BACKGROUND May be to strengthen the road of independence of an auditor on which the very premise of any audit is built, the Companies Act, 2013 (“the 2013 Act”) has brought a prominent change in the appointment of auditors by introducing the concept of rotation of auditors. Many a times, an introduction of new provisions is subject matter of divergent views; the applicability of transitional provisions for the rotation of auditors faces the same fate. Presently, the companies are battling the question of how to interpret the transitional provision in relation to rotation of auditors as to whether the auditors, who have already been the auditors of the company for more than one or two terms of five years, as the case may be, are required to be changed in the annual general meeting (“AGM”) to be held on or before September 30, 2016 (for the companies having April to March as its financial year) or they can be continued for one more year, that is, upto AGM to be held on or before September 30, 2017 ? The issue has garnered a lot of attention and has been subject to varied and contrary views. Genesis of this article is to highlight the issue and provide an appropriate answer thereto.
PROVISIONS OF APPOINTMENT OF AUDITORS UNDER THE 2013 ACT Section 139 of the 2013 Act deals with appointment of auditors. Section 139(1), inter alia, requires a Company to appoint auditor at the first AGM to hold office from the conclusion of that AGM till the conclusion of its sixth AGM and thereafter, till the conclusion of every sixth AGM. Section 139(2) provides for mandatory rotation of the auditors in case of all listed and other prescribed class of companies. Under the concept of rotation of auditors, the appointment of one term of five consecutive years for an individual as auditor or two terms of five consecutive years each for a firm as auditor is provided. The third proviso to section 139(2) provides for a transition period, that is, the companies existing on/before the commencement of the 2013 Act (from April 1, 2014), which are required to comply with such rotation are required to do so ‘within three years from the date of commencement of this Act’.
ISSUE TO INTERPRET
In the light of the third proviso to section 139(2), the issue that arises is – Whether the transition period for rotation is to be counted from the date of commencement of the 2013 Act, i.e. April 1, 2014, or from the date of conclusion of AGM held after the commencement of the 2013 Act ?
POSITION UNDER THE COMPANIES ACT, 1956
It is worthwhile to note that the appointment of the auditors has always been made from AGM to AGM, i.e. under the Companies Act, 1956 (for a year at a time) and continues to be so under the 2013 Act (though now for the maximum period of block of five years at a time). Thus, though auditors carry out audit for financial year(s), their appointment ranges from AGM to AGM and not for any particular year or financial year as such. This proposition, was also enunciated in the clarification issued by the Department of Company Affairs in the context of appointment of auditors under the Companies Act, 1956. In fact, in any event, if audit of more than one financial year is to be completed between two AGMs, the appointment would not be qua a specific financial year but the auditor so appointed at the AGM would carry out the audit of all financial years which were then pending for completion till the next AGM. Of course, it is a different matter that now under the 2013 Act, the provision for appointment is for a block of five years.
INTERPRETATION BY COMPANIES (AUDIT AND AUDITORS) RULES , 2014
Section 139(4) of the 2013 Act is very pertinent to the issue under discussion and which provides-
“The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors in pursuance of s/s. (2).”
Rules prescribed in this regard by the Central Government are contained in the Companies (Audit and Auditors) Rules, 2014 and Rule 6 thereof is the most relevant to the issue. Rule 6, inter alia, contains illustrations explaining the rotation in case of individual auditor as well as in the case of an audit firm. The relevant portion of such Rule, being the illustration explaining rotation in case of audit firm, is reproduced herein:
Thus, whether one goes by Rule 6 or by the third proviso to section 139(2) to consider the transitional period ?
