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Accordingly, COS would not just mean physical completion of work, but would also include completion of some other auxiliary activities and basic formalities like quality testing, etc. which are pre-requisites to arrive at the invoiceable figure.
By this Notification, three more banks, namely, Oriental Bank of Commerce, Vijaya Bank and Andhra Bank have been added to collect MVAT & CST w.e.f. 22-7-2011.
For the year 2011-12, due date for payment of Profession Tax has been extended from 30th June, 2011 to 31st August, 2011 for the tax payable by an enrolled person who has already enrolled on or before 31st May, 2011.
By this Circular it is clarified that Profession Tax is not applicable to Mathadi Mandal, Mathadi Kamdar and Hamal.
Import of services whether liability of recipient prior to 18-4-2006 existed? Charging section i.e., section 66A of the Finance Act, 1994 introduced w.e.f. 18-4-2006, demand prior to 18-4-2006, relying on Rule 2(1)(d)(iv) of the Service Tax Rules, wholly impermissible.
Facts:
The assessee received management consultant’s service from the service provider stationed outside India. The Department relied on Rule 2(1)(d)(iv) of the Service Tax Rules, 1994 to recover service tax from the assessee on the premise that the service was provided by a person from a country other than India but the service was received by the assessee in India. The Tribunal relying on the decisions in the case of Indian National Shipowners Association v. Union of India, 2009 (13) STR 235 held that the assessee was not liable to pay any service tax for the period prior to 18-4-2006, the date with effect from which section 66A was introduced in the Finance Act, 1994. The Revenue contended that the facts in the aforementioned case were different and that in the present case the management consultant service was received in India. The respondent contended that in absence of any charging section prior to 18-4-2006, reliance could not be placed on Rule 2(1)(d)(iv) of the Service Tax Rules, 1994 to levy service tax from the recipient.
Held:
Following the judgments in the case of Laghu Udyog Bharti v. Union of India, 2006 (2) STR 276 SC and Indian National Shipowners Association v. Union of India, 2009 (13) STR 235, the Court held that any demand of service tax in absence of the charging section prior to 18-4-2006 by merely rely-ing on Rule 2(1)(d)(iv) was wholly impermissible.
In
pre-operative period, the assessee had incurred expenditure of
Rs.16,93,153, which was debited under 8 heads, all of which were revenue
in nature. The assessee was not able to link any expenditure with a
particular item of fixed asset. However, since during the pre-operative
period the assessee was engaged only in putting up fixed assets on
rented land, it had capitalised this sum of Rs.16,93,153 to various
items of fixed assets in the ratio of cost of the asset to total cost.
The Assessing Officer (AO) disallowed Rs.2,70,744 being the amount of
depreciation on this sum of Rs.16,93,153 on the ground that the
expenditure incurred is revenue in nature and there is no link between
item of asset and the expenditure incurred. Aggrieved the assessee
preferred an appeal to the Tribunal.
Held:
In
view of the ratio of the decision of the Delhi High Court in CIT v. Food
Specialities Ltd., 136 ITR 203 (Del.) and also the ratio of the
decision of the Madras High Court in CIT v. Lucas-TVS Ltd., 110 ITR 346
(Mad.), the expenditure was required to be capitalised. Also the
proportionate method of allocating the expenditure to various items of
fixed assets is fair and reasonable. Accordingly, the assessee is
entitled to claim depreciation on the sum of Rs.16,93,153 being
pre-operative expenses capitalised to various items of fixed assets. The
Tribunal decided the appeal in favour of the assessee.
In the past, we have witnessed succession issues even amongst kings. For example, we have seen diametrically opposite succession issues in our epics Ramayana and Mahabharata.
Majority of the private sector listed companies in India are family-owned and family-run companies.
According to an empirical study conducted in 2008, in India, there were 224 billion $ listed companies accounting for 81% of the total market cap of all the companies listed on the Bombay Stock Exchange (BSE). Further, the promoters’ stake in those billion-dollar companies was 67% of the total market cap of those companies. Moreover, only about six companies (ICICI Bank, L&T, HDFC, IDFC, ITC and IFCI) have no identifiable individual promoter or promoter group.
(Source: Building Billion $ Indian Companies by Market Cap, by Dr. Pravin P. Shah, Growth Publishers, 2008)
Worldwide, majority of the businesses in number as well as in value are family-run and family-managed. Hence, the succession issues are a global phenomenon.
In India, we have witnessed that wealth does not pass in the family beyond the third or fourth generation or business does not remain with the family beyond the third or fourth generation. One of the main reasons for this is that the succession issues are not properly managed.
To illustrate various issues and challenges involved in succession management, various real-life examples are given at appropriate places. The purpose is not to criticise any particular person, group or family, but to learn from the way they handled succession issues and/or their mistakes.
In this article, masculine pronouns are used for brevity and refer to both males and females. Hence, ‘he’ also means ‘she’ and vice versa.
Can succession be managed?
The basic question is can you manage succession, just as you manage a project or a business?
Yes, it is possible to manage succession, just as managing a project or a business. The basic principles are the same. In Kautilya’s Arthashastra, Rajguru Chanakya explains how the succession in the kingdom from generation to generation should be handled.
Let us discuss some of the important ingredients of effective succession management in family-run companies and how to achieve them.
Step-1: Awareness and recognition
The present leader should recognise the reality and be aware of various events which are likely to happen, such as the following:
Step-2: Define vision–mission–goals for succession management
It is essential for the present leader to define his vision, mission and then set the goals. For example, his mission statement could be: “Have a smooth and effective succession consistent with the family values and harmony”.
Step-3: Understand pre-requisites for effective succession management
Following are the major pre-requisites for effective succession management:
Step-4: Understand what influences succession decisions
A leader should learn the factors which may influence the effective and smooth succession management and decisions. Some of them are summarised below:
Culture, personal value systems and family tradition: For example, elder son always succeeds the father.
A problem would arise if the female members do not agree to the thinking that they cannot work in the family companies or they cannot succeed to the family businesses.
Step-5: Identify succession challenges/issues
In India, we are witnessing the succession issues in more and more family-run companies, such as Birla, Tata, Bajaj and Reliance, and even in a professionally-run company like ICICI.
For example, in the Birla group, Mr. G. D. Birla was succeeded by his grandson Mr. Aditya Birla, bypassing his father.
In the Bajaj family, because the brothers, sons and cousins are contenders, there are succession disputes among them.
In the Tata group, presently the successor-Chairman is being selected, who may or may not be from the Tata family.
The present leader should identify the challenges that he is likely to face in effective succession management. For this purpose, he should proceed systematically. He should list out the family members, their present ages, and the likely major future events and their timings, e.g., children’s education and training, their entry in the family business, his retirement and the succession. Based on this, he should prepare a list of likely succession challenges he will face in years to come.
One of the major problems in a family-run company is to decide about the succession criteria. For example, whether the succession should be based on merits or on seniority.
Hence, every family should define the family values and the personal values system it wants to follow in this respect. This requires tough decisions on the part of the family, particularly, in a family-run listed company.
If there is only one potential successor, the question may be about his present capability, his potential to be a leader, his age, his will-ingness, etc.
Sometimes, a potential successor is capable of succeeding, but he may not be interested in the family business and he may want to set up his own business or profession. The present business may not measure up to his ambitions and aspirations. Post liberalisation and globalisation of the Indian economy, a vast number of opportunities have opened up for starting new businesses.
Further, a potential successor may not be interested in being in any business; he may want to be a doctor or a professor or a social activist.
Let us suppose that the father wants to retire in one or two years, and therefore, the succession question has arisen.
Let us further suppose that he has one son who is actively involved in the management of some of the companies in the group. He is capable of succeeding the father, but he is not ready to take over the full rein of the group because he is not willing to devote full time and attention required for managing the business.
If an outside person is brought in as a CEO, then the question of working relations between the son and the outside CEO would arise.
In several wealthy families, it is witnessed that some children do not have a fire in their belly or they just want to enjoy life with the family wealth.
The potential successor may have the technical competence, but he may not have leadership quality or skills which may also be very important for a particular business.
In a knowledge-based business, the potential successor may not have the required knowledge as well as skills and he may not be willing to acquire the same. That would really pose a challenge because a person cannot manage or control a function which he cannot himself do.
The problem is more complex in a knowledge-based service company (e.g., financial services, IT software, etc.) than in a manufacturing company.
In some cases, where the present leader is relatively young or is not likely to, or willing to, give up his rein in a timely manner, then also there may be a conflict with the potential successor even if there is a single successor. He may not be willing to wait for a longer time required for succession.
In such cases, one solution may be that the existing leader gradually delegates more and more responsibilities to the potential successor, so that the potential successor is able to do worthwhile work commensurate with his abilities.
If the potential successor does not have the capability as well as potential, but the promoter insists that his family member should be a successor, then it may adversely affect the functioning of the company.
If the son (or daughter) of the promoter has no capability at present, but has the potential to succeed, and if he takes over the reins today, then he may become diffident or he may not be able to properly manage the company.
If in a family, there is more than one contender for succession, then also there may be a problem. E.g., brothers, uncle and nephew, cousins, son and nephew may be contenders in which case the conflict may arise (e.g., Bajaj family). Further, if an elder brother is less capable than a younger brother, the problem of selecting the successor may be a vexed issue.
If a successor is very much younger to the top one or two senior executives, there may be an issue of whether the younger promoter would be able to lead very senior executives.
The management style of the present leader and the potential successor may be diametrically opposite. Therefore, he may not be interested in working under him or following his footsteps. This may create a potential conflict between them.
Several families have decided that the equity shares held in the listed company will pass on only to the male members, and the female members will get the wealth in monetary terms. This raises several vexed issues. For example, how to monetize the shares in the family-controlled listed company to give the monetary value to the female members in the family? When should this be done? What if at the time of inheritance, the other male members in the family do not have adequate liquidity to buy the shares from the female members who will inherit the same?
Succession issues are there even in a professional firm of chartered accountants and lawyers. However, in a partnership concern the issues involved are different from those in a limited company because in a partnership concern there may not be hierarchy of positions.
Step – 6 : Develop appropriate solutions to challenges
One should develop appropriate solution(s) for each issue. It may not be possible to develop a solution immediately. But one should periodically think of the solutions, may be with the help of others.
If there are two possible contenders, then both may be given a title of joint managing director and then a division of functional responsibilities be made between them according to their capabilities.
Real-life examples: Some real-life examples will illustrate the point.
Real-life example-1
Facts
Some 20 years ago, a promoter of an unlisted software company recognised that he has 2 sons studying in a college and one day they may enter his business. At that time, succession issues may arise, and therefore, he wanted to plan in advance. For that purpose, he decided to start another business in the same line which would gradually become of equal value.
He also wanted that during his active life, he should have the final say in respect of both the businesses. Once his sons become capable, he would gradually give the responsibilities to them. He wanted that the succession should be very smooth and tax-efficient.
Issues
Solution
An appropriate solution which would meet his requirements from a taxation angle as well from a business angle was developed by his chartered accountant. This demonstrates the role a chartered accountant can play in the succession planning.
Outcome
Today, his both the sons are involved in managing two different businesses which have synergies, but each one is running the business independently. This has avoided the potential conflict between the father and his two sons which could have arisen if there was a single business.
Similarly, it is also reported that the RPG Group has divided its companies between the two brothers.
Real-life example-2
Compare this with the case of Dhirubhai Ambani Group where RIL is the company and there are two contenders to succession, Mukesh and Anil. Everyone is well aware about the legal battle which was fought between the two brothers regarding the succession and division of the RIL businesses, their assets and related issues.
Should succession be to the same business?
Is it possible to separate ownership and management: In India, it is very uncommon. But in developed countries, it is very common.
Step-7: Have code of family governance
In a family-run company, the succession management, governance of the company and governance of the family go hand in hand. Hence, every wealthy family should have a code of family governance or family code of conduct and preferably, it should be in writing. Examples of corporate houses which have adopted such a code, include, GMR, Lanco, etc.
The family code of conduct should cover division of assets/businesses amongst the family members, rules for business decisions, succession criteria, training and grooming of the family members to a defined carrier path, inheritance, separation from the family, misconduct, etc.
The code should also cover all other major aspects, such as code of conduct in public, various decision-making rules, remuneration policy for family members, the personal lifestyle related issues, such as residence, type and number of cars each member could have, club membership, etc.
Every family member should be required to read and understand them. There should be a characteristic approach. Those who follow the family code of conduct should be appropriately rewarded and those who do not follow it should be appropriately punished.
Step-8: Is it possible to develop entrepreneurs/ leaders?
It is often debated whether it is possible to develop entrepreneurs or leaders, or are they born and not made? The answer is Yes and No.
