#Wake up MCA – Circular on Indian Private Subsidiaries of Companies Incorporated Outside India Stokes Confusion

Ministry of Corporate Affairs (MCA) is expected to clear confusion and not compound it much less through a clarification. The clarification issued by MCA on 25th June (here is the link : http://www.mca.gov.in/Ministry/pdf/General_Circular_23_2014.pdf) about the status of Indian Subsidiaries of Foreign Companies has been lapped up by media as a major celebratory news without examining the legal status and interpretation of the words used.

Let us understand the position of Indian subsidiaries of companies incorporated outside India under Companies Act, 1956 (‘Old Act’). A private company being a subsidiary of a company incorporated outside India was deemed as subsidiary of a public company in India under Section 4(7) of Old Act. The only exception was if 100% of the shareholding of Indian private company was held by companies incorporated outside India.

After notification of Section 2(11), 2(46), 2(68), 2(71) and 2(87) of Companies Act 2013 (‘New Act’), the provisions of Section 4 of Old Act are not in operation (well, this is another story for another time but let us presume this for a moment). This means no reference to Section 4(7) is necessary while interpreting the New Act and determining status of such companies. With fangs of Section 4(7) of Old Act gone, the Indian private subsidiaries can no longer be deemed to be a subsidiary of a public company unless the New Act again brings them to such a category.

Section 2(87) makes a company or body corporate a subsidiary of another company or body corporate (i.e. holding company), if the holding company controls more than 50% of the total share capital. A holding company can be a company (which means company registered under Indian laws) or a body corporate ( which includes a company incorporated outside India). This means if a company incorporated outside India holds more than 50% shares in Indian company, then such Indian Company becomes a subsidiary of company incorporated outside India. 

So far so good. Now the big question: Whether Indian private company, a subsidiary of company incorporated outside India, retains its status as a private company or becomes a ‘deemed subsidiary of a public company’? Provision similar to 4(7) is no longer in place. This question needs interpretation of definition of a public company.

Moving over to public company under 2(71), its proviso makes interesting reading. It needs reproduction here for proper understanding:

“Provided that a company which is a subsidiary of a company, not being a private company, shall be deemed to be public company for the purposes of this Act even where such subsidiary company continues to be a private company in its articles.”

The language is plain and clear. The  interesting part is that the proviso uses the term ‘company’ and not body corporate. It does not have an explanation similar to Section 2(87) which says – “the expression company includes body corporate”. The question thus arises is, whether the Indian private company, which became a subsidiary of a company incorporated outside India by virtue of explanation in 2(87) and inclusion of ‘company incorporated outside India’ in definition of ‘body corporate’ in Section 2(11),  will be deemed to be a public company in India under proviso to Section 2(71)?”

The proviso uses the term ‘company’. It is difficult to import explanation attached to 2(87) in interpreting the term ‘company’ used in 2(71). Indian private company became subsidiary of a company incorporated outside India due to deeming provision in Section 2(87) read with 2(11). Becoming a subsidiary has its own consequences and it does not mean that it becomes a public company under 2(71) unless there is a clear cut deeming provision in 2(71).

Section 2(71) is clear in its terms and is similar to Section 3(1)(iv)(c) of Old Act. Under the Old Act, an Indian private company became a deemed subsidiary of public company by virtue of Section 4(7) and not because of Section 3(1)(iv)(c). In New Act, a provision similar to Section 4(7) does not exist. Hence, Indian private company, albeit a subsidiary of a company incorporated outside India (whether private or not private as per laws of that country), is not deemed to be a subsidiary of a public company. This view gains strength from the fact that Section 2(71) has used the term ‘company’ and this does not include body corporate. Legislature, having used different terms in different provisions, obviously meant differently.

We attain clarity to this extent. Let us examine the need of clarification by MCA. The relevant part extracted below makes interesting reading:

“An existing company, being a subsidiary of a company incorporated outside India, registered under the Companies Act, 1956, either as private company or a public company by virtue of section 4(7) of that Act, will continue as a private company or public company as the case may be, without any change in the incorporation status of such company.”

MCA clarification stokes confusion. Let me have the liberty of pointing it out:

1. Where was the need to refer to Section 4(7) though it is no longer in operation?

2. If MCA had to clarify the questions asked on 4(7), a simple clarification that since 4(7) is no longer there, the Indian private companies hitherto deemed as subsidiaries of public companies will retain their original status as private companies.

