Audit Committee and approval of Related Party Transactions

The Companies Amendment Act, 2017 read with Notification S.O. 1833(E) dated 7th May 2018 amended law related to the audit committee. Certain transactions related to related parties shall be voidable unless ratified by the audit committee. In this post, we will discuss updated law related to approval of related parties in the audit committee.

Detail discussion in the law governing audit committee and its terms of references was posted earlier click here.

The term of reference suggested under clause (iv) of Section 177(4) – approval or any subsequent modification of transactions of the company with related parties -is one of most important and sensitive for corporate governance.

FIRST PROVISO

The Companies Amendment Act, 2015 with effect from 14th December 2015 inserted the first proviso to Section 177(4)(iv) as under:

“Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be entered into by the company subject to such conditions as may be prescribed;”

Rule 6A of the Companies (Meeting of the Board and its Powers) Rules, 2014 prescribes the procedure for omnibus approval as mentioned in the First Proviso to clause (iv) of Section 177(4). Rule 6A was as given below.

CONDITIONS

These conditions mentioned in Rule 6A are:

• The Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include criteria mentioned in Clause 6A(1);
• The Audit Committee shall consider the certain factors while specifying the criteria for making omnibus approval;
• The Audit Committee shall satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company;
• The omnibus approval shall contain or indicate certain details related to a transaction;
• Omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year;
• Omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company; and
• Any other conditions as the Audit Committee may deem fit.”

Criteria

According to Clause (1) of Rule 6A, the Audit Committee shall, after obtaining approval of the Board of Directors, specify the criteria for making the omnibus approval which shall include the following, namely:-

(a) the maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year;

(b) the maximum value per transaction which can be allowed;

(c) extent and manner of disclosures to be made to the Audit Committee at the time of seeking omnibus approval;

(d) review, at such intervals as the Audit Committee may deem fit, related party transaction entered into by the company pursuant to each of the omnibus approval made;

 (e) transactions which cannot be subject to the omnibus approval by the Audit Committee.

 The Audit committee may fix these criteria as a policy for omnibus approvals of related party transactions on annual basis. This policy shall have the approval of the Board of Directors. Related Party Transactions which fulfil these criteria may get omnibus approval otherwise case to case approval shall be required. Policy among other criteria shall have the maximum aggregate value of transactions for a financial year (contest here is the financial year), maximum value per transaction, and disclosure requirement. The policy shall also have provision for timely review of these omnibus approvals. The policy may exclude certain transaction from omnibus approval in addition to the other exclusions given in the law.

Factors

According to Clause (2) of Rule 6A, the Audit Committee shall consider the following factors while specifying the criteria for making omnibus approval, namely: –

(a) the repetitiveness of the transactions (in past or in future);

(b) the justification for the need of omnibus approval.

A related party transaction which is not of repetitive nature may not get omnibus approval, even if such transaction may take place more than one time. This is the duty of audit committee to consider justification for the need of omnibus approval.

Repetitive Nature

According to Clause (3) of Rule 6A, the Audit Committee shall satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such approval is in the interest of the company.

Repetitive nature is one prominent condition under this Rule for omnibus approval of related party transaction by the audit committee. Not only clause (3) put it as a condition but clause (2) put it a factor to be considered by audit committee while granting omnibus approval to a related party transaction. The audit committee has to satisfy that related party transaction under consideration for omnibus approval has repetitive nature to satisfy a condition under clause (3) and the factor of repetitiveness shall be considered to satisfy the condition under clause (2).

Such omnibus approval of related party transaction by the audit committee should be in the interest of the company. Any related party transaction disparaging the interest of company bound to be rejected by the audit committee and may subject to judicial or regulatory review.

Certain Details

According to Clause (4) of Rule 6A, the omnibus approval shall contain or indicate following details related to related party transaction

• name of the related parties;
• nature and duration of the transaction;
• the maximum amount of transaction that can be entered into;
• the indicative base price or current contracted price and the formula for variation in the price, if any; and
• any other information relevant or important for the Audit Committee to take a decision on the proposed transaction.

Non – availability of certain details

According to the proviso to clause (4) of Rule 6A, where the need for related party transaction cannot be foreseen and aforesaid details are not available, audit committee may make omnibus approval for such transactions subject to their value not exceeding rupees one crore per transaction.

