IMPLICATIONS OF KEY AMENDMENTS TO COMPANIES ACT, 2013 ON MANAGEMENT AND AUDITORS

Standards on Auditing (SA) 250, Consideration of Laws and Regulations in an Audit of Financial Statements, deals with the auditor’s responsibility to consider laws and regulations when performing an audit of financial statements. The provisions of some laws or regulations have a direct effect on the financial statements in that they determine the reported amounts and disclosures in an entity’s financial statements, e.g., the Companies Act, 2013 (‘2013 Act’). Other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures in the financial statements, but compliance with which may be fundamental to the operating aspects of the business, to an entity’s ability to continue its business, or to avoid material penalties (e.g., compliance with the terms of an operating license, compliance with regulatory solvency requirements, or compliance with environmental regulations), non-compliance with such laws and regulations may therefore have a material effect on the financial statements. The Code of Ethics issued by the ICAI also includes specific sections on Responding to Non-Compliance of Laws and Regulations (NOCLAR)1 for listed companies. However, the auditor is not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations.

The MCA has issued various amendments to the Companies Act, 2013, including an amendment to Schedule III of the Companies Act, 2013 to increase transparency and to provide additional disclosures in the financial statements, and CARO 2020 to enhance the reporting requirements for auditors. The MCA has also amended the provisions of Rule 11 of the Companies (Audit and Auditors) Rules, 2014 to include additional matters in the Auditor’s Report w.e.f. 1st April, 2021 (except the requirement related to audit trail which is applicable w.e.f. 1st April, 2022).

This article attempts to provide an overview of the key amendments relating to the definition of listed company, Corporate Social Responsibility and managerial remuneration and related challenges emanating from these amendments and the enhanced role of management and auditors.

I. AMENDMENT TO DEFINITION OF LISTED COMPANY
Section 2(52) of the 2013 Act provides the definition of a listed company. Listed companies under this Act are required to adhere to stricter compliance norms when it comes to filing of annual returns, maintenance of records, appointment of auditors, appointment of independent directors and woman directors, constitution of board committees, etc. This may dis-incentivise (or demotivate) private companies / unlisted public companies from seeking listing of their debt securities even though doing so might be in the interest of the company. Effective 1st April, 20212, the MCA amended section 2(52) of the 2013 Act and Companies (Specification of Definitions Details) Rules, 2014 to exclude the following class of companies from the definition of a listed company:

•  Public companies which have not listed their equity shares on a recognised stock exchange but have listed:

– Non-convertible debt securities, or
– Non-convertible redeemable preference shares, or
– Both the above categories
issued on private placement basis in terms of the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 / SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013, respectively.

• Private companies which have listed their non-convertible debt securities on private placement basis on a recognised stock exchange in terms of the SEBI (Issue and Listing of Debt Securities) Regulations, 2008.

• Public companies which have not listed their equity shares on a recognised stock exchange but whose equity shares are listed on a stock exchange in a permissible foreign jurisdiction as specified in the sub-section of section 23(3)3 of the 2013 Act.

It may be noted that SEBI has not modified the definition of a listed company. Accordingly, the implications are limited to the provisions prescribed under the 2013 Act. Some of these considerations are discussed below:

Relaxation for companies from compliances under 2013 Act
Listed companies are required to comply with additional stringent requirements under the 2013 Act, e.g., at least 1/3rd of the total number of directors to be independent directors, appointment of one woman director on the board, appointment of an internal auditor and compliance with auditor’s rotation norms. Companies which no longer qualify as listed companies pursuant to the above amendment would not be required to comply with such stringent requirements.

Besides, it is interesting to note that though the intent of the amendment is to provide relaxations for private / public companies, there might be some unintended consequences as well. One such unintended consequence is the debenture redemption norms. Section 71(4) of the 2013 Act read with Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014 prescribes the quantum of debenture redemption reserve and the investment or deposit of sum in respect of debentures maturing during the year ending on the 31st day of March of the next year, unless specifically exempted. It may be noted that in accordance with Rule 18(7)(b)(iii)(B), debenture redemption reserve is not required to be created by listed companies having privately-placed debentures. Pursuant to the amendment, these exemptions may no longer be available; creation of the debenture redemption reserve and investment of sums in respect of debentures might become applicable for listed companies having privately-placed debentures. However, this will be subject to clarification by the MCA or the ICAI.

