLors' role. Moreover,
il an audiLor reporLs cerLain maLLers as "poLenLial lraud"
Lo Lhe CenLral CovernmenL wiLhouL esLablishinq proper
lacLs, Lhen iL may creaLe siqnilcanL hardship boLh lor
Lhe company and Lhe audiLor. Under Lhis view, 60 days'
LimelimiL Lo reporL "suspecLed lrauds" will noL sLarL
immediaLely on Lhe daLe Lhe company receives complainL
abouL a poLenLial lraud and audiLor become aware ol
Lhe same; raLher, iL should sLarL lrom Lhe daLe when Lhe
manaqemenL/AudiL CommiLLee have made reasonable
proqress on Lhe maLLer and Lhe audiLor has sufhcient
reasons Lo believe LhaL a lraud is beinq commiLLed.
DeLerminaLion ol such a sLaqe is a maLLer ol |udqmenL and
needs Lo be decided based on Lhe lacLs and circumsLances
ol each case.
Based on Lhe wordinqs used in Lhe AudiL Rules and
manaqemenL/public expecLaLions and undersLandinq
ol audiLors' role, we preler Lhe second view on Lhis
maLLer. However, il Lhere is a prolonqed delay lrom Lhe
manaqemenL/AudiL CommiLLee in Lhe evaluaLion ol a
poLenLial lraud, Lhe audiLor may decide Lo reporL Lhe
maLLer Lo Lhe CenLral CovernmenL, wiLhouL waiLinq lor
compleLion ol such evaluaLion. We undersLand LhaL
Lhe lCAl is developinq quidance on audiLors' reporLinq
responsibiliLies and recommend LhaL iL conlorms Lo Lhe
second view.
c) Please reler discussion on issue aL (b) above. 1he 2013
AcL and Lhe AudiL Rules require Lhe audiLor Lo make iLs
own assessmenL and exercise prolessional |udqmenL
wheLher Lhere is a sullcienL reason Lo believe LhaL an
ollence involvinq lraud is beinq or has been commiLLed. ll
Lhe audiLor aqrees wiLh Lhe manaqemenL/AudiL CommiLLee
conclusion LhaL no lraud is involved, reporLinq Lo Lhe
CenLral CovernmenL is noL required. However, il an audiLor
does noL aqree wiLh Lhe manaqemenL/AudiL CommiLLee
conclusion, then the auditor needs to further probe the
maLLer and come Lo conclusion wheLher Lhe lraud/poLenLial
lraud is involved. ll, alLer lurLher probe, Lhe audiLor has
sullcienL reason Lo believe LhaL an ollence involvinq lraud
is beinq or has been commiLLed, Lhen Lhe audiLor will need
Lo lle iLs reporL Lo Lhe CenLral CovernmenL alonqwiLh Lhe
AudiL CommiLLee/manaqemenL observaLions. We believe
LhaL lCAl will clarily Lhis posiLion as parL ol iLs proposed
quidance on audiLors' responsibiliLy lor lraud reporLinq.
^3 Beginning of a new era |
Is the auditor required to report all Irauds/suspected Irauds,
including, cases where a company may be deIrauding 3rd
parties, says, customers, vendors, investors, or is IalsiIying
its books oI accounts, to the Central Covernment?
BoLh Lhe 2013 AcL and Lhe AudiL Rules require Lhe CenLral
CovernmenL reporLinq only in cases where an ollence involvinq
lraud is beinq or has been commiLLed aqainsL Lhe company
by iLs ollcers or employees. We believe LhaL in oLher cases,
includinq, cases where a company may be delraudinq 3rd
parties, the auditor is not required to report directly to the
CenLral CovernmenL. NoneLheless, an audiLor needs Lo consider
impacL ol Lhese lrauds/poLenLial lrauds on Lhe audiL and while
lnalizinq audiLors' reporL on Lhe lnancial sLaLemenLs. Specilc
aLLenLion is drawn Lo SA 2^0 The Auditors Responsibilities
Relating to Fraud in an Audit of Financial Statements. An auditor
needs Lo ensure compliance wiLh SA 2^0 lor conducLinq Lhe
audiL as well as communicaLion ol lraud Lo Lhe manaqemenL, Lo
Lhose charqed wiLh qovernance and oLhers.
Ceneral Circular 8/2014 clarihes that auditor's report in
respect oI hnancial years, which commenced earlier than 1
April 2014, will be governed by the relevant provisions oI the
195 Act. How does this Circular apply in the context oI Iraud
reporting to the Central Covernment? The 195 Act did not
contain any requirement Ior Iraud reporting directly to the
Central Covernment.
One view is LhaL Ceneral Circular 8/201^ deals only wiLh
lnancial sLaLemenLs, board reporL and maLLers covered in Lhe
audiLors' reporL. RequiremenL concerninq lraud reporLinq Lo
Lhe CenLral CovernmenL is a noL an audiLors' reporL relaLed
maLLer; raLher, iL is an independenL requiremenL, i.e., audiLor's
oLher reporLinq responsibiliLy. Hence, Lhe Ceneral Circular is noL
relevanL in Lhis conLexL. RaLher, an audiLor is required Lo reporL
any lraud, which comes Lo iLs aLLenLion on or alLer 1 April
210^, Lo Lhe CenLral CovernmenL alLer adopLinq Lhe procedure
prescribed.
1he second view is LhaL requiremenL lor lraud reporLinq is
covered secLion 1^3 ol Lhe 2013 AcL, which deals wiLh all
maLLers relaLinq Lo powers and duLies ol an audiLor, includinq iLs
reporLinq responsibiliLies. Hence, one should read Lhe Ceneral
Circular in conLexL ol overall secLion 1^3; and noL merely
lor maLLers Lo be covered in Lhe audiLors' reporL. 1o supporL
Lhis view, iL may also be arqued LhaL secLion 1^3(12) ol uses
Lhe phrase "il an audiLor ol a company, in Lhe course ol Lhe
perlormance ol his duLies as audiLor, has reason Lo believe
." Hence, iL is imporLanL LhaL lraud comes Lo Lhe audiLors'
knowledqe while perlorminq duLies as an audiLor under Lhe
2013 AcL and noL oLherwise. For Lhe year ended 31 March
201^, an audiLor is perlorminq duLies under Lhe 1956 AcL and
noL Lhe 2013 AcL. Hence, any lraud noLiced as parL ol 31 March
201^ yearend audiL will noL Lriqqer reporLinq Lo Lhe CenLral
CovernmenL. However, any lraud/poLenLial lraud noLiced as
parL ol audiL lor Lhe lollowinq year, i.e., lnancial year beqinninq
on or alLer 1 April 201^, will Lriqqer reporLinq Lo Lhe CenLral
CovernmenL.
We believe LhaL Lhe second view seems Lo be more appropriaLe.
We recommend LhaL lCAl may clarily Lhis posiLion as parL ol iLs
proposed quidance on lraud reporLinq.
During the course oI limited review as required by Clause 41
to the Listing Agreement, the audit hrm notices that a Iraud
has been committed against the company by its oIhcers or
employees. From the perspective oI Iraud reporting under
section 143(12), will Irauds identihed by the auditor in the
course oI a limited review under clause 41 be covered?
ln accordance wiLh secLion 1^3(12) ol Lhe 2013 AcL, reporLinq
Lo Lhe CenLral CovernmenL is Lriqqered il Lhe audiLor noLices
lraud/poLenLial lraud in Lhe course ol perlorminq duLies as
audiLor. Clause ^1 requires LhaL unaudiLed lnancial resulLs ol a
company should be sub|ecLed Lo limiLed review by iLs sLaLuLory
audiLors. 1his implies LhaL an audiLor conducLs limiLed review
ol quarLerly lnancial inlormaLion in Lhe capaciLy as audiLor ol
Lhe company and any lraud noLiced durinq Lhe review is durinq
Lhe course ol perlorminq duLies as audiLor. Hence, Lhe audiLor
needs Lo reporL Lhe lraud/poLenLial lraud idenLiled in Lhe
course ol limiLed review in accordance wiLh Lhe requiremenLs ol
Lhe 2013 AcL and Lhe AudiL Rules.
CAPC reporting
Under Lhe 1956 AcL, Lhe CenLral CovernmenL issued Lhe CARO
2003. CARO 2003 conLains various maLLers on which Lhe
audiLors ol companies (excepL exempLed companies) have Lo
make a sLaLemenL in Lheir audiL reporL. 1he AudiL Rules issued
under Lhe 2013 AcL do noL conLain a similar order. RaLher, Lhe
AudiL Rules require an audiLor Lo commenL on Lhe lollowinq
Lhree addiLional maLLers:
WheLher Lhe company has disclosed Lhe impacL, il any, ol
pendinq liLiqaLions on iLs lnancial posiLion in Lhe lnancial
sLaLemenLs
WheLher Lhe company has made provision, as required
under any law or accounLinq sLandards, lor maLerial
loreseeable losses, il any, on lonqLerm conLracLs includinq
derivaLive conLracLs
WheLher Lhere has been any delay in Lranslerrinq amounLs,
required Lo be Lranslerred, Lo Lhe lnvesLor LducaLion and
ProLecLion Fund (lLPF) by Lhe company.
Considerinq Lhe above, iL appears LhaL CARO Lype reporLinq
may no lonqer be required under Lhe 2013 AcL. However, one
should noL rule ouL Lhe possibiliLy LhaL Lhe CenLral CovernmenL
may prescribe such reporLinq requiremenLs in due course.
lnLeresLinqly, whilsL Lhe MCA has so lar noL prescribed Lhe
CARO or iLs equivalenL under Lhe 2013 AcL, Form AOC^
(lor llinq lnancial sLaLemenLs and oLher documenLs wiLh Lhe
ReqisLrar) requires deLails reqardinq AudiLors' ReporLinq under
Lhe CARO 2003.
1he requiremenLs conLained in clauses (a) and (b) in any case
require an audiLor Lo qualily/modily Lhe audiL reporL il provision
lor loreseeable losses and liLiqaLions is noL made, and Lhe
amounLs involved are maLerial. However, because ol specilc
requiremenLs conLained in Lhe 2013 AcL, Lhe audiLor may
provide a qreaLer locus on Lhese issues in Lhe audiL.
ln addiLion Lo specilc issues/aspecLs, one pervasive and key
issue lor audiLor reporLinq was relaLed Lo Lhe applicabiliLy daLe.
ln accordance wiLh Lhe noLilcaLion, new requiremenLs apply
lrom 1 April 201^. However, iL was noL clear as Lo how exacLly
Lhis requiremenL will apply. lL appeared LhaL Lhe lollowinq Lhree
views were possible:
(i) 1he new requiremenL is applicable Lo all audiL reporLs lor
accounLinq periods commencinq on or alLer 1 April 201^.
(ii) lL is applicable Lo all audiL reporLs lor accounLinq periods
endinq on or alLer 1 April 201^.
(iii) lL is applicable Lo all audiL reporLs issued on or alLer 1
April 201^, irrespecLive ol Lhe period Lo which iL perLains.
As menLioned earlier, Lo address Lhe issue, Lhe MCA has issued
Lhe Ceneral Circular no. 8/201^ daLed ^ April 201^. 1he
Circular clariles LhaL Lhe AudiLor's ReporL in respecL ol lnancial
years, which commenced earlier Lhan 1 April 201^, will be
qoverned by Lhe relevanL provisions ol Lhe 1956 AcL. Hence,
view (i) will apply lor Lhe maLLers covered under Lhe audiLor
reporL. ln our view, Lhis approach is loqical as iL ensures LhaL Lhe
new requiremenL is applied prospecLively.
Penalty on auditors
SecLion 1^7(5) ol Lhe 2013 AcL sLaLes LhaL "where, in case
ol audiL ol a company beinq conducLed by an audiL lrm, iL is
proved LhaL Lhe parLner or parLners ol Lhe audiL lrm has or
have acLed in a lraudulenL manner or abeLLed or colluded in any
lraud by, or in relaLion Lo or by, Lhe company or iLs direcLors or
ollcers, Lhe liabiliLy, wheLher civil or criminal as provided in Lhis
AcL or in any oLher law lor Lhe Lime beinq in lorce, lor such acL
shall be ol Lhe parLner or parLners concerned ol Lhe audiL lrm
and ol Lhe lrm |oinLly and severally."
1he AudiL Rules clarily LhaL in case ol criminal liabiliLy, Lhe
liabiliLy will devolve only on Lhe concerned parLner or parLners,
who acLed in a lraudulenL manner or abeLLed or, as Lhe case
may be, colluded in any lraud.
1he AudiL Rules have clariled Lhe posiLion only wiLh respecL Lo
Lhe criminal liabiliLy buL noL Lhe civil liabiliLy. Hence, one may
arque LhaL lor civil liabiliLy, |oinL and several liabiliLies ol Lhe
parLners and Lhe lrm can be enlorced even il all Lhe parLners
have noL colluded in commiLLinq Lhe lraud.
BoLh under Lhe 2013 AcL and RC^9, requiremenLs concerninq
relaLed parLy LransacLions may be divided inLo lour key parLs,
viz., idenLilcaLion ol relaLed parLies, relaLed parLy LransacLions,
approval process and disclosure requiremenLs. lL is clear lrom
discussion below LhaL in mosL cases, RC^9 conLains sLricLer
requiremenLs visvis Lhose under Lhe 2013 AcL. 1he delniLion
ol 'relaLed parLy' under RC^9 is likely Lo resulL in idenLilcaLion
ol siqnilcanLly hiqher number ol relaLed parLies visvis Lhose
under Lhe 2013 AcL. RC^9 conLains a broader delniLion ol
'relaLed parLy LransacLions' which is expecLed Lo cover all Lypes
ol relaLed parLy LransacLions. Unlike Lhe 2013 AcL, RC^9 does
noL exempL relaLed parLy LransacLions lrom special resoluLion ol
disinLeresLed shareholders based on criLeria, viz., (i) LransacLion
is in Lhe ordinary course ol business and aL arm's lenqLh, or (ii)
prescribed Lhreshold reqardinq LransacLion value and share
capiLal are noL breached. 1he only exempLion lrom special
resoluLion ol disinLeresLed shareholders under RC^9 is LhaL
Lhe LransacLion does noL breach maLerialiLy Lhreshold. A lisLed
company needs Lo consider Lhe Lwo requiremenLs carelully and
apply sLricLer ol Lhe Lwo.
RelaLed parLies
transactions
Identihcation oI related parties
Dehnition under the 2013 Act
1he 2013 AcL delnes Lhe Lerm "relaLed parLy" Lo mean:
(i) A direcLor or his relaLive
(ii) KMP or his relaLive
(iii) A lrm, in which a direcLor, manaqer or his relaLive is a
partner
(iv) A privaLe company in which a direcLor or manaqer is a
member or direcLor
(v) A public company in which a direcLor or manaqer is a
director and
1
holds alonq wiLh his relaLives, more Lhan 27
ol iLs paidup share capiLal
(vi) A body corporaLe whose board, manaqinq direcLor or
manaqer is accusLomed Lo acL in accordance wiLh Lhe
advice, direcLions or insLrucLions ol a direcLor or manaqer,
excepL il advice/ direcLions/ insLrucLions are qiven in Lhe
professional capacity
(vii) Any person on whose advice, direcLions or insLrucLions
a direcLor or manaqer is accusLomed Lo acL, excepL
il advice/ direcLions/ insLrucLions are qiven in Lhe
professional capacity
1 Reler discussion below reqardinq 'common direcLorship.'
(viii) Any company which is:
A holdinq, subsidiary or an associaLe company ol
such company, or
A subsidiary ol a holdinq company Lo which iL is
also a subsidiary
(ix) Such oLher persons as may be prescribed.
Related parties under enabling clause
(clause (ix))
ln accordance wiLh Lhe dralL rules, Lhe lollowinq persons were
Lo be covered under Lhe enablinq clause:
"(1) A direcLor or KMP ol Lhe holdinq, subsidiary or
associaLe company ol such company or his relaLive,
or
(2) Any person appoinLed in senior manaqemenL in
Lhe company or iLs holdinq, subsidiary or associaLe
company, i.e., personnel ol Lhe company or iLs
holdinq, subsidiary or associaLe company who are
members ol core manaqemenL Leam excludinq
board ol direcLors comprisinq all members ol
manaqemenL one level below Lhe execuLive
direcLors, includinq Lhe luncLional heads."
1here was a concern LhaL Lhe delniLion, parLicularly, relaLions
prescribed under the draft rules, will result in a long list
ol relaLed parLies lor larqe conqlomeraLes havinq mulLiple
subsidiaries/operaLions. Many ol Lhese persons may noL be
in a posiLion Lo inluence Lhe acLions ol a company, and may
noL even be known Lo Lhe company. For example, a direcLor
or KMP ol Lhe subsidiary or associaLe, in mosL cases, may noL
be able Lo inluence Lhe parenL/invesLor. Also, Lhe persons aL
one level below execuLive direcLors and luncLional heads do
noL have auLhoriLy and responsibiliLy lor planninq, direcLinq
and conLrollinq Lhe acLiviLies ol a company. RaLher, Lhey work
under Lhe supervision ol Lhe board ol direcLors. Hence, Lhe
dralL rules may have creaLed siqnilcanL adminisLraLive burden
on companies Lo idenLily and Lrack relaLed parLy relaLions/
LransacLions on a conLinuous basis, which may noL serve much
uselul purpose. Clobal pracLice is also noL Lo include Lhem in
relaLed parLies.
ln Lhe DelniLion Rules, Lhis issue has been larqely addressed.
ln Lhe DelniLion Rules, Lhe enablinq clause includes only a
direcLor/ KMP ol Lhe holdinq company or his relaLive as Lhe
relaLed parLy. We welcome Lhe chanqe made in Lhe DelniLion
Rules.
Common directorship
1he delniLion ol "relaLed parLies" in Lhe 2013 AcL provided
LhaL relaLed parLy wiLh relerence Lo a company, amonq oLher
maLLers, includes a public company in which a direcLor or
manaqer ol Lhe company is a direcLor or holds along with his
relaLives, more Lhan 27 ol iLs paid up share capiLal (emphasis
added).
1o explain, assume LhaL ABC LimiLed and DLF LimiLed are Lwo
public companies. 1here is no relaLion beLween Lhe companies,
excepL relaLion below.
Mr. X is a repuLed prolessional. He has recenLly been
appoinLed as independenL direcLor on Lhe board ol ABC.
Mr. X is also an independenL direcLor on Lhe board ol DLF.
Based on common direcLorship, one will have concluded
LhaL ABC and DLF are relaLed parLies Lo each oLher.
ConsequenLly, all companies where Mr. X is a direcLor
would have become relaLed parLies Lo ABC and DLF.
Consider anoLher scenario. Mr. X is a repuLed prolessional.
He has recently been appointed as independent director
on Lhe board ol ABC. One ol Lhe relaLives ol Mr. X holds 27
share capiLal in DLF. Based on Lhe above clause, DLF would
have been a relaLed parLy Lo ABC. However, lrom DLF's
perspecLive, ABC will noL have been a relaLed parLy.
lL appears LhaL Lhe CovernmenL may noL have inLended LhaL
a company should idenLily a public company as iLs relaLed
parLy merely because Lhere is a common direcLor. 1o relecL
iLs Lrue inLenLion and avoid undue hardship, Lhe CenLral
CovernmenL has proposed Lo issue Lhe Companies 1st (Removal
of 0|fhcu|t|es) Crcer, 2014. ln accordance wiLh Lhe proposed
order, Lhe word 'or' hiqhliqhLed above should be read as Lhe
word 'and.' For Lhe purpose ol Lhis publicaLion, iL is assumed
LhaL Lhe proposed order is lnal and will become law soon.
