NFRA: Double Review mechanism on Indian Companies

NFRA: Double Review mechanism on Indian Companies

BACKGROUND

National Financial Reporting Authority (“NFRA”) is newly set up independent regulator of the Audit profession. It is one such body proposed under Companies Act 2013 to double check and to oversee the quality of service rendered by Chartered Accountants in India to provide review on matters relating to Accounting and Auditing standards and thereby suggesting measures of improvement.

Prior to the set up of NFRA, ICAI used to monitor the Auditors of big companies. However, NFRA is not meant to replace ICAI totally. For large entities including Listed entities, NFRA shall monitor and enforce the compliances with Accounting and Auditing standards.

This move for establishment of NFRA is to act against erring Auditors and Auditing firms to reduce the corporate scams in India, thereby to ensure better compliances by the Indian Corporates.

When is the Notification passed?

The Central Government vide its notification dated 13^thNovember 2018 has introduced the National Financial Reporting Authority (“NFRA”) Rules, 2018. The National Financial Reporting Authority Rules, 2018 comprises of 19 Rules for the regulation of the authority, its members, auditors and body corporate.

When is the NFRA Rules effective?

To be effective from the 14^thNovember 2018.

What are the relevant provisions to NFRA?

·        Sub section (2) and (4) of Section 132:- Constitution of National Financial Reporting Authority

·        Sub section (1) of Section 139:- Appointment of Auditors

·        Sub section (1) of Section 469:- Power of Central Government to Make Rules

The section 132 in brief discuss about the power of the Central government to constitute the NRFA and the functions to be performed by the NFRA, its constitution (appointment of chairperson and members), powers to investigate and make orders, provisions of appeals and the maintenance of book of accounts by the authority, audit of the accounts of the authority by Comptroller and Auditor-General of India, and reporting by the authority to the central government, while section 139 is related to the provisions of appointment of auditor and matters incidental thereto,

In pursuance of the provisions of section 469, the central government has introduced the NFRA Rule, 2018.

What is the function of NFRA?

•        Establishing high quality standards of accounting and auditing

•        Over viewing accounting functions performed by auditor and body corporates

•        Maintain details of particulars of auditors appointed in the companies and bodies corporate specified in rule 3;

•        Recommend accounting and auditing standards for approval by the Central government;

•        Monitor and enforce compliance with accounting standards and auditing standards;

•        Oversee the quality of service of the professions associated with ensuring compliance with such standards and suggest measures for improvement in the quality of service;

•        Promote awareness in relation to the compliance of accounting standards and auditing standards, auditors’ responsibilities, audit quality and such other matters through education, training, seminars, workshops, conferences and publicity;

•        Power to investigate and report its findings to the Central Government

•        Co-operate with national and international organizations of independent audit regulators in establishing and overseeing adherence to accounting standards and auditing standards; and

•        Perform such other functions and duties as may be necessary or incidental to the aforesaid functions and duties.

Which companies are governed by NFRA?

•        All Listed Company includes companies listed in India or Outside India and

•        Unlisted public companies having paid-up capital of not less than rupees 500 crores or

•        Companies having annual turnover of not less than rupees 1000 crores or

•        Companies having in aggregate, outstanding loans, debentures and deposits of not less than rupees 500 crores as on the 31st March of immediately preceding financial year.

•        Insurance companies, banking companies, companies engaged in the generation or supply of electricity,

•        Companies governed by any special Act for the time being in force

•        Bodies corporate incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of sub-section (4) of section 1 of the Companies Act 2013

•        Companies as classified by the Central Government

•        Body Corporate registered outside India which is Associate or Subsidiary of company registered in India (as referred in above clauses), having income or net worth of such subsidiary or associate company exceeds twenty per cent. of the consolidated income or consolidated net worth of such company or the body corporate

Which forms/ Compliances to be done by the eligible companies?

·        Every body corporate excluding the company incorporated under Companies Act, 2013 or previous law and also excluding the one governed under this rule shall, within 15 days of appointment of an auditor under sub-section (1) of section 139, inform the Authority in Form NFRA-1, the particulars of the auditor appointed by such body corporate

·        Provided that a body corporate registered outside India which is Associate or Subsidiary of company registered in India shall provide details of appointment of its auditor in Form NFRA-1.

