Highlights of 2nd Amendment to PIT Regulations

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-by Dibisha Mishra

(dibisha@vinodkothari.com ; corplaw@vinodkothari.com)

 

SEBI vide Notification dated 25th July, 2019 further amended the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015. The major part of this amendment is to make curative changes in the Regulations, in response to difficulties expressed by the stakeholders. In this regard, VK&Co. also had occasion to make representation to SEBI, a few of which have been brought in via this amendment.

 

Highlights of the SEBI (PIT) (Second Amendment) Regulations, 2019.are as follows:

 

  1. Employees having access to unpublished price sensitive information are to be identified as ‘designated persons’ [DPs]: Keeping the intent of regulating and monitoring trading by such employees, the earlier provision of identifying them as ‘designated employees’ was merely a laxity in drafting since no corresponding duties/obligations were put upon ‘designated employees’ anywhere in the PIT Regulations.
  2. Mandatory closure of trading window from the end of every quarter till 48 hours after the declaration of financial results [the word ‘can’ substituted by ‘shall’]
  3. Permitted transactions by DPs while trading window is closed:

a. off-market inter-se transfer between DPs having possession of the same unpublished price sensitive information where both parties have made informed trade decision;

b. transaction through block-deal mechanism between persons having possession of the same unpublished price sensitive information where both parties have made informed trade decision;

c. arising out of a statutory or regulatory obligation to carry out a bona fide transaction;

d. exercise of stock options in respect of which the exercise price was pre-determined;

e. pursuant to a trading plan;

f. pledge of shares for a bonafide purpose like raising of funds subject to pre-clearance by the compliance office

g. acquisition by conversion of warrants or debentures, subscribing to rights issue, further public issue, preferential allotment or tendering of shares in a buyback offer, open offer, delisting offer: Difficulties were frequently being faced by companies as to whether the trading window bar will apply to corporate actions involving transaction in shares. This amendment makes a clear way out for the same. While only a few corporate actions are listed in the amendment, these should be taken as illustrative rather than exhaustive.

4. In order to qualify as a “material financial relationship”, payment by way of loan or gift should flow from a designated person equivalent to at least 25% of his annual income [excluding payment is based on arm’s length transactions] in last twelve months.

5. Educational institutions from which designated persons have graduated, is to be disclosed to the intermediary or fiduciary on an annual basis and as and when the information changes.

Unregulated Deposit Banning Bill passed by Lok Sabha,2019

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The Unregulated Deposit Banning Bill, 2019[1] was introduced in the Lok Sabha on 24th July, 2019 and has since been passed.

The Bill enacts into law the provisions promulgated by a Presidential Ordinance[2] from 21st February 2019.

From our preliminary comparison, it appears that the Bill is largely the same as the text of the Ordinance.

However, a very significant, though very vague, amendment is the insertion of section 41 in the Bill which provides as under: “The provisions of this Act shall not apply to deposits taken in the ordinary course of business”

Of course, one will keep wondering as to what does this provision imply? What exactly is deposit taking in ordinance course of business? Is it to exclude deposits or loans taken for business purposes? Notably, almost all the so-called deposits that were taken during the Chit funds scam in West Bengal were apparently for some business purpose, though they were effectively nothing but money-for-money transactions. While the intent of this exception may be quell fears expressed across the country by small businesses that even taking of loans for business purposes will be barred, the provision does not jell with the meaning of excluded deposits which gives very specific carve-outs.

Also, one may potentially argue that deposit-taking itself may be a business. Or, deposits sourced may be used for money-lending business, which is also a deposit taken in ordinary course of business.

Basically, the insertion of this provision in section 41 may completely rob the statute of its intent and impact, even though it has an understandable purpose.

Please see our write ups on the Ordinance

 

[1] http://164.100.47.4/BillsTexts/LSBillTexts/PassedLoksabha/182C_2019_LS_Eng.pdf
[2]https://www.prsindia.org/sites/default/files/bill_files/Banning%20of%20Unregulated%20Deposit%20Schemes%20Ordinance%2C%202019.pdf

Highlights of Companies (Amendment) Bill, 2019

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by Vinod Kothari 

The Companies (Amendment) Bill, 2019 has been placed before the Parliament[1] on 25th July, 2019. While the Bill, 2019 is largely to enact into Parliamentary law the provisions already promulgated by way of Presidential Ordinance, the Bill also brings some interesting changes.