RULE 6 AND LEGISLATIVE INTENT
It must be appreciated that the provisions of law would have to be read and interpreted with underlying intent of the law makers. Such intent would have to be gathered from a combined reading of the provisions of the 2013 Act and the relevant Rules framed. It would be appreciated that, for such significant change in the provisions of law compared to prevailing position, law makers have thought it fit to provide for and grant enough transition time to the companies so as to smoothly adopt the new regime. In fact, the intention of the Legislature has been to provide reasonable time to companies so as to not only comply with the new requirement but also to do away with impediments or hardships which may result due to rotation of auditors. Such intention is evident from the discussion at the parliamentary committee (i.e. Yashwant Sinha Committee) before the enactment of the 2013 Act on the matter of section 139(2). Extract of minutes read as:
“…ii) Since a period of three years has been provided for companies as transitional period to align the tenure of auditors in accordance with the provisions of new Bill, which appears to be reasonable, no further change is necessary in the provisions…”
The words “….within three years from the date of commencement of this Act” should be read and interpreted in the manner which meets the underlying intent which is clearly spelt out in the Rules. In Rule 6, the illustration explaining the rotation mentions in the column heading, “Number of years for which an audit firm has been functioning as auditor in the same company [in the first AGM held after the commencement of provisions of section 139(2)]”. Thus, both law makers and law administrators obviously were aware of the fact that the term of an auditor is not with reference to ‘financial year’. This is also evidenced from the fact that the term used in the third proviso to section 139(2) is ‘year’ and not ‘financial year’.
If the term”….within three years from the date of commencement of this Act” is to be read verbatim, it would mean that the transition period would effectively be reduced to only two years instead of three years stated in the Act. While it is true that the literal rule of interpretation is the paramount rule of interpretation, there is no doubt that such literal interpretation should be in line with the intention of the legislature. A construction which will fructify the legislative intent is to be preferred. In fact, a beneficial provision is to be interpreted so liberally as to give it a wider meaning instead of giving it restrictive meaning which would negate the very object.
Now, note the observation and recommendation in the report of the Companies Law Committee (“the Committee Report”), set up on June 4, 2015, to make recommendations to the Government on issues arising from the implementation of the 2013 Act. Relevant Para 10.5 of the Committee Report reads as under:
“…The Committee noted that the three years’ transitional period provided to companies was reasonable and required no modification. Further, the intention of the legislation had been accurately translated in the Rules, and for this purpose, a transitional time period of three years had already been given. Hence, the Committee felt that there was no need for any change. However, the Committee, felt that Rule 6 ought to provide clarity that the three years’ transition period would be counted from AGM to AGM, and not from the commencement of the Act.”
[Underlined for emphasis]
The above recommendation of the Committee further leads to affirm that the intention of the legislature is that the transition period is to be computed not from the commencement of the Act but from AGM held after the commencement of the 2013 Act, as provided under Rule 6.
RULE TO PREVAIL
A question that may now be raised – would a rule override the provisions of the Act ? But it may also be appreciated that Rules made under an Act must be treated as if they are in the Act and have the same force as the sections in the Act. Rules can be resorted to for the purpose of construing the provisions of the statute where the provisions are ambiguous or doubtful and a particular construction has been put upon the statute by the rules.
In this connection, one must attend to the decision of the Hon’ble High Court of Delhi in the case of All India Lakshmi Commercial Bank Officers’ Union and Another vs. Union of India and Others [1985] 150 ITR 1, the relevant portion of which is reproduced herein:
“…Rule have to be so interpreted that they are intra vires. Recourse also cannot be had to the rules made under the authority of the Act for the purpose of construing the provisions of the statute except where the construction of the statute may be ambiguous or doubtful and a particular construction has been put upon the statute by the rules…”
In the present situation, the literal interpretation of the law, having regard to the intention of the legislature, no doubt that there exists some ambiguity in the provisions of the Act in relation to the computation of transitional period for rotation of auditors. Therefore, due consideration should be given to the interpretation laid down by the Rules, that is, Rule 6.
