Accounting and Auditing Update - Dec 2014

December 2014

ACCOUNTINGAND AUDITINGUPDATE

In this issue

The Companies Act, 2013

– Increased reporting framework p3

– Emphasis on investor protection p7

– Impact on auditors p18

– Corporate social responsibility: an analysis p21

– Enhanced responsibility for directors p25

– The impact on M&A/restructurings p28

A step closer to reporting on internal financial controlOn the path of better governance p33

Regulatory updates p36

© 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Editorial

As we draw to the close of the calendar year, it seems like a good time to step back and consider the Companies Act, 2013 and the impact that it has had thus far on the corporate world. From an initial period of confusion, there seems to be slowly but surely a greater appreciation of the nuances of the legislation and engagement in actual implementation efforts by companies across the country. This month’s issue of the Accounting and Auditing Update (AAU) contains an updated anthology of our articles, over the past few months, on the key aspects of the Companies Act, 2013. These articles have been updated to include clarifications and implementation related insights that have been gained as companies have sought to apply in practice this landmark legislation.

A distinctive feature of this implementation exercise has been the somewhat shifting goalposts of rules and clarifications that have periodically emerged from the Ministry of Corporate Affairs (MCA). On one hand, this is a welcome sign as the MCA has been open to engaging with and listening to the genuine concerns and grievances of stakeholders; but equally, this does raise the question as to whether the original legislation and rules could have been exposed to comments and framed in a more tighter and well-knit fashion.

We are unfortunately, not still out of the woods on implementation yet. There remain a number of difficult and tricky areas where companies and other stakeholders continue to hope and wait for clarifications or relaxations from the MCA. It is perhaps advisable that any further changes/clarifications be issued immediately to enable companies to know with confidence what they need to do as they approach their first year end under this landmark legislation.

This month, in addition to our regular round up of regulatory updates, we also highlight the salient aspects of the recently issued guidance note by the Institute of Chartered Accountants of India (ICAI) on the area of Internal Financial Controls. We will cover this area with more insights on the practical application in the forthcoming issues of the AAU.

As always we would like to remind you that in case you have any suggestions or inputs on topics we cover, we would be delighted to hear from you.

Happy reading!

Jamil Khatri

Deputy Head of Audit, KPMG in IndiaGlobal Head of Accounting Advisory Services

Sai Venkateshwaran

Partner and Head,Accounting Advisory Services, KPMG in India


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Key pointers for CFOs

Internal control reporting extends beyond traditional

SOX 404 coverage

Requirement to attest financial statements

increases the onerous responsibilities of the CFO

CFO is considered as a KMP

Increase in auditors’ responsibilities will require the CFO to spend significant

time with the auditors

Additional requirement of preparing consolidated financial statements of

unlisted parent companies

CFO is now acknowledged as a key participant in raising the

bar on governance

CFO and his relatives are covered in the definition of

`related party’

Significant efforts of the CFO will be required during the auditor transition as a

result of mandatory rotation


The Companies Act, 2013

Continue

2


01

The impact on M&A/restructurings

Enhanced

responsibility of directors

Emphasis on

Focus onsix critical

themes

Increased reporting framework

Corporate

social responsibility

Impact on

auditors

04

0206

0305

investor protection

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Increased reporting framework The changes made by the Companies Act, 2013 (2013 Act) have been far reaching in several areas. As far as financial reporting changes are concerned, the 2013 Act benchmarks and adopts leading industry practices.

Consolidated financial statementsThe 2013 Act mandates preparation of consolidated financial statements (CFS) by all companies, including unlisted companies, having one or more subsidiaries, joint ventures or associates. Previously, the Securities and Exchange Board of India (SEBI) required only listed companies to prepare CFS. The CFS would be in addition to the standalone financial statements and the MCA has clarified that Schedule III related disclosures made in the stand-alone financial statements are not required to be repeated in the CFS. In the CFS, the company would need to give all disclosures relevant to CFS only.

The 2013 Act requires CFS to be prepared even for companies who do not have any subsidiaries but only have associates and joint ventures. Though mandating preparation of CFS is a step in the right direction to align the reporting requirements to the international reporting practices, since standalone financial statements do not present a true picture from an economic entity perspective, there could be some practical challenges as follows:

• Initially the way the 2013 Act was written, there was no exemption available similar to International Financial

Reporting Standards (IFRS) for the intermediate holding companies if the ultimate parent company prepares CFS that are publicly available. This could lead to preparation of CFS at multiple levels for companies with multi-layered structures. (for example, many real estate groups). Let us assume company X (ultimate holding company within a group structure) has a subsidiary (company A). Company A in turn has another subsidiary company B. In such a scenario, both company X and company A would be required to prepare CFS under the 2013 Act. Under IFRS, company A could have availed the exemption (subject to the other conditions) if the CFS prepared by company X are publically available. The utility of CFS for companies with no public interest (for example, a private limited company with private limited subsidiaries) could be questioned.

The MCA has amended the Rules to clarify that an intermediate wholly-owned subsidiary company incorporated in India would not be required to prepare CFS. The requirements, however, remain unchanged for those intermediate wholly-owned subsidiary companies whose immediate parent is a company incorporated outside India.1 Refer illustration below:

Theme 1

1. Source: MCA notification dated 14 October 2014


Source: KPMG in India analysis

Exemption to wholly-owned subsidiary company

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• Companies that do not have one or more subsidiaries but have associates or joint ventures have to prepare CFS from the year ending 31 March 2016. Thus, such companies have been given a relief of one year from the preparation of CFS

• Absence of transitional provisions for the companies preparing CFS for the first time could pose challenges in retrospective application of the principles of consolidation, especially in computing goodwill or capital reserve

• Interestingly, the definition of a subsidiary under the 2013 Act is different from the definition under the Indian accounting standards. The 2013 Act defines a subsidiary as an entity where the parent owns more than one-half of the total share capital, which may be different than the voting share capital considered under the accounting standards.

Cash flow statementsAll companies, except small and one person companies are now required to present cash flow statement as part of their financial statements. Currently only companies other than small and medium sized companies2 are required to present cash flow statements.

DepreciationThe Indian accounting standards state that the depreciable amount of an asset has to be systematically allocated over its useful life. Additionally, the Schedule XIV of the Companies Act, 1956 (1956 Act) specified minimum rates of depreciation to be provided by a company. Now, Schedule II to the 2013 Act enshrines within the Act itself the principle for recognising depreciation on the assets over their useful lives and provides an indicative useful lives of the assets. For a large number of assets, the indicative useful lives suggested by the Schedule II to the 2013 Act is significantly lower than those envisaged in the Schedule XIV to the 1956 Act.The reduction in useful lives of many assets could significantly impact not only the depreciation on new additions to fixed assets but also the depreciation on fixed assets existing at the date Schedule II comes into force. On transition, the carrying

amount of an asset is depreciated over the remaining useful life of the asset as per Schedule II of the 2013 Act.

If based on Schedule II, the remaining useful life of the asset is nil, then the written down value of the assets could either be recognised in opening retained earnings or in the statement of profit and loss.

The 2013 Act also permits companies to depreciate assets over their useful lives which may be different from the specified useful lives as per Schedule II to the 2013 Act. Similarly, the 2013 Act also permits companies to use a residual value other than the 5 per cent as prescribed in Schedule II. Accordingly, such companies would have the flexibility to determine the useful lives or residual value for assets based on actual planned usage without being constrained by a regulatory prescribed maximum life, provided a justification is given for the same in the financial statements of the company and is duly supported by technical advice.

The 2013 Act also requires that useful life and depreciation for significant components of an asset should be determined separately. This is likely to have a significant impact for several companies that previously capitalised the total cost of an asset without distinguishing individual parts that may have a shorter useful life. While the component approach may result in accelerated depreciation in the first instance, it would also permit companies to capitalise the cost of major replacements/overhauls, which may currently be charged as period costs when incurred. This would involve considerable judgement and its potential impact on the accounting systems can not be undermined as well. In light of the significant impact on corporate India, the MCA has made component accounting mandatory for financial year commencing on or after 1 April 2015 to provide companies with time to comply with the requirements of the 2013 Act.3

For amortisation of the intangible assets, Schedule II to the 2013 Act provides that the provisions of relevant Indian accounting standards would apply.

2. Small and medium sized company is defined in the Companies (Accounting Standards) Rules, 2006 issued by the Ministry of Corporate Affairs (7 December 2006)

3. MCA notification dated 29 August 2014


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Re-opening or revision of financial statements/board’s reportCurrently, companies are generally not permitted to revise or re-open previously approved financial statements/revise the board’s report. Internationally, material misstatements in the accounts related to previous years, whether due to occurrence of fraud or error are recognised in the financial statements of the period in which such misstatements occurred. The 2013 Act aligns the provisions with the international practice on re-opening/revision of financial statements in the following circumstances:

• A statutory/regulatory authority (for example, central government, SEBI, income tax authorities) can apply to the prescribed authority or a court of law when the accounts of the company were prepared in a fraudulent manner or the affairs of the company were mismanaged, thereby casting a doubt on the reliability of the financial statements. There is no time restriction to the revision initiated by a statutory regulatory authority

• Voluntary revision can be undertaken on application by the Board of Directors, if in their opinion the financial statements/board’s report do not comply with the requirements of the 2013 Act (for example, non-compliance with accounting standards discovered later). Voluntary revision is permitted after obtaining approval of the prescribed authority in respect of three preceding financial years. Detailed reasons for revision are required to be disclosed in the board’s report.

These provisions seek to align the requirements in this area with the international standards and are expected to enable all stakeholders to understand the impact of material errors and frauds on the financial statements previously reported for each individual year in the past. These provisions also seek to operationalise the previous decision by the SEBI which requires listed companies to restate financial information for the impacts arising from the audit qualifications.4

The new requirements are likely to result in implementation challenges in incidental areas such as determination of taxable profits and ‘Minimum Alternate Tax’ liabilities for the previous periods that would be impacted by the restated information. Further, a company would also need to consider whether it is required to/may voluntarily file a revised income tax return based on the revised accounts.

Uniform accounting yearThe 2013 Act requires all companies to adopt a uniform financial year of 1 April to 31 March with limited exceptions for a company that is a holding company or a subsidiary of a company incorporated outside India, which may follow a different financial year for consolidation outside India. In the event of a company seeking to avail of such an exemption (for example, an Indian subsidiary of a multinational that wants to follow a 31 December year-end), it would need to take an approval from the prescribed authority.

As part of transition provisions, companies would be given a period of two years to change their accounting year to 1 April to 31 March. The following illustration explains the transition timeline:

To illustrate, let us take company A that has a calendar year end as its annual reporting period. The Section mandating this change is notified and effective from 1 April 2014. In line with the transitional provisions, company A will have to align the accounting year to April- March by 31 March 2016. It would follow that company A can follow calendar year end for 2013 and 2014, but would have to align to March year end by 31 March 2016. This requirement would help comparability of financial information between companies in India and would avoid the practice of changing year ends by companies. An important point to note is that this exemption may not be available for a company that is an associate or joint venture of a company incorporated outside India.

Adjustments to reservesCurrently, under the 1956 Act, companies are permitted to adjust certain costs and charges directly against reserves either using specific clauses under the 1956 Act (for example, Section 100 on capital reduction or Section 78 on utilisation of share premium balance) or under court approved schemes of mergers and amalgamations (for example, Sections 391-394). Many companies were using these provisions to write-off unrecoverable assets, charge-off ‘onetime’ costs or to adjust costs associated with redemption of debt instruments. These direct adjustments to reserves often result in inaccurate reflection of profits and losses and affect comparability between companies (as also comparison with global peers).

The 2013 Act now prohibits most of such adjustments and this would reflect in a uniform and accurate representation of financial results. However, it is currently uncertain whether the restrictions imposed by the 2013 Act would also cover ‘special reserves’ existing at the time of the transition to the 2013 Act, which were previously set-up by companies with the specific objective of adjusting future costs and write-offs.

The restrictions on utilisation of securities premium deserve to be mentioned separately. The prescribed class of companies will be able to utilise the securities premium only to issue fully paid equity bonus shares, writing off expenses/commission paid/discount allowed pertaining to issuance of equity shares and buy back of its shares. This would mean that such prescribed companies will not be able to utilise the securities premium to adjust premium payable on redemption of redeemable preference shares or debentures. The gain or loss on such redemption would be routed through statement of profit and loss which is in line with international standards.


4. Source: SEBI’s PR No. 67/2012 dated 26 June 2012

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Mandatory reporting on internal financial controlsFor the first time, the 2013 Act requires directors of the listed companies to provide assurance on adequacy and effectiveness of internal financial controls. The term internal financial control is defined in the 2013 Act to mean inter alia orderly and efficient conduct of business, and prevention and detection of frauds and errors. This is an onerous requirement. In order to provide assurance on internal financial controls, companies will have to document and test controls every year.

