Declaration and Payment of Dividend-I

Chapter VIII of the Companies Act,2013 titled 'Declaration and Payment of Dividend' comprises sections 123 to 127(both inclusive)as under :

• Section 123 : Declaration of dividend
• Section 124 : Unpaid dividend account(not yet made applicable)
• Section 125 : Investor Education and Protection Fund(not yet made applicable)
• Section 126 : Right to dividend, rights shares and bonus shares to be held in abeyance pending registration of transfer of shares 
• Section 127 : Punishment for failure to distribute dividends

Comparison of the Companies Act,2013 vis a vis the Companies Act,1956
Various changes made by section 123 of the 2013 Act as regards declaration and payment of dividend are as under:

• Transfer of profits to reserves made optional. Unlike the 1956 Act, it is not necessary to transfer specified percentage of profits to reserves where company intends to declare dividend above a specified percentage.  
• Company will have to provide entire unabsorbed losses and depreciation of earlier years before declaring dividend. Unlike the 1956 Act, it is not sufficient to provide merely lower of loss after depreciation and depreciation.
• Section 123 clearly provides that dividends shall not be declared out of reserves other than free reserves. Since revaluation reserves are excluded from definition of free reserves by section 2(43), declaration of dividends out of revaluation reserves is barred. There was no such express bar in the 1956 Act.
• If company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years. Such restriction was not there in the 1956 Act.
• Sub-section (6) of section 123 provides that a company which fails to comply with sections 73 and 74 of the 2013 Act (relating to acceptance of deposits from public/members/repayment of deposits accepted before commencement of the Act) shall not, so long as such failure continues, declare any dividend on its equity shares. There was no such express bar in the 1956 Act

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Duty of confidentiality of CA under Code of Ethics

Ingredients of professional misconduct under clause (1) of Part I to the Second Schedule to the Chartered Accountants Act,1949

(i)A CA in practice discloses information acquired in the course of his professional engagement.  
(ii)Such disclosure is to any person other than his client so engaging him.  
(iii)Such disclosure is otherwise than as required by any law for the time being in force. 
(iv)Such disclosure is without the client’s consent. 

If all the above conditions (i) to (iv) are satisfied, disclosure of information by a CA in practice tantamount to professional misconduct. It does not matter whether disclosure is deliberate or unintentional. Also, it does not matter whether client’s interest is actually harmed or not.

One can see that duty of confidentiality is not an absolute on but a qualified one. If disclosure is "as required by any law for the time being in force", the CA cant be held guilty under Clause (1). So legal requirement to disclose(for example section 143(12) of the Companies Act,2013 is good defence in professional misconduct proceedings under clause (1)  especially when the legal requirement overrides the duty of confidentiality(eg section 143(13) of the Companies Act,2013)

Sub-sections (12) of section 143 casts a duty on auditor to report fraud  to the Central Govt if:

• in the course of the performance of his duties as auditor, 
• the auditor has reason to believe that an offence involving fraud is being or has been committed
• the fraud is against the company by officers or employees of the company 

Sub-sections (13) of section 143 provide as under:

• No duty to which an auditor of a company may be subject to (e.g. duty of confidentiality under the Chartered Accountants Act,1949) shall be regarded as having been contravened by reason of his reporting the matter as above if it is done in good faith. [Section 143(13)]

So if auditor reports fraud to Central Government in confirmity with Section 143(12) in good faith, he gets the benefit of protection of section 143(13) and cannot be held guilty of violating duty of confidentiality under clause (1) of Part I to the Second Schedule to the Chartered Accountants Act,1949

Auditor to attend Annual General Meeting

Under the 1956 Act, it was entirely up to the auditor whether to attend any general meeting of the company or not and whether or whom to depute as his representative at such meetings. Section 146 of the 2013 Act brings a sea change in this. Now, auditor shall, unless otherwise exempted by the company, attend any general meeting : (i) by himself or (ii) through his authorised representative who is qualified to be an auditor.

Section 146 deals with:

• Duty of company to forward notices of general meetings to auditors 
• Auditor’s duty to attend general meeting and right to be heard at general meeting

  

Notices of general meetings to be forwarded to the auditor of the company

The first limb of section 146 provides that all notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of the company. The forwarding of notices and other communications is required irrespective of whether the agenda for the meeting contains any item related to accounts or audit or auditors.