·        The companies that are in existence as on the date of commencement of these rules and are not covered under these rules, are required to file Form NFRA-01 i.e. Notice to the authority by a body corporate regarding its auditor, within 30 days of commencement of these rules with the Authority

·        Just like once xbrl always xbrl, If a company ceases to be governed under this rule either because it ceases to be a listed company or because the limit as specified for Paid up, Turnover and aggregate of Loans, debentures and deposits declines, it shall continue to be governed by the Authority for a period of three years even after such cessation

What is the last date to file annual return?

In addition to performing Annual KYC for each Director in the month of April every year, the Auditors of each applicable company/ entity to file a return with the Authority on or before 30th April every year.

 

What is the punishment in case of Non Compliances in this regard?

On violation by a company or any officer of a company or an auditor or any other person of the provisions of these rules provisions of section 450 of the Act will apply which says that;

If a company or any officer of a company or any other person contravenes any of the provisions of this Act or the rules made thereunder, or any condition, limitation or restriction subject to which any approval, sanction, consent, confirmation, recognition, direction or exemption in relation to any matter has been accorded, given or granted, and for which no penalty or punishment is provided elsewhere in this Act, the company and every officer of the company who is in default or such other person shall be punishable with fine which may extend to ten thousand rupees, and where the contravention is continuing one, with a further fine which may extend to one thousand rupees for every day after the first during which the contravention continues.

 

What is the manner of enforcement of orders passed in disciplinary proceedings?

(1) The auditor in case of monetary penalty under rule 11 shall deposit the amount of penalty with the Authority within 30 days of the order, or in case of appeal against the order of the Authority, it shall deposit 10% of the amount of the monetary penalty with the Appellate Tribunal.

(2) If, within 30 days of the order passed under rule 11, the auditor neither pays the penalty nor appeals against the order, the Authority shall, without prejudice to any other action, inform about such non-compliance to every company or body corporate (including those not covered by rule 3) in which the auditor is functioning as auditor and every such company or body corporate shall appoint a new auditor in accordance with the provisions of the Act.

 

Conclusion

To conclude all, it is hereby suggested to abide by the rules formulated by the authority, otherwise the person in default can undergo severe punishment like imposing penalty and an order debarring the auditor from practice or provisions of section 450 of the Act shall apply.

CHALLENGES OF APPOINTMENT AS RESIDENT DIRECTOR

CHALLENGES OF BEING A NOMINEE DIRECTOR

BACKGROUND

After implementation of Companies Act 2013 especially Section 149 of the Companies Act 2013 where every company to have a Board of Directors consisting of individuals as directors and shall have as per sub section 3, at least one director who should be resident in India, there was opportunities for many consulting firms in India to grab the opportunity and sell one more Service for Nominee Resident Director for Foreign entities who wishes to set up their businesses in India. This move to have Resident Director in the company was to keep track of the company in case of foreign promoters through resident Director. The Resident Director is first chased by the different authorities like GST, Income Tax, ROC or any other law if the company makes any default.

However, many don’t even know that in addition to the statutory duties of different laws the Directors have fiduciaries duties as the Directors are "Trustees" of the company hence they must act diligently, in good faith and honestly even if they are Directors in the company just to fulfill the compliance of Resident Director.

Directors are responsible for management, success and failures in performance of affairs of the company, including violations of various Statutes applicable to the company

Some foreign companies are set up for some tenders or contracts and their intention is not doing the compliances, like holding regular Board Meetings, Annual General Meetings, filling annual returns, maintenance of registered office, minutes, GST compliances, Income tax compliances, RBI compliances and so on, as a result they are on a verge to receive notices for non-compliance from the departments.

Thus, it is very important for Resident Director to save themselves for penal actions for the non-compliances done by the company and ensure the good corporate governance.

APPOINTMENT OF RESIDENT NOMINEE DIRECTOR

We in this article will talk about the nominee resident director appointed by the foreign company on board to represent the interest of such company along-with the compliance of Sec 149

However, the foreign company can appoint a resident nominee director to grab hold on the compliances, by entering into the Service Agreement between the director and the company, but this agreement will not invalidate the accountability, the director is liable for as per the provisions of Companies Act, 2013, i.e. the director even after entering the service agreement are liable for penal provisions under the Companies Act, GST Act, Income Tax Act, and any other act for the time being in force, they cannot escape on from their liability just because of the contract entered, they will still be liable for the actions.