The directors would then have to rely on the management’s evaluation of adequacy and operating effectiveness of such control. The term internal financial control as defined in the 2013 Act is wider in coverage even when compared to the requirements of the Sarbanes Oxley Act which includes internal control over financial reporting. Although the requirement for auditors to report on internal financial controls is deferred to financial year commencing 1 April 20155, there is no change in the requirements related to reporting by the directors.

We expect that the regulators and rule makers will provide additional guidance to companies on how these internal financial controls are required to be tested in order to provide this level of assurance. Recently, the ICAI has issued

Guidance Note on Audit of Internal Financial Controls over Financial Reporting. This guidance note provides guidance to the statutory auditors for their reporting on adequacy of internal financial controls and operating effectiveness of such controls and also restricts such reporting by an auditor to internal control over financial reporting (ICOFR).

Internal auditThe Rules require all listed companies to appoint an internal auditor. Unlisted public companies are required to appoint an internal auditor if certain criteria related to share capital, turnover or outstanding borrowings were achieved. In addition, the rules also require private limited companies to appoint internal auditors based on the turnover or borrowings criteria. (Refer Table 1)

The Rules have also clarified that the internal auditor may or may not be an employee of the company and that non- practicing chartered accountants can also be appointed as internal auditors. The Rules specify that the internal auditor should report to the company’s board. The audit committee of the company or the board shall, in consultation with the internal auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal audit.

Appointment of internal auditor for unlisted public companies and private companies (Table 1)

Criteria Categories of companies Thresholds

Paid up share capital Unlisted public companies >INR500 million

Outstanding deposits at any point of time during the preceding financial year Unlisted public companies >INR250 million

TurnoverUnlisted public companies

and private companies

>INR2,000 million

Outstanding loans and borrowings from banks or public financial institutions at any point of time during the preceding financial year

>INR1,000 million


Source: The Companies (Accounts) Rules, 2014 - Rule 135. Source: MCA notification dated 14 October 2014

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Emphasis onInvestor Protection

Theme 2

While institutional investors, corporates and promoters are often able to safeguard their interests through the knowledge and resources that they possess; it is the individual and minority investors whose interests sometimes remain vulnerable to the decisions and actions taken by the companies and those charged with governance.

The Report of the Expert Committee on Company Law (the Report) constituted by the Ministry of Company Affairs vide Order dated 2 December 2004 under the Chairmanship of Dr. Jamshed J. Irani examined the question as to whether a separate Act is required for investor protection. The Committee noted that a framework exists in India to deal with criminal offences; the requirement is to provide a suitable orientation to corporate law so that the investor, irrespective of size, is recognised as a stakeholder in the corporate processes, as a separate Act would require special enforcement mechanism with attendant coordination issues. It was identified that in order to have clearly laid down rules leading to corporate governance, transparency, accountability and a mechanism to enforce non-compliance should be built in the Company Law itself. Therefore, the Companies Act, 2013 (2013 Act) incorporates a number of provisions that are directed towards investor protection.

This Section provides an overview of the investor protection measures included in the 2013 Act.

Oppression, mismanagement and class action suitsAs per Section 399 of the Companies Act, 1956 (1956 Act):

• in case of a company having share capital, not less than 100 members of the company or not less than one-tenth of the total number of its members, whichever is less, or any member or members holding not less than one-tenth of the issued share capital of the company, provided that the applicant or applicants have paid all calls and other sums due on their shares

• in the case of a company not having a share capital, not less than one-fifth of the total number of its members

have a right to apply to the Company Law Board for considering the case and pass an appropriate order so as to address the concern of oppression or mismanagement.


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While similar provisions exist in the 2013 Act, it also introduces the concept of class action suits. As per Section 245 of the 2013 Act, if any class of investors are of the opinion that the management or affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors, then these investors or a class of them can, as a class, file an application before the Tribunal1 on behalf of the members or depositors, seeking passage of appropriate orders.

The following are the classes of investors who can apply to the Tribunal:

i. in the case of a company having a share capital, not less than 100 members of the company or not less than 10 per cent of the total number of its members, whichever is less, or any member or members singly or jointly holding not less than 10 per cent of the issued share capital of the company, subject to the condition that the applicant or applicants have paid all calls and other sums due on his or their shares

ii. in the case of a company not having a share capital, not less than one-fifth of the total number of its members, or

iii. not having less than 100 depositors or not less than 10 per cent of the total number of depositors, whichever is less, or any depositor or depositors singly or jointly holding not less than 10 per cent of total deposits of the company.

The Tribunal, under Section 245, has the powers to pass one or more of the following orders:

i. restraining the company from committing an act which is ultra vires the articles or memorandum of the company or leads to breach of any provision of the company’s memorandum or articles

ii. declaring a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by mis-statement to the members or depositors

iii. restraining the company and its directors from acting on such resolution

iv. restraining the company from doing an act which is contrary to the provisions of the 2013 Act or any other law for the time being in force

v. restraining the company from taking action contrary to any resolution passed by the members.

Apart from the above, the Tribunal can also pass an order to claim damages, compensation or demand or any other suitable action from or against:

a. the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct, or any likely act or omission or conduct on its or their part

b. the auditor, including the audit firm of the company for any improper or misleading statement of particulars made in his audit report, or for any fraudulent, unlawful or wrongful act or conduct

c. any expert, advisor, consultant or any other person for any incorrect or misleading statement made to the company, or for any fraudulent, unlawful, wrongful act or conduct, or any likely act or conduct on his part.

The provisions of the 2013 Act are different from those in the 1956 Act in two aspects. Firstly, unlike the 1956 Act, not only the equity shareholders or members, but also depositors can apply to Tribunal. Secondly, the right to seek compensation from the company, its directors, auditors, any expert or advisor has also been added.

The Section provides protection to the investors from those in control of the company. It is clear that the intent of the legislation is that apart from the company and its directors, the auditor, an expert, an advisor or consultant can also be asked to pay for damages/compensation if it is found that these parties acted in a fraudulent, unlawful or wrongful manner.

Class action suits can have their own advantages. The first advantage is reduction in cost of litigation which an investor has to bear. While the companies can withstand long-legal battles, it is often commented that, individual depositors and shareholders are not able to bear the legal costs over a long-term. A class of investors coming together and applying for the same cause could reduce the cost of litigation for the investors. The second advantage is a potential change in behaviour. The new law applies significant pressure on the directors, auditors, advisors and/or consultants to act professionally, with due care and without any bias. It is also expected that as the law would get settled and as the cases would get decided, what is acceptable and what is not, would get clearly defined. While the advantages of a class action suit would likely benefit the investors; the companies, directors, auditors, advisors and consultants would potentially have to deal with increased litigation and associated costs including dealing with frivolous or illegitimate claims by unscrupulous stakeholders.

Addressing grievances of investorsCompanies having more than 1,000 shareholders, debenture holders, deposit holders or other security holders at any time, during the financial year are required to constitute a ‘Stakeholders Relationship Committee’ to resolve the grievances of security holders. It is envisaged that an investor grievance redressal mechanism with a non-executive chairman would help ensure protection of the interest of investors through timely intervention.

1. National Company Law Tribunal


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Related party transactions (RPTs)Related party transactions has been an area of focus for auditors, regulators and the shareholders. There have been concerns that related party transactions could be used for siphoning of funds and defrauding investors. Due to this reason, the 1956 Act contained provisions like Section 297 and Section 299. Perhaps, it was felt that the extant Sections 297 and 299 of the 1956 Act do not comprehensively cover the relationships where a director or the board could be seen to have compromised in their fiduciary duties towards the company and its investors. Therefore, the term ‘related parties’ has been defined in the 2013 Act (the 1956 Act did not define related party). The definition of ‘related party’ with respect to a company is a wide definition and includes holding company, subsidiary company, sister subsidiary, associate company, directors, key management personnel (including relatives), firms/companies where directors/relatives are interested. Further, ‘relatives’ in relation to an individual covers specified relationships without distinguishing between financially dependent and independent relatives.

The 2013 Act has made significant amendments vis-à-vis related party transactions regarding the approval process of related party transactions by requiring audit committee approval for all transactions.

Certain transactions with related parties, which are not in the ordinary course of business and which are not at an arm’s length would require the consent of the Board of Directors of the company. Further, shareholders’ approval is required for transactions where certain thresholds are met.

It is expected that the Board of Directors, while approving such transactions, would keep the investors’ interest above their personal interest and discharge their fiduciary duties effectively. In case it is proved otherwise, the 2013 Act provides for serious consequences like fine and imprisonment, including class actions suit against the directors.

It may also be noted that the director’s report under Section 134 of the 2013 Act is also required to include the details of related party transactions requiring consent of the Board/special resolution of members along with the justification for entering into them.

In January 2013, the Securities and Exchange Board of India (SEBI) had released its ‘Consultative Paper on Review of Corporate Governance Norms in India’ to align the existing corporate governance norms in India with the then existing Companies Bill, 2012 and other international practices. Consequent to the enactment of the 2013 Act, the SEBI Board on 13 February 2014, approved the proposals to amend the corporate governance norms for listed companies in India. The amendments are applicable to all listed companies with effect from 1 October 20142. The SEBI norms require approval of all material related party transactions by shareholders through special resolution and seem to be more onerous than the related Section under the 2013 Act.

Implementation challenges for related party reporting under the Companies Act, 2013

With the growing involvement of investors and other stakeholders in companies, the concern around transparency in transactions with related parties has often been a topic of much debate and discussion. With the objective to steer corporate India towards an increased degree of transparency in such transactions, Section 188 in the 2013 Act and the Revised Clause 49 (RC 49) in the Equity Listing Agreement issued by the Securities and Exchange Board of India (SEBI) have been brought into effect. These changes require the audit committee to review and approve such transactions and refer these to the Board of Directors and/or shareholders (as the case may be) and seek their approval.

Both, the 2013 Act as well as RC 49 require companies to adhere to stringent compliance requirements surrounding RPTs. Compliance with the additional requirements calls for significant efforts on the part of companies.

In the following paragraphs, we have identified key challenges that companies are expected to face while implementing processes to help ensure compliance with the related party requirements.

Identification of related parties

The definition of related parties is different in Section 2(76) of the 2013 Act, and AS 18, Related Party Disclosures. The 2013 Act have expanded the scope of related parties quite significantly by including, for example, key managerial personnel (KMP) and their relatives with reference to a company or directors (excluding independent directors) and KMP and their relatives of the parent company. Companies need to ensure that the related party identification process is comprehensive to cover all the parties covered by different definitions.

SEBI requirements

Under RC 49, an entity shall be considered as related to the company if:

i. such entity is a related party under section 2(76) of the 2013 Act, or

ii. such entity is a related party under Indian accounting standards.

Further, companies should put in place a process to contemporaneously update the list by capturing all changes to the list of the related parties. Such changes could include new directors/relatives, acquisitions, joint ventures, investment in associates. The process to update the list would require regular notification by directors on changes in their or their relatives’ business interests.

2. Requirements relating to the appointment of women directors will be applicable from 1 April 2015. [SEBI’s circular CIR/CFD/POLICY CELL/7/2014 dated 15 September 2014]


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Approval for RPTs

Audit committee approval - whether ‘prior’ or ‘post facto’

Section 177 of the 2013 Act requires all related party transactions to be approved by the audit committee. However, the Section does not specify whether the audit committee approval needs to be a pre-approval or a post facto approval3.

Section 188 of the 2013 Act requires that specified transactions with related parties that are not in the ordinary course of business and which are not at an arm’s length would require consent of the Board of Directors of the company. Additionally, certain specified transactions would require prior shareholders’ approval by special resolution3 and those transactions are as follows:

• Sale or purchase of goods which exceeds 10 per cent of turnover or INR1 billion, whichever is lower*

• Sale or purchase of property of any kind which exceeds 10 per cent of net worth or INR1 billion, whichever is lower*

• Leasing of property of any kind which exceeds 10 per cent of turnover or 10 per cent of net worth or INR 1billion, whichever is lower*

• Availing or rendering of any service which exceeds 10 per cent of turnover or INR500 million, whichever is lower*

• Appointment to any office or place of profit in company, subsidiary, or associate where the monthly remuneration exceeds INR0.25 million

• Remuneration for underwriting subscription of any securities or derivatives which exceeds one per cent of net worth.

*Applies to transaction or transactions to be entered into either individually or taken together with the previous transactions during a financial year.

Section 188 also allows that RPTs may be ratified (and not necessarily pre-approved) by the board/shareholders and such ratification should be within three months from the date of the contract.

SEBI requirements

As per RC 49, RTP is a transfer of resources, services, or obligations between a company and a related party, regardless of whether a price is charged and all such transactions will require a prior approval of the audit committee.

The audit committee may also grant an omnibus approval to all related party transactions for a period of one year and such transactions shall be reviewed quarterly by the Committee. In case related party transactions can not be foreseen and the company does not have any details of the transaction like name of related party, nature and period of transaction, current base price, etc. it shall give an omnibus approval for a value not exceeding INR10 million per transaction.