Private / public companies listing non-convertible debt securities and / or non-convertible redeemable preference shares on a private placement basis are excluded from the definition of ‘Listed company’ as per the amended definition. One may argue that Ind AS applies to all listed companies. Since these companies are not listed companies as defined under the 2013 Act, such companies would not be required to comply with Ind AS (unless other thresholds are met). A closer look at the aforesaid Rules indicates that Ind AS applies to companies whose ‘equity or debt securities are listed’ – instead of ‘listed company’. Hence, strictly speaking, the other possible view is that private / public companies having listed non-convertible debt securities / non-convertible redeemable preference shares on a private placement basis would need to comply with Ind AS. These companies need to consider GAAP applicable to them and their auditors, while issuing an opinion on true and fair view and compliance with accounting standards u/s 133 of the Act, will need to consider this amendment.

Auditors reporting on Key Audit Matters (KAM)
Auditors are required to report Key Audit Matters in the audit report of a listed entity which has prepared a complete set of general purpose financial statements as required by SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report. KAMs are those matters that, in the auditor’s professional judgement, were of most significance in the audit of the financial statements of the current period. The Standard on Quality Control – 1 and SA 220, Quality Control for an Audit of Financial Statements, define a listed entity as an entity whose shares, stock or debt are quoted or listed on a recognised stock exchange, or are traded under the regulations of a recognised stock exchange or other equivalent body.

Different definitions of ‘Listed company’ under the 2013 Act and SA 220 may raise an applicability issue. One may argue that auditing standards are prescribed u/s 143(10) of the 2013 Act. Accordingly, the question is whether a listed company should be understood uniformly for all purposes under the 2013 Act, including while reporting on KAMs, or the definition of SA 220 be applied while auditing and reporting on the company’s financial statements. The definitions under the 2013 Act are for compliance with the legal requirements under the 2013 Act and do not apply to accounting and auditing matters. Since auditors are responsible to conduct audit in accordance with the SA, the auditor should follow the definition of a listed entity as envisaged in the SAs while reporting on KAMs. Hence, one may argue that auditors of all listed companies (even those not considered as listed companies under the 2013 Act) would continue to report on KAMs as required by SA 701. The MCA and the ICAI may consider clarifying this aspect.

Auditor’s reporting on CARO 2020
The Central Government, in exercise of the powers conferred on it under sub-section (11) of section 143 of the Companies Act, 2013 (hereinafter referred to as ‘the Act’), issued the Companies (Auditor’s Report) Order, 2020 on 25th February, 2020. Called CARO 2020 for short, it is applicable for the financial years commencing on or after 1st April, 2021 to a prescribed class of entities including listed companies, public companies and private companies meeting the prescribed thresholds.

One may take a view that CARO 2020 does not prescribe the listing of securities by any company (including a private company) as a criterion for applicability. Hence the change in definition of a listed company may not impact the applicability of CARO. The MCA and the ICAI may consider clarifying this issue. However, reporting on CARO 2020 would continue to apply to all public companies (listed or unlisted).

II. AMENDMENT TO CORPORATE SOCIAL RESPONSIBILITY (CSR) PROVISIONS
Section 135 of the 2013 Act and the Companies (Corporate Social Responsibility Policy) Rules, 2014 (‘CSR Rules’) prescribe the norms relating to CSR. The MCA has recently overhauled the norms and brought significant changes in implementation of CSR initiatives, introduced new concepts like mandatory impact assessment, and prescribed the manner of dealing with unspent CSR amounts. These amendments were notified on 22nd January, 2021. CARO 2020 has also introduced specific additional reporting requirements for the auditors related to unspent amount under sections 135(5) and 135(6) of the 2013 Act. The revised Schedule III under the 2013 Act has added specific disclosures to be made by companies in respect of CSR spend.

The requirement of audit of CSR activities has not been made mandatory under the 2013 Act. However, various provisions of the Companies (Company Social Responsibilities Policy) Rules, 2014 require the monitoring and reporting mechanism for CSR activities.