It is not possible to develop or train a person to be an entrepreneur or a leader to deal with every aspect. However, there are a number of areas where he could be given proper and appropriate education and training to make him a better entrepreneur and leader.
Secondly, it is not a question whether it is doable or not because in a family-run company if a successor has to be from the family, then it is essential that he is given proper education in this respect, so that his chances as a successful leader are improved.
Step-9: Build capability of potential successors: train and groom
It is very important to groom the potential successor for taking over the rein when the existing leader would retire. This requires proper education and training of the potential successor. The potential successor should not assume that because he is from the promoter family, he has a birth-right to succeed or that he can manage the family-run business.
For effective succession management, efforts must be made on building the capability of every potential successor. The capability-building exercise should begin from home and right from the childhood.
Every child in the family must be given basic education and appropriate higher education. Nowadays, recognising the need for this aspect, many management colleges have Family-Business Management courses.
Besides the formal college education, the potential successor should be properly trained and groomed in being a next generation leader.
The training and grooming should be not only at the Board level. He should be given a thorough training in all the key result areas of the business, though eventually he may select one or more of those areas for him to play a major role in years to come.
Step-10: Determine suitability of potential successors: match-making
A potential successor would have certain skill sets and knowledge base. He would also have his likes/dislikes and his ambitions/inspirations.
Moreover, his present strengths and weaknesses should be identified.
Similarly, every business has Key Result Areas or Critical Success Factors for being successful in that business. Hence, it is necessary to compare the Key Result Areas of the family business and compare them with the knowledge and skill sets and the likes and dislikes of a potential successor.
Thereafter, identify the gap and determine whether it is possible and if yes, how to bridge the gap.
In one company, we suggested that the group should set up a separate unlisted company for those members in the family whose background and skill sets were not appropriate for the listed company’s business. These family members are allowed to run the business of that company independently, so that they do not adversely affect the business or activities of the listed company. This recommendation has worked very well with that group.
Step-11: Involve independent directors/mentors/ consultants
The leader should keep in mind that many times an outsider can play a better role as a mentor for the next generation than he himself can. The mentor(s) may be an independent director, close relative, family friend or a consultant.
The mentor(s) should be carefully selected. He should act in an impartial, unbiased and objective manner. He may act as the situation demands, e.g., as a guide, a mediator, provide assistance in objective analysis of the issues, alternatives and their consequences, an arbitrator, etc.
In a listed company, independent directors should ensure that there is a proper succession planning and execution, particularly, where the present leader is approaching retirement or is not keeping good health.
If in case of a listed company, there are several contenders from the family for succession, then ideally the Board or its committee should make the final selection of the successor.
Step-12: Periodical review and revision
Succession management is not a one-time exercise; it is a life-long journey. The decisions taken in the past may require a change or the actions taken in the past may not work out, and therefore, changes may be required in the past succession planning.
Further, if there is an untimely death of the leader, or if he develops some health problem, then a change in the succession timing may required. For example, Mr. Ashok Birla died in an accident at a relatively young age, and therefore, his son Yash Birla had to succeed him at a much younger age.
An annual review of the performance of the key family members should be conducted which will also make the potential successor(s) aware about his (their) progress. For this purpose, the group should establish the evaluation process and the specific criteria.
Step-13: Decide entry and exit timing
One of the important aspects of effective succession is to determine the timing of retirement of the present leader and succession of the successor.
The succession timing should be well planned: it should not be too abrupt so as to leave a vacuum during the transition phase or too late to de-motivate the potential successor.
The potential successor should enter the family-run business as soon as possible. The leader should gradually delegate more and more responsibilities so that the appropriate opportunities are provided to the next generation for taking up the baton.
The present promoter-in-charge may continue as a mentor (e.g., as a non-executive chairman) for a few years until the successor is fully ready to take over the reins of the company. For example, Mr. Narayan Murthy at Infosys did so for a few years. Thus, the practice of having separate persons as CEO and chairman may be followed.
What role can chartered accountants play?
For most family-run companies, particularly small and medium enterprises, chartered accountants are the first point of contact for any issue. At minimum, a chartered accountant can play the following roles:
Epilogue
A good and effective succession management is achieved through a judicious combination of various factors, such as planning, structure, discipline, mindset, culture, determination, training, implementation, and the like.
Succession management involves ethical and moral issues rather than legal issues. Hence, the approach to this aspect would vary from family to family depending upon its concepts, views and value systems.
Proper succession management, like many other projects, requires thinking and, as Henry Ford put it, “Thinking is the hardest thing there is and that is why very few engage in it”.
On 22nd May, 1992 various premises in the occupation of the appellant Radheshyam Kejriwal besides other persons were searched by the officers of the Enforcement Directorate. The appellant was arrested on 3rd May, 1992 by the officers of the Enforcement Directorate in exercise of the power u/s.35 of the Foreign Exchange Regulation Act, 1973 (hereinafter referred to as the ‘Act’) and released on bail on the same day. Further the appellant was summoned by the officers of the Enforcement Directorate to give evidence in exercise of the power u/s.40 of the Act and in the light thereof his statement was recorded on various dates, viz., 22nd May, 1992, March 10, 1993, March 16, 1993, 17th March, 1993 and 22nd March, 1993. On the basis of materials collected during search and from the statement of the appellant it appeared to the Enforcement Directorate that the appellant, a person resident in India, without any general or specific exemption from the Reserve Bank of India made payments amounting to Rs.24,75,000 to one Piyush Kumar Barodia in March/April, 1992 as consideration for or in association with the receipt of payment of U.S. $ 75,000 at the rate of Rs.33 per U.S. dollar by the applicant’s nominee abroad in Yugoslavia. It further appeared to the Enforcement Directorate that the transaction involved conversion of Indian currency into foreign currency at rates of exchange other than the rates for the time being authorised by the Reserve Bank of India. In the opinion of the Enforcement Directorate the act of the appellant in making the aforesaid payment of Rs.24,75,000 in Indian currency at the rate of Rs.33 per U.S. dollar against the official rate of dollar, i.e., Rs.30 per dollar (approximately), contravened the provisions of section 8(2) of the Act. Further the said payment having been made without any general or special exemption from the Reserve Bank of India, the appellant had contravened the provisions of section 9(1)(f) of the Act and accordingly rendered himself liable to imposition of penalty u/s.50 of the Act. The Enforcement Directorate was further of the opinion that by abetting in contravening the pro-visions of sections 9(1)(f)(i) and 8(2) of the Act read with the provisions of section 64(2) of the Act, the appellant had rendered himself liable for penalty u/s.50 of the Act.
Accordingly, a show-cause notice dated 7th May, 1993 was issued by the Special Director of the Directorate of Enforcement calling upon the appellant to show cause as to why adjudication proceedings as contemplated u/s.51 of the Act be not held against him for the contraventions pointed above. Show-cause notice dated 7th May, 1993 referred to above led to institution of proceedings u/s.51 of the Act (hereinafter referred to as the ‘adjudication proceedings’). The Adjudication Officer came to the conclusion that the allegation made against the appellant of contravention of the provisions of sections 8, 9(1)(f)(i) and 8(2) of the Act read with section 64(2) of the Act could not be sustained. According to the Adjudication Officer, it had not been proved beyond reasonable doubt that a sum of Rs.24,75,000 had been actually paid, since there was no documentary evidence except the statement of Shri Piyush Kumar Barodia and a retracted statement of Shri Radheshyam. Since the Enforcement Directorate had not challenged the adjudication order it had become final.
Since any person contravening the provisions of section 8 and 9 of the Act besides other provisions is liable to be prosecuted u/s.56, a notice for prosecution came to be issued on 29-12-1994. After hearing, a complaint was lodged before the Metropolitan Magistrate. The application of the appellant for dropping the prosecution inter alia on the ground that on the same allegation the adjudication proceedings have been dropped was rejected by the Metropolitan Magistrate by his order dated 2-9-1997. The criminal revision application before the Calcutta High Court was rejected by an order dated 10-8-2001.
On further appeal, the Supreme Court observed that the ratio of various decisions on the subject could be broadly stated as follows:
(i) Adjudication proceedings and criminal prosecution can be launched simultaneously;
(ii) Decision in adjudication proceedings is not necessary before initiating criminal prosecution.
(iii) Adjudication proceedings and criminal proceedings are independent in nature to each other;
(iv) The finding against the person facing prosecution in the adjudication proceeding is not binding on the proceedings for criminal prosecution;
(v) An adjudication proceeding by the Enforcement Directorate is not a prosecution by a competent court of law to attract the provisions of Article 20(2) of the Constitution or section 300 of the Code of Criminal Procedure;
(vi) The finding in the adjudication proceedings in favour of the person facing trial for identical violation will depend upon the nature of the finding. If the exoneration in the adjudication proceedings is on technical ground and not on the merits, prosecution may continue; and
(vii) In case of exoneration, however, on the merits where the allegation is found to be not sustainable at all and the person held innocent, criminal prosecution on the same set of facts and circumstances cannot be allowed to continue, the underlying principle being the higher standard of proof in criminal cases.
In the opinion of the Supreme Court, therefore, the yardstick would be to judge as to whether the allegation in the adjudication proceedings as well as the proceeding for prosecution is identical and the exoneration of the person concerned in the adjudication proceeding is on the merits. In case it is found on the merits that there is no contravention of the provisions of the Act in the adjudication proceeding, the trial of the person concerned shall be in abuse of the process of the Court.
Bearing in mind the principles aforesaid, the Supreme Court proceeded to consider the case of the appellant. The Supreme Court noted that in the adjudication proceedings, on the merits the adjudicating authority had categorically held that the charges against Shri Radheshyam Kejriwal for contravening the provisions of section 9(1)(f)(i) and section 8(2) r.w.s. 64(2) of the Foreign Exchange Regulation Act, 1973 could not be sustained. The Supreme Court held that in the face of the aforesaid finding by the Enforecement Directorate in the adjudication proceedings that there is no contravention of any of the provisions of the Act, it would be unjust and an abuse of the process of the Court to permit the Enforcement Directorate to continue with the criminal prosecution. In the result, the Supreme Court by majority allowed the appeal and set aside the judgment of the learned Metropolitan Magistrate and the order affirming the same by the High Court and the appellant’s prosecution was quashed.
However, in a dissenting judgment separately delivered by P. Sathasivam J., it was held that considering the interpretation relating to sections 50, 51 and 56 by various decisions, in a statute relating to economic offences, there was no reason to restrict the scope of any provisions of the Act. These provisions ensured that no economic loss was caused by the alleged contravention by the imposition of an appropriate penalty after adjudication u/s.51 of the Act and to ensure that the tendency to violate is guarded by imposing appropriate punishment in terms of section 56 of the Act. Section 23D of the Foreign Exchange Regulation Act, 1947 had a proviso which indicated that the adjudication for the imposition of penalty should precede making of complaint in writing to the Court concerned for prosecuting the offender. The absence of a similar proviso to section 51 or to section 56 of the present 1973 Act was a clear indication that the Legislature intended to treat the two proceedings as independent of each other. There was nothing in the present Act to indicate that a finding in adjudication is binding on the Court in a prosecution u/s.56 of the Act or that the prosecution u/s.56 depends upon the result of adjudication u/s.51 of the Act. The two proceedings were independent and irrespective of the outcome of the decision u/s.50, there could not be any bar in initiating prosecution u/s.56. The scheme of the Act made it clear that the adjudication by the concerned authorities and the prosecution were distinct and separate. It was further held that no doubt, the conclusion of the adjudication, in the case on hand, the decision of the Special Director dated 18th November, 1996 may be a point for the appellant and it is for him to put forth the same before the Magistrate. Inasmuch as the FERA contains certain provisions and features which cannot be equated with the provisions of the Income-tax Act or the Customs Act and in the light of the mandate of section 56 of the FERA, it is the duty of the Criminal Court to discharge its functions vested with it and give effect to the legislative intention, particularly, in the context of the scope and object of the FERA which was enacted for the economic development of the country and augmentation of revenue. Though the Act has since been repealed and is not applicable at present, those provisions cannot be lightly interpreted taking note of the object of the Act.
In view of the above analysis and discussion, the dissenting Judge agreed with the conclusion arrived at by the Metropolitan Magistrate, Calcutta as well as the decision of the High Court.
Dilemma :
It is often said
‘. . . . when hospitality becomes an art, it loses its very soul’. Yet, delivery
of soulful services requires unfettered independence. Controls and curbs in such
a scenario are inhibitions, to say the least. Where subjectivity is the name of
the game, the truth may be puzzling. It may take some work to grapple with. It
may be counter-intuitive. It may contradict deeply held prejudices. It may not
be consonant with what we desperately want to be true. But our preferences do
not determine what’s true. We have a method, and that method helps us to reach
not absolute truth, only asymptotic approaches to the truth — never there, just
closer and closer, always finding vast new oceans of undiscovered possibilities.