All material RPTs shall require approval of the shareholders through special resolution and the related parties shall abstain from voting on such resolutions. RC49 has been amended and provides that shareholders’ appoval and the approval of the audit committee is not required in the following cases:

a. where the transactions have been entered into between two government companies (government company to have the same meaning as per section 2(45) of the 2013 Act)

b. where transactions are entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with such holding company and placed before the shareholders at the general meeting for approval.

All entities falling under the definition of related parties should abstain from voting irrespective of whether the entity is a party to the particular transaction or not. This requirement exists irrespective of the fact that the transactions with the related parties may be at an arm’s length and in the ordinary course of business.

Materiality has been defined as 10 per cent of the annual consolidated turnover of the company as per its last audited financial statements.

The 2013 Act requires the approval of the audit committee for all RPTs and RC 49 requires prior approval of the audit committee for all RPTs. Accordingly, for a listed company, prior approval of the audit committee shall be required for all RPTs. Additionally, the 2013 Act requires prior approval of the Board if the transaction with the related party that is covered under Section 188 is not in the ordinary course of business or not at an arm’s length.

For unlisted companies, prior audit committee approval is not expressly required by the 2013 Act. From a governance perspective, it may be advisable that unlisted companies have a procedure in place whereby prior approval of the audit committee is obtained for the RPTs and post facto approval is limited to urgent situations.


3. In order to address the implementation challenges, the Union Cabinet has proposed certain amendments to the Companies Act, 2013 - please refer to page 32

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Audit committee to approve ‘transactions’ or ‘contract or arrangements’

As mentioned above, Section 177 of the 2013 Act requires the audit committee to approve all RPTs. Whereas, specific transactions listed under Section 188 of the 2013 Act refers to ‘contracts or arrangements’ with related parties which are to be considered for approval by the audit committee and the Board and/or shareholders.

In our experience, many companies are obtaining approval for contracts or arrangements covering all transactions with their related parties to be approved by their the audit committees. While formalising the agreement, a company should identify all transactions including, but not limited to, the scope of services, terms and conditions, pricing for the services, etc. Additionally, during the year, the company should monitor the RPTs to attempt to ensure that approvals of the audit committee are in place for all the RPTs.

SEBI requirements

Further, the definition provided by RC 49 under the Equity Listing Agreement of the SEBI and AS 18 also includes transactions where no consideration is charged in case of a RPT. For example, in cases where employees of one company provide services such as accounting support, IT support, bookkeeping support, property services, etc. to another group company and no consideration is charged by the entity providing services, such a transaction should also be considered as a ‘RPT without consideration’. Another common example is where subsidiaries or other related parties use the office of the parent company as registered office and no consideration is being charged, then such a transaction should be considered as ‘RPT without consideration’.

Materiality

As stated above, under the 2013 Act, materiality has been specified for each category of transaction in cases when transactions require shareholders’ approval. The materiality thresholds are to be evaluated party wise for each transaction category and cumulatively for all transactions with a particular party during the financial year. For example, the company may enter into different transactions like sale of goods, purchase of fixed assets, loans taken, etc. with a particular party. For the purpose of determining materiality the respective thresholds for each category of transactions would apply.

SEBI requirements

Under RC 49, a transaction with a related party shall be considered material if the transaction/transactions to be entered into individually or taken together with previous transactions during a financial year, exceeds ten per cent of the annual consolidated turnover of the company as per the last audited financial statements of the company. For calculation of materiality, RC 49 does not specifically define the term ‘turnover’. However, the quarterly results submitted as per the SEBI regulations disclose net turnover (net of excise duty). Accordingly, the company could use net turnover for computation of materiality under RC 49.

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Justification of arm’s length and ordinary courseArm’s length

The expression ‘arm’s length transaction’ has been defined in Section 188 as a transaction between two related parties that is conducted as if they were unrelated, so that there is no conflict of interest. No method/basis to determine whether a transaction is at an ‘arm’s length’ has been prescribed under the 2013 Act.

The company may refer to the Guidance Note issued by the Institute of Chartered Accountant of India (ICAI) on transfer pricing, which indicates that, in general, comparable market price is a sound indicator of an arm’s length price. If the price has been accepted by the tax authorities as an arm’s length price, it is likely to meet the definition under the 2013 Act subject to the assessment of other terms and conditions. There could be special conditions attached to transactions, for example, extended credit period, which would need to be evaluated.

A company may also refer to SA 550, Related Parties, issued by the ICAI which suggests the following steps in order to determine whether the transactions are at an arm’s length:

– Comparison of the terms with those of an identical or similar transaction with one or more unrelated parties

– Comparison of the terms to known market terms for identical or similar transactions

– In making the comparison, consideration should be given not only to the price but also to other terms and conditions, for example, credit terms, contingencies, and specific charges.

A company may also refer to international guidelines/principles i.e. OECD4 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration for determining an arm’s length pricing.

Ordinary course of business

The term ‘ordinary course of business’ has not been defined in the 2013 Act. Hence, reference may be made to judicial precedents wherein the courts have commented on the meaning of ‘ordinary course of business’.

The ambit of the terms ‘ordinary course of business’ is fairly wide and based on views taken by the courts. It would include various attributes, e.g. transactions in the context of the business, normal and incidental to the business, customary and regular to the conduct of the business. Thus, what could be covered within the expression ‘ordinary course of business’ will have to be seen in the context of the business of the relevant company and the transactions which are sought to be classified with such expression.

This area requires careful consideration and should be analysed on a case to case basis.


4. The Organisation for Economic Co-operation and Development

Source: KPMG in India analysis

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Tracking of RPTsPost approval of transactions by the audit committee, Board of Directors, and shareholders, as the case may be, companies also need to put in place a process to ensure that any unapproved transactions are not entered into with the related parties. Further, for transactions approved by the audit committee with certain specified limits, the volume of transactions should not exceed such limits. In practice, companies tend to adopt one of the following processes for ensuring this:

• Circulate a list of related parties and approved transactions to all key stakeholders e.g. business heads who then take ownership to ensure that no transactions are entered into with related parties except those mentioned in the list provided

• Tag related parties in the accounting systems and impose a cap for particular voucher types for approved transactions. The accounting system will prompt the user to obtain additional approval once the limit is reached.

One of the key issues that companies are facing is sensitising business teams regarding the various compliances required for RPTs. This is of critical importance in large companies where decision making is decentralised and the possibility of entering into transactions with the related parties without due assessment and approval is a possibility due to lack of knowledge/awareness among the business teams.

Voting on RPTsSection 188 states that for approval of RPTs, ‘related parties’ can not vote. This posed a significant impediment in obtaining the shareholders’ approval.This issue has been largely resolved with the clarification of the MCA on 17 July 2014 which elaborated that only related parties interested in the transaction would not be allowed to vote for such resolutions. Other related parties of the company who had no interest in the transactions were permitted to vote.

SEBI requirements

As per RC 49 in case of shareholders’ resolution, all entities falling under the definition of related parties shall abstain from voting irrespective of whether the entity is a party to the particular transaction or not. Thus, there is lack of alignment between the requirements of both the authorities.

However, the 2013 Act provides no relief for transactions between fellow subsidiaries and transactions with a joint venture, where all the shareholders would be precluded from voting on the transactions given that they would be interested parties. This is expected to pose significant difficulties in case of transactions wherein a holding company would be required to vote in case of a transaction between its wholly owned subsidiary and partially owned subsidiary.

Loans to directors or companies in which directors are interested5

Section 185 of the 2013 Act places restrictions on loans and advances, including any loan represented by book debt to directors and any other person in whom the director is interested. The company shall not directly or indirectly, advance any loan, including any loan represented by a book debt:

– to any of its directors

– to any other person in whom the director is interested including any body corporate, board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director to directors, of the lending company

– give any guarantee or provide any security in connection with any loan taken by him or such other person.

The above Section shall not apply to:

– loans given by a holding company to its wholly owned subsidiary company provided such a loan is utilised by the subsidiary company for its principal business activities

– any guarantee given or security provided by holding company in respect of any loan made to its subsidiary company, provided such a loan is utilised by the subsidiary company for its principal business activities

– loan given to a managing director or a whole time director as a part of the conditions of service extended by the company to all its employees or pursuant to any scheme approved by the members by a special resolution

– loans or guarantees or securities given by the company which in the ordinary course of its business provides such loans or guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India (RBI).

The major change is that Section 185 applies to private companies also (unlike Section 295 of the 1956 Act which applies only to those private companies which were subsidiaries of public companies).

Further, the explicit exemption to giving of loans by a holding company to its subsidiary and to provision of security/guarantee by a holding company for loans taken by its subsidiary has also not been retained entirely. While this is going to cause a significant difficulty to partly owned subsidiaries who work on the finances provided by the holding companies, it would provide alienation to the investors’ money from being exposed to risk other than those risks which were perceived by the investors while making the investment. The MCA has clarified that a holding company is allowed to give guarantee or provide security in respect of loans made by banks or financial institutions, to its subsidiary company provided such loans are exclusively used by the subsidiary for its principal business activities.6 Further, both giving loans and providing guarantee or security in connection with borrowings from a bank or financial institution are permitted in case of a wholly owned subsidiary provided



6. Source: MCA’s general circular No. 03/2014 dated 14 February 2014

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these are related to the subsidiary’s principal business activities. The scope of the exemption available is limited in respect of partly owned subsidiaries, as it covers only guarantees and security provided for borrowings from banks and financial institutions and does not extend to loans given by a holding company to its partly owned subsidiary company.

Loan and investment by company

As per Section 186 of the 2013 Act, a company shall not, directly or indirectly,

– give any loan to any person or other body corporate

– give any guarantee or provide security in connection with a loan to any other body corporate or person

– acquire by way of subscription, purchase or otherwise, the securities of any other body that exceeds 60 per cent of its paid-up share capital, free reserves and securities premium account or 100 per cent of its free reserves and securities premium account, whichever is more.

Where giving of any loan or guarantee or providing any security or acquisition exceeds the limits specified above, prior approval by means of a special resolution passed at a general meeting shall be necessary.

No investment shall be made or loan/ guarantee/security provided by the company unless the resolution sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting and the prior approval of the public financial institution concerned, where any term loan subsisting is obtained. Provided that prior approval of a public financial institution shall not be required where the aggregate of the loans and investments so far made, the amount for which guarantee or security so far provided to or in all other bodies corporates, along with the investments, loans, guarantee, or security proposed to be made or given does not exceed the limit as specified in Section 186(2), and there is no default in repayment of loan installments or payment of interest thereon as per the terms and conditions of such loan to the public financial institution.

The company shall not give any interest free loans to its related parties (including wholly owned subsidiaries) or any employees including directors and key managerial personnel. At a minimum, interest will be charged at a rate not lower than prevailing yield of one year, three year, five year, or 10 year government security closest to the tenor of the loan.

The above requirements of Section 186 would not apply to a banking company, an insurance company, a housing financial company or a Non-Banking Financial Company (NBFC) registered with the Reserve Bank of India.

Whistle-blowing mechanism

Apart from corporate governance and transparency, the 2013 Act also requires all listed companies, companies which accept deposits from the public and companies which have borrowed money from banks and public financial institutions in excess of INR 500 million, to establish a vigil mechanism for directors and employees to report genuine concerns in such manner as may be prescribed.

The 2013 Act also requires that the vigil mechanism to be put in place should provide for adequate safeguards against victimisation of persons who use such mechanism and make provision for direct access to the Chairperson of the audit committee in appropriate or exceptional cases. This provision in the 2013 Act could help ensure that the audit committee gets the information of cases/situations which could jeopardise the interest of the investors and others interested in the working and operation of the company.

Serious Fraud Investigation Office

The entire gamut of corporate governance and transparency oriented measures in the 2013 Act would work only if there is a mechanism to monitor compliance. An investigation into the affairs of a company can be initiated by the central government in the following circumstances:

i. on receipt of report from the Registrar of Companies or inspector

ii. on intimation of a special resolution passed by the company that its affairs are required to be investigated

iii. in public interest

iv. on request of any department of the central government or state government.

The investigation into the affairs of the company can be in the hands of inspectors as appointed by the central government or by assignment of the case to the Serious Fraud Investigation Office (SFIO). The 2013 Act gives statutory status to the SFIO. SFIO will typically comprise experts from various relevant disciplines including law, banking, corporate affairs, taxation, capital market, information technology and forensic audit.

The investigation report by the SFIO filed with the court for framing of charges shall be treated as a report filed by a police officer. The SFIO shall have power to arrest in respect of certain offences which attract the punishment for fraud. Recognition of the SFIO would strengthen and expedite the investigation process. The legal and statutory powers vested with the SFIO and its broad-based composition with experts drawn from various relevant disciplines would help make the process more effective.


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The Companies Act, 2013 – deposits Introduction

The Companies Act, 2013 (2013 Act) has introduced several measures which are expected to provide protection to depositors. It has also increased the reporting requirements of companies accepting deposits by requiring them to file circulars and statements of deposits with the registrar of companies. In addition, the 2013 Act also provides for stringent penalties for any violations in complying with the provisions of this Act.