Hence, lor a company, public company will be relaLed parLy only
il boLh Lhe criLeria are meL:
(i) DirecLor or manaqer ol Lhe company is a direcLor in Lhe
public company, and
(ii) DirecLor or manaqer holds alonq wiLh his relaLives more
Lhan 27 ol paid up share capiLal in Lhe public company
^8 | Companies Act 2013
Dehnition under the PC49
RC^9 delnes Lhe Lerm 'relaLed parLy' in a broader manner. 1he
delniLion under RC^9 includes all relaLed parLies under Lhe
2013 AcL. ln addiLion, iL includes relaLed parLies under lndAS
2^. RC^9 sLaLes LhaL a 'relaLed parLy' is a person or enLiLy LhaL
is relaLed Lo Lhe company. ParLies are considered Lo be relaLed
il one parLy has Lhe abiliLy Lo conLrol Lhe oLher parLy or exercise
siqnilcanL inluence over Lhe oLher parLy, direcLly or indirecLly,
in makinq lnancial and/or operaLinq decisions and includes Lhe
lollowinq:
(1) A person or a close member ol LhaL person's lamily is
relaLed Lo a company il LhaL person:
a) ls a relaLed parLy under secLion 2(76) ol Lhe 2013 AcL
b) Has conLrol or |oinL conLrol or siqnilcanL inluence
over Lhe company, or
c) ls KMP ol Lhe company or ol a parenL ol Lhe company
(2) An enLiLy is relaLed Lo a company il any ol Lhe lollowinq
condiLions apply:
a) 1he enLiLy is a relaLed parLy under secLion 2(76) ol Lhe
2013 AcL
b) 1he enLiLy and Lhe company are members ol Lhe same
qroup (which means LhaL each parenL, subsidiary and
lellow subsidiary is relaLed Lo Lhe oLhers)
c) One enLiLy is an associaLe or |oinL venLure ol Lhe oLher
enLiLy (or an associaLe or |oinL venLure ol a member ol
a qroup ol which Lhe oLher enLiLy is a member)
d) BoLh enLiLies are |oinL venLures ol Lhe same Lhird parLy
e) One enLiLy is a |oinL venLure ol a Lhird enLiLy and Lhe
other entity is an associate of the third entity
l) 1he enLiLy is a posLemploymenL benelL plan lor Lhe
benelL ol employees ol eiLher Lhe company or an enLiLy
relaLed Lo Lhe company. ll Lhe company is iLsell such a
plan, Lhe sponsorinq employers are also relaLed Lo Lhe
company, or
q) The entity is controlled or jointly controlled by a
person idenLiled in (1), or
h) A person idenLiled in (1)(b) has siqnilcanL inluence
over Lhe enLiLy (or ol a parenL ol Lhe enLiLy).
An explanaLion Lo Lhe delniLion sLaLes LhaL lor Lhis purpose, Lhe
Lerm 'conLrol' will have Lhe same meaninq as delned in Lhe SEBI
(Substantial Acquisition of Shares and Takeovers) Regulations,
2011. 1hese requlaLions delne Lhe Lerm 'conLrol' Lo include
"riqhL Lo appoinL ma|oriLy ol Lhe direcLors or Lo conLrol Lhe
manaqemenL or policy decisions exercisable by a person or
persons acLinq individually or in concerL, direcLly or indirecLly,
includinq by virLue ol Lheir shareholdinq or manaqemenL riqhLs
or shareholders aqreemenLs or voLinq aqreemenLs or in any
oLher manner."
Dehnition oI relative
1he 2013 AcL delnes Lhe Lerm 'relaLive' as 'wiLh relerence Lo
any person means anyone who is relaLed Lo anoLher, il:
(i) 1hey are members ol a Hindu Undivided Family
(ii) They are husband and wife, or
(iii) One person is relaLed Lo Lhe oLher in such manner as may
be prescribed'
1he dralL rules prescribed a lisL ol 15 relaLions Lo be covered
under (iii) above. ln Lhe DelniLion Rules, Lhis lisL has been
raLionalized Lo exclude qrandparenLs and qrandchildren. Now, iL
covers only 8 relaLions (see 1able 3).
Table 3: List oI relatives
FaLher (includinq sLeplaLher) Daughter
MoLher (includinq sLep
moLher)
DauqhLer's husband
Son (includinq sLepson) BroLher (includinq sLep
broLher)
Son's wile SisLer (includinq sLepsisLer)
ln Lhe conLexL on independenL direcLors, RC^9 sLaLes LhaL Lhe
Lerm 'relaLive' will have Lhe same meaninq as delned under Lhe
2013 AcL and rules prescribed Lhereunder.
(1) Amonq oLher maLLers, Lhe delniLion ol 'relaLive' is likely
Lo have siqnilcanL impacL on aspecLs such as coveraqe ol
relaLed parLy LransacLions or appoinLmenL, qualilcaLion
and disqualilcaLion ol audiLor and independenL direcLors.
We believe LhaL raLionalizaLion ol Lhe lisL ol relaLives is an
improvemenL lrom Lhe delniLion conLained in Lhe dralL
rules and iL may somewhaL reduce challenqes in ensurinq
conLinuinq independence ol Lhe audiLor/independenL
direcLors. However, Lhe lacL remains LhaL a person may
noL be able Lo conLrol/inluence acLions ol oLher person il
Lhe oLher person is noL lnancially dependenL on him/her.
Similarly, a person may be able Lo inluence oLher persons
who are lnancially dependenL on him or her, even il Lhey
are noL covered in specilc lisL or relaLions. Coinq lorward
Lhis aspecL may be revisiLed by Lhe MCA.
(2) Reler discussion under Lhe head 'common direcLorship',
includinq chanqe made Lhrouqh Lhe proposed Companies
1st ,Pemova| of 0|fhcu|t|es) Crcer, 2014. lnLeresLinqly,
the concerned clause for identifying related party is not
based on Lhe principle ol reciprociLy. Hence, iL is possible
LhaL one company idenLiles oLher company as iLs relaLed
parLy. However, iL does noL necessarily mean LhaL Lhe
second company will also idenLily Lhe lrsL one as iLs
relaLed parLy. RaLher, iL will perlorm iLs own independenL
evaluaLion. See example below.
ABC LimiLed and DLF LimiLed are Lwo public companies.
Mr. X, a repuLed prolessional, is an independenL direcLor
on Lhe board ol ABC. Mr. X is also a direcLor on Lhe
board ol DLF. Wile ol Mr. X holds 27 share capiLal in
DLF. Besides Lhis, Lhere is no relaLionship beLween
Lwo companies. ln Lhis case, ABC will LreaL DLF as iLs
related party as both the criteria for identifying a public
company as relaLed parLy are meL. For DLF, ABC is noL a
relaLed parLy since criLerion (ii) explained under Lhe head
'common direcLorship' is noL meL.
Also, iL may be noLed LhaL Lhe proposed order is relevanL only lor Lhe idenLilcaLion ol public company as relaLed parLy. 1here is no
chanqe in Lhe criLerion Lo deLermine wheLher a privaLe company is relaLed parLy Lo Lhe company. Also, iL is perLinenL Lo noLe LhaL Lhe
above dillerenLiaLion beLween privaLe and public companies is lrom Lhe perspecLive ol Lhe company who is beinq idenLiled as relaLed
parLy and noL Lhe company who is idenLilyinq iLs relaLed parLy. 1able ^ explains Lhis aspecL lrom ABC LimiLed's perspecLive:
Table 4: Pelated party identihcation
ABC LimiLed Public/PrivaLe Public/PrivaLe Public/PrivaLe Public/PrivaLe
DLF LimiLed Public Public PrivaLe PrivaLe
Common direcLor Yes Yes Yes Yes
DirecLor's shareholdinq in DLF 27 Nil 27 Nil
DirecLor's shareholdinq in ABC Nil 27 Nil 27
WheLher DLF is relaLed parLy Lo
ABC
Yes No Yes Yes
Whether ABC is related party to
DLF (DLF's perspecLive)
Yes, il ABC is a
privaLe company.
No, if ABC is a public
company.
Yes in boLh Lhe
cases.
Yes, il ABC is a privaLe
company. No, il ABC is
a public company.
Yes in boLh Lhe
cases.
(3) WhilsL Lhe RC^9 uses Lhe Lerms such as 'close member ol lamily', '|oinL venLure' and 'qroup,' iL does noL delne Lhose Lerms.
lL may be arqued LhaL since delniLion ol relaLed parLies is based on lndAS 2^, a lisLed company should reler lndAS lor
appropriaLe delniLion ol Lhese Lerms.
(^) 1he delniLion ol 'relaLed parLy' under Lhe RC^9 is much more exhausLive. RelaLed parLies under secLion 2(76) ol Lhe 2013 AcL
are |usL one elemenL ol relaLed parLy relaLionships covered under Lhe RC^9. RC^9 is likely Lo resulL in idenLilcaLion ol much
hiqher number ol relaLed parLies and idenLilcaLion on a more consisLenL basis. Consider Lhe example in diaqram 1 below:
Company S
50% 50% 30%
Company A
Company Z Company H
Diagram 1
ln Lhis example, analysis under Lhe 2013 AcL is likely Lo be as
below:
For company H, company A is an associaLe company and
iLs relaLed parLy.
1he delniLion ol relaLed parLy in Lhe 2013 AcL does
noL reler Lo |oinL venLure as relaLed parLy. However, Lhe
delniLion ol "associaLe company" includes "|oinL venLure
company." 1hus, lor company H, company S is also a
relaLed parLy.
On Lhe same basis as (b) above, lor company Z, company S
is a relaLed parLy.
lL is assumed LhaL Lhere is no oLher relaLionship beLween
parLies. Basis Lhis, lor company A, company H is noL a relaLed
parLy. Similarly, lor company S, neiLher H nor Z is relaLed
parLy. Company S and A are noL relaLed parLies Lo each oLher.
Company Z and H are also noL relaLed Lo each oLher.
All Lhree relaLed parLy relaLionships idenLiled under Lhe 2013
AcL conLinue under RC^9. ln addiLion, Lhe lollowinq new
relaLionships qeL idenLiled:
For company A, company H is a relaLed parLy under clause
2(c) ol 'relaLed parLy' delnaLion under RC^9.
On similar lines, boLh H and Z are relaLed parLies Lo
company S.
Company S and A are relaLed parLies Lo each oLher under
clause 2(e) ol 'relaLed parLy' delnaLion under RC^9.
Lven under RC^9, company Z and H are noL relaLed Lo each
oLher.
Identihcation oI relevant
transactions
SecLion 188 ol Lhe 2013 AcL deals wiLh Lhe relaLed parLy
LransacLions wiLh respecL Lo:
a) Sale, purchase or supply ol any qoods or maLerials
b) Sellinq or oLherwise disposinq ol, or buyinq, properLy ol
any kind
c) Leasinq ol properLy ol any kind
d) Availinq or renderinq ol any services
e) AppoinLmenL ol any aqenL lor purchase or sale ol qoods,
maLerials, services or properLy
l) RelaLed parLy's appoinLmenL Lo any ollce or place ol
prolL in Lhe company, iLs subsidiary company or associaLe
company, and
q) UnderwriLinq Lhe subscripLion ol any securiLies or
derivaLives Lhereol, ol Lhe company.
ln conLrasL, RC^9 delnes Lhe relaLed parLy LransacLions as
a LransacLion involvinq "Lransler ol resources, services or
obliqaLions beLween a company and a relaLed parLy, reqardless
ol wheLher a price is charqed."
ln Lhe delniLion under RC^9, specilc aLLenLion is drawn Lo Lhe
use ol Lhe word 'resource' which may include even iLems LhaL
do noL meeL criLeria lor recoqniLion as an asseL. 1o illusLraLe, a
lisLed company is Lranslerrinq Lo iLs lellow subsidiary 'research
work' carried ouL in Lhe pasL which does noL meeL AS 26
criLeria lor recoqniLion as an inLanqible asseL. Under RC^9, Lhe
proposed LransacLion will be covered as Lransler ol resource.
Hence, RC ^9 conLains a broader delniLion which is expecLed Lo
cover all Lypes ol relaLed parLy LransacLions.
1he Lwo issues discussed below reqardinq idenLilcaLion ol
relaLed parLy LransacLions are noL relevanL under RC^9.
5ection 188(1)(b) oI the 2013 Act covers contract with
related parties with respect to selling or otherwise disposing
oI, or buying, property oI any kind." Does the term 'property'
cover only 'immovable property'? Cr will it include even
movable property and intangible assets?
WhilsL secLion 188(1)(b) ol Lhe 2013 AcL covers "sellinq or
oLherwise disposinq ol, or buyinq, properLy ol any kind," secLion
188(1)(a) deals wiLh "sale, purchase or supply ol any qoods
or maLerials." 1his indicaLes LhaL 'qoods or maLerials' are noL
covered under secLion 188(1)(b) and discussions below are
relevanL only lor oLher iLems.
SecLion 188 ol Lhe 2013 AcL does noL delne Lhe Lerm
'properLy.' However, iL may be noLed LhaL explanaLion (iv) Lo
SecLion 232, which deals wiLh merqer and amalqamaLion ol
companies, sLaLes LhaL "lor Lhe purpose ol Lhis secLion, Lhe
Lerm properLy includes asseLs, riqhLs and inLeresLs ol every
descripLion."
1he above quidance, alonqwiLh Lhe Lerm used, viz., 'properLy ol
any kind' seems Lo indicaLe LhaL all lorms ol properLy, includinq
inLanqible asseLs such as inLellecLual properLy riqhLs, may be
covered under SecLion 188(1)(b).
FurLher, secLion ^^ ol Lhe 2013 AcL sLaLes LhaL shares,
debenLures or oLher inLeresL ol any member in a company will
be movable properLy Lranslerable in Lhe manner provided by
Lhe arLicles ol Lhe company. 1his indicaLes LhaL even shares/
securiLies are included in delniLion ol "properLy."
Since Lhis is a leqal maLLer, we suqqesL LhaL a company consulLs
iLs leqal prolessionals belore Lakinq any lnal view on Lhe
maLLer.
5ince the term 'property' includes 'securities' also, does
5ection 188(1)(b) cover only sale/or transIer oI securities in
the secondary market or would allotment oI securities, i.e.,
primary issue oI securities, also be covered?
As discussed in Lhe response Lo previous issue, Lhe exisLinq
shares consLiLuLe properLy. Hence, a relaLed parLy LransacLion
involvinq sale/purchase, eLc., ol Lhe exisLinq shares/securiLies
alloLLed in Lhe pasL is likely Lo Lriqqer compliance under secLion
188. 1his requires a company Lo assess wheLher iL meeLs any ol
Lhe exempLion criLeria and approvals required.
Fresh alloLmenL ol shares/securiLies may noL consLiLuLe
properLy since Lhe company did noL own Lhose shares belore
Lhe alloLmenL. Also, Lhe word 'buy' may noL include lresh
alloLmenL ol shares. Basis Lhis, one may arque LhaL lresh
alloLmenL/subscripLion ol securiLies Lo relaLed parLies does noL
Lriqqer secLion 188.
We believe LhaL Lhis is a maLLer ol leqal inLerpreLaLion and a
company needs Lo consulL leqal prolessionals belore Lakinq any
lnal view.
Approval process
1houqh relaLed parLy LransacLions boLh under Lhe 2013
AcL and RC^9 require approval ol similar bodies, Lhere are
dillerences in Lhe condiLions which Lriqqer such approvals.
ParLicularly, RC^9 does noL exempL maLerial relaLed
parLy LransacLions lrom special resoluLion ol disinLeresLed
shareholders based on Lhe criLeria, viz., (i) LransacLion is in
Lhe ordinary course ol business and aL arm's lenqLh, or (ii)
prescribed Lhresholds reqardinq LransacLion value and share
capiLal are noL breached. LisLed companies need Lo consider
Lhe requiremenLs carelully and apply Lhe same in a manner
LhaL compliance wiLh boLh requiremenLs can be ensured. ln
oLher words, Lhey need Lo comply wiLh sLricLer ol Lhe Lwo
requiremenLs.
The 2013 Act
SecLion 188(1) ol Lhe 2013 AcL provides below lor approval ol
relaLed parLy LransacLions:
"(1) LxcepL wiLh Lhe consenL ol Lhe Board ol DirecLors
qiven by a resoluLion aL a meeLinq ol Lhe Board and
sub|ecL Lo such condiLions as may be prescribed, no
company shall enLer inLo any conLracL or arranqemenL
wiLh a relaLed parLy wiLh respecL Lo:
a) Sale, purchase or supply ol any qoods or maLerials
b) Sellinq or oLherwise disposinq ol, or buyinq, properLy
ol any kind
c) Leasinq ol properLy ol any kind
d) Availinq or renderinq ol any services
e) AppoinLmenL ol any aqenL lor purchase or sale ol
qoods, maLerials, services or properLy
l) Such relaLed parLy's appoinLmenL Lo any ollce or
place ol prolL in Lhe company, iLs subsidiary company
or associaLe company, and
q) UnderwriLinq Lhe subscripLion ol any securiLies or
derivaLives Lhereol, ol Lhe company
Provided LhaL no conLracL or arranqemenL, in Lhe case
ol a company havinq a paidup share capiLal ol noL less
Lhan such amounL, or LransacLions noL exceedinq such
sums, as may be prescribed, shall be enLered inLo excepL
wiLh Lhe prior approval ol Lhe company by a special
resoluLion.
Provided lurLher LhaL no member ol Lhe company shall
voLe on such special resoluLion, Lo approve any conLracL
or arranqemenL which may be enLered inLo by Lhe
company, il such member is a relaLed parLy.
Provided also LhaL noLhinq in Lhis subsecLion shall apply
Lo any LransacLions enLered inLo by Lhe company in iLs
ordinary course of business other than transactions
which are noL on an arm's lenqLh basis."
ln accordance wiLh secLion 177(^)(iv) ol Lhe 2013 AcL, one
ol Lhe luncLions ol Lhe AudiL CommiLLee is "approval or any
subsequenL modilcaLion ol LransacLions ol Lhe company wiLh
relaLed parLies."
Under Lhe 2013 AcL, a company needs approval ol Lhe AudiL
CommiLLee, il applicable, on all relaLed parLy LransacLions
and subsequenL modilcaLions LhereLo. 1his is irrespecLive
of whether they are in the ordinary course of business and
consummaLed aL arm's lenqLh or Lhey do noL breach Lhe share
capiLal/LransacLion value Lhresholds prescribed in Lhe Board
Rules.
For a LransacLions meeLinq boLh Lhe criLeria (i) LransacLion is
entered into the ordinary course of business, and
(ii) LransacLion is aL arms' lenqLh price, neiLher Lhe board
approval nor Lhe special resoluLion ol disinLeresLed
shareholders is required. For LransacLions, which are eiLher noL
in Lhe ordinary course ol business or noL aL arm's lenqLh, Lhe
company will need aLleasL approval ol Lhe board, irrespecLive ol
Lhe share capiLal/LransacLion value.
Reqardinq Lhe special resoluLion ol disinLeresLed shareholders,
Lhere is an addiLional exempLion which needs Lo be considered,
viz., Lhe company saLisles boLh Lhe criLeria (i) paidup share
capiLal ol Lhe company is below Lhe prescribed Lhreshold, and
(ii) LransacLion value does noL exceed Lhe prescribed limiL. 1hus,
a company requires approval Lhrouqh shareholder's special
resoluLion aL qeneral meeLinq, il criLeria aL (i) and (ii) below are
meL. Members ol Lhe company, who are relaLed parLies, are noL
permiLLed Lo voLe on Lhe special resoluLion.
(l) RelaLed parLy LransacLions are eiLher noL in Lhe ordinary
course ol business or noL aL arm's lenqLh, and
(ll) Company's paidup share capiLal is noL less Lhan
prescribed limiL, or LransacLion(s) amounL exceeds
speciled Lhreshold.
1here is no chanqe in approval process under Lhe Board Rules. However, moneLary Lhresholds lor passinq special resoluLion have
increased visvis Lhe dralL rules. See 1able 5.
