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Companies Law Committee Report: Hits & Misses

Published on Mon, Feb 08,2016 | 17:02, Updated at Mon, Feb 08 at 17:02Source : Moneycontrol.com 

By: Dolphy D’Souza, Partner in Indian member firm of EY Global

The Companies Act 2013 was one of the most significant legal reforms in India. However, several representations were received by the Government on the practical difficulties faced during its implementation. A Company Law Committee was constituted to look into the concerns and make recommendations on the necessary changes required to the Companies Law. The Committee had to deal with over 2000 comments received from different sources. Given the sheer enormity and complexity of the exercise, it is indeed a commendable feat that the Committee could finalize its report in a little more than six months.
This article discusses a few hits and misses.

HITS
The proposals to allow multi-layering of investment companies will bring more ease of doing business. Many conglomerates need multi-layer investment structures for genuine reasons such as fund-raising, creating sector specific sub-groups, and private equity investment. Companies will have greater flexibilities in raising finance where PE investor wants to invest in specific businesses or group of entities, instead of making investment at ultimate parent level.

The Committee acknowledged that a complete embargo on providing loans to subsidiaries would impact even genuine transactions and therefore impair the ease of doing business. The Committee therefore recommended that it may be considered to allow companies to advance a loan to any other person in whom director is interested subject to prior approval of the company by a special resolution. The Committee also recommended that loans extended to including subsidiaries in this manner should be used by the subsidiary for its principal business activity only, and not for further investment or grant of loan.
Interest rates are different for different currencies. For some currencies those rates are even zero or negative. Therefore, a loan to a subsidiary in USD currency cannot be subjected to a relatively higher Indian benchmark rate. The Committee has understood this basic economic concept and recommended that in the case of loan given in a foreign currency the effective yield (and not the interest rate) should not be lower than the Indian benchmark rate.  It will now be possible for companies to lend money in currencies at the interest rate applicable to those currencies.

With respect to CSR, companies were not clear regarding whether the CSR spending requirement was a mandatory obligation, and the consequences of not spending the CSR amount. Particularly, the question was whether unspent CSR amount should be carried forward to be spent in later years. The Committee recommended the continuance of the current provisions and reiterated the principle of “spend or disclose”. If the company has disclosed the CSR expenditure and the unspent amount, that would meet the compliance requirement of the law, and there was no obligation to carry forward the unspent amount for spending in future. This recommendation would put all doubts on CSR expenditure being voluntary to rest.

Consider an Indian parent company that has more than 200 subsidiaries, spread across the globe. These subsidiaries would prepare their local financial statements in accordance with the respective local legislation. The parent company would be required to maintain the financial statements of the subsidiaries on its web-site or file the subsidiaries financial statements with the ROC. If such subsidiaries financial statements were required to be prepared under Indian GAAP or Ind AS, it would result in enormous amount of time, cost and effort being wasted. The Committee clarified that the subsidiaries financial statements as per their own local GAAP would suffice. The Committee also felt that no change in Company Law was required as existing provisions were capable of the said interpretation.

The definition of deposits include advances received from customers that are not appropriated within a period of twelve months; for example, a company receives advances for services that may be rendered after twelve months such as a warranty service or an annual maintenance contract. This has created practical difficulties for a lot of companies. The Committee felt that the rules should be relaxed to exclude such amounts after due consideration.

MISSES
There is a marked increase in compliance requirements mandated for private companies under the new Companies Act as compared to the 1956 Act. While one may argue that these provisions may be required for increasing accountability of private companies, there are concerns whether there is a need for increasing so much complexity in private companies where public at large has no direct financial interest. The MCA had issued notification dated 5 June 2015 which provided marginal relaxations for private companies. Nonetheless, there continue to be many requirements in the new Companies Act, e.g., preparation of consolidated financial statements, internal financial control reporting (ICFR), rotation of auditors, approval of related party transactions, internal audit, restrictions on giving loans to directors, vigil mechanism, etc. which apply to private companies. These requirements did not exist for private companies under the 1956 Act. Also, globally in many countries such requirements are not made applicable to private companies. The committee has not made any recommendations to make compliance easy for private companies. This is a missed opportunity to increase the ease of doing business for private companies.

Globally an independent director (ID) is expected to serve as a strategic advisor to management and as a watchdog to protect the interest of the minority shareholders. However, Schedule IV of the Companies Act imposes highly onerous obligations on ID’s including taking executive responsibilities. ID’s will be required to approve related party transactions, conduct at least one separate meeting without attendance on non-independent directors, protect whistle-blowers, safeguard the interest of all stakeholders; particularly the minority shareholders and perform the delicate act of balancing conflicting interest of stakeholders. Given the responsibilities of ID’s have become highly onerous, companies may find it extremely challenging to hire good quality ID’s. The Committee has not made any recommendation to ease this challenge.

A company on whom significant influence is exercised is an associate. The Committee has recommended that significant influence be defined “as holding 20% of voting power, or control of or participation in taking business decisions under an agreement.”  Now if an investor exercises control over business decisions, then the company on whom the control is exercised is a subsidiary company rather than an associate. These anomalies need to be corrected in the report, and the difference between subsidiaries where control is exercised and associates where significant influence is exercised needs to be clearly articulated.

An auditor has to report fraud to the Central Government that he detects during the performance of his duties. That fraud has to be of amount greater than INR 1 crore. This limit may be appropriate for a company that has an annual turnover of INR 1,000 crore. However, it would be completely out of whack for a company that has a turnover of let’s say INR 80,000 crore. The Committee did not provide any relief on this account. The author recommends that the limits for reporting to the Central Government should be linked to turnover. For example, the limit for a company with annual revenue of INR 10,000 crore or more may be increased to INR 10 crore.

Many companies keep their accounting records and databases in servers located outside India. The Companies (Accounts) Rules require that accounting records and databases should be maintained in a back-up server located within India. This would entail companies to incur additional and significant cost of maintaining a local server. The Committee recommended only a limited change to this requirement. Where free data access to all regulatory agencies of the country are allowed under a bilateral or multi-lateral treaty, the data server may be allowed to be kept in those specific countries. Consequently, it appears that at this stage, most companies will have to incur additional cost, time and effort of maintaining a local data server.

Conclusion
Overall the report of the Companies Law Committee is a good effort. It removes several small hurdles and also has some sweeping positive changes. However, a lot more can still be achieved. The report invites comments from the public, and hopefully through that process we can aspire for a more robust and practical Company Law.
 
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