In other words, the audit committee may grant omnibus approval to a foreseen transaction for which these details required under clause (4) of Rule 6A are not available at the time of granting omnibus approval. Such approval, as per clause (5) of Rule 6A, shall have validity for one financial year. The value of such omnibus approval for such foreseen related party transaction shall not exceed rupees one crore per transaction. This limit shall not be calculated for a standalone transaction but for a related party transaction with repetitive nature which satisfy the condition of clause (3) of Rule 6A.

Period for approval

According to Clause (5) of Rule 6A, omnibus approval shall be valid for a period not exceeding one financial year and shall require fresh approval after the expiry of such financial year.

All omnibus approval granted by audit committee during a financial year shall expire at the end of financial year of the company. The financial year shall end according to the definition under Section 2(41) of the Companies Act, 2013. At the start of new financial year a company may not enter into such related party transaction without approval or omnibus approval by the audit committee. Such fresh approval shall be granted only after the expiry of earlier financial year not before that period. This is advisable to have meeting of audit committee to grant fresh omnibus approval in earliest possible time of the financial year for smooth transactions.

“Financial Year”, in relation to any company or body corporate, means the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st day of January of a year, the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate is made up. [Section 2(41)]

Selling or disposing of Undertaking

According to Clause (6) of rule 6A, omnibus approval shall not be made for transactions in respect of selling or disposing of the undertaking of the company.

All transaction in respect of selling or disposing of the undertaking of the company shall not be granted omnibus approval.

Other Conditions

According to Clause (7) of Rule 6A, the audit committee may impose any other conditions as the Audit Committee may deem fit to grant the omnibus approval.

THREE NEW PROVISO

Now, the Companies Amendment Act, 2017 with effect from 7th May 2015 inserted second, third and fourth proviso as under:

“Provided further that in case of the transaction, other than transactions referred to in section 188, and where Audit Committee does not approve the transaction, it shall make its recommendations to the Board:

Provided also that in case any transaction involving an amount not exceeding one crore rupees is entered into by a director or officer of the company without obtaining the approval of the Audit Committee and it is not ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be voidable at the option of the Audit Committee and if the transaction is with the related party to any director or is authorised by any other director, the director concerned shall indemnify the company against any loss incurred by it:

Provided also that the provisions of this clause shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.”

Recommendation

As per newly inserted second proviso, the audit committee shall make its recommendation to the Board:

• where it does not approve a transaction, or
• in case of the transaction other than a related party transaction under Section 188.

Voidable Transaction

As per newly inserted third proviso (first part), a transaction shall be voidable at the option of an audit committee, if:

• any amount not exceeding one crore rupees is entered into by a director or officer of the company without obtaining the approval of the Audit Committee; and
• it is not ratified by the Audit Committee within three months from the date of the transaction.

Indemnify a loss

As per newly inserted third proviso (second part), the director concerned shall indemnify the company against any loss incurred by it, if –

• the voidable transaction (as mentioned in the first part) is with the related party to any director; or
• the voidable transaction (as mentioned in the first part) is authorised by any other director (other than audit committee).

Exemption in case of a wholly owned subsidiary

The provisions of clause (iv) of Section 177(4) shall not apply to a transaction, other than a transaction referred to in section 188, between a holding company and its wholly owned subsidiary company.

Transaction governed by Section 188 are –

(a) sale, purchase or supply of any goods or materials;
(b) selling or otherwise disposing of, or buying, the property of any kind;
(c) leasing of the property of any kind;
(d) availing or rendering of any services;
(e) appointment of any agent for purchase or sale of goods, materials, services or property;
(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company; and
(g) underwriting the subscription of any securities or derivatives thereof, of the company.

The Companies Amendment Act, 2017 related to the audit committee.

The Companies Amendment Act, 2017 read with Notification S.O. 1833(E) dated 7th May 2018 amended law related to the audit committee. Certain transactions shall be voidable unless ratified by the audit committee. In this post, we see changes in updated law related to Audit committee.

REQUIREMENT

According to Section 177(1) as amended, The Board of Directors of every listed public company and such other class or classes of companies, as may be prescribed, shall constitute an Audit Committee.[1]

Rule 6 of the Companies (Meeting of the Board and its Powers) Rules, 2014 as amended prescribes, The Board of directors of every listed public company and a company covered under rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014 shall constitute an ‘Audit Committee’ and a ‘Nomination and Remuneration Committee of the Board’.[2]

Which means companies prescribed to have audit committee are –

• the Public Companies having paid up share capital of ten crore rupees or more; or
• the Public Companies having a turnover of one hundred crore rupees or more; or
• the Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding fifty crore rupees.