Auditor’s responsibilities
Wherever an eligible company undertakes CSR activity itself, the key responsibilities of the auditor are summarised below:
• Auditors should check compliance with section 135 of the 2013 Act and check whether the expenditure has been incurred as per the CSR policy formulated by the company;
• The auditor is also required to check whether the activity / project undertaken is within the purview of Schedule VII of the Act;
• If mere contribution / donation is given for a specified purpose, then whether it is specifically allowed as per Schedule VII of the Act;
• The auditor, while opining on the financial statements, will also be required to check whether separate
disclosure of expenditure on CSR activities has been made as per Schedule III applicable for the financial
year ending 31st March, 2021 and additional disclosures as per revised Schedule III have been made by the company for the financial year commencing on or after 1st April 2021;
• The auditor to check whether the company has recorded a provision as at the balance sheet date to the extent considered necessary in accordance with the provisions of AS 29 / Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets, in respect of the unspent amount;
• To check compliance with relevant Standards on Auditing for audit of CSR spend including:
– SA 250 – Consideration of Laws and Regulations in an Audit of Financial Statements;
– SA 720 (Revised) – The Auditor’s Responsibilities Relating to Other Information.

Eligible CSR activities in the context of Covid-19
The MCA has issued a Circular dated 30th July, 2021 clarifying that spending of CSR funds for Covid-19 vaccination for persons other than the employees and their families is an eligible CSR activity under Schedule VII of the Companies Act, 2013. Management would need to establish necessary internal controls to track that the spend is made to benefit persons other than employees and their families.

Increased focus on impact creation
The amendments require every company with an average CSR obligation of INR 10 crores or more (in the three immediately preceding F.Y.s) to undertake an impact assessment of their CSR projects having an outlay of INR 1 crore or more and has been completed not less than one year before undertaking the impact study. The assessment should be carried out through an independent agency and the impact assessment reports should be placed before the board and should be annexed to the annual report on CSR.

Enhanced monitoring mechanism
The amendments significantly enhance the monitoring mechanism and require the CSR committee to formulate and recommend an annual action plan in pursuance of its CSR policy to the board of directors. The action plan should include the prescribed matters such as the manner of execution of such projects or programmes, modalities of utilisation of funds and implementation schedules, and the monitoring and reporting mechanism for the projects or programmes.

The board of the company is required to satisfy itself that the funds disbursed have been utilised for the CSR purposes and in the manner as approved by it. It should be certified by the Chief Financial Officer or the person responsible for the financial management of the company.

The amendments have introduced a new format for the annual report on CSR activities to be included in the board’s report of a company for the F.Y. commencing on or after 1st April, 2020. Some of the new disclosures to be made by companies in the annual report include details of impact assessment of CSR projects (if applicable) along with the report and amount spent on impact assessment, details of the amount available for set-off and details of unspent CSR amount for the preceding three F.Y.s, including amount transferred to unspent CSR account and fund specified in Schedule VII of the 2013 Act. In case of creation or acquisition of a capital asset, additional disclosures are prescribed.

The auditor will also be required to read the information included in the annual report as required by SA 720, The Auditor’s Responsibilities Relating to Other Information.

Unspent CSR amount – Reporting in CARO 2020
Section 135 prescribes a mandatory spending of 2% of the average net profits made by the company during the three immediately preceding financial years on CSR activities. Earlier, section 135 followed a ‘comply or explain approach’, i.e., the board of directors was required to explain in the Board Report the reason for not spending the minimum CSR amount. Accordingly, no provision for unspent amount was required to be made before the amendment.

The MCA observed that a tenable reason does not expel or extinguish the obligation to spend the stipulated CSR amount4. With this objective in mind, section 135 and the CSR Rules were amended and the ‘comply or explain’ approach was replaced with a ‘comply or pay penalty’ approach. The amended provisions now require the following in respect of ‘unspent amounts’:

• On-going CSR projects [Section 135(6)]: In this case, the company should transfer the unspent amount to a special bank account within a period of 30 days from the end of the financial year. The company should spend such amount within a period of three F.Y.s from the date of such transfer as per its obligation towards the CSR policy. In case it fails to do so, it would be required to transfer the same to a fund specified in Schedule VII of the 2013 Act within a period of 30 days from the date of completion of the third financial year.

