17 May 2023
Company A and company B are under the same management. Company A owns a plot, the market value of which is about 2.50 Cr. Company A allows company B to construct a showroom on plot of A. Company B gives proposed map as per its own requirements, which is submitted to development authority by Company A. Map approval charges and development charges are paid by Company A to the Development Authority. The cost of construction of showroom is borne by B. No rent is charged by A from B for giving possession and allowing use of plot by Company B. Period of allowing use of plot is likely to be quite long. There is no written agreement between two Companies.
Any transaction between two companies under the same management should be made at arms length price, whereas in the instant case there is no consideration.
On these facts of the case, my questions are:
1. Is there violation of any Act!? 2. Should the Auditor report such transaction in his Audit report, if no reference of this transaction is made in the Notes on Accounts? 3. How and in what manner the Auditor should report in his Audit Report?
10 July 2024
Based on the scenario described, here are the considerations for each of your questions:
1. **Violation of any Act:** - From a legal and regulatory perspective, allowing Company B to construct a showroom on Company A's plot without any consideration (rent) can raise issues related to transfer pricing regulations and related-party transactions under the Income Tax Act, 1961. - Section 40A(2)(b) of the Income Tax Act pertains to related-party transactions where if expenses are paid to a related party without adequate consideration, the deduction could be restricted. - Under Companies Act, 2013, related-party transactions should be at arm's length to avoid conflicts of interest and ensure fair dealing among companies under the same management.
2. **Auditor's Reporting:** - If there is no mention of this transaction in the Notes on Accounts or any disclosure in the financial statements of Company A or Company B, the auditor should inquire into the nature of the transaction. - The auditor should ascertain whether this arrangement has been properly accounted for and disclosed in the financial statements. If it has not been disclosed and it is material, the auditor should consider reporting it as a material related-party transaction in the audit report.
3. **Auditor's Reporting in Audit Report:** - The auditor should report on related-party transactions as per the requirements of the Companies Act, 2013, and the auditing standards applicable in India. - If the auditor becomes aware of any related-party transaction that has not been disclosed adequately in the financial statements, the auditor should express an appropriate opinion or qualification in the audit report. - This may include a qualification indicating that the financial statements do not disclose certain related-party transactions adequately, or that the auditor is unable to determine the full implications of the transaction due to lack of information or documentation. - It is crucial for the auditor to discuss the matter with the management of both companies and seek clarification on the nature, terms, and implications of the transaction.
In summary, while the scenario described does not inherently violate any Act, it does raise concerns related to related-party transactions and proper disclosure in financial statements. The auditor's role is to ensure transparency and compliance with regulatory requirements by reporting on related-party transactions appropriately in the audit report.
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