Round-up of regulatory updates during 2021

We have attempted to collate all major regulatory amendments notified throughout the year, with our resources on the same. Below we present a regulatory round-up for the year 2021, be it for MCA, SEBI, RBI or the like, along with the links to our major articles/ FAQs on the same.

This version: 4th December, 2021

Can companies avail GST benefits on CSR spending?

– By Harsh Juneja | Executive (corplaw@vinodkothari.com)

Background

Section 135(5) of the Companies Act, 2013 (‘the Act’) requires every eligible company (as per section 135(1)) to spend at least 2% of the average of net profits of immediately preceding 3 financial years towards Corporate Social Responsibilities(‘CSR’) activities. The CSR spending may sometimes include contributions made to NGOs or other beneficiaries, or money paid to implementing agencies. However, quite often, the expense may relate to procurement of goods or services which are applied to one or more CSR activities. This procurement of goods or services comes with the tax cost, viz., GST. So the question is, does this GST paid, while acquiring goods or services, give rise to an input tax credit, such that the same may be claimed as a set off? A related, and more important question is, whether CSR expense for the purpose of sec. 135 (5) be the amount net of the ITC, if the ITC is claimable, or the gross amount paid?

Input Tax Credit

Eligibility

Section 16(1) of the Central Goods and Service Tax (‘CGST Act, 2017’) prescribes the eligibility criteria for taking Input Tax Credit. It states that “Every registered person shall, subject to such conditions and restrictions as may be prescribed and in the manner specified in section 49, be entitled to take credit of input tax charged on any supply of goods or services or both to him which are used or intended to be used in the course or furtherance of his business and the said amount shall be credited to the electronic credit ledger of such person.”

Hon’ble CESTAT Mumbai, in the case of M/s Essel Propack Ltd. vs Commissioner of CGST, Bhiwandi, gave a view that the CSR gives a company an economically, socially and environment sustainability in the society in the long run, as a company can not operate without providing benefits to its stakeholders. Therefore, it held that if companies are unable to claim input services in respect of activities relating to business, production and sustainability of the companies themselves would be at stake.

Hon’ble High Court of Karnataka, in its judgement, in the case of M/s Commissioner of Central Excise, Bangalore vs. Millipore India (P) Ltd., also was of view that CSR Expenses are mandatorily incurred by employers towards benefit of the society and “to maintain their factory premises in an eco-friendly manner”. Therefore, the tax paid on such services shall form part of the costs of the final products and thus, the company can claim these taxes paid as input services.

Uttar Pradesh Authority for Advance Ruling (‘AAR’) in the matter of M/s Dwarikesh Sugar Industries Ltd held that a company is mandatorily required to undertake CSR activities and thus, forms a core part of its business process. Hence, the CSR activities are to be treated as incurred in “the course of business”.

Section 135(7) is a penal provision under the Act which deals with penalty on non-compliance of section 135(5)  and (6). It was observed by the AAR that a Company fulfilling eligibility criteria under section 135(1) of the Act is required to mandatorily spend towards CSR and thus, must comply with these provisions to ensure smooth run of business.

Thus, Uttar Pradesh AAR held that the expenses incurred by the Company in order to comply with requirements of CSR under the Act qualify as being incurred in the course of business and are eligible for ITC in terms of the Section 16 of the CGST Act, 2017.

Contrary ruling: Free Supply of Goods

Section 17(5)(h) of the CGST Act excludes “goods lost, stolen, destroyed, written off or disposed of by way of gift or free samplesfor the purpose of availing ITC on payment of GST. The term ‘gift’ is not defined anywhere in the CGST Act. However, in layman’s language, gift means a thing given willingly to someone without payment.

In the matter of M/s. Polycab Wires Private Limited, Kerala AAR held that distribution of necessaries to calamity affected people under CSR expenses shall be treated as is if they are given on free basis and without collecting any money. Hence, for these transactions, it was held that ITC shall not be available as per section 17(5)(h).