DUTIES AND RESPONSIBILITY OF THE RESIDENT NOMINEE DIRECTOR

The Companies Act holds all Directors and Company Secretary liable for offences committed by the company. The same can be authenticated from the definition of "Officer who is in default" u/s 2(60) of the Companies Act, which is reproduced below:

(i) whole-time director;

(ii) key managerial personnel;

(iii) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;

(iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default;

(v) any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act, other than a person who gives advice to the Board in a professional capacity;

(vi) every director, in respect of a contravention of any of the provisions of this Act, who is aware of such contravention by virtue of the receipt by him of any proceedings of the Board or participation in such proceedings without objecting to the same, or where such contravention had taken place with his consent or connivance;

(vii) in respect of the issue or transfer of any shares of a company, the share transfer agents, registrars and merchant bankers to the issue or transfer.

Even for other applicable enactments of Taxation, Corporate, Labour & Industrial Laws, Pollution laws, etc. do invariably contain a section as "Offences by Companies". e.g. Section 278B of Income Tax Act, Section 141 of Negotiable Instruments Act & Section 14A of the Employees P.F. (Misc. Prov.) Act, all of these specifically provides that in case of default every person who at the time of offence was 'Incharge of and was responsible to the Company for the conduct of its business as well as the company shall be guilty of the offence and be punished accordingly. Hence all the Directors on Board are normally liable for any default in compliance with various Act.

The resident director, once appointed as the director of the company as stated above is liable under the provisions of the various acts that are applicable on the company, he is accountable for the actions of the company,

To avoid or mitigate the problems in future a resident director may perform actions such as

·        Regular audit of the bank statements and transactions. E.g. to check Money laundering activities if any or any illegal activities. Bank Statements reveals majority of activities of the company.

·        Monthly visit to company premises and having checks on the management of the company

·        Obtaining compliance certificate from the practicing professionals like Practicing Company Secretary and Auditors who are Chartered Accountants

·        Regularly conducting the due diligence

·        To check whether the GST returns are filled on time or not

·        To check whether the accurate and effective Income tax returns are filled on time or not

·        To make sure that the accuracy and timely RoC returns submission

·        Also, the Resident Director is required to check that the registered office is maintained at all times so that all the notices and orders are received on time

·        Any other activities that can be undertaken to make sure that the risk of penal provisions get reduced and the company follows good governance.

2018 witnessed many fraudulent cases which Corporate Scams in India are more. Given facts and provisions states that the law relating to the liability of company directors for offences under various laws has been made more stringent in recent years on account of major corporate scams.

It is suggested that the resident director, should be very careful and diligent in the matters of the company in which he/ she is Director to avoid penal provisions in future.

PENAL PROVISIONS UNDER VARIOUS ACTS ON THE DIRECTORS

Under Companies Act, 2013

The Company Act prescribes certain penalties for various offences under the act, like for non filing of return of allotment within 15 days from the date of allotment the company, its promoters and directors shall be liable to a penalty for each default of one thousand rupees for each day during which such default continues but not exceeding twenty-five lakh rupees, or

Punishment in contravention of section 73 or section 76 where every officer of the company who is in default shall be punishable with imprisonment which may extend to seven years and with fine which shall not be less than twenty-five lakh rupees but which may extend to two crore rupees,

And many more

Under CGST Act, 2017

Under the CGST Act also where any tax, interest or penalty due from a private company in respect of any supply of goods or services or both for any period cannot be recovered, then, every person who was a director of the private company during such period shall, jointly and severally, be liable for the payment of such tax, interest or penalty unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company

Under Income Tax Act, 1961

As per section 278B, where an offence under the Income-tax Act has been committed by a company, then every person who, at the time the offence was committed was in charge of and was responsible to the company for the conduct of the business of the company as well as the company shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly. However if such person proves that the offence was committed without his knowledge or that he had exercised all due diligence to prevent the commission of such offence then he shall not be deemed to be guilty of the offence.

Under other laws

He should make sure that all the compliances are followed at time, and in case he discovers any fraudulent activity, then he should intimate the same to the concerned affected group, so that he could prove that he was not involved in any activity that has adverse effect on the members/public or so.

Solutions for avoiding undue harassment of Directors

To escape or mitigate the liability of prosecution of all Directors can be done away if you insist the management to passing appropriate resolution is Board Meeting allocating the duties and responsibilities for compliance of different laws by different Individual Director(s) after recording consent of individual concerned Director in writing.

