Conglomerates in the modern day often choose to divide and segregate their business operations, often by incorporating separate legal entities, resulting in the formation of group companies. A company may have multiple subsidiaries, associates, joint ventures, or sister entities all across the country or, sometimes, the globe. Such groups may also be the result of acquisitions and takeovers as part of expansion activities. Being a part of such a corporate cluster triggers various compliances and disclosures under our multiple laws, the most important of them being the requirement to consolidate the financial statements of the companies.
Apart from statutory compulsion, the benefits of consolidating accounts include; better financial reporting of group entities, providing a clearer picture of the relationships between the entities, and elimination of duplication and repetition. However, the ambiguity in some of the provisions dealing with the consolidation of financial statements has caused difficulty for companies in interpreting the law accurately and ensuring proper compliance. This Article attempts to shed light on the compliances relating to consolidation and the various exemptions provided to companies, with specific reference to the proviso granting exemption to companies with foreign subsidiaries.
Consolidation of Financial Statements under the Companies Act, 2013 and rules made thereunder.
Section 129(3) of the Companies Act 2013 requires all companies with one or more subsidiaries or associates to prepare a consolidated financial statement of the company and all of its subsidiaries and associates, in addition to the Standalone Financial Statements, and place the same before the shareholders in the AGM along with the Standalone Financial Statements. It shall be prepared in the same form and manner as the Standalone Financial Statements and shall be in accordance with the Accounting Standards. Further, the company shall attach with its financial statement a separate statement containing the salient features of the financial statement of its subsidiaries or associates and joint ventures in Form AOC-1.[1]
As per Rule 6 of the Companies (Accounts) Rules, 2014, consolidation of financial statements shall be made in accordance with Schedule III and Accounting Standards, more specifically, AS-21. The law also provides certain exemptions to various sets of companies from the applicability of these provisions.
]Exemptions
Rule 6 provides exemptions to certain classes of companies under various circumstances from compliance with the provisions relating to consolidation, as follows:
Exemption from Accounting Standards
A Company exempted from consolidation under the Accounting Standards is required to comply with requirements under Schedule III only.
2. Conditional Exemption
An unlisted company that meets certain conditions shall be exempted from consolidation altogether:
The company is a wholly or partially owned subsidiary of another company
The members (except the holding company), entitled to vote or otherwise, shall be intimated in writing and proof of intimation is available with the company
No member objects to the company not presenting consolidated financial statements;
its ultimate or any intermediate holding company files consolidated financial statements which comply with the applicable Accounting Standards.
3. Time-Bound Exemption for companies without Subsidiaries
In the case of companies which do not have subsidiaries but only associate companies or Joint ventures, a time-bound exemption is provided for the financial year 2014-15 from complying with Schedule III.
4. Companies with foreign subsidiaries[2]
This article focuses, in particular, on the fourth proviso and its possible interpretations.
Companies with Foreign Subsidiaries
The fourth proviso to Rule 6 provides that “the Rule shall not apply to companies having subsidiaries outside India only for the financial year commencing on or after 1st April 2014.” Companies having only foreign subsidiaries enjoy this exemption. Companies that have Indian subsidiaries, or both Indian and foreign subsidiaries, do not come within the purview of this exception. This is one school of thought.
Another interpretation of this proviso is that the word “only” shall be ascribed to the period of operation of the exemption, that is, only for the financial year commencing on or after 1st April 2014. But in this interpretation, the target group of this exemption becomes “companies having foreign subsidiaries”, which includes companies having both Indian and foreign subsidiaries. It would appear that the companies having foreign subsidiaries shall be eligible for this time-bound exemption for one financial year, even if it has Indian subsidiaries.
The author is of the view that the word “only” is to be ascribed to “foreign subsidiaries” since it seems highly unlikely that the intention of the legislature would be to grant a blanket exemption to companies with both Indian and foreign subsidiaries, even for a financial year. If that is the case, it could be misused by companies by creating an overseas shell company with the sole purpose of availing exemption from consolidation.
