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    3. 2014
    4. Making the company law work

    Making the company law work

    07 Dec 2014

    Making the company law work

    The government has made 45-odd changes in the Companies Act of 2013, through circulars, notifications or orders, ever since the provisions of the new company law came into effect on April 1 this year. Last week, the Union Cabinet cleared another 14 changes in the Act, paving the way for tabling amendments in the ongoing session of Parliament.

    Over the last seven months, the bulk of the changes that have taken place pertain to provisions and rules in related-party transactions, corporate social responsibility (CSR) spend, easing rules for private companies, issue of consolidated financial statements, and the role of directors and key managerial personnel. Most of these changes were driven by calls from stakeholders -industry, auditors, consultants – to ease the environment to do business, while striking a balance for meeting a higher corporate governance threshold in the way business is conducted. Some of these changes were necessitated by avoidable drafting errors in the Act.

    Business Standard spoke to various stakeholders from industry, audit community and corporate legal experts to get a drift of the impact of these changes on the way the Act will affect businesses.

    Related-party transactions

    While going about making these clarifications and changes, the ministry of corporate affairs has devoted most of its time and effort to issues surrounding related-party transactions. Ever since the new company law came into effect, stricter provisions around related-party transactions were something that was hurting the industry the most, with most complaining that they were difficult to implement, affecting day-to-day business operations. The government has, over the months, brought about changes to make these provisions more industry-friendly. According to an analysis by KPMG Accounting Advisory Services, eight major changes were made in the provisions pertaining to related-party transactions over the past seven months. These do not include the amendments suggested by the Cabinet last week.

    One of its clarifications was that if any company and a public company have common director, and if that director – either by himself or along with his relatives – holds more than two per cent in the paid-up share capital of the company, then the companies will be termed ‘related party’. This provision was clarified so that a common director does not create a conflict of interest and minority shareholders are not harmed because of that director’s actions.

    One major clarification came in relation to merger and amalgamations, where the government said mergers and amalgamations would be done according to the provisions of the Companies Act of 1956, and the provisions regarding the related party transactions would not be applied to such cases. Mergers and amalgamations, according to the new law, have to be sanctioned by National Company Law Tribunal (NCLT), instead of high courts. The Madras Bar Association has already filed a case against NCLT formation and the case is sub-judice.

    In July, the government clarified that the related parties of the company themselves can’t vote when any related-party transaction comes up to a stage where there is need to pass a special resolution. In effect, this meant that only minority shareholders can vote in such a resolution. The government has now proposed that instead of special resolution, which requires 75 per cent approval, only an ordinary resolution needs to be passed, which requires just 50 per cent approval.

    A special resolution is required in case a transaction value crosses a certain threshold. Industry associations felt that the prescribed threshold was very low. Subsequently, in a major relief, the government raised the threshold, bringing more clarity to the issue of passing the related-party transaction.

    Sai Venkateshwaran, partner and head – accounting advisory services at KPMG in India, says the government seeks to partly align the requirements of the Act with the Securities and Exchange Board of India (Sebi) requirements, whereas in some other aspects, it has sought to provide greater relaxation, compared to the Sebi requirements.

    Key amendments to companies act, 2013 (since april 2014)

    Related party transactions

    Thresholds for approvals

    • The threshold prescribed for paid-up share capital has been removed

    Exemptions from approval requirements

    • The contracts which are entered into by companies before commencement of Section 188 of the 2013 Act do not require fresh approval under Section 188 till the expiry of original term of such contracts
    • Only the related party in context of the contract or arrangement for which the special resolution is being passed is required to abstain from voting
    • The transactions arising out of compromises, arrangements and amalgamations will not require approvals in Section 188 otherwise required for related-party transactions

    Amendments to related party definition

    • Related party does not include independent directors

    Internal financial controls

    • The Ministry of Corporate Affairs has deferred the reporting by auditors on internal financial control and its operating effectiveness to financial years 2015-16 onwards

    Consolidated financial statements

    • Preparation of consolidation financial statements shall not apply to an intermediate wholly-owned subsidiary, other than a wholly-owned subsidiary whose immediate parent is a company incorporated outside India
    • Companies which do not have any subsidiary but only have associates companies and/or joint ventures, are exempt from the requirement of preparation of consolidated financial statements for FY15

    Financial statements prior to April 1, 2014

    • Financial statements, auditors report and board report in respect of financial years that commenced earlier than April 1, 2014 shall be governed by the 1956 Act

    Subsidiaries of overseas companies

    • The ministry has clarified there is no bar in the Act for a company incorporated outside India to incorporate a subsidiary either as a public company, or a private company
    • An existing subsidiary of a company incorporated outside India, registered under the Company Act, 1956 either as private company or a public company of that Act, will continue without any change in the incorporation status of such company

    Independent Directors

    • Independent director can be appointed for a period less than five years but such appointment shall be considered as one term, and cannot hold office for more than two consecutive terms
    • For an independent director pecuniary relationship with a company does not include receipt of remuneration by way of fee, reimbursement of expenses for participation in board meeting and profit-related commission approved by members while considering his appointment

    Corporate Social Responsibility

    The ministry has clarified certain issues relating to the provisions of Section 135 and the provisions of CSR rules. Some key clarifications are:

