The Economic Times reported that, the government is about to introduce a new Companies Bill — nearly 20 years in the making — as it takes a big step towards improving transparency and regulation of business houses in India. Efforts to overhaul the legislation have snaked through red tape but there is unlikely to be further hitches.
A panel of MPs has scrutinised the Bill and most changes it recommended have been incorporated. Businesses too are keen that the bill is passed quickly, hassled as they are, by the back-and-forth on the various contentious changes the government had proposed.
So chances are that the Companies Bill, 2011, which will replace the Companies Act, 1956, will be passed by Parliament in the monsoon session. Yet, that does not mean a perfect law is on the cards. Corporate lawyers say the Bill still has many flaws that could create problems for directors, shareholders and other stakeholders of companies.
The proposal to set aside funds for corporate social responsibility is a big worry. The room for government to lay out rules for determining how the law will be implemented in letter and spirit is another prime concern. ET Magazine takes a deep look at some of these concerns.
Corporate social responsibility
Companies must set aside 2% of net profit for CSR activities
What is the Concern:
The CSR clause covers all companies that have either net worth in excess of Rs 500 crore, or turnover of Rs 1,000 crore or more, or net profit of Rs 5 crore or more. They have to set aside 2% of the average net profit of the preceding three years for CSR activities.
That is a lot of money. It won’t pinch much during the good times. But what happens when the economy slows or during recession? The Companies Bill 2011 makes no exception, though an ‘errant’ company can explain the reason for not spending the amount in its annual report.
Corporate affairs minister M Veerappa Moily has assured the industry that the clause is not mandatory in nature, but many say the disclosure requirement makes the CSR spend binding. Expect a long-drawn-out legal battle.
Managing Partner Shardul Shroff of law firm Amarchand Mangaldas describes this mandatory provision as coercive extraction, akin to tax. He says it is unfair for companies where promoters already have sufficient CSR initiatives.
“When a company must borrow and has to fund CSR, why should the shareholders not have a say, especially when the 2% available surplus is to be employed in paying interest. Should such a fund be diverted to CSR instead of development finance?” asks Shroff.
Luthra & managing partner Rajiv K Luthra says the concerns of CSR can be addressed through coordinated actions between various ministries and diligent subordinate legislation. For instance, tax treatment of these expenses. “One certainly hopes that they will be deductible for computing taxable income,” says Luthra.
What Can Go Wrong:
Industry fears hefty fines for non-compliance, though there is no mention of penalty in the Bill. They also fear political extortion. Politicians can force companies contribute to their “trusts”. They can even demand that a company develops their constituencies.
Key Takeaway: Many business houses have been amplifying their focus on CSR activities. The lure to be seen as a caring organisation is big and so the consensus is that there is no need to make CSR mandatory.
Companies can have only two layers of subsidiaries for investment
What is the Concern:
Companies have traditionally created multiple investment subsidiaries. These offshoots can come up at home or overseas, particularly in tax-friendly nations such as Mauritius for routing investments into another country. Large Indian business houses have several hundred subsidiaries that act as investment arms of the holding company or subsidiaries of the holding company. These are used to start new ventures, acquire businesses and enter into joint ventures.
Several entities have been found to be using a web of subsidiaries to siphon funds from profitable ventures. By permitting only two levels of subsidiaries, the Bill hopes to check such practices.
But companies worry that will restrict their ability to do business. “Restricting the number of subsidiaries could result in curbing the flexibility of corporate entities,” says Akshay Chudasama, partner, J Sagar Associates.
Another concern is about continuing with the structure in place and the prospective effect of the law. “What happens to existing structures? The Bill does not provide any timeline for unwinding the current structure,” says Mehul Modi, senior director, DeloitteTouche Tohmatsu India.
What Can Go Wrong:
M&A activity can get severely affected due to a restriction on investment subsidiaries. Also, infrastructure companies and property developers that typically use multiple subsidiaries for fund raising and doing business could be badly affected.
(Sourced from Economic Times)