Expert Advisory Committee

1.20 Query

Appointment of an employee chartered accountant as statutory

auditor/certifying authority in a group of companies

1.A chartered accountant-‘C’- partly in practice, is employed by a public limited company ‘A Ltd.’, which is also an MRTP company.

2.Substantial portion of the shareholding of ‘A’ Ltd. is held by one family ‘X’. Three members of the said family, namely, ‘P’,’Q’ and ‘R’ are whole time directors of ‘A Ltd.’. The fourth whole-time director of the company-‘K’- is not a member of the family ‘X’. There are four other directors on the Board of ‘A Ltd.’, being institutional nominees, advocate, etc.

3. Members of the family ‘X’ including ‘P’,’Q’ and ‘R’ and their relatives (as defined by the Companies Act, 1956) hold 100 per cent shares in certain private limited companies and are directors thereof. They are also directors in certain other private limited companies being appointed by the Memorandum/Articles of Association of those companies, without being shareholders thereof.

4.The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:

(i) Whether ‘C’ can be appointed as the external auditor of (a) the private limited company in which the members of family ‘X’ are either share-holders and directors or nominees and directors: (b) the private limited companies in which ‘K’ is a nominee and director.

(ii) Can ‘C’ accept the said assignment? In case, the answer is in the affirmative, whether any disclosure is required to be made and, if so, what should be the wording of such a disclosure. In case, the answer is in the negative, the reason therefor.

(iii) Can ‘C’ certify data required by governmental/semi-governmental authorities, financial institutions, banks etc., in the case of:

(a) the company in which he is employed;

(b) the private limited companies in which the members of family ‘X’ are either shareholders and directors or nominees and directors.

In case the answers to the above are in the affirmative, whether any disclosure is required to be made and, if so, what should be the wording of such a disclosure. In case, the answers to the above are in the negative, the reasons thereof.

Opinion September 9,1985

1.The Committee notes that Section 226 (3) of the Companies Act, 1956 prohibits the appointment of a Chartered Accountant as auditor of a company; if he is “………(b) an officer or employee of the company; (c) a person who is a partner or who, is in the employment of an officer or employee of the company……….”. The Committee further notes that Section 226 (4) provides that a “person shall also not be qualified for appointment as auditor of a company if he is by virtue of sub-section (3) disqualified for appointment as auditor of any other body corporate which is that company’s subsidiary or holding company or a subsidiary of the company’s holding company, or would be so disqualified if the body corporate were a company.”

2.The Committee notes that the meaning of “holding company” and ‘subsidiary’ is given in Section 4 of the Companies Act, the relevant extracts of which are reproduced below:

“(1)For the purpose of this Act, a company shall, subject to the provisions of sub-section (3) be deemed to be a subsidiary of another if, but only if-

(a) that other controls the composition of its Board of Directors; or

(b) that other—

(i) where the first mentioned company is an existing company in respect of which the holders of preference shares issued before the commencement of this Act have the same voting rights in all respects as the holders of equity shares, exercises or controls more than half of the total voting power of such company;

(ii) where the first mentioned company is any other company, holds more than half in nominal value of its equity share capital; or

“2. For the purposes of sub-section (1), the composition of a company’s Board of Directors shall be deemed to be controlled by another company, if, but only if, that other company by the exercise of some power exercisable by it at its discretion without the consent or concurrence of any other person can appoint or remove the holders of all or a majority of the directorship, but for the purposes of this provision that other company shall be deemed to have power to appoint to a directorship with respect to which any of the following conditions is satisfied, that is to say—

(a) That a person cannot be appointed thereto without the exercise in his favour by that other company of such a power as aforesaid;

(b) that a person’s appointment thereto follows necessarily from his appointment as director or manager of, or to any other office or employment in, that other company; or

“3. In determining whether one company is a subsidiary of another—

(a) any share held or power exercisable by that other company in a fiduciary capacity shall be treated as not held or exercisable by it;

(b) subject to the provisions of clauses (c) and (d) any shares held or power exercisable—

(i) by any person as a nominee for that other company (except where that other is concerned only in a fiduciary capacity); or

(ii) by or by a nominee for a subsidiary of that other company, not being a subsidiary which is concerned only in a fiduciary capacity shall be treated as held or exercisable by that other company;

(c) any shares held or power exercisable by any person shall be treated as held or exercisable by that other company by virtue of the provisions of any debentures of the first mentioned company or of a trust deed for securing any issue of such debentures shall be disregarded;

(d) any shares held or power exercisable by, or by a nominee for, that other or its subsidiary (not being held or exercisable as mentioned in clause (c) shall be treated as not held or exercisable by that other, if the ordinary business of that other or its subsidiary, as the case may be, includes the lending of money and the shares are held or the power is exercisable as aforesaid by way of security only for the purposes of a transaction entered into in the ordinary course of that business.”

3.The Committee is of the view that on the strict inter-pretation of Section 226 (3) of the Act for the appointment of ‘C’ as the statutory auditor of the said companies is not attracted since he is neither an employee of ‘P’, ‘Q’ and ‘R’, who are whole time directors of the company (a company being a separate legal entity) nor an employee of the said companies.

4.The Committee also notes that from the facts of the query, the manner of appointment of ‘P’, ‘Q’ and ‘R’ and their relatives and members of family ‘X’, as directors of the said private companies, is not clear. It is therefore not possible for the Committee to express an opinion on whether the provisions of the sub-sections (2) and (3) of section 4 of the Act are applicable. In case, they are applicable, then the said private limited companies become subsidiaries of ‘A’ Ltd., thereby disqualifying ‘C’ from being appointed as the statutory auditor of such companies.

5.The Committee further notes that the Research Committee of the Institute of Chartered Accountant of India, in a note on ‘Independence of Auditors;[1] has stated that, “Independence of the auditor has not only to exist in fact, but also appear to so exist to all reasonable persons. The relationship between the auditor and his client should be such that firstly he is himself satisfied about his independence and secondly no unbiased person would be forced to the conclusion that, on an objective assessment of the circumstances, there is likely to be an abridgement of the auditor’s independence.” The Committee is therefore of the opinion that even though from the point of view of section 4, a subsidiary-holding relationship is not established, ‘C’ should use his judgement in deciding whether his independence would be impaired as statutory auditor of the said companies since these companies as well as ‘A’ Ltd. of which he is an employee, appear to be virtually controlled by one family. Accordingly, he may not accept the assignment.

6.Regarding appointment of the chartered accountant for certification of data required by governmental/semi-governmental authorities financial institutions, banks, etc., the Committee notes that the Companies Act has not prescribed any disqualification. However, certain Acts/Rules/Regulations/terms of appointment may prescribe such disqualifications, e.g., Chartered Accountant’s Certificate on the Statement showing consumption of Imported Raw Materials, Components and Consumables under Import-Export Policy, wherein he is required to state in the prescribed format of the certificate that he is not a partner, director or an employee of the concerned firm or its associates. The Committee is of the opinion that in similar situations even though the relevant Act/Rules/Regulations/terms of appointment etc. do not prescribe a disqualification, a chartered accountant should not accept the assignment of certifying data as it is likely to impair his independence. The Committee is further of the opinion that, for the same reason, where holding-subsidiary relationship exists between two or more companies, he should not accept such an assignment. In the context of the present query, the committee is of the opinion, even though a subsidiary-holding relationship is not established between the concerned companies from the point of view of section 4, ‘C’ should follow the course of action suggested in para 5 above.

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[1] Compendium of Notes (1983) PP 17.