COMPOSITION

According to Section 177(2) as amended, The Audit Committee shall consist of a minimum of three directors with independent directors forming a majority. The majority of members of Audit Committee including its Chairperson shall be persons with the ability to read and understand the financial statement.

In case of Section 8 companies subject to their compliance with exemption notification dated 5th June 2015, there is no requirement of independent director forming the majority in the audit committee.

TERMS OF REFERENCE

According to sub-section (4) of Section 177, the term of reference of the audit committee shall be specified by the Board of Directors of the company constituting the audit committee. These terms of reference shall include –

• the recommendation for appointment, remuneration and terms of appointment of auditors of the company;
• review and monitor the auditor’s independence and performance, and effectiveness of audit process;
• examination of the financial statement and the auditors’ report thereon;
• approval or any subsequent modification of transactions of the company with related parties;
• scrutiny of inter-corporate loans and investments;
• valuation of undertakings or assets of the company, wherever it is necessary;
• evaluation of internal financial controls and risk management systems; and
• monitoring the end use of funds raised through public offers and related matters.

According to section 177(6), the Audit Committee may investigate any matter in relation to these items, seek external professional advice and have full access to records of the company. This is its statutory power without any such formal term of reference by the Board of Directors.

The term of reference suggested under clause (iv) of Section 177(4) – approval or any subsequent modification of transactions of the company with related parties – will discussion in a future post here in detailed.

DUTIES REGARDING AUDITORS

According to Section 177(5), The Audit Committee may call for the comments of the auditors about:

• internal control systems,
• the scope of the audit, including the observations of the auditors,
• review of financial statement before their submission to the Board, and
• may also discuss any related issues with the internal and statutory auditors and the management of the company.

According to Section 177(7), the auditors of a company and the key managerial personnel shall have a right to be heard in the meetings of the Audit Committee when it considers the auditor’s report but shall not have the right to vote.

REPORTING IN BOARD REPORT

According to Section 177(8), the Board’s report under sub-section (3) of Section 134 shall disclose

1. the composition of an Audit Committee, and
2. where the Board had not accepted any recommendation of the Audit Committee, along with the reasons therefor.

VIGIL MECHANISM

Section 177 of the Companies Act, 2013 introduces vigil mechanism to Indian corporate law.

Every listed company or such other companies shall establish a vigil mechanism for directors and employees to report genuine concerns in such manner as may be prescribed. [Section 177(9)]

The vigil mechanism shall provide for adequate safeguards against victimisation of persons who use such mechanism and make provision for direct access to the chairperson of the Audit Committee in proper or exceptional cases. The details of establishment of such mechanism shall be disclosed by the company on its website and in the Board’s report. [Section 177(10)]

Even if the provision of vigil mechanism is part of section related to audit committee, this is completely independent of requirement of audit committee. Even in the companies where audit committee is not mandatory, vigil mechanism may be prescribed by the Government.

Rule 7 of the Companies (Meeting of Boards and its powers) Rules 2014 explain provisions for establishment of vigil mechanism.

Every listed company and the companies belonging to the following class or classes shall establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances-

1. the Companies which accept deposits from the public;
2. the Companies which have borrowed money from banks and public financial institutions in excess of fifty crore rupees. [Rule 7(1)]

The companies which are required to constitute an audit committee shall oversee the vigil mechanism through the committee and if any of the members of the committee have a conflict of interest in a given case, they should recuse themselves and the others on the committee would deal with the matter on hand. [Rule 7(2)]

In case of other companies, the Board of directors shall nominate a director to play the role of audit committee for the purpose of vigil mechanism to whom other directors and employees may report their concerns. [Rule 7(3)] As this Director is entrusted with particular duty, Form GNL – 3 should be filed.

The vigil mechanism shall provide for adequate safeguards against victimisation of employees and directors who avail of the vigil mechanism and also provide for direct access to the Chairperson of the Audit Committee or the director nominated to play the role of Audit Committee, as the case may be, in exceptional cases. [Rule 7(4)]

In case of repeated frivolous complaints being filed by a director or an employee, the audit committee or the director nominated to play the role of audit committee may take suitable action against the concerned director or employee including reprimand. [Rule 7(5)]

[1] From 1st April 2014 to 6th Amy 2018 – The Board of Directors of every listed company and such other class or classes of companies, as may be prescribed, shall constitute an Audit Committee.