Applicability

The provisions of the 2013 Act, relating to acceptance of deposits, are applicable to all companies except the banking companies, non-banking financial companies (NBFCs) and housing finance companies. Therefore, the provisions relating to deposits under the 2013 Act apply to following two categories of the companies:

• a company that accepts deposits from its members after passing a resolution in its general meeting according to the Rules prescribed and subject to the fulfilment of the specified conditions (Section 73(2) of the 2013 Act)

• a company that is eligible to accept deposits from public (i.e. eligible company as defined in the Rules).

The 2013 Act not only regulates the deposits accepted after the commencement of the 2013 Act but also the deposits accepted before such commencement.

Key provisions

Definition of deposits

The definition of deposits when read along with the list of exceptions provided under the Rules to the 2013 Act is much wider than that what was provided in the the Companies Act, 1956 (1956 Act) and its Rules. Various amounts received by a company are now considered as deposits which were earlier excluded from being considered as deposits.

As per the 2013 Act, ‘deposit’ includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include such categories of amounts as have been prescribed in the Rules to the 2013 Act.

The Rules under the 2013 Act prescribe the categories and items which are not included in the definition of deposits.

Unlike as per the exclusion provided in the Rules under the 1956 Act, the Rules under the 2013 Act prescribe that amounts received from members and the relatives of directors are deposits even in the case of a private company. Under the 2013 Act, a private company will have to adhere to stricter norms in the case of deposits accepted from its members and it can not accept deposits from relatives of its directors, those would be considered to be public deposits. Further, amounts received towards subscription to any securities, if not allotted within 60 days of receipt, shall be treated as a deposit, if such application money is not refunded to the subscriber within 15 days from the end of 60 days of receipt. However, amounts received from directors continue to be excluded from the ambit of deposits, if such amount is not out of any funds borrowed by the director by way of loan or accepting deposits.

Also, advances received by a company for supply of goods or provision of services shall be considered as deposits if not appropriated against such supply of goods or provision of services within 365 days of acceptance of such deposits. However, security deposits taken for the performance of a contract for supply of goods or provision of services shall not be considered as deposits. Thus, every private company and a non-eligible public company will have to settle the advances against goods or services within 365 days to comply with the provisions of the 2013 Act.

Any amount received from any other company shall continue to be excluded from the definition of deposits. Thus, any advance received from a company shall not be considered as deposit, even if not appropriated against goods or services within 365 days.


Summary

The 2013 Act aims to substantively raise the bar on governance and deals with some very relevant themes. On the flip side, some of the requirements are quite onerous and thrusts greater responsibility and obligation on the board of directors and managements of the Indian companies.

The Sections covering related parties under the 2013 Act and the RC 49 under SEBI have laid down extremely stringent compliance requirements on companies with regard to RPTs. The reading of multiple Sections and RC 49 in tandem to ensure compliance is proving challenging for many companies. The implementation difficulties get further

accentuated by the fact that all companies irrespective of size have to comply with these requirements and lack of congruence between SEBI and the MCA on prescribing these guidelines and requirements.

The MCA has already tabled a draft notification which proposes relaxation of requirements of Section 185, 186, and 188 to private companies (see page number 32 for more details). Considering the key challenges as noted above many stakeholders expect further relaxations and clarifications to emerge in the foreseeable future in the context of RPTs.

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Only an ‘eligible company’ can invite and accept public deposits

A noteworthy provision with regards to acceptance of deposits is that the 2013 Act and the Rules have prescribed certain prerequisites for a public company to invite and accept public deposits. As per the 2013 Act, only an ‘eligible company’ can accept public deposits, it being, a public company having a net worth not less than INR1 billion or turnover of not less than INR5 billion. Further, such public company should have taken a prior consent of the company in a general meeting by way of a special resolution. Thus, all public companies can not invite and accept public deposits. Consequently, smaller size public companies not meeting the eligibility criteria would now face limitations in accessing public deposits.

Mandatory repayment of deposits accepted before the commencement of the 2013 Act

One of the most significant obligations imposed by the 2013 Act is that, it requires the companies to repay all the deposits accepted by them before the commencement of the 2013 Act and interest due thereon, within a year from such commencement or when they become due, whichever is earlier. However, the 2013 Act provides that a company can get a relief by way of extension of time for repayment if the Tribunal allows the same, considering the financial condition of the company, on application made by the company to the Tribunal. This provision will help in streamlining the existing deposits as per the regulations of the 2013 Act. However, it might not be an easy task for all companies to comply with this requirement. This could impact the cash flows and liquidity of some companies. Also, clarification has been provided by way of an explanation in the Rules that in case of a company which has accepted public deposits as per the provisions of the 1956 Act, and its rules, and has been repaying such deposits and interest thereon in accordance to such provisions, the company need not repay such deposits within a year, if it complies with other requirement of the 2013 Act and Rules and also, if it continues to repay such deposits and interest thereon on due dates for remaining period of such deposits. Thus, if a company is an ‘eligible company’

within the meaning of the Rules and complies with other requirements under the 2013 Act and its Rules, it need not repay the deposits accepted by it before the commencement of the 2013 Act within one year.

To illustrate this vide an example, if a public company having turnover of less than INR5 billion and net worth of less than INR1 billion, has accepted deposits which are maturing in 2016, the company will have to repay all the public deposits within a year i.e. before 31 March 2015 even though it is making repayments of deposits and interest duly, as the company is not an eligible company as per the 2013 Act and Rules there under.

Introduction of deposit insurance

The 2013 Act has imposed a new obligation on companies accepting deposits by compelling the company to provide insurance to the depositor, in respect of both, the principal amount and interest due thereon. However, the 2013 Act provides that the minimum aggregate insurance should not be less than INR20,000 for each depositor. The Rules, however, have allowed a company to accept the deposits without deposit insurance contract till 31 March 2015. The amount of insurance premium paid on the insurance contracts is to be borne by the company accepting the deposits. This provision is expected to help in protecting the interest of small depositors to a certain extent in case of default by the company.

Cap on interest rates on deposits

The 2013 Act, when read along with the Rules, provides that the rate of interest on the deposits accepted should not exceed the maximum rate of interest prescribed by the Reserve Bank of India (RBI) for acceptance of deposits by NBFCs. Rules under the 1956 Act prescribed the ceiling of 12.5 per cent per annum.


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Penal provisions

The 2013 Act provides stringent penal provisions in case of fraudulent invitation and acceptance of deposits. The 2013 Act provides that every officer of the company responsible for the acceptance of deposits shall be personally responsible, without any limitation of liability, if it is proved that such deposits had been accepted with intent to defraud the depositors.

Other relevant provisions

Limits on acceptance of deposits

The 2013 Act and the Rules prescribe limits on acceptance of deposits from members and public. In case of an eligible company other than a government company, the limit for acceptance of deposits from members is capped at 10 per cent of the paid-up share capital and free reserves. Also, the limit for acceptance of deposits from the public is limited to 25 per cent of paid-up share capital and free reserves. A company, other than an eligible company, can accept or renew deposits from its members upto 25 per cent of paid-up share capital and free reserves. In case of government companies, the limit is extended to 35 per cent of paid-up share capital and free reserves.

Maintenance of liquid assets

Similar to the provisions of the 1956 Act, which required a company to maintain liquid assets by way of making prescribed deposits or investments, the 2013 Act also requires a company to deposit a sum not less than 15 per cent of the deposits maturing during a financial year and before the end of the next financial year in a deposit repayment reserve account with a scheduled bank. The 2013 Act also states that the sum in such account shall not be used for any purpose other than repayment of the deposits.

Creation of security

The Rules under the 2013 Act prescribe that all the deposits accepted from the members in the case of companies under Section 73(2) of the 2013 Act and secured public deposits accepted by eligible companies should be secured, to the extent not covered by the deposit insurance, by creating a charge on specified assets excluding intangible assets. Such deposits are secured for the principal amount and interest thereon.

Premature repayment

Similar to provisions of the 1956 Act, the 2013 Act also provides that if the deposit is repaid before its maturity, on request of the depositor, the interest payable on such deposits should be reduced by one per cent except for few conditions like repayment for complying with other rules, etc.

Reporting requirements

The 2013 Act prescribes that every eligible company shall issue a circular containing information like the credit rating, financial position of the company and information related to deposits, etc. This circular shall be issued as an advertisement in an Engilsh and vernacular newspaper and also uploaded on the website of the company. This is expected to bring more awareness amongst the depositors and probable depositors about the financial condition of a company. Also, every company shall file a return annually with the Registrar in a prescribed form with prescribed information relating to deposits accepted by the company.

Duration of deposits

The provisions related to duration of a deposit are similar to those in the 1956 Act. The 2013 Act provides that deposits should not be repayable within six months or after 36 months of acceptance or renewal. However, subject to certain conditions, a company may accept a deposit repayable within six months but not within three months from the date of acceptance or renewal.

Conclusion

The 2013 Act seems to have much more stringent provisions relating to the acceptance of deposits as compared to the 1956 Act. Small public companies and private companies might have to bear the brunt of these new challenges in raising funds because of the strict provisions in the 2013 Act. Also, companies might have to settle some advances to comply with the provisions of the 2013 Act. This might create new challenges for such companies as they might face some unplanned cash outflows. Nonetheless, inclusion of such stern provisions gives the impression that the safety of the depositors has been given the highest priority by the lawmakers. Such provisions could go a long way in helping ensure prompt repayment of deposits and interest thereon to depositors and greater public confidence in such deposits.


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Impact on auditorsThe 2013 Act has some significant implications for auditors.

Theme 3Mandatory rotation of auditors

Certain specified companies can not appoint or reappoint an audit firm (including an LLP) as auditor for more than two consecutive terms of five years each (in case of an individual there would be one term of five years). The specified companies are as following:

a. listed companies

b. all unlisted public companies having paid up share capital of INR100 million or more

c. all private limited companies having paid up share capital of INR200 million or more

d. all other companies having paid up share capital below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of INR500 million or more.

The mandatory rotation of auditors’ requirement is not applicable to small companies and one person companies. In determining the period of five consecutive years or ten consecutive years, as the case may be, the tenure of auditors prior to 1 April 2014 would be considered. The Rules provide a three year transition period for complying with the provisions of the 2013 Act. For example, if an audit firm has served as the auditor of a company for a period of seven years on 1 April 2014 then the firm would need to rotate out after a maximum period of three years.

Additionally, in determining the tenure of the audit firm prior to 1 April 2014, tenure of the other firms operating under the same network of audit firms would also be considered. The Rules clarify that term ‘same network’ includes the firms operating or functioning, hitherto or in future, under the same brand, trade name or common control.

There is a cooling off period of five years for both individual auditors and audit firms within which the auditor can not be re-appointed. Audit firms having a common partner or partners with the outgoing audit firm or operating under the same trademark or brand will also not be eligible for appointment till the cooling off period of the outgoing firm has expired.

If a partner, who is in charge of an audit firm and certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years for that company.

Rules further clarify that only a tenure break of five years or more is to be considered in meeting the rotation criteria.

Auditor appointment and removalTerm of appointment

As per the Rules, an individual or a firm would be appointed as an auditor for a five-year term with annual ratification at the annual general meeting by ordinary resolution. If the appointment is not ratified, it appears that the process for change of auditor would have to be followed.

On initial appointment under the 2013 Act, the period of appointment could be less than five years, as it depends on the transition requirements and the remaining tenure.

While considering an auditor appointment, the audit committee/board of directors would have to consider any order or pending proceeding against the auditor/audit firm or any partner of the audit firm relating to matters of professional conduct before the Institute of Chartered Accountants of India (ICAI), any court or other competent authority.

The introduction of a fixed tenure for audit appointment is a welcome move. Viewed in conjunction with other provisions of the 2013 Act, it provides a certain level of balance to the role and responsibilities of auditors. Also, while it may now be difficult to remove an auditor prior to the expiry of their term, the conditions of a special resolution and the central government approval, if applied in the spirit that they have been drafted, could be supportive of greater auditor independence and objectivity.

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Disqualifications of auditors

An auditor would not be eligible for appointment:

• if he holds any security or interest not only in the company but also in its subsidiary/holding/fellow subsidiary as well as in its associate. Besides, holding of security or interest by relative(s) of the auditor would also result in disqualification except that relatives can hold securities or interest with ‘face value’ not exceeding INR0.1 million). Any acquisition of security or interest by relatives beyond these limits is required to be corrected within 60 days

• if he, or his relative or partner is indebted in excess of INR0.5 million to the company or its subsidiary/holding/fellow subsidiary as well as in its associate

• if he or his relative or partner has given a guarantee or provided any security in connection with indebtedness of any third person to the company, or its subsidiary/holding/fellow subsidiary as well as in its associate in excess of INR0.1 million

• if person or a firm who, whether directly or indirectly, has business relationship with the company, or its subsidiary/holding/fellow subsidiary as well as in its associate except those that are in the ordinary course of business and at an arm’s length like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other businesses

• if person whose relative is a director or is in the employment of the company as a director or key managerial personnel

• person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies

• if person who has been convicted by a court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction.