Table 5: Monetary thresholds Ior passing special resolution
Criteria Board Rules Draft rules
Paid-up share capital threshold `10 crores or more `1 crores or more
Transaction value threshold
Sale, purchase or supply ol any qoods
or maLerials (DirecLly or Lhrouqh aqenL)
More Lhan 257 ol annual Lurnover
1oLal LransacLion value durinq Lhe year exceeds
57 ol annual Lurnover or 257 ol neL worLh ol
Lhe company as per iLs lasL audiLed lnancial
sLaLemenLs
Sellinq or oLherwise disposinq ol, or
buyinq, properLy ol any kind (DirecLly
or Lhrouqh aqenL)
More Lhan 107 ol neL worLh
Leasinq ol properLy ol any kind
More Lhan 107 ol neL worLh or 107 ol
Lurnover
Availinq or renderinq ol any services
(DirecLly or Lhrouqh aqenL)
More Lhan 107 ol neL worLh
AppoinLmenL Lo any ollce or place ol
prolL in Lhe company, iLs subsidiary
company or associaLe company
RemuneraLion exceeds `250,000 per
monLh
RemuneraLion exceeds `100,000 per monLh
UnderwriLinq Lhe subscripLion ol
any securiLies ol Lhe company or
derivaLives Lhereol
RemuneraLion exceeds 17 ol neL
worth
RemuneraLion exceeds `1,000,000
1o claim exempLion lrom special resoluLion ol disinLeresLed
shareholders either the transaction has to be in the ordinary
course ol business and aL arm's lenqLh or below Lhe prescribed
Lhreshold. Based on Lhe criLeria above, iL needs Lo be ensured
LhaL paidup share capiLal ol Lhe company is below Lhe Lhreshold
qiven in Lable 5 as well as LhaL Lhe LransacLion value does noL
exceed Lhreshold qiven in Lable 5. ll eiLher ol Lhe Lwo criLeria
is breached, a company will noL be eliqible Lo avail exempLion
unless Lhe LransacLion enLered inLo by Lhe company is in iLs
ordinary course of business and it has been entered into on an
arm's lenqLh basis.
Pevised Clause 49
Under RC^9, all relaLed parLy LransacLions require prior
approval ol Lhe AudiL CommiLLee, irrespecLive ol wheLher
Lhey are maLerial or noL. RC^9 also requires all maLerial
relaLed parLy LransacLions Lo be approved by Lhe shareholders
Lhrouqh special resoluLion. RelaLed parLies should absLain lrom
voLinq on such resoluLions. Unlike Lhe 2013 AcL, RC^9 does
noL exempL maLerial relaLed parLy LransacLions lrom special
resolution of disinterested shareholders based on the criteria,
viz., (i) LransacLion is in Lhe ordinary course ol business and aL
arm's lenqLh, or (ii) prescribed Lhresholds reqardinq LransacLion
value and share capiLal are noL breached.
RC^9 does noL make any relerence Lo Lhe board approval
lor relaLed parLy LransacLions. However, one may arque LhaL
under Lhe principles ol corporaLe qovernance, any maLLer Lo be
relerred Lo Lhe shareholders is rouLed Lhrouqh Lhe board. Also,
under RC^9, one ol Lhe luncLions ol Lhe board is Lo "moniLor
and manaqe poLenLial conlicLs ol inLeresL ol manaqemenL,
board members and shareholders, includinq misuse ol
corporate assets and abuse in related party transactions.
1his suqqesLs LhaL Lhe board also need Lo approve all maLerial
relaLed parLy LransacLions enLered inLo by a lisLed company.
A LransacLion wiLh a relaLed parLy is considered Lo be maLerial
il Lhe LransacLion/LransacLions Lo be enLered inLo individually
or Laken LoqeLher wiLh previous LransacLions durinq a lnancial
year, exceeds 57 ol Lhe annual Lurnover or 207 ol Lhe neL worLh
ol Lhe company as per iLs lasL audiLed lnancial sLaLemenLs,
whichever is hiqher.
Interaction between the 2013 Act and PC49
A lisLed company needs Lo apply sLricLer ol Lhe 2013 AcL and RC^9 requiremenLs. Considerinq Lhe impacL ol Lhe 2013 AcL and
RC^9, Lhe approval requiremenLs will operaLe as below:
(l) 1o comply wiLh RC^9, a lisLed company needs Lo qeL all relaLed parLy LransacLions approved by Lhe AudiL CommiLLee.
lL also needs Lo qeL all maLerial relaLed parLy LransacLions approved by Lhe Board and Special ResoluLion ol DisinLeresLed
Shareholders. 1he exempLions qiven under Lhe 2013 AcL will noL apply.
(ll) For immaLerial LransacLions ol lisLed companies and all relaLed parLy LransacLions ol nonlisLed enLiLies, approval requiremenLs
ol Lhe 2013 AcL apply. lL is noLed LhaL due Lo dillerences in criLeria, even an immaLerial relaLed parLy LransacLion (as per RC^9)
may need board/disinLeresLed shareholder approval under Lhe 2013 AcL. For example, Lhis may arise because LransacLion is
noL in Lhe ordinary course ol business and/or noL on arms' lenqLh basis, and Lhe share capiLal or LransacLion vale Lhresholds are
breached.
Diaqram 2 below explains pracLical applicabiliLy ol Lhe approval process. 1he diaqram illusLraLes approval requiremenLs ol boLh Lhe
2013 AcL and RC^9.
Audit Committee approval,
if applicable
1
Board of Directors approval
Listed company?
Boards approval and
special resolution
of disinterested
shareholders is required.
Special resolution of
disinterested
shareholders is
required.
Special resolution of
disinterested
shareholders is
not required.
Neither boards approval
nor special resolution of
disinterested
shareholders is required.
Disclosure in the board report - Refer Form AOC-2
Related party transactions
NO
NO
NO
NO
NO
Has the transaction been
entered into by the company
in its ordinary course of
business?
Has the transaction been
entered into on arms length
basis?
Yes
Yes
Yes
Yes
No
Is the share capital of the
company below prescribed
limit?
Is the transaction amount
within prescribed threshold
(refer table 5)?
Yes
Yes
1
Under the 2013 Act, non-listed companies, which do not meet the prescribed criteria, are not required to constitute Audit Committee. In such case, Audit Committee approval requirement does not apply.
Is the related party transac-
tion material (RC49)?
1he discussion reqardinq pracLical issues locuses on Lhe 2013
AcL. NoneLheless, mosL ol iL would also be relevanL lor purposes
ol complyinq wiLh Lhe lisLinq requiremenLs. AL appropriaLe
places, we have made relerences Lo RC^9.
5ection 177(4)(iv) oI the 2013 Act requires the Audit
Committee approval on any transaction entered into by
a company with its related parties, including subsequent
modihcation thereto. Is the Audit Committee approval
required prior to execution oI the contract with a related
party? Cr will it be acceptable to obtain the approval aIter the
contract has been executed?
One view is LhaL secLion 177(^)(iv) does noL specilcally use
Lhe word 'prior approval.' Hence, one view is LhaL iL may be
accepLable Lo obLain approval even alLer Lhe execuLion ol Lhe
conLracL. 1he second view is LhaL Lhe Lerm used is 'approval'
and noL 'raLilcaLion.' 1his seems Lo indicaLe LhaL Lhe approval
should be obLained prior Lo execuLion ol Lhe conLracL. 1he
proponenLs ol second view also sLaLe LhaL iL will be more
prudenL lor a company Lo obLain Lhe approval belore enLerinq
inLo any LransacLion wiLh a relaLed parLy. ll Lhe AudiL CommiLLee
does noL approve any previously execuLed conLracL, iL may
have Lhe ellecL ol derailinq Lhe enLire LransacLion and causinq
lnancial loss Lo Lhe company as well as Lhe counLerparLy.
ln case ol lisLed companies, RC^9 specilcally requires all
related party transactions to be preapproved by the Audit
CommiLLee.
WiLh reqard Lo Lhe board approval/special resoluLion ol
disinLeresLed shareholders secLion 188(3) ol Lhe 2013 AcL
provides as below:
"Where any conLracL or arranqemenL is enLered inLo by
a direcLor or any oLher employee, wiLhouL obLaininq Lhe
consenL ol Lhe Board or approval by a special resoluLion
in Lhe qeneral meeLinq under subsecLion (1) and il iL is
noL raLiled by Lhe Board or, as Lhe case may be, by Lhe
shareholders aL a meeLinq wiLhin Lhree monLhs lrom Lhe
daLe on which such conLracL or arranqemenL was enLered
inLo, such conLracL or arranqemenL shall be voidable aL Lhe
opLion ol Lhe Board and il Lhe conLracL or arranqemenL is
with a related party to any director, or is authorised by any
oLher direcLor, Lhe direcLors concerned shall indemnily Lhe
company aqainsL any loss incurred by iL."
ApparenLly, secLion 188(3) does noL inLend Lo allow companies
Lo Lake posLlacLo approval lor relaLed parLy LransacLions.
RaLher, iL prescribes Lhe correcLive measures Lo be Laken and
impacL, il a company does noL comply wiLh Lhe requiremenLs ol
secLion 188(1) on a Limely basis.
Let us assume that a company is entering into related
party transaction requiring the Audit Committee and the
Board approval. From the process perspective, is there any
requirement to obtain the board approval hrst or the Audit
Committee approval hrst?
NeiLher Lhe 2013 AcL and nor Lhe Board Rules prescribe any
parLicular process low/order lor obLaininq required approvals.
For example, Lhere is no specilc requiremenL wheLher a
company should obLain Lhe AudiL CommiLLee approval lrsL
or Lhe Board approval lrsL, il boLh Lhe approvals are needed.
1ypically, one expecLs LhaL Lhe approval ol shareholder, i.e.,
special resolution of disinterested shareholders, will be obtained
only alLer oLher approvals have Laken place. ln oLher cases,
more Lhan one view seems possible.
One view is LhaL secLion 188 qenerally requires Lhe board
approval Lo be obLained belore enLerinq inLo a conLracL
or arranqemenL wiLh Lhe relaLed parLy. However, Lhere
is no clear requiremenL lor Lhe AudiL CommiLLee pre
approval. 1his seems Lo indicaLe LhaL a company can siqn
Lhe aqreemenL wiLh a relaLed parLy by havinq Lhe AudiL
CommiLLee approval as condiLion precedenL. Hence, in one
scenario, Lhe company can Lake Lhe board approval lrsL
and Lhe AudiL CommiLLee approval laLer.
1he second view is LhaL Lhe AudiL CommiLLee is required Lo
acL in accordance wiLh Lhe Lerms ol relerence made by Lhe
board. lL would noL be appropriaLe il Lhe AudiL CommiLLee
re|ecLs a LransacLion, which has already been approved
by Lhe board. Hence, in pracLice, Lhe board may lrsL reler
proposed relaLed parLy LransacLion Lo Lhe audiL commiLLee.
Upon receivinq Lhe audiL commiLLee approval/re|ecLion,
Lhe board will make iLs decision. 1o supporL Lhis view, one
may also draw relerence Lo JJ lrani CommiLLee ReporL
2
.
1he reporL, amonq oLher maLLers, sLaLed LhaL all maLLers
relaLinq Lo relaLed parLy LransacLions and oLher maLLers
involvinq conlicLs ol inLeresL should be relerred Lo Lhe
board only Lhrouqh Lhe AudiL CommiLLee.
2 ReporL daLed 31 May 2005 issued by Lhe LxperL CommiLLee on Lhe Company Law, chaired by Dr. Jamshed J. lrani.
ln case ol lisLed companies, RC^9 requires all relaLed parLy
LransacLions Lo be preapproved by Lhe AudiL CommiLLee. 1his
indicaLes LhaL in case ol lisLed companies, only Lhe second view
should be applied. For nonlisLed companies also, Lhe second
view is prelerred approach. ln oLher words, iL is prelerable
approach Lo qeL Lhe AudiL CommiLLee approval lrsL belore
relerrinq a relaLed parLy LransacLion Lo Lhe board.
Related parties not entitled to vote
For transactions requiring approval through special resolution
at the general meeting, second proviso to the section 188(1)
states that no member oI the company will vote on such
special resolution, iI such members are related parties. PC49
also contains similar requirement Ior approval oI material
related party transactions. Is the prohibition Irom voting
applicable to all shareholders who are related parties? Cr
does it apply to only those related parties who are conhicted
with respect to the specihed transaction?
Consider the example in diagram 3. 5ubsidiary 5 intends to
make royalty payment to Parent P, which is concluded to be
not at arm's length or not in the ordinary course oI business.
Also, the prescribed threshold criteria are breached, requiring
special resolution at the general meeting. Members oI the
company, who are related parties, are not permitted to vote
on the special resolution. It is clear that P is not entitled
to vote on the special resolution. However, it is not clear iI
other related parties also are not entitled to vote. In simple
words, what is not clear is Irom whose perspective the related
parties should be considered. In this case whether it is related
parties oI 5, or related parties oI P who are shareholders in
5 or both or all related parties that may have a conhict oI
interest in that transaction. Particularly, in this Iact pattern,
the question is whether Investor A can vote on the special
resolution.
Public
shareholding
29%
Parent P
51%
Investor A
20%
Subsidiary
S
Diagram 3
NeiLher Lhe 2013 AcL nor Lhe Board Rules nor RC^9 are clear
which relaLed parLies are noL enLiLled Lo voLe. 1his is likely Lo
resulL in mulLiple views on Lhe maLLer.
1he lrsL view is LhaL a perusal ol Lhe second proviso Lo SecLion
188(1) indicaLes LhaL all members ol a company, who are
relaLed parLies, are barred lrom voLinq on special resoluLion Lo
approve a relaLed parLy conLracL/arranqemenL. However, such
a sLricL inLerpreLaLion ol Lhe proviso creaLes an ambiquiLy. Also,
iL is likely Lo resulL in undue hardship Lo Lhe parLies who may
noL be conlicLed in Lhe LransacLion. 1hese parLies may arque
LhaL wiLhouL any reason, Lhey are beinq deprived ol leqal riqhLs
available under Lhe 2013 AcL.
1he supporLers ol lrsL view arque LhaL il cerLain provisions
ol law are noL clear, one needs Lo look aL overall conLexL lor
inLerpreLinq/undersLandinq Lhose requiremenLs. ln Lhis case,
Lhe requiremenLs have been inLroduced Lo avoid conlicL ol
inLeresL. Hence, one should apply requiremenLs keepinq Lhis
conLexL in Lhe mind.
Considerinq Lhe above, supporLers ol Lhe lrsL view arque LhaL
only such members who are relaLed Lo a company and have an
inLeresL in Lhe sub|ecL maLLer ol special resoluLion should noL be
allowed Lo voLe. Hence, in Lhe above example, invesLor A should
noL be barred lrom voLinq unless A is also inLeresLed parLy in
Lhe LransacLion and/or relaLed Lo parenL P.
1he second view is LhaL subsidiary S is inLeresLed in makinq
paymenL Lo iLs parenL P. Hence, iL may aLLempL Lo inluence
decision ol iLs relaLed parLies. ConsequenLly, no relaLed parLy
ol subsidiary S should be enLiLled Lo voLe. Under Lhis view,
invesLor A, who is relaLed parLy Lo S, will also noL be enLiLled Lo
voLe. One ma|or drawback wiLh Lhis view is LhaL invesLor A may
be an unrelaLed parLy Lo P and may wanL Lo sLop such royalLy
paymenL because iL is unreasonable. However, lnvesLor A will
noL be enLiLled Lo voLe.
1he Lhird view is LhaL all relaLed parLies ol ParenL P, who are
also shareholders in subsidiary S, are noL enLiLled Lo voLe.
1he accepLance ol Lhis view may pose addiLional pracLical
challenqes since subsidiary S may noL be aware abouL relaLed
parLies ol P.
1he lourLh view is LhaL relaLed parLies ol boLh S and P (who are
shareholders in S) are noL enLiLled Lo voLe.
We believe LhaL Lhe lrsL view is loqically correcL and probably
relecLs Lhe inLenLion ol Lhe leqislaLor. lL may be appropriaLe
lor Lhe MCA and Lhe SLBl Lo clarily. UnLil such quidance or
clarilcaLion is provided, iL may be appropriaLe lor a company Lo
consulL leqal prolessionals belore Lakinq any lnal view.
Special resolution in case of wholly owned
subsidiaries
In certain cases, it may so happen that all shareholders in
a company are related parties and thereIore not entitled
to vote. For example, consider a scenario where a wholly
owned subsidiary proposes to enter into a transaction with
its holding company. It is concluded that the transaction
requires special resolution at the general meeting. Members
oI the company, who are related parties, are not permitted
to vote on the special resolution. In this case, how does the
subsidiary comply with the special resolution requirement?
1he Board Rules sLaLe LhaL in case ol wholly owned subsidiary,
Lhe special resoluLion passed by Lhe holdinq company will be
sullcienL lor Lhe purpose ol enLerinq inLo Lhe LransacLions
beLween wholly owned subsidiary and holdinq company.
ln many cases, lndian companies are wholly owned subsidiaries
ol overseas companies. A readinq suqqesLs LhaL in such cases,
Lhe overseas company need Lo pass special resoluLion. However,
since Lhe 2013 AcL/RC^9 do noL have any |urisdicLion over Lhe
overseas enLiLies, one may arque LhaL Lhis may noL apply in
such cases.
Consider anoLher example. Assume LhaL XYZ PrivaLe LimiLed
is a |oinL venLure beLween Lhree companies, viz., X LimiLed, Y
LimiLed and Z LimiLed. XYZ is enLerinq inLo a common relaLed
parLy LransacLion wiLh all Lhree shareholders. ln Lhis case, iL
is unclear as Lo how XYZ will comply wiLh Lhe requiremenL
concerning special resolution of disinterested shareholders, if
such resoluLion is needed. Usinq an analoqy ol wholly owned
subsidiaries, one may arque LhaL special resoluLion passed by X
LimiLed, Y LimiLed and Z LimiLed may be sullcienL compliance.
AlLernaLively, iL may also be arqued LhaL since Lhere are no
disinLeresLed shareholders, Lhe requiremenL concerninq special
resoluLion is inlrucLuous lor XYZ LimiLed.
We suqqesL LhaL MCA and SLBl provide an appropriaLe quidance
on such issues.
Master agreements
With regard to the Audit Committee/Board/disinterested
shareholders' approval required on related party transactions,
can a company take a view that it will be suIhcient compliance
iI it obtains the required approval on the master agreements
("MA") with broad terms agreed therein? Cr is it mandatory
to obtain separate approval on each transaction?
NeiLher Lhe 2013 AcL nor Lhe Board Rules nor RC^9 provide
any quidance on wheLher a company needs Lo obLain separaLe
approval ol Lhe AudiL CommiLLee/Board/disinLeresLed
shareholders, as applicable, on each conLracL/LransacLion or
iL is sullcienL compliance il Lhe company obLains Lhe required
approval on Lhe MA wiLh Lhe broad Lerms aqreed Lherein.
Under Lhe second view, Lhe company does noL require separaLe
approval lor any subaqreemenL/purchase order execuLed
beLween parLies.
One view is LhaL secLion 188 relers Lo 'any conLracL or
arranqemenL.' 1herelore, separaLe approval lor each conLracL,
includinq subaqreemenL, is required. However, Lhe second view
is LhaL Lhe Lerm arranqemenL has wider meaninq Lhan Lhe Lerm
'conLracL/aqreemenL.' Hence, one may arque LhaL lor sLandard
conLracLs involvinq sale/renderinq ol qoods/services, iL is
possible Lo obLain Lhe requisiLe approval only on Lhe MA, which
lays down all criLical Lerms and condiLions such as Lype ol qood/
service, pricinq arranqemenL, crediL period and paymenL Lerms.
Based on Lhe Lerms aqreed in Lhe MA, subsequenL LransacLions
are consummaLed and Lhese LransacLions are closely aliqned
wiLh Lhe Lerms aqreed in Lhe MA. ln Lhis case, one may arque
LhaL subsequenL purchase orders/subaqreemenLs are merely
an execuLion ol whaL has already been aqreed and approved.
