Specified Bank Notes: Disclosure as part of Financial Statements by Vallari Dubey

The Central Government on recommendation of the Central Board of Directors of the Reserve Bank of India (‘the Board’) decided to cease bank notes of denomination of value of five hundred rupees and one thousand rupees as legal tender, vide notification S.O. 3407(E)[1] dated Nov 8, 2016, a scheme which is commonly connoted as the ‘the Demonetization Scheme’. As per the notification, such bank notes shall be termed as ‘Specified Bank Notes’.

Mandatory disclosure in Financial Statements by Companies

All the companies[2] are mandatorily required to prepare their financial statements as per the provisions of Section 129 of the Companies Act, 2013 (‘the Act’)[3], which mandates inter alia, that such statements shall be as per the requirements expressed in Schedule III of the Act.

On 31 st March, 2017, the Ministry of Corporate Affairs issued a notification (G.S.R. 308(E))[4], amending the Schedule III of the Act. Appropriately, it stipulates that all companies while formulating their financial statements as provided under Section 129, shall also disclose relevant particulars pertaining to Specified Bank Notes, held and transacted during the period commencing from Nov 8, 2016 to Dec 31, 2016. Such disclosure shall be in a tabular form as prescribed in the notification.

Inclusion in Audit Report

There is a consequent change in the Companies (Audit and Auditors) Rules, 2014 as well vide notification **. As per the amendment notification, necessary inclusion shall have to be made in the Auditor’s Report by the auditor of the company for the relevant period, apropos to “whether the company had provided requisite disclosures in its financial statements as to holdings as well as dealings in Specified Bank Notes during the period from 8th November, 2016 to 30th December, 2016 and if so, whether these are in accordance with the books of accounts maintained by the company”.[5]

Rationale

In confirmation of the Notification by Central Government, declaring Specified Bank Notes as ceased legal tender, following are but not limited to, the possible factors behind amending the Act with regard to SBNs:

• Permissible transactions.[6] Government through notification dated Nov 8, 2016 (O. 3408(E)), excluded certain transactions from the purview of notification S.O. 3407(E) for the purpose of public convenience for a specified time period, and which was extended further. In order to ensure that the company entered into specified permissible transactions only, it is pertinent to report the same to the stakeholders.

• The disclosure with regard to SBN which has to be in the prescribed format, purports to bring forth the following:

1. Cash in hand held at the beginning of the scheme and at the end of the scheme at Nov 8, 2016 and Dec 30, 2016 respectively sub-categorized into SBN and notes of other denomination.
2. Quantum of SBN inert alia notes of other denomination.
3. Quantum and type of dealings in both SBN and notes of other denomination.

• Whether SBNs were used in the way they were meant to be used as instructed by RBI, further, auditor’s report shall make relevant comments if the disclosures made are in line with the books of accounts of the company to give surety to the stakeholders and whether such disclosures are true at all.

Impact in general & on NBFCs in particular

Sub-section (1) to Section 129 clearly provides, inter alia that the financial statements shall be prepared in accordance with and in the form(s) as prescribed under Schedule III of the Act.

The second notification construes to amend the Companies (Audit and Auditors) Rules, 2014, effectively the auditor shall, in addition to other matters report his view and comments regarding disclosures about SBNs and whether they are in line with the books of accounts of the company. (Rule 11 of Companies (Audit and Auditors) Rules, 2014)[7]

As per Rule 13, if the auditor comes across any fraud, the same shall be reported and requisite action shall be taken, depending on the quantum of fraud. So, if the fraud pertains to use of SBNs, by the company, the same shall be reported by the auditor accordingly.

Non-Banking Finance Companies

As per Section 129, all the companies have to comply with the provisions except where specific exclusions have been made. On scrutiny, we find that no exclusion in respect of any of the provisions for Section 129 has been made for a Non-Banking Finance Company (NBFC), meaning thereby, that all the notifications (supra) which are applicable to companies shall also apply pari passu to NBFCs also, for that matter.

