The proposed amendments on CSR and on regulation of private limited companies are quite excessive in scope.
The recent reform announcements ought to shake the Indian economy and corporate houses out of their slumber, provided Parliament does not stop the government in its tracks.
Opposition parties have raised an uproar in Parliament against FDI in retail. If the policy changes earlier announced by the government survive the onslaught of Parliament, the lost excitement is expected to return.
This should not only restore, but revitalise foreign investors’ confidence in the India Inc story. Many corporations have started reviving their plans for making an entry into India.
One such announcement was made by the Cabinet in October to amend the Companies Bill, 2011, which is expected to be introduced in its amended avatar in the ongoing winter session of Parliament.
One critical proposal in the amended Companies Bill that should worry businesses is that of corporate social responsibility (CSR) being made mandatory for companies with net worth exceeding Rs 500 crore, or their turnover exceeding Rs 1,000 crore, or their net profit exceeding Rs 5 crore.
Under this proposal, both private and public companies will be treated alike. Thus, a company that crosses any one of these limits will be legally required to contribute 2 per cent of its average profits of the preceding three years towards CSR activities listed in the Companies Bill. The errant company’s board of directors will also need to provide reasons for non-compliance.
This could hit companies hard, since 2 per cent of a company’s average profits is a significant chunk of money, especially when there is no clarity on whether such spending will be eligible for tax deduction from the income of the company.
The amendment further emphasises that preference should be given to local areas where the company operates.
In effect, it could generate more benefits to Indian States with a larger number of companies. Ideally, the location of CSR activities should have been left to the company’s discretion.
Another change is the shift of the benchmark rate for inter-corporate loans from the existing prevailing ‘bank rate’ of the RBI to the prevailing ‘interest on dated government securities’.
Consequently, interest rate on inter corporate loans cannot be lower than the prevailing interest on dated government securities. This shouldn’t be a significant change.
Other amendments include punishing a person who falsely induces a person to enter into financing arrangements with a view to obtaining credit facilities; retirement by rotation not being applicable to independent directors; the auditing partner of the statutory audit firm to be rotated at the discretion of the members of the company and not necessarily on an annual basis, and; the appointment of auditors for five years to be subject to ratification by the members at each annual general meeting.
TOO MUCH CONTROL
The above amendments do not address some defective provisions in the Companies Bill. One of them is the limiting of the layer of subsidiaries to a total of two, for the purpose of making investments. This will unnecessarily restrict the investment structures that companies choose to adopt.
The concerns that companies operate with a complicated, opaque web of subsidiaries could have been addressed by enhancing disclosure standards, rather than imposing limits on the layers of subsidiaries.
Another concern is that private companies will be subject to greater control and regulations.
Presently, private companies are subjected to fewer compliance requirements than public companies.
The basis for relatively less statutory control is that these companies do not access public funds and thus public interest in them is minimal.
On this basis, the Companies Act, 1956, gives them an array of exemptions, some of which would now be taken away by the Companies Bill. This is going completely in the opposite direction — from a less controlled regime to one of greater control, which would adversely alter how private companies manage their affairs.
For example, private companies will require shareholders’ approval for preferential allotment of shares; they can issue only two classes of shares — equity and preference shares; voting rights will have to be proportionate to shareholding; they will be unable to commence business unless a prescribed declaration is filed with the Registrar of Companies (RoC); the profit and loss account will not be separately filed with RoC, meaning that their profit and loss positions will now come within the public domain, consent from directors will be required prior to appointment, loans to directors and their affiliated persons and inter-corporate loan, guarantee and investments will be subject to stringent conditions; and, interested directors will be debarred from voting.
Interestingly, a new Clause 462 has been introduced in Companies Bill giving power to the Central government to notify class or classes of companies to which certain provisions will not apply.
Possibly, the exemptions to private companies may be provided by way of separate notifications of the Central government. Whatever be the case, it would have made more sense if the private companies had continued to be less regulated.
Further, the Companies Bill does not clearly provide that acts and actions undertaken pursuant to the Companies Act, 1956 will be grandfathered i.e. the Companies Bill will not repeal them.
If that is the intention, then the language of Clause 465 dealing with this subject needs to be corrected.
Last but not the least, the benefits to ‘small companies’ should now be significantly enhanced.
Presently, these newly introduced categories of companies are exempted from preparing cash flow statements, their annual returns have to be signed by a company secretary, they can hold board meetings once in six months, and any merger will be through the Central government approval route, instead of National Company Law Tribunal route.
While the market reaction to the amendments has been largely positive, its long-term effects cannot be anticipated at this stage.
All in all, it’s a welcome step in the right direction, but still lacks complete transparency as to the intent, and the cause-and-effect relationship between the drafting and the interpretation of numerous clauses.
One hopes that the outcome is unequivocally a boost for India Inc. We hope it gets passed in this session of Parliament.
(The author is a partner with J. Sagar Associates. Views are personal.)