However, a contrast has been drawn in the Uttar Pradesh AAR Ruling towards goods given as ‘gift’ and given as a part of CSR activities. Gifts are voluntary and occasional in nature whereas CSR expenses are obligatory and regular in nature. AAR held that since CSR expenses are not incurred voluntarily and have to be incurred regularly, they are not to be treated as ‘gift’ and thus, should not be restricted under section 17(5)(h) for claiming ITC.

Availing Benefit through Beneficiary

A company contributes a sum towards a beneficial organisation such as NGOs, Charitable Trusts and Section 8 Companies (‘implementing agencies’) towards fulfillment of CSR activities. However, these implementing agencies also need to hire services of vendors to complete these activities. These vendors charge GST on the services rendered by them. Since these implementing agencies often do not generate any output, the question raises can these organizations also claim ITC on the services rendered by them?

There is a concept of ‘pure agent’ in GST. Explanation to Rule 33 of CGST Rules, 2017 prescribes that a pure agent means a person who –

The implementing agencies fulfill this eligibility criteria of being a ‘pure agent’. Rule 33 also contains some conditions on the fulfilment of which, expenses incurred by the supplier as a pure agent of the recipient of the supplier of goods or services, are excluded from the value of supply-

In our case, if an implementing agency avails any goods or services from a vendor to fulfil the CSR activities for a company, then the payment of any such amount to the vendor shall be treated as a supply made as a pure agent by the implementing agency on behalf of recipient of supply, i.e., the company. Thus, these expenses incurred by the implementing agencies shall be excluded from the value of supply and therefore, are not liable for payment of GST.

CSR Contribution: Pre-GST or Post-GST?

The Act does not clarify that the amount to be contributed towards CSR activities should be inclusive or exclusive of taxes. However, it seems that since GST is charged on supply of goods and services, irrespective of the intention of social benefit, the amount contributed towards CSR can be both inclusive and exclusive of GST. Having said that, the question still pertains on the inclusivity of the amount of GST paid towards the amount of CSR expenditure for the purpose of section 135(5) of the Companies Act, 2013.

Conclusion

While it seems that rationally, expenses incurred on GST for fulfillment of CSR activities should be eligible for claiming ITC, however, there is still some ambiguity in terms of legal provisions. There is one view of Kerala AAR which restricts CSR contribution under section 17(5)(h) while the Uttar Pradesh AAR had a complete inverse view. A clarification from the relevant authorities is sought in this regard so that this perplexity created by different rulings may be solved. When all is said and done, a question still pertains on the amount of the expenditure which is to be considered for the purpose of calculation of CSR expenditure.

 

 

Corporate law and company articles: resolving complementarity, conflict and congruence

 

Introduction

Articles of a company are the rulebook for the indoor management of a company and should be observed at all times subject to the provisions of the Companies Act, 2013 (“the Act”) which has an overriding effect on the articles of a company. Any inconsistency in the articles of a company to that of the Act is ultra vires and gives the Act an upper hand. However, when an apparent inconsistency arises on account of a stricter provision in the articles, can articles be disregarded on grounds of repugnancy? Or whether there can be legal enforceability of articles that are complementing the main provisions of the Act without defeating the intent of law? The question assumes importance in light of certain practical situations which cropped up recently.

Read more

Addressing subsequent applicability of Section 139(2) of the Companies Act

Whether existing auditor needs to vacate immediately?

Abhishek Saraf | Manager (corplaw@vinodkothari.com)

Background

On and from the enforcement of the provisions of the Companies Act, 2103 (the “Act”), statutory auditor of a company is required to be appointed for a fixed term of 5 consecutive years (except in the case of appointment of first auditor and appointment of auditor in Government Company). The said requirement is different from the provisions of corresponding section 224 and 224A of the erstwhile Companies Act, 1956 (“Act, 1956”) where a statutory auditor was appointed year on year basis.

