Cost accounting and audit seemed to be a not-so-relevant subject matter till lately when the Cost Audit Branch of the Ministry of Corporate Affairs has started issuing notices checking for compliance with the Companies Act provisions. However, there may be certain lacunae in such notices and some interesting legal propositions involved.
I. Introduction
India was the first country in south Asia to make cost audit mandatory for some business sectors. As India gained independence, industrialization and developmental efforts intensified and for this purpose, various concessions and facilities were given to industrialists to promote manufacturing. However, due to monopolistic practices and other ulterior reasons, there would often be found scenarios where the pricing of manufactured products was complained to be excessive - the manufacturers would justify such pricing relying on higher cost of inputs. In parallel, there would be under-invoicing of imports to evade customs duties or over-invoicing of exports to avail export benefits. Thus, cost inflation and manipulation was rampant throughout the industrial chain. Needless to say, at that time, some kind of price control or check was imperative for certain key industrial sectors, from a public benefit perspective but not at the cost of curtailing development.
As such, provisions relating to maintenance of cost accounting records under section 209(1)(d) of the Companies Act, 1956 were introduced. For certain businesses, it was made mandatory to maintain cost accounting records, get them audited by a cost auditor and adhere to the regulatory provisions contained in the law. However, as decades have passed and industrialization requirements of the country have changed, easing up of such provisions has been done in the new Companies Act, 2013 ('the Act'). Section 148 of the Act now provides for cost accounting and audit requirements for certain limited activities. The Notes on Clauses in the Companies Bill, 2011, explaining this section reads as under:
"Clause 148. - This clause corresponds to section 233B of the Companies Act, 1956 and seeks to empower the Central Government after consultation with regulatory body to direct class of companies engaged in production of such goods or providing such services as may be prescribed to include in the books of accounts particulars relating to utilization of material or labour or to such other items of cost. The Central Government may direct the audit of cost records of the company by Cost Accountant in practice appointed by Board and on such remuneration as determined by the members. The auditor conducting the cost audit shall comply with the cost auditing standards. The clause further provides that the qualifications, disqualifications, rights, duties and obligations as apply to auditor shall also be applicable to cost auditor as well. The Central Government may call for further information and explanation, if necessary, after considering cost audit report. The clause further defines cost auditing standards. The clause also provides penalty for the company, every officer of the company, cost auditor of the company who is in default, if any default is made in compliance with the provision."
If we examine the section and the prescribed rules thereunder closely, it is evident that the scope and applicability of cost accounting and audit provisions under the new Act have considerably been diluted. However, lately, the Cost Audit Branch of the Ministry of Corporate Affairs ('MCA') has been issuing show cause notices ('SCN') to various companies, bringing cost audit provisions out of the oblivion and into relevance and concern once again.
II. Legal provisions
The governing legal provisions regarding cost audit are laid down in section 148 of the Act read with the Companies (Cost Records and Audit) Rules, 2014 ('Cost Audit Rules'). These provisions, inter alia, provide for the following:
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Maintenance of cost accounting records: As per Rule 3 and Rule 5 of the Cost Audit Rules, read with section 148(1) of the Act, every company engaged in a business enlisted in Table A (Regulated Sector) and B (Non-Regulated Sector), having an overall turnover from all its products and services of Rs. 35 Crore or more during the immediately preceding financial year, shall be required to maintain cost accounting records.
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Applicability of cost audit: Rule 4 of the Cost Audit Rules, read with section 148(1) and 148(2) of the Act, provides that every company which is required to maintain cost accounting records as per Rule 3, shall get its cost records audited. The Rule provides for certain threshold limits for cost audit becoming applicable. Further, the Rule provides for certain exceptions by stating that cost audit shall not be applicable for companies:
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whose revenue from exports, in foreign exchange, exceeds 75% of the total revenue; or
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which is operating from a Special Economic Zone; or
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which is engaged in the generation of electricity for captive consumption through the captive generating plant.
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Appointment of cost auditor: Rule 6 of the Cost Audit Rules lays down the requirement of appointing a cost auditor. It mandates that in cases where a cost audit is required to be carried out, a cost auditor shall be appointed within 180 days (about 6 months) of the commencement of every financial year.
The provisions further lay down penal consequences for not following the above legal provisions for cost audit which are as follows:
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For company and its officers: As per section 147(1), the company shall be punishable with fine which shall be not less than Rs. 25 thousand but which may extend to Rs. 5 lakhs and every officer of the company who is in default shall be punishable with fine which shall be not less than Rs. 10 thousand but which may extend to Rs. 1 lakh. Earlier, the officers of the company were also punishable with imprisonment. However, as per the latest amendment to the section, the offence (w.e.f. 21.12.2020) is now punishable with fine only for any violation.