Auditor reporting responsibility

The reporting requirements have been extended from what was required under the 1956 Act. Further, the central government in consultation with the National Financial Reporting Authority, has the power to direct the inclusion of specified matters into the auditors’ reports for specified classes/description of companies.

The 2013 Act requires that the auditor has to report:

• Where the company has failed to provide any information and explanations to the auditors, the details of the same and their effect on financial statements

• Whether the company has adequate internal financial controls in place and the operating effectiveness of such controls. The Ministry has issued a circular dated 14 October 2014 that reporting by auditors on internal

financial controls shall be mandatory for the financial years beginning on or after 1 April 2015. However, voluntarily auditors can make a statement on the same in the auditor’s report for 2013-14

• Observations or comments on financial transactions or matters which have any adverse effect on the functioning of the company

• Any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith (this is in addition to the assertion relating to maintenance of proper books of account).

Additionally, the Rules now require the auditor’s report should also include their views and comments on the following matters:

• Whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statements

• Whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts

• Whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company.

There are a number of areas that require further amplification in the Rules to enable consistent application. For instance, the scope of the expression ‘financial transactions or matters’ which have any ‘adverse effect on the functioning of the company’ is extremely wide. It may also be seen as requiring the auditor to comment on propriety matters which in the auditor’s view could potentially have an adverse impact of the functioning of the company. Hitherto such matters were not specifically commented upon by an auditor.

Unless the responsibilities are specifically defined, it is very likely that a lot of diversity would exist in application such that the very purpose of the provision would be defeated. It may be appropriate if the scope of the expression ‘financial transactions and matters’ is limited to items having significant impact on financial statements. Also the 2013 Act or the Rules do not define the scope of the term ‘internal financial controls’. To facilitate a consistent application, a clarification that the scope of the term is limited to internal controls over financial reporting should be incorporated in the Rules/relevant auditing standards.

Recently, the ICAI has issued Guidance Note on Audit of Internal Financial Controls over Financial Reporting. This guidance note provides guidance to the statutory auditors for their reporting on adequacy of internal financial controls and operating effectiveness of such controls.


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Reporting of frauds by auditor1

In case an auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he is required to report the matter to the central government immediately but not later than 60 days of his knowledge in the following manner:

• He will forward his report to the board or the audit committee, as the case may be, immediately after he comes to knowledge of the fraud in order to seek their reply or observations within 45 days

• On receipt of such reply or observations the auditor is required to forward his report and the reply or observations to the board or the audit committee along with his comments (on such reply or observations of the board or the audit committee) to the central government within 15 days of receipt of such reply or observations

• If the auditor fails to get the any reply or observations from the board or audit committee with the stipulated period of 45 days, he should forward his report to the central government along with a note containing the details of his report that was earlier forwarded to the board or the audit committee for which he failed to receive any reply or observations within the stipulated time.

• The report is required to be sent to the Secretary, MCA.

The increase of reporting requirements is well intentioned to ensure that such matters are brought to the attention of the government/regulatory authorities. However, the construct of the Rules make these reporting requirements very challenging. For instance, the auditor is required to comment not only on confirmed frauds but also suspected frauds.

In many instances where fraud or suspected fraud exists, the auditor may struggle to have adequate or timely information to comply with these reporting requirements. Additionally, the current construct of the Rules may push auditors to report earlier than what may be prudent/appropriate mainly to avoid the risk that the auditor is non compliant and subject to penalty provisions under the 2013 Act. In the case of entities with large and widespread customer base (e.g., electricity supply companies) instances of frauds can not be totally avoided and such situations could lead to repetitive reports being sent to the central government.

Liability of the auditor

The rules clarify that for any criminal liability of any audit firm, liability other than fines would devolve only on the concerned partner or partners, who acted in a fraudulent manner or abetted or colluded in any fraud.

Removal of auditor before expiry of his term

Application for removal of auditor also contains matters such as qualifications in the auditor’s report in last three years, pending civil or criminal proceedings between the company and the concerned officers, pendency of audit and current state of the accounts at the time of removal of auditors, etc. This would enable a more qualitative assessment by the MCA in granting permission for removal of auditors.

Other changes - National Financial Reporting Authority

An independent authority, viz. National Financial Reporting Authority (NFRA) is to be constituted to make recommendations to the central government on the formulation and laying down of accounting and auditing policies and standards, monitor and enforce compliance therewith and oversee the quality of service of relevant professions. NFRA has been vested with quasi judicial powers to investigate matters of professional or other misconduct (as defined in the Chartered Acoountants Act, 1949) by chartered accountants ‘for such class of bodies corporate or persons‘ as may be prescribed. At present, matters relating to professional or other misconduct are handled by the ICAI.


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Theme 4

The Government has introduced mandatory ‘corporate social responsibility’ (CSR) requirements in the Companies Act, 2013 (2013 Act). The 2013 Act mandates companies to spend on social and environmental welfare, making India perhaps one of the very few countries in the world to have such a law and requirement. The CSR provisions have become effective from 1 April 2014, and the Ministry of Corporate Affairs (MCA) has issued further clarifications relating to the CSR requirements through a circular dated 18 June 2014 (Circular).

ApplicabilityIn India, Corporate Social Responsibility (CSR) activities have traditionally been in a voluntary form. The Companies Act, 2013 (2013 Act) prescribes a framework for all companies meeting the prescribed criteria to contribute two per cent of their profits for a CSR purpose. The 2013 Act puts greater responsibility on companies to set out a clear framework and process to ensure strict compliance.

The CSR Rules (Rules) state that every company including its holding or subsidiary, as well as foreign companies having project office/branch in India, meeting certain criteria (i.e. equaling or exceeding net worth of INR5billion, net profit of INR50 million, or turnover of INR10 billion) during any financial year, is required to comply with the CSR provisions.

The MCA Circular issued on 18 June 2014 clarifies that the above threshold limits for CSR applicability during, say, financial year 2014-15 must be checked during any of the preceding three financial years i.e. 2013-14, 2012-13 and 2011-12. The profits calculated under the Companies Act, 1956 (1956 Act) are not required to be recalculated and hence, the net profit threshold of INR5 billion should be considered for profit calculated as per Section 349 of the 1956 Act (Section in the 1956 Act corresponding to Section 198 in the 2013 Act) for financial years 2013-14, 2012-13, and 2011-12.

Once a company has been determined to be covered under the CSR provisions, in order for the requirement to cease to be applicable, the company would need to prove that for three consecutive years the CSR provisions do not apply to it. The CSR provisions would then cease to apply from the fourth year and not during the preceding three financial years, which means that the company would be required to continue with the CSR committee and the CSR spend during the three preceding financial years.

Appointment of the committeeA committee is required to be formed consisting of three or more directors of the company, out of which at least one director should be an independent director. Following is the role of the CSR committee:

• Formulate strategy and activities

• Recommend expenditure amount to execute the strategy

• Regularly monitor CSR policy.

The rules specify that CSR policy should:

• Specify the projects and programmes to be undertaken and also list the CSR projects/programmes which the company plans to undertake during the implementation year, and the modalities of execution in the areas/sectors chosen along with implementation schedules.

• The surplus arising out of the CSR activity will not be part of business profits of a company.

Corporate social responsibility: an analysis


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Board responsibilityThe 2013 Act puts responsibility of the CSR on the Board of Directors and they are required to:

• To approve the CSR policy (recommended by the CSR committee) and disclose the contents of the policy in its report and place it on the company’s website

• Ensure that the CSR activities are undertaken by the company

• Ensure 2 per cent spending on CSR activities

• Report CSR activities in the Board of Director’s report and disclose non-compliance (if any) with the CSR provisions and reasons for not spending the amount.

What constitutes eligible CSR spendActivities which may be considered as eligible CSR spend are provided in the Schedule VII of the 2013 Act. The following are the key headline activities specified in the Schedule VII:

• Environment sustainability

• Empowering women and promoting gender equality

• Education

• Poverty reduction and eradicating hunger

• Social business projects

• Reducing child mortaility and improving maternal health

• Improvement of health

• Imparting of vocational skills

• Contribution towards central and state government funds for socio-economic development and relief including contribution to the Prime Minister’s National Relief Fund

• Slum area development

• Swach Bharat Kosh

• Clean Ganga Fund

• Such other matters as may be prescribed.

The MCA has also clarified that CSR activities enumerated in schedule VII of the 2013 Act are broad-based and are intended to cover a wide range of activities. Thus, these prescribed activities should be interpreted liberally to capture their essence.

The companies should give preference to the local area and the area around it where it operates for spending the amounts earmarked for CSR activities.

If a company sets up a trust or Section 8 company (companies set up for charitable purposes), society, foundation or any other form of entity operating within India to facilitate implementation of its CSR activities in accordance with its stated CSR policy, then the company should:

• Specify the projects/programmes to be undertaken by such an organisation, for utilising funds provided by it

• Establish a monitoring mechanism to ensure that the allocation is spent for the intended purpose only.

The Rules also allow a company to conduct/implement its CSR programmes through trusts, societies or Section 8 companies operating in India which are not set up by the company itself. Such spends may be included as part of its prescribed CSR spend only if such organisations have an established track record of at least three years in carrying on activities in related areas.

The Rules also allow companies to collaborate with other companies for undertaking projects or programmes or CSR activities in such a manner that the CSR Committees of respective companies are in a position to report separately on such projects or programmes. CSR activities shall not include activities exclusively for the benefit of employees and their family members.


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Quantum of spendThe CSR committee of a company has to ensure that the company spends two per cent of its average net profit before tax, of the preceding three years, on CSR activities within India. Since the profits calculated under the 1956 Act are not required to be recalculated (as mentioned above), profits as per Section 349 of the 1956 Act must be considered for this purpose. Section 198 of the 2013 Act/349 of the 1956 Act mentions certain additions and deletions to be made while calculating the net profit of a company (mainly to exclude capital payments/receipts, income tax, set-off of past losses, etc.). Important considerations for companies include the following:

• Can past losses be set-off against profits of subsequent years? To explain this issue with an example, consider three years’ profits are INR100, INR20, INR (200) (i.e. loss of 200). One calculation of the profit could be 100 + 20 + (200) = (80) and therefore, no CSR spend requirement. Other calculation could be to take loss of 200 as nil for that year (since it would be set off against future years’ profits) and hence, profit would be 100 + 20 + 0 = 120. Thus, average profit would be INR 40 (i.e. 120/3) and consequently there would be CSR spend requirement of INR0.8. Currently, there is no authoritative guidance on this aspect that has been issued by the government

• Dividend from other Indian companies which are covered under and complying with the CSR provisions must be excluded. The words ‘covered under and complying with the CSR provisions’ seem to indicate that dividend of those companies must be excluded which meet the CSR threshold limit and comply with the provisions, although they may not be required to spend on CSR due to negative average net profit.

It seems that net profit and average net profit are two different calculations as they are defined separately. However, it would be possible to have a harmonious reading of the 2013 Act and Rules, and give effect to both the definitions while calculating the net profit as well as average net profit. This view can be substantiated from the fact that the Rules, in case of net profit for foreign companies, state that the same would be calculated as per provisions of the 2013 Act read with Section 198.


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Challenges and key considerations in implementationWhile the expenditure has been made mandatory, there are no specific penal consequences prescribed for failure, provided the reasons of default are disclosed in the Board of Directors’ report as well as its website, if any. The reason for such leniency may be to gauge the initial response of the companies without being cumbersome.

The Rules provide that any surplus arising from the CSR activities would not form part of business profits of the company. Hence, such surplus should be used only for the purpose of future CSR activities.

Another key question arises as to whether any capital expenditure would qualify as CSR spend. For example, a company purchases ambulance vehicles for the purpose of its CSR project and capitalises the same in its books. Since the CSR provisions talk about ‘spend’ and not the nature of expenditure, it may appear that the full cost of vehicles should qualify as CSR spend. However, if the asset is capitalised in books of the company and is at its disposal to be utilised in any manner in the future, only depreciation may be considered as the CSR spend for the year in which the asset is utilised towards the CSR activities. Consequently, if any asset is given away as donation or as a contribution to any CSR trust/foundation, full capital expenditure could be considered as the CSR spend.

Schedule VII provides a list of CSR activities. The Circular reiterates that CSR expenditure is expected to be in a project mode (i.e. planning, budgeting, allocating responsibility for, scheduling of the activities) and accordingly, mere donations (except to funds specified in Schedule VII) or arbitrary activities (even if otherwise qualifying under Schedule VII) would not be considered as eligible CSR activity. Also, activities exclusively benefitting employees or their families would not qualify under these provisions. However, there could be a scenario, though not absolutely intended, where few employees are benefitted by the company’s welfare activities. In such a case, while there is no clear authoritative guidance, an analogy could be drawn from the CSR guidelines issued by the Department of Public Enterprises for the Central Public Sector Enterprises (CPSEs) which state that the CSR activities, where

employees are less than 25 per cent of the beneficiaries of infrastructural facilities such as schools and hospitals, would fall within the guidelines. However, this topic is ambiguous and further clarification from the MCA would be helpful to many companies.