In addition to the introduction of a minimum tenure of 5 years, the Act also brought the concept of mandatory rotation of the statutory auditors so appointed so to ensure the auditors do no develop too much familiarity with the auditee. In fact, the Report[1] of the CII Task Force on Corporate Governance also discussed on the proposal of the rotation of auditors as well as audit partners to discourage any sort of an affinity between the auditors and the company.

The provisions relating to mandatory rotation of the statutory auditors have been provided under section 139(2) of the Act.

Section 139(2) of the Act states that-

“(2) No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or re-appoint 

(a) an individual as auditor for more than one term of five consecutive years; and

(b) an audit firm as auditor for more than two terms of five consecutive years:

…..”

Section 139(2) of the Act provides for a mandatory rotation of statutory auditors for the following classes of companies:

(i) Listed companies

(ii) Unlisted public companies having paid up share capital of INR 10 crores or more;

(iii) Private companies having paid up share capital of INR 50 crores or more; and

(iv) Companies having paid up share capital of below threshold limit mentioned in (ii) and (iii) above, but having public borrowings from financial institutions, banks or public deposits of INR 50 crores or more.

Once the bar on re-appointment applies; there is a mandatory cooling-off period of 5 years where the outgoing auditor should not be in any way be related to the incoming auditor.

Further, the requirement of appointment of auditors for a minimum tenure as well as the rotational requirement has been exempted for certain classes of companies which have been mentioned below:

Exemption from minimum tenure of 5 years Exemption from rotational provisions
 

·         All companies in case of appointment of first auditor

 

·         Government companies

 

·         One person company

 

·         Small companies

Application of rotational requirements during the transitional period

From the date of enforcement of section 139 of the Act, i.e., 1st April, 2014, companies were given a time period of three years to comply with sub-section (2) of the Act. However, considering the practical difficulties, MCA vide its Companies (Removal of Difficulties) Third Order, 2016 amended the transitional provisions of Section 139(2) of the Act to allow companies to comply with the provisions relating to rotation of auditors not later than date of the 1st AGM of the company held after 3 years from the date of commencement of the Act.

With this amendment, it was clarified that the auditor who has utilized the tenure of 5 years or 10 years, as applicable may continue the office till the conclusion of AGM held for the FY ended 31st March 2017 and the company shall appoint new auditor in accordance with section 139 (1) in the same AGM.

 

Treatment in case of subsequent applicability of rotational provisions

It is to be noted that the third proviso to sub-section (2) of section 139 contained the provisions to address the first-time applicability on companies on and from the commencement of the said section. It was given to allow smooth transition from the old regime to the new regime. The proviso specifically provided 3 years’ time from commencement of the Act which has expired long back.

Another situation that requires to be addressed is the fate of the auditors of the companies which subsequently get covered under sub-section (2) of section 139.

In this regard, it is important to note the language of the said sub-section states the following:

No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or re-appoint XXX

Addressing the said issue, the view expressed in Ramaiya[2] is that the auditor will have to vacate his office at the next forthcoming AGM of the company, even if the existing term is not complete.

However, we will hold a different view on the same based on the following reasons:

  • It is to be noted that the appointment or re-appointment of statutory auditors is done for a fixed term which should not be of more than 5 consecutive years and the provisions does not mentions for appointment for any specified years and further has done away with ratifying the appointment every year[3].
  • Secondly, as the language suggests, the provisions of the Section 139(2) is applicable only at the time of  appointment or re-appointment.
  • If the existing term, which was in accordance with Section 139 (1) of the Act, is not complete, there is no case of appointment or reappointment. Hence, it is only when the existing term is complete that the question of rotation will arise.
  • Furthermore, mandatory rotation of statutory auditor as per Section 139(2) of the Act cannot be equated with ineligibility to be appointed as an auditor of a company under Section 141(3) of the Act, which sinks in immediately.

Concluding Remarks

In view of the rationale given above, it can be concluded that since the question of rotation will arise only at the time of appointment or re-appointment which again can only be seen only after the completion of the tenure of 5 years, therefore, the interpretation of requiring the continuing auditor to vacate its office at the ensuing AGM post first time applicability does not seem to be correct.

