Multinational Accounting Firms’ Operations in India: Supreme Court directs review of regulatory framework in S. Sukumar vs. Institute of Chartered Accountants of India & Ors. (23 February 2018)

Date of the Judgment: 23 February 2018
Citation: S. Sukumar vs. The Secretary, Institute of Chartered Accountants of India & Ors. Civil Appeal No. 2422 of 2018 (Arising out of SLP (Civil) No. 1808 of 2016) with Writ Petition (Civil) No. 991 of 2013
Judges: Adarsh Kumar Goel, J., Uday Umesh Lalit, J.
Can multinational accounting firms (MAFs) operate in India without adhering to the country’s laws? The Supreme Court of India addressed this critical question in a case involving allegations that MAFs were circumventing regulations through their arrangements with Indian Chartered Accountancy Firms (ICAFs). The court’s judgment highlights concerns about the regulatory gaps and the need for a robust oversight mechanism to ensure transparency and accountability in the accounting profession. This case examines the extent to which MAFs are operating within the legal framework of India, specifically concerning the Chartered Accountants Act, 1949, and related financial regulations.

Case Background

The case originated from a writ petition filed in the High Court of Karnataka, which sought action against MAFs and ICAFs for allegedly violating the Chartered Accountants Act, 1949 (CA Act), and the Code of Professional Conduct. The petitioner contended that MAFs were illegally providing accounting, auditing, and taxation services in India through ICAFs. The petition also raised concerns about the lack of effective steps to enforce the law, particularly concerning the operations of PricewaterhouseCoopers Private Limited (PwCPL) and its network audit firms. The petitioners argued that these firms were violating the Foreign Direct Investment (FDI) policy, the Reserve Bank of India Act (RBI), and the Foreign Exchange Management Act (FEMA).

The petitioners also highlighted the Satyam scandal, where the auditors, M/s. Pricewater House, failed to detect the fraud, and the Global Trust Bank (GTB) collapse, where Lovelock and Lewes (LL), a member firm of PwC India, failed to point out the high level of NPAs. The petitioners argued that the ICAI had not taken adequate action against these firms despite these serious violations.

Timeline

Course of Proceedings

The High Court of Karnataka disposed of the writ petition, observing that the ICAI had already taken action. However, a separate writ petition was filed directly in the Supreme Court, raising similar issues and additional allegations against PwCPL and its network firms. The Supreme Court decided to hear both matters together due to the identical nature of the core issues.

Legal Framework

The Supreme Court considered the following key legal provisions:

• Section 2(2) of the Chartered Accountants Act, 1949: Defines what constitutes “to be in practice” for a member of the Institute. It states, “A member of the Institute shall be deemed “to be in practice”, when individually or in partnership with chartered accountants [in practice], he, in consideration of remuneration received or to be received— (i) engages himself in the practice of accountancy; or (ii) offers to perform or performs services involving the auditing or verification of financial transactions, books, accounts or records, or the preparation, verification or certification of financial accounting and related statements or holds himself out to the public as an accountant; or (iii) renders professional services or assistance in or about matters of principle or detail relating to accounting procedure or the recording, presentation or certification of financial facts or data; or] (iv) renders such other services as, in the opinion of the Council, are or may be rendered by a chartered accountant [in practice]; and the words “to be in practice” with their grammatical variations and cognate expressions shall be construed accordingly.”
• Section 25 of the Chartered Accountants Act, 1949: Prohibits companies from engaging in the practice of chartered accountancy. It states, “(1) No company, whether incorporated in India or elsewhere, shall practise as chartered accountants. (2) If any company contravenes the provisions of sub-section (1), then, without prejudice to any other proceedings which may be taken against the company, every director, manager, secretary and any other officer thereof who is knowingly a party to such contravention shall be punishable with fine which may extend on first conviction to one thousand rupees, and on any subsequent conviction to five thousand rupees.”
• Section 29 of the Chartered Accountants Act, 1949: Deals with reciprocity, stating that if a country prevents Indian professionals from practicing accountancy, its citizens will not be allowed to practice in India. It states, “(1) Where any country, specified by the Central Government in this behalf by notification in the official Gazette, prevents persons of Indian domicile from becoming members of any institution similar to the Institute of Chartered Accountants of India or from practising the profession of accountancy or subjects them to unfair discrimination in that country, no subject of any such country shall be entitled to become a member of the Institute or practise the profession of accountancy in India.”
• Regulation 3 of the Foreign Exchange Management (Investment in Firm or Proprietary concern in India) Regulations, 2000: Restricts investments by persons outside India in firms or proprietary concerns without RBI permission. It states, “Save as otherwise provided in the Act or rules or regulations made or directions or orders issued thereunder, no person resident outside India shall make any investment by way of contribution to the capital of a firm or a proprietary concern or any association of persons in india; Provided that the Reserve Bank may, on an application made to it, permit a person resident outside India subject to such terms and conditions as may be considered necessary to make an investment by way of contribution to the capital of a firm or a proprietary concern or any association of persons in India.”
• Clause 3.3.2 (III) of the Circular 2 of 2010 of the Consolidated FDI (CFDI) Policy: States that a person resident outside India other than NRIs/PIO may seek prior approval of Reserve Bank for making investment by way of contribution to the capital of a firm or a proprietorship concern or any association of persons in India.
• First and Second Schedules of the CA Act: These schedules outline professional misconduct for chartered accountants in practice and generally.

Arguments

The petitioners argued that MAFs were violating the CA Act, FDI policy, and FEMA regulations by operating in India through ICAFs. They contended that:

• MAFs were using Indian CA firms as a front to provide services without being registered with the ICAI, thereby circumventing the regulatory framework.
• The use of similar brand names by Indian firms gave the impression that they were part of an international network, which was misleading to the public.
• MAFs were sharing fees and profits with non-members of the ICAI, which is prohibited under the Code of Ethics.
• MAFs were receiving investments from foreign entities in violation of FDI policy and FEMA regulations, including through circuitous routes like interest-free loans and grants.
• PwC firms were involved in accounting scandals, such as the Satyam scam and the GTB collapse, and had not been adequately penalized.

The respondent firms, including PwC, argued that:

• They were operating within the legal framework, with all partners of the Indian firms being Indian nationals and registered with the ICAI.
• The use of a common brand name was for maintaining uniform standards and quality of service across the global network.
• The grants received were for capacity building and not investments, and they were taxed accordingly.
• The network charges paid to Services BV were for operationalizing global standards and were not profit-sharing.
• They were not in violation of Section 25 of the CA Act, as the firms were managed and controlled by Indian nationals.

The ICAI submitted that it had taken action against its members for professional misconduct but could not take action against MAFs directly as they were not registered with the ICAI. The Central Board of Direct Taxes (CBDT) and the Enforcement Directorate (ED) stated that investigations were ongoing regarding income tax implications and FEMA violations, respectively. The Reserve Bank of India (RBI) clarified that it only issues circulars and regulations but does not conduct investigations for compliance.

The petitioners innovatively argued that the MAFs were using a circuitous route to invest in Indian firms, disguising investments as interest-free loans and grants. They also highlighted that the network charges were essentially profit-sharing, which is prohibited under the CA Act.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues:

1. Whether the MAFs are operating in India in violation of law in force in a clandestine manner, and no effective steps are being taken to enforce the said law.
2. If so, what orders are required to be passed to enforce the said law.

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities:

Judgment

The Supreme Court held that there was a prima facie case of MAFs violating the CA Act, FDI policy, and FEMA regulations. The Court observed that MAFs were using ICAFs to circumvent the law by operating under common brand names, sharing resources, and receiving remittances from foreign entities. The Court emphasized the need for a robust regulatory framework and a separate oversight body for the auditing profession.

The Court cited the case of State of Rajasthan vs. Gotan Lime Stone Khanji Udyog Pvt. Ltd. (2016) 4 SCC 469 and State of Karnataka vs. Selvi J. Jayalalitha (2017) 6 SCC 263 to emphasize the principle of lifting the corporate veil when the corporate personality is used as a cloak for fraud or improper conduct or for violation of law.

The Court observed that the ICAI should have taken the matter to a logical end, by drawing adverse inference, if information was withheld by the concerned groups.

What weighed in the mind of the Court?

The Supreme Court was primarily concerned with the lack of transparency and accountability in the operations of MAFs in India. The Court noted that the existing regulatory framework was inadequate to address the challenges posed by MAFs, who were circumventing the law through complex arrangements with ICAFs. The Court also emphasized the importance of maintaining the integrity of the auditing profession and protecting the public interest.

The Court’s reasoning was based on a combination of factual findings and legal analysis. The Court considered the factual evidence of how MAFs were operating in India, including their arrangements with ICAFs, their use of common brand names, and their financial transactions. The Court also analyzed the relevant legal provisions, including the CA Act, FDI policy, and FEMA regulations, to determine whether these operations were in violation of the law.

The Court also considered the principle of lifting the corporate veil, which allows courts to look beyond the legal structure of a company to determine the real parties in interest. The Court applied this principle to the case, noting that the partnership firms were merely a face to defy the law and the real beneficiaries were the foreign entities.

The Court did not consider any alternative interpretations of the law that were presented by the respondent firms. The Court rejected the argument that the firms were operating legally because all partners were Indian nationals, noting that the real control was with the foreign entities.

The Court’s decision was unanimous, with both judges agreeing on the need for a regulatory revisit and the importance of protecting the public interest. The Court’s reasoning was based on a thorough analysis of the facts and the relevant legal provisions.

The Court quoted the following from the judgment:

• “It can hardly be disputed that profession of auditing is of great importance for the economy. Financial statements audited by qualified auditors are acted upon and failures of the auditors have resulted into scandals in the past.”
• “As found by the Expert Committee in its report, there is a compliance by MAFs only in form and not in substance, by having got registered partnership firms with the Indian partners, the real beneficiaries of transacting the business of chartered accountancy remain the companies of the foreign entities. The partnership firms are merely a face to defy the law.”
• “The principle of lifting the corporate veil has to apply when the law is sought to be circumvented. In expanding horizons of modern jurisprudence, it is certainly permissible. Its frontiers are unlimited.”

Key Takeaways

• The Supreme Court has raised serious concerns about the operations of multinational accounting firms (MAFs) in India.
• The Court has highlighted the need for a more robust regulatory framework and a separate oversight body for the auditing profession.
• The Court has emphasized that compliance with the law must be in substance, not just in form.
• The Court has underscored the importance of protecting the public interest and maintaining the integrity of the auditing profession.
• The Court has directed the Union of India to constitute a committee of experts to review the statutory framework and suggest remedial measures.
• The Court has directed the ED to complete its pending investigation and the ICAI to further examine the related issues.

Directions

The Supreme Court issued the following directions:

1. The Union of India was directed to constitute a three-member expert committee to examine the statutory framework for regulating MAFs, consider the need for a separate oversight body for auditors, and suggest remedial measures. The committee was to be formed within two months and submit its report within three months thereafter.
2. The Enforcement Directorate (ED) was directed to complete its pending investigation within three months.
3. The Institute of Chartered Accountants of India (ICAI) was directed to further examine all the related issues at an appropriate level within three months and take further steps as necessary.

Development of Law

The ratio decidendi of this case is that the operations of multinational accounting firms (MAFs) in India require a thorough review and that the existing regulatory framework is inadequate to address the challenges posed by these firms. The Supreme Court emphasized that the principle of lifting the corporate veil should be applied when the law is sought to be circumvented. This judgment also highlights the need for a separate oversight body for the auditing profession to maintain its integrity and protect the public interest. This case also emphasizes that compliance with the law must be in substance, not just in form.

Conclusion

The Supreme Court’s judgment in S. Sukumar vs. Institute of Chartered Accountants of India & Ors. is a landmark decision that addresses the complex issue of multinational accounting firms’ operations in India. The Court’s directions for a regulatory review and further investigations underscore the need for transparency, accountability, and effective enforcement of the law. This case has significant implications for the accounting profession in India and may lead to substantial changes in the way MAFs operate in the country.