The key feature of the Bill is to replace the existing system of judicial prosecution for offences by a departmental process of imposition of penalties. As a result, while the monetary burden on companies may go up, but offenders will not be having to face criminal courts and the stigma attached with the same.

Some of the other highlights of the changes are as follows:

Dematerialisation of securities may now be enforced against private companies too

It is notable that amendments were made by the Companies (Amendment) Act, 2017 effective from 10th September, 2018 effective from 2nd October, 2018, whereby all public unlisted companies were required to ensure that the issue and transfer of securities shall henceforth be done in dematerialised mode only. This provision alone had brought about major cleansing of the system, as in lots of cases, shareholding records included men of straw.

However, the reality of India’s corporate sector is private companies, constituting roughly 90% of the total number of incorporated companies.

The provision of section 29 is now being extended to all companies, public and private. This means, that the Govt may now mandate dematerialisation for shares of private companies too. Whether this requirement will be made applicable only for new issues of capital by private companies, or will require all existing shares also to be dematerialised, remains to be seen, but if it is the latter, the impact of this will be no lesser than “demonetisation-2” at least for the corporate sector. Evidently, all shareholders of all private companies will have to come within the system by getting their holdings dematerliaised.

CSR is now mandatory, and unspent amounts will go to PM’s Funds

When the provision for corporate social responsibility was introduced by Companies Act 2013, the-then minister Sachin Pilot went public to say, the provision will follow what is globally known as “comply or explain” (COREX). That is, companies will not be mandated to spend on CSR – the board report will only give reasons for not spending.

Notwithstanding the above, over the last few months, registry offices have sent show-cause notices to thousands of companies for not spending as required, disregarding the so-called reasons given in the Board report.

Now, the rigour being added takes CSR spending to a completely different level:

  • If companies are not able to spend the targeted amount, then they are required to contribute the unspent money to the Funds mentioned in Scheduled VII, for example, PM’s National Relief Fund.
  • Companies may retain amounts only to the extent required for on-going projects. There will be rule-making for what are eligible on-going projects. Even in case of such on-going projects, the amount required will be put into a special account within 30 days from the end of the financial year, from where it must be spent within the next 3 years, and if not spent, will once again be transferable to the Funds mentioned in Schedule VII.
  • Failure to comply with the provisions makes the company liable to a fine, but very seriously, officers of the company will be liable to be imprisoned for upto 3 years, or pay a fine extending to Rs 5 lacs. Given the fact that the major focus of the Injecti Srinivas Committee Report, which the Ordinance tried to implement, was to restrict custodial punishment only to most grave offences involving public interest, this by itself is an outlier.

Unfit and improper persons not to manage companies

The concept of undesirable persons managing companies was there in sections 388B to 388E of the Companies Act, 1956. These sections were dropped by the recommendations of the JJ Irani Committee. Similar provisions are now making a comeback, by insertions in sections 241 to 243 of the Act. These insertions obviously seem a reaction to the recent spate of corporate scandals particularly in the financial sector. Provisions smacking similar were recently added in the RBI Act by the Finance Bill.

The amendment in section 241 empowers the Central Govt to move a matter before the NCLT against managerial personnel on several grounds. The grounds themselves are fairly broadly worded, and have substantial amplitude to allow the Central Govt to substantiate its case. Included in the grounds are matters like fraud, misfeasance, persistent negligence, default in carrying out

obligations and functions under the law, breach of trust. While these are still criminal or quasi-criminal charges, the  notable one is  not conducting the business of the company on  “sound business principles or prudent commercial practices”. Going by this, in case of every failed business model, at least in hindsight, one may allege the persons in charge of the management were unfit and improper.

Once the NCLT has passed an order against such managerial person, such person shall not hold as a director, or “any other office connected with the conduct and management of the affairs of any

Company”. This would mean the indicted person has to mandatorily take a gardening leave of 5 years!

Disgorgement of properties in case of corporate frauds

In case of corporate frauds revealed by investigation by SFIO, the Govt may make an application to NCLT for passing appropriate orders for disgorgement of profits or assets of an officer or person or entity which has obtained undue benefit.