Further, the Hon’ble High Court of Delhi in the case of Bansal Export (P) Ltd. and Another vs. Union of India and Others 145 ITR 642 has held as under:
“…Delegated legislation should not be regarded as some form of inferior legislation – it carried out the maker’s command as effectively as does an Act or Parliament…” Also, the Hon’ble High Court of Allahabad in the case of Kanodia Cold Storage vs. Commissioner of Incometax [1995] 215 ITR 369 has observed as under:
“The Rules framed under the Act have statutory force of law, therefore…”
INSTANCES UNDER THE 2013 ACT WHERE RULES PROVIDED FOR SUBSTANTIVE LAW
Furthermore, there have been instances under the 2013 Act itself where the related rules have provided for something that was neither provided nor empowered by the Act. In fact, in few such cases, the Act was subsequently amended in order to incorporate such provisions so as to remove any kind of difficulty in interpretation or implementation thereof. Some such examples are –
Section 185 of Act prohibits a company from advancing any loan or giving any guarantee to its director or to any other person in whom the said director is interested. Transactions in the nature of loans and guarantees between a holding company and its wholly owned subsidiary (“WOS”) were exempted from the applicability of Section 185. This exemption was already provided for in the Companies (Meetings of Board and its Powers) Rules, 2014 as it has later been incorporated in the Act vide the Companies (Amendment) Act, 2015.
Further, the requirement of shareholders’ approval for a related party transaction between a holding company and WOS was dispensed with vide the Companies (Amendment) Act, 2015. This exception was earlier present under the Companies (Meetings of Board and its Powers) Rules, 2014 and now has been incorporated in the substantive law itself.
The Companies (Declaration and Payment of Dividend) Rules, 2014 were amended by the Companies (Declaration and Payment of Dividend) Amendment Rules, 2014 whereby companies were prohibited from declaring dividend unless the previous year or years’ losses and unabsorbed depreciation which had not been provided for by the company were set off against current year’s profits. This provision was incorporated in the substantive law by amendment to section 123 of the Act.
With regard to preparation of consolidated financial statements (“CFS”), Section 129(3) provided that a subsidiary includes a joint venture and associate. Through the Companies (Accounts) Rules, 2014, it was provided that the preparation of CFS shall not be required by a company which does not have a subsidiary or subsidiaries but has one or more associate companies or joint ventures or both for the financial year 2014-15.
In all these cases, since the related rules provided for unambiguous beneficial provisions, no noise was created about them. Our fraternity as well as the industry had accepted without any doubt the law created by the rules, even though it was not specifically provided under the Act. Ideally, the case of rotation of auditors would have followed suit. However, unfortunately, these provisions have been made subject to controversy.
CONCLUSION
One may argue that this provision contained in the rules should be incorporated in the substantive law by way of amendment in the Act or a suitable clarification. But, even in the absence of such an amendment or clarification, in view of the foregoing discussion, it leaves no doubt that for the auditors who are holding the office for 5 years or more or 10 years or more, as the case may be, before the commencement of the 2013 Act, the transition period of three years would be computed from AGM held after the commencement of the Act, that is, it would have commenced at the time when AGM was held on or after April 1, 2014 and would be operative till the time AGM is held somewhere in and around June – September 2017 to approve the financial statements for the financial year 2016-17.
It may also be appreciated that the rotation of auditors, being a transitional provision, would at the most, have effect only for another year, an amendment by way of an amendment Bill may never see the light of day. At best, a clarificatory notification may come through or the Central Government may exercise its power u/s. 470 of the 2013 Act and pass an order for removing the difficulty.
“The secret of change is to focus all of your energy, not on fighting the old, but on building the new.” – Socrates. The recent past has been a period of challenges with prosperity for the profession and the prosperity would sustain only if these changes and challenges are accepted in its right spirit. The mandatory provisions on rotation of auditors is a response to the aftermath of many crises that have been witnessed in the past and are here to stay. Thus, we accept the rotation as an effective tool for the independence in the auditing process so as to enhance the credibility of the financial statements.
