Companies Bill 2012 has received mixed reactions, and industry bodies and professionals have sought numerous clarifications from the Government. While the Bill has attempted to increase transparency in governance by introducing specific provisions, there are multiple instances where private enterprises have not been exempted from certain provisions. This can create additional compliance burden for private enterprises.

Internal financial controls

Every auditor’s report should state the adequacy (design) and operating effectiveness of the company’s internal financial controls. Based on the definition of internal financial controls, the auditor’s role is significantly widened.

There seems to be greater focus on policies and procedures, operational controls, and propriety of financial transactions. This scope is definitely wider than that prescribed under the Sarbanes-Oxley Act (SOX) in the US. SOX, which is mostly based on the COSO (Committee of Sponsoring Organisations) framework, was backed by detailed guidance for auditors. More importantly, SOX is applicable to publicly traded companies. Smaller listed companies in the US are still struggling with the compliance cost of SOX.

Private enterprises in India will not be able to sustain the additional compliance cost or meet the intended rigours of such provisions.

Audit and financial reporting

It was expected that financial reporting requirements, including mandatory audit, would be eased for private companies. Countries such as the UK, Japan and Singapore provide relief for small or dormant companies. The Bill has introduced these two concepts in a limited way, and their application seems confusing. On the other hand, the Bill has added requirements for the preparation and audit of consolidated financial statements.

Further, companies will no longer have the flexibility to choose their financial year and should mandatorily follow April to March, with one exception requiring approval from the Tribunal.

Related-party transactions

Unlike in the existing provisions, private companies will no longer be exempt from rules relating to inter-company loans, investments and guarantees. The Bill proposes to bring more transparency to certain related-party transactions and introduces the concept of ‘arm’s length pricing’. This is not only subjective, but also highly litigious. Related parties will now be prohibited from voting on special resolutions required to approve these transactions, and the intent loses its relevance for closely-held or family-owned private enterprises.

Corporate social responsibility

There has been endless debate on the introduction of provisions related to mandatory corporate social responsibility (CSR) activities, which will require spending at least two per cent of average net profits of the three preceding years.

A substantial number of trading/ reseller businesses work on wafer-thin margins and will not be able to absorb this additional cost. The argument for promoting financial inclusion by prescribing mandatory CSR hasn’t gained acceptance. The industry has termed this another form of tax, while there is speculation from some quarters that the CSR funds will be misused. Additionally, there is no clarity on whether CSR spending is tax deductible.

Companies that meet the financial thresholds of the proposed CSR provisions will be required to constitute a CSR committee consisting of at least one independent director. Most experts believe these provisions should be read in context, citing the fact that only public companies are mandated to have independent directors.

One expects to see a substantial refinement of these provisions, probably through detailed rules and guidelines. Most public policy debates are focused on ‘more governance and less regulation’, and one hears about regulators articulating this theme in their conversations with stakeholders. Most likely, these enabling rules and guidelines will not only be copious, but also require considerable administrative machinery to ensure compliance.

If the current enforcement mechanisms in India were effective and robust, there would be no need for such onerous regulations.

The author is a chartered accountant

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