[1] https://www.prsindia.org/sites/default/files/bill_files/Companies%20%28Amendment%29%20Bill%2C%202019_0.pdf

Employee share based payments: Understanding the taxation aspects

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By Rahul Maharshi (rahul@vinodkothari.com), (finserv@vinodkothari.com)

Introduction

Employee share based payments (ESBPs) are an effective way of incentivising employees. ESBPs work as a two way growth strategy for both company as well as the employees. On one hand, it helps the employees to participate in the growth of the entity and in turn reap out the benefits from it, on the other hand it helps the entity to boost the growth rate and align the vision of the employees with that of the company. The ESBPs work as a catalyst for the employee growth as well as the growth of the company.

The theme of this article revolves around the taxation aspects of different types of ESBPs, but before we proceed further, let us have a quick understanding about the different types of ESBPs. Read more →

SEBI requires companies to be serious in reporting Insider Trading lapses

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Pammy Jaiswal

Partner, Vinod Kothari and Company

corplaw@vinodkothari.com

The listed entities are burdened with the compliance requirements under numerous regulations issued by SEBI including the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’). The said regulations lay down various to dos for the listed companies as well as the designated persons (‘DP’) for the purpose of regulating and prohibiting the insider trading in the securities of the listed company.

SEBI has vide its circular[1] dated 19th July, 2019 laid a format for reporting insider trading lapses thereby forcing all companies to follow a standard reporting format. The existing practice of companies using rather informal and self- generated reporting formats will no longer be available to them.

It is not that insider trading lapses noted by companies are those of profiteering based on Unpublished Price Sensitive Information (UPSI). Most of the noted instances in practice are technical and unintentional breaches of either the trading window closure or contra trading restrictions. Most of these are reported to the audit committee or stakeholder’s relationship committee which typically takes action based on the gravity of the offence. However, reporting to SEBI was done on a rather diminutive manner.

Further, the circular also provides for recording the violations in the digital database maintained by the compliance officer under the PIT Regulations for the purpose of taking appropriate action against the offender. The said circular is effective with immediate effect.

Current Reporting Scenario

The current practice of the corporates for reporting the violation under the code (either for entering into contra-trade within a period of six months or trading during the closure of trading window, etc.) along with the action taken by the entity is diverse. While some companies used to mark a copy of the reprimand to SEBI while sending the same to the concerned DP or their immediate relatives, others used to send a brief of the violation along with the action taken to SEBI depending on the frequency and gravity of the violation so made in accordance with their respective codes.

Revised Reporting

The revised reporting format contains all the required fields for the entity (listed entity, intermediary or fiduciary) to report the violation to SEBI. Following is the summary of details that is mandatory required to be filled up about the entity, the DP or his immediate relative and the violation along with the action taken by the entity:

Information about the entity Information about the DP/ immediate relative Transaction details
·            Name and capacity of the entity.

·            Action taken by the entity.

·            Reasons for the action taken.

 ·     Name and PAN.

 

·     Designation and functional role of DP.

 

·     Whether a part of the promoter and promoter group or holding CXO position.

 

 

 ·      Name of the scrip

·      No. and value of shares traded (including pledge)

·      In case trading value exceeds Rs. 10 lakhs date of disclosure made under regulation 7 of the PIT Regulations by both the entity as well as the concerned person.

 

·      Details of violation observed under the PIT Regulations.

 

·      Instances of any violation in the previous financial year.
Concluding Remarks

Evidently, the format contains concrete information about the violation which will place SEBI in a better position to oversee and take on record the instances of violation taking place in the regulated entities. While the current practice had deficiencies in terms of the basic information supplied to SBI, the revised reporting format will take care of the same henceforth.

However, the prompt reporting will be a task for the entities. At the same time, SEBI will now be in receipt of the complete information on the offence and may take strict action against the offender or may even direct the entities to take stricter action in cases where it feels the action taken is not commensurate with the nature and gravity of the violation.

 

Our other resources on SEBI PIT Regulations can be viewed here

[1] https://www.sebi.gov.in/legal/circulars/jul-2019/standardizing-reporting-of-violations-related-to-code-of-conduct-under-sebi-prohibition-of-insider-trading-regulations-2015_43618.html

Abrupt auditor resignations: SEBI seeks transparency

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By Vinod Kothari & Vinita Nair,

Partner, Vinod Kothari & Co

corplaw@vinodkothari.com

Original: July 19, 2019

Version: October 19, 2019

 

A SEBI proposal by way of a Consultative Paper[1] dated July 18, 2019 to amend Reg. 33 of SEBI (LODR) Regulations, 2015 (Regulations) sought to lay down in the rule book of listed entities that when auditors want to resign in the middle of an auditing assignment, they cannot be allowed to leave citing reasons such as “pre-occupation”. They must be encouraged and asked to open their heart, and speak out the real reason, or confirm that there is no reason other than the one that they mention while resigning. Also, the auditor must not leave the auditee in the lurch, and complete the on-going audit engagement to the point of completing the audit of the year or limited review of the quarter. The resignation must be discussed with the Audit Committee chairman, and thence, to the Audit Committee, highlighting the concerns, if any. The views of the Audit Committee will be filed before the stock exchanges.