3. The use of words “registered under …..by virtue of Section 4(7)….” were unnecessary. No company was ever ‘registered’ …. ‘by virtue of Section 4(7)’  under the Old Act. Section 4(7) was a deeming provision and not a provision dealing with registration of companies.

4. The reading of the clarification leads to conclusion that the status of the company continues. What does this mean? This leads us to believe that if a company, though incorporated as private company, but was deemed as a public company ‘by virtue of Section 4(7)’  will continue to be deemed as a public company irrespective of incorporation status.

Unfortunately, Indian pink press and media is interpreting differently.  They are spreading the message that companies incorporated outside India can happily treat their India private arms as private companies. The clarification says otherwise.

Wake up MCA!

Clarifications must be issued after proper legal scrutiny. The impromptu clarifications with poor language cause more inconvenience to the stakeholders. I am sure MCA still has bench strength of persons having deep knowledge of Company Law.

© Ashish Makhija: ashish@ashishmakhija.com

Disclaimer: The views expressed here are views based on my personal interpretation and should not be deemed as legal or professional advise on the subject. If relied upon, the author does not take any responsibility for any liability or non-compliance.

 

 

 

 

 

# Alignment of Financial Year to 31st March ending by Companies

The era of having different financial years by the companies is over. This means 2 things – one, the financial year ending will be uniform and the financial year will be of 12 months except in few cases.The companies are supposed to align their financial years to end on 31st March within 2 years from 1.4.2014. This transition period allows companies to retain different financial year for 2014-15 and 2015-16.  From 2016-17, the companies will have no option but to end their financial year on 31st March 2017.

The companies incorporated under Companies Act, 2013 do not get any transition period. If the date of incorporation is on or after 1st January of the year then the financial year will end on 31st March of the following year. A company incorporated before 1st January will have financial year ending on following 31st March.

Is there an option to follow different financial year than 31st March?

It is possible to have different financial year ending for companies which are  the holding or subsidiary of company incorporated outside India subject to approval of National Company Law Tribunal. The period can also be different than a year i.e. 12 month period.

Companies have to gear up to new era of Corporate Management & Governance. More to follow.

© Ashish Makhija: ashish@ashishmakhija.com

 

#Way Out – Deposits from Members

Deposit Rules 2014 bar deposit or loan from a member, which was hitherto permitted under the Companies Act, 1956. Leaving aside contentious issues of Section 74 for repayment of deposits, the question that bothers the companies is as to how to accept loan from members. If they are not directors, it will be treated as a deposit.

Going around, here is the typology:

  • Member creates a Fixed Deposit in a Bank
  • Bank grants loan to the Company on the pledge of the Fixed Deposit

Company gets loan from Bank, which is outside the definition of Deposits being exempted specifically. The grant of security by the member to the Bank for loan taken by the Company cannot be treated as deposit by any stretch of imagination.

The only time this can become deposit is when the company fails to repay it as per the term and the bank encashes the Fixed Deposit. In this situation, the member will step into the shoes of the Bank and will become lender to the Company. At this stage, he may become a depositor. This situation can be clearly avoided.

You may wish to read the detailed opinion. Here it is:

  1. I.    QUERY

1.1.Whether the security given by a member (who is not a director) of a Company to a Bank, for securing the loan given by the Bank to the Company, will be considered as ‘deposit’ to the Company by the member in terms of the provisions of the Companies Act, 2013?

II. REPLY TO THE QUERY

2.1.          In order to reply to the aforesaid query, it is imperative to understand the relevant provisions in relation to the term ‘deposit’, under the Companies Act, 2013 (“New Act”) and the Companies Act, 1956 (“Old Act”).

2.2.The Explanation to the Section 58A of the Old Act is reproduced as follows:

Section 58A:

Explanation. – For the purposes of this section, “deposit” means any deposit of money with, and includes any amount borrowed by, a company but shall not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India.”

2.3.         Further, it is to be noted that the ‘categories of amount’ excluded from the definition of deposit as mentioned in the Explanation to the Section 58A of the Old Act, were prescribed in the Companies (Acceptance of Deposits) Rules, 1975. Relevant provisions of the Companies (Acceptance of Deposits) Rules, 1975 are reproduced as under:

“Section 2: Definitions.

….