Generally, the Board is a blend of different Directors (in our case two are foreign and one would be resident for the sake of compliance), so we can nominate each one of them with their specific law compliance duties. Such that as regards to the defaults in maintenance and audit of Account Books under Companies Act and Taxation Laws, the Board may make any one functional director responsible and incharge of finance and accounts (called Director-Finance), liable for proper compliances with relevant laws. Similarly, other Director may he held responsible for compliance of various Labour and Industrial Laws like Factories Act, ESI, Provident Fund, I.D. Act and Gratuity Act, etc. A Company Secretary may be appointed shall be held responsible for compliance with Companies Act. Similarly, responsibility for compliance with other laws should be entrusted to nominated Director(s) and they be held responsible and made incharge of their functions and the applicable law(s). 

This will make such 'nominated Director(s) more cautious, responsible and diligent, knowing his statutory duties and obligations in case of violation of any one law. All other Directors in the Board will give him due support for making full compliance but in case of prosecution for non-compliance he alone will be responsible and prosecuted by the Authorities and other Directors would be spared.

What is required is to create such documents to prove that the Board had after due deliberations and with written consent of the nominated Director had passed proper resolution in the Board Meeting to that effect. Further as every Company has to keep "Register of Directors" and also file "Return of Directors" with the Registrar of Companies under Section 170(2) of Companies, which Section reads as under:

"2. A return (Form DIR-12) containing such particulars and documents as may be prescribed, of the directors and key managerial personnel shall be filed with the Registrar within 30 days of the appointment of every director and key managerial personnel, as the case may be and within 30 days of any change taking place."

Thus, in the Register of Directors maintained by company and also the Statutory Return of Directors in Form DIR-12 submitted by company to the Registrar of Companies, the company should indicate against the name of each Director specific Law(s) allocated to him for compliance of which he has been declared in charge and responsible to the Company, as per Resolution passed by the Board. This fact must be indicated by adding 'Remarks' in the Statutory Return of Directors. Similarly, it must also be recorded in Register of Directors maintained u/s 170(1) of the Companies Act. Certified copy of such a Return of Directors can be obtained by anyone from Registrar of Companies, which document will conclusively prove the responsibility of that Director alone to comply with law. In case of any violation of that law, only that Director who is declared as In charge and responsible to the Company, as per Board resolution will have to face the trial and all other Directors will be saved of the harassment and punishment, if any.

Such kind of resolution is permissible under provision of Section 2(60) of the Companies Act, 2013 and other applicable laws. The relevant text of Section 2(60) "Officer in default" is reproduced below:

(iii) where there is no key managerial personnel, such director or directors as specified by the Board in this behalf and who has or have given his or their consent in writing to the Board to such specification, or all the directors, if no director is so specified;

(iv) any person who, under the immediate authority of the Board or any key managerial personnel, is charged with any responsibility including maintenance, filing or distribution of accounts or records, authorises, actively participates in, knowingly permits, or knowingly fails to take active steps to prevent, any default.

Based on the board Resolution and the Directors' Registers maintained u/s 170(1) of the Act, no Governmental authority will prosecute other Directors. However, if per chance any other Director of the company is wrongly arrayed as an accused person for an offence, the Court will not take cognizance, if the Director files certified copy of relevant Board resolution accompanied with certified copy of Directors' Register and also Certified copy of Return of Directors filed u/s 170(2) of the Act.

To summarize the resident nominee director should disclose the mandate between him and the foreign company and should indulge in the due diligence of the company, such practice will ensure smooth working for the company and will lower the risk of penal provisions on the director also.

However, it is very difficult to understand the real intention of the promoters of the company and Resident Director cannot control the acts by the promoter group. E.g. if the Promoter has mentioned in the MOA that he would perform trading of electronic goods and despite this, the promoters carries on Bitcoin business which is prohibited in India, then, controlling on such fraudulent acts is difficult for a person who has been appointed as just for compliance of Sec 149 of Companies Act 2013. Being vigilant is a piece of advice given to the Resident Director and as soon as he/ she gets to know of any illegal acts, then, he/ she should act immediately.

It is important to enter into Indemnity Bond, Representations & Warranties, Service Agreement before being appointed as Director. It is also advisable to get yourself insured under Director Insurance Policy to safeguard your personal assets in case of frauds.

In case you have any further clarifications, I would be happy to answer. My contact number is 9540074449