Approach :
‘We make our world
significant by the courage of our questions and the depth of our answers’. We
can judge our progress by our willingness to embrace what is true rather than
what feels good. In the business of hospitality, the guest is god — begin by
respecting the dictum. After all, class in the business of hospitality is always
more subtle, more intricate, more elegant than what most auditors would like to
imagine.
Knowledge gathering :
Trade nuances :
You have to know the past to
understand the present. Inquiry and interaction are handy tools. In exchange for
freedom of inquiry, the auditor is obliged to appreciate the subtlety of the
oft-hidden controls. A gentle ‘housekeeping’ turndown service in the evening,
for instance, doubles up as a reality check on the profile and preferences of
guests, even room occupancy discrepancies. Numerous are such nuances of the
trade; universally true, and not difficult at all for an open minded auditor to
pick up, gauge or rely upon. Obsolescence, though, is an important word here.
With the changing times, customs need to be tested and disproved assertions be
proved worthless.
Marketing innovations :
From dynamic demand-based
pricing concepts to global distribution systems, luxury hospitality today
embraces the A to Z of marketing, perceptions that auditors often grapple to
come to terms with, not to speak of the efforts to evaluate these. Experience
shows however, that even modern techniques such as these are often prone to
fallacies, and the cure for such fallacious arguments is better arguments. To
counter fallacies, auditors need imagination and skepticism both; not to be
afraid to speculate, but careful to distinguish speculation from fact.
Technological advancements :
Like most trades, high-end
hospitality products and services imbibe the best of technology in all spheres,
be it environment consciousness, information technology or engineering marvels.
Unfortunately, there is no short cut here — either go through the grind yourself
or seek help of experts.
Statutes :
Name a statute and it is
applicable to hotels — ranging from labour laws, indirect and direct taxes,
licences for almost everything you see in operation, food and hygiene,
pollution, GAAPs — the list is endless . . . . this is possibly an area however,
where not much advocacy would be required for auditors; supposed to be their
core competence. I may however caution here that ‘while it is of interest to
note that some dolphins are reported to have learned English — up to fifty words
used in correct context — no human being has been reported to have learned
dolphinese.’ Over confidence does no good.
Creating checkpoints :
Prevention :
Finding the occasional straw
of truth awash in a great ocean of confusion and bamboozle requires
intelligence, vigilance, dedication, and courage. But if we don’t practise these
tough habits of thought, we cannot hope to solve the truly serious problems that
face us.’ Easier said than done — eh ! Not really. For instance, like banks,
hotels have daily revenue closing systems such as ‘Night Audits’ and ‘Income
Audits’. The real challenge in a typical hospitality set-up is the multiplicity
of transaction points; while you rack your brains to repair one leak, another
one crops up. The best use of the gigantic risk and control matrices most
hospitality giants employ, to my mind, would be when robots eventually replace
human employees in the hospitality industry — human brains are far too suave and
thoughtful to be restricted by a ‘risk and control’ matrix.
Inquisitiveness :
Far from straightjacket
operations, the hospitality industry renders detective controls by far the most
effective tool in the hands of internal auditors. A probing mind together with
IT-empowered tools such as CAATs do wonders to dig out clues from unsuspecting
areas. Contrarian thoughts such as ‘The hen is the egg’s way of making
another egg’ work wonders, says experience. ‘What is called for is an exquisite
balance between two conflicting needs : the most skeptical scrutiny of all
hypotheses that are served up to us and at the same time a great openness to new
ideas. If you are only skeptical, then no new ideas make it through to you. On
the other hand, if you are open to the point of gullibility and have not an
ounce of skeptical sense in you, then you cannot distinguish useful ideas from
the worthless ones . . . .’
Conclusion :
The luxury hospitality
industry is in perpetual ‘floatation’, so to say; thus straightjacket auditing
means are often ineffective. Given the multiplicity and voluminous transaction
points, this industry is particularly susceptible to irregularities/frauds. To
get a grip, one must sway with the wave to be in total control.
January 2010 brought a firm assertion from the Ministry of
Corporate Affairs (MCA) indicating International Financial Reporting Standards
(IFRS) is the only way forward — but companies may reach the destination in a
phased manner starting 2011. One year hence, news is in the air that based on
several representations from India Inc, the Ministry is likely to postpone the
convergence. On the other hand, India will have to rethink whether it wants to
go back on its word given to the G20. Hence, to balance the mounting global
pressure and India Inc’s demands, the Ministry is said to be contemplating
making it optional.
In the meantime, the Institute of Chartered Accountants of
India (ICAI) has already issued near-final IFRS-equivalent Indian Accounting
Standards (Ind-AS), pending approval of the Ministry.
Now, for India Inc, the most vital step is to be ready for
Ind-AS as is, and wait and watch for any further bumps (amendments) on this
roller-coaster ride.
One of the standards that will make your ride bumpier is Ind-AS
12 Income Taxes. For almost every adjustment that it is made to comply
with IFRS, there will be a deferred tax impact staring right back at you.
Bridging the gap between the income statement approach under
Indian GAAP and the balance sheet approach under IFRS itself is intimidating to
many. This article makes an attempt at simplifying the new concepts IAS 12
brings.
To understand the impact of deferred taxes, it is imperative
to understand why deferred tax is required in the first place. The example below
explains why deferred taxes are accounted for.
Company X purchases a machine costing Rs.100 million having a
useful life of two years. As per the tax laws, 100% depreciation is allowed in
the first year itself. Profit before depreciation and tax was Rs.200 million.
The profits of the Company X, without considering the deferred tax impact is as
shown in Table I.
Notes :
(1) The effective tax rate is different from the actual tax
rate in both the years.
(2) Although the profits and the tax rate for both the
years remain unchanged, the tax expense is different and consequently the
profit after tax is different.
Is this accounting in line with our basic concepts ?
1. Accrual concept :
As per the accrual concept, tax should be accounted for in
the books of accounts as and when it accrues. However, current tax is provided
based on taxation laws.
2. Matching concept :
Taxes should be accounted for in the same period as the
related incomes and expenses are accrued.
Hence, to prepare the books of accounts in line with the
above-mentioned concepts, we account for ‘deferred taxes’.
What is deferred tax ?
Deferred tax is the tax on:
In simple terms, deferred tax is a tax (book entry) on the
gap between the books of account and the tax books.
Income statement approach :
Accounting Standard (AS) 22 Taxes on Income advocates
income statement approach. Under this approach, profit as per books is compared
with profit as per tax. Then, deferred tax is created on all timing differences.
Timing differences are the differences between taxable income and
accounting income for a period that originate in one period and are capable of
reversal in one or more subsequent periods. No deferred tax is created on
permanent differences.
Under this approach, deferred tax is created on only those
items that have an impact on the income statement. In other words, ‘income
statement approach’ assumes that all the incomes are accrued in the income
statement. However, items like gain on revaluation of fixed assets (i.e.,
revaluation reserve) are not considered for deferred tax purposes. Also, in
insurance companies and banks, investments are marked to market and the gain
thereon is parked in a reserve till it is realised. Although the income is
earned in the above cases deferred tax on the same is not recognised as the
transactions don’t impact the income statement directly.
Hence, IASB, in 1996, came up with the concept of temporary
differences/balance sheet approach.
Balance sheet approach :
‘Temporary difference’ is wider in scope as compared to
‘timing difference’. It also covers those differences that originate in the
books of accounts in one period and are capable of reversal in the same books,
of accounts in one or more subsequent periods. For example, gain on revaluation
arises in books of accounts and reverses in the same books by way of higher
depreciation charge. Now, many argue that the revaluation gain is a notional
gain and does not give rise to any tax in future periods. To understand the
logic behind the balance sheet approach, it is important to go back to the
definition of an asset. An asset is a resource controlled by the entity as a
result of past events and from which future economic benefits are expected to
flow to the entity. For example, when an asset costing Rs.100 is valued at
Rs.120, it means that the asset owner will receive future economic benefit of
Rs.120. Since the asset owner has paid just Rs.100 to get a benefit of Rs.120,
the upfront benefit of Rs.20 (120-100) is considered for deferred tax. In short,
it is based on an assumption that the recovery of all assets and settlement of
all liabilities have tax consequences and these consequences can be estimated
reliably and cannot be avoided.
Temporary Difference is defined as a difference
between the carrying amount of an asset or liability and its tax base, where
tax base is the amount that will be deductible for tax purposes.
Where the economic benefits are not taxable or expense not deductible, the tax
base of the asset is equal to its carrying amount.
In simple terms, an entity will have to draw a tax balance sheet. The numbers appearing in the tax balance sheet is termed as ‘tax base’. This tax base will be compared with the carrying amount of assets and liabilities in the books of accounts. Deferred tax will be calculated on the difference so calculated. For example — if interest expense is allowed on cash basis under tax laws, no expense would have been booked. Hence, no corresponding liability would exist as per tax books i.e., tax base is nil. On the other hand, a liability for the interest will be recorded in the books of accounts. The difference in carrying the amount of the liability is regarded as a temporary difference under the balance sheet approach.
To better understand the concept of ‘tax base’, a few examples have been given below:
1)A machine costs Rs.100. For tax purposes, depreciation of Rs.30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. The tax base of the machine is Rs.70.
2)Dividends receivable from a subsidiary of Rs.100. The dividends are not taxable. Thus, the tax base of the dividends receivable is 100. (Note: If the economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.)
3) Similarly, a loan receivable has a carrying amount of Rs.100. The repayment of the loan will have no tax consequences. The tax base of the loan is Rs.100.
4) Current liabilities include interest revenue received in advance of Rs.100. The related interest revenue was taxed on a cash basis. The tax base of the interest received in advance is nil.
Temporary differences are of two types:
1) Taxable temporary differences (Deferred tax liability):
Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit/loss of future periods when the carrying amount of the asset or liability is recovered or settled. For example — incomes accrued as per books of accounts (fair value of financial instruments) but taxable on receipt basis and lower depreciation charge in books of accounts.
In simple words, where the carrying value of assets is more as per books of accounts or carrying value of liability is less as per books of accounts when compared to tax base, it results in taxable temporary differences.
2)Deductible temporary differences (Deferred tax assets):
Deductible temporary differences are temporary differences that will result in amounts that are deductible in determining taxable profit/loss of future periods when the carrying amount of the asset or liability is recovered or settled. For ex-ample — higher depreciation charge in books of accounts. In simple words, where the carrying value of assets is less as per books of accounts or carrying value of liability is more as per books of accounts when compared to tax base, it results in deductible temporary differences.
Deferred tax on items recognised outside profit or loss:
Current tax and deferred tax shall be recognised outside profit or loss if the tax relates to items that are recognised, in the same or a different period, outside profit or loss. Therefore, current tax and deferred tax that relate to items that are recognised, in the same or a different period:
a) in other comprehensive income, shall be recognised in other comprehensive income (OCI)
b) directly in equity, shall be recognised directly in equity i.e., in the Statement of Changes in Equity (SOCIE).
For example, deferred tax on revaluation of as-sets should be recognised in revaluation reserve in OCI. Hence, there will not be any charge to profit or loss.
Deferred tax on revaluation of assets:
IFRSs permit or require certain assets to be carried at fair value or to be revalued (for example, IAS 16 Property, Plant and Equipment, IAS 38 Intangible Assets, IAS 39 Financial Instruments: Recognition and Measurement and IAS 40 Investment Property). However, as per the tax laws, revaluation of assets is not considered while computing the taxable income. Consequently, the tax base of the asset is not adjusted. Nevertheless, the future recovery of the carrying amount (on sale or otherwise) will result in a taxable flow of economic benefits to the entity and the amount that will be deductible for tax purposes will differ from the amount of those economic benefits. The difference between the carrying amount of a revalued asset and its tax base is a temporary difference and gives rise to a deferred tax liability or asset. This is true even if:
a) the entity does not intend to dispose of the asset. In such cases, the revalued carrying amount of the asset will be recovered through use and this will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods; or
b) tax on capital gains is deferred if the proceeds of the disposal of the asset are invested in similar assets. In such cases, the tax will ultimately become payable on sale or use of the similar assets.
For example, Company A buys an asset worth Rs.100 on 1st April, 2010. The useful life of the asset is five years and the tax laws allow it to be depreciated over four years. One year later, on 31st March, 2011, the Company revalues the asset to Rs.120. In such a case the temproary difference will be as shown in Table 2.