(b) “deposit” means any deposit of money with, and includes any amount borrowed by, a company, but does not include

 (ii) any amount received as a loan from any banking company or from the State Bank of India or any of its subsidiary banks or from a banking institution notified by the Central Government under section 51 of the Banking Regulation Act, 1949 (10 of 1949), or a corresponding new bank as defined in clause (d) of section 2 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or from a co-operative bank as defined in clause (b-ii) of section 2 of the Reserve Bank of India Act, 1934 (2 of 1934) ;

 …

 (ix) any amount received by a private company from a person who, at the time of the receipt of the amount, was a director, relative of director or member:

Provided that the director or member, as the case may be, from whom money is received, furnishes to the company at the time of giving the money, a declaration in writing to the effect that the amount is not being given out of funds acquired by him by borrowing or accepting from others; 

Explanation.-For the removal of doubts, it is hereby declared that any deposit received or renewed by a company before the commencement of the Companies (Acceptance of Deposits) Amendment Rules, 1978, shall continue to be governed by the rules applicable at the time of such deposit or renewal as the case may be.

…”

(emphasis supplied)

2.4.         Therefore, it is apparent from the conjoint reading of the Explanation to the Section 58A of the Old Act and the relevant provisions of the Companies (Acceptance of Deposits) Rules, 1975 as reproduced above, that any amount received by a private company from its members shall not be considered as deposits and hence, the company was not required to make the compliances required thereto under the Old Act.

2.5.            However, under the New Act, the term ‘deposit’ is defined under Section 2 (31) as    under:

“deposit” includes any receipt of money by way of deposit or loan or in any other form by a company, but does not include such categories of amount as may be prescribed in consultation with the Reserve Bank of India;

2.6.         Further, it is to be noted that the ‘categories of amount’ excluded from the definition of deposit as mentioned in Section 2 (31) of the New Act, were prescribed in the Companies (Acceptance of Deposits) Rules, 2014. Relevant provisions of the Companies (Acceptance of Deposits) Rules, 2014 are reproduced as under:

“Section 2: Definitions.

….

(c) “deposit”includes any receipt of money by way of deposit or loan or in any other form, by a company, but does not include

 (iii) any amount received as a loan or facility from any banking company or from the State Bank of India or any of its subsidiary banks or from a banking institution notified by the Central Government under section 51 of the Banking Regulation Act, 1949 (10 of 1949), or a corresponding new bank as defined in clause (d) of section 2 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970), or in clause (b) of section 2 of Banking Companies  (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980) or from a co-operative bank as defined in clause (b-ii) of section 2 of the Reserve Bank of India Act, 1934 (2 of 1934) ;

 …

 (viii) any amount received from a person who, at the time of the receipt of the amount, was a director of the Company:

Provided that the director from whom money is received, furnishes to the company at the time of giving the money, a declaration in writing to the effect that the amount is not being given out of funds acquired by him by borrowing or accepting loans or deposits from others; 

…”

(emphasis supplied)

2.7.         It is thus, apparent from the combined reading of the provisions of both the Acts as reproduced hereinabove that now, under the New Act, any amount received by the Company from its member is no longer  not under the exempted category and shall be treated as deposit within the meaning of the term ‘deposit’ under the New Act.

2.8.         In the facts and circumstances of the case, the Company has received a loan from a Bank and has not received any amount from its member. It is only that the member has given a security to the Bank in order to secure the amount so lent to the Company by the Bank.

2.9.         It is imperative to deal with the essential limbs of the definition of deposits under the Companies (Acceptance of Deposits) Rules, 2014 which defines the term deposits as deposit”includes any receipt of money by way of deposit or loan or in any other form, by a company, but does not include …………..”.Plain reading of the said phrase indicates that the definition of deposits under the Rules has three limbs and includes any receipt of money by way of:

a)    Deposit

b)    Loan

c)    In any other form

Now, the Security provided by the member in the present case cannot be construed as giving of  deposit or loan to the Company. However, it is important to interpret the  phrase “in any other form”appearing in the definition.

2.10.      The phrase ‘in any other form’ has been used to express the ‘form of receipt of money’. The law maker has inserted the said phrase to capture any other form of receipt viz. security deposit, advances etc. Thus the phrase has been inserted to include all forms of receipt of money regardless of the term used for its depiction in the financial statements. The fundamental requirement of receipt of money should be present in the transaction, for it to be termed as deposit. In any case, providing security is neither a deposit nor a loan.  Thus, giving of security by a member towards the loan availed by the Company can in no manner be construed as receipt of money and consequently as a deposit.