1hey do noL resulL inLo any new conLracL/arranqemenL. Hence,
Lhere is no need lor obLaininq any separaLe approval on Lhe
same. However, il Lhe subaqreemenL conLains Lerms, which are
dillerenL lrom Lhe MA, or Lhere is any modilcaLion in Lerms or
Lhe underlyinq circumsLances have chanqed, separaLe approval
is needed. Also, lor Lhe conLracLs, which are hiqhly complex
and specialized in naLure, iL may noL be possible Lo delne all
criLical Lerms under Lhe MA. RaLher, a company needs Lo obLain
separaLe approval lor each such conLracL.
Since Lhe 2013 AcL or Board Rules or RC^9 do noL deal wiLh
Lhis aspecL, a company may need Lo evaluaLe iLs specilc lacLs
and circumsLances and consulL prolessionals, includinq leqal
prolessionals, belore Lakinq any lnal view.
Non-reciprocal relationship
As mentioned earlier, identihcation oI related parties under
the 2013 Act is not based on the principle oI reciprocity. It
is possible that one company identihes other company as its
related party. However, it does not necessarily mean that the
second company will also identiIy the hrst one as its related
party. Let us assume that ABC Limited and DEF Limited are
two public companies. Based on its evaluation and criteria
prescribed, ABC determines that DEF is its related party.
However, Ior DEF, ABC is not a related party. ABC is proposing
to sell a big piece oI land to DEF. It is determined that the
transaction is not in the ordinary course oI business. Also, the
prescribed threshold criteria are breached.
In the above case, how the approval process will work? Do
both ABC and DEF need to obtain approvals required Ior
related party transaction?
lL appears LhaL Lhe idenLilcaLion ol relaLed parLies and
relaLed parLy LransacLions is an independenL exercise lor each
company. Such idenLilcaLion is likely Lo deLermine, amonq
oLher maLLers, approvals required. ln Lhe example above, ABC
has idenLiled DLF as iLs relaLed parLy and, Lherelore, proposed
land deal is relaLed parLy LransacLion lrom ABC's perspecLive.
1his requires ABC Lo obLain Lhe requisiLe approvals, viz., Lhe
AudiL CommiLLee and Board approval and special resoluLion ol
disinLeresLed shareholders, as appropriaLe.
From DLF's perspecLive, ABC is noL a relaLed parLy. Hence,
one may arque LhaL proposed land deal is noL a relaLed parLy
LransacLion lor DLF. Basis Lhis, iL may be arqued LhaL DLF need
noL obLain approvals required lor relaLed parLy LransacLions.
Ordinary course of business
Since RC^9 does noL conLain any exempLion lrom approval
process based on Lhe 'ordinary course ol business' criLerion,
Lhis discussion is noL direcLly relevanL under RC^9. However,
demonsLraLinq LhaL a LransacLion has been enLered inLo by
a company in iLs ordinary course ol business is likely Lo help
in Lhe approval process and demonsLraLinq qood corporaLe
qovernance. Hence, Lhe lollowinq discussion may be uselul even
under RC^9 lrom Lhis perspecLive.
What is meant by the phrase 'ordinary course oI business'?
What are the key Iactors to be considered in determining
whether a transaction is in the ordinary course oI business?
1he phrase 'ordinary course ol business' is noL delned under
Lhe 2013 AcL or Lhe Board Rules. lL seems LhaL Lhe ordinary
course ol business will cover Lhe usual LransacLions, cusLoms
and pracLices ol a business and ol a company.
ln many cases, iL may be apparenL LhaL a LransacLion has been
enLered inLo by a company in iLs 'ordinary course ol business.'
For example, a car manulacLurinq company sells cars Lo iLs
sisLer concern. 1he price charqed lor Lhe sale is Lhe same as
whaL iL charqes Lo oLher corporaLe cusLomers who are unrelaLed
parLies. ln Lhis case, iL seems clear LhaL Lhe company has
enLered inLo Lhe LransacLion in iLs ordinary course ol business.
Similarly, in cerLain exLreme cases, iL may be clear LhaL Lhe
LransacLion is hiqhly unusual and/or exLraordinary lrom Lhe
company as well as iLs business line perspecLive. Hence, iL is
noL in Lhe ordinary course ol business. SA 550 Related Parties
conLains Lhe lollowinq examples ol LransacLions ouLside an
enLiLy's normal course ol business:
Complex equiLy LransacLions, such as corporaLe
restructurings or acquisitions
Transactions with offshore entities in jurisdictions with
weak corporaLe laws
1he leasinq ol premises or Lhe renderinq ol manaqemenL
services by Lhe enLiLy Lo anoLher parLy il no consideraLion
is exchanqed
Sales LransacLions wiLh unusually larqe discounLs or
returns
1ransacLions wiLh circular arranqemenLs, lor example,
sales wiLh a commiLmenL Lo repurchase, or
1ransacLions under conLracLs whose Lerms are chanqed
belore expiry.
1he above examples are |usL illusLraLive and noL conclusive. ln
cases where related party transaction is not falling under either
ol Lhe Lwo exLremes, Lhe assessmenL ol wheLher a LransacLion
is in Lhe ordinary course ol business is likely Lo be hiqhly
sub|ecLive, |udqemenLal and will vary on caseLocase basis. No
auLhoriLaLive quidance is available on makinq Lhis assessmenL.
1he experience indicaLes LhaL companies may like Lo consider
Lhe lollowinq aspecLs:
WheLher Lhe LransacLion is covered in Lhe main ob|ecLs or
ob|ecLs incidenLal Lo Lhe main ob|ecLs as envisaqed in Lhe
Memorandum ol AssociaLion
WheLher a LransacLion is usual or unusual, boLh lrom Lhe
company and iLs line ol business perspecLive. 1o illusLraLe,
a parLicular Lelecom company may noL have ouLsourced
iLs l1 process in Lhe pasL. However, mosL ol oLher Lelecom
companies have already ouLsourced Lheir l1 process Lo
save cosL. ln Lhis case, one may arque LhaL Lhe LransacLion
may be unusual lor Lhe company; however, iL is noL unusual
lor Lhe Lelecom indusLry.
Frequency: ll a LransacLion is happeninq quiLe lrequenLly
over a period ol Lime, iL is more likely Lo be LreaLed as an
ordinary course ol business. However, Lhe inverse does noL
necessarily hold Lrue.
WheLher LransacLion is Lakinq place aL arm's lenqLh: SA
550 conLains "sale wiLh unusually larqe discounLs or
reLurns" as an example ol LransacLion which is noL in Lhe
normal course ol business. Hence, arms' lenqLh price is
also one lacLor lor Lhis evaluaLion. However, iL may noL
be sole deLermininq lacLor. ln cerLain cases, a company
may be able Lo demonsLraLe LhaL even LransacLions aL
below cosL price are in Lhe ordinary course ol business.
For example, il a company is sellinq cars aL below cosL Lo
increase iLs markeL share. 1he same price is applicable Lo
all cusLomers, includinq relaLed parLies.
Business purpose ol Lhe LransacLion: For example, a
company has 20 loor buildinq lor iLs ollce. OuL ol Lhis,
Lwo loors are vacanL and Lhe company leases Lhe same
Lo iLs sisLer concern aL markeL renL. ln Lhis case, one may
arque LhaL lease has been enLered inLo by Lhe company in
iLs ordinary course ol business. Consider anoLher example.
A solLware company purchased land and consLrucLed
building thereon just to lease the entire building to its
qroup company. ln Lhis case, iL may be dillculL Lo |usLily
LhaL LransacLion represenLs ordinary course ol business.
WheLher LransacLion is done on similar basis wiLh oLher
third parties
Size and volume ol LransacLion
Finally, Lhe assessmenL ol wheLher a LransacLion is in Lhe
ordinary course ol business is likely Lo be very sub|ecLive,
|udqemenLal and will vary on caseLocase basis. 1he lacLors
menLioned above may help companies in makinq Lhis
assessmenL. However, Lhey cannoL Lake inLo accounL Lhe unique
circumsLances ol each business and LransacLion or replace Lhe
exercise ol |udqmenL by Lhe manaqemenL.
Arms length
Since RC^9 does noL conLain any exempLion lrom Lhe approval
process based on Lhe "arms' lenqLh" criLerion, Lhis discussion
is noL direcLly relevanL under RC^9. However, demonsLraLinq
LhaL a LransacLion has been enLered inLo by a company on
an arms' lenqLh basis is likely Lo help in Lhe approval process
and demonsLraLinq qood corporaLe qovernance. Hence, Lhe
lollowinq discussion may be uselul even under RC^9 lrom Lhis
perspecLive
Are there any specihc methodologies/approaches to be
used Ior identiIying whether a related party transaction
has been entered into on an arms' length basis? II no such
methodologies/approaches are prescribed under the 2013
Act, can a company use the methodologies/approaches
prescribed under other statutes, e.g., the Incometax Act?
What are other key Iactors to be considered?
1he 2013 AcL or Lhe Board Rules do noL prescribe
meLhodoloqies and approaches, which may be used Lo
deLermine wheLher a LransacLion has been enLered inLo on an
arm's lenqLh basis. One may consider Lhe lollowinq aspecLs in
Lhis reqard:
1P quidelines under Lhe lncomeLax AcL, 1961, prescribe
meLhodoloqies/approaches Lo be used lor deLermininq
arms' lenqLh price. ln absence ol specilc quidance
under Lhe 2013 AcL, one may lnd meLhodoloqies/
approaches under Lhe 1P quidelines Lo be uselul.
However, iL may be noLed LhaL Lhe ob|ecLive ol Lhe 1P
quidelines is dillerenL lrom LhaL ol Lhe 2013 AcL. 1he
purpose of the TP guidelines is to ensure that there is no
Lax leakaqe. 1he 2013 AcL requiremenLs aim Lo proLecL
minoriLy shareholders' inLeresL. Hence, one may need Lo
lacLor Lhese dillerences in ob|ecLive and make suiLable
ad|usLmenLs Lo Lhe meLhodoloqies/approaches under Lhe
1P quidelines.
SecLion 188 does noL require Lhe 'reqisLered valuer'
cerLilcaLion Lo deLermine 'arm's lenqLh' price. However,
one may evaluaLe Lhe same on case by case basis. ln many
cases, wheLher Lhe LransacLion is aL arms' lenqLh price may
be clear lrom Lhe lace ol Lhe LransacLion iLsell, wiLhouL
any lurLher analysis. For example, reler earlier example
where a car manulacLurinq company sells cars Lo iLs sisLer
concern aL Lhe same price which is charqed Lo unrelaLed
corporaLe cusLomers. ln Lhis case, one may arque LhaL
price is aL arms' lenqLh wiLhouL involvinq reqisLered valuer.
ln oLher cases, complex analysis/valuaLion may be needed.
ln such cases, Lhe involvemenL ol reqisLered valuer may
help companies in demonsLraLinq LhaL LransacLion has
been enLered inLo on arms' lenqLh basis.
Under Lhe 2013 AcL, an explanaLion sLaLes LhaL Lhe
expression 'arm's lenqLh LransacLion' means a LransacLion
between two related parties that is conducted as if they
are unrelaLed, so LhaL Lhere is no conlicL ol inLeresL.
NeiLher Lhe 2013 AcL nor Lhe Board Rules clarily how
a company can demonsLraLe Lhe absence ol 'conlicL ol
inLeresL.' From common parlance perspecLive, iL appears
LhaL Lo demonsLraLe Lhis, a company will need Lo show
LhaL Lhe exisLence ol special relaLionship beLween Lhe
contracting parties has not affected the transaction and its
criLical Lerms, includinq Lhe price, quanLiLy and oLher Lerms
and condiLions qoverninq Lhe LransacLion. Hence, Lerms ol
Lhe LransacLion are comparable Lo Lhose which unrelaLed
parLies would have aqreed lor a similar LransacLion.
Disclosure in the board report
SecLion 188 (2) ol Lhe 2013 AcL requires LhaL every conLracL/
arranqemenL enLered inLo under secLion 188 (1) will be relerred
Lo in Lhe board reporL alonq wiLh |usLilcaLion.
RC^9 prescribes Lhe lollowinq addiLional disclosures lor lisLed
companies:
Policy on dealing with related parties on its website and in
the annual report
DeLails ol maLerial relaLed parLy LransacLions on a quarLerly
basis alonq wiLh Lhe compliance reporL on corporaLe
qovernance
Disclosure by senior manaqemenL Lo Lhe Board ol all
maLerial lnancial and commercial LransacLions where Lhey
have a personal inLeresL LhaL may have a poLenLial conlicL
wiLh Lhe inLeresL ol Lhe company
The 2013 Act requires that every contract/ arrangements
entered into under section 188(1) is reIerred in the board's
report, along with |ustihcation Ior entering into such
transaction. Does it require a company to disclose even
the transactions, which are entered into by the company
in its ordinary course oI business and at arms' length price
and thereIore, require neither board approval nor special
resolution oI disinterested shareholders, in the board report?
From a readinq ol 188(2), iL seems clear LhaL only LransacLions
covered under Lhe secLion 188(1) require disclosure in Lhe
board reporL. 1ransacLions meeLinq Lhe exempLion criLeria in
Lhird proviso, viz., LransacLions enLered inLo by a company in
iLs ordinary course ol business and aL arms' lenqLh price, are
compleLely ouLside Lhe scope ol secLion 188(1). Hence, Lhe
2013 AcL does noL require disclosure ol such LransacLions in
Lhe board reporL.
WhilsL Lhe above view seems clear lrom Lhe 2013 AcL, Lhe MCA
has prescribed Form AOC2 in Lhe AccounLs Rules lor disclosure
ol relaLed parLy LransacLions in Lhe board reporL. 1he lorm
includes disclosure lor (i) all (boLh maLerial and immaLerial)
relaLed parLy LransacLions which are noL on arms' lenqLh basis,
and (ii) maLerial relaLed parLy LransacLions which are on an
arms' lenqLh basis. lL seems LhaL in prescribinq disclosures aL (ii)
above, Lhe Form AOC2 has qone beyond disclosures required
under Lhe 2013 AcL.
Since Lhe Form noLiled by Lhe MCA has prescribed specilc
disclosures, we believe LhaL a company may, ouL ol abundanL
cauLion, disclose maLerial relaLed parLy LransacLions even il
Lhey are enLered inLo on an arms' lenqLh basis. We believe LhaL
Lhe MCA should resolve Lhis inconsisLency and amend Form
AOC2 Lo omiL disclosures noL required by Lhe 2013 AcL.
This disclosure regarding related party transactions in the board
reporL is applicable Lo boLh lisLed and nonlisLed companies.
ln addiLion, lisLed companies need Lo make disclosures
required under RC^9. 1o avoid/ minimize duplicaLion ol similar
disclosures and qive meaninqlul inlormaLion Lo users, a lisLed
company may need Lo sLrucLure iLs board reporL, annual
corporaLe qovernance reporL and annual reporL carelully.
1he 2013 AcL or Lhe Board Rules do noL conLain any specilc
LransiLional provisions. 1he SLBl Circular reqardinq amendmenL
Lo Lhe RC^9 sLaLes as below:
"1he provisions ol Clause ^9(Vll) as qiven in ParLB shall
be applicable Lo all prospecLive LransacLions. All exisLinq
maLerial relaLed parLy conLracLs or arranqemenLs as
on Lhe daLe ol Lhis circular which are likely Lo conLinue
beyond 31 March 2015 shall be placed lor approval ol
Lhe shareholders in Lhe lrsL Ceneral MeeLinq subsequenL
Lo 1 OcLober 201^. However, a company may choose Lo
qeL such conLracLs approved by Lhe shareholders even
belore 1 OcLober 201^."
How does the applicability oI the 2013 Act impact related
party contracts that have been previously entered into by
a company and are alive on the commencement oI 5ection
188? Can a company take a view that these contracts are
grandIathered and hence no Iresh approval is required? What
will be the implication oI any subsequent amendment to these
contracts?
1he 2013 AcL or Lhe Board Rules do noL provide any specilc
quidance on Lhis issue. One view is LhaL Lhe 2013 AcL is
applicable Lo all conLracLs, includinq conLracLs previously
enLered inLo by a company. Hence, il a company enLers inLo
any new LransacLion/subaqreemenL/purchase order under Lhe
previously siqned conLracL, iL will need Lo obLain approvals,
il any, required under Lhe 2013 AcL. However, Lhe second
view is LhaL secLion 188 does noL prescribe any reLrospecLive
applicaLion. RaLher, iL is applicable only Lo new conLracLs/
arranqemenL enLered inLo by a company. Hence, one may
arque LhaL 'qrandlaLherinq' may be permiLLed. However, any
modilcaLion in Lhe naLure and Lype ol LransacLion wiLh relaLed
parLies will Lriqqer approval requiremenLs under Lhe 2013 AcL.
For lisLed companies, RC^9 requires LhaL all exisLinq maLerial
relaLed parLy conLracLs or arranqemenLs, which are likely Lo
conLinue beyond 31 March 2015, should be placed lor approval
ol Lhe shareholders in Lhe lrsL Ceneral MeeLinq subsequenL Lo
1 OcLober 201^. However, a company may choose Lo qeL such
conLracLs approved by Lhe shareholders even belore 1 OcLober
201^.
Hence, a lisLed company, lor maLerial conLracLs/arranqemenLs
likely Lo conLinue beyond 31 March 2015, needs Lo comply wiLh
Lhe approval requiremenLs ol RC^9. ln oLher cases, iL seems
likely LhaL qrandlaLherinq may be permiLLed. However, any
modilcaLion in Lhe naLure and Lype ol LransacLion wiLh relaLed
parLies will Lriqqer approval requiremenLs under Lhe 2013 AcL.
We recommend LhaL belore Lakinq any lnal view on Lhe
maLLer, a nonlisLed company should consulL wiLh Lhe leqal
prolessionals.
Loans to directors and
subsidiaries
ln accordance wiLh secLion 185 ol Lhe 2013 AcL, a company
cannoL, direcLly or indirecLly, qive any loan, includinq loan
represenLed by a book debL, Lo any ol iLs direcLors or Lo any
oLher person in whom Lhe direcLor is inLeresLed or qive any
quaranLee or provide any securiLy in connecLion wiLh any loan
Laken by him or such oLher person.
1he 2013 AcL explains Lhe expression 'any oLher person in
whom direcLor is inLeresLed' Lo include "a body corporaLe, Lhe
board ol direcLors, manaqinq direcLor or manaqer, whereol
is accusLomed Lo acL in accordance wiLh Lhe direcLions or
instructions of the board, or of any director or directors,
ol Lhe lendinq company." ApparenLly, Lhis explanaLion may
cover subsidiary companies. Hence, one inLerpreLaLion was
LhaL a holdinq company cannoL qive any loan Lo/quaranLee/
securiLy on behall ol iLs subsidiary. 1his view, alonq wiLh Lhe
lacL LhaL secLion 185 is applicable lrom 12 SepLember 2013,
has creaLed siqnilcanL hardship lor many companies. 1his was
parLicularly lor Lhe reason LhaL in many cases, a subsidiary
may noL be able Lo raise lnance wiLhouL supporL ol iLs holdinq
company.
Since Lhe noLilcaLion ol secLion 185, Lhe MCA has Lried
addressinq Lhis hardship Lhrouqh various circulars; however,
Lhese circulars were noL very clear.
1o address Lhis issue, Lhe Board Rules provide Lhe lollowinq
exempLions. 1hese exempLions are sub|ecL Lo a condiLion LhaL
loans should be uLilized by Lhe subsidiary company lor iLs
principle business acLiviLies.
Any loan made by a holdinq company Lo iLs wholly owned
subsidiary company or any quaranLee qiven or securiLy
provided by a holdinq company in respecL ol any loan made
Lo iLs wholly owned subsidiary company is exempLed lrom
Lhe requiremenLs under 185.
Any quaranLee qiven or securiLy provided by a holdinq
company in respecL ol loan made by any bank or lnancial
insLiLuLion Lo iLs subsidiary company (includes subsidiaries
LhaL are noL wholly owned) is exempLed lrom Lhe
requiremenLs under Lhis secLion.
ln oLher words, Lhere seems Lo be prohibiLion only wiLh respecL
Lo qivinq ol loans Lo a subsidiary LhaL is noL a wholly owned
subsidiary. lL is undersLandable LhaL mosL companies will Lake
Lhe posiLion sLaLed in Lhe Board Rules, Lhouqh Lhe concern
wheLher Lhe rules can override Lhe 2013 AcL remains.
