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 3 Beginning of a new era | 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
4 | Companies Act 2013 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. 5 Beginning of a new era | 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. 6 | Companies Act 2013 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. Practical perspectives 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. 7 Beginning of a new era | 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. Practical perspectives 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. 8 | Companies Act 2013 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. 9 Beginning of a new era | Practical issues and perspectives 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 10 | Companies Act 2013 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. 11 Beginning of a new era | 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. 12 | Companies Act 2013 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. Practical issues and perspectives 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. 13 Beginning of a new era | 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." 14 | Companies Act 2013 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. Practical issues and perspectives 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 15 Beginning of a new era | 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. 16 | Companies Act 2013 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. 17 Beginning of a new era | 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. Practical issues and perspectives 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: 18 | Companies Act 2013 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. 19 Beginning of a new era | 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. 20 | Companies Act 2013 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." 21 Beginning of a new era | Practical issues and perspectives 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. 22 | Companies Act 2013 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. 23 Beginning of a new era | 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. Practical issues and perspectives 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. 25 Beginning of a new era | 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. 26 | Companies Act 2013 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." Practical perspectives 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. 27 Beginning of a new era | 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. 28 | Companies Act 2013 Practical issues and perspectives 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. 29 Beginning of a new era | Practical perspectives 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. 30 | Companies Act 2013 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." 31 Beginning of a new era | Practical issues and perspectives 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. 32 | Companies Act 2013 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^. 33 Beginning of a new era | Practical issues and perspectives 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. 3^ | Companies Act 2013 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. 35 Beginning of a new era | 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." 36 | Companies Act 2013 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. 37 Beginning of a new era | Practical perspectives 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. Practical perspectives 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. 38 | Companies Act 2013 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. 39 Beginning of a new era | Practical perspectives 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. Transitional requirements 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^. 40 | Companies Act 2013 Practical perspectives 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. 41 Beginning of a new era | 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. Practical issues and perspectives 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. 44 | Companies Act 2013 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. Practical perspectives 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. Transitional requirements 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. ^5 Beginning of a new era | 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. Practical perspectives 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. 46 | Companies Act 2013 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.' 47 Beginning of a new era | (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. ^9 Beginning of a new era | Practical perspectives (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. 50 | Companies Act 2013 (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. 51 Beginning of a new era | 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." Practical issues and perspectives 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. 52 | Companies Act 2013 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. 53 Beginning of a new era | 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. 5^ | Companies Act 2013 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)? 55 Beginning of a new era | Practical issues and perspectives 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. 56 | Companies Act 2013 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. 57 Beginning of a new era | 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. 58 | Companies Act 2013 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. 59 Beginning of a new era | 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. 60 | Companies Act 2013 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 Practical issues and perspectives 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. 61 Beginning of a new era | 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. Transitional requirements 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^." Practical issues and perspectives 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. 62 | Companies Act 2013 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 63 Beginning of a new era | 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. Practical perspectives 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. 64 | Companies Act 2013 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. 65 Beginning of a new era | Transitional requirements 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. 66 | Companies Act 2013 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. 67 Beginning of a new era | Practical issues and perspectives 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 68 | Companies Act 2013 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. 69 Beginning of a new era | 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." 70 | Companies Act 2013 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. 71 Beginning of a new era | 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. 72 | Companies Act 2013 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. Transitional requirements 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.
73 Beginning of a new era | 74 | Companies Act 2013 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 Practical perspectives 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." 75 Beginning of a new era | 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. Practical issues and perspectives 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) 76 | Companies Act 2013 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. 77 Beginning of a new era | 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 Paidup share capiLal `10 crores or more `100 crores or more 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. 78 | Companies Act 2013 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. 79 Beginning of a new era | 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 LisLed companies All companies All companies Nonlisted public companies meeting either oI the Iollowing criteria Paidup share capiLal `10 crores or more `100 crores or more 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, 80 | Companies Act 2013 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 Nonlisted public companies meeting either oI the Iollowing criteria 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. 81 Beginning of a new era | 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. 82 | Companies Act 2013 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 LisLed companies All companies All companies Nonlisted public companies meeting either oI the Iollowing criteria 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 `100 crores or more `25 crores or more OuLsLandinq deposiLs aL any Lime durinq Lhe precedinq lnancial year `25 crores or more `25 crores or more 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. Practical perspectives 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.
83 Beginning of a new era | 8^ | Companies Act 2013 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. 85 Beginning of a new era | 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. 86 | Companies Act 2013 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 87 Beginning of a new era | 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 88 | Companies Act 2013 89 Beginning of a new era | Our ollces Ahmedabad 2 nd loor, Shivalik lshaan Near C.N. 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Country Kids 'N City Slicks, Inc. v. Vicki Sheen, Bill Sheen, Ladawn Bragg, and Flake Wells, Doing Business As Carousel Kids, 77 F.3d 1280, 10th Cir. (1996)