[2] The Board of directors of every listed public company and a company covered under rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2014 shall constitute an ‘Audit Committee’ and a ‘Nomination and Remuneration Committee of the Board’

Revised/New Standards on Auditing (SAs) issued by AASB

SA	Subject	Date
SQC 1	Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements	01/04/2009
200	Overall objectives of the Independent Auditor and the conduct of an Audit in accordance with Standards on Auditing	—
210	Terms of Audit Engagements	01-04-2010
220	Quality Control for an Audit of Financial Statements	01-04-2010
230	Audit Documentation	01-04-2009
240	The Auditor’s Responsibility Relating to Fraud in an  Audit of Financial Statements	01-04-2009
250	Consideration of Laws and Regulations in an Audit of Financial Statements	01-04-2009
260	Communication with those Charged with Governance	01-04-2009
265	Communicating Deficiencies in Internal Control to those Charged with Governance and Management	01-04-2010
299	Responsibility of Joint Auditors	01-04-1996
300	Planning of Audit of Financial Statements	01-04-2008
315	Identifying and Assessing the Risks of Material Misstatement  through Understanding the Entity and its Environment	01-04-2008
320	Materiality in Planning and Performing an Audit	01-04-2010
330	The Auditor’s Response to Assessed Risks	01-04-2008
402	Audit Considerations Relating to an Entity Using a Service Organisation	01-04-2010
450	Evaluation of Misstatements Identified during the Audit	01-04-2010
500	Audit Evidence	01-04-2009
501	Audit Evidence – Specific Considerations for Selected Items	01-04-2010
505	External Confirmations	01-04-2010
510	Initial Audit Engagements – Opening Balances	01-04-2010
520	Analytical Procedures	01-04-2010
530	Audit Sampling	01-04-2009
540	Auditing Accounting Estimates, Including Fair  Value Accounting Estimates, and Related Disclosures	01-04-2009
550	Related Parties	01-04-2010
560	Subsequent Events	01-04-2009
570	Going Concern	01-04-2009
580	Written Representations	01-04-2009
600	Using the Work of Another Auditor	01-04-2002
610	Using the work of an Internal Auditor	01-04-2010
620	Using work of an Auditor’s expert	01-04-2010
700	Forming an Opinion and Reporting on Financial Statements	01-04-2012
705	Modifications to the Opinion in the Independent Auditor’s Report	01-04-2012
706	Emphasis of Matter Paragraphs and Order Matter Paragraphs in the Independent Auditor’s Report	01-04-2011
710	Comparatives Information – Corresponding Figures and Comparative Financial Statements	01-04-2011
720	The Auditor’s Responsibility in Relation to Other Information in Documents Containing Audited Financial Statements	01-04-2010
800	Special Consideration – Audits of Financial Statements Prepared in Accordance with Special Purpose Framework	01-04-2011
805	Special Consideration – Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement	01-04-2011
810	Engagements to Report on Summary Financial Statements	01-04-2011
SRE	Standards on Review Engagements
2400	Engagements to Review Financial Statements	01-04-2010
2410	Review of Interim Financial Information Performed by  the Independent Auditor of the Entity	01-04-2010
3000	Assurance Engagements other than Audits or Reviews of Historical Financial information	—
SAE	Standards on Assurance Engagements
3400	The Examination of Prospective Financial Information	01-04-2007
3402	Assurance Reports on Controls at a Service Organisation  Related Services	01-04-2011
SRS	Standards on Related Services
4400	Engagements to Perform Agreed-upon Procedures Regarding Financial Information	01-04-2004
4410	Engagements to Compile Financial Information	01-04-2004
D.	Statements on Auditing
1	Statement on Auditing Practices	—
2	Statement on Qualifications in Auditor’s Report	—
3	Statement on CARO 2003	—
4	Statement of payments to Auditors for other services	—
5	Statement on responsibility of Joint Auditors	—
E.	Guidance Notes
1	Guidance Note on Tax Audit u/s. 44AB of Income-tax Act, 1961	—
2	Guidance Notes on Accounting Aspects	—
3	Guidance Note on Turnover in case of Contractors	—
4	Guidance Note on Applicability of Accounting Standard (AS)-25 to Interim Financial Results	—