Loans and
invesLmenLs
Loans and investments by
companies
SecLion 186 ol Lhe 2013 AcL requires LhaL a company will
noL (i) qive loan Lo any person/oLher body corporaLe, (ii) qive
quaranLee or provide securiLy in connecLion wiLh a loan Lo any
person/oLher body corporaLe, and (iii) acquire securiLies ol any
oLher body corporaLe, exceedinq Lhe hiqher ol:
607 ol iLs paidup share capiLal, lree reserves and
securiLies premium, or
1007 ol iLs lree reserves and securiLies premium.
1he 2013 AcL sLaLes LhaL lor providinq loan/qivinq quaranLee/
securiLy or acquirinq securiLy exceedinq Lhe above limiL, a
company will need Lo Lake prior approval by means ol a special
resoluLion passed aL Lhe qeneral meeLinq.
Unlike Lhe 1956 AcL, Lhe 2013 AcL did noL conLain any
exempLion lor loan made/quaranLee qiven/securiLy provided by
a holdinq company Lo iLs wholly owned subsidiary companies.
ConsequenLly, iL was required LhaL a company will include
Lhe amounL ol loan/quaranLee/securiLy Lo iLs wholly owned
subsidiary as well in Lhe 607/1007 limiL. 1his was likely Lo
creaLe hardship lor many subsidiary companies, which are
siqnilcanLly dependenL on Lheir parenL lor lnancinq. Also, in
many cases, loans qiven, quaranLee and securiLy provided by
Lhe parenL may have immediaLely breached Lhe 607 or 1007
limiL.
1o address Lhe above challenqe, Lhe Board Rules provide LhaL
where a loan or quaranLee is qiven or where a securiLy has been
provided by a company Lo iLs wholly owned subsidiary company
or a |oinL venLure company, or acquisiLion is made by a holdinq
company ol Lhe securiLies ol iLs wholly owned subsidiary
company, Lhe requiremenL concerninq special resoluLion aL
Lhe qeneral meeLinq will noL apply. However, Lhe company will
disclose the details of such loans or guarantee or security or
acquisiLion in Lhe lnancial sLaLemenLs.
From a readinq ol Lhe Board Rules concerninq secLion 185 and
186, Lhe lollowinq posiLion emerqes:
A parenL company can qive loan Lo/ provide securiLy
or guarantee on behalf of its wholly owned subsidiary
company or acquire securiLies ol wholly owned
subsidiaries. 1hese loans/quaranLees/securiLy will noL be
included Lo deLermine wheLher Lhe company has breached
Lhe 607/1007 limiL. 1his ellecLively brinqs Lhe posiLion aL
par wiLh whaL was prevalenL under Lhe 1956 AcL.
A parenL company can provide securiLy or quaranLee on
behall ol iLs subsidiary company which is noL wholly owned
subsidiary company. However, iL cannoL qive any loan Lo
such subsidiary company. 1hese quaranLees/securiLy will
be included in deLermininq wheLher Lhe company has
breached Lhe 607 or 1007 limiL.
Loan qiven Lo, securiLy/quaranLee provided on behall ol Lhe
|oinL venLure company will noL be included in deLermininq
wheLher Lhe company has breached Lhe 607 or 1007 limiL.
ln Lhe Board Rules, Lhere is no relaxaLion/exempLion on
Lhe requiremenL concerninq charqinq ol inLeresL on loans.
Hence, iL appears LhaL a company may need Lo charqe
inLeresL aL Lhe speciled raLe on all iLs loans, includinq loans
qiven Lo wholly owned subsidiaries and |oinL venLures. ln
accordance wiLh Lhe 2013 AcL, raLe ol inLeresL cannoL be
less Lhan prevailinq yield on one year, Lhree year, lve year
or Len year CovernmenL SecuriLy closesL Lo Lhe Lenor ol Lhe
loan.
1hese chanqes in Lhe rules help resolvinq many pracLical
challenqes LhaL were likely Lo arise. However, an unresolved
issue is LhaL a company can no lonqer qive inLeresL lree loan Lo
iLs wholly owned subsidiary. 1his is likely Lo creaLe siqnilcanL
hardship lor many qroups. Also, Lhe concern reqardinq rules
overridinq Lhe law remains.
Omnibus resolution
One ol Lhe paraqraphs in Lhe Board Rules sLaLes LhaL special
resoluLion passed aL a qeneral meeLinq Lo qive any loan or
quaranLee or invesLmenL or provide any securiLy will specily Lhe
LoLal amounL up Lo which Lhe board ol direcLors is auLhorized
Lo qive such loan or quaranLee, Lo provide securiLy or acquire
invesLmenLs. 1his suqqesLs LhaL omnibus resoluLion will be
permiLLed. 1he dralL rules had permiLLed omnibus resoluLion
only lor quaranLees.
Investment in mutual funds
SecLion 186 ol Lhe 2013 AcL deals wiLh all loans and
invesLmenLs made by a company, includinq loans eLc. Lo a
person. Hence, Lhere is a concern wheLher invesLmenLs in
muLual lunds will also be included in Lhe 607/1007 limiL. Under
Lhe 1956 AcL, secLion 372A dealL only wiLh inLercorporaLe
loans and invesLmenLs. Hence, such invesLmenLs were noL
included in Lhe 607/1007 limiL.
lL may be noLed LhaL in secLion 186, subparaqraph dealinq wiLh
loans, guarantee and security refer to person as well as body
corporaLe. However, Lhe subparaqraph dealinq wiLh invesLmenL
covers only acquisiLion ol securiLies ol a body corporaLe. ln
an earlier decision, Lhe Supreme CourL has held LhaL muLual
lunds consLiLuLed as LrusL are noL body corporaLe. 1his seems
Lo suqqesL LhaL secLion 186 does noL apply Lo invesLmenLs in
muLual lunds and Lhey will noL be included in Lhe 607/1007
limiL.
Foreign currency loans
Under Lhe 2013 AcL, Lhe raLe ol inLeresL cannoL be less Lhan
prevailinq yield on one year, Lhree year, lve year or Len year
CovernmenL SecuriLy closesL Lo Lhe Lenor ol Lhe loan. 1his is
likely Lo resulL in an apparenL issue in case ol loreiqn currency
loans. For example, an lndian company is makinq loan Lo a body
corporaLe in Japan where inLeresL raLes are neqliqible. ln such a
case, iL may noL be appropriaLe Lo require companies Lo charqe
inLeresL based on Lhe raLes applicable Lo qovernmenL securiLies
in lndia. 1o address Lhis issue, Lhe MCA should clarily LhaL
currency ol Lhe qovernmenL securiLies should be consisLenL
wiLh Lhe currency ol loan.
Loan between fellow subsidiaries
As menLioned earlier, Lhere appears Lo be a prohibiLion on
Lhe parenL company qivinq loans Lo iLs subsidiary LhaL is noL
a wholly owned subsidiary. 1his raises an inLeresLinq issue
wheLher a company can qive loan Lo iLs lellow subsidiary.
Assume LhaL parenL P has Lwo subsidiaries, viz., S1 and S2. 1he
parenL owns 757 equiLy capiLal ol S1 and 1007 equiLy capiLal
ol S2. lL seems clear LhaL P cannoL qive loan Lo S1. 1he issue is
wheLher S2 can qive loan Lo S1.
One view is LhaL S2 will noL have any business/commercial
reason Lo qive loan Lo S1, excepL Lheir relaLionship wiLh Lhe
ParenL P. Hence, iL may be arqued LhaL S2 is qivinq loan Lo
S1 on behall ol iLs parenL. Since secLion 185 ol Lhe 2013 AcL
prohibiLs provision ol boLh direcL and indirecL loans, some
believe LhaL loan proposed Lo be qiven by S2, in subsLance,
conLravenes Lhe 2013 AcL.
Accordinq Lo Lhe supporLers ol Lhe second view, one should noL
qeneralize Lhe siLuaLion Lo sLaLe LhaL a subsidiary will always
act on behalf of its parent and apply all the restrictions of the
parenL Lo iLs subsidiary. ln Lheir view, il one can esLablish LhaL
P has noL provided any backLoback lundinq Lo S2 and S2 has
made iLs independenL decision Lo provide loan Lo S1, S2 will noL
be acLinq on behall ol iLs parenL P. 1he supporLers ol Lhis view
believe LhaL in such cases, S2 can provide loan Lo S1, wiLhouL
qeLLinq impacLed by Lhe prohibiLion on iLs parenL company.
Companies should consider lacL paLLern specilc Lo Lheir
siLuaLion and seek leqal consulLaLion belore proceedinq on
Lhese maLLers.
Loan from foreign parent
lL appears LhaL Lhe resLricLions under secLions 185 and 186
ol Lhe 2013 AcL apply Lo a company which is providinq Lhe
loan. 1hese secLions do noL prohibiL Lhe borrower company
lrom accepLinq loan lrom iLs parenL. LeL us assume LhaL an
overseas company inLends Lo provide inLeresL lree loan Lo iLs
parLly owned lndian subsidiary. ln Lhis case, one may arque LhaL
since secLions 185/186 do noL apply Lo Lhe loreiqn company,
Lhere is no resLricLion on Lhe company qivinq loan Lo iLs lndian
subsidiary. Similarly, Lhese secLions do noL prohibiL lndian
subsidiary lrom accepLinq loan lrom iLs loreiqn parenL. Hence, iL
may be arqued LhaL such loan is noL in conLravenLion ol secLions
185 and 186 ol Lhe 2013 AcL. lL may be appropriaLe lor Lhe
MCA Lo clarily Lhis.
One paraqraph in Lhe Board Rules sLaLe LhaL where Lhe
aqqreqaLe ol Lhe loans and invesLmenL so lar made, quaranLee
and securiLy so lar provided, alonqwiLh Lhe invesLmenL,
loan, quaranLee or securiLy proposed Lo be made, exceed Lhe
limiLs prescribed, Lhen no invesLmenL or loan will be made
or quaranLee will be qiven or securiLy will be provided unless
previously auLhorized by special resoluLion passed aL Lhe
qeneral meeLinq.
An explanaLion Lo Lhe above paraqraph ol Board Rules clariles
LhaL iL would be sullcienL compliance il such special resoluLion
is passed wiLhin one year lrom Lhe daLe ol noLilcaLion ol Lhis
secLion.
1he main paraqraph in Lhe Board Rules and explanaLion LhereLo
are dralLed in a conlusinq manner. A collecLive readinq ol Lhe
Lwo indicaLes LhaL lor loans exisLinq aL Lhe enacLmenL daLe, i.e.,
1 April 201^, and new loans qranLed durinq Lhe lrsL year, a
company can pass special resoluLion by 31 March 2015 il Lhe
607/1007 limiL is breached. ln oLher words, a company is noL
required Lo Lake priorapproval by special resoluLion lor makinq
loans or invesLmenL or providinq securiLy/quaranLee durinq Lhe
lrsL year in excess ol Lhe limiL. ln such cases, resoluLion may be
passed by 31 March 2015.
lL is undersLandable LhaL many companies may preler Lakinq
Lhis view. However, like many oLher insLances, Lhere is a
concern LhaL Board Rules may be overridinq Lhe 2013 AcL since
Lhe 2013 AcL requires prior approval by special resoluLion. We
suqqesL LhaL belore Lakinq lnal view, a company may like Lo
consulLs iLs leqal prolessionals.
1he 2013 AcL requires LhaL every company wiLh neL worLh ol
`500 crore or more, or Lurnover ol `1,000 crore or more or
a neL prolL ol `5 crore or more durinq any lnancial year will
consLiLuLe a CSR commiLLee.
1he CSR Rules sLaLe LhaL every company, which ceases Lo
be a company covered under Lhe above criLeria lor Lhree
consecuLive lnancial years, will noL be required Lo (a) consLiLuLe
Lhe CSR CommiLLee, and (b) comply wiLh oLher CSR relaLed
requiremenLs, Lill Lhe Lime iL aqain meeLs Lhe prescribed criLeria.
Constitution of CSR committee
1he 2013 AcL requires a company, which meeLs Lhe CSR
applicabiliLy criLeria, Lo consLiLuLe a CSR commiLLee comprisinq
Lhree or more direcLors. 1he 2013 AcL also sLaLes LhaL ouL
of these three directors, at least one director should be an
independenL direcLor.
1he CSR Rules sLaLe LhaL a nonlisLed public company
or a privaLe company, which is noL required Lo appoinL
an independenL direcLor as per Lhe 2013 AcL/ DirecLors'
AppoinLmenL Rules, can have iLs CSR CommiLLee wiLhouL an
independenL direcLor. Also, a privaLe company havinq only Lwo
direcLors on iLs board can consLiLuLe Lhe CSR CommiLLee wiLh
Lhe Lwo direcLors.
Corporate social
responsibility
Some people arque LhaL Lhe CSR Rules are chanqinq Lhe
requiremenLs ol Lhe 2013 AcL. Hence, an issue arises wheLher
a subordinaLe leqislaLion can override Lhe main leqislaLion.
However, mosL people are likely Lo welcome Lhe clarilcaLions
provided in Lhe CSR Rules.
C5P expenditure
ln accordance wiLh Lhe 2013 AcL, Lhe board ol each company
covered under Lhe CSR requiremenL needs Lo ensure LhaL
Lhe company spends, in every lnancial year, aL leasL 27 ol
iLs averaqe neL prolLs made durinq Lhe Lhree immediaLely
precedinq lnancial years in pursuance ol CSR policy. NeiLher
Lhe 2013 AcL nor Lhe CSR Rules prescribe any specilc penal
provision il a company lails Lo spend Lhe 27 amounL. However,
the board, in its report, needs to specify the reasons for not
spendinq Lhe speciled amounL.
Scope/ applicability
5ection 135(1) oI the 2013 Act, dealing with the applicability
criteria Ior C5P requirements, reIers to net worth/turnover/
net proht 'during any hnancial year'. What is meant by
the phrase 'during any hnancial year'? Does it require a
company to consider its net worth/turnover/net proht Ior the
immediately preceding hnancial year or the current hnancial
year?
One view is LhaL 'lnancial year' relers Lo compleLed period/year
in respecL ol which Lhe lnancial sLaLemenLs ol a company are
madeup. 1he supporLers ol Lhis view reler Lhe lollowinq:
1he delniLion ol 'neL prolL' in Lhe CSR Rules relers Lo neL
prolL as per Lhe lnancial sLaLemenLs.
A proviso Lo Lhe rule 3(1), dealinq wiLh CSR applicabiliLy Lo
loreiqn companies, relers Lo neL worLh/Lurnover/neL prolL
as per Lhe balance sheeL and P&L.
A company cannoL deLermine wiLh cerLainLy wheLher a
criLerion is meL Lill Lhe compleLion ol a lnancial year. 1o
illusLraLe, iL may be possible LhaL cumulaLive Lurnover ol
a company breaches prescribed `1,000 crore limiL aL one
poinL in Lime durinq Lhe year. However, Lhe posiLion may
chanqe aL a laLer daLe, say, due Lo siqnilcanL sale reLurn.
1hus, a company uses iLs lnancial sLaLemenLs lor Lhe
immediaLely precedinq lnancial year Lo deLermine CSR
applicabiliLy.
1he supporLers ol Lhe second view emphasize on Lhe use ol
Lhe word 'durinq'. 1hey menLion LhaL dicLionary meaninq ol
Lhe word 'durinq' is 'LhrouqhouL Lhe course' or 'aL one poinL
wiLhin a period ol Lime'
3
. Hence, Lhis word is more connecLed
wiLh Lhe concurrenL evaluaLion or evaluaLion LhrouqhouL
Lhe period. Considerinq Lhese arqumenLs, Lhe supporLers
ol Lhis view believe LhaL a company considers iLs neL worLh/
Lurnover/neL prolL durinq Lhe currenL year Lo deLermine CSR
applicabiliLy. For example, none ol Lhe Lhresholds are currenLly
meL in Lhe case ol ABC LimiLed. 1hey are likely Lo be meL
durinq Lhe lnancial year 201516. ABC complies wiLh Lhe CSR
requiremenLs as soon as iL meeLs Lhose criLeria in 201516, and
cannoL delay iL Lo 1 April 2016 and onwards.
A clarilcaLion lrom Lhe MCA will help in seLLlinq Lhis issue.
UnLil such quidance or clarilcaLion is provided, our prelerred
approach is Lo apply Lhe second view, i.e., a company considers
iLs neL worLh/Lurnover/neL prolL durinq Lhe currenL year Lo
deLermine CSR applicabiliLy. Under Lhis view, iL may so happen
LhaL a company may meeL Lhe prescribed criLeria Loward Lhe
yearend. 1hus, iL may noL be able Lo spend 27 ol iLs averaqe
neL prolL on CSR acLiviLies durinq Lhe currenL year. 1his may
require Lhe company Lo explain iLs lacLual posiLion and reason
lor noL spendinq in Lhe board reporL.
WhilsL Lwo views seem possible lor decidinq Lhe CSR
applicabiliLy, Lhe provisions lor exiL lrom Lhe CSR requiremenLs
seem more clear. 1he rules sLaLe LhaL a company can move ouL
ol CSR requiremenLs only il Lhe prescribed criLeria are noL meL
lor Lhree consecuLive years.
Paragraph 3(1) oI the C5P Pules states as below:
"Every company including its holding or subsidiary, and
a Ioreign company dehned under clause (42) oI section
2 oI the Act having its branch oIhce or pro|ect oIhce in
India, which Iulhls the criteria specihed in subsection
(1) oI section 135 oI the Act shall comply with the
provisions oI section 135 oI the Act and these rules."
Does it mean that iI a company is covered under the C5P
requirements, its parent/subsidiary will also be automatically
covered by the C5P requirements?
1he reason lor relerrinq Lo holdinq/subsidiary company in Lhe
rule is noL clear. ApparenLly, Lwo views seem possible. 1he
lrsL view is LhaL a parenL/subsidiary company cannoL claim
exempLion lrom Lhe CSR applicabiliLy merely because iLs
subsidiary/parenL company complies wiLh Lhe same. AlLhouqh,
Lhe paraqraph conLains Lhe phrase 'includinq iLs holdinq
or subsidiary,' iL also sLaLes LhaL 'which lullls Lhe criLeria
speciled in subsecLion (1) secLion 135 ol Lhe 2013 AcL'.
Hence, each company in Lhe qroup should evaluaLe wheLher iL
meeLs Lhe prescribed criLeria. ll so, iL will comply wiLh Lhe CSR
requiremenLs.
1he second view is LhaL il a company saLisles Lhe prescribed
criLeria lor CSR applicabiliLy, CSR requiremenLs auLomaLically
become applicable Lo iLs holdinq and subsidiary companies. lL
does noL maLLer wheLher Lhey saLisly Lhe prescribed criLeria or
noL.
1he lormer view seems a more plausible inLenLion, which Lhe
MCA should conlrm.
3 hLLp://www.macmillandicLionary.com/dicLionary/briLish/durinq
hLLp://www.LhelreedicLionary.com/durinq
Do the C5P requirements also apply to the Ioreign companies,
viz., Indian branch/pro|ect oIhces oI Ioreign companies
operating in India?
NeiLher secLion 135 ol Lhe 2013 AcL nor secLions 379 Lo 393
dealinq wiLh loreiqn companies nor Lhe Foreiqn Companies
Rules reler Lo applicabiliLy ol Lhe CSR requiremenLs Lo loreiqn
companies havinq lndian/branch pro|ecL ollce.
However, paraqraph 3(1) ol Lhe CSR Rules, as reproduced in
Lhe previous discussion, makes iL clear LhaL a loreiqn company
havinq iLs branch/pro|ecL ollce in lndia will comply wiLh Lhe CSR
requiremenLs, il Lhe branch/pro|ecL ollce lullls Lhe prescribed
criLeria.