In the above case, the deferred tax liability created on revaluation on 31st March, 2011, of Rs.45 reverses in the subsequent periods. The accounting entry for the year 2011 would be:
Revaluation reserve A/c Dr. 45
To Deferred tax liability A/c 45
Suppose on 31st March, 2013, the Company decides to sell the asset at Rs.70. In this case, there would be a gain of Rs.10 as per the books of accounts. However, the tax books will show a gain of Rs.45, thus offsetting the temporary difference of Rs.35.
Indian GAAP:
Accounting Standard (AS) 22 Taxes on income does not permit creation of deferred tax on the excess depreciation charged on the revalued portion. It is not considered as a timing difference, but a permanent one. The underlying reason is that, under the income statement approach, a deferred tax liability is not created on the date of revaluation (since it does not have an effect on the income statement). Thus, deferred tax assets (reversal of deferred tax liability) cannot be recorded on the excess depreciation charged.
Deferred tax on business combination:
IFRS 3 Business Combinations require the identifiable assets acquired and liabilities assumed in a business combination to be recognised at their fair values at the acquisition date. Temporary differences arise when the tax bases of the identifiable assets acquired and liabilities assumed are not affected by the business combination or are affected differently. For example, when the carrying amount of an asset is increased to fair value but the tax base of the asset remains at cost to the previous owner, a taxable temporary difference arises which results in a deferred tax liability. The resulting deferred tax liability affects goodwill.
For example, Company A merges Company B with itself. In the process it acquires net assets of Rs.1,000 crore (fair value Rs.1,200 crore) for Rs.1,500 crore. Goodwill being the difference between the consideration paid and fair value was Rs.300 crore (1,500 — 1,200 crore). Now, Company A will have to calculate the deferred tax on the fair valued por-tion of Rs.200 crore (1,200 — 1,000 crore), the tax base being the cost to previous owner of Rs.1,000 crore as compared to the revised carrying amount of Rs.1,200 crore. The deferred tax would hence be 100 crore (assuming tax rate of 50%). These Rs. 100 crore will be added to goodwill and the total goodwill will be Rs.400 crore (300 + 100 crore). The accounting entry would be:
Goodwill A/c Dr. 100
To Deferred tax liability A/c 100
Indian GAAP:
As per Accounting Standard Interpretation (ASI) 11* Accounting for Taxes on Income in case of an Amalgamation, deferred tax on such differences should not be recognised as this constitutes a permanent difference. The consequent differences between the amounts of depreciation for accounting purposes and tax purposes in respect of such assets in subsequent years would also be permanent differences.
It may be noted that ASI 11 has been issued by the ICAI but has not been incorporated in the standards notified under the Companies (Accounting Standards) Rules, 2006. Hence, ASI 11 is not applicable to companies. However, it is generally noted that companies treat such difference as permanent difference and do not create any deferred tax on the same.
Deferred tax on consolidation:
IAS 12 requires re- calculation of deferred tax at consolidated level. In effect, an entity will have to calculate deferred tax impact on inter-company transactions.
For example — Company H, the holding company, sells goods costing Rs.1,000 to Company S, the subsidiary company, for Rs.1,200. The goods are lying in the closing stock of Company S. Assume tax rate 0f 50%. Then entry in the consolidated
books is as follows:
Deferred tax asset A/c Dr. 60
To Deferred tax expense A/c 60
[(1,200-1,000)*50%]
Here, the deferred tax asset is created because the profit element of Rs.200 (1,200 — 1,000) is not eliminated in the tax books i.e., the consolidated books has an inventory of Rs.1,000 but the tax books of Company S has an inventory of Rs.1,200.
Please note: the tax rate used in this case would be the rate applicable to the Company S, since the deduction will be available to Company S.
Indian GAAP:
Under Indian GAAP, the practice followed is to consolidate the books by adding line-by-line items. Deferred tax is also calculated in the consolidated books as a summation of deferred tax appearing in the individual books of accounts.
Deferred tax on undistributed profits:
As per IAS 28 Investments in Associates, an entity is required to account for its investment in associates as per equity method in the consolidated financial statements. Under the equity method, the investment in an associate is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition, reduced by distributions received. On the other hand, its tax base will remain the cost of investment. The difference between the books of accounts and tax base is investor’s share of undistributed reserves of the investee entity. In simple terms, an entity will have to provide for deferred tax on its share of undistributed reserves of the investee company in its consolidated books.
Similar is the treatment under IAS 31 Interests in Joint Ventures where an entity elects equity method of accounting.
Nevertheless, an entity is exempted from the above requirement if the following conditions are satisfied:
a) the investor/venturer is able to control the timing of the reversal of the temporary difference; and
b) it is probable that the temporary difference will not reverse in the foreseeable future.
However, an investor in an associate/a venturer in a joint venture, generally, does not control that entity and is usually not in a position to determine its dividend policy. Therefore, in the absence of an agreement requiring that the profits of the associate/venturer will not be distributed in the foreseeable future, an investor/venturer recognises a deferred tax liability arising from taxable temporary differences associated with its investment in the associate/joint venture.
Deferred tax on land:
The Income-tax Act, 1961 provides for indexation of cost of non-depreciable assets like land, when computing the capital gain/loss on sale. This indexed cost of land (i.e., its tax base) will exceed the book value of land by the indexation benefit provided. Hence, a deferred tax asset will have to be created on this difference.
Indian GAAP:
Since the indexation benefit neither affects the current year’s tax profit, nor the profit as per books, deferred tax is not provided as per Indian GAAP.
Carried forward business losses and unabsorbed depreciation:
A deferred tax asset shall be recognised for the carried forward business losses and unabsorbed depreciation to the extent that it is probable that future taxable profit will be available against which such losses and depreciation can be utilised.
Although the term ‘probable’ is not defined by the standard, probable in general terms is ‘more likely than not’.
Indian GAAP:
AS 22 mandates virtual certainty for recognition of deferred tax assets in case of carried forward business losses and unabsorbed depreciation.
As per ASI 9 Virtual certainty supported by convincing evidence, virtual certainty is not a matter of perception. It should be supported by convincing evidence. Evidence is matter of fact. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Keeping in view ‘virtual certainty’ as against ‘probable certainty’ it seems that Indian GAAP is more conservative on the matter of recognition of deferred tax asset.
Exceptions:
There continues to remain certain items over which the standard does not permit creation of deferred taxes, as below:
1) Initial recognition of goodwill:
Para 21 of IAS 12 Income Taxes prohibits recognition of deferred tax liability on initial recognition of goodwill, because goodwill is measured as a residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill.
2) Initial recognition of an asset or liability in a transaction which:
i) is not a business combination, and
ii) at the time of transaction, affects neither accounting profit nor taxable profit/loss.
For example, a penalty was paid in the process of bringing an asset to its working condition as intended by the management and hence, it was capitalised. As per taxation laws, penalty is not allowed as an expense. Now, this penalty affects neither accounting profit nor taxable profits. Hence, as per the above said exception, no deferred tax shall be created on this difference.
Re-assessment:
At the end of each reporting period, an entity reassesses unrecognised deferred tax assets. The entity recognises a previously unrecognised deferred tax asset to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recovered. For example, an improvement in trading conditions may make it more probable that the entity will be able to generate sufficient taxable profit in the future for the deferred tax
asset to meet the recognition criteria.
Discounting:
The principles of IFRS require long-term assets and liabilities to be discounted to the present value. In most cases detailed scheduling of the timing of the reversal of each temporary difference is impracticable and highly complex for the purpose of reliable determination of deferred tax assets and liabilities on a discounted basis. Therefore, the deferred tax assets and liabilities shall not be discounted.
Current/Non-current:
IAS 1 Presentation of financial statements requires an entity to present current and non-current assets, and current and non-current liabilities, as separate classifications in its statement of financial position. However, an entity shall not classify deferred tax assets/liabilities as current assets/ liabilities, i.e., deferred taxes shall always be clas-sified as non-current.
Takeaways:
As mentioned above, deferred taxes will impact almost all IFRS adjustments. One will have to consider all IFRS adjustments like fair valuation, use of effective interest rates, derivative and hedge accounting to calculate accurate deferred taxes.
To conclude, there are three important takeaways:
1) An entity will have to calculate the tax base for each asset and liability and compare the same with the financial statements,
2) Items that were earlier considered as permanent difference as per Indian GAAP may have to be considered as temporary difference as per IFRS, and
3) Deferred taxes, for certain items, will be rec-ognised outside profit or loss i.e., in OCI or SOCIE.
44th RRC of BCAS was held at Matheran during 22nd to 25th January 2011 at Hotel Usha Askots and Hotel Byke.
Participants reached Matheran by lunch time on 22nd January 2011, after having fun of travelling through mountains upto Dasturi and then walking through enjoyable & cool forest. Some of them took narrow-gauge train to reach Matheran avoiding the walk.
DAY 1: INAUGURAL SESSION
Mr. Mayur Nayak President of the Society welcomed the members. He explained the need to think in different way in the present situation and for that purpose chartered accountants need to know importance of Group Leading and Group Discussion. He mentioned how this is helpful in career path. For the benefit of the outstation members attending the RRC, he narrated Society’s activities which are conducted through out the year.
This session was chaired by Mr. Kishor Karia, Past President of the Society.
The day ended with tasty dinner.
Day : 2
After the breakfast, participants discussed the paper written by Mr. K.C. Devdas, chartered accountant on Recent Judgments in Direct Taxes. The Group Discussion was followed by a presentation paper.
Thereafter the Mr. K. C. Devdas, chartered accountant analyzed the implications and rationale of various Tribunal, High Court, and Supreme Court Judgments. He explained that every decision of the judgment forum is with respect to a set of facts and it is important for readers to appreciate these facts before using the judgment for any purpose. He also felt that retrospective amendments, to unsettle the settled position of law, should be avoided as it causes hardship to innocent tax payers.
This session was chaired by Mr. Anil Sathe, Past President of the Society.
In the evening participants enjoyed an entertainment program before the dinner.
Day 3:
After the breakfast, some of the participants discussed the paper written by Mr. Sunil Gabhawalla, chartered accountant on Case Studies in Service Tax and others discussed paper written by chartered accountant Mrs. Geeta Jani ,on Case Studies in International Taxation. For the first time two papers were discussed simultaneously considering the era of specialisation and requirement of focused study. After the Group Discussion, both the Paper Writers dealt with their respective subjects simultaneously at different locations.
Mrs. Geeta Jani dealt with various cases on International Taxation which are of relevance to participants in their day to day practice. She also dwelt upon the possible scenario, once the Direct Taxes Code became a law. She also discussed possible impact of Controlled Finance Corporations (CFC) Regulations, a concept which is new India.
This session was chaired by Mr. Rajesh Kothari, Past President of the Society.
Thereafter Mr. Khurshed Pastakia, chartered accountant presented paper on IFRS – Recent Developments. He informed the participants about the impact of IFRS on
Indian Economy. He was of the view that though there would be a number of issues in implementation of certain standards, given the fact that India is committed for convergence of IFRS, these should be overcome by continuous dialogue between the Industry, the Profession and the Regulators.
This session was chaired by Mr. Ashok Dhere, Past President of the Society.
In the evening an unique and innovative programme — RRC Nostalgia was held for the first time in the history of RRC. In this program views of three Past Presidents of the Society, were presented namely Mr. Pradyumnabhai Shah, Mr. Hemendra Shah and Mr. C. C. Dalal, as recorded through video. They had attended the First RRC of the Society at Matheran. Other Past Presidents present at the 44th RRC also presented their views and shared some memories of RRCs in the past. Almost all Past Presidents were of
the opinion that Group Discussion with active participation by all participants is the foundation of RRC. This is the Motto of RRC right from the beginning which should not be forgotten in the current times of presentation of papers on screen. This message is very important for the mutual benefit of all professionals irrespective of their age. Few participants from the audience added glory to the programme by sharing their thoughts.
This programme was ably anchored by Mr. Ameet Patel, Past President of the Society.
The day ended with Gala Dinner and Musical Evening.
Day 4:
After the breakfast the participants discussed the paper written by Mr. Pradip Kapasi, chartered accountant on Capital Gains – Some Current Issues. The Group Discussion was followed by his presentation on the subject. He dealt with some burning issues affecting the general tax paying assesses. He analysed in great detail vigours of section 50C of the Income-tax Act. He explained various precautions that are necessary to be taken to mitigate the problems caused by the deeming fictions contained in section 45 (2), 45 (3) and 45 (4). His command over the topic and flawless analysis resulted in participants giving him a very patient hearing.
This session was chaired by Mr. Pradeep Shah, Past President of the Society.