In essence, the proposal of SEBI tried to implement what seems to be the clear intent – that the veil of secrecy behind auditor resignation, where everyone can sense that everything is not alright but does not get to know what exactly it is – should be lifted.

The Consultative Paper was open for public comments till 8th August, 2019. Accordingly, on 18th October, 2019, SEBI came out with a Circular[2] implementing the aforesaid proposal. While the Circular does not amend Reg. 33 of Regulations, as proposed, it has laid down the doables for the auditors of the listed entities and material subsidiaries at the time of resignation.

Inspiration of the amendment

The inspiration of the amendment is the recent turmoil in the corporate sector, where, mostly in the midst of worsening financial position, auditors put in papers. There are rumours of auditors’ discomfort with the financial statements; mostly people smell transactions that may involve transfer of assets to connected entities, inflation of profits or hiding of losses. One wonders as to why most of these resignations come only when the financial position of the entity is suddenly worsening – is it that in good times, financial statements are immune from such vulnerable transactions or practices? However, it mostly seems that an impending default will bring the entity into regulatory glare, and the auditor may have to face persecution action.

What has made the auditor fraternity even more jittered is the action of the regulators against auditors of a failed financial entity, seeking to use the very heavy provisions of section 140 (5) of the Companies Act. It is just a matter of time when the country will witness class action suits against auditors, which abound in the Western world.

The instinctive auditor action in such cases is, to try to control the damage by quitting the scene, rather than qualifying the statements which, in the past, have been affirmed by the same auditor. Of course, the reasons cited can be as slippery as “pre-occupation” or lack of bandwidth.

It was reported in 2018 that the Minister of State for Corporate Affairs, P P Chaudhary’s written reply to the Rajya Sabha stated that as per the filings in MCA 21 registry, auditors of 204 listed entities had resigned since January 1, 2018 to July 17, 2018.

ICAI also constituted a Group and the task of developing guidance for the members was entrusted to the Auditing and Assurance Standards Board (AASB). In December 2018, ICAI released ‘Implementation Guide on Resignation/Withdrawal from an Engagement to Perform Audit of Financial Statements’ [3] which provides matters to be included in the resignation letter (Para 19) which is similar to the Annex-B of the SEBI Consultative Paper. It additionally required the response from the management or those charged with governance, on the written communication made by the auditor, to be included in the resignation letter.

Is it wrong to resign?

No, as ICAI’s auditing standards (SA-705) provides the situation under which an auditor may resign from the audit. If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall resign from the audit, where practicable and not prohibited by law or regulation.

Is it necessary to cite reason for resignation?

Section 140 (2) of Companies Act, 2013 mandates an auditor to indicate the reason and other facts as regard to its resignation while filing the statement of resignation with the Registrar and the Comptroller and Auditor-General of India, where applicable.

What is the meaning of resignation?

It is important to note that the appointment of an auditor is done for a term of 5 years. Therefore, even if an auditor resigns after completion of the audit for a financial year, within the term of 5 years, it is still a case of resignation.

Provisions of section 139 (9) may be interpreted to mean that the auditor may actually state before a general meeting, within the term of 5 years, that he is not willing to be reappointed. However, is that a case of resignation?

Read with section 140 (2), even an unwillingness to be reappointed becomes a case of resignation. This is so because the appointment is done for 5 years, and the ratification of the appointment at the annual general meeting, every year during the 5 year term, has been done way with by the Companies (Amendment) Act, 2017 w.e.f. May 7, 2018.

Therefore, the following are some examples of what may be construed as a case of resignation:

(a) The auditor was appointed in the AGM of Year 1, for completing the audit for FY 1 to FY 5, until the conclusion of the AGM for year 5. At the end of Year 2, after completing the audit of year 2, auditor gives a letter to the management that the auditor is not willing to audit for year 3.