Hean|n of net roht
In accordance with section 135(1) oI the 2013 Act, one oI the
criteria Ior the C5P applicability is that a company has a net
proht oI `5 crore or more during any hnancial year. The 2013
Act does not specihcally explain the meaning oI net proht Ior
this purpose.
In accordance with section 135(5) oI the 2013 Act, a
company meeting the C5P applicability criteria needs to
spend, in every hnancial year, at least 27 oI its average net
prohts made during the three immediately preceding hnancial
years, in pursuance oI its C5P policy. An explanation to the
section 135(5) states that Ior the purpose oI this section,
the averae net proht will be calculated in accordance with
section 198. 5ection 198 deals with calculation oI proht
Ior managerial remuneration and requires specihc addition/
deduction to be made in the proht Ior the year.
In addition, C5P Pules dehne "net proht" as below. The C5P
Pules do not reIer whether the dehnition is relevant Ior the
applicability criteria or C5P expenditure.
"'Net proht' means the net proht oI a company as per
its hnancial statement prepared in accordance with the
applicable provisions oI the Act, but shall not include the
Iollowing, namely:
(i) Any proht arising Irom any overseas branch or
branches oI the company, whether operated as a
separate company or otherwise; and
(ii) Any dividend received Irom other companies in India,
which are covered under and complying with the
provisions oI section 135 oI the Act."
How should one resolve the above contradiction?
1here may be Lwo possible ways ol lookinq aL Lhe delniLion
ol neL prolL in Lhe CSR Rules. 1he lrsL view is LhaL Lhe CSR
Rules delne neL prolL lor Lhe purposes ol applicabiliLy as well
as Lhe amounL Lo be spenL on CSR acLiviLies. 1he supporLers
ol Lhis view arque LhaL boLh under secLion 198 and Lhe CSR
Rules, sLarLinq poinL Lo make ad|usLmenLs is neL prolL as per
Lhe lnancial sLaLemenLs. 1o reconcile Lwo requiremenLs, Lhey
believe LhaL a company uses neL prolL as per Lhe lnancial
sLaLemenLs as sLarLinq poinL and make ad|usLmenL required
under Lhe CSR Rules Lo arrive aL "neL prolL" under Lhe
CSR Rules. 1he company uses "neL prolL" so deLermined
Lo make specilc ad|usLmenLs required under secLion 198.
1he supporLers ol Lhis view arque LhaL iL beLLer achieves Lhe
ob|ecLive lor which Lhe Lerm "neL prolL" was delned in Lhe
CSR Rules, i.e., a company can exclude dividends received lrom
oLher companies covered under CSR lrom neL prolL so as Lo
ensure LhaL a qroup does noL incur CSR expendiLure on Lhe
same income Lwice. Also, iL helps in ensurinq LhaL only income
earned in lndia is sub|ecL Lo CSR expendiLure.
1he second view is LhaL Lhe CSR Rules delne neL prolL in Lhe
conLexL ol Lhe applicabiliLy criLerion lor CSR requiremenLs. 1he
amounL LhaL needs Lo be spenL on CSR is based on Lhe average
net rohts deLermined in accordance wiLh secLion 198. 1he
supporLers ol Lhis view believe LhaL under secLion 198, debiLs
and crediLs are allowed only lor iLems speciled in Lhe secLion. ll
a company makes any debiL/crediL lor any oLher iLem, includinq,
iLems speciled in Lhe CSR Rules, neL prolL so deLermined is noL
as per secLion 198. Hence, il Lhis view is Laken, Lhere will be no
conlicL beLween Lhe 2013 AcL and Lhe CSR Rules. However, iL
implies LhaL prolL arisinq lrom overseas branches and dividend
received lrom oLher lndian companies covered under Lhe CSR
requiremenL will noL qeL excluded lrom Lhe 'averaqe neL prolL',
lor deLermininq CSR spend.
lL may be arqued LhaL Lhe lrsL view beLLer relecLs inLenLion
ol includinq 'neL prolL' delniLion in Lhe CSR Rules. Also, one
may arque LhaL iL conlorms Lo Lhe harmonious inLerpreLaLion
ol Lhe 2013 AcL and Lhe CSR Rules. Hence, Lhe lrsL view is
prelerred approach. However, Lhis view is noL beyond doubL and
arqumenLs can be made Lo supporL second views also. Since
Lhis is a leqal maLLer, we suqqesL LhaL a company consulLs Lhe
leqal prolessionals belore Lakinq any lnal view on Lhe maLLer.
CSR expenditure and its accounting
The 2013 Act requires the board oI each company covered
under the C5P to ensure that the company spends, in every
hnancial year, at least 27 oI its average net prohts made
during the three immediately preceding hnancial years in
pursuance oI its C5P policy. II a company Iails to spend the
27 amount, is there any legal/constructive obligation on
companies to spend the shortIall in the subsequent years?
NeiLher Lhe 2013 AcL nor Lhe CSR Rules prescribe any specilc
penal provision il a company lails Lo spend Lhe amounL.
Also, there does not appear to be any legal obligation on
companies Lo make qood shorL spend ol one year in Lhe
subsequenL years. 1his indicaLes LhaL Lhere is no leqal obliqaLion
on companies Lo incur CSR expendiLure. However, due Lo
disclosure ol shorL spend in Lhe board reporL, many repuLed
companies can illallord noL Lo spend Lhe prescribed amounL.
Hence, Lhe naminq and shaminq policy will creaLe an implied
pressure on companies Lo spend Lhe requisiLe amounL. Also,
repuLed companies, who have noL been able Lo spend Lhe
requisiLe amounL in one year, may Lry Lo spend Lhe shorLlall in
subsequenL years.
What is the appropriate accounting Ior C5P expenditure
incurred? Is a company required to charge such amount as
an expense to P&L? Alternatively, can a company take a view
that C5P is not a mandatory expense and/or expense relating
to business and thereIore, it should be charged directly to
equity?
1he arqumenL LhaL CSR expense is a volunLary cosL and/or
expense noL relaLed Lo business does noL appear Lo be Lenable.
A company needs Lo incur Lhis expendiLure under Lhe qoverninq
law, viz., Lhe 2013 AcL. Nonincurrence ol Lhis expendiLure may
severely impacL Lhe repuLaLion ol a company.
ALLenLion is drawn Lo paraqraph 5 ol AS 5 which sLaLes as
below:
"All iLems ol income and expense which are recoqnised in
a period should be included in Lhe deLerminaLion ol neL
prolL or loss lor Lhe period unless an AccounLinq SLandard
requires or permiLs oLherwise."
The Framework for the Preparation and Presentation of
Financial Statements delnes Lhe Lerm "expense" as below:
"Expenses are decreases in economic benelLs durinq Lhe
accounLinq period in Lhe lorm ol ouLlows or depleLions ol
assets or incurrences of liabilities that result in decreases
in equity, other than those relating to distributions to
equiLy parLicipanLs."
Considerinq Lhe above, we believe LhaL CSR expendiLure is an
iLem ol expense lor Lhe company which needs Lo be charqed Lo
P&L. 1his approach may also supporL Lhe company's claim Lo a
Lax deducLion.
Let us assume that a company has incurred lower amount on
C5P activities in year 1. It expects to coverup the short
spent amount in the subsequent years. Is the company
required to create a provision toward such shortspent
amount?
As discussed earlier, Lhere is no leqal obliqaLion on a company
Lo spend on CSR or cover lor Lhe shorLlalls in Lhe spend in
subsequenL years. lL may so happen LhaL a company does noL
spend Lhe requisiLe amounL, buL discloses LhaL iL will cover Lhe
shorLlalls in subsequenL years, Lhereby creaLinq a consLrucLive
obliqaLion lor iLsell.
WhilsL Lhere is no doubL LhaL provision lor consLrucLive
obliqaLion is required under lFRS and lndAS; Lhe answer Lo
Lhis quesLion under lndian CAAP seems clear lrom Lhe Lwo
LAC opinions. ln boLh Lhese opinions, Lhe LAC seems Lo have
Laken a view LhaL consLrucLive obliqaLion are noL provided lor.
ln Lhe recenL opinion published in The Chartered Accountant
ol July 2013, Lhe LAC opined "Since as per DeparLmenL ol
Public LnLerprises Cuidelines, Lhere is no such obliqaLion on Lhe
enLerprise, provision should noL be recoqnised. Accordinqly,
Lhe commiLLee is ol Lhe view LhaL Lhe requiremenL in Lhe DPL
Cuidelines lor creaLion ol a CSR budqeL can be meL Lhrouqh
creaLion ol a reserve as an appropriaLion ol prolLs raLher Lhan
creaLinq a provision as per AS 29. On Lhe basis ol Lhe above,
Lhe commiLLee is ol Lhe view LhaL in Lhe exLanL case, iL is noL
appropriaLe Lo recoqnise a provision in respecL ol unspenL
expendiLure on CSR acLiviLies. However, a CSR reserve may be
creaLed as an appropriaLion ol prolLs."
AnoLher opinion is conLained in Volume 28, Ouery no 26. ln
Lhis query LAC opined "A published environmenLal policy ol
Lhe company by iLsell does noL creaLe a leqal or conLracLual
obliqaLion. From Lhe FacLs ol Lhe Case and copies ol documenLs
furnished by the querist, it is not clear as to whether there
is any legal or contractual obligation for afforestation,
compensaLory alloresLaLion, soil conservaLion and reloresLaLion
Lowards loresL land. ln case Lhere is any leqal or conLracLual
obliqaLion, compensaLory alloresLaLion, lellinq ol exisLinq
Lrees or even acquisiLion ol land could be Lhe obliqaLinq
evenL dependinq on Lhe provisions ol law or Lhe Lerms ol Lhe
conLracL."
Let us assume that a company incurs higher C5P expenditure
during any hnancial year, say, 37 oI its average net proht. Can
it carry Iorward the beneht oI higher expenditure and use the
same to spend lower amount in the subsequent years?
NeiLher Lhe 2013 AcL nor CSR Rules provide any quidance on
wheLher a company can carry lorward Lhe benelL ol hiqher
expendiLure and use Lhe same Lo spend lower amounL in
subsequenL years.
Since Lhere is no leqal obliqaLion lor CSR expendiLure in
Lhe lrsL place, Lhe quesLion ol carryinq lorward Lhe benelL
ol hiqher expendiLure in one year Lo spend lower amounLs
in subsequenL years may noL be so relevanL. Also, lrom an
accounLinq perspecLive, Lhe excess expendiLure may noL meeL
Lhe delniLion ol an asseL, exacLly like Lhe lower expendiLure noL
meeLinq Lhe delniLion ol a liabiliLy. 1his requires a company Lo
charqe oll Lhe enLire expendiLure incurred durinq Lhe year Lo iLs
P&L.
Can a company incur capital expenditure on C5P related
activities? II so, how such expenditure will be included in
the 27 limit? Will the company include the entire amount
in the year in which capital expenditure is incurred or only
depreciation oI the capital expenditure will be included in 27
limit Ior each year?
Paraqraph 7 ol Lhe CSR Rules explains CSR expendiLure in an
inclusive manner. lL sLaLes as below:
"CSR expendiLure shall include all expendiLure includinq
conLribuLion Lo corpus, or on pro|ecLs or proqrams
relaLinq Lo CSR acLiviLies approved by Lhe Board on Lhe
recommendaLion ol iLs CSR CommiLLee, buL does noL
include any expendiLure on an iLem noL in conlormiLy or
noL in line wiLh acLiviLies which lall wiLhin Lhe purview ol
Schedule Vll ol Lhe AcL."
Considerinq Lhe above, one may arque LhaL a company can
incur boLh capiLal and revenue expendiLure on CSR acLiviLies.
However, no quidance is available on how capiLal expendiLure
will be included in Lhe CSR limiL. Many believe LhaL il Lhe
conLribuLion is made Lo a LrusL, Lhen iL does noL maLLer wheLher
Lhe LrusL has spenL iL on capiLal asseLs or operaLinq expendiLure,
and boLh would be counLed in Lhe 27 limiL ol Lhe currenL year.
However, il a company iLsell is incurrinq CSR expendiLure, Lhe
capiLal asseLs will be owned by Lhe company. ConsequenLly, in
such cases, one may arque LhaL only depreciaLion on Lhe capiLal
asseL will be counLed as Lhe CSR expendiLure. Some income
may be qeneraLed lrom use ol Lhe capiLal asseL earmarked
lor CSR acLiviLy, say, lee collecLed lrom school run lor poor
children. 1he CSR Rules are clear LhaL such income will noL lorm
parL ol Lhe business prolL lor Lhe company; raLher, iL needs Lo
be incurred on CSR acLiviLies.
1he MCA may consider clarilyinq Lhis issue. UnLil such quidance
is provided, iL may be appropriaLe lor a company Lo consulL
leqal prolessionals belore Lakinq lnal view.
The rule 4(5) states that the C5P pro|ects/programs/
activities, which beneht only the employees oI a company
and their Iamilies, will not be considered as C5P activity.
Let us assume that a company is incurring expenditure on
C5P activities which beneht both (i) general public, and
(ii) employees oI the company and their Iamilies. Will the
expenditure on such activities be included in the 27 C5P
expenditure limit?
A readinq ol Lhe rule ^(5) indicaLes LhaL employees ol a
company and Lheir lamily should noL be sole benelciaries ol
Lhe CSR acLiviLies beinq carried ouL by a company. However,
iL may be accepLable, il LoqeLher wiLh Lhe qeneral public,
some employees also qeL benelL lrom Lhe CSR acLiviLies ol a
company. ln our view, Lo meeL Lhis requiremenL in subsLance, iL
needs Lo be ensured LhaL employees and Lheir lamilies are noL
Lhe mosL siqnilcanL users.
1o illusLraLe, assume LhaL a company is operaLinq a school lor
poor children. ln Lhe same school, children ol some low paid
workers ol Lhe company have also been qranLed admission.
1hese children consLiLuLe 5107 ol Lhe LoLal school populaLion.
ln Lhis case, expendiLure on runninq Lhe school will qualily as
Lhe CSR acLiviLy. Consider anoLher scenario. 1he company
has a lacLory aL a place which is very lar lrom Lhe ciLy. 1o
laciliLaLe educaLion lor children ol iLs employees, Lhe company
is operaLinq a school near Lo iLs lacLory. ln Lhe school, Lhe
company has also qranLed admission Lo Lhe children ol some
villaqers sLayinq close Lo Lhe lacLory; however, Lhe number
ol such children is relaLively small, say, 5107. ln Lhis case, iL
may be dillculL Lo arque LhaL Lhe expendiLure qualiles as CSR
expendiLure.
A relaLed issue arises in cases where a company is disLribuLinq
iLs producLs aL lree ol cosL, purely as CSR acLiviLy. LeL us
assume LhaL a pharmaceuLical company disLribuLes lree
medicine lor LreaLmenL ol poor people. lL is also assumed LhaL
Lhe acLiviLy qualiles as CSR under Lhe 2013 AcL read wiLh Lhe
CSR Rules. 1he cosL ol producLion ol medicine qiven lree is
`65 and Lheir maximum sellinq price is `100. 1he 2013 AcL
or Lhe CSR Rules do noL provide any quidance on wheLher Lhe
cosL or sellinq price ol medicine should be included in Lhe CSR
expendiLure. However, lrom common parlance perspecLive, iL
may be arqued LhaL acLual cosL is Lhe expendiLure incurred by
a company and iL may noL include any opporLuniLy cosL. Hence,
Lhe prelerred view is LhaL acLual cosL ol producLion (i.e., acLual
expendiLure incurred) should be considered lor Lhis purpose
and Lhe amounL spenL by pharmaceuLical company on CSR is
`65
Let us assume that a company has created a trust to carry
out its C5P activities. 5hould the company consolidate that
trust under A5 21?
1he lCAl has considered Lhe issue reqardinq Lhe consolidaLion
of trust in the Guidance Note on Accounting for Employee
Share-based Payment. 1he Cuidance NoLe sLaLes LhaL AS 21
requires consolidation of only those controlled entities which
provide economic benelLs Lo Lhe company. Since an LSOP
LrusL does noL provide any economic benelL Lo Lhe company
in Lhe lorm ol reLurn on Lhe invesLmenL, iL is noL required be
consolidaLed.
1ypically, LrusLs creaLed lor CSR acLiviLies are independenL
and Lhe company is noL a benelciary. One may arque LhaL
no economic benelLs, in lorm ol reLurn on invesLmenL, low
back Lo Lhe company. Hence, Lhe CSR LrusL should noL be
consolidaLed.
A company makes payment to an implementation agency Ior
carrying out C5P activities on its behalI. 5hould the company
treat payment made to an implementation agency or actual
expenditure incurred by the agency as C5P expenditure?
1he implemenLaLion aqency carries ouL Lhe underlyinq acLiviLies
on Lhe company's behall. 1he rules require Lhe CSR commiLLee
Lo moniLor Lhe acLiviLies ol Lhe aqency. FurLher, Lhe aqency
needs Lo provide periodic reporLs on Lhe pro|ecLs/acLiviLies
underLaken and expendiLure incurred Lo Lhe company. 1hese
aspecLs suqqesL LhaL any paymenL made by a company Lo
Lhe implemenLaLion aqency does noL discharqe Lhe company
ol iLs obliqaLion. RaLher, Lhe aqency is holdinq money on Lhe
company's behall and iL needs Lo be ensured LhaL Lhe amounL
is acLually spenL on Lhe sLaLed purpose. Hence, one may arque
LhaL any amounL paid by a company Lo Lhe implemenLinq
aqency is only an advance paymenL. lL cannoL be LreaLed as CSR
expendiLure, unLil Lhe expendiLure is acLually incurred by Lhe
aqency.
How should a newly incorporated company comply with the
requirement concerning 27 C5P expenditure? Let us assume
that MNC Limited is incorporated during the hnancial year
201415. MNC met C5P applicability criteria in the hrst
year oI incorporation itselI. How can MNC comply with the
requirement concerning C5P expenditure 27 oI average net
proht Ior the three immediately preceding hnancial years?
1wo views seem possible. 1he lrsL view is LhaL secLion
135(5) requires 27 ol Lhe averaqe neL prolLs made durinq
Lhree immediaLely precedinq lnancial years Lo be spenL on
CSR acLiviLies. Since MNO was noL in exisLence lor Lhe pasL
Lhree years and does noL have prolL/loss available lor Lhree
precedinq lnancial years, CSR expendiLure requiremenL is noL
applicable Lo iL. ln oLher words, Lhe CSR requiremenL lor MNO
will be meL only alLer iL has a hisLory ol Lhree lnancial years.
1he second view is LhaL when a company is in exisLence lor less
Lhan Lhree years, Lhe averaqe ol periods in exisLence should
be considered. JusL because Lhe company is in exisLence lor
less Lhan Lhree years, does noL make Lhe requiremenL ol CSR
redundanL.
lL may be appropriaLe lor Lhe MCA Lo clarily Lhis issue. UnLil
such quidance or clarilcaLion is provided, one may arque LhaL iL
is noL necessary lor a company Lo be in exisLence lor 3 years Lo
sLarL incurrinq CSR expendiLure. Hence, Lhe second view seems
Lo be Lhe prelerred approach.
Can a company incur expenditure on activities not covered
under the 5chedule VII and include the same in the 27
expenditure limit?
1he CSR Rules are clear LhaL only Lhe expendiLure incurred on
acLiviLies menLioned in Lhe Schedule Vll is included in Lhe 27
expendiLure limiL.
The requirements concerning C5P are applicable Irom 1 April
2014. For companies covered under the requirement, how
does the requirement concerning 27 expenditure apply in the
hrst year?
A readinq ol Lhe 2013 AcL and Lhe CSR rules suqqesLs LhaL
in Lhe lrsL year ol applicaLion, a company covered under
Lhe requiremenL needs Lo incur 27 ol iLs averaqe neL prolL
lor pasL 3 years (i.e., lnancial year 201112, 201213 and
20131^) on Lhe CSR acLiviLies. LeL us assume LhaL a company
covered under Lhe CSR requiremenLs has earned neL prolL ol
`50 crores, (`12 crores) (neL loss) and `3^ crores durinq Lhe
immediaLely precedinq Lhree years. ln Lhis case, Lhe company's
averaqe neL prolL is `2^ crores i.e., oneLhird ol (`50 crores
`12 crores + `3^ crores). Hence, Lhe company needs Lo spend
27 ol iLs averaqe neL prolL, i.e., 27 ol `2^ crores, on CSR
acLiviLies.