In concluding session Mr. Uday Sathaye, Chairman Seminar Committee took an overview of the RRC and recognised the contribution made by everybody in general and Mr. Nayan Parikh, Past President of the Society in particular for his innovative idea of design of Paper Book which was appreciated by all the participants. Mr. Mayur Nayak, President of the Society thanked everybody for making the RRC memorable in the history of Society. Participants departed after lunch to their respective destinations with a commitment to meet again next year at 45th RRC.
24 Stock exchange —
Membership card — Not personal property of member — Cannot be attached and sold
in execution of a decree against member.
[ Cochin Stock Exchange
Ltd v. Dhanalakshmi Bank Ltd & Ors., (2010) 159 Comp. Cas. 365 (Ker.)]
In a suit filed by the bank
against the second and third respondents, the petitioner stock exchange was
impleaded as a party. A decree was sought against it for realisation of the
plaint claim by sale of the membership card of the second respondent in it and
it was granted. The bank i.e., decree holder applied for sale of the
membership card of the second respondent. The petitioner stock exchange filed
objections to the execution contending that the membership card was not a
private property which could be attached and sold in execution of a decree and
that the petitioner stock exchange could not be compelled to sell the card of
the second respondent.
The High Court allowing the
petition held that since the membership was only a personal privilege, which on
a declaration that he was a defaulter vested with the stock exchange, the
direction issued in the decree was without jurisdiction and in violation of the
statutory provisions. Even though the stock exchange failed to challenge the
decree, the directions issued in violation were not executable. The bank was
free to realise the decree debt from the property of the second and third
respondents in accordance with law and also against their person, if the decree
provided so.
25 Substituted service —
Only when the Court is satisfied that defendants cannot be served personally —
Civil Procedure Code, Order 5, Rule 20.
[ Harbhajan Singh & Anr.
v. L.Rs. of Gardhara Singh, AIR 2010 Raj 170]
In the year 1983, the
respondent/plaintiff filed a suit for specific performance of the contract
against the appellants/defendants. The summons issued by the Court could not be
served in the ordinary course and therefore, on an application preferred on
behalf of the respondent/plaintiff, the service upon the appellants/defendants
was directed to be effected by way of substituted service i.e., by
publication of the summons in the daily newspaper. On publication of the summons
as directed by the Court, the service upon the appellants/defendants was treated
to be complete and since nobody appeared on their behalf when the matter was
called out, ex parte proceedings were ordered against them. Ultimately,
the suit was decreed ex parte.
The appellants/defendants
filed an application under Order IX, Rule 13, CPC for setting aside the ex
parte decree. It was stated therein that at the relevant time, when the suit
was filed, the appellant/defendant Harbhajan Singh was residing at Village
Rodala, Tehsil Ajnala, district Amristar and the appellant/defendant Amritpal
Singh was in defence service, however, the summons were not served upon
them personally.
The Court held that the mode
of substituted service can be resorted to only when the Court is satisfied that
there is reason to believe that the defendant is keeping out of way for the
purpose of avoiding service or that for any other reason, the summons cannot be
served in the ordinary way. The personal service of summons in the ordinary way
is a rule and the substituted service is an exception. Therefore before passing
any order for substituted service on the basis of the material on record, the
Court must be satisfied that the conditions stipulated in O.5, R.20 exists.
However, there is a presumption that service substituted by the order of the
Court shall be as effectual as if it had been made on the defendant personally.
In the instant case the
Court had directed for substituted service upon the defendants by way of
publication in the newspaper on mere asking of the plaintiff without recording
any finding as to in what circumstances the defendants could not be serviced in
the ordinary course. The substituted service being presumptive in nature should
not be resorted to by the Court unless on the basis of the material on record,
it stands satisfied that the defendants are avoiding the service or for any
other reason, the summons cannot be served upon them personally in the ordinary
way. On the facts and in the circumstances of the case, the Court could not have
proceeded to pass an order for substituted service in a casual manner solely on
the basis of the plaintiff’s desire to serve the defendants by substituted
service. Hence service of summons cannot be considered to be sufficient and in
accordance with law. The ex parte order was set aside.
23 Right to Information —
Notes or jotting by Judges or their draft judgments cannot be said to be
information held by public authority — Right to Information Act, 2005, S. 2.
[ Secretary General, SC
of India v. Subhash Chandra Agarwal, AIR 2010 Del. 159 (FB)]
The appeal is against the
order passed by the ld. Single Judge whereby the request of the respondent (a
public person) for supply of information concerning declaration of personal
assets by the Judges of the Supreme Court was upheld.
One of the issue that arose
for consideration was the meaning of term information u/s.2(f) of the Act. The
Court held that the preamble to the Act says that the Act is passed because
‘democracy requires an informed citizenry and transparency of information which
are vital to its functioning and also to contain corruption and hold Govt. and
their instrumentalities are accountable to the governed’. The Act restricts the
right to
information to citizens (S. 3). An applicant seeking in formation does not have
to give any reasons
why he/she needs such information except such details as may be necessary for
contracting him/her. Thus, there was no requirement of locus standi for
seeking information.
The Court further held that
the source of right to information does not emanate from the Right to
Information Act. It is a right that emerges form the constitutional guarantees
under Article 19(1)(a) of the Constitution of India. The Right to Information
Act is not repository of the right to information. Its repository is the
constitutional rights guaranteed under Article 19(1)(a). The Act is merely an
instrument that lays down statutory procedure in the exercise of this right. Its
overreaching purpose is to facilitate democracy by helping to ensure that
citizens have the information required to participate meaningfully in the
democratic process and to help the governors accountable to the governed. In
construing such a statute the Court ought to give to it widest operation which
its language will permit. The Court will also not readily read words which are
not there and introduction of which will restrict the rights of citizens for
whose benefit the statute is intended.
The words ‘held by’ or
‘under the control of u/s. 2(j) will include not only information under legal
control of public authority, but also all such information which is otherwise
received or used or consciously retained by the public authority in the course
of its functions and its official capacity. There are any numbers of examples
where there is no legal obligation to provide information to public authorities,
but where such information is provided, the same would be accessible under the
Act. For example, registration of births, deaths, marriages, applications for
election photo identity cards, ration cards, PAN cards, etc.
The apprehension that unless
a restrictive meaning is given to S. 2(1)(j), the notes or jottings by the
Judges or their draft judgments would fall within the purview of the Information
Act was misplaced. Notes taken by the Judges while hearing a case cannot be
treated as final view expressed by them on the case. They are meant only for the
use of Judges and cannot be held to be a part of a record ‘held’ by the public
authority. However, if the Judge turns in notes along with the rest of his files
to be maintained as a part of the record, the same may be disclosed. It would be
thus retained by the registry. Even the draft judgement signed and exchanged is
not to be considered as final judgments, but only tentative view liable to be
changed. A draft judgment therefore, obviously cannot be said to be information
held by a public authority.
21 Nominee rights — Bank
account — Death of depositor — Banking Regulation Act, 1949 S. 45ZA(2).
[ Ram Chander Talwar &
Anr. v. Devender Kumar Talwar & Ors., (2010) 159 Comp. Cas. 646 (SC)]
The appellant who was the
nominee in the bank account held by his deceased mother claimed full rights over
the money lying in the account, to the exclusion of the respondent who was none
else than his full brother. The claim is based on S. 45ZA of the Banking
Regulation Act, 1949, which according to him, made the nominee of the depositor
the sole beneficiary, vested himwith all the rights of the sole depositor.
The Supreme Court held that
S. 45ZA(2) of the Banking Regulation Act, 1949 merely puts the nominee in the
shoes of the depositor after his death and clothes him with the exclusive right
to receive the money lying in the account. It gives him all the rights of the
depositor so far as the depositor’s account is concerned. But by no stretch of
imagination does it make the nominee the owner of the money lying in the
account. The Banking Regulation Act, 1949 is enacted to consolidate and amend
the law relating to banking. It is in no way concerned with the question of
succession. All the monies receivable by the nominee by virtue of S. 45ZA(2)
would, therefore, form part of the estate of the deceased depositor and devolve
according to the rule of succession to which the depositor may be governed.
22 Partnership at will —
Notice given by one partner specifically stating that thereby he was dissolving
the firm — Partnership would stand dissolved — Partnership Act, 1932; S. 7 and
S. 42.
[ Hukumchand Bhaulal
Patani & Ors. v. Dhanlal Premraj Kale & Ors., AIR 2010 (NOC) 1106 (Bom.)]
The Respondent Nos. 1 to 3
were the original plaintiffs. They had filed the suit for declaration that the
partnership firm in the name and style ‘H.B. Patani & Company’ had been
dissolved and for settlement of accounts with interest on the amount due. The
Trial Court decreed the suit declaring that the partnership had been dissolved
on 20-1-1980 and the share of the plaintiffs in the partnership firm was ½ and
that of the present appellants ( original defendants Nos. 1 to 5) was ½.
The partnership was for
dealing in kerosene and crude oil. Premchand Kale had ½ share and the appellant
Nos. 1 to 5 who formed a joint family had ½ share in the partnership. The
partnership was at will and therefore a partner had a right to terminate
partnership with three months’ notice. The appellant No. 1 Hukumchand had joined
the partnership as Karta of the Joint Undivided Hindu Family (‘HUF’) of the
appellant Nos. 1 to 5. By notice dated 26-10-1979, Premraj Kale terminated the
partnership. In the circumstances suit was filed. It was also stated that due to
death of Premraj Kale on 14-12-1980 also, the partnership had come to an end. It
was also said that after the dissolution of the partnership firm, the defendant
appellants did not have right to do business in the property of the plaintiffs.
The decree passed by the Trial Court for declaration and settlement of account
was confirmed, which was challenged in the second appeal. The Court held that S.
7 of the Indian Partnership Act, 1932 defines ‘partnership at will’ to mean that
where no provision is made by contract between the partners for the duration of
their partnership, or for the determination of their partnership, the
partnership is ‘partnership at will’. S. 43 prescribes the manner for
dissolution of partnership at will. It says that where the partnership is at
will, the firm may be dissolved by any partner by giving notice in writing to
all the other partners of his intention to dissolve the firm. As per S. 42(c),
subject contract between the partners a firm is dissolved by the death of a
partner. In the case, there was nothing to show that the partnership deed
indicates that even after the death of one partner, another partner was entitled
to continue the partnership firm. So, in the absence of any specific term in the
deed of partnership for its continuation after the death of one of the partners,
it is to be presumed that after the death of Premchand, the partnership firm
stood dissolved in terms of S. 42(c) of the Partnership Act.
There were only two partners
in the partnership firm, namely, Hukumchand who was admitted as Karta on behalf
of HUF and Premchand who was admitted in his individual capacity. There was no
provision in the partnership deed to include any new partner by either partner
or by the surviving partner. So, it does not appear that the partnership firm
was expected to continue even after the termination notice by Premchand or
subsequent to his death. There was no provision in the partnership deed for
taking a new partner in place of the retired or died deceased partner. The
partnership was at will and it had come to an end and stood dissolved as a
result of notice given by Premchand specifically stating that he was dissolving
the partnership firm, so also by his subsequent death.
Apart from the above carve-outs, certain other deviations can also be expected e.g., different accounting treatment for Foreign Currency Convertible Bonds (FCCB), existing Indian GAAP carrying value of the fixed assets may be considered as ‘deemed cost’ as on the transition date, treatment of foreign exchange differences, etc.
Moreover with tax authorities still holding the cards close to their chest, it appears that the converged accounting standards may not be acceptable for tax filings for next three to five years and till then the current Indian GAAP would be used for tax purposes. This will ultimately result into three sets of financial statements being pre-pared by Indian companies.
In any debate on convergence or adoption or carve-outs, India must first aspire to uphold the purity of IFRS and be fully IFRS-compliant nation and second it should take a stand that it has full belief in the proposed deviations as being the best practices and then the confidence and conviction to influence the International Accounting Standards Board (IASB) through consensus about what it believes is right and the need to bring the required improvement/amendments in IFRS rather than remaining as a carved-out nation. We cannot just take short-term nationalist and local view rather we need to take long-term global view on IFRS.
If carve-outs/deviations are managed with this objective and attitude, then India and Indian entities would benefit in the long term.
The Foreign Contribution
Regulation Act, 2010 (FCRA 2010) is an enactment that is relatively unknown even
to practising Chartered Accountants. Besides it is a law where compliance is
difficult to monitor and implementation presents practical difficulties. The
result is that the law is often practised in breach.
It was felt that the earlier
Act of 1976 (FCRA 1976) required a complete overhaul as it had failed to keep
pace with the changing face of India’s economic growth. In fact there was a
lobby that felt that the law had outlived its utility and needed to be scrapped.
Particularly after the introduction of the Prevention of Money Laundering Act,
2002, it was felt that FCRA did not serve any meaningful purpose.