Other than on-going projects [Section 135(5)]: When there is no on-going project, the unspent amount should be transferred to a fund specified in Schedule VII of the 2013 Act within a period of six months from the end of the financial year.

Additional reporting requirements for CSR have been introduced in CARO 2020 which require the auditor to report on the above two aspects.

Implementation challenges
The following implementation challenges will need to be considered and evaluated by both the company and the auditor in this regard:

• The CSR amendments do not link the applicability of the amendments to any financial year. It may be noted that the applicability of this amendment is prospective and therefore provision may be required for shortfall for the F.Y. 2020-21 and onwards.

• Assessment of presentation of unspent amount in the CSR bank account in the financial statements may be critical as such amounts would not be available for any other purpose. Ind AS 7 / AS 3 on Cash Flow Statement requires companies to disclose, together with a commentary by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the entity. Thus, the amounts in the unspent CSR bank account should be disclosed as restricted cash with adequate commentary by the management in the financial statements.

• While preparing quarterly financial information, an issue may arise whether provision for CSR obligation for the entire year should be recognised in the first quarter or the provision for unspent amount should be made at the end of the year. In this regard, the ICAI has clarified that for the unspent amount a legal obligation arises to transfer to specified accounts depending upon the fact whether or not such unspent amount relates to on-going projects. Therefore, liability needs to be recognised for such unspent amount as at the end of the financial year. However, the amount spent during the interim period needs to be charged as expense for the same interim period. It cannot be deferred to the remaining interim periods of the financial year.

The amendments have also prescribed significant penalties, e.g., in case of non-compliance with provisions relating to unspent amount a penalty twice the default amount would be imposed on the company subject to a maximum of INR 1 crore. The auditor will need to evaluate the implications on the audit report in case of non-compliance with the mandatory and stringent CSR provisions.

III. MANAGERIAL REMUNERATION
Section 149(9) of the 2013 Act provides that an independent director may receive remuneration by way of profit-related commission as may be approved by the members. In case of no / inadequate profit, section 197 of the 2013 Act permitted payment of remuneration only to its executive directors or managers.

The MCA has extended the model followed for remuneration to executive directors to non-executive directors (including independent directors) by amending section 149 and section 197, and Schedule V to the 2013 Act. Schedule V now prescribes the following limits for payment of remuneration to each non-executive director (including independent directors):

While Schedule V has been amended to include the limits for non-executive directors, Explanation II which provides for computation of effective capital for a managerial person has not been amended. It provides as below:
• Where the appointment of the managerial person is made in the year in which the company has been incorporated, the effective capital shall be calculated as on the date of such appointment;

• In any other case the effective capital shall be calculated as on the last date of the financial year preceding the financial year in which the appointment of the managerial person is made.

In the absence of a specific amendment, one may take the view that similar provisions should be applied for other directors also, i.e., for a non-executive director. The MCA may issue a clarification in this regard.

The above amendment is effective from 18th March, 2021. This means that companies would need to comply with the amended provisions in F.Y. 2020-21 and onwards.

Amendment to remuneration policy
The earlier remuneration policies of the company would not have the flexibility of payment of remuneration in case of no / inadequate profits as payment of remuneration to non-executive directors (including independent directors). Since the amendments now permit payment of remuneration in case of loss / inadequate profits, the remuneration policy of the company would need to be updated so as to comply with these requirements.

Auditor’s reporting
Auditor’s reporting on director’s remuneration in its audit report (under ‘Report on Other Legal and Regulatory Requirement’) will encompass remuneration paid to non-executive directors as well. Since remuneration would be paid to non-executive directors (including independent directors) in case of no / inadequate profits, the auditors would need to verify compliance in this regard.

BOTTOMLINE
The overhaul of the CSR provisions, amendments to the definition of listed company and managerial remuneration highlights the intent of the MCA aimed towards developing a robust and coherent regulatory and policy framework and underlying ecosystem. The primary responsibility of effective implementation of these amendments lies with the management by ensuring their compliance in a timely manner. However, the reporting responsibilities and issuing a true and fair view on the financial statements of the company lies with the auditor. The auditor should keep track of these fast-changing regulations and their consequential implications on the audit report, especially in case there is any non-compliance.

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