[1] To view the Report, click here

[2] Page 2473 of A Ramaiya Guide to the Companies Act (19th Edition)

[3] The requirement to ratify was done away with vide the Companies (Amendment) Act, 2017 w.e.f. 7th May, 2018.

Our other relevant articles –

  1. https://vinodkothari.com/2021/06/rbi-guidelines-at-odds-with-the-companies-act-on-appointment-of-auditor/
  2. https://vinodkothari.com/2021/04/faqs-appointment-of-statutory-auditors/
  3. https://vinodkothari.com/wp-content/uploads/2019/05/Concept-of-Retiring-Auditors-under-Act-2013-1.pdf
  4. https://vinodkothari.com/2018/05/alignment-of-audit-auditors-rules-with-amendment-act-2017/

RPT provisions in India and other countries

RPT-provisions-in-India-and-other-countries

Other ‘I am the best’ presentations can be viewed here

Our other resources on related topics –

  1. https://vinodkothari.com/article-corner-on-related-party-transactions/

An overview of the regulatory framework of dividends

An overview of the regulatory framework of dividends

Other ‘I am the best’ presentations can be viewed here

Our other resources can be accessed here –

  1. http://vinodkothari.com/wp-content/uploads/2020/02/Note-on-declaration-on-interim-dividend_revised-converted.pdf
  2. http://vinodkothari.com/wp-content/uploads/2018/01/Article-on-SS-3.output.pdf
  3. https://vinodkothari.com/2021/06/dividend-restrictions-on-nbfcs/
  4. https://vinodkothari.com/2016/07/faqs-on-dividend-distribution-policy/

Unspent CSR & Role of IAs

Unspent CSR

Other ‘I am the best’ presentations can be viewed here

Our other resources on related topics –

  1. https://vinodkothari.com/2021/01/csr-comply-or-suffer-provisions-made-effective/
  2. https://vinodkothari.com/2021/01/corporate-social-responsibility-2021-amendments/
  3. https://vinodkothari.com/2021/01/faqs-on-csr-2021-amendments/
  4. https://vinodkothari.com/csr/

Business Responsibility and Sustainability Reporting

Business Responsibility and Sustainability Reporting

Other ‘I am the best’ presentations can be viewed here

Our other resources on related topics –

  1. https://vinodkothari.com/2021/06/brsr-reporting-actions-and-disclosures-required-for-business-sustainability/
  2. https://vinodkothari.com/wp-content/uploads/2020/08/Cartload-of-details-in-BRSR.pdf
  3. https://vinodkothari.com/2020/08/brr-in-process-to-become-a-fully-loaded-electronic-form/
  4. https://vinodkothari.com/2016/01/global-overview-of-business-responsibility-reporting/

Structuring of debt instruments

Structuring of debt instruments

Other ‘I am the best’ presentations can be viewed here

Our other resources on related topics –

  1. https://vinodkothari.com/2017/04/understanding-compulsorily-convertible-debentures/
  2. https://vinodkothari.com/2021/03/presentation-corporate-bonds-debentures/
  3. https://vinodkothari.com/2021/06/centralised-database-for-corporate-bonds-debentures/
  4. https://vinodkothari.com/2020/04/covid-19-and-debenture-restructuring/
  5. https://vinodkothari.com/2020/11/sebis-stringent-norms-for-secured-debentures/
  6. https://vinodkothari.com/2021/08/consolidation-sebi-non-convertible-securities/
  7. https://vinodkothari.com/2021/08/checklist-for-issuance-of-listed-debt-securities-on-private-placement-basis/
  8. https://vinodkothari.com/2013/03/on-the-meaning-of-deposit-f-or-deposit-regulations/
  9. https://vinodkothari.com/2019/01/mca-requires-reporting-of-what-is-not-a-deposit/
  10. https://vinodkothari.com/wp-content/uploads/2019/06/FAQs-DPT-3_VKC_28.06.2019.pdf