It would be worthwhile to note here that the said existing guidelines requiring CPSEs to spend on CSR are being harmonised with the CSR provisions under the 2013 Act. Thus, it may follow that certain CPSEs currently required to spend only one per cent of their net profit would now be required to spend a minimum of two per cent, and that too, of net profit before tax as against the current requirement of net profit after tax.

Further, while expenditure mandated by any other statute can not qualify as CSR spend, the Circular provides a relief by permitting allocation of salary cost to the CSR spend on timely basis in relation to any employee working on CSR projects. Even contribution made to the corpus of a trust/society/Section 8 company would qualify as a CSR spend. This is a welcome step as it eases pooling of funds to undertake CSR on a large scale through a common dedicated expertise.

The Finance Act, 2014 has clarified that expenditure on the CSR would not be considered as ‘for business purpose’ under Section 37 of the Income Tax Act, 1961, and accordingly would be disallowed unless specifically allowed under Sections 30 to 36.

ConclusionThe CSR concept is expected to evolve and implementation issues encountered to get sorted out in due course. In the interim, a key guidance should perhaps be the underlying spirit behind the Sections of the law relating to the CSR. The involvement of companies in social development could bring in required professionalism as well as technology, and CSR could be a powerful instrument for the holistic development of our country.


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Theme 5

The level of change and the complexities associated with implementing the changes introduced by the Companies Act, 2013 (2013 Act) are likely to be significant and pervasive for many companies. The effects of these changes would be felt notably by directors, audit committees and key managerial personnel.

Enhanced responsibility for directors

Mandatory director appointment

Appointment of directors

• In keeping with the theme of raising the bar on governance, the 2013 Act increases the maximum number of directors from 12 at present to 15. Further, the central government’s approval is not required for enhancement of this limit to 15; the maximum number can be increased by a special resolution. This could help companies in engaging directors with varied skill sets thereby, improving the quality of oversight on the affairs of the company.

• All companies are required to have at least one director who is an Indian resident i.e., having spent at least 182 days in India. This requirement might pose some challenges for foreign companies who have limited operations in the country but who have to comply with the requirements of the 2013 Act because of the wider definition of foreign companies.

• All listed companies and unlisted public companies with a share capital of INR1 billion or more or turnover of INR3 billion or more are required to have at least one woman director, thus paving way for gender diversity in the governing body of companies. The Rules provide a one year transition period to unlisted companies and the amendment to the Revised Clause 49 of the Equity listing agreement also makes this requirement applicable from 1 April 2015.

• Public companies with share capital of INR100 million or more, turnover of INR1 billion or more, or with loans/debentures/deposits of more than INR500 million are required to have at least two independent directors (listed companies are required to have one-third of the Board of Directors as independent directors). This requirement will impact unlisted public companies but is unlikely to impact listed companies because of the pre-existing requirements to appoint independent directors under the equity listing requirements issued by the SEBI.


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• The 2013 Act requires independent directors to be persons who possess relevant expertise and experience and the directors or their relatives should have no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year.

• No person is permitted to act as a director or alternate director in more than 20 companies at the same time and of which the maximum number of public companies in which a person can be appointed as a director is 10. For listed companies, the revised clause 49 prescribes that a person shall not serve as an independent director in more than seven listed companies. Further, any person who is serving as a whole time director in any listed company shall serve as an independent director in not more than three listed companies.

• The directors intending to be appointed as independent directors should also not have been an employee, proprietor, a partner of the firm of auditors, company secretaries, cost auditors, consultants or legal advisors, in any of the three financial years immediately proceeding the financial year in which the director is proposed to be appointed.

Duties of directors

The 2013 Act lays down specific and inclusive duties of directors:

• acting in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, the shareholders and other stakeholders

• exercising duties with due and reasonable care, skill and diligence and exercising independent judgement

• not being involved in a situation in which there may be a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company

• not achieving or attempting to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates.

In addition to enunciation of leading industry practices, the 2013 Act also enables easier prosecution of delinquent directors.

Reporting on internal financial controlsUnder section 134(5)(e) directors of a listed company are required to state under the Directors` Responsibility Statement that the internal financial controls laid down are adequate and are operating effectively. 2013 Act has defined internal financial controls to mean the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company`s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.

Under Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014, every listed company and every other public company having a paid up share capital of INR250 million or more

calculated at the end of the preceding financial year are required to state the details in respect of adequacy of internal financial controls with reference to the financial statements in the report by the Board of Directors.

The 2013 Act, therefore, entrusts two separate requirements on the directors with regard to reporting on internal financial controls - one, a discussion in the Board of directors’ report on internal financial controls with a reference to financial statements and two, a specific assertion in the Directors` Responsibility Statement about the adequacy and effectiveness of internal financial controls in general.

We expect that the regulators and rule makers will provide additional guidance to companies on how these internal financial controls are required to be tested in order to provide this level of assurance.

However, for all companies, the auditors are required to provide an assurance on the adequacy and effectiveness of internal financial controls. In October 2014, the MCA has clarified that the reporting on the internal financial control systems (IFC) by auditors, mandatory for financial years commencing on or after 1 April 2015. It is important to note that the one year transition is only with respect to the auditors’ reporting responsibility and the directors would still be requried to comment on IFC as highlighted above in the Board’s report for the year ended 31 March 2015.

Recently, the ICAI has issued a Guidance Note on Audit of Internal Financial Controls over Financial Reporting. This guidance note provides guidance to the statutory auditors for their reporting on adequacy of internal financial controls and operating effectiveness of such controls and also restricts such reporting by an auditor to ICOFR.

Additional responsibility on independent directorsThe 2013 Act clarifies that the independent directors are liable only for acts or omissions which occurred with their knowledge, attributable through the Board processes, and with their consent, connivance or when they had not acted diligently.

Independent directors are not entitled to any remuneration, other than sitting fee, reimbursement of expenses and any profit related commission as approved by the members. Stock options are specifically prohibited.

Code for independent directors

Schedule IV of the 2013 Act includes a code for independent directors that lays down specific guidelines for professional conduct, roles and functions, duties, manner of appointment/reappointment/resignation and an evaluation mechanism.

Independent directors will need to conduct at least one meeting in a year of all independent directors without the attendance of non-independent directors and members of the management to review performance of non-independent directors and the chairperson of the company, and also assess the quality, quantity and timeliness of flow of information between the company management and the Board that is necessary for the Board to effectively and reasonably perform their duties.


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The independent directors have been entrusted with an important task to evaluate the performance of the Board of Directors. Conversely, the performance evaluation of the independent directors shall be done by the entire Board of Directors, excluding the director being evaluated.

Mandatory independent director rotation

The 2013 Act also contains restrictions on reappointment of independent directors. Tenure of independent directors is limited to maximum of two consecutive tenures of five consecutive years with a cooling off period of three years thereafter. During the cooling-off period, such a person can not be inducted in any capacity in the company either directly or indirectly. For this purpose, the tenure shall be computed prospectively from the commencement of the 2013 Act.

Audit committeeAll listed companies and public companies with paid-up capital of INR100 million or more, debt /debentures/deposits more than INR500 million or turnover of INR1 billion or more are required to constitute an audit committee of minimum three directors, with independent directors in majority.

Under the 1956 Act (section 292A), public companies having paid-up capital of not less than INR50 million were required to constitute an audit committee. The MCA has on 12 June 2014 amended the Rules. As per the amendment, the public companies (meeting the above criteria) that were not required to constitute audit committee under section 292A of the 1956 Act would now constitute their audit committee within one year from the commencement of the amended Rules or appointment of independent directors, whichever is earlier.

The role of the committee has sharpened with specific responsibilities including recommending appointment of auditors and monitoring their independence and performance, approval of related party transactions, scrutiny of inter-corporate loans and investments, valuation of undertaking/assets, etc.

The audit committee is contemplated as a major vehicle for ensuring controls, sound financial reporting and overall good corporate governance. There appears to be an increased focus on the audit committee especially to protect the interests of other stakeholders by bringing into the committee’s purview, a requirement to review/approve transactions with related parties and enhanced financial reporting requirements.

Remuneration of directorsNo change in overall/individual limits on managerial remuneration in public companies. Maximum limit of managerial remuneration retained at 11 per cent (of net profits).

Accountability of directors for CSR complianceAs per Section 135 of the 2013 Act, companies with a specified net worth, turnover or net profit are required to mandatorily spend two per cent of its average net profit towards specified CSR activities. Every qualifying company needs to constitute a CSR committee of the Board consisting of three or more directors.

Though the CSR provisions under the 2013 Act required minimum three directors for the constitution of the CSR committee, the Rules clarify that a company which is not required to appoint an independent director under section 149 of the 2013 Act can constitute a CSR committee without such independent director.


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Theme 6

The impact on M&A/restructurings1

As the heading suggests, this theme deals with:

Particulars New provisions

Existing provisions

Arrangements/amalgamations/demergers (restructuring)

section 230-234

section 391-394

Minority buy-out section 236 section 395

Buy-back of shares section 68-70 section 77A

Differential voting rights section 43 section 86

Investment through not more than two layers

section 186 section 372A

RestructuringBrief overview

The overall restructuring process format under the 2013 Act continues to be similar as under the Companies Act, 1956 (1956 Act), except for the following major changes:

• Approvals from statutory authorities enhanced, however, the same is made time bound

• National Company Law Tribunal (NCLT) to assume jurisdiction of the High Court as sanctioning authority in relation to restructuring

• Concept of fast track restructuring, without NCLT approval, introduced

• Amalgamation of/demerger from foreign company into Indian company made restrictive. However, amalgamation of/demerger from Indian company into foreign company is introduced

• There are bound to be significant differences in prescribed procedural formats, statutory approval requirement and mainly the style of functioning of the High Court and NCLT.

The MCA may remove some of the transitional difficulties by issuing Rules. However, till such time uncertainty and consequential ambiguity would continue. It is important to note that Rules are subordinate legislation and can provide clarity regarding the provisions or set out operational processes, etc. However, the Rules can not deal with issues which may require amendment to 2013 Act. Such issues may require amendment to the 2013 Act which may prolong continuation of some of the ambiguity for a longer time.

Some general concerns:

• Practical difficulties in the absence of detailed transitional provisions

• The MCA may issue guidance for removing such difficulties.

Arrangements with shareholders/creditors

Basic format of process continues to be same under the 2013 Act. However, certain disclosure/approval requirements have been enhanced and certain conceptual changes brought in as under:

• The concept of restructuring to be a single window clearance under the 1956 Act is diluted to some extent and the 2013 Act requires that if the arrangement involves buy-back of shares or variation of rights, the restructuring scheme should comply with the provisions applicable to buyback or variation of rights.

• Increased disclosure requirements in the notice to members/creditors in a bid to boost transparency and keeping all stakeholders well informed.

• To encourage maximum participation from members, postal ballot has been made compulsory and combined results of voting by members present at the meeting and by postal ballot needs to be considered.

• Arrangement can be objected only by a person holding at least 10 per cent shareholding or owning five per cent debt. This will avoid all superfluous objection and litigations.


1. Majority of the sections of the 2013 Act relating to this theme have not been notified and the corresponding rules have not been issued. This is on account of pendency of the NCLT formation.

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• Notice of compromise or arrangement to be given to the Central Government (CG), Income tax, Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Stock exchanges, Registrar of Companies (ROC), Official Liquidator (OL), Competition Commission of India (CCI), and other sector regulators/authorities as necessary. The authorities are allowed a period of 30 days from receipt of the notice to respond and if no response is received within such time, it is presumed that they have no representation.

This would effectively act as a pre-approval and make the process time bound.

• An important change is the requirement to furnish auditor’s certificate to the effect that the accounting treatment specified in the scheme is in conformity with the prescribed Accounting Standards in all cases. Currently, such certificate was required only in relation to listed companies per listing agreement with stock exchanges.

In addition, following significant changes are made in the amalgamation process:

• Creation of treasury stock pursuant to amalgamation/demerger. Cross holding of shares resulting in creation of treasury stock should be cancelled and no shares should be issued against the same.

• Yearly statement confirming implementation of the scheme, to be in accordance with the Order, is required to be submitted till completion of the scheme.

• In the case of amalgamation of a listed transferor company into an unlisted transferee company, the 2013 Act allows unlisted company to remain unlisted by giving exit option to the dissenting shareholders. This provision seems to suggest automatic delisting even without complying with the SEBI Delisting Guidelines.

• The 2013 Act provides that ‘free reserves’ should not include any change in the carrying amount of an asset or of a liability recognised in equity. Therefore, the reserve generated from recording assets at fair value under purchase method of accounting may not be considered as free reserve and may not be available for declaration of dividend, issue of bonus shares, buyback of shares, etc.

