Comments
Companies Bill, 2012 is a long-awaited overhaul of the existing Companies Act, 1956, focusing on ways of enhancing accountability, corporate governance and alignment with global trends in financial reporting. The Bill proposes a new framework for regulating related-party transactions for improved governance.
support and investments
Inter-corporate loans and investments are common in several companies. Typically, real estate, infrastructure and retail companies have complex group structures, with holding companies financing subsidiaries through investments, long-term loans and guarantees. The Bill could have a far-reaching impact on the ability of companies to finance group entities.
Currently, the Act prescribes compliance for loans to, guarantees on behalf of, or investments in any body corporate exceeding the higher of 60 per cent paid-up capital, free reserves and securities premium, or 100 per cent free reserves and securities premium. However, the Act excludes loans/ guarantees/ investments made by a holding company to its wholly-owned subsidiary. While the Bill retains the threshold, it significantly increases the scope by covering transactions with ‘any person’ as opposed to the Act’s requirement of ‘any body corporate’. Further, there is no exemption for such arrangements between a holding company and wholly-owned subsidiary. Lastly, the Bill proposes to peg the minimum interest rate for such loans to Government securities with a similar tenor; the Act pegs it to the bank rate published by the Reserve Bank of India.
Under the Act, loans or financial guarantees can be provided to directors or any other person in whom the director is interested with the approval of the Central Government. Further, such approval is not required for arrangements with subsidiaries. The Bill prohibits such arrangements with directors or parties where the director is interested. This is particularly onerous as the restriction extends to arrangements with subsidiaries.
The changes could have significant adverse implications for group structures designed for operational convenience and tax benefits in which interest-free funding by a holding company to its subsidiary is a critical feature. It may create difficulties for subsidiary companies that cannot seek independent funding without support from the holding company.
Other transactions
The Act requires board resolutions and, in some instances, Government approval for sale, purchase or supply of goods and services, and underwriting of shares and debentures with certain related parties. However, it does not cover transactions between two public companies, and those involving immovable properties. The Bill proposes to expand the scope of ‘related parties’ by including others such as the chief financial officer and independent directors. It also proposes to cover additional transactions such as leases, transfer of immovable properties, appointment of related parties in subsidiary and associate companies, and appointment of agents.
The Bill requires including in the Director’s report every contract/ arrangement entered into with a related party, together with a justification for it. This could mean the onus is on the Board of Directors to ensure such transactions are at arm’s length. The practical implications include need for more documentation and active participation from independent directors. In addition, companies with a paid capital or transaction value exceeding prescribed limits, transactions with related parties in the ordinary course of business that are not at ‘arm’s length’ will require shareholder approval at the general meeting. These measures would give shareholders a better idea of the company’s related-party transactions and governance.
The Bill may require companies to reassess their funding structures and the basis of related-party transactions. Similarly, independent directors may need to get more involved in assessing whether such transactions are at ‘arm’s length’.
(The author is Global and India Head of Accounting, Indian advisory services, KPMG in India.)
Comments
COMMENT NOW
Comments
Comments have to be in English, and in full sentences. They cannot be abusive or personal. Please abide by our community guidelines for posting your comments.
We have migrated to a new commenting platform. If you are already a registered user of TheHindu Businessline and logged in, you may continue to engage with our articles. If you do not have an account please register and login to post comments. Users can access their older comments by logging into their accounts on Vuukle.