Also, it is pertinent to note the language of the third proviso granting time-bound exemption for one financial year. One may compare the same with the provision in hand.
Provided also that nothing contained in this rule shall subject to any other law or regulation, apply for the financial year commencing from the 1st day of April 2014 and ending on the 31st of March 2015, in case of a company which does not have a subsidiary or subsidiaries but has one or more associate companies or Joint ventures or both, for the consolidation of financial statement in respect of associate companies or joint ventures or both, as the case may be.
The provision gives companies with only associate companies and not subsidiaries a one-time pass from consolidating the accounts under the Rule for the Financial Year 2014-15, considering the challenges they may face while transitioning from the erstwhile Companies Act, 1956, to the new regulations under the Companies Act, 2013. This proviso clearly mentions the start and end of the period for which the exemption is provided, and the intention to give a time-bound single-year exemption is made amply clear. In contrast to this, the proviso relating to companies with foreign subsidiaries is ambiguous with respect to its period of applicability.
However, the phrase “for the financial year commencing on or after 1st April 2014” being used in the singular tense instead of the plural does make room for the possibility that the exemption is meant for a single year and, therefore, could be a mere transitional relaxation. But either way, companies still use this exception to shield them from the applicability of consolidating financial statements through an erroneous interpretation of the law.
Not a blanket exemption
There is a wide misconception that, per the fourth proviso to Rule 6, companies with foreign subsidiaries are not required to prepare and file Consolidated Financial Statements. However, a close reading of the provision shows that the fourth proviso is not an exemption from consolidation entirely. The proviso merely exempts companies from compliance under Rule 6, that is, from preparing the consolidated financials in accordance with Schedule III and Accounting Standards. The Rule must be read together with Section 129, and the phrase “nothing in this rule shall apply” shall be given due consideration. Companies with only foreign subsidiaries are therefore required to comply with the provisions of Section 129(3), which requires them to prepare consolidated financials in accordance with the Accounting Standards.
Exemption under Accounting Standards
As per the first proviso to Rule 6, in case the company is not required to consolidate accounts under the Accounting Standards, the company shall comply with the provisions of consolidation in accordance with Schedule III of the Act. The proviso refers to a set of companies exempted from following the Accounting Standards.
As per para 11 of AS-21, a subsidiary should be excluded from consolidation when:
control is intended to be temporary because the subsidiary is acquired and held exclusively with a view to its subsequent disposal in the near future; or
it operates under severe long-term restrictions, which significantly impair its ability to transfer funds to the parent.
If a parent company only has subsidiaries that fall under the above-mentioned categories, such a company shall not be required to consolidate accounts as per AS-21. Investments in such exempted subsidiaries should be accounted for in accordance with Accounting Standard (AS) 13, Accounting for Investments. The reasons for not consolidating a subsidiary should also be disclosed in the consolidated financial statements.
Hence, if the company has only foreign subsidiaries and is eligible for any of the exemptions under the Accounting Standards, such a company is exempted from following Schedule III as well as Accounting Standards while preparing consolidated financial statements. Whether this means the company is not required to consolidate accounts at all or is simply exempted from the compliance of Schedule III and Accounting Standards is still unclear. Nevertheless, such exempted companies are still required to attach Form AOC-1 to its Directors Report along with its financial statements.
Conclusion
Legislative drafting errors and ambiguities in interpretation can have a significant impact on the legal system. They can lead to uncertainty and confusion and can make it difficult to enforce the law. The provisions relating to consolidation, in the opinion of the author, are a classic example of bad drafting. The lack of clarity in the target group of the fourth proviso, as well as its period of applicability, has resulted in inadvertent non-compliance with the provisions by several entities.
Adv Kavya R Das
REFERENCES
[1] Rule 5 of the Companies (Accounts) Rules, 2014
[2] Fourth proviso to Rule 6 of the Companies (Accounts) Rules, 2014