Column : A mixed bag of company law reforms

Written by Lalit Kumar | Updated: Nov 10 2012, 08:33am hrs
The relative lull within the corporate circles in recent months has been countered by a strong impetus, with the government seemingly determined to get started with major reforms while simultaneously quieting the critics who had been accusing it of policy paralysis. Arguably, one of the most awaited reforms in many years is the new company law, which is set to replace the Companies Act, 1956. To add to the list of its reforms, the Union Cabinet recently announced certain amendments to the originally introduced (and later withdrawn) Companies Bill, 2011, a move which shows that reforms are being pushed ahead and that there should surely be light at the end of the tunnel for the new company law. Expectations are high that it would be introduced and passed in the winter session of Parliament.

One of the proposed landmark changes is to make corporate social responsibility or CSR, as is its popular moniker, mandatory for all corporations with (a) R500 crore of net worth or (b) R1,000 crore of turnover or (c) R5 crore of net profit. If any one of the aforesaid limits is crossed, then that corporation must be compulsorily ready to part with 2% of average profits earned in the last three years, towards one of the listed CSR activities. These activities include both social and environmental activities, ranging across eradicating extreme hunger and poverty, promoting education, empowering women, combating diseases, and ensuring environmental sustainability. This will mean that even a loss-making company will have to contribute towards CSR activities provided it meets any of the other two tests.

Interestingly, the amendment proposed by the Union Cabinet omits the words make every endeavour from the original clause relating to CSR as provided in the Companies Bill, 2011. This effectively ends the debate as to whether CSR initiatives are mandatory or voluntary. Now, the board of directors has to ensure (and not just to make every endeavour) that the corporation contributes a portion of its profit towards CSR activities. If the board fails to comply, it will have to give reasons for non-implementation or non-compliance. Further, it has been provided that the company, for its CSR activities, should give preference to the areas where it operates, meaning richer states with more corporate houses will get more benefits than those which lack them.

This amendment will not make much difference to iconic corporations such as Tata, Infosys, Vedanta, Bharti and Reliance since they are, in any case, voluntarily taking up CSR initiatives. But for others, the mandatory contribution could pinch. Whether making it mandatory is good or bad is certainly a matter of debate. Those who support the move argue that all corporate houses owe their existence to society. So, if they give some portion back to it, then it is a socially beneficial reform. Certainly, the mandatory provision of CSR would provide clarity over when and where to contribute. Those who oppose mandatory and strictly outlined CSR initiatives argue that corporate houses should not and cannot be forced to take social responsibility because that is the states responsibilitybusinesses should focus on earning and delivering profits to the owners of capital, leaving it to the state to be the agent of social and environmental development. The state, in any case, taxes corporate houses to use the proceeds thereof for such initiatives.

Still, there is a glaring lack of clarity over whether there would be any tax deduction available to the corporate on the amount contributed towards CSR. The argument that the corporate will be forced to increase the cost of production to cover the mandatory contribution made towards CSR is also not out of place. While the importance of CSR cannot be questioned, its mandatory treatment is debatable. The shift to the mandatory requirement should ideally have taken place after taking into account the industry experiences and the ground realities facing corporations making normal profits.

Another changed reform is with respect to interest rates that will be allowed on inter-corporate loans. Currently, inter-corporate loans cannot be made at a rate lower than the prevailing bank rate made public by RBI, currently fixed at 9%. It is proposed to change this to the prevailing interest on dated government securities. Dated government securities are long-term securities issued by RBI on behalf of the government, which carry a fixed or floating rate of interest while the bank rate made public by RBI is a fixed rate. Though this change should not really affect inter-corporate lending as the dated government securities interest rate is usually around the current bank rate of 9%; however, its floating nature could keep changing the borrowing and lending costs for the corporates.

Certain welcome changes are proposed, such as provisions relating to punishment of a person who falsely induces a person to enter into an agreement with banking and financial institution with a view to obtaining credit facilities; exemption of independent directors from the requirement of retiring by rotation, which will ensure longer continuation of the independent directors on the board of a company; rotation of auditing partner of the statutory audit firm at the discretion of the members of the company instead of a compulsory rotation every year; appointment of auditors for 5 years will be subject to ratification by the members at each annual general meetingbasically, this will not be any different from a yearly reappointment of auditors, which is provided under the existing Companies Act.

All said, the Union Cabinet has taken a strong and unprecedented stance towards reforming the vintage company laws of India. While some reforms may appear rigid or unfair to smaller corporations, the overall intent is positive and forward looking. India Inc has been revived and provided food for thought as it mulls the next steps towards implementation of the imminent new-look Companies Bill.

The author is a partner with J Sagar Associates. These are his personal views