For companies having other than 31 March yearend, an
additional issue is whether they are required to apply the C5P
requirements Irom 1 April 2014 or Irom the beginning oI their
next hnancial year. Will a company having 31 December year
end apply the requirement Irom 1 April 2014 or 1 January
2015 onward?
lnLeresLinqly, Lhe CSR Rules sLaLe LhaL reporLinq requiremenLs
ol Lhe 2013 AcL will apply Lo lnancial years commencinq on or
alLer 1 April 201^. However, Lhere is no such clear quidance on
Lhe consLiLuLion ol CSR commiLLee and/or CSR expendiLure.
One view is LhaL a company deLermines il iL meeLs Lhe
Lhresholds speciled in secLion 135(1) on a lnancial year
basis. Once Lhe applicabiliLy criLeria is meL, Lhe company seLs
up a CSR commiLLee and sLarLs spendinq 27 ol iLs averaqe neL
prolLs deLermined in accordance wiLh secLion 198 ol Lhe 2013
AcL. 1hus, a company wiLh a calendar year end will examine
Lhis requiremenL aL 1 January 2015 and sLarL spendinq lor Lhe
calendar year 2015. 1hus, iL will noL be required Lo spend on
CSR lor Lhe year ended 31 December 201^.
1he second view is LhaL since Lhe secLion is applicable lrom
1 April 201^, Lhe inLenLion is Lo make companies spend lrom
LhaL daLe onwards. 1he Lhree years ol averaqe neL prolL lor a
calendar year company would comprise ol calendar year 2011,
2012 and 2013.
1he MCA may clarily Lhis issue. Pendinq Lhe issue ol such
quidance/clarilcaLion, iL may be noLed LhaL CSR requiremenLs
ol Lhe 2013 AcL are primarily driven by disclosure
requiremenLs. Since iL is clear LhaL disclosures will apply lrom
Lhe lnancial year beqinninq on or alLer 1 April 201^, iL may
be arqued LhaL oLher CSR requiremenLs will also apply lrom
Lhe same daLe. Hence, view 1 is Lhe prelerred approach. 1his
implies LhaL a company, which has calendar yearend and meeLs
Lhe prescribed criLeria, will apply CSR requiremenLs lrom 1
January 2015 onward.

Composition oI the board/
nonexecutive directors
BoLh under Lhe 2013 AcL and RC^9, direcLors are caLeqorized
inLo Lwo classes, viz., execuLive direcLors (LD) and non
execuLive direcLors. NonexecuLive direcLors are lurLher sub
caLeqorized inLo independenL direcLors (lD) and oLhers (NLD).
4
WhilsL Lhe 2013 AcL recoqnizes Lhe concepL ol LD, lD and NLD,
iL prescribes minimum requiremenL only in respecL ol lD. For Lhe
balance composiLion, a company is lree Lo choose beLween LD
and NLD. ln conLrasL, RC^9 requires LhaL Lhe board ol direcLors
ol a lisLed company should have an opLimum combinaLion ol
execuLive and nonexecuLive direcLors. lL also requires LhaL
minimum 507 ol Lhe board should comprise ol nonexecuLive
direcLors, which include boLh lDs and NLDs.
NeiLher Lhe 2013 AcL nor Lhe DirecLors' AppoinLmenL Rules nor
RC^9 conLain any specilc inlormaLion abouL luncLions, roles
and responsibiliLies ol NLD. WiLh reqard Lo liabiliLy ol NLD, Lhe
2013 AcL sLaLes LhaL NLD, noL beinq a promoLer or KMP ol
Lhe company, will be held liable, only in respecL ol such acLs ol
omission or commission by a company which had occurred wiLh
his knowledqe, aLLribuLable Lhrouqh board processes, and wiLh
his consenL or connivance or where he had noL acLed diliqenLly.
RC^9 conLains such a clause lor lD, buL noL lor NLDs.
Corporate
qovernance
From a pracLical perspecLive, unlike an lD, an NLD is noL
expecLed Lo be independenL ol Lhe company and iLs promoLers/
shareholders, eLc. AL Lhe same Lime, an NLD does noL lorm parL
ol Lhe execuLive manaqemenL Leam.
ln accordance wiLh Lhe Hiqqs ReporL published by Lhe BriLish
qovernmenL in 2003, NLDs are expecLed Lo play key role in Lhe
lollowinq areas:
(I) Strategy: NLDs should consLrucLively challenqe and
conLribuLe Lo Lhe developmenL ol sLraLeqy.
(II) Performance: NLDs should scruLinise and moniLor Lhe
perlormance ol manaqemenL.
(III) Risk: NLDs should saLisly Lhemselves LhaL lnancial
inlormaLion is accuraLe and LhaL lnancial conLrols and
sysLems ol risk manaqemenL are robusL and delensible.
(IV) People: NLDs are responsible lor deLermininq appropriaLe
levels ol remuneraLion ol execuLive direcLors and have a
prime role in appoinLinq and where necessary removinq
senior manaqemenL, and in succession planninq.
^ For Lhe purposes ol Lhis publicaLion, oLher nonexecuLive direcLors, i.e., nonexecuLive direcLors, oLher Lhan independenL
direcLors, are relerred Lo as "NLD."
Woman director
1he 2013 AcL requires prescribed class ol companies Lo have aL leasL one woman direcLor on Lhe board. ln accordance wiLh Lhe AcL,
exisLinq companies meeLinq Lhe prescribed criLeria need Lo comply wiLh Lhe requiremenL wiLhin oneyear.
1he DirecLors' AppoinLmenL Rules conLain criLeria lor appoinLmenL ol woman direcLor which is similar Lo whaL was proposed under
Lhe dralL rules. See Lable 6 below.
Table : Criteria Ior appointment oI woman director
Company Directors' Appointment Pules Draft Rules
LisLed companies All companies All companies
Nonlisted public companies meeting either oI the Iollowing two criteria
Paidup share capiLal `100 crores or more `100 crores or more
1urnover `300 crores or more `300 crores or more
Under Lhe dralL rules, nonlisLed public companies, which meL
Lhe prescribed criLeria, were qiven Lhree year Limelrame Lo
comply wiLh Lhe requiremenL. 1his Lime limiL has been removed
lrom Lhe DirecLors' AppoinLmenL Rules.
1he DirecLors' AppoinLmenL Rules also require Lhe lollowinq:
A newly incorporaLed company, which meeLs Lhe
prescribed criLeria, needs Lo appoinL a woman direcLor
wiLhin six monLhs lrom Lhe daLe ol iLs incorporaLion.
1he board needs Lo lllup any inLermiLLenL vacancy ol
woman direcLor aL Lhe earliesL buL no laLer Lhan Lhe
immediaLe nexL board meeLinq or Lhree monLhs lrom Lhe
daLe ol such vacancy, whichever is laLer.
RC^9 also requires all lisLed companies Lo have aLleasL one
woman direcLor on Lhe board. RC^9 is applicable lrom 1
OcLober 201^ and does noL allow any LransiLional provision Lo
meeL Lhis requiremenL. 1his suqqesLs LhaL all lisLed companies
will need Lo have aLleasL one woman direcLor on Lheir board,
on or belore 1 OcLober 201^. However, nonlisLed public
companies meeLinq Lhe prescribed criLeria will need Lo appoinL
woman direcLor wiLhin one year lrom Lhe daLe ol enacLmenL ol
Lhe 2013 AcL, i.e., Lhey need Lo appoinL woman direcLor by 31
March 2015.
In accordance with the Directors' Appointment Pules one oI
the criteria for appointment of woman director in non-listed
public companies is that the company has paidup share
capital of `100 crore or more. For this purpose, will the paid
up share capital include nonconvertible preIerence shares
also? Will the securities premium received on issue oI shares
also be included in the paidup share capital?
SecLion 2(6^) ol Lhe 2013 AcL delnes Lhe Lerm "paidup share
capiLal" Lo mean "such aqqreqaLe amounL ol money crediLed
as paidup as is equivalenL Lo Lhe amounL received as paidup in
respecL ol shares issued and also includes any amounL crediLed
as paidup in respecL ol shares ol Lhe company, but does not
include any other amount received in respect of such shares,
by whatever name called." (Emphasis added)
ln accordance wiLh secLion 2(8^) ol Lhe 2013 AcL, share means
a share in Lhe share capiLal ol a company and includes sLock.
ln accordance wiLh secLion ^3, share capiLal ol a company can
be ol Lwo kinds, viz., equiLy share capiLal and prelerence share
capiLal. lL does noL dillerenLiaLe beLween converLible and non
converLible prelerence shares. Moreover, Lhe delniLion ol "LoLal
share capiLal," qiven in Lhe DelniLion Rules, Lo include paidup
equiLy share capiLal and converLible prelerence share capiLal
is relevanL only lor Lhe delniLion ol Lerms subsidiary company
and associaLe company. 1he same delniLion cannoL be used lor
any oLher purpose.
Hence, we believe LhaL lor Lhe appoinLmenL ol woman direcLor,
paidup share capiLal includes paidup equiLy share capiLal and
paidup prelerence share capiLal, wheLher converLible or noL.
Also, lrom Lhe words hiqhliqhLed in secLion 2(6^), iL appears
LhaL paidup share capiLal includes only amounL received
Loward lace value ol shares. AmounL received Loward securiLies
premium is noL included in Lhe paidup share capiLal. Also, Lhe
share applicaLion money pendinq alloLmenL is noL included in
Lhe paidup share capiLal.
An explanation to the criteria Ior appointment oI woman
director states that "Ior the purposes oI this rule, it is hereby
clarihed that the paidup share capital or turnover, as the
case may be, as on the last date oI latest audited hnancial
statements will be taken into account." In this regard, the
Iollowing issues need to be considered:
Let us assume that a company is getting its quarterly
hnancial statements, prepared in accordance with A5
25 (either Iull or condensed), audited. Does it require
the company to consider the paidup share capital or
turnover, as the case may be, in quarterly hnancial
statements to decide whether applicability criteria are
met?
In the case oI annual hnancial statements, there is always
some timelag between the yearend and the date on
which audited hnancial statements are available. 5hould
the company continue using previous year hnancial
statements in the interim?
SecLion 2(^0) ol Lhe 2013 AcL delnes Lhe Lerm 'lnancial
sLaLemenLs' Lo include, amonq oLher maLLers, balance sheeL as
aL Lhe end ol Lhe lnancial year, P&L lor Lhe lnancial year and
cash low sLaLemenL lor Lhe lnancial year. 1his suqqesLs LhaL
audiLed lnancial sLaLemenLs lor Lhe compleLed lnancial year
should be considered Lo decide Lhe applicabiliLy. FurLher, we
believe LhaL a company should use only lndian CAAP lnancial
sLaLemenLs lor Lhis purpose.
1he use ol Lhe word "laLesL audiLed lnancial sLaLemenLs"
indicaLes LhaL Lill Lhe Lime audiLed lnancial sLaLemenLs lor
Lhe immediaLely precedinq lnancial year are ready and
available, a company may conLinue usinq Lhe earlier period
lnancial sLaLemenL Lo deLermine il Lhe applicabiliLy criLeria
are meL. 1hus, a company could delay Lhe appoinLmenL ol Lhe
woman direcLor by delayinq Lhe issuance ol audiLed lnancial
sLaLemenLs wiLhin Lhe prescribed Lime limiLs in Lhe 2013 AcL.
lnLeresLinqly, neiLher Lhe 2013 AcL nor Lhe rules qive any Lime
limiL Lo comply wiLh Lhe requiremenL lor appoinLmenL ol woman
direcLor il Lhe company meeLs Lhe prescribed criLeria aL a laLer
daLe, i.e., Lhe daLe subsequenL Lo Lhe commencemenL ol Lhe
2013 AcL. 1o illusLraLe, leL us assume LhaL on 1 April 201^, ABC
LimiLed (nonlisLed public company) did noL meeL Lhe prescribed
criLeria lor appoinLmenL ol woman direcLor. 1wo years laLer,
Lhese criLeria are meL. ln such cases, no Lime limiL is qiven lor
complyinq wiLh Lhis requiremenL. lL appears LhaL ABC may need
Lo appoinL a woman direcLor immediaLely.
Independent directors
1he 2013 AcL sLaLes LhaL every lisLed company will have aL leasL oneLhird ol LoLal number ol direcLors as independenL direcLors, wiLh
any lracLion Lo be rounded oll as one. ln addiLion, Lhe 2013 AcL empowers Lhe CenLral CovernmenL Lo prescribe minimum number ol
independenL direcLors lor oLher class ol public companies.
ln accordance wiLh Lhe CazeLLe Copy ol Lhe 2013 AcL, exisLinq companies meeLinq Lhe prescribed criLeria need Lo comply wiLh Lhe
requiremenL wiLhin oneyear
5
.
1he dralL rules sLaLed LhaL public companies covered under Lhe prescribed class should have aL leasL oneLhird ol Lhe LoLal number
ol iLs direcLors as independenL direcLors. ln Lhe DirecLors' AppoinLmenL Rules, minimum number ol direcLors lor nonlisLed public
companies meeLinq prescribed criLeria has been chanqed Lo 2, irrespecLive ol Lhe board size. Also, Lhe criLeria lor appoinLmenL ol
independenL direcLors have chanqed in Lhe DirecLors' AppoinLmenL Rules. See Lable 7 below.
Table 7: Criteria Ior appointment oI independent directors
Particulars Directors' Appointment Pules Draft rules
All listed companies
No. ol independenL direcLors 1/3rd ol board size 1/3rd ol board size
Nonlisted public companies
No. ol direcLors Two 1/3rd ol board size
Criteria either of the following
1urnover `100 crores or more `300 crores or more
Aggregate outstanding loans,
debentures and deposits
Lxceedinq `50 crores Lxceedinq `200 crores
5 MCA websiLe: hLLp://www.mca.qov.in/MinisLry/pdl/CompaniesAcL2013.pdl, assessed 5 May 201^.
1he DirecLors' AppoinLmenL Rules also require Lhe lollowinq:
Any class ol companies, lor which a hiqher number ol
independenL direcLors has been speciled in Lhe law lor
Lhe Lime beinq in lorce, will comply wiLh Lhe requiremenLs
speciled in Lhe law.
ll a company covered under Lhis rule is required Lo appoinL
hiqher number ol independenL direcLors due Lo Lhe
composiLion ol iLs audiL commiLLee, such hiqher number ol
independenL direcLors will apply Lo Lhe company.
1he board needs Lo lllup any inLermiLLenL vacancy ol an
independent director at the earliest but not later than the
immediaLe nexL Board meeLinq or Lhree monLhs lrom Lhe
daLe ol such vacancy, whichever is laLer.
1he DirecLors' AppoinLmenL Rules rules also sLaLe LhaL a non
lisLed public company, which ceases Lo lulll any ol Lhe Lhree
condiLions laid down in Lhe rule lor Lhree consecuLive years, will
noL be required Lo comply wiLh Lhese provisions unLil such Lime
as iL meeLs any ol Lhe condiLions.
1he DirecLors' AppoinLmenL Rules rules also sLaLe LhaL direcLor,
il any, appoinLed by Lhe small shareholders will be LreaLed as
independenL direcLor provided LhaL such direcLor meeLs Lhe
criLeria lor beinq independenL direcLor and qives requisiLe
declaraLion.
Pevised clause 49
RC^9 requires LhaL where Lhe Chairman ol Lhe board is a
nonexecuLive direcLor, aL leasL oneLhird ol Lhe board should
comprise independenL direcLors. ln case Lhe Chairman is an
execuLive direcLor, aL leasL hall ol Lhe board should comprise
independenL direcLors. Since Lhe requiremenL under RC^9
is sLricLer, a lisLed company will need Lo comply wiLh RC^9
requiremenLs. Some oLher key dillerences beLween Lhe 2013
AcL and RC^9 are qiven below:
Board of subsidiary companies: RC^9 requires LhaL Lhe
board ol all maLerial nonlisLed lndian subsidiaries ol a
lisLed parenL company will have aL leasL one independenL
direcLor lrom Lhe board ol Lhe parenL company. 1here is no
such requiremenL under Lhe 2013 AcL.
Meaning: Meaninq ol Lhe Lerm "independenL direcLor"
qiven in RC^9 conLains mosL ol Lhe aLLribuLes prescribed
in Lhe 2013 AcL. RC^9, however, conLains Lhe lollowinq
addiLional criLeria:
(i) 1he person should noL be a maLerial supplier, service
provider or cusLomer or a lessor or lessee ol Lhe
company
(ii) 1he person should noL be less Lhan 21 years ol aqe.
Nominee directors: BoLh under Lhe 2013 AcL and RC^9,
nominee direcLor is noL LreaLed as an independenL direcLor.
Stock options: BoLh under Lhe 2013 AcL and RC^9, an
independenL direcLor is noL enLiLled Lo any sLock opLion in
Lhe company. However, neiLher Lhe 2013 AcL nor RC^9
provide any clariLy as Lo how a company should deal wiLh
sLock opLions qranLed in Lhe pasL and ouLsLandinq aL Lhe
daLe ol enacLmenL. One arqumenL is LhaL a company may
need Lo cancel/lorleiL Lhese opLions immediaLely. lL may be
appropriaLe lor Lhe MCA/SLBl Lo clarily Lhis maLLer.
Limit on number of directorship: RC ^9 requires LhaL
a person can serve as an lD in noL more Lhan 7 lisLed
companies. ll Lhe person is wholeLime direcLor in any
oLher lisLed company, Lhen he can serve as an lD in noL
more Lhan 3 lisLed companies. 1he 2013 AcL does noL
conLain any separaLe resLricLion on number ol direcLorship
lor lDs. However, iL is perLinenL Lo noLe LhaL Lhe 2013 AcL
resLricLs Lhe number ol direcLorship lor an individual Lo 20.
OuL ol LoLal 20 companies, number ol public companies
in which a person can be appointed as a director cannot
exceed 10.
Tenure and rotation requirement: Under Lhe 2013 AcL,
an independenL direcLor holds ollce lor a Lerm up Lo 5
consecuLive years on Lhe board ol a company. He is eliqible
lor reappoinLmenL on passinq ol a special resoluLion by Lhe
company. However, no independenL direcLor can hold ollce
lor more Lhan 2 consecuLive Lerms ol lve years each.
Under Lhe 2013 AcL, Lhis provision will apply prospecLively.
An independenL direcLor LhaL compleLes Lwo Lerms will be
eliqible lor appoinLmenL alLer Lhe expiry ol Lhree years
ol ceasinq Lo become an independenL direcLor; provided
durinq LhaL period ol Lhree years, he remains independenL
wiLh respecL Lo LhaL company.
RC^9 also conLains similar provision lor independenL
direcLors' roLaLion, excepL LhaL roLaLion requiremenL is noL
enLirely prospecLive. RC^9 sLaLes LhaL a person, who has
already served as an lD lor lve or more years in a company
as on 1 OcLober 201^, will be eliqible lor appoinLmenL, on
compleLion ol presenL Lerm, lor one more Lerm ol up Lo
lve years. Since Lhe requiremenL under RC^9 is sLricLer, a
lisLed company needs Lo comply wiLh Lhe same.
Limitation of liability: RC^9 sLaLes LhaL an independenL
director will be held liable, only in respect of such acts of
omission or commission by a company which had occurred
wiLh his knowledqe, aLLribuLable Lhrouqh board processes,
and wiLh his consenL or connivance or where he had noL
acLed diliqenLly wiLh respecL ol Lhe provisions conLained in
Lhe LisLinq AqreemenL. 1he 2013 AcL also conLains similar
proLecLion clause.