2.11.      In the conspectus of the aforesaid discussion, the Security provided by the member towards the loan taken by the Company from the Bank doesn’t fall within the definition of ‘deposit’ under the New Act. Further, the security so given by the member of the Company to the Bank would not cause the said loan to be considered as the amount given by the member to the Company, indirectly, in the nature of a ‘deposit’ as the definition does not cover the cases of indirect loans. It is pertinent to add that the situation will be different if the Bank realises money from the security of the member upon failure of the company to pay back the loan. In such a case, the member will step into the shoes of the Bank and then it may be possible to deem that the member has given a deposit/loan to the company. In other words, in the eventuality of realisation of security that the member may become as a lender to the company brining such a transaction under the ambit of deposit.

© Ashish Makhija: ashish@ashishmakhija.com

Disclaimer : This opinion is based on relevant facts for the opinion and is based on my personal interpretation of the provisions of the Companies Act, 2013. I undertake no responsibility for any non-compliance if reliance is placed on the aforesaid opinion.

Prohibited Non-audit services by an Auditor under CA 2013 – Can the auditor prepare and file tax returns of the same company?

Traditionally companies have engaged auditors to provide a range of non-audit services. This is because an auditor, due to his continuous engagement with the company, is in a better position to provide these services. Currently, whether non-audit services can be rendered to an audit client is determined by the Code of Ethics and the Guidance Note on Independence of Auditors issued by ICAI. Unlike 1956 Act, the 2013 Act contains specific provisions that prohibit auditors of a company to render non-audit services to an audit client (or its holding company or its subsidiary company).

Prohibited non-audit service includes:

  • accounting and book keeping services;
  • internal audit;
  • design and implementation of any financial information system;
  • actuarial services;
  • investment advisory services;
  • investment banking services;
  • rendering of outsourced financial services;
  • management services; and
  • any other kind of services as may be prescribed

The list of the prohibited services is quite wide and not happily worded. A major difficulty has arisen in the interpretation of following clauses:

a)     Rendering of outsourced financial services

b)     Management Services

a)     “Rendering of Financial Services” is no where defined in the Act or the Rules made thereunder. Any of the Services and products provided to consumers and businesses by financial institutions such as banksinsurance companiesbrokerage firmsconsumer finance companies, and investment companies all of which comprise the financial services industry shall be construed as financial services. Though nowhere defined in the Act the term financial services can in no manner be construed in a wider manner and has to be considered in a very stricter sense, as otherwise it would imbibe in its purview every services rendered by a Chartered Accountant.

(b)   “Management Services” –The word management means activities which influence policy or decisions of managerial nature affecting the company as a whole or substantially as a whole. [Commissioner for Corporate Affairs (Vic) v Bracht (1988) 14 ACLR 728 (Aust)]. Broadly the services in relation to  facility, equipment, staffing, contract negotiation, administration, and marketing shall be deemed to be included under the purview of management services. Thus services related with the day to day managerial activities of the Company shall be included under the definition of management services.

But in any case the approval of Board or Audit Committee will be required for engaging statutory auditor for any permitted services. The Section 144 amply clarifies this fact and it will be mandatory for the Company to get the services approved by the Board or its Audit Committee before engaging the statutory auditors for providing any services.

Status of Services Allowed to be rendered by an Auditor under Companies Act, 2013

S.No Services along with Statutory Audit Whether allowed or not Basis
1. Tax Audit , MAT, VAT , Service Tax Allowed Since not included in any of the aforesaid prohibited services hence permitted.Further the code of ethics specifically allows the performance of tax audit alongwith statutory audit as it does not hinders with the independence of the auditor
2. Certification in respect of  say- TUNOVER Certificate, Shareholding, Business running, net worth , 43 B Payment under Income Tax, Debtors agencing to Bank , Assets liability statement  etc  ( or in other words what are not permitted under service tax Allowed Issue of certificate does not fall under any of the prohibited services. 
3. Filling of various returns  (Only filling not preparation) Allowed Since not included in any of the aforesaid prohibited services hence permitted and in no manner be treated as a hindrance to the independence of the statutory auditor.
4. Representation before various Statutory  / Tax authorities in response to notice or for procedural work Allowed As not covered in any of the aforesaid prohibited services and in no manner enters within the bracket of independence of auditor.
5. Filling of correction, revision etc before tax & statutory authority Allowed As not covered in any of the aforesaid prohibited services and in no manner enters within the bracket of independence of auditor
6. Valuation of shares Allowed Valuation of shares does not falls under the list of prohibited services. However the provisions of the Code of ethics have to be followed before undertaking any assignment of valuation of shares if also engaged as a statutory auditor.