Auditor’s duty to attend general meeting and right to be heard at general meeting

The second limb of section 146 deals with auditor’s attendance at general meetings and auditor’s right to be heard at general meetings. The second limb of section 146 provides as under:

(A)he auditor shall, unless otherwise exempted by the company, attend any general meeting

(i)by himself, or

(ii)through his authorised representative who is qualified to be an auditor.

(B)The auditor shall have right to be heard at such meeting on any part of the business which concerns him as the auditor.

The following points are noteworthy:

• Section 146 makes auditor’s attendance at general meetings compulsory either by himself or authorized representative qualified to be an auditor. 
• Such attendance is compulsory whether or not any matter related to accounts or audit or auditors is scheduled in the agenda of the general meeting. 

'Quarantining’ audit from other serivces

Quarantining’ audit from other services - Services which auditor should not provide to the auditee-company-Section 144 of the Companies Act,2013

Section 144 stipulates what the Cadbury Report termed as ‘quarantining audit from other services’ but recommended against the same. Section 144 of the Act provides that an auditor appointed under this Act shall not directly or indirectly  provide any of the following “other services” (i.e. services other than statutory audit under the 2013 Act) to auditee-company or its holding company or subsidiary company :

• accounting and book-keeping services; 
• internal audit; 
• design and implementation of any financial information system; 
• actuarial services; 
• investment advisory services; 
• investment banking services; 
• rendering of outsourced financial services; 
• management services; and 
• any other kind of services as may be prescribed.

Services other than the above may be provided by the auditor to the company only if the services are approved by the Board of directors or the audit committee, as the case may be.

Transitional provisions

An auditor or audit firm who or which has been performing any non-audit services on or before the commencement of this section shall comply with this section before the closure of the first financial year after the date of such commencement.

“Directly or indirectly”

The Explanation to section 144 defines the expression “directly or indirectly” as under :

(A) In case auditor being an individual

(B) In case of auditor being a firm (including LLP incorporated under the LLP Act)

The term “directly or indirectly” shall include rendering of services : either by himself or  through his relative  or  through any other person connected or associated with himself  through any other entity, whatsoever, in which such individual has significant influence or  through any other entity, whatsoever, in which such individual has control or  through any other entity whose name or trade mark or brand is used by such individual.

The term “directly or indirectly” shall include rendering of services: either by itself or  through any of its partners or  through its parent or  through its subsidiary or  through its associate entity or  through any other entity in which the firm has significant influence or  through any other entity in which the firm has control or  through any other entity whose name or trade mark or brand is used by the firm  through any other entity in which any partner of the firm has significant influence  through any other entity in which any partner of the firm has control  through any other entity whose name or trade mark or brand is used by any of its partners.

It may be noted that the expressions, ‘associate entity’, ‘associated person’, ‘connected person’ are used in the Explanation to section 144 but are not defined in the Act.

Compulsory Rotation of auditors

Concept of mandatory audit firm rotation

Mandatory audit firm rotation is defined in the Sarbanes-Oxley (SOX) Act as the imposition of a limit on the period of years during which an accounting firm may be the auditor.

Rationale of mandatory rotation of auditors - To enhance audit quality

The idea behind mandatory rotation of auditors is to enhance audit quality. Quality of an audit is a function of (1) the competence of the audit firm (i.e., the auditor’s ability to detect material omissions or mis-statements in the client’s financial statements), and (2) the level of actual threats to auditor independence (i.e., the probability the auditor will reveal material errors). The US Supreme Court has emphasized the importance of the connection between investor confidence and the appearance of independence of auditor “….Public faith in the reliability of a corporation’s financial statements depends upon the public perception of the outside auditor as an independent professional. If investors were to view the auditor as an advocate for the corporate client, the value of the audit function itself might well be lost.” [United States v. Arthur Young & Co. 465 U.S. 805, 819 n.15 (1984)].

