Sep 10, 2013

Companies Act draft rules put a cap on term of auditors

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The government has released draft rules to implement the new Companies Act that, among other things, says that the mandatory rotation of auditors will take place retrospectively, and lists activities that can be defined as corporate social responsibility (CSR).

The new draft rules, put up on the website of the corporate affairs ministry, are spread over 16 chapters, including accounting policies, appointment of auditors and directors, the revival of companies, prevention of mismanagement, and the incorporation of companies outside India. The rules for the remaining chapters will be released after consultations with regulators such as the Securities and Exchange Board of India and the Reserve Bank of India.

The government has invited comments from various stakeholders on these rules by 8 October. The remaining chapters are likely to be made public in two instalments, on 16 and 24 September.

On 14 August, Parliament passed the new companies Bill, which overhauls the Companies Act of 1956. The new legislation is aimed at easing the process of doing business in the country and improving governance by making firms more accountable.

The Companies Act is a detailed statute which provides the skeletal framework for operations and daily functioning of a company along with the duties of those in charge of companies, particularly directors and promoters. The Act is implemented through rules.

A person on the rule-making committee said the final set of rules is likely to be officially notified in two-three months.

The new law caps the tenure of a company’s auditor to a maximum period of 10 years in case the auditor is a company and 5, if the auditor is an individual. “The rules provide many clarifications with respect to rotation of auditors. The five-year period for rotation in the case of an individual and 10-year period in the case of a firm will be calculated retrospectively and will include holding office as auditor prior to the commencement of the Act,” Dolphy D’souza, partner and national leader, IFRS (international financial reporting standards) services at EY, said in an emailed statement.

“Further, the new auditor cannot be a network firm,” he added. In India, many of the large global auditors operate through a network of several firms.

D’souza also said that the new rules had given “some breather in terms of reporting on fraud by auditors” to the government. “The reporting is required to be made within 30 days, but only with regards to material fraud. Materiality shall mean frauds that are happening frequently or frauds where the amount involved or likely to be involved is not less than 5% of net profit or 2% of turnover of the company for the preceding financial year,” he said.

The legislation was unclear on this.

The draft rules have specified at least nine broad activities on which companies can spend money in order to fulfil the new CSR obligations. These activities include eradicating extreme hunger and poverty, promotion of education, promoting gender equality and empowering women, reducing child mortality and improving maternal health, combating HIV and AIDS, ensuring environmental sustainability, employment enhancing vocational skills, social business projects, and contribution towards the Prime Minister’s relief fund.

On 21 August, Mint had reported that some of these activities could be made eligible for companies to fulfil their CSR-spending obligations.

The new companies law effectively mandates that firms with a net worth of more than Rs.500 crore or revenue of more than Rs.1,000 crore or net profit of more than Rs.5 crore spend 2% of their average net profit over the three preceding years on CSR activities.

Pavan Kumar Vijay, managing director at New Delhi-based Corporate Professionals Capital Pvt. Ltd, said the rules regarding CSR could see significant changes. “This has become a very political issue. Different industrial and political forces would like various new categories of activities included in the list,” he said.

Vijay added that rules regarding the proposed National Financial Reporting Authority could also see some changes. The new authority will monitor compliance with accounting and auditing standards. It will also have the power to investigate auditors that are registered under section 22 of the Chartered Accountants Act, 1949.

In the 21 August report, Mint had cited various analysts as saying that tax rules related to CSR remain a grey area. Vijay said that the income-tax Act is a legislation at par with the companies Act, and making any changes in income-tax rules would be the prerogative of the finance ministry.

The new rules stipulate that company boards report on steps taken for energy conservation and their impact, foreign exchange earnings and outgo, and technology absorption, including spending on research and development.

The rules require every listed company and every other company that has a paid-up share capital of Rs.100 crore or more to appoint at least one woman director on its board.

Moreover, deemed public companies having paid-up share capital of more that Rs.100 crore or aggregate outstanding loans or borrowings or debentures or deposits in excess of Rs.200 crore, are required to have at least one-third of their board made up of independent directors. Such companies, while appointing an independent director, will also have to state that in their opinion, the appointee is qualified to be an independent director.

The concept of an independent director has been formally introduced for the first time in the new Act. Every such independent director will be allowed a maximum two terms of five years each.

Any company that has a minimum paid-up share capital of Rs.5 lakh is deemed to be a public company.

The new rules define at least 15 different ways in which one person can be considered to be a “relative” of another person, crimping the ability of promoters to have their associates nominated on the boards of their companies as independent directors.

The rules have been drafted by the corporate affairs ministry in consultation with industry lobby groups, including the Confederation of Indian Industry, Federation of Indian Chambers of Commerce and Industry and the Associated Chambers of Commerce and Industry of India, the Institute of Chartered Accountants of India and investors associations.

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