The ministry of corporate Affairs (MCA) had tightened the rules for company audits last year mandating companies to provide a new declaration saying they have not lent money to an intermediary with an understanding that the intermediary will in turn loan, or fund, it to a third company.
While the rules will apply to all companies, market participant say they will have significant impact on NBFCs who routinely enter such arrangements.
The development assumes significance as several cases have come to light in the last few years where the promoters of NBFCs have diverted funds of the lender to private entities who in turn moved this money into third party companies.
The new rules mandate company auditors to evaluate such funding arrangements and determine if they are in violation of foreign exchange and anti-money laundering rules.
The Institute of Chartered Accountants (ICAI), which regulates auditors, issued a guidance note on Monday on how auditors need to approach this new law. In the guidance note ICAI noted that the new rules have “cast onerous responsibility on auditors as scope of reporting under these rules is very wide.”
“The rules are expected to apply to even banks and NBFCs since the section applies to all the companies under the Companies Act, and no specific exemption has been provided for NBFCs,” said a person with direct knowledge of the matter.
To understand the implications of these rules, consider an NBFC A lends money to an intermediary company say B. A also enters a tacit understanding that B will use the money received from A to loan or fund a different company say C.
Auditors say such arrangements per se are not illegal, however the guidelines of Prevention of Money Laundering Act (PMLA) and Foreign Exchange Management Act (Fema) have to be followed. Auditors have been put in charge to check if such rules have been followed.
“What has happened in the past is that NBFCs sent funds to foreign intermediaries who in turn invested the money in domestic companies. Such arrangements may be considered round tripping,” said an auditor who works for a big four firm.