Companies to which provisions for compulsory rotation of auditor’s apply [Section 139(2)]

Provisions for compulsory rotation of auditors in section 139(2) shall apply to :

• listed companies
• a company belonging to such class or classes of companies as may be prescribed

Rule 5 of the Companies (Audit and Auditors) Rules, 2014 provides that for the purposes of sub-section (2) of section 139, the class of companies shall mean the following classes of companies excluding one person companies and small companies:—

(a)all unlisted public companies having paid up share capital  of rupees ten crore or more;

(b)all private limited companies having paid up share capital  of rupees twenty crore or more;

(c)all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more

The provisions of section 139(5)/139(7) dealing with Government Companies and companies owned or controlled directly or indirectly by Government override only section 139(1) but not section 139(2). Therefore, provisions of section 139(2) shall also apply to Government companies and companies owned or controlled directly or indirectly by Government if such companies are listed companies or fall in prescribed class or classes of companies i.e. covered by Rule 5 above.

Provisions as to compulsory rotation of auditors

The following provisions may be noted:

No listed company or a company belonging to such class or classes of companies as may be prescribed, shall appoint or re-appoint—

(a) an individual as auditor for more than one term of 5 consecutive years; and

(b) an audit firm (including LLP) as auditor for more than two terms of 5 consecutive years.

Cooling off period

The cooling off period is the minimum gap between expiry of maximum tenure and appointing the auditor again which is stipulated by law. The provisions in this regard are as under:

• An individual auditor who has completed his term as per (a) above shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of his term; 
• An audit firm (including LLP) which has completed its term under (b) above, shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Provisions cannot be circumvented by appointing partner of audit firm whose tenure is over - On the date of appointment no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of 5 years. The words ‘same company’ in section 139(2) of the 2013 Act are significant. It appears that there is no bar on appointing the rotated auditor (auditor/audit firm who has completed term) as auditor of holding company/subsidiary/co-subsidiary/associate of the company in question during the cooling-off period.

Every company, existing on or before the commencement of this Act which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within three yearsfrom the date of commencement of this Act.

The above provisions shall not prejudice the right of the company to remove an auditor or the right of the auditor to resign from such office of the company. [Section 139(2)]

The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors. [Section 139(4)]

Manner in which the companies to rotate their auditors on the expiry of term

Rule 6 of the Companies (Audit and Auditors) Rules, 2014 provides as under :

• The Audit Committee shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the incumbent auditor on expiry of the term of such incumbent. 
• Where a company is required to constitute an Audit Committee, the Board shall consider the recommendation of such committee, and in other cases, the Board shall itself consider the matter of rotation of auditors and make its recommendation for appointment of the next auditor by the members in annual general meeting. 
• For the purpose of the rotation of auditors—(i) in case of an auditor (whether an individual or audit firm), the period for which the individual or the firm has held office as  auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be;(ii)the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms. 
• The term “same network” includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control. 
• For the purpose of rotation of auditors,—(a) a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation;(b) if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of five years.

Illustration explaining rotation in case of individual auditor

Number of consecutive years for which an audit firm has been functioning as auditor in the same company [in the first AGM held after the commencement of provisions of section 139(2)]	Maximum number of  consecutive years for which the firm may be appointed in the same company (including transitional period)	Aggregate period which the firm would complete in the same company in view of columns I and II
I	II	III
5 years	3 years	8 years or more
4 years	3 years	7 years
3 years	3 years	6 years
2 years	3 years	5 years
1 year	4 years	5 years

Note: 1. Individual auditor shall include other individuals or firms whose name or trade mark or brand is used by such individual, if any.

2. Consecutive years shall mean all the preceding financial years for which the individual auditor has been the auditor until there has been a break by five years or more.

Illustration explaining rotation in case of audit firm

Illustration 2:—

Number of consecutive years for which an audit firm has been functioning as auditor in the same company [in the first AGM held after the commencement of provisions of section 139(2)]	Maximum number of  consecutive years for which the firm may be appointed in the same company (including transitional period)	Aggregate period which the firm would complete in the same company in view of columns I and II
I	II	III
10 years (or more than 10 years)	3 years	13 years or more
9 years	3 years	12 years
8 years	3 years	11 years
7 years	3 years	10 years
6 years	4 years	10 years
5 years	5 years	10 years
4 years	6 years	10 years
3 years	7 years	10 years
2 years	8 years	10 years
1 year	9 years	10 years

Note : 1. Audit Firm shall include other firms whose name or trade mark or brand is used by the firm or any of its partners.