Audit Committee
1he 2013 AcL requires each lisLed company and such oLher class ol companies, as may be prescribed, Lo consLiLuLe Lhe AudiL
CommiLLee. ln Lhe Board Rules, Lhresholds lor consLiLuLion ol Lhe commiLLee have been made more sLrinqenL visvis Lhe dralL rules
(see Lable 8 below). 1hese chanqes in Lhe criLeria will require more companies Lo consLiLuLe Lhe AudiL CommiLLee.
Table 8: Criteria Ior constitution oI the Audit Committee
Company Board Rules Draft Rules
Nonlisted public companies meeting either oI the Iollowing criteria
1urnover `100 crores or more No such criterion
Aggregate outstanding loans, or
borrowings, or debentures or deposits
`50 crores or more `200 crores or more
Due Lo Lhe use ol Lhe word "or" in Lhe Lhird criLerion lor non
lisLed public companies, Lhere seems Lo be a conlusion wheLher
a company needs Lo consider loans separaLely, debenLures
separately and deposits separately or they should be considered
in LoLaliLy. ln our view, lrom Lhe use ol Lhe word "aqqreqaLe,"
iL is clear LhaL all ol Lhem have Lo be considered LoqeLher. 1o
illusLraLe, a nonlisLed public company, which has ouLsLandinq
bank loan ol `20 crores, ouLsLandinq debenLures ol `23 crores
and outstanding deposits of `12 crores, has meL Lhird criLerion
under Lhe Board Rules. Hence, iL needs Lo consLiLuLe Lhe AudiL
CommiLLee.
Pevised clause 49
RC^9 requires all lisLed companies Lo consLiLuLe Lhe AudiL
CommiLLee. Civen below is an overview ol dillerences relaLinq
Lo Lhe AudiL CommiLLee beLween Lhe 2013 AcL and RC^9:
Under Lhe 2013 AcL, an audiL commiLLee comprises ol
minimum ol Lhree direcLors wiLh independenL direcLors
lorminq a ma|oriLy. RC^9 requires Lhe audiL commiLLee
Lo comprise ol minimum Lhree direcLors wiLh LwoLhird
members beinq independenL direcLors.
1he 2013 AcL requires LhaL ma|oriLy ol audiL commiLLee
members includinq iLs chairperson should have an abiliLy Lo
read and undersLand Lhe lnancial sLaLemenL. ln conLrasL,
RC^9 requires LhaL all members should be lnancially
liLeraLe and aL leasL one member should have accounLinq
or relaLed lnancial manaqemenL experLise.
RC^9 requires LhaL Lhe Chairman ol Lhe AudiL CommiLLee
should be an independenL direcLor. lL also requires Lhe
Chairman ol Lhe AudiL commiLLee Lo aLLend Lhe ACM Lo
answer shareholder queries. No such requiremenL exisLs
under Lhe 2013 AcL,
Nomination and Remuneration
Committee
BoLh Lhe 2013 AcL and RC^9 require all lisLed companies Lo consLiLuLe NRC. 1he 2013 AcL empowers Lhe CenLral CovernmenL Lo
prescribe addiLional class ol companies, which need Lo consLiLuLe NRC. ln Lhe Board Rules, Lhresholds lor consLiLuLion ol NRC have
been made more sLrinqenL visvis Lhe dralL rules (see Lable 9 below). 1hese chanqes in Lhe criLeria will require more companies Lo
consLiLuLe NRC.
Table 9: Criteria Ior constitution oI NPC
Company Board Rules Draft Rules PC49
LisLed companies All companies All companies All companies
Paidup share capiLal `10 crores or more `100 crores or more NA
1urnover `100 crores or more No such criterion NA
Aggregate outstanding loans, or
borrowings, or debentures or deposits
`50 crores or more `200 crores or more NA
BoLh Lhe 2013 AcL and RC^9 requires LhaL NRC will comprise ol
Lhree or more nonexecuLive direcLors, ouL ol Lhis, aLleasL one
hall should be independenL direcLors. RC^9 specilcally requires
LhaL Lhe Chairman ol NRC should be an independenL direcLor;
however, Lhere is no such requiremenL under Lhe 2013 AcL.
1he 2013 AcL allows Lhe chairperson ol Lhe company (wheLher
execuLive or nonexecuLive) Lo be appoinLed as a member ol Lhe
NRC. However, Lhe person cannoL chair NRC. RC^9 does noL
qive such an opLion.
Vigil mechanism
Under Lhe 2013 AcL, each lisLed company and such oLher class
ol companies, as may be prescribed, need Lo esLablish a viqil
mechanism lor direcLors and employees Lo reporL qenuine
concerns. ln addiLion Lo lisLed companies, Lhe dralL rules
required Lhe lollowinq companies Lo esLablish viqil mechanism:
Companies which accepL deposiLs lrom Lhe public
Companies which have borrowed money lrom banks and
public lnancial insLiLuLions in excess ol `50 crore.
1he Board Rules reLain Lhe same criLeria. 1hese requiremenLs
are sLricL and would cover many privaLe companies LhaL have
borrowed money lrom banks and public lnancial insLiLuLions in
excess ol `50 crore.
Under Lhe Board Rules, a company will oversee Lhe viqil
mechanism in Lhe lollowinq manner:
Companies, which are required Lo consLiLuLe an audiL
commiLLee, will oversee Lhe mechanism Lhrouqh Lhe audiL
commiLLee. ll any ol Lhe members ol Lhe audiL commiLLee
have a conlicL ol inLeresL in a qiven case, Lhey should
recuse Lhemselves and oLhers members should deal wiLh
Lhe maLLer.
For oLher companies, Lhe board will nominaLe a direcLor Lo
play Lhe role ol audiL commiLLee Lo whom oLher direcLors
and employees may reporL Lheir concerns.
1he Board Rules require LhaL viqil mechanism will provide lor
adequaLe salequards aqainsL vicLimizaLion ol employees and
direcLors usinq Lhis mechanism. Also, in excepLional cases, a
company should qive such employees/direcLors a direcL access
Lo Lhe AudiL CommiLLee Chairperson or Lhe direcLor playinq Lhe
AudiL CommiLLee role, as Lhe case may be.
1he Board Rules provide LhaL in Lhe case ol repeaLed lrivolous
complainLs beinq lled by a direcLor or an employee, Lhe audiL
commiLLee or Lhe direcLor playinq Lhe audiL commiLLee role may
Lake suiLable acLion aqainsL Lhe concerned direcLor or employee
includinq reprimand.
RC^9 also conLains similar requiremenLs lor esLablishmenL ol
viqil mechanism. However, iL does noL specily as Lo how a lisLed
company will oversee such mechanism. Also, iL does noL conLain
any specilc provision lor Lakinq acLion in Lhe case ol repeaLed
lrivolous complainLs beinq lled by a direcLor or an employee.
5ubsidiary companies
WiLh reqard Lo corporaLe qovernance ol subsidiary companies,
RC^9 conLains Lhe lollowinq specilc requiremenLs:
1he board ol a maLerial nonlisLed lndian subsidiary ol a
lisLed parenL company will have aL leasL one independenL
direcLor lrom Lhe board ol Lhe parenL company.
1he AudiL CommiLLee ol Lhe lisLed parenL company will
also review Lhe lnancial sLaLemenLs, in parLicular, Lhe
invesLmenLs made by Lhe nonlisLed subsidiary company.
1he minuLes ol Lhe board meeLinqs ol Lhe nonlisLed
subsidiary company will be placed aL Lhe board meeLinq
ol Lhe lisLed parenL company. 1he manaqemenL should
periodically bring to the attention of the board of the listed
parenL company, a sLaLemenL ol all siqnilcanL LransacLions
and arranqemenLs enLered inLo by Lhe nonlisLed subsidiary
company.
1he company will lormulaLe a policy lor deLermininq
"maLerial" subsidiaries and such policy will be disclosed Lo
Lhe sLock exchanqes and in Lhe Annual ReporL.
A company will noL dispose ol shares in iLs maLerial
subsidiary which will reduce iLs shareholdinq (eiLher on iLs
own or LoqeLher wiLh oLher subsidiaries) Lo less Lhan 507
or cease Lhe exercise ol conLrol over Lhe subsidiary wiLhouL
passinq a special resoluLion in iLs qeneral meeLinq.
Sellinq, disposinq and leasinq ol asseLs amounLinq Lo
more Lhan 207 ol Lhe asseLs ol Lhe maLerial subsidiary will
require prior approval ol shareholders by way ol Lhe special
resolution
Similar requiremenLs do noL exisL under Lhe 2013 AcL.
Internal audit
1he 2013 AcL requires such class or classes ol companies, as may be prescribed, Lo appoinL an inLernal audiLor Lo conducL inLernal
audiL ol Lhe luncLions and acLiviLies ol Lhe company. 1he dralL as well AccounLs Rules require all lisLed companies Lo appoinL inLernal
audiLor. ln Lhe AccounLs Rules, Lhe Lhreshold lor appoinLmenL ol inLernal audiLor by nonlisLed public companies has chanqed. Under
Lhe AccounLs Rules, privaLe companies meeLinq prescribed criLeria are also required Lo appoinL inLernal audiLor. 1his was noL required
under Lhe dralL rules. 1able10 provides comparison ol Lhe Lwo criLeria.
Table 10: Criteria to appoint internal auditor
Particulars Accounts Rules Draft rules
Paid up Share capiLal durinq Lhe precedinq lnancial year `50 crores or more `10 crores or more
1urnover durinq Lhe precedinq lnancial year `200 crores or more No such criteria
OuLsLandinq loan/borrowinq lrom bank or public lnancial
insLiLuLions aL any Lime durinq Lhe precedinq lnancial
year
OuLsLandinq deposiLs aL any Lime durinq Lhe precedinq
lnancial year
Private companies meeting either oI the Iollowing criteria
1urnover durinq Lhe precedinq lnancial year `200 crores or more
No privaLe company was covered.
OuLsLandinq loan/borrowinq lrom bank or public lnancial
insLiLuLions aL any Lime durinq Lhe precedinq lnancial
year
`100 crores or more
1he AccounLs Rules also require Lhe below:
An exisLinq company, which meeLs Lhe prescribed criLeria,
will comply wiLh Lhe requiremenLs wiLhin six monLhs lrom
Lhe commencemenL ol Lhis secLion.
1he AudiL CommiLLee or Lhe Board, in consulLaLion wiLh
Lhe inLernal audiLor, will lormulaLe Lhe scope, luncLioninq,
periodiciLy and meLhodoloqy lor conducLinq inLernal audiL.
A perusal ol Lhe 2013 AcL read wiLh Lhe AccounLs Rules
indicaLes LhaL a company may eiLher enqaqe exLernal aqency
or have inLernal resources Lo conducL inLernal audiL. FurLher,
a lrm noL reqisLered wiLh Lhe lCAl may also be appoinLed as
inLernal audiLor.

Key requiremenLs ol Lhe 2013 AcL concerninq merqers,
amalqamaLion and reconsLrucLion are qiven below:
A company will lle a scheme wiLh 1ribunal lor approval
lor (i) reducLion in share capiLal, (ii) makinq compromise/
arranqemenL wiLh crediLors and members, and (iii) merqer/
amalqamaLion ol companies.
Sub|ecL Lo Lhe RBl approval, boLh inbound and ouLbound
crossborder merqers and amalqamaLions beLween lndian
and loreiqn companies will be permiLLed. However, Lhe
overseas |urisdicLions where crossborder merqers and
amalqamaLions are allowed will be noLiled.
An applicaLion can be made Lo Lhe Lribunal lor makinq
compromise or arranqemenL involvinq CDR. Any such
scheme should, amonq oLher maLLers, include:
(i) A reporL by Lhe audiLors ol Lhe company Lo Lhe ellecL
LhaL iLs lund requiremenLs alLer Lhe CDR will conlorm
Lo liquidiLy LesL based on Lhe esLimaLes provided by Lhe
board ol direcLors.
(ii) A valuaLion reporL in respecL ol Lhe shares and Lhe
property and all assets, tangible and intangible,
movable and immovable, ol Lhe company by a
reqisLered valuer.
Mergers,
amalqamaLion and
reconstruction
1he Lribunal will noL sancLion a scheme ol capiLal
reducLion, merqer, acquisiLion or oLher arranqemenL unless
Lhe accounLinq LreaLmenL prescribed in Lhe scheme is in
compliance wiLh noLiled AS and a cerLilcaLe Lo LhaL allecL
by Lhe company's audiLor has been lled wiLh Lhe Lribunal.
Hence, compliance wiLh noLiled AS will be mandaLory lor
all companies.
A Lransleree company will noL hold any shares in iLs own
name or in Lhe name ol LrusL eiLher on iLs behall or on
behall ol iLs subsidiary/associaLe companies. 1he 2013 AcL
will require such shares Lo be cancelled or exLinquished.
This will prohibit creation of any treasury shares under the
scheme.
ln case ol merqer/amalqamaLion ol companies, Lhe
lollowinq documenLs should also be circulaLed lor meeLinq
proposed beLween Lhe company and concerned persons:
(i) ReporL ol Lhe experL on valuaLion, il any
(ii) SupplemenLary accounLinq sLaLemenL il Lhe lasL
annual lnancial sLaLemenLs ol any ol Lhe merqinq
company relaLe Lo a lnancial year endinq more Lhan
six monLhs belore Lhe lrsL meeLinq ol Lhe company
summoned lor approvinq Lhe scheme.
1he merqer ol a lisLed company inLo an unlisLed company
will noL auLomaLically resulL in Lhe lisLinq ol Lhe Lransleree
company.
Only persons holdinq noL less Lhan 107 ol Lhe shareholdinq
or havinq ouLsLandinq debL noL less Lhan 57 ol LoLal
ouLsLandinq debL can raise ob|ecLions Lo Lhe scheme.
1he provision ol Lhe 2013 AcL concerninq merqers,
amalqamaLion and reconsLrucLion ol companies are yeL Lo be
noLiled. 1he MCA has issued Lhe dralL rules concerninq Lhese
provisions. However, Lhe lnal rules on Lhis sub|ecL are sLill
awaiLed. 1he daLe lrom which Lhe provisions ol Lhe 2013 AcL
concerninq merqers, amalqamaLion and reconsLrucLion will
apply is unknown.
Glossary
10 Lakh 1 Million
1 Crore 10 Million
100 Crore 1 Billion
1he Companies AcL 1956 1956 AcL
1he Companies AcL 2013 2013 AcL
Abridqed Financial SLaLemenL AFS
Annual General Meeting AGM
AS 5 Net Proht or |oss for tne Per|oc, Pr|or Per|oc |tems anc Cnanes |n /ccount|n Po||c|es AS 5
AS 6 Depreciation Accounting AS 6
AS 10 Accounting for Fixed Assets AS 10
AS 11 The Effects of Changes in Foreign Exchange Rates AS 11
AS 21 Consolidated Financial Statements AS 21
AS 23 Accounting for Investments in Associates in Consolidated Financial Statements AS 23
AS 25 Interim Financial Reporting AS 25
AS 26 Intangible Assets AS 26
AS 27 Financial Reporting of Interests in Joint Ventures AS 27
AS 29 Provisions, Contingent Liabilities and Contingent Assets AS 29
AS 30 Financial Instruments: Recognition and Measurement AS 30
(AS issued by Lhe lCAl and noL yeL noLiled)
Build Own OperaLe 1ransler BOO1
BuilL OperaLe 1ransler BO1
Companies (AudiLor's ReporL) Order, 2003 (as amended) CARO
CorporaLe DebL ResLrucLurinq CDR
Chiel LxecuLive Ollcer CLO
Chiel Financial Ollcer CFO
ConsolidaLed Financial SLaLemenLs CFS
Clause ^1 ol Lhe LquiLy LisLinq AqreemenL Clasue ^1
Company Law Board CLB
Continuous Process Plant CPP
CorporaLe Social ResponsibiliLy CSR
DebenLure RedempLion Reserve DRR
LxperL Advisory CommiLLee ol lCAl LAC
LxecuLive DirecLor LD
LxLraordinary Ceneral MeeLinq LCM
Lmployee SLock OpLion Plan LSOP
Fully ConverLible DebenLure FCD
Generally Accepted Accounting Principles GAAP
CovernmenL ol lndia Col / CenLral CovernmenL
lnLernaLional AccounLinq SLandards Board lASB
lnsLiLuLe ol CharLered AccounLanLs ol lndia lCAl
lndependenL DirecLor lD
lnvesLor LducaLion and ProLecLion Fund lLPF
lnLernaLional LLhics SLandards Board lor AccounLanLs lLSBA
Code ol ConducL issued by lLSBA lLSBA code
lnLernaLional Financial ReporLinq SLandards lFRS
lncome 1ax AcL, 1961 lncomeLax AcL
lndian AccounLinq SLandards noLiled by MCA as lndian equivalenL ol lFRS lndAS
lndAS 2^ Related Party Disclosures lndAS 2^
Cenerally AccepLed AccounLinq Principles in lndia lndian CAAP
lnsurance RequlaLory and DevelopmenL AuLhoriLy lRDA
lnlormaLion 1echnoloqy l1
Key Manaqerial Personnel KMP
LquiLy LisLinq AqreemenL LA / LisLinq AqreemenL
MasLer AqreemenL MA
Ministry of Corporate Affairs MCA
ManaqemenL Discussion and Analysis MD&A
NaLional Advisory CommiLLee on AccounLinq SLandards NACAS
Non Bankinq Financial Company NBFC
NaLional Company Law 1ribunal NCL1 / 1ribunal
NonLxecuLive DirecLors oLher Lhan lndependenL DirecLors NLD
NaLional Financial ReporLinq AuLhoriLy NFRA
AccounLinq SLandards noLiled under Lhe Companies NoLiled AS or AS
(AccounLinq SLandards) Rules 2006 (as amended)
NominaLion and RemuneraLion CommiLLee NRC
SLaLemenL ol ProlL and Loss / ProlL and Loss AccounL P&L
Public PrivaLe ParLnership PPP
Reserve Bank ol lndia RBl
Revised Clause ^9 ol Lhe LquiLy LisLinq AqreemenL RC^9
ReqisLrar ol Companies RoC
SLandards on AudiLinq issued by lCAl SA
SA 2^0 The Auditors Responsibilities Relating To Fraud SA 2^0
In An Audit Of Financial Statements
SA 550 Related Parties SA 550
SecuriLies and Lxchanqe Board ol lndia SLBl
SLBl (SubsLanLial AcquisiLion ol Shares and 1akeovers) RequlaLions 1997 SLBl 1akeover Code
SLandalone/ SeperaLe Financial SLaLemenLs SFS
SLaLemenL ol Chanqe in LquiLy SOClL
1he SarbanesOxley AcL ol 2002 ol Lhe US SOX
Transfer Pricing guidelines TP guidelines
UniLed Kinqdom UK
UniLes SLaLes US
US SecuriLies and Lxchanqe Commission US SLC / SLC
WriLLen Down Value WDV
1he Companies (AccounLs) Rules, 201^ AccounLs Rules
1he Companies (AppoinLmenL and OualilcaLion ol DirecLors) Rules, 201^ DirecLors' AppoinLmenL Rules
1he Companies (AppoinLmenL and RemuneraLion ol Manaqerial Personnel) Rules, 201^ Manaqerial Personnel Rules
1he Companies (AudiL and AudiLors) Rules, 201^ AudiL Rules
1he Companies (CorporaLe Social ResponsibiliLy Policy) Rules, 201^ CSR Rules
1he Companies (DeclaraLion and PaymenL ol Dividend) Rules, 201^ Dividend Rules
1he Companies (MeeLinqs ol Board and iLs Powers) Rules, 201^ Board Rules
1he Companies (Share CapiLal and DebenLures) Rules, 201^ SCD Rules
1he Companies (SpecilcaLion ol DelniLions DeLails) Rules, 201^ DelniLion Rules
1he Companies (ReqisLraLion ol Foreiqn Companies) Rules, 201^ Foreiqn Companies Rules
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Companies Act 2013 Begining of A New Era

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Companies Act 2013 Begining of A New Era

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Beginning of a new era

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