In this article we will
discuss the basic provisions of FCRA 2010 with particular focus on the changes
brought about vis-à-vis FCRA 1976. It may however, be noted that the Act
has not yet received assent of the President and will come into force only
thereafter, on such date as is notified in the Official Gazette by the Central
Government.
The basic purpose of FCRA
2010 as mentioned in the preamble to the Act is “to
consolidate the law to regulate the acceptance and utilisation of foreign
contribution or foreign hospitality by certain individuals or associations or
companies and to prohibit acceptance and utilisation of foreign contribution or
foreign hospitality for any activities detrimental to the national interest and
for matters connected therewith or incidental thereto.”
It is generally believed
that both these Acts cover only the Non-Profit Organisations (NPOs) and not
others. It is true that organisations having a definite cultural, economic,
educational, religious or social programme are specifically covered. However, it
also covers persons in sensitive government positions, political parties and
persons associated with the news media. After all, the avowed purpose of the Act
is to regulate and prohibit acceptance and utilisation of foreign contribution
for any activities detrimental to national interest. As such the provisions of
FCRA 2010 can be broadly classified in the following three categories and we
will discuss each of them separately :
(1) Prohibition on certain
persons from accepting foreign contribution.(2) Restriction on certain
persons from accepting foreign hospitality.(3) Regulating the
acceptance of foreign contribution by persons having a definite cultural,
economic, educational, religious or social programme. NPOs are covered under
this category.
Before we discuss the above,
it is essential to understand two most important terms used in both the Acts.
Foreign contribution :
Foreign contribution is
defined to mean any donation, delivery or transfer made by a foreign
source of any article, currency (whether Indian or foreign) or any
security. It will be appreciated that the definition is very wide both in terms
of coverage and the mode of transfer of the assets covered. It brings within its
ambit not only money, but practically any asset transferred from a foreign
source. It covers all modes of receipt of foreign contribution, be it transfer,
gift or delivery in any manner. Even advance or loan received from a foreign
source would be treated as foreign contribution.
The definition is also broad
enough to cover any indirect receipt from a foreign source. Even if the money or
article is routed through several intermediaries, it will not be cleansed of
being treated as foreign source if the original source is foreign.
The only exception is with
regard to gifts received for personal use, and that too only if the market value
of the article gifted is not more than such sum as may be specified in the rules
to be framed by the Central Government. Under FCRA 1976, the monetary limit was
set in the Act itself at Rs.1,000 which was found grossly inadequate, as it had
failed to keep pace with inflation and the consequent depreciation in the value
of money. Hopefully, the rules will not only set a more realistic limit (say
Rs.50,000), but will also periodically revise the same.
The definition of foreign
contribution created all kinds of practical difficulties and FCRA 2010 has
sought to address some of them. An explanation is inserted to the definition of
foreign contribution to provide that any amount received by any person from a
foreign source by way of fee (including fees charged from foreign students) or
towards cost in lieu of goods sold or services rendered by such person in the
ordinary course of business, trade or commerce, whether within or outside India,
shall not be treated as foreign contribution. As such fees paid by a foreign
student for enrolment to an Indian educational institution or fees for enrolment
to any seminar or workshop will not be treated as foreign contribution.
Though this seems to be a
well-intentioned change, it leaves several problems unattended. Only the cost in
lieu of goods sold and services rendered is excluded from the definition of
foreign contribution. What if the goods are sold or services rendered by adding
a nominal margin ? In any case how would one determine the exact cost, would it
include overheads or not ? Even if the NPO has no intention of making profits,
it might realise some surplus, as it would price its product or service based on
certain costing assumptions. It would be impossible to arrange the affairs in
such a manner that sale proceeds exactly match the cost. If the NPO has
recovered even one rupee above the cost, would it lose the benefit of the
explanation ? Clearly, restricting the explanation only to the cost will be
practically unworkable and self-defeating.
Another interesting example is that of a temple trust offering the facility of online Aarti at a charge. If the payment is from a person who is not a citizen of India, then it would be treated as foreign contribution and would not qualify for exemption as the payment cannot strictly be treated as ‘fees’, nor can it be said to be for services in the ordinary course of trade, commerce or business.
Further, the term ‘goods or services rendered in the ordinary course of business, trade or commerce’ seems too restrictive and will hopefully be liberally interpreted to also cover goods sold or services rendered by the NPO in the course of carrying out its charitable activities.
Foreign source:
To understand the meaning of the term foreign contribution, one has to understand the term foreign source. This is an inclusive definition, again with a very wide coverage. It covers a foreign government or its agency, any international agencies (other than certain specified agencies such as United Nations, World Bank, etc.), foreign citizen, foreign company, any other foreign entity such as trade unions, trusts, societies, clubs, etc. formed or registered outside India. It also covers multi-national corporations and any company where more than 50% of the share capital is held by foreign government, entity or citizen.
Receipts from foreign citizen are considered as foreign source and hence by implication one could argue that amounts received from Indian citizen would not be treated as foreign source. As such, even foreign currency would be treated as received from Indian source, if it is received from an Indian citizen. The basic principle is to determine the source from which the currency or asset is being received. If the source is Indian, then it does not matter whether the currency is Indian or not. Conversely, if the source is foreign, then even if the receipt is in Indian Rupees, the same would be considered as foreign contribution.
Multi-national company has been defined to mean a corporation incorporated in a foreign country if it has a subsidiary or branch or place of business in two or more countries, or otherwise carries on business or operations in two or more countries. Thus a foreign company having operations in any one or more country besides India would fit into this definition. For example several foreign banks operating in India would fall under this category.
What is most damaging is that even Indian companies where foreign shareholding is more than 50% would be treated as foreign source. With liberalised FDI norms and also liberalisation of permissible foreign investment limits in listed Indian companies, there are several Indian companies where the foreign holding is more than 51%.
Any donations received from such companies (for example, Hindustan Unilever, HDFC, ICICI Bank, etc.) or even from branches of foreign companies (for example, Citibank, Standard Chartered Bank, etc.) would be treated as foreign contribution. Such companies cannot give donations to Indian trusts or even place advertisements in souvenirs brought out by such trusts, unless the trusts are either duly registered with the Central Government or have taken prior permission for receiving such donation. It was hoped that this situation would be remedied in FCRA 2010, but unfortunately the position has remained practically unaltered or has been made even more stringent.
Now let us examine the provisions of FCRA 2010 from the three broad categories as enumerated above.
Prohibition on certain persons from accepting foreign contribution:
The following persons are prohibited from accepting foreign contribution:
(a) Candidate for election;
(b) Correspondent, columnist, cartoonist, editor, owner, printer or publisher of a registered newspaper;
(c) Judge, government servant or employee of any entity controlled or owned by the govern-ment;
(d) Member of any Legislature;
(e) Political party or its office bearers;
(f) Organisations of a political nature as may be specified;
(g) Associations or company engaged in the production or broadcast of audio news or audio-visual news or current affairs programmes through any electronic mode or form or any other mode of mass communication;
(h) Correspondent or columnist, cartoonist, editor, owner of the association or company referred to in (g) above.
However, foreign contribution can be accepted by the above-mentioned persons in the following specific situation:
(a) By way of remuneration for himself or for any group of persons working under him;
(b) By way of payment in the ordinary course of business transacted in or outside India or in the course of international trade or commerce;
(c) As agent of a foreign source in relation to any transaction made by such foreign source with the Central or State Government;
(d) By way of gift or presentation as a member of any Indian delegation. However, the gift or present should be accepted in accordance with the rules made by the Central Government;
(e) From his relative;
(f) By way of any scholarship, stipend or any payment of like nature.
It is important to note that barring the above exceptions, there is blanket prohibition on the above-mentioned persons from accepting foreign contribution. The provisions are extremely stringent and are reminiscent of the FERA days where a foreign exchange offence was considered as destroying the economic fibre of the country and hence was to be dealt with as ruthlessly and strictly as a criminal offence.
It is clear that the above prohibition is in order to protect ‘national interest’, which can be a very ubiquitous term. However, whatever the intention, it is quite evident that FCRA 2010 has failed to keep pace with the liberalised exchange control regulations. For example, FDI is permitted to the extent of 26% in news and current affairs TV channels. However, under FCRA 2010, companies engaged in production of such TV programmes or their key employees cannot accept foreign contribution. Mercifully, amounts received in the ordinary course of business or in the course of international trade are exempt.
Interestingly, correspondent, columnist, cartoonist, editor, owner, printer or publisher of registered newspapers were covered by FCRA 1976, but the same did not cover such persons connected with the audio-visual and the electronic media. Perhaps this was because in 1976 the radio and the TV channels were Government controlled and did not have the kind of foreign participation that we have today. As such they were not considered sensitive areas from the perspective of national interest. FCRA 2010 now covers both the print and the electronic media.
The language used for bringing the electronic media and its key personnel within the ambit of FCRA 2010 seem out of place with reference to the television and audio industry. The terms ‘columnist, cartoonist, etc.’ are borrowed from the old clause under FCRA 1976 relating to print media, and seem quite inappropriate in the context of the electronic media.
Under FCRA 1976, even gifts received by the above category of persons required previous permission of the Central Government, if the value of the gift exceeded Rs.8,000 per annum. Even where the value of the gift was less than Rs.8,000, the Central Government was required to be intimated about the details of the gift. Mercifully, FCRA 2010 now gives specific exemption in respect of foreign contribution received from a relative as defined under the Companies Act, 1956.
Restriction on certain persons from accepting foreign hospitality:
FCRA 1976 as well as FCRA 2010 prohibit members of Legislature, office bearers of a political party, judges and government servants from accepting any foreign hospitality except with the prior permission of the Central Government. It is not necessary to obtain such prior permission in case of medical emergency outside India. However, even in such medical emergency, the person receiving the hospitality is required to intimate the Central Government about the receipt of such hospitality, the source from which and the manner in which the hospitality was received by him within one month.
Foreign hospitality is defined to mean any offer, not being a purely casual one, made in cash or kind by a foreign source for providing a person with the costs of travel to any foreign country or with free boarding, lodging, transport or medical treatment.
It is interesting to note that a purely casual offer is not considered as foreign hospitality. But it is not clear as to what kind of offer would be considered as a ‘purely casual’ one.
Regulating the acceptance of foreign contribution by persons having a definite cultural, economic, educational, religious or social programme:
NPOs are directly affected by the provisions of FCRA (both FCRA 1976 and 2010), and the Government closely monitors the inflow of foreign contribution into this sector.
Both under FCRA 1976 and FCRA 2010, any individual or organisation carrying out a definite cultural, economic, educational, religious or social programme is required to be registered with the Central Government or obtain prior permission of the Central Government before accepting any foreign contribution. Such an NPO cannot in turn transfer the foreign contribution received by it to any other person unless such other person is also registered or has obtained prior permission.
The process of registration is stringent and fraught with bureaucratic process. Unless the NPO has a track record of at least three years, as a matter of practice, registration has generally not been granted under FCRA 1976. Under FCRA 2010, the requirement of having a track record is now codified, as the Act specifically provides that before granting registration, the Central Government shall verify whether the NPO has undertaken reasonable activ-ity in its chosen field for the benefit of society. If the NPO is not able to fulfil the requisite conditions for registration, then the only alternative would be to apply for prior permission, which would be valid only for the specific purpose and source for which it is obtained. Even for prior permission the NPO would have to show that it has a reasonable project for the benefit of society for which the foreign contribution is proposed to be utilised.
The Central Government, before granting registration or prior permission, is required to ensure that the person or organisation is in no way working to the detriment of national interest. For example, (and the below-mentioned items are only illustrative) it should not be engaged in?:
(a) Religious conversion through inducement or force;
(b) Creating communal tension or disharmony;
(c) Propagation of sedition or advocating violent methods to achieve its ends;
(d) Undesirable purposes.
Besides, permission can be denied if the acceptance of foreign contribution is likely to affect prejudicially the sovereignty and integrity of India or is against the security, strategic, scientific or economic interest of the State; or is opposed to public interest.
This clearly brings out that the Central Government has almost absolute powers to deny registration or prior permission. The manner in which some of the above criteria can be interpreted is extremely subjective and fear is that too much power is placed in the hands of the bureaucracy and this may lead to undesirable consequences.
Under FCRA 1976, prior permission was relatively simpler to obtain as compared to registration and was generally granted within 90 days if the paper-work was proper. Under FCRA 2010, it is specified that application for registration or prior permission should, after inquiry, be ordinarily granted within 90 days of the application or the Government should communicate the reasons for not granting the same. No specific consequences are provided for not processing the application within the 90 days and hence the provisions are rightly viewed with a great deal of skepticism, as it is unlikely that the sanctity of the time frame of 90 days will be observed.