(b) Same case as above, however, instead of the auditor indicating unwillingness to be reappointed, the audit committee while evaluating the performance of the auditor does not recommend continuation of appointment.

(c) Same case as (a), however, the auditor becomes ineligible to continue.

 

Case (a) is a case of resignation; (b) is a case of removal and (c) is a case of vacation of office resulting in casual vacancy.

SEBI’s prescription: Reveal the truth

The resigning auditor shall reveal all the reasons for resignation in the resignation letter along with the efforts made by the auditor prior to resignation. Whom the concern was raised? In relation to what the concern was raised? Why the concern was not addressed – due to a management-imposed limitation or circumstances beyond the control of the management. The auditor is expected to pour his heart out in the resignation letter, which is in line with the prescription made in ICAI’s implementation guide.

Role of Audit Committee

There are recourse available with the auditors of the listed entity/ material subsidiary as follows:

  1. In case, the listed entity/ material subsidiary does not co-operate or they do not provide information as required by the auditors, which may hamper the audit process, the Auditors may approach the Chairman of the Audit Committee and the Chairman shall receive such concern directly without waiting for the quarterly meetings.
  2. In case, the auditor proposes to resign, all concerns with respect to the resignation, along with the relevant documents shall be brought to the notice of the Audit Committee. In cases, where the proposed resignation is due to non-receipt of information / explanation from the company, the auditor shall inform the Audit Committee of the details of information / explanation sought and not provided by the management, as applicable.
  3. The auditor can provide an appropriate disclaimer in the audit report in accordance with the ICAI/ NFRA if the requisite information is not provided to the auditor as sought.

After the auditor approaches the Chairman/ Audit Committee, the Audit Committee has to communicate its views to the management and the auditor, which is also required to be disclosed to the stock exchange within 24 hours after the date of such Audit committee meeting.

As per the Regulations, the Audit Committee is responsible for the appointment, performance evaluation, ensuring independence of the auditors, finalising the audit plan and reviewing and monitoring effectiveness of the audit process. In view of the Circular, the companies shall now be required to modify the letter of appointment of the existing auditors. Further, the Audit Committee is also required to mandatorily review management letters / letters of internal control weaknesses issued by the statutory auditors.

Auditor’s duty to complete pending assignments

While the language of the Consultative Paper seemed unclear, the  Circular has clarified that the auditor shall be required to complete the audit in the following manner before resigning:

  1. If the resignation of the auditor is tendered within 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.
  2. If the resignation of the auditor is tendered after 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.
  3. If the auditor has signed the limited review/ audit report for the first 3 quarters- the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

A comparison between the Consultation Paper and the Circular

A quick snapshot of the major highlights of the Circular along with a comparison with what was proposed in the Consultation Paper is given below:

Sl. No. Requirement SEBI’s Consultation Paper SEBI’s Circular Impact of the change
1 Time of resignation i. If the auditor has signed the audit report for all the quarters (limited review/ audit) of a financial year, except the last quarter, then the auditor shall finalize the audit report for the said financial year before such resignation.

 

ii. In all other cases, the auditor shall issue limited review/audit report for that quarter before such resignation (i.e. previous quarter in reference to the date of resignation).

 

iii. In case of material unlisted subsidiary, the auditor shall issue the limited review/audit report for that financial year/ quarter, as applicable, before such resignation (i.e. previous financial year/ quarter in reference to the date of resignation)

 

 iv.                 i. Resignation of the auditor within 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter.

v.

ii.                   Ii. Resignation of the auditor after 45 days from the end of the quarter- the auditor shall, before such resignation, issue the limited review/ audit report for such quarter as well as the next quarter.

iii.

iv.                 Iii. If the auditor has signed the limited review/ audit report for the first 3 quarters- the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of such financial year as well as the audit report for such financial year.

 With respect to the quarterly audits, the auditors shall be obligated to issue limited review report for the next quarter as well where the resignation is after 45 days from the end of the quarter. This shall provide the listed entity a reasonable time to search another auditor.

 

Further, with respect to the rest, the same was in line with the proposal provided in the Consultation Paper.
2. Reporting of concerns to Audit Committee i.                Approach the Chairman of the Audit Committee and the Chairman to receive the concern directly and immediately without waiting for the quarterly meetings.

 

ii.              All concerned reasons alongwith the relevant documents for shall be brought to the Audit Committee’s notice in case the resignation is due to non-receipt of information/ explanation from the company.