2. Consecutive years shall mean all the preceding financial years for which the firm has been the auditor until there has been a break by five years or more.

Rotation of auditors to be factored in while appointing joint auditors

Rule 6(4) of the Companies (Audit and Auditors) Rules, 2014 provides that  where a company has appointed two or more individuals or firms or a combination thereof as joint auditors, the company may follow the rotation of auditors in such a manner that both or all of the joint auditors, as the case may be, do not complete their term in the same year.

Enabling provision for rotation of audit partners

Rotation of auditor/audit firm is not to be confused with rotation of audit partner/team. The former is mandatory. The latter is optional. Moreover, rotation of auditor applies to auditor irrespective of whether auditor is individual/audit firm. Rotation of audit partner applies only when auditor is audit firm.

Subject to the provisions of this Act, members of a company may resolve to provide that in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members [section 139(3)(a)]

Duty of Auditor to report fraud to Central Govt

Backdrop
Sub-sections (12) to (14) of section 143 of the Companies Act,2013 are new provisions . There were no provisions along these lines in the Companies Act,1956

Duty of auditor/cost auditor/secretarial auditor to report fraud
Sub-sections (12) of section 143 casts a duty on auditor to report fraud  to the Central Govt if:

• in the course of the performance of his duties as auditor, 
• the auditor has reason to believe that an offence involving fraud is being or has been committed
• the fraud is against the company by officers or employees of the company 

Sub-sections (13) and (14) of section 143 provide as under:

• No duty to which an auditor of a company may be subject to (e.g. duty of confidentiality under the Chartered Accountants Act,1949) shall be regarded as having been contravened by reason of his reporting the matter as above if it is done in good faith. [Section 143(13)]
• The provisions of section 143 are applicable mutatis mutandis to cost auditor (section 148) and secretarial auditor (section 204).[Section 143(14)]

Only frauds against company by officers/employees to be reported .Frauds committed by the company (on outsiders/creditors/investors etc.) are outside the scope of reporting requirements under section 143(12). If auditor reports frauds committed by the company, he cannot avail the immunity under section 143(13) and would be liable for professional misconduct for breach of confidentiality under clause (1) of Part I of the Second Schedule to the CA Act, 1949.


Manner of reporting frauds to the Central Government
Rule 13 of the Companies (Audit and Auditors) Rules, 2014 prescribes the manner of reporting to Central Government under section 143(12).

Rule 13 provides that  in case the auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he shall report the matter to the Central Government immediately but not later than sixty days of his knowledge and after following the procedure as under :

Draft Report to BOD/Audit Committee

• Auditor shall forward his report to the Board or the Audit Committee,as the case may be, immediately after he comes to knowledge of the fraud, seeking their reply or observations within forty-five days;

Report to Central Govt. after considering reply/observation of BOD/ Audit Committee

• On receipt of such reply or observations the auditor shall forward hisreport and the reply or observations of the Board or the AuditCommittee alongwith his comments (on such reply or observationsof the Board or the Audit Committee) to the Central Governmentwithin fifteen days of receipt of such reply or observations;

If no reply within 45 days

• In case the auditor fails to get any reply or observations from theBoard or the Audit Committee within the stipulated period of fortyfivedays, he shall forward his report to the Central Government alongwith a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time.
• The report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by registered post with acknowledgement due or by speed post followed by an e-mail in confirmation of the same.
• The report shall be on the letter-head of the auditor containing postal address, e-mail address and contact number and be signed by the auditor with his seal and shall indicate his Membership Number.
• The report shall be in the form of a statement as specified in Form ADT-4.

The provision of  Rule 13 shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148 and section 204 respectively.

Punishment for contravention of section 143(12)

• If any auditor, Cost Accountant or Company Secretary in practice do not report fraud committed or being committed as above, he shall be punishable with fine which shall not be less than Rs. 1,00,000 but which may extend to Rs. 25,00,000. [Section 143(15)]
• In addition to punishment under section 143(15), it would appear that the auditor of the company would also be liable to punishment under subsection (2) of section 147  since the said provision refers to contravention of ‘any provision of ....... section 143’.