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For cost auditor of the company: As per section 147(2) to (4), the cost auditor shall be punishable with fine which shall be not less than Rs. 25 thousand but which may extend to [or four times the remuneration of the auditor, whichever is less]. Further, it provides that if the intention of an auditor was to knowingly or willingly to deceive the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment for a term which may extend to one year and fine which shall be not less than Rs. 50 thousand but which may extend to Rs. 25 lakhs [or eight times the remuneration of the auditor, whichever is less]. In addition, where the auditor has been convicted, he shall be further liable to (i) refund the remuneration received by him to the company, and (ii) pay for damages to the company, statutory bodies or authorities for loss arising out of incorrect or misleading statements of particulars made in his audit report.
III. Key issues
(A) Cost audit may not be applicable to all the companies
As per section 148(1) of the Act read with Rule 3 of the Cost Audit Rules the Central Government by order may ask for cost accounting records only of the companies who are engaged in either the manufacturing of certain goods or the companies which provide services. This forms the only basis for the concept of the cost audit i.e., only the manufacturing companies or the service provisioning companies are to be cost-audited. Hence, all the companies are not required to maintain the cost audit records.
Even if the cost audit rules require any non-manufacturing or non-service provisioning company to be following the cost accounting and audit compliances, it is to be remembered that any rules (being in the nature of delegated legislation) are always to be read subject to the statutory provision and cannot go beyond that.
Further, Rule 3 of the Cost Audit Rules, lays down a turnover threshold of Rs. 35 crores and if any company has a greater turnover in the immediately preceding financial year, it would require maintaining cost records. Such companies have further been categorized and tabulated in Table-A (Regulated Sector) and Table-B (Non-Regulated Sector) and HSN codes (explained in later paragraphs) have been enumerated to identify the goods that they may be manufacturing in order to attract cost audit provisions.
Rule 4(3)(i) then provides for an exception for certain companies on which cost audit is not applicable. The companies which fall under this exception are:
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whose revenue from exports, in foreign exchange, exceeds seventy-five per cent of its total revenue; or
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which is operating from a special economic zone.
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which is engaged in generation of electricity for captive consumption through Captive Generating Plant. For this purpose, the term "Captive Generating Plant" shall have the same meaning as assigned in rule 3 of the Electricity Rules, 2005.
(B) Notices being issued merely on the basis of HSN Codes
HSN stands for Harmonized System of Nomenclature, and is a six-digit numeric code issued by the World Customs Organization ('WCO') for uniformity between various local laws/classification vis-à-vis international trade. Now, Rule 3 of the Cost Audit Rules tabulates various products and services in the regulated and unregulated sectors (Table-A and Table-B of such Rules, respectively) on the basis of HSN codes.
As explained above, the purpose of these tables and HSN codes is to identify companies to which the cost accounting and audit provisions would be applicable provided they are into manufacturing such products.
However, much confusion has arisen because even companies which are, say, into the trading of such goods are being investigated and issued SCNs.
(C) Effect of decriminalization by the 2020 amendment of the Act:
Vide the Companies (Amendment) Act 2020, the words "with imprisonment for a term which may extend to one year or" were omitted from section 148. Thus, the punishment by way of imprisonment was decriminalized. So, in a case where the SCN has been received for a contravention done prior to the amendment, the same cannot be punished with imprisonment post such amendment.
This flows directly from the application of section 6 of the General Clauses Act, 1897, which provides that in case any law is repealed, anything that was not in force or existing at the time of such repeal, cannot be revived. Thus, in case of investigations or proceedings which have been initiated after such amendment, the law will have to be read as amended and as decriminalized by the amendment. (It is important to note that for the purpose of applicability of section 6 of the General Clauses Act, the term 'repeal' shall include 'omission', which has been carried out w.r.t. section 148 by the above stated amendment).
(D) Limitation under section 468 of the Criminal Procedure Code, 1973 (CrPC):
Section 468 of the CrPC provides for a limitation period of six months from the commission of the offence, in cases where the offence is punishable with fine only. Thus, in case of any proceeding under section 148 of the Act, wherein a person is sought to be punished, such limitation would have to be respected. In this regard, reference must be made to the recent decision of the Hon'ble Madras High Court in the case of Vikram Kapur v Deputy Registrar of Companies [2022] 141 taxmann.com 292 (Madras), wherein it has been held that since the complaint was filed in 2018 for a contravention of section 148 of the Act relating to F.Y. 2013-14, the proceedings were beyond limitation as per section 468 of the CrPC.
IV. Conclusion
Cost audit provisions are regulatory and report-seeking in nature and so far as they are complied with, there is no impact or restriction resulting from them. However, many companies which are covered under cost audit, have not complied and till lately have never been questioned. The MCA may have recently been issuing SCNs and trying to ensure stricter compliance, but with the decriminalization (which is of course, welcome) that has been recently done and with the passage of time and limitation as explained above, the fate of these proceedings now initiated by the MCA is yet to be determined.
Originally Published 05 January 2023
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