5	Guidance Note on Remuneration paid to key management personnel – Whether a related party transaction	—
6	Guidance Note on Applicability of Accounting Standard (AS)-20, Earnings Per Share	—
7	Guidance Note on Terms used in Financial Statements	—
8	Guidance Note on Treatment of Reserves created on Revaluation of Fixed Asset	—
9	Guidance Note on Accrual Basis of Accounting	—
10	Guidance Note on Accounting for Depreciation for Companies	—
11	Guidance Note on Some Important Issues arising from the Amendments in Schedule XIV to the Companies Act, 1956	—
12	Guidance Note on Availability of Revaluation Reserve for Issue of Bonus Shares	—
13	Guidance Note on Accounting for Leases	—
14	Guidance Note on Accounting for Corporate Dividend Tax	—
15	Guidance Note on Accounting for Treatment of Excise Duty	—
16	Guidance Note on Accounting for Dot Com Companies	—
17	Guidance Note on Accounting for Employee Share Based Payments	—
18	Guidance Note on Accounting for State Level Value Added Tax	—
19	Guidance Note on Accounting for Fringe Benefits Tax	—
20	Guidance Note on Accounting by Schools	—
21	Guidance Note on Accounting for Credit available in respect of Minimum Alternative Tax under the Income-tax Act, 1961	—
22	Guidance Note on recognition of Revenue by Real Estate Developers	—
23	Guidance Note on Accounting on Measurement of Income Tax for Interim Financial Reporting in the context of AS 25	—
24	Guidance Note on Accounting for MODVAT/CENVAT	—
25	Guidance Note on Accounting of Self-Generated Certified Emission Reductions (CERs) (Issued 2012)	—
26	Guidance Note on Accounting for Rate Regulated Activities	—
27	Guidance Note on Accounting for Real Estate Transaction (Revised 2012)	—
28	Guidance Note on Oil and Gas Producing Activities (Revised 2013)	—
29	Guidance Note on Accounting for Derivative Transactions (Released 2015)	—
30	Guidance Note on Expenditure on Corporate Social Responsibility Activities (Issued 2015)	—
31	Guidance Notes on Auditing Aspects	—
32	Audit of Abridged Financial Statements	—
33	Audit of Accounts of Non-Corporate Entities	—
34	Audit of Cash and Bank Balances	—
35	Audit of Consolidated Financial Statements	—
36	Audit of Debtors, Loans & Advances	—
37	Audit of Expenses	—
38	Audit of Fixed Asset	—
39	Audit of Investments	—
40	Audit of Liabilities	—
41	Audit of Miscellaneous Expenditure (Revised)	—
42	Audit of Payment of Dividend	—
43	Audit of Revenue	—
44	Audit Reports and Certificates for Special Purposes	—
45	Audit of Accounts of Liquidators	—
46	Auditor’s Report on Revised Accounts of Companies Before Circulation to Share holders	—
47	Capital & Reserves	—
48	Certificate on Corporate Governance	—
49	Certificate to be issued by the Auditor of a Company pursuant to Companies (Acceptance of Deposits) Rules, 1973	—
50	Certificate of Documents for Registration of Charges	—
51	Computer Assisted Audit Techniques (CAATs)	—
52	Duty Cast on the Auditors u/s. 45-MA of the Reserve Bank of India Act, 1934	—
53	Independent of Auditors (Revised)	—
54	Preparation of Financial Statements on Letterheads and Stationery of Auditors	—
55	Provision for Proposed Dividend	—
56	Reports of the Audit Report	—
57	Revision/Rectification of Financial Statements	—
58	Sections 227(3)(e) and (f) of the Companies Act, 1956 (Revised)	—
59	Section 293A of the Companies Act and the Auditor	—
60	Special considerations in the Audit of Small Entities	—
61	Audit of Property, Plant & Equipment	—
62	Certification of XBRL Financial Statements 4 and Industry Specific Guidance Notes	—
63	Audit of Banks (Revised 2015) edition	—
64	Audit of Members of Stock Exchanges (Revised)	—
65	Audit of Companies Carrying on General Insurance Business	—
66	Audit of Companies Carrying on Life Insurance Business	—
67	Guidance on Reporting under the Companies (Auditor’s Report) Order, 2015 (CARO, 2015) and Consequential Amendment to the Format of the Auditor’s Report of a Company).
68	Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013
69	Guidance Note on Reporting under Section 143(3)(f) of the Act and Reporting under Section 143(3)(h) of the Act
Secretarial Standards notified under the Companies Act, 2013
SS1	Meetings of the Board of Directors
SS2	General Meetings