Scheme of amalgamation/demerger: key issues

• Lack of clarity on treasury shares already held by companies

• Lack of clarity about time till which yearly statement about implementation of scheme is required to be filed.

Fast track amalgamations/demergers

• The 2013 Act has introduced a simplified procedure for merger and amalgamation between:

i. holding company and its wholly owned subsidiary

ii. two or more ‘small companies’, or

iii. such other prescribed classes of companies.

Any such merger can be given effect to without the approval of the NCLT, subject to compliance with certain other procedures.

• Small company is defined as follows:

– A non-public company

– Not being a holding/subsidiary company, a company for charitable purposes or a company established under a special Act

– Having paid-up capital less than INR5 million (the amount can be prescribed up to INR50 million) or turnover less than INR20 million (the amount can be prescribed up to INR200 million) as per the last audited financials.

Thus, a company not meeting either criterion should remain a small company.

• Transferor and transferee companies need to file declaration of solvency

– Prima facie companies with negative networth can not use the fast track route.

• CG may, if it is of the opinion that scheme is not in public interest or in interest of creditors, instead of approving the scheme, may refer the scheme to the NCLT. In such a case, the NCLT may direct that process under section 232 should be carried out. This will result in duplication of efforts and take away all benefits of the fast track process.

• If the process is completed as fast track without the NCLT order, beneficial rates of stamp duty provided in certain states may not be available.

• Significant benefits of fast track are:

– Approval of NCLT is not required

– Notice is not required to be given to various authorities like Income tax, etc. (as required in normal amalgamation/demerger process)

– Auditor’s certificate of compliance with applicable accounting standards is not required

– All the above will result in reduction in burden of administration, compliances, timelines and costs.


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Fast track mergers: key issues

• Practical difficulties in obtaining approval of the CG vis-à-vis NCLT

• Power of the CG to transfer the scheme to NCLT for application of normal amalgamation provisions which are more onerous

• Positive confirmation required from shareholders and creditors holding 90 per cent in value.

Foreign company amalgamation/demerger (cross border merger)

• The 2013 Act has enabling provisions for cross border mergers subject to:

– eligible jurisdictions being notified by the CG

– rules prescribed by the CG in this respect

– approval of the RBI.

Purchase of minority shareholding – section 236

• The 2013 Act allows any person or group of persons holding 90 per cent or more of the issued equity capital of a company to purchase the remaining equity shares of the company from minority shareholders at a price determined by a registered valuer.

• Similarly, the minority shareholders of the company may also offer to purchase the majority shareholders’ shareholding.

• Although this provision applies to all companies, it may prove beneficial to delisted companies with minority shareholding and enable the majority shareholder to buy-out minority shareholder at a fair price.

Key issues

• Doubts are raised as to whether offer from majority is binding on minority

• Timeline and other procedures for offer from minority is not clearly specified

• Mechanism for higher price sharing with minority shareholders is not clear.

Power of company to purchase its own securities – section 68 to 70

Process of buy-back continues to be same as under section 77A of the 1956 Act, except for the following significant changes:

• The 2013 Act prescribes minimum gap of one year between two buy-backs, i.e., a gap of one year from end of first buy-back till commencement of next buy-back. Multiple buy-backs within a year would not be possible under the 2013 Act.

• Under the 2013 Act, a company which has defaulted in repayment of deposits, redemption of debentures, etc. is not allowed to buy-back for a further period of three years after the default is remedied. The 1956 Act prohibited buy-back only till such default was remedied.

• The 2013 Act has added compliance with provisions relating to declaration of dividend as an eligibility condition for buy-back.

Key issues

• Multiple buy-back in a year not allowed

• Prohibition of three years post remedy of defaults, may impact many buy-back plans.

Equity shares with differential voting rights (DVRs) – section 43

• DVR provisions made applicable even to private limited companies.

• Issue of DVRs subject to following key conditions (prescribed as per Rules) for any company, private or public:

– DVRs can not exceed 26 per cent of post issue paid up equity share capital

– Track record of distributable profits for preceding three financial years

– Existing equity shares with voting rights can not be converted into shares with DVRs and vice-versa

– No subsisting default (dividend payment, deposits, redemption of preference shares, repayment of debentures, etc.)

– Company is not penalised for any offence under the RBI Act, SEBI Act, SCRA, FEMA or any other special Acts

– Onerous disclosure requirements.

Key issues

• DVR provisions made applicable to even private companies

• Lack of clarity on treatment under the 2013 Act of existing DVRs issued by companies.


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Investment through not more than two layers

• An Indian company is allowed to make investments through maximum of two investment companies between the holding company and the operating company. Exceptions are overseas acquisition and multi-layering mandated under any law

• The provisions are applicable to investments by a company. Therefore, two layers need to be determined in relation to an investing company and not the ultimate holding company of that investing company. Key issue

• Lack of clarity on ‘two layers of investment companies’ before an operating company in the structure:

– would it mean an overall restriction of not more than two investment companies vis-à-vis the entire structure or with respect to each individual operating company in the structure?

Conclusion

Since a new legislation is replacing half a-century old corporate law in a phased manner and envisages some forward looking provisions, there are obvious teething troubles. Many of the privileges and exemptions enjoyed by private companies under the 1956 Act stand withdrawn under the 2013 Act leading to stricter compliance and disclosure requirements for private companies. This in turn would require revamping and scaling up internal processes by the private companies. The long-term objective appears to be boosting standards of corporate governance in private companies. Further, ambiguities arising on account of partial notification of provisions of the 2013 Act vis-à-vis active provisions of the 1956 Act would also need to be addressed.

Schemes of restructuring would still require 75 per cent approval from shareholders. There are transitional overlaps vis-à-vis NCLT and the courts which are yet to be reconciled. Similarly, the new concept of short form merger, chiefly introduced with the objective of saving time on internal group restructurings, would also need to be fine-tuned to address practical challenges and difficulties in order to serve its purpose. While the 1956 Act permitted merger of foreign company with an Indian company, the converse was not possible. A fresh concept of cross border merger has now been introduced under the 2013 Act governing both the situations (i.e., inbound as well as outbound mergers). However, there is a need to bring about corresponding amendments in tax and regulatory regime in order to avoid overlaps/unintended consequences or hardships and facilitate smooth cross border mergers.


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The Ministry of Corporate Affairs (MCA) has been issuing various amendments and clarifications to the 2013 Act and the corresponding Rules in order to address the implementation challenges faced by corporates and professionals.

Continuing with the endeavour for effective implementation of the 2013 Act, the Union Cabinet, on 2 December 2014 introduced the Companies (Amendment) Bill, 2014 in the Parliament to make certain amendments to the 2013 Act. Changes proposed include approval process of related party transactions, fraud reporting by auditors, areas where the Rules overreached the 2013 Act, and other procedural relaxations.

In the paragraphs below, we have provided a list of the amendments proposed in the 2013 Act.

Related party transactions

• Currently, clause 49 of the equity listing agreement provides that an audit committee may grant an omnibus approval for a related party transaction proposed to be entered into by the company, subject to certain conditions. Such omnibus approval would be valid for a period not exceeding one year and will require fresh approvals after the expiry of one year.

Now, to align with the equity listing agreement, it is proposed under the 2013 Act that an audit committee would be empowered to provide omnibus approvals for related party transactions on an annual basis.

• Similar to clause 49 of the equity listing agreement, it is proposed to exempt related party transactions between holding companies and wholly-owned subsidiaries from the requirement of approval by non-related shareholders.

• Currently, section 188 of the 2013 Act requires companies to obtain prior approval of the shareholders by a special resolution if certain conditions are met.

Now, it is proposed that the ‘special resolution’ is replaced with ‘ordinary resolution’ for approval of related party transactions by non-related shareholders.

Fraud reporting by auditors

Currently, the 2013 Act doesnot provide any threshold for reporting of frauds by auditors. Now, enabling provisions are proposed to prescribe thresholds beyond which fraud should be reported to the central government.

Additionally, it is proposed that frauds below the prescribed threshold will be reported to the audit committee and disclosed in the board’s report. Inter-corporate loans

• Currently, Rule 10 of the Companies (Meetings of Board and its Powers) Rules, 2014 requires that the following transactions are exempted from the requirements of section 185 of the 2013 Act provided that loans made are

utilised by the subsidiary company for its principal business activities:

– loan made by a holding company to its wholly-owned subsidiary company or any guarantee given or security provided by a holding company in respect of any loan made to its wholly-owned subsidiary company; and

– guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary company.

The above requirement is proposed to be included in the relevant section under the 2013 Act.

Dividend

• Currently, the Companies (Declaration and Payment of Dividend) Rules, 2014 (as amended) requires a company to set-off carried over previous losses and depreciation against the profit of the current year, in order to declare dividend.

The above requirement is proposed to be included in the relevant section of the 2013 Act.

• It is proposed to rectify the requirement of transferring equity shares for which unclaimed/ unpaid dividend has been transferred to the Investor Education and Protection Fund even though the dividend has been claimed.

Punishments/offences

• Specific punishment for deposits accepted under the 2013 Act is proposed.

• Bail restrictions to apply only for offence relating to fraud.

• Special courts to try only offences carrying imprisonment of two years or more.

Other procedural relaxations

• Public inspection of board resolutions filed with the Registrar of Companies is proposed to be prohibited.

• It is proposed to omit the requirement for minimum paid-up share capital along with consequential changes.

• Common seal is proposed to be made optional, and consequential changes for authorisation for execution of documents has been proposed.

• Winding up cases to be heard by a bench consisting of two members instead of a three members of the National Company Law Tribunal.


2. Also refer to KPMG First Notes dated 4 December 2014 and amendments proposed under the Companies (Amendment) Bill, 2014 as published by the Press Information Bureau on 2 December 2014

The Union Cabinet proposes certain amendments to the Companies Act, 20132

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A step closer to reporting on internal financial controlsOn the path of better governance

The Companies Act, 2013 (2013 Act) has set the tone towards enhanced corporate governance. A significant step towards this is extension of the financial reporting to include reporting over internal financial controls, which includes consideration of efficient conduct of business, compliance with applicable regulations and reliable financial information.

Section 134(5)(e) of the 2013 Act requires the directors’ responsibility statement to state that the directors, in the case of a listed company, had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively.

Further, Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the Board of Directors’ report (board’s report) of all companies to state in detail the adequacy of internal financial controls with reference to the financial statements. The inclusion of the matters relating to internal financial controls in the directors’ responsibility statement is in addition to the requirement for the directors to state that they have taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of the 2013 Act, for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities.

Section 143 (3)(i) of the 2013 Act requires the auditors’ report to state whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. The said requirement is applicable to all companies under the 2013 Act.

Introduction of the Guidance Note In order to comply with the requirements under Section 143 (3)(i) of the 2013 Act, the Institute of Chartered Accountants of India (ICAI) on 29 October 2014 has issued the Guidance Note on Audit of Internal Financial Reporting (Guidance Note). The Guidance Note contains detailed guidance on various intricacies involved in the audit of internal financial controls. Given the concept of internal financial controls has now been widened in terms of scope and applicability, the new reporting requirements will throw up many challenges for the industry and auditors. Further, the internal control framework is still under discussion, and in the meanwhile this guidance note is expected to provide extensive guidance in understanding, implementation and evaluation of various aspects related to this reporting requirement to industry and the auditors.

Structure of the Guidance Note

The Guidance Note contains two parts i.e. Part A and Part B. Part A of the Guidance Note provides an overview of the requirement of internal financial controls and introduces critical terms like framework, internal financial controls and respective roles and responsibility of auditors and the management in brief.

Part B of the Guidance Note provides detailed guidance explaining the requirements of internal financial controls along with the requirements of SA 315, Identifying and assessing the risk of material misstatement through understanding the entity and its environment. Further, it also covers technical guidance on the audit of internal financial controls and provides implementation guidance on 21 topics which are detailed enough to help management and auditors discharge their respective responsibilities. The appendices to the Guidance Note cover the illustrative engagement letters, management representation letter, audit reports and examples of control deficiencies.

This article aims to

• Summarise the structure and content of the Guidance Note on Internal Financial Controls

• Discuss the key considerations on the implementation aspects of reporting on internal financial controls.


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Similarity with COSO 2013

One of the most widely used frameworks available internationally is the ‘Internal Control - Integrated Framework’ issued by the Committee of Sponsoring Organisations of the Treadway Commission commonly referred to as the ‘COSO Framework’. The COSO framework was first issued in 1992 and revised as recently as 2013 and is referred to as COSO 2013.

It is interesting to note that the Guidance Note has indicated the presence of five components and 17 principles functioning and operating together in an integrated manner, which is the hallmark of the COSO 2013 framework as well. This highlights that the guidance is inclined towards the COSO 2013 guidance.

Framework

An internal control framework enables the management to benchmark the adequacy and existence of the internal control system in a company, as well as assess its implementation and effectiveness.