 

 i.                   Approach the Chairman of the Audit Committee and the Chairman to receive the concern directly and immediately without waiting for the quarterly meetings.

 

ii.                 All concerned reasons alongwith the relevant documents for shall be brought to the Audit Committee’s notice in case the resignation is due to non-receipt of information/ explanation from the company.

 The consultation Paper as well as the Circular are in sync.

 

The change shall enhance the role of the Chairman of the Audit Committee w.r.t. reporting the concerns to the management.
3. Deliberation by the Audit Committee Audit Committee shall deliberate on the matter and communicate its views to the management and the auditor. Audit Committee shall deliberate on the matter and communicate its views to the management and the auditor not later than the date of the next Audit Committee meeting. The Circular is in the line with the proposal made in the Consultation Paper.

 

The change shall keep the management in loop and it shall also know the detailed reasons of the resignation of the auditor within a specific time period.

 
4. Disclaimer in case of non-receipt of information from the entity If the reason for the auditor’s resignation is the entity not providing information, the auditor shall provide an appropriate disclaimer in the audit report to that extent. The auditor shall provide an appropriate disclaimer in the audit report, which may be in accordance with the Standards of Auditing as specified by ICAI / NFRA in case the entity does not provide information as sought. Again the Circular is in line with the Consultation Paper.

 

Such change shall now put the entity under an obligation to provide necessary support/ relevant information/ co-operation to the auditor in order to complete the audit.

 
5. Ensuring proper terms and conditions in the letter of appointment No such proposal The aforesaid shall be included in the letter of appointment of the auditor.

 

Where the auditor has already been appointed, the company shall issue modified letter of appointment.

 Considering the appointment of auditors must have been made in listed entities in the AGM held in the FY 19-20 and shall be valid till FY 2023-24, actionable on the part of the listed entities is to amend/ modify the terms of engagement and issue a fresh letter of appointment to the auditors.

 
6. Certification in Annual Secretarial Compliance Report (ASC) No such proposal A practicing company secretary shall be required to certify the aforesaid in the ASC Report. The same shall be an additional responsibility of the practicing company secretary while issuing ASC Report.

 
7. Disclosure of the views of the Audit Committee’s to the Stock Exchange The views of the Audit Committee and the Board of Directors of the entity be required to be submitted to the stock exchanges along with the disclosure of the resignation letter of the auditor in the format as prescribed.

 

 Post the deliberation of the views by the Audit Committee, the same shall be disclosed to the Stock Exchanges as soon as possible but not later than 24 hours after the date of such Audit Committee meeting. The Circular lays down a time which aligns with the requirement of Regulation 7(A) of Part A para A of Schedule III of the SEBI Listing Regulations.

 

The Circular does not prescribe any format for disclosing the views of the Audit Committee to the Stock Exchange.

 
8. Format of resignation letter Provided as Annexure- B Provided as Annexure- A Slight cosmetic changes have been made in the format.

Concluding remarks

Thankfully, for all Indians, one can relate most tricky situations in life to a Bollywood song, and that really helps to dismiss the gravity of the matter. When it comes to something like auditor’s resignations (judaai), or auditors’ silence (khamoshi), there will a large number of songs or flicks on such situations, evidently the popular themes for Bollywood. Therefore, without claiming to be the best for the situation, here is one that may possibly help to lighten the pain that SEBI and investors may be having:

कभी ऐसा लगता है

दिल में एक राज़ है

जिसे कहना चाहूँ, पर मैं कह पाऊँ ना

आँखों ही आँखों में कह जाती है जो ये

खामोशियों की ये कैसी ज़ुबां

मैंने सुना जो ना उसने कहा

 

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/jul-2019/1563449963980.pdf#page=1&zoom=auto,-15,842

[2] https://www.sebi.gov.in/legal/circulars/oct-2019/resignation-of-statutory-auditors-from-listed-entities-and-their-material-subsidiaries_44703.html

 

[3] https://resource.cdn.icai.org/52929aasbicai-igr.pdf

Applicability of NFRA Rules on overseas subsidiaries and associates: Conflict between the Rules and FAQs

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Pammy Jaiswal

Partner, Vinod Kothari and Company

 

Background

National Financial Reporting Authority (‘NFRA’) being a quasi-judicial authority has been empowered by the Central Government to independently regulate and monitor the accounting and auditing standards (‘A&AS’). The intent of NFRA is to oversee the quality of A&AS of large entities as mentioned under Rule 3 (1) of the NFRA Rules.

