Companies Act draft rules bring clarity on auditor rotation, CSR spending

All public companies whose paid-up share capital exceeds Rs 100 crore or which have in aggregate outstanding loans or deposits exceeding Rs 200 crore may soon be required to have one-third independent directors on their boards. Also, auditors may need to directly report to the government, within 30 days, if they are satisfied that material fraud is happening in the company. Further, India Inc will also have to put the income from on going CSR activities into its corporate social responsibility (CSR) fund in addition to the 2% of net profits of the preceeding three years.

These are among the important clarifications that have been brought by the ministry of corporate affairs (MCA) by the way of rules to the new Companies Act, 2013. The new companies law, which was recently passed by Parliament and also got the President's assent, will replace the current Companies Act, 1956 once the rules are finalised and notified. The MCA has asked stakeholders, including the public, to respond to the first set of draft rules, covering 16 out of total 29 chapters of the Companies Act 2013, covering over 240 clauses, by October 8.

Auditor Rotation:

As per the draft rules, auditors will directly inform about a fraud or potential fraud in the company where the amount involved or likely to be involved is not less than 5% of the net profit or 2% of turnover of the company for the preceding financial year.

"Auditors will get 30 days to bring any fraud/potential fraud to the notice of the government but only with regards to material fraud. This is a relief," said Dolphy D'souza, National Leader & Partner in a member firm of Ernst & Young Global . This is because, the relevant clause in the Companies Bill 2012 had put the entire onus of reporting any fraud on the auditors.

On the issue of mandatory rotation of auditors, the draft rule makes it clear that the 5-year period (for individual auditor) and 10-year period (for audit firm) will be calculated retrospectively – that is from a specified date before the commencement of the new Companies Act, 2013.

The rules also make it clear that as part of the rotation of auditors, the companies cannot appoint a auditor from a network firm. Reacting to this draft rule, N Venkatram managing partner (audit), Deloitte Haskins & Sells said: "So far the auditors have been appointed for one-year term. The retrospectivity will need to be examined legally."

On the issue of appointment of auditors, , D'souza said the audit committee will recommend the auditor to the Board. "If the Board is not satisfied with such recommendation and wants to proceed with its own nominee, it shall have to explain the reasons for not accepting the recommendation of the audit committee in the Board's Report," he said. As per the draft rules, the audit committee or the Board shall also consider the completed and pending proceedings against the auditor before the Institute of Chartered Accountant of India or the National Financial Reporting Authority or Tribunal or any Court of Law.

Internal Auditor:

 According to Satyavati Berera, executive director and leader risk advisory services, PwC India, some ambiguity still persists on the draft rules pertaining to the eligibility and appointment of the internal auditor. As per the new law, the internal auditor can be a chartered accountant, cost accountant or other board nominated professionals. "While the definition of chartered accountant given in the Act recognizes only a CA having a certificate of practice, ICAI restricts whole time employees from holding a certificate of practice. Also given the new regime of severe penal consequences, the jury is still out on whether board would be comfortable with an 'in house person' performing the role of an internal auditor.

CSR & One Person Company:

As per the draft rules, the allocation of funds for CSR will include not only 2% of the average net profits of the eligible companies but any income arising there from ongoing CSR activities. Also, any surplus arising out of CSR activities will also need to be part of the CSR fund, it said. Also, the rules make it clear that the 2% CSR spending amount to be computed with reference to average net profits (before tax) for the preceding three years. The rules also clarify that profits arising from branches outside India are to be excluded. According to Rajiv Chugh, tax partner, EY, "The computation of CSR amount is similar to the manner in which managerial remuneration is to be computed but using the block concept of profits of preceding three years. However, in my view, the manner of computation needs to be simplified to ensure there is no controversy for already beleaguered corporate India." The draft rules on CSR also allow companies to fund other trusts, societies, NGOs and pool resources with other companies to undertake the CSR activities, subject to riders. All such funding of trusts and NGOs will need the mandatory approval of the CSR Board to be constituted by every company that is qualified for CSR activities.

On One Person Company (OPC), the draft rules said OPC will have to convert itself into a public company or a private company when the paid up share capital exceeds Rs 50 lakh or when its average annual turnover exceeds Rs 2 crore.

Independent directors & NCLT:

 According to the draft rules, all public companies whose paid-up share capital exceeds R100 crore or which have in aggregate outstanding loans or borrowings or debenture or deposits exceeding Rs 200 crore will be required to have one-third independent directors on their board. Similarly, every listed company will have to appoint at least one woman director on its Board within one year of commencement of the rules. And those companies whose paid-up share capital exceeds Rs 100 crore will need to appoint at least one women director within three years from the commencement of the rules. The draft rules also proposes to allow the National Company Law Tribunal (NCLT) to review and rectify any mistake in its decision/order within two years provided such an order is not under any appeal.

The MCA said the second tranche of these rules would be released next week. The first tranche covers rules governing new norms for the board of directors, auditors, registration and incorporation of companies, revival of sick companies, financial accounts of corporates, foreign incorporated companies and National Company Law Tribunal and Appellate Tribunal, among others.

Besides, draft rules have been issued for chapters on declaration and payment of dividends, prevention of oppression and mismanagement