A Regulatory Affair: Fair Value Discovery in Preferential Share Issues

Payal Agarwal, Vinod Kothari and Company ( payal@vinodkothari.com )

The recent cases of intervention by the stock market regulator and stock exchanges in preferential allotment of listed companies have brought to fore an important but fundamental point. That is,  with a price band fixed under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’), and considering the liquidity in listed (and frequently traded) shares, whether there is a need for an independent valuation report, has become a question of great interest. Since the issue is currently under litigation will want to say that it will be interesting to see the evolution of jurisprudence on this important issue. While the issue is of relevance to minority shareholders, but it also touches a key issue in valuation as to whether there is a fair value beyond the quoted value of a company whose shares are not infrequently traded.

Further, there might be scenario, where a preferential allotment triggers an open offer under SEBI (Substantial Acquisition of Shares and Disclosure Requirements) Regulations, 2011 (“SAST Regulations”).  The SAST Regulations provides formula for determining offer price, which establish a clear nexus between the price of shares offered under preferential allotment and price of shares under open offer as per SAST Regulations. Given that the pricing of open offer is influenced by the pricing under preferential allotment, should the price under the ICDR Regulations be accepted or fair valuation of shares should be sought in order to ensure fair compensation to shareholders?

At this stage of discussion, it becomes important to look into the relevant provisions and the meaning of “fair value” and understand how fair it is to have a preferential allotment without ascertainment of such fair value by an independent valuer.

 

Regulatory provisions with respect to preferential allotment

Preferential allotment in listed companies are governed by the following provisions –

  • Section 42 of the Companies Act, 2013 [“Companies Act”], read with Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014
  • Section 62(1)(c) of the Companies Act. read with Rule 13 of Companies (Share Capital and Debentures) Rules, 2014
  • Chapter V of ICDR (Regulation 164)

Preferential offers under section 62(1)(c) can be made to any person, if so authorised by a special resolution passed in general meeting if the price of such shares is determined by way of a valuation report of a registered valuer. However, if one goes through allied Rule 13 of SCD Rules, it becomes clear that the companies whose shares are listed on a stock exchange are not required to obtain a valuation report from a registered valuer. The said rules clearly bring out a distinction between preferential offers made by a listed company versus those made by unlisted companies. Sub-rule (2) specifically states that for companies whose shares are listed on a recognised stock exchange, the requirements under the relevant SEBI regulations (ICDR Regulations) will apply, while the unlisted companies will be governed by the provisions of the Companies Act; and sub-rule (3) states that the price under the preferential allotment shall not be less than the price determined on the basis of valuation report of registered valuer. Hence, it becomes clear that in case of a listed company, as per section 62 and rule 13, there is no requirement of a valuation report, per se. Instead, the legislature has left it to be regulated by SEBI regulations. Therefore, one will have to look for what ICDR says.

Reg. 164 of ICDR lays the floor limit of the price, which is to be calculated as the higher of average of weekly high and low of volume weighted average price of related equity shares quoted on a recognised stock exchange for –

  1. 26 weeks preceding the relevant date
  2. 2 weeks preceding the relevant date

The Regulation does not call for an independent valuation report. This must be read in contradistinction to regulation 165, which deals with pricing of infrequently traded shares. Reg. 165 rather specifically requires an independent valuation.

Requirement of independent valuation under regulatory provisions

 

The above clearly demonstrates that the regulations have consciously exempted listed entities from seeking an independent valuation where listed shares are frequently traded. The regulations, in fact, draw a timeframe to extract weighted averages of the market prices to ensure that the fluctuations in prices, if any, are ironed out and the resultant price is the even price at which the market has transacted during that period. This, admittedly and reasonably too, is based on the assumption that ‘market’ is the best reflection of a fair price which a willing seller and a willing investor are ready to deal in. This view can also be substantiated with similar stipulations in other laws and valuation standards.

