The Hindu Business Line : Virtues of consolidation

SHAREHOLDERS' permission is required not only for selling an undertaking of a company but also for starting a new venture and offering shares for subscription other than on rights basis. But curiously, even a 100 per cent subsidiary can be created by directors all by themselves without even so much as a whisper to the shareholders. This marginalisation of shareholders is indeed shocking given the seminal consequences of strategic investments.

Section 372A of the Companies Act, 1956 deigns to bring the shareholders into the picture only when a public company seeks to invest in the shares of companies or grant loan or give guarantee to them (hereinafter inter-company investments for short) to the extent of an amount which aggregates to more than 60 per cent of its paid-up share capital plus free reserves or 100 per cent of free reserves, whichever is greater. That the amount carved out for such inter-corporate investments can be substantial is evident from the fact that Reliance Industries Ltd (RIL), for example, could, besides investing in shares of other group companies such as Reliance Energy Ltd, pump in as much as 50 per cent of the share capital of Reliance Infocomm Ltd.

Should not the shareholders be taken into confidence before committing substantial funds into another company that has the result of branching of into another business given the fact that such approval would be required were the company to create a new division for the purpose under its own banner instead of floating a new company?

To the credit of Reliance it must be said that its promoters have in the process of creating wealth for themselves never given a short shrift to public investors' interest. As to why a separate company is created overlooking the tax advantage of being able to set off the loss from one division against the profits of another, the only plausible explanation is the advantage afforded by accounting opacity.

In India, Accounting Standard 21 issued by the ICAI is mandatory only when a holding company sets out to publish consolidated accounts. Similarly, Accounting Standard 23, dealing with investments in associates, is mandatory only when the investor company sets out to publish consolidated accounts of itself as well as those of the associate company.

In the event, a company despite owning a substantial chunk of shares in another company so as to make the latter its subsidiary can get away with a lenient Accounting Standard 13, which ordains that long-term investments should be carried at cost in the balance-sheet unless there is a dilution in the cost of such investments due to factors other than temporary in which case such decline should be recognised. Companies do take advantage of this long rope. Shareholders do get an inkling of the worth of such investments if the investee companies are themselves listed and their shares are traded in the bourses.

Mandatory consolidation brooks no delay if only to bring about transparency and to better enlighten the readers about the implications of togetherness born of substantial investments.

Obsession with 20 per cent

Clause 41 of the Standard Listing Agreement permits a 20 per cent leeway to listed companies in the matter of actual results for the entire financial year vis-à-vis the disaggregated quarterly results furnished at the end of each quarter.

It also similarly permits the same latitude for the half-yearly results vis-à-vis the disaggregated results of the first two quarters. These twin latitudes strike a discerning reader as odd given the fact the companies are given two months' time from the end of the respective quarter to report their quarterly results. How can the aggregate of the disaggregated results fly off the mark vis-à-vis the aggregated figures by 20 per cent, except when a company is overtaken by unexpected events in the subsequent quarters?

At any rate, the board is duty-bound to disclose the impact of extraordinary events on the profit or loss. In the event, the 20 per cent leeway defies comprehension. Remember, the unaudited results are by no means ad hoc. They are supposed to be subjected to limited review by auditors. They are not provisional either.

They are supposed to convey the actuals for period under review. With the advent of computers, accounting is no longer drudgery. Results can be updated almost on a real-time basis, thanks to the computing powers of advanced software which no company can pretend not to afford.

Quarterly results are meant to level the playing field for all the players in the stock market. It is specially meant to neutralise the advantage to insiders who are normally privy to the goings on in a company, including the operating results that play a vital role in share market valuations for scrip. Any inaccuracy therein is fatal to lesser investors who may not keep their ears to ground. Institutional investors, thanks to their research skills, get to know every whiff of information impacting on valuations but not the small investors. Hence the quarterly results. This solemn requirement should not be allowed to be diluted at any cost.

This is not the only instance of law being held to ransom by the magic figure of 20 per cent. As per Section 40A(3) of the Income-tax Act, expenditures in excess of Rs 20,000 paid for otherwise than by a cross cheque or cross bank draft attracts a 20 per cent disallowance. Why only 20 per cent disallowance? Complete disallowance would have had a chastening effect. A mere 20 per cent disallowance is just a slap on one's wrist. It is another matter that only the most naïve fall foul of this seemingly solemn requirement.

The wily avoid its impact deftly by resorting to multiple bills and multiple payments sometimes in the course of the same day even as the law enforcers have looked on bemused.

Till May 31, 1999, taxpayers dreaded the imminent prospect of a 20 per cent penal tax triggered by prima facie adjustments made to the return made by the assessing officer culminating in even a rupee of additional income. Mercifully, it has been scrapped.

(The author is a Delhi-based chartered accountant.)