What is worst is that the certificate for registration is now valid for a period of five years, after which the registration process will have to be repeated. This is in deviation of the present situ-ation under FCRA 1976 where registration once granted is valid for the lifetime unless specifically revoked. The Central Government has wide powers under specified situations to cancel the certificate of registration, after making such inquiry as it deems fit. For example, the certificate can be cancelled if the NPO has obtained the same by making false statements or has violated any terms and conditions of registration or of FCRA or its rules or it is necessary to do so in public interest. The certificate can also be cancelled if the NPO has not been engaged in any reasonable activity for the benefit of society for two consecutive years. Foreign contribution can be received only in a single designated bank account and it is not permissible to open multiple bank accounts. Of-ten funding agencies demand that separate bank account be opened specifically to manage and monitor the foreign contribution sent to India by them. Unfortunately that is not permitted under FCRA and needs to be clearly explained to the funding agencies.
Often trusts have projects in far-flung and remote places and it is always advisable to open a bank account at the project site. Recognising this need, it is provided that more than one bank account can be opened for actual utilisation of such foreign contribution. Such bank account is popularly referred to as project account and typically, the funds are transferred from the designated account, to the project account for direct spending on the project. No other deposits are allowed to be made in such project account as they are meant only for disbursement of expenses. Such project accounts were permitted under FCRA 1976 also by way of administrative directions, but under FCRA 2010, the same is legitimised by a specific provision in the Act itself.
This restriction on opening separate bank ac-counts, throws up some tricky problems for trusts carrying out work in remote areas. What if the trust engaged in micro credit activity receives foreign contribution as part of its revolving fund and from such fund gives petty loans to local artisans? Arguably, the loan recovered would go back into the revolving fund and would continue to be treated as foreign contribution. The amount recovered could be less than Rs.100 but it would not be possible to deposit the same in the project account, and would have to be physically carried to be deposited in the designated bank account, which may be at the head office far from the field office. Similarly any expenses reversed or any re -imbursement received cannot be re-deposited in the project account from where it was made in the first place and will have to be deposited only in the main designated account. Therefore, the problem that existed under FCRA 1976 will continue to trouble NGOs under FCRA 2010 as well.
Surplus funds in the designated bank account can be invested in approved assets. However, there is a specific ban on using such assets for speculative business. Rules will be made to specify which activities will be construed as speculative business. The investments as well as the income from such investments will continue to be characterised as foreign contribution and accordingly the interest earned or proceeds realised on encashment of the investments will have to be re-deposited in the designated bank account.
The NGOs will have to maintain records and accounts in the prescribed manner and intimation will have to be sent to the Central Government reflect-ing the amount of each contribution received, its source and manner in which the same was utilised. The designated bank also has to report the details of the foreign contributions routed through them directly to the specified authority.
In recent times concerns have been raised that trusts do not spend adequate amounts on their core objects. There isn’t enough transparency in the administration of the trusts, resulting in disproportionately high administrative expenses. Apparently to address these concerns, further controls over trusts are introduced, providing that not more than 50% of the foreign contribution received in a financial year by the trust shall be utilised to meet administrative expenses. Administrative expenses exceeding 50% can be defrayed only with the prior approval of the Central Government, which will prescribe the elements that will be included in the administrative expenses and the manner in which such administrative expenses shall be calculated.
Scholarships and stipend:
Under FCRA 1976, scholarship, stipend or any payment of like nature from any foreign source, received by any citizen of India was required to be intimated to the Central Government within the prescribed time and manner. There were some exceptions and relaxation, but by and large this was one provision that was most often observed in breach. Very few, if any, were actually intimating the Central Government about the scholarship or stipend received by them.
Fortunately the FCRA 2010 has done away with the requirement of intimating the Central Government about the receipt of such scholarship or stipend. In fact, even persons who are prohibited from accepting foreign contribution (as discussed above) are free to accept scholarship or stipend, as a specific exception has been carved out for the same.
In summary:
The FCRA 2010 is by and large an old wine in a new bottle. Unfortunately, in a lot of respects the provisions have been made far more stringent than what they were under FCRA 1976. Philanthropy is ingrained in the Indian psyche and a vast number of organisations do yeoman work, they serve the most basic problems of the neediest of the needy, where government machinery has woefully failed. Such organisations need to be encouraged and provided with a framework where they can function efficiently and effectively. However the reality is that charitable trusts have found themselves targeted from several sides in recent years. It is unfortunate that for the misdeeds of a few, all charitable entities have to deal with punitive legislation. The Foreign Contribution Regulation Act, 2010 is one more of such regulations that is only going to add to the already onerous burden that such trusts have to endure.
20. Will — Suspicious
circumstances — Attestation of Will Succession Act, S. 63.
[Smt. Subasini
Choudhary v. Smt. Bisakha Kar & Ors., AIR 2010 Orissa 174.]The petitioner had filed
the said case for probate of a Will u/s.276 of the Indian Succession Act. The
case of the petitioner was that the residential house site over plot No. 3 in
Unit-III, Bhubaneswar City belongs to late Rama Chandra Kar, S/o. Late
Banchhanidhi Kar of Dargha Bazar, Cuttack. The said Rama Chandra Kar died on
5-3-1996. Before his death, he executed his last Will and testament in favour
of the petitioner on 14-11-1995 in presence of witnesses. When the matter was
pending before the Court below, a finding has been recorded in the impugned
order that in spite of sufficiency of service of notice, the opp. parties, who
were arrayed as parties, did net appear in the said case, except the State of
Orissa. The lower Court below, ultimately dismissed the Probate Misc. Case.
The Court observed that there is nothing in law which requires the
registration of a Will and Wills are in a majority of cases not registered at
all. The Supreme Court in the case of Ishwardeo Narain Singh, AIR 1954 SC 280
held that to draw any inference against the genuineness of the Will on the
ground of its non-registration was wholly unwarranted.In the instant case, there
are materials appearing on the face of the Will that the testator was
neglected by all his kith & kin which by implication includes his daughter
also. It was therefore, more fortified that no suspicious circumstances can be
presumed as because, the testator had only one daughter who was debarred by
execution of the Will. It is well settled in law that the mode of proving the
Will does not ordinarily differ from that of proving any other document except
as to the special requirement of attestation prescribed in the case of a Will
in S. 63 of the Indian Succession Act. The onus of proving the Will is on the
propounder and in the absence of suspicious circumstances surrounding the
execution of the Will, proof of testamentary capacity and the signature of the
testator as required by law is sufficient to discharge the onus. Slight
discrepancy in their evidence is plausible when they are giving evidence after
a gap of eight or nine years.
29 Hindu Law — Joint family property inherited by brothers
from their father — Not a coparcenary Hindu joint property.
[Hardial Singh v. Nahar Singh, (Deceased through LR’s
& Ors.) AIR 2010 (NOC) 1087 (P&H)]
The plaintiff (present respondent) brother of Inder Singh
claimed that the disputed suit land to be joint Hindu coparcenary property of
the plaintiff and the defendant. The defendant was the Karta of joint Hindu
family. Suit land was inherited by the plaintiff and the defendant from their
father Pali alias Nika Singh who had inherited it from his father.
It was the case of the plaintiff that the defendant was not
competent to transfer the suit land without legal necessity. Therefore, the
transfer was said to be against the law. The Trial Court held that suit property
was joint Hindu family coparcenary property. The Appellate Court further held
that the half share of the property inherited by the plaintiff’s father Shri
Pali was ancestral.
The Court held that the property, even if joint between the
plaintiff and the defendant, could only be treated to be the joint property and
not Hindu joint coparcenary property.
The Court further observed that a father cannot change the
character of the joint family property into absolute property of his son by
merely marking a will and bequeathing it or part of it to the son as if it was
the self-acquired property of the father. In the hands of the son, the property
will be ancestral property and the natural or adopted son of that son will take
interest in it and be entitled to it by survivorship, as joint family property.
However, an affectionate gift of his self-acquired property by a father is not
ipso facto ancestral property in the hands of the son.
Property inherited by a Hindu male from his father, father’s
father, or father’s father’s father, is ancestral as regards his male issue,
even though it was inherited by him after the death of a life-tenant. Thus, if a
Hindu settles the income of his property on his wife for her life, and the
property after her death passes to his son as his heir, it is ancestral property
in the hands of the son as regards the male issue of such son.
Thus, when the property is held by brothers, it could be said
to be only joint property in their hands, but not a coparcenary Hindu joint
property in which the plaintiff could claim interest by birth qua the share of
the defendant.
30 Internal communications within Government
Departments/Officer — Not govt. order unless issued in accordance with law.
[ UOI & Anr. v. Kartick Chandra Mondal and Another,
AIR 2010 SC 3455]
The respondents Shri K. C. Mondal and Shri S. K. Chakraborty,
were engaged to work as casual labours in the office of the Ordnance Factory
without going through the regular process of recruitment of their names being
sponsored by the Employment Exchange, which was the extant policy at the
relevant point of time. After their engagement as casual labours, they worked
for two years with appellant no. 2, i.e., till 1983 and they were
disengaged from service in the month of April, 1983 on the ground that their
names were not sponsored by the Employment Exchange.
The respondents thereupon filed an application before the
CAT. The Tribunal, granted the prayer of the respondents on the ground that 10
other similarly placed casual workers of the Ordnance Factory Board were
regularised. The Tribunal relying on a office memo issued a direction to the
appellants to re-engage the respondents as casual labours if there was
work/vacancy in preference to freshers and those who rendered lesser length of
service as casual labours.
The Court held that the said office memorandum stated that
the same would apply only to those persons who might have been continuing as
casual workers for a number of years and who were not eligible for regular
appointment and whose services might be terminated at any time. Therefore, it
envisaged and could be made applicable to only those persons who were in service
on the date when the aforesaid office memorandum was issued. Unless and until
there is a clear intention expressed in the notification that it would also
apply retrospectively, the same cannot be given a retrospective effect and would
always operate prospectively. Further the aforesaid communication were exchanged
between the officers at the level of board hierarchy only. An order would be
deemed to be a Government order as and when it is issued and publicised.
Internal communications while processing a matter cannot be said to be orders
issued by the competent authority unless they are issued in accordance with law.
The Court further observed that even assuming that the
similarly placed persons were ordered to be absorbed, the same if done
erroneously cannot become the foundation for perpetuating further illegality. If
an appointment is made illegally or irregularly, the same cannot be the basis of
further appointment. An erroneous decision cannot be permitted to perpetuate
further error to the detriment of the general welfare of the public or a
considerable section. This has been the consistent approach of the Court.
28 Appeal — Order — Non-reasoned order — Absence of reasons
suggestive of order being arbitrary and in breach of principle of natural
justice.
[Shapoorji Pallonji & Co. Ltd. v. Commissioner of C. Ex.
Pune-1, 2011 (263) ELT 206 (Bom.)]
The appeal was filed by the assessee against the order passed
by CESTAT. The appellant challenged the order of the Tribunal for want of
reasons and contended that the impugned order was arbitrary. It was submitted
that the impugned order of the Tribunal was arbitrary and suffered from
non-application of mind.
The issue that arose for consideration was whether it was
permissible for the Tribunal to brush aside the submission advanced by the
appellant without threadbare discussion and without recording reasons in support
of the view taken.
The Court held that the impugned order passed by the Tribunal
did not state any reasons for the view taken. In absence of reasons in support
of the order it was difficult to assume that the Tribunal had properly applied
its mind before passing the order directing predeposit.
It was further observed that no doubt, it was true that there
is no precise statutory or other definition of the term ‘arbitrary’.
Arbitrariness in making an order by the authority manifests itself in different
forms. Non-application of mind by the authority making an order was only one of
them. Every order passed by the judicial or quasijudicial authority must
disclose due and proper application of mind by the person making the order. This
may be evident from the order itself or the record contemporaneously maintained
by the authority. Application of mind is best demonstrated by disclosure of its
mind by the authority making the order. Absence of reasons either in the order
passed by the authority or in the record contemporaneously maintained, is
clearly suggestive of the order being arbitrary and in breach of the principles
of natural justice, hence illegal and unsustainable. In the result, the impugned
order was set aside.
27 Appeal — Defect in Memorandum of Appeal filed by
Department.
[Commissioner of C. Ex and Customs, Daman v. J. M. Mehta,
2011 (263) ELT 57 (Guj.)]
During the course of hearing of appeals filed by the Revenue
against a consolidated order passed by CESTAT, various errors/defects had been
noticed; one of the principal error being non-swearing of the affidavit
accompanying each of the appeals and non-mentioning of the dates on which the
appeal Memorandum had been signed. In each of the appeals various fundamental
defects had occurred rendering the appeals invalid in law.