Meaning of fair valuation under various applicable laws

Meaning of fair value under applicable accounting standards –

 

Ind AS 113 deals with the fair valuation of equity shares.  This Ind AS defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, and thus considers fair value to be “a market based measurement and not an entity specific measurement.”

Clause 18 of the Ind AS 113 provides, “If there is a principal market for the asset or liability, the fair value measurement shall represent the price in that market.”

Meaning of fair value under the Income Tax Rules

Rule 11UA (1)(c) of the Income Tax Rules provides for the fair value of shares listed in a stock exchange.

It renders the transaction value of such shares to be the fair value in case the transaction has been done through stock exchange. Otherwise, the fair market value of such shares are taken to be –

“(a)the lowest price of such shares and securities quoted on any recognized stock exchange on the valuation date, and

(b)the lowest price of such shares and securities on any recognized stock exchange on a date immediately preceding the valuation date when such shares and securities were traded on such stock exchange, in cases where on the valuation date there is no trading in such shares and securities on any recognized stock exchange”

Meaning of fair value under the Valuation Standards

Rule 18 of the Companies (Registered Valuers and Valuation) Rules, 2017 requires the registered valuer to follow such valuation standards as prescribed by the Central Government. For valuation with effect from 01st July, 2018, all registered valuers are mandatorily required to apply the ICAI Valuation Standards in their valuation assignments for the purposes of the Companies Act, 2013.

The definition of ‘fair value’ under ICAI Valuation Standard (101) is the same as that in IndAS 113, that is, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the valuation date. IVS 101 further states that fair value assumes that the price is negotiated in a free market. The ICAI Valuation Standards recognises three approaches for valuation, being – market approach,  income approach, and cost approach.

Where the assets to be valued are traded in active market, the market approach is followed for valuation purposes.

Paragraphs 18-20 gives guidance over the valuation as follows –

“18. A valuer shall consider the traded price observed over a reasonable period while valuing assets which are traded in the active market.

  1. A valuer shall also consider the market where the trading volume of asset is the highest when such asset is traded in more than one active market.
  2. A valuer shall use average price of the asset over a reasonable period. The valuer should consider using weighted average or volume weighted average to reduce the impact of volatility or any one time event in the asset.”

The stipulations as above clearly reflect that for quoted shares, fair valuation is based on quoted prices only. Given that IVS too refers to ‘traded prices’, a registered valuer would rely on such traded prices to arrive at a fair value. It may be reiterated that ICDR uses a ‘range’ of time so as to spread out the fluctuations in prices, which has been similarly captured in the IVS.

One may argue that the price of a company’s shares can be tampered with, by the company as per its whims and wishes. However, for a listed company, whose every information is readily available on public domain, does such an argument hold good? In view of the strict regulatory surveillance constantly placed by SEBI and stock exchanges on listed companies, this does not seem to be a possible scenario.

Valuation in respect of infrequently traded shares

The aforesaid logic and arguments may not hold good in case of shares that are infrequently traded or are unlisted. As indicated above, the applicable rules/regulations and standards prescribe a different methodology to arrive at fair values of such shares. For instance, regulation 165 of ICDR requires the minimum price in case of infrequently traded shares to be determined on the basis of valuation as per applicable parameters. Also, the SAST Regulations requires the offer price in case of infrequently traded shares to be determined by way of valuation taking into account various valuation parameters such as comparable trading multiples, book value and such others.

To reiterate, such distinction made out between frequently traded and infrequently traded shares clearly buttresses the views here.

Conclusion

The chances of a listed company acquiring a fair deal without falling into the formalities of fair valuation does not seem to be a scarce event. Listed companies are well governed under the provisions of ICDR Regulations as regards pricing of shares under preferential allotment. To ensure shareholder protection, ICDR already prescribes a minimum threshold based on average quoted prices. The prices depend on the market price of related equity shares quoted and traded on stock exchanges. Further, fair value of equity shares depend on market value of such shares and there does not seem to be chances of much disparity among the price under ICDR versus that as determined by way of fair valuation.