1.18     Query

Appointment of a sole proprietor as an auditor of a company in which a partner of the sole proprietor in another firm of chartered accountants has interest

1.M. Pvt. Ltd. appointed M/s. X & Co., Chartered Accountants, a proprietorship firm of X, its first statutory auditors under Section 224 (5) of the Companies Act, 1956. X is also a partner in M/s. XY & Co., Chartered Accountants. Y, the other partner in XY and Co., is the son of N, a director of M Pvt. Ltd.

2.The paid-up share capital (in fully paid-up shares) of M. Pvt. Ltd. is Rs. 3,28,400/-. Some of the shareholders of the company and their shareholdings are as follows:

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

(i) Whether Y has a substantial interest in M. Pvt. Ltd. in terms of clause (4) of Part I of the Second Schedule to the Chartered              Accountants Act.

 

(ii) If Y has substantial interest in M. Pvt. Ltd., whether any disclosure for the same is called for in audit report of X despite the fact that he is the auditor in his individual capacity? If yes, in what manner the same shall be disclosed?

 

 (iii) Is any disclosure called for by the directors regarding the interest in the appointment/re-appointment of X and Co., (whether X is obliged to disclose it or not in his audit report) in the Directors’ Report or in the notice of the first annual general meeting in which the retiring auditors, X and Co., shall be re-appointed under section 224(1) of the Companies Act, 1956.

                                                                          Opinion                                        July 10, 1987

1.The Committee notes that the Council of the Institute has issued the following Notification, which appears at page 57 of the ‘The Chartered Accountants Act, 1949’, published by the Institute:

“No. 1-CA (44) 71: In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India specifies that a member of the Institute shall be deemed to be guilty of professional misconduct, if he expresses his opinion on financial statement of any business or enterprise in which one or more persons who are his “relatives” within the meaning of Section 6 of the Companies Act, 1956 have either by themselves or in conjunction with such member a substantial interest unless he discloses the interest also in his report. Explanation: For this purpose the expression “substantial interest” shall have the same meaning as is assigned thereto under Explanation 3 to Section 13 of the Income Tax Act, 1961”.

2.The Committee further notes that in the case of a company, the term ‘substantial interest’ has been assigned the following meaning under explanation 3 to Section 13 of the Income-tax Act, 1961:

       (i) When the concern is a company, a person shall be deemed to have a substantial interest therein, if its shares, other than preference shares, carrying not less than 20 per cent of the voting power are, at any time during the previous year, owned beneficially by him alone or partly by him and partly by one or more of the other persons referred to in section 13(3) ….”

3.The Committee notes that according to Section 6 of the Companies Act, 1956 and Section 13(3) of the Income-tax Act, 1961 only N (father of Y) and minor brother and sister of Y, are the ‘relatives’ of Y, unless Y, uncle of Y, and other relatives of Y are members of an HUF, in which case uncle of Y will also be considered as a relative. It is assumed that uncle of Y is not the member of HUF, consisting of Y and his relatives. The Committee also notes that their combined shareholdings (including X’s and Y’s but excluding uncle of Y) in the company ‘M’ Ltd. are less than 20% of the total paid-up share capital of the company. The Committee is therefore of the opinion that, in this case, X can be appointed as the auditor of the company and no disclosure in necessary in this regard either in the auditor’s report or in the Directors’ Report or in the notice of the first annual general meeting in which XY and Co. is appointed as auditors u/s 224 of the Companies Act, 1956.

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