    • The list of activities as mentioned in Schedule VII must be interpreted liberally so as to capture the essence of the subjects enumerated in the said Schedule
    • One-off events such as marathons/ awards/ charitable contribution/ advertisement/ sponsorships of TV programmes, etc would not be qualified as part of CSR expenditure
    • Expenses incurred by companies for the fulfilments of any Act/ Statute of regulations are not counted as CSR expenditure
    • Salaries paid by the companies to regular CSR staff as well as to volunteers of the companies can be factored into CSR project cost
    • Expenditure incurred by foreign holding company for CSR activities in India will qualify as CSR spend of the Indian subsidiary, if the CSR expenditures are routed through Indian subsidiaries and if the Indian subsidiary is required to do so under Section 135 of the Act
    • Contribution to corpus of a trust/ society/ Section 8 companies will qualify as CSR expenditure as long as (a) they are created exclusively for undertaking CSR activities or (b) where the corpus is created exclusively for a purpose directly relatable to a subject covered in the Act

    Depreciation

    Useful life and residual value of the assets

    • Companies are permitted to have longer or even shorter lives than as prescribed under Schedule II. However, a justification for the difference has to be disclosed in its financial statements. The justification must be supported by a technical advice

    Corporate social responsibility
    The government has brought several clarifications on CSR spending. It prescribed certain areas in Schedule 7, in which a company can carry out its CSR activities. A subsequent notification, however, clarified that such a list of activities prescribed in the Act should be “interpreted liberally”. The government also clarified that while the companies can count the salaries paid to regular CSR staff as part of CSR budget, they cannot consider expenses incurred for the fulfilment of any law as CSR.

    Following the clarifications, salaries paid by companies to regular CSR staff as well as to volunteers can be factored in to the CSR project cost as part of the CSR expenditure, notes Yogesh Sharma, partner, Grant Thornton India LLP.

    Independent directors and financial statements
    The Act has defined the role of independent directors, making them a crucial cog in uplifting corporate governance practices in the board. However, in a major relaxation to industry, the government has stated that any transaction with the independent directors, which is covered under the related-party transactions, and is under ‘ordinary course of business’ and ‘arm’s length basis’, will not be considered a pecuniary relationship.

    According to V Balaji, partner, Deloitte Haskins & Sells, a clarification has also been issued to state that any remuneration that the independent director receives as prescribed in the Act will not be treated as part of a pecuniary relationship. “He/she can be considered for appointment in the holding company, subsidiary or associate company of such company,” he adds.

    The company, if it has many step-down wholly-owned subsidiaries, then only the top holding company needs to bring a consolidated statement. The government also clarified that the consolidated financial statement need not be prepared by a company, which has no subsidiaries, but has only associate companies or joint venture companies.

    Recent Cabinet amendments
    The government has decided to remove the requirement of paid-up share capital to start a company. In the Act, any private company had to show certain amount in bank account in order to get a commencement certificate.

    The government proposes to further loosen related party provisions. The Cabinet has also cleared provisions prescribing punishment under the new Act for the illegal deposits obtained from any company, prohibiting public inspection of board resolutions filed with the Registrar of Companies, introducing a threshold so that auditors shall only report frauds above that limit, among others. The plan is also to bring out the guidelines of the terms “ordinary course of business” and “arm’s length basis”, which will be a guide to businesses on nature of transactions.

    A host of concessions to private companies – mostly small and mid-sized ones – from some stringent provisions of the Act is also in the offing.


    More changes in the offing

    The Companies Act, 2013, was notified on August 29 last year. Out of 470 sections in the Act, 283 sections and 22 sets of rules corresponding to such sections have so far come into force. The Companies (Amendment) Bill, 2014, set to be tabled in the current session of Parliament, will amend certain provisions in the Act. The proposed changes, cleared by Union Cabinet last week, include:

    • Omitting requirement for minimum paid-up share capital
    • Making common seal optional for execution of documents
    • Prescribing specific punishment for deposits accepted under the new Act
    • Prohibiting public inspection of Board resolutions filed in the registry
    • Including provision for writing off past losses/depreciation before declaring dividend for the year
    • Rectifying the requirement of transferring equity shares for which unclaimed/unpaid dividend has been transferred
    • Enabling provisions to prescribe thresholds beyond which fraud shall be reported to the Centre. Any fraud below the threshold will be reported to the Audit Committee and disclosed in the Board’s report
    • Exemption u/s 185 (loans to directors) provided for loans to wholly-owned subsidiaries and guarantees/securities on loans taken from banks by subsidiaries
    • Empowering audit committee to give omnibus approvals for related-party transactions on an annual basis
    • Replacing ‘special resolution’ with ‘ordinary resolution’ for approval of related-party transactions by non-related shareholders
    • Exempt related-party transactions between holding companies and wholly-owned subsidiaries from the requirement of approval of non-related shareholders
    • Bail restrictions to apply only for offence relating to fraud u/s 447
    • Winding-up cases to be heard by two-member bench, instead of three-member bench
    • Special courts to try only offences carrying imprisonment of two years or more

    The article appeared in the Business Standard.

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