Evidently NFRA intends to oversee the A&AS of large entities in terms of being listed or the size of the company or being functionally different entities like electricity companies or insurance companies, etc. Such entities have the presence of its subsidiaries and associates all around the world which may be contributing materially in terms of Rule 3 (1) (e) of the NFRA Rules to the net worth and turnover of the Indian parent entity.

While the last date for filing one time return by bodies corporate is approaching fast i.e. 31st July, 2019, there seems to a lot of ambiguity in the applicability of the NFRA Rules.

This note has been prepared with the intent to showcase the conflict between the provisions of the Companies Act, 2013 (‘Act’) read with its allied Rules and the FAQs issued by NFRA.

Various Provisions of the Act applying to bodies corporate

  • Applicability section of the Act

The first section of the Act laying down the applicability of the Act clearly mentions the following under clause (f) of sub-section (4) – “such body corporate, incorporated by any Act for the time being in force, as the Central Government may, by notification, specify in this behalf, subject to such exceptions, modifications or adaptation, as may be specified in the notification.”

This provision makes it very clear that the Ministry of Corporate Affairs (‘MCA’) has been vested with the powers of applying the provisions of the Act to any bodies corporate. Further, the provision is also quite clear that such body corporate may be either incorporated under the Act or any other Act. This implies that even for foreign companies, the MCA has the power to apply the provisions of the Act subject to the changes as may be notified.

  • Definition of the term body corporate

Section 2 (11) defines the term ‘body corporate’ to include a company incorporated outside India. Here also, the intent of law is explicitly clear to cover the bodies corporate governed by foreign laws.

  • Chapter 22 of the Act

Section 379 (2) of the Act provides that a foreign company which is substantially owned and controlled by an Indian citizen or by an Indian company is required to comply with the provisions of the Act as mentioned thereunder.

Areas of conflict

While the consolidated financial statements of the Indian parent entities include the accounts of the subsidiaries and associates also, it cannot be argued that the quality of auditing and accounting is anywhere less relevant than the A&AS of the Indian parent. Therefore, it seems in fitness of things under clause (e) of Rule 3 (1) of the NFRA Rules to include foreign subsidiary and associates if they fulfil the condition of materiality under the said Rules (foreign subsidiaries and associates whose income or net worth exceeds 20% of the consolidated income and net worth of the Indian parent [‘material subsidiaries and associates]).

However, the FAQs[1] issued by NFRA have taken a different stand altogether with respect to the applicability of the NFRA Rules. It states that only those material subsidiaries and associates are covered under the scope which are having place of business in India.

While it sounds very surprising that if this wouldn’t have been the case, the condition of the foreign subsidiaries and associates which has an Indian parent, doing business back in India is very unlikely.

In any event, if merely by not having a business in India absolves the material subsidiaries and associates from the overview of the NFRA that would frustrate the whole intent and objective of the NFRA and allow such subsidiaries and associates to escape from the regulation of NFRA by virtue of the additional clause in the FAQs.

It seems that this condition of having business in India should have either be mixed with section 379 of the Act which talks about foreign companies having business in India or should may have actually been intended to be referred to the Indian parent’s business in India.

Further, if the question is one of jurisdiction as of how the Act extends its application to foreign bodies corporate not having business in India is concerned, it may be noted that section 1 (4) of the Act allows the Central Government to extend the provision of Act to bodies corporate, and it may therefore, it may be construed that in a manner of speaking is actually extended to foreign bodies corporate which have a business connection in India by virtue of having an Indian parentage.

Conclusion

One of the major questions in front of the stakeholders is the jurisdiction of NFRA which the FAQs have seemingly restricted to bodies corporate having place of business in India. However, considering the other provisions of the Act, it is quite clear that NFRA has been constituted not only to govern the auditors registered in India but also those in abroad as MCA has left number of provisions open under the Act which applies to bodies corporate.

If one interprets the applicability of NFRA on Indian bodies corporate, the whole intent and object of setting this regulatory body will get frustrated.

Related articles –

  1. https://vinodkothari.com/2019/07/faqs-on-national-financial-reporting-authority-nfra-rules-2018/
  2. https://vinodkothari.com/wp-content/uploads/2019/07/MCA-Notifies-NFRA-Rules.pdf

 

[1] https://nfra.gov.in/sites/default/files/FAQ.pdf