Implications

Referring to the Notifications (supra) concerning SBNs and on examination of the same, we list the following implications they are expected to have:

• Given the fact that companies have to report SBN transactions, the first step in the process of compliance would be finding the information or more particularly digging the information in this case, which is to be reported. Prima facie, it is hard to understand the implications and harder to perform the follow up compliance. The question which now arises, is how the Companies shall deal with this?

• The first task is to extract the information. In order to know the details of relevant transactions in SBN, one shall coordinate with banks. Considering that bank accounts of Companies are tend to be scattered, extracting such information would be a tedious task to do. Moreover, since banks are not bound to provide such details, the chances that they would be willing to sufficiently coordinate are less.

• Additionally, there are less prospects that any Company would keep a track of the denomination of notes transacted in its ledgers. In purpose of penetrating the same, the only way out is to ensure that proper tallying of the number of notes it deposited with the number of SBNs it is showing in Books of Accounts (‘BoAs’), is performed.

• Due to this notification a particular class of companies will be affected heavily and they are NBFCs. A lot of NBFCs deal with informal segments, especially micro finance institutions, and therefore, they are required to deal in cash. For instance, during demonetisation, several NBFCs authorised their borrowers to deposit cash directly in their bank accounts, who otherwise were repaying in cash. Though this is not violation of law, however, one will have to face a lot of practical difficulties while tracking the quantum of SBNs deposited to their bank accounts by the third parties and may have to rely on their bankers for co-operation.

• Lastly, all the Companies have to stick by the timeline of reporting, being that, calling and holding Board Meetings, considering and approving Financial Statements along with the Audit Report and presenting the same before the shareholders as prescribed by the Act. Generally, most of these compliances happen around May or June, given that shareholders have to approve the same by September end. This calls for immediate action on part of Companies, extracting and compiling required information with respect to Specified Bank Notes.

Penal Provisions for Non-Disclosure

As per Section 129(7), any contravention on non-disclosure or insufficient/inappropriate disclosure under Schedule III as per Section 129 of the Act, the stated officials and directors in the company shall be held liable to fine and imprisonment of the requisite amount. Meaning thereby, dealings and holdings in SBN undisclosed as required shall attract hefty penalty.

Section 448 of the Act enunciates “Punishment for false statement”. It says:

‘’Save as otherwise provided in this Act, if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement,—

(a) which is false in any material particulars, knowing it to be false; or

(b) which omits any material fact, knowing it to be material,

he shall be liable under section 447.’’

This implies that transactions in SBNs, which are material in nature if remain unreported shall attract the provisions of this Section, thereby holding the directors and also the auditors of the company subject to punishment prescribed in Section 447 of the Act.

This Section also covers those disclosures which are ‘false in material particulars’, indicating that any Financial Statement and/or the Auditor’s Report if contains disclosures pertaining to SBNs which are materially and in essence false, will again attract penal liabilities onto persons responsible.

Provisions in law with respect to penal actions again put a lot of onus on the Board of Directors, Principal Officers and Auditors of the Company and the Company itself to exercise utmost intelligence and due diligence in complying with the Notifications concerning disclosures of SBNs, as any non-compliance can prove to be extremely dangerous and could possibly lead to adverse circumstances.

Conclusion

The probability of extracted information, compiled and presented being flawless and/or immune to any doubts seems very less. Regardless of the amount of time and energy involved, Companies have to follow the Notifications. And since the risk of fault persists, it is likely that the authorities might refute the reporting of the Company. Given that, it is prudent to devise proper mechanism without much delay and have strong arguments in place to defend when required.

[2] Exemption or application with specific exclusion as provided shall apply in case of insurance companies, banking company, company engaged in generation or supply of electricity and Government companies engaged in production of defense equipments. (Refer Section 129 of the Act)