The deponent stated that the affidavit was signed for and on
behalf of the appellant viz. the Commissioner without specifying as to
whether the said gentleman had been authorised to make the affidavit for and on
behalf of the appellant. The affidavit was neither sworn before a Judicial
Magistrate, nor an Executive Magistrate, nor a Notary Public, nor any other
Gazetted Officer who is empowered to administer the oath. Thus, the affidavit
was a mere sheet of paper without being an affidavit as understood in the legal
parlance.
Thus, the appeals had been filed in contravention of the
statutory requirements of High Court Rules and were not valid appeals in the
eyes of law. However, bearing in mind the larger interest of the exchequer, the
appeals were not dismissed as such and permission was granted to withdraw the
appeals so as to enable the appellant to prefer fresh set of appeals.
However, in order that such serious lapses do not recur the
same was brought to the notice of the persons higher up in hierarchy so as to
enable them to put in place an appropriate procedural machinery.
26 Amalgamation — Conveyance — Order of Company Court
approving scheme of amalgamation resulting in transfer of property to transferee
company is a conveyance — Indian Stamp Act 1899, S. 2(10), (14).
[Delhi Towers Ltd. v. G.N.C.T. of Delhi, (2010) 159
Comp. Cas 129 (Del.)]
The applicant was aggrieved by refusal of the authorities of
the Government of NCT of Delhi to accept the scheme of amalgamation approved by
the Court in exercise of jurisdiction u/s.394 of the Companies Act, 1956 without
the payment of a stamp duty.
It was urged that the stamping authorities are not accepting
the scheme of amalgamation without payment of stamp duty thereon.
The Delhi High Court held that a proposed scheme of
amalgamation of companies is a voluntary act of the parties (companies) without
any compulsion, statutory or otherwise at all. The scheme when approved by the
majority of members and creditors, binds the minority dissenters as well. The
Court exercises only a supervisory jurisdiction while examining it. No element
of adjudication is involved in the order of approval. The Court is not empowered
to consider the merits of the terms on which the scheme for amalgamation has
been proposed by the consenting parties. The role of the Court is confined to
considering whether the scheme was not violative of the principles of law,
public policy, and was not opposed to public interest. The order of approval of
the scheme results in amalgamation and absorption of the assets and assets and
liabilities of the transferor company with those of the transferee company which
includes immovable property.
It is the “instrument whereby property is legally and
equitably transferred” which is made liable for payment of stamp duty. Section
349(2) of the Companies Act, 1956 provides that the properties and liabilities
of the transferor company stand transferred to the transferee company by virtue
of the order of the Court. The statute does not provide any exception to the
definition of ‘instrument’ or ‘conveyance’. Transfer of property on effectuation
of a scheme of amalgamation after its acceptance by the approval of the Court is
not a transfer by any statutory prescription. Merely because a scheme for
amalgamation requires approval by Court, it makes no difference at all to its
real nature. It is nothing better than and remains a compromise or settlement.
It would be immaterial for chargeability to stamp duty that approval and
effectuation of the scheme or arrangement required Court intervention by way of
the necessary approval. Thus, for the purposes of imposition of stamp duty, it
would be immaterial whether the conveyance was by operation of law, statutory
operation, or by virtue of a private contract between parties. Exemption has to
be by specific statutory provision.
Section 2(10) of the Indian Stamp Act, 1899 contains an
inclusive definition of ‘conveyance’. The definition of ‘conveyance’ in the
Bombay Stamp Act, 1958 was an inclusive definition. The amendment to that Act by
the Maharashtra Act No. 27 of 1985 was only with a view to setting at rest any
doubts and to clarify and explicitly state what was already included in the
unamended definition of conveyance. A scheme of amalgamation approved by a Court
in exercise of jurisdiction under the Companies Act, 1956 and given effect
thereafter, where under property is conveyed from one company to another, was
covered within the unamended definition of the term ‘conveyance’ in the Bombay
Stamp Act as well. Merely because the Legislature has not amended the existing
statutory provision as applicable to Delhi to specifically include transfer of
property under an order approving a scheme of amalgamation in the definition of
conveyance, it does not amount to exclusion from applicability of the Indian
Stamp Act and chargeability to stamp duty thereon. The statutory definition of
‘conveyance’ u/s.2(10) of the 1899 Act is an inclusive definition of wide import
which cannot be confined to specific instruments mentioned in the statute. An
order passed by the Company Court in exercise of jurisdiction u/s.394 of the
Companies Act, 1956 approving a scheme of amalgamation proposed by the parties,
is covered under the definition of ‘conveyance’ u/s.2(10) of the Indian Stamp
Act, 1899.
A scheme of amalgamation which was placed before the Court
and stands approved u/s.391 to 394 of the Companies Act, 1956 would be covered
under the definition of ‘instrument’ as contained in Section 2(14) and would be
chargeable to stamp duty.
Accordingly, an approved scheme of amalgamation amounts to a
transfer inter vivos between two companies who were juristic persons in
existence at the time of passing of the order and sanctioning of the scheme
whereby right, title and interest in the immovable property of the transferor
company are transferred to the transferee company. The transfer takes place in
the present and is not postponed to any later date and is covered under the
definition of conveyance u/s.2(10) of the Stamp Act.
The trading environment is amongst the inherently more risky
control environments in any organisation. The susceptibility to fraud and the
ability of financial errors tends to be inherently higher in this area. The last
two decades have witnessed a large number of incidents comprising of frauds,
mismarking (valuation) and trading with excessive positions. Let’s get a closer
look at auditing a trading environment.
A typical trading environment is centred around the trader in
an organisation. The control environment around the trader comprises of a
supervisor who oversees his activities, back office or operations which performs
confirmation and settlement function, mid office which performs valuation and
analysis, finance, risk management and other control environment functions. Mid
office is known by different names in different organisations (including finance
and back office). However, the reference here is to the function which performs
valuations and analyses the profit & loss.
The following aspects tend to be the key areas in an audit of
trading environment :
1. Supervision :
Oversight by the trader’s supervisor(s) is a major control
point in a trading business. While this is not an independent function, the
supervisor will be in best position to spot any untoward trading or frauds. Key
elements of the audit should include a review of nature and quality of
information available on trading positions from independent functions, ability
of the supervisor to review the risks of trading positions on real-time basis
and role of the supervisor in monitoring abnormal events such as abnormal spurts
in profitability, risk positions and number of trades. Special emphasis should
be on review of trades at abnormal rates and surveillance mechanism to detect
circular trading, market manipulation and rate reasonableness review for
non-exchange traded products.
A number of frauds have occurred as trades have been
cancelled and rebooked or modified before being valued by valuation teams
(finance or mid office) and restored back to original status after a valuation
is done. This is done to artificially lower the cost of purchases before
securities or positions are valued (and calculation of profitability) and then
bring them to realistic values again after this is done. To counter this, all
cancellation of trades or modification of trades should be reviewed by the
supervisor as well as someone independent in back office/operations along with
reasons for the cancellation/modifications on a daily basis. The auditor should
assess if this process is working effectively.
Apart from daily trade reviews, it is important that the
traders are subjected to a mandatory leave policy without access to office
resources or communication and that they have no edit access to systems used for
valuation of securities/positions.
2. Settlement and confirmations functions :
Settlement function pertains to payment and receipt of funds
or securities (including shares and bonds). Confirmation pertains verifying
genuineness of trades either by matching with the exchange or with the
counterparty.
This function is commonly conducted by a back office (or
operations). This function may not be complex if the products are traded on
exchanges (like equity shares) or has a clearing house (like the bond trades
done on Negotiated Dealing System — Order matching) or has a confirmation
platform (like swap derivative trades). This is because the confirmation and/or
settlement is centralised with a clearing house which makes the process more
simple and quick. In all other cases, this may be complex.
The most important aspect to review in this area is the level
of independence of the back office/operations — both in form as well as
substance. While it is easy to assess the formal reporting lines to establish
independence, it is difficult to review whether the back office is independent
in substance. Matters such as exception reports, rigour of follow-up of open
items, decisions taken by the back office/operations head in conflicting
situations generally demonstrate their independence.
Apart from this, a review of design of process, adequacy,
quality and past experience of staff are important.
One of the other big risk factors in the back
office/operations processes pertains to segregation of duties and oversight to
avoid one person having too much control in their hands :
In case, the products are not exchange-traded or not settled via a clearing house, confirmations are obtained from each contracting party (counter-party) separately. At times, it may take time to obtain this. In such cases, focus on follow-up of aged outstanding confirmations and ability to enforce the legality of trade in light of confirmation being challenged are additional factors to be reviewed.
3. Valuations:
Valuation of portfolio/positions is usually performed by a mid office (in case there is one) or finance team. This may be a simple matter of picking last traded rates from an exchange quotation or can be complex in case the prices for valuation are not easily available. These have historically been areas of a number of frauds and mismarking incidents globally.
The auditor should review the policies and procedures for valuation. In case the products are exchange-traded (or valuation rates are easily available) the following matters should be looked at with a significant sense of judgment?:
In case, rates for valuations are not easily available, additional factors such as independence of those agencies or parties providing rates and ability of them to be able to correctly capture market be-haviour also needs to be reviewed.
Lastly, one also needs to consider the nature of profitability analysis. The valuation function should analyse and circulate a P&L explain statement regularly (preferably daily) which highlights where and why the organisation made trading revenues and losses. This goes a long way in understanding what trading activity is being conducted and whether profits are from genuine trading opportunities.
4. Risk management:
Risk management, is usually an independent group which oversees various risks emanating out of trad-ing. The most closely watched risk in a trading environment is market risk followed by credit risk.
Market risk:
While organisations having significant trading ac-tivities would usually implement a key element of market risk, such as Value at risk/DV01 or DeAR, depending on size and complexity, the auditor needs to evaluate whether a more granular structure is needed. In more complex trading scenarios, market risk should have a granular limit structure to monitor all applicable metrics (or Greeks) of market risks. The auditor also needs to consider reviewing the accuracy of risk metrics generated by risk systems/risk management. At times, use of external experts may be desirable to confirm accuracy of risk and valuation models. Market risk utilisation reports should be circulated to an important level of management and governance committees (where applicable). Finally, the limit setting process itself and level of limit utilisation are important factors to be looked at.
Credit risk:
While this may not apply in certain products, it is essential that any credit risk pertaining to customers and counterparties is monitored and captured. In case of derivative instruments, a reasonable measure needs to be devised to convert notional exposure to measurable credit risk metric.
5. Regulatory reporting:
Regulatory reporting requirements for organisations trading in equity shares (companies) are not significant. However, they are significant for a bank, insurance or an NBFC which trades more in fixed income or foreign exchange products.
Sustainability of reporting process including adequacy of staff, timeliness of reporting and accuracy of reporting tend to important from a regulatory reporting standpoint. Sustainability can be achieved by adequate trained back-up staff. Timeliness needs to be monitored by use of calendars and reporting checklists. Accuracy needs to be evaluated carefully. For automated reports the logic of items captured for reporting needs to be evaluated. For manually prepared reports, experience of staff and adequacy of documented procedures becomes important.
6. Technology and continuity:
Technology or systems are the back bone of trading environment. While system development, vendor support, etc. may be linked to an audit of trading activity, strictly this may not fall in a routine review of trading activities. Instead, robustness of systems, stability, capacity, security, access controls and reconciliations assume more importance in trading. The first three aspects may be investigated along with help of technology department by use of technical reports.
System security and access controls go a long way in avoiding unauthorised access and trading frauds. A regular review of access privileges (both at system and database end) is a must. Care should be taken to verify if access controls have not been ‘cleaned’ only for the purpose of a specific audit.
Trading environment usually comprises of a number of systems. Trade flow between systems and reconciliation controls to ensure that all systems have correctly captured information need a close review. A few frauds could have been avoided if this detective control would have worked correctly.
Business continuity planning helps manage disruptions. Auditors should consider evaluation of business continuity testing conducted and ability of trading activity to resume business in various critical scenarios.
7. Oversight and governance routines by management:
Finally, the management oversight routines and governance routines form the next line of security for an organisation. Senior management reviews over performance of the trading activity is important. Performance review should not be confined to profitability — but should include how well the desk manages risks and adheres to internal guidelines. In larger organisations, governance groups like asset liability committees (ALCO) are formed. It is important to evaluate the substance of their review through MIS.
Trading environments continue to become more complex with increasing number of products. This area also witnesses more and more sophisticated techniques for frauds. Internal audits in these areas go a long way in safeguarding an organisation’s assets.
Some well-known incidents which led to large trading losses in history with reasons:
