Can a relative of a director be our company's auditor?

You are about to appoint an auditor. The CA you have in mind is your director's brother-in-law, or your cousin, or a friend whose spouse holds a few shares in your company. Before you pass the resolution, you need to know whether the law lets you.

The starting point: who can be an auditor at all

Only a chartered accountant can be appointed as auditor of a company. A firm can be appointed by its firm name if most of its partners practising in India are qualified (s.141(1), Companies Act 2013). Where a firm, including a limited liability partnership, is appointed, only the partners who are chartered accountants may act and sign for the firm (s.141(2), Companies Act 2013).

Being a CA is necessary but not enough. Section 141(3) then lists people who are not eligible even if they are CAs.

The direct answer on relatives

Two separate rules bite on relatives. People often mix them up, so keep them apart.

Rule one: the relative sits in your company's management. A person is not eligible if his or her relative is a director, or is employed by the company as a director or key managerial personnel (s.141(3)(f), Companies Act 2013).

So if the CA's brother is a director of your company, that CA cannot be your auditor. The reverse also holds: a CA cannot audit a company in which his or her relative is a director.

Key managerial personnel means the Chief Executive Officer, managing director or manager, the company secretary, the whole-time director and the Chief Financial Officer. It also covers an officer, not more than one level below the directors and in whole-time employment, whom the Board designates as key managerial personnel, and any other officer who may be prescribed (s.2(51), Companies Act 2013).

Rule two: the relative holds shares, owes money, or gave a guarantee. A person is not eligible if the person, or his or her relative or partner, is holding any security of or interest in the company. The same bar applies to a subsidiary, a holding company, an associate company or a subsidiary of the holding company (s.141(3)(d)(i), Companies Act 2013). Loans and guarantees are covered in the same clause, and the limits are below.

Who counts as a "relative"

The word has a narrow legal meaning. It is not "anyone in the family".

Under the Act, a relative of a person is someone who:

• is a member of the same Hindu Undivided Family,
• is the person's husband or wife, or
• is related in a manner that the rules prescribe (s.2(77), Companies Act 2013).

The prescribed list names these relatives: father (including step-father), mother (including step-mother), son (including step-son), son's wife, daughter, daughter's husband, brother (including step-brother) and sister (including step-sister) (rule 4, Companies (Specification of definitions details) Rules, 2014).

Note what is not on the list. Cousins, uncles, aunts, nephews, in-laws other than son's wife and daughter's husband, and friends are not relatives unless they are members of the same Hindu Undivided Family. A brother's wife is not on the list either.

That does not make every such link safe. A cousin may still fall under the business relationship rule below.

The rupee limits (rule 10)

The Act leaves the amounts to the rules. The Audit and Auditors Rules set them as follows (rule 10, Companies (Audit and Auditors) Rules 2014).

Shareholding by the auditor's relative. A relative of the auditor may hold securities of the company with a face value not exceeding ₹1 lakh (rule 10(1)). The Act's own proviso lets a relative hold securities up to ₹1,000 or such sum as may be prescribed (s.141(3)(d)(i), Companies Act 2013). The prescribed sum in rule 10(1) is ₹1 lakh face value.

This allowance is for the relative. The limit does not permit the auditor personally to hold any shares. The disqualification covers a person who, or whose relative or partner, holds securities, and the proviso only gives room to the relative.

The same condition applies, wherever relevant, to a company with no share capital or other securities (rule 10(1), first proviso).

Indebtedness. An auditor, or the auditor's relative or partner, who owes the company more than ₹5 lakh is not eligible. The bar extends to debts owed to a subsidiary, holding or associate company, or a subsidiary of the holding company (rule 10(2)).

Guarantees. An auditor, or the auditor's relative or partner, who has given a guarantee or provided security for a third person's debt to the company, above ₹1 lakh, is not eligible (rule 10(3)).

Business relationship

A person or a firm who, directly or indirectly, has a business relationship with the company is not eligible. The same applies to its subsidiary, holding company or associate company, or a subsidiary of the holding or associate company (s.141(3)(e), Companies Act 2013).

The rules define the term widely. "Business relationship" means any transaction entered into for a commercial purpose (rule 10(4), Companies (Audit and Auditors) Rules 2014). Two things are excluded:

• Commercial transactions that are professional services which an auditor or audit firm may lawfully render under the Act and the Chartered Accountants Act, 1949.
• Ordinary-course transactions at arm's length price, such as a company selling products or services to the auditor as a customer. The rule gives telecommunications, airlines, hospitals and hotels as examples of such businesses.

The other disqualifications, briefly

Section 141(3) has more clauses. A person is also not eligible if he or she is:

• a body corporate, other than a limited liability partnership registered under the LLP Act, 2008 (s.141(3)(a)),
• an officer or employee of the company (s.141(3)(b)),
• a partner of, or in the employment of, an officer or employee of the company (s.141(3)(c)),
• in full-time employment elsewhere, or a person or partner holding appointment as auditor of more than twenty companies at the date of appointment or reappointment (s.141(3)(g)),
• convicted by a court of an offence involving fraud, until ten years have passed from the date of conviction (s.141(3)(h)), or
• rendering, directly or indirectly, any service referred to in section 144 to the company, its holding company or its subsidiary company (s.141(3)(i)).

All these are in the Companies Act 2013.

Section 144 bars an auditor from a list of services. These include accounting and book keeping, internal audit, design and implementation of any financial information system, actuarial services, investment advisory services, investment banking services, outsourced financial services and management services (s.144, Companies Act 2013). A CA who keeps your books cannot also be your auditor. The bar applies whether the service is rendered directly or indirectly, and an individual auditor is treated as rendering a service if it is rendered through his relative or through an entity he significantly influences or controls (Explanation to s.144, Companies Act 2013).

Step by step: checking before you appoint

• List the people at your company. Directors, the CEO or managing director, the company secretary, the CFO, whole-time directors, and any officer the Board has designated as key managerial personnel.
• List the candidate's relatives under rule 4. Ask the candidate to check this list against your list in step one. Include members of the candidate's Hindu Undivided Family.
• Check shareholdings. Ask whether the candidate, a relative or a partner holds any security of, or interest in, your company or its group companies. Keep the ₹1 lakh face value allowance for relatives in mind.
• Check loans and guarantees. Ask about amounts owed to the company group above ₹5 lakh, and guarantees above ₹1 lakh.
• Check business dealings. Look at your own accounts. Is the candidate or the firm a supplier, landlord or customer other than in ordinary course at arm's length?
• Check the services. Make sure the candidate does not provide any section 144 service to you, directly or through a relative or a connected entity.
• Collect the written consent and the certificate. Before the appointment is made, the company must obtain the auditor's written consent and a certificate that the appointment, if made, will be in accordance with the prescribed conditions (s.139(1), second proviso, Companies Act 2013).
• Read the certificate. The auditor certifies that the individual or the firm is eligible and not disqualified under the Act, the Chartered Accountants Act, 1949 and the rules or regulations made under them. It also covers the term, the limits, and a true list of pending professional-conduct proceedings (rule 4(1), Companies (Audit and Auditors) Rules 2014).
• Inform the Registrar. The company must inform the auditor of the appointment and file a notice of it with the Registrar within fifteen days of the meeting in which the auditor is appointed (s.139(1), fourth proviso, Companies Act 2013). The notice goes in Form ADT-1 (rule 4(2), Companies (Audit and Auditors) Rules 2014).

What happens if the link arises after appointment

A clean appointment can turn bad. A relative may buy shares, a partner may lend the company money, or a director's family member may join the board.

If the auditor incurs any s.141(3) disqualification after appointment, the auditor must vacate office. The vacation is deemed a casual vacancy (s.141(4), Companies Act 2013).

For shareholding there is a grace period. If a relative acquires securities above the rule 10 limit, the auditor must take corrective action to bring the holding within the limit within sixty days of the acquisition (rule 10(1), second proviso, Companies (Audit and Auditors) Rules 2014).

The sixty days is given for shareholding only. Do not assume it applies to loans, guarantees or a relative becoming a director.

What not to do

• Do not rely on a verbal "no problem". Get the written consent and the certificate before the appointment (s.139(1), Companies Act 2013).
• Do not treat "not on the relative list" as "no problem". A cousin may be outside s.141(3)(f) but still be a supplier under s.141(3)(e).
• Do not give the auditor a bookkeeping or internal audit job. That is a barred service under s.144 and disqualifies the person under s.141(3)(i).

Consequences if the rules are broken

If any of sections 139 to 146 is contravened, the company is punishable with a fine of not less than ₹25,000 and up to ₹5 lakh. Every officer in default is punishable with a fine of not less than ₹10,000 and up to ₹1 lakh (s.147(1), Companies Act 2013).

An auditor who contravenes section 139, 143, 144 or 145 faces a separate fine of not less than ₹25,000, extending to ₹5 lakh or four times the remuneration, whichever is less (s.147(2), Companies Act 2013).

An auditor who contravenes these sections knowingly or wilfully, intending to deceive the company, its shareholders, creditors or tax authorities, faces imprisonment up to one year and a fine of ₹50,000 to ₹25 lakh or eight times the remuneration, whichever is less (proviso to s.147(2), Companies Act 2013).

What to do now

• Next step: Before you appoint or reappoint, compare the candidate's relatives, shareholdings, loans, guarantees and business dealings against the lists above (s.141(3), Companies Act 2013; rule 10, Companies (Audit and Auditors) Rules 2014).
• Deadline: The consent and certificate must be in hand before the appointment is made (s.139(1), second proviso, Companies Act 2013). Notice of appointment goes to the Registrar within fifteen days of the meeting (s.139(1), fourth proviso). If a relative's shareholding goes above the limit, act within sixty days (rule 10(1), second proviso).
• Consequence: Company fine of ₹25,000 to ₹5 lakh, and officer fine of ₹10,000 to ₹1 lakh (s.147(1), Companies Act 2013). An auditor who becomes disqualified must vacate office (s.141(4)).

Have a CA review your facts before you act or file.

FAQs

Can the auditor's wife hold shares in my company?
A wife is a relative under s.2(77) of the Companies Act 2013. A relative may hold securities of face value up to ₹1 lakh (rule 10(1), Companies (Audit and Auditors) Rules 2014). Above that, the auditor is disqualified.

My director's cousin is a CA. Can he audit us?
A cousin is not in the rule 4 list, so s.141(3)(f) does not bar him on that ground alone, unless he is in the same Hindu Undivided Family (s.2(77), Companies Act 2013; rule 4, Companies (Specification of definitions details) Rules, 2014). Check the other grounds as well, especially business relationship and shareholding.

The auditor's relative has a loan from our company. Is that a problem?
Only if it is more than ₹5 lakh, including loans from the company's subsidiary, holding or associate company or a subsidiary of the holding company (rule 10(2), Companies (Audit and Auditors) Rules 2014).

Is a CA who is also our tax consultant disqualified?
Professional services that an auditor may lawfully render under the Act and the Chartered Accountants Act, 1949 are excluded from "business relationship" (rule 10(4)). But the services in section 144, such as accounting and book keeping or internal audit, are barred (s.141(3)(i) and s.144, Companies Act 2013). Match each service to the lists.

Where do I confirm the current amounts?
The limits above are from rule 10 as notified in 2014; we found no later amendment, but that is not a guarantee. Check the current text on the MCA portal before you rely on any figure for an appointment.

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See Also

• Can our auditor also keep our books and do our tax work?
• What must our first board meeting do within 30 days of incorporation?
• What Your Auditor Must Check and Report: Section 143 and Fraud Reporting