The MCA has not yet notified the adoption of any internationally accepted framework and is expected to release an indigenously developed framework. In the meanwhile, the ICAI through this Guidance Note has suggested to consider ‘Guide to Internal Controls over Financial Reporting’, issued by the Committee on Internal Audit of the ICAI (now the Internal Audit Standards Board) read with Appendix 1 ‘Internal Control Components’ of SA 315, Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment, as a necessary framework for companies.

The above referred guidance was issued in 2007 and appears to be aligned towards the COSO 1992 framework and does not talk about 17 principles around the five components of internal financial controls. The COSO 1992 guidance has undergone a change since the ICAI had last issued its Guide to Internal Control, and currently the ICAI is under the process of revising this guidance. Further, the Guidance Note

refers to the inter relationship of 17 principles with the five components. Given the fact that existing guidance may not be sufficient to benchmark the internal financial controls, the industry would expect a framework to be issued by the MCA.

Responsibility of auditorsAs discussed, Section 143(3)(i) of the 2013 Act requires the auditors’ report to state whether the company has an adequate internal financial controls system in place and the operating effectiveness of such controls. The Guidance Note has interpreted the term ‘internal financial controls’ differently for auditors and stated that the auditor needs to obtain reasonable assurance to state whether an adequate internal financial controls system was maintained and whether such internal financial controls system operated effectively in the company in all material respects with respect to financial reporting only. As the per the Guidance Note, Paragraph A1 of Standards on Auditing (SA) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing, states “The auditor’s opinion on the financial statements deals with whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. Such an opinion is common to all audits of financial statements”. The auditor’s opinion, therefore, does not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity.

The 2013 Act specifies the auditor’s reporting on internal financial controls only in the context of audit of financial statements. Consistent with the practice prevailing internationally, the term ‘internal financial controls’ stated in Section 143 (3)(i) of the 2013 Act would relate to ‘internal financial controls over financial reporting’ in accordance with the objectives of an audit stated in SA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing.


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Universal applicabilityThe reporting over internal financial controls is applicable to all companies under the 2013 Act. It is important to note that even the financial reporting framework (the accounting standards) in India has the concept of ‘small and medium companies’ basis certain specified thresholds. Such small and medium companies are eligible for certain exemptions from the applicability of certain disclosure and presentation requirements under the financial reporting framework. Internationally as well, internal financial controls reporting requirements are limited to listed companies in many of the jurisdictions.

Given the current scenario, the internal financial controls reporting requirements are applicable to all companies in India which would entail significant preparedness on the part of the management to build up a holistic compliance framework thus requiring considerable time and effort, particularly in the case of small and medium sized businesses. Moreover, currently the rules are not expected to apply in a phased manner for the small and medium sized businesses leaving them with little or virtually no time for transition. The transition could be a steep hill climb for such businesses and a tailored approach may be required for them to balance the cost and benefits on compliance with the reporting requirements.

Reporting date

The Guidance Note has clarified that the reporting is as at the balance sheet date. The auditor should report if the company has an adequate internal control systems in place and whether they were operating effectively as at the balance sheet date. Further, it clarifies that reporting on internal financial controls will not be applicable with respect to interim financial statements, unless such reporting is required under any other law or regulation.

Implication over consolidated financials There seems to be lack of alignment between section 134(5)(e) and Rule 8(5)(viii) with respect to management’s internal control reporting requirement. Reading the two pieces of literature, it is unclear whether the requirements relating to reporting on internal financial controls would be applicable to the consolidated financial statements or only to the stand-alone financial statements. Currently, the Guidance Note has been prepared from the perspective of the stand-alone financial statements. It would be helpful if the MCA could clarify the requirements of the 2013 Act and corresponding Rules in relation to reporting requirements for internal financial controls.

Documentation and basis of reportingThe management is now required to develop and maintain documentation for their internal financial controls system which must evidence the existence and adequacy of the internal financial controls, enables proper monitoring, support reporting on internal financial control effectiveness, and form a basis of evaluation by other parties interacting with the entity, such as regulators, auditors, or customers.


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Extension of the Company Law Settlement Scheme, 2014

In order to grant relief to the companies that had defaulted in filing their annual returns and financial statements within the prescribed time limit, the Ministry of Corporate Affairs (MCA) on 12 August 2014 had decided to introduce the Company Law Settlement Scheme, 2014 (scheme). This scheme was effective from 15 August 2014 to 15 October 2014. On consideration of requests received from various stakeholders, the MCA had extended the scheme up to 15 November 2014. This scheme has now been extended up to 31 December 2014.

(Source: General circular No. 44/2014 dated 14 November 2014)

The ICAI releases exposure draft on Accounting Standard 10, Property, Plant and Equipment

The Institute of Chartered Accountants of India (ICAI) has released an exposure draft on AS 10, Property, Plant and Equipment (ED). The ED has been released primarily to:

• improve accounting for fixed assets by demanding component based accounting

• incorporate changes related to the costs of dismantling and removing items and restoring the site on which an asset is located

• improve accounting for spares

• bring consistency between this standard and other Accounting Standards.

The ED deals with accounting for property, plant and equipment which are covered by the current AS 10, Accounting for Fixed Assets. The ED also deals with depreciation of property, plant and equipment which is presently covered by AS 6, Depreciation Accounting.

The ED is open for comments up to 18 December 2014.

(Source: ED as released by the ICAI)

Clarification regarding applicability of Chapter III (Prospectus and Allotment of Securities) of the Companies Act, 2013

Chapter III of the Companies Act, 2013 lays provisions relating to ‘prospectus and allotment of securities’. The Ministry of Corporate Affairs (MCA) has clarified that the provisions of the said chapter are not applicable to the issue of Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Bonds (FCBs) issued by the Indian companies exclusively to persons resident outside India, considering that the issue of such FCCBs and FCBs is regulated by regulations issued by the Ministry of Finance and the Reserve Bank of India (regulations).

The provisions of Chapter III will, however, be applicable if specifically required by such regulations.

(Source: MCA General circular No. 43/2014 dated 13 November 2014)

Regulatory updates


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Important decisions at the SEBI Board meeting

At the recent board meeting, the Securities and Exchange Board of India (SEBI) took the following key decisions:

SEBI (Prohibition of Insider Trading) Regulations, 2014

The SEBI Board has approved new regulations relating to ‘prohibition of insider trading’. The key features of the new regulations are as under:

a. The definition of ‘insider’ has been made wider by including persons connected on the basis of being in any contractual, fiduciary or employment relationship that allows such person access to Unpublished Price Sensitive Information (UPSI). Now, immediate relatives will be presumed to be connected persons, with a right to rebut the presumption

b. In the case of connected persons, the onus of establishing that they were not in possession of UPSI shall be on such connected persons

c. Clear prohibition on communication of UPSI has been provided except for legitimate purposes such as during performance of duties or discharge of legal obligations

d. Definitions of UPSI and General Available Information (GAI) have been provided. UPSI has been defined as information not generally available and which may impact the price. The definition of UPSI has been strengthened by providing a test to identify price sensitive information. GAI has been defined as the information that is accessible to the public on a non-discriminatory platform which would ordinarily be a stock exchange platform

e. Additionally, it has been provided that to facilitate legitimate business transactions, UPSI can be communicated with safeguards

f. Insiders who are liable to possess UPSI throughout the year would have the option to formulate prescheduled trading plans. Trading plans would, however, have to be disclosed on the stock exchanges and strictly adhered to. Trading plans shall be available for bona fide transactions.

Conversion of Listing Agreements into Regulations - SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2014

The SEBI Board has laid down ‘SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2014’ (Regulations). These regulations are expected to be broad-ranging in respect of the diverse types of listed securities. These regulations would consolidate and streamline the provisions of existing equity listing agreements thereby helping ensure better enforceability.

1. These regulations would be applicable for the following type of securities:

a. Specified Securities (includes equity and convertibles) - Listed on Main Board and SME Platform

b. Non-convertible Debt Securities

c. Non-Convertible Redeemable Preference Shares (NCRPS)

d. Indian Depository Receipts

e. Securitised Debt Instruments

f. Units issued by Mutual Fund Schemes.

2. Structuring of the regulations:

a. The common obligations applicable to all listed entities have been enumerated at the beginning of these regulations. Obligations which are applicable to specific type of securities have been laid down in separate respective chapters.

b. Further, these regulations have been sub-divided into three parts:

• substantive provisions incorporated in the main body of these regulations

• procedural requirements in the form of Schedules to the regulations

• various formats/forms of disclosures to be specified by the SEBI through circular(s).

3. These regulations contain important provisions such as:

a. Overarching principles for making disclosures and obligations

b. Mandatory filing on stock exchanges through the electronic platform

c. Mandatory appointment of a company secretary as the compliance officer except for units of mutual funds listed on stock exchanges

d. Introduction of enabling provisions for the Annual Information Memorandum.

Additionally, changes have been brought about to provide clarity or maintain consistency or remove redundancies. For example, such changes include manner of dealing with unclaimed shares, aligning connected provisions pertaining to disclosures on website and issuing advertisements, disclosures in annual report, documents and information to be provided to holders of securities, terms and structure of securities, and operational modalities in the manner of review of audit reports with modified opinion, etc.

(Source - PR No. 130/2014 dated 19 November 2014)


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The Companies Act, 2013 (2013 Act) is largely operationalised from 1 April 2014. The Ministry of Corporate Affairs (MCA) has been issuing various amendments and clarifications to the 2013 Act and the corresponding Rules in order to address the implementation challenges faced by the corporates and professionals.

Continuing with the endeavour for effective implementation of the 2013 Act, the Union Cabinet, on 2 December 2014 introduced the Companies (Amendment) Bill, 2014 in the Parliament to make certain amendments to the Act. Changes proposed include approval process of related party transactions, fraud reporting by auditors, areas where the Rules overreached the Act, and other procedural relaxations.

For a list of amendments proposed in the Act, please refer to KPMG in India’s First Notes dated 4 December 2014.

(Source: Companies (Amendment) Bill, 2014 dated 2 December 2014)

Non-Banking Finance Company – revised regulatory framework

The Reserve Bank of India (RBI) on 10 November 2014 made certain amendments to the regulatory framework governing the Non-Banking Finance Companies (NBFCs). Key revised requirements relate to:

• Minimum net owned funds

• Deposit acceptance

• Criteria for classifying non-deposit taking NBFCs and systematically important non-deposit taking NBFCs

• Prudential norms related to different categories of NBFCs

• Asset classification

• Percentage of provision required for standard assets

• Corporate governance and disclosure related norms.

(Source: RBI’s circular RBI/2014-15/299 dated 10 November 2014)


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www.kpmg.com/in



The Companies Act, 2013 (the Act) is largely operationalised from 1 April 2014. The Ministry of Corporate Affairs (MCA) has been issuing various

amendments and clarifications to the Act and the corresponding Rules in order to address the implementation challenges faced by corporates and professionals.

Continuing with the endeavour for effective implementation of the Act, the Union Cabinet, on 2 December 2014 introduced the Companies (Amendment) Bill, 2014 in the Parliament to make certain amendments to the Act. Changes proposed include approval process of related party transactions, fraud reporting by auditors, areas where the Rules overreached the Act, and other procedural relaxations.

This issue of First Notes provides a list of the amendments proposed in the Act.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.


The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. Printed in India. (NEW1214_016)

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Introducing IFRS Notes

IFRS Convergence: ICAI issues exposure drafts on financial instruments and revenue recognition

As part of the initiatives towards India’s convergence with IFRS from 2016-17, the Accounting Standards Board of the Institute of Chartered Accountants of India has recently issued exposure drafts on Ind AS 109, Financial Instruments (ED on financial instruments) and Ind AS 115, Revenue from Contracts with Customers (ED on revenue).

These exposure drafts are in line with the requirements of the corresponding International Financial Reporting Standards (IFRS) (IFRS 9, Financial Instruments and IFRS 15, Revenue from Contracts with Customers), the International Accounting Standards Board has recently issued.

In this issue of IFRS Notes, we have provided an overview of these exposure drafts along with key impact areas.

November 2014

The November 2014 edition of the Accounting and Auditing Update provides insights into the mutual funds industry in India, recent changes that affect the industry and its accounting and

reporting issues.

We examine some of the key changes that Ind AS application will have for companies relating to accounting for fixed assets. We also highlight the key differences and salient features of the COSO 2013 Framework for internal control with the earlier COSO 1992 framework.

This month we also highlight the key impacts of the Companies Act, 2013 in the area of acceptance of deposits by companies.

As is the case each month, we cover key regulatory developments during the recent past as well as examination of the concept of significant influence in an accounting context.

KPMG in India is pleased to present Voices on Reporting - a monthly series of knowledge sharing

calls to discuss current and emerging issues relating to financial reporting.

On 20 November 2014, we covered following three topics:

1. Roadmap for IFRS convergence in India

2. Exposure draft on Ind AS 101, First-time Adoption of Indian Accounting Standards

3. An overview on the Ind AS convergence process.

Feedback/Queries can be sent to [email protected]

Back issues are available to download from: www.kpmg.com/in

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Accounting and Auditing Update - Dec 2014

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