ICAI Code of Ethics– Marching Ahead of Times
“The basic human instinct is to place personal gains above service. Therefore, persons who as individuals and as a class, are willing to place public good above their personal gain have enjoyed respect and honour. But such a relationship can be maintained or enhanced only if the professional body to which they belong would interpret the concept of public interest as broadly as possible. The respect and confidence enjoyed by a profession, to a great extent, is dependent on the strictness and scrupulousness with which such a code is adhered to by self-discipline. Read on…”
1 Evolution of Professional Discipline: From Self-Regulation to Shared Regulation
A Chartered Accountant, whether in public practice or in service, should both be, and appear to be, free of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity and objectivity.
Self-discipline requires complying with the Ethics not only in letter but also in spirit. The fabric of disciplining the profession was originally weaved on the basis of the self-regulations. Today it has changed to the shared regulations, as happened all over the globe. However, the importance of laying down the Code of Ethics is still a duty which the profession should retain with itself. This can be done only if the Code marches ahead of the times.
The Council of the Institute of Chartered Accountants of India (the Council) has always placed importance in keeping the Code ahead of the legal requirements. For instance, Peer Review was introduced in the profession much before the Chartered Accountants (Amendment) Act 2006 brought in Quality Review. Similarly, various pronouncements of the ICAI became applicable before the concept of non-assurance services got codified in section 144 of the Companies Act, 2013.
The law regarding the disciplining the profession has also evolved over time. The scams which hit the global profession at the turn of the century and our country in the first decade have forced the change from the self-regulations to the shared regulations. Prior to 2006, there was no concept of monetary penalties being imposed on an erring member when found guilty of professional misconduct. Even reprimand had been considered as an effective deterrent to prevent a professional from doing what is prohibited. Removal of name from the Register of Members had been the severe punishment with permanent removal as the extreme form of punishment. With changing times, monetary penalties have become part of the law. The concept of the monetary penalties has become more pronounced after the Companies Act, 2013 has been implemented.
2 Adoption of the IESBA Code and the 2019/2020 Reforms
In such fast-changing times, the Council has done well to keep pace with the global ethical standards. The International Ethics Standards Board for Accountants (IESBA) lays down the ethical standards to be complied with by professional accountants. In 2009 ICAI Council adopted for the first time the IESBA Code, popularly referred to as the IFAC Code of Ethics. They were introduced in the Code of Ethics as Part A. The provisions of the Chartered Accountants Act, the Regulations and the Council decisions were retained as Part B. Since 2006, the powers of the Council to issue notifications have been changed to issuing guidelines.
The global ethical standards underwent significant revision in the last 10 years. In 2018, IESBA issued the revised Code of Ethics. The ICAI has been quick to adopt these standards. The same were introduced in our Code of Ethics in 2019 and made applicable in a staggered manner from 1st July 2020.
Five Pivotal Changes in the Revised Code of Ethics
- Prohibition of Management Responsibilities to audit clients (Implemented w.e.f. 1st July 2020).
- Duty of Accountant in case of breach of independence standards (Implemented w.e.f. 1st July 2020).
- Responding to Non-Compliance of Laws and Regulations (NOCLAR) (Deferred for the time being).
- Restriction on fees from a single client exceeding fifteen percent (Deferred for the time being).
- Restriction on Taxation Services to Audit clients (Deferred for the time being).
The first two have been implemented with effect from 1st July 2020. The remaining three have been deferred for the time being to allow detailed deliberation and structured stakeholder engagement.
3 Management Responsibilities vs. Section 144 of the Companies Act
“The revised IESBA Code of Ethics as adopted by us, uses the term Management Responsibilities. It rightly points out that an audit firm should not take up any management responsibilities with respect to an audit client.”
The revised IESBA Code of Ethics as adopted by us, uses the term Management Responsibilities. It rightly points out that an audit firm should not take up any management responsibilities with respect to an audit client. Obviously, such responsibilities will lead to conflict of interest with the role as an auditor. It creates self-review and self-interest threats. But the Code clarifies that providing advice and recommendations to assist the management of an audit client in discharging its responsibilities is not assuming management responsibilities. Thus, certain non-assurance services can be rendered to an audit client if the auditor does not take up the management responsibilities.
However, section 144 of the Companies Act does not permit taking up the Management Services and no distinction is made in the law whether such services are rendered with or without taking up the Management Responsibilities. It is well known that the Companies Act, 2013 made the conduct of the business too stiff. Hence, various Removal of Difficulties Orders were issued and later the law was significantly amended, in 2015, 2017, 2018 and 2020. The motto of the Government of India since 2014 has been ‘ease of doing businesses’. In line with this thinking, section 144 of the Companies Act, to the extent of management services needs re-consideration to calibrate the Indian profession to meet the global challenges.
Similarly, some of the provisions of the IESBA Code now incorporated in our Code will create practical difficulties for the Indian profession. The IESBA Code requires Rotation of Partners. This was implemented in the ICAI Code of Ethics in 2009. However, with Rotation of Firms becoming applicable under the Companies Act 2013, the rotation of partners has lost its significance. The global ethics still do not require rotation of firms and hence the concept of rotation of partners is justified in that Code. Since India has stricter legal provisions i.e. rotation of firms, one wonders what is the use of rotation of partners. The rotation of partners requires a cooling period not only for the engagement partner but also for the entire audit team. When the firm itself will retire in a period of ten years at the most, the requirement of rotation of partners is not required. This aspect needs to be reconsidered by the Council.
4 Responding to NOCLAR (Non-Compliance of Laws and Regulations)
“Responding to Non-compliance of Laws and Regulations (NOCLAR) is an important global development. The IESBA Code envisages that if a professional accountant comes across an instance of non-compliance of laws, compliance of which is of critical importance, then a professional accountant cannot keep his eyes closed. He needs to escalate the issue within the organisation up to the level of Those Charged With Governance (TCWG).”
Responding to Non-compliance of Laws and Regulations (NOCLAR) is an important global development. The IESBA Code envisages that if a professional accountant comes across an instance of non-compliance of laws, compliance of which is of critical importance, then a professional accountant cannot keep his eyes closed. He needs to escalate the issue within the organisation up to the level of Those Charged With Governance (TCWG). If at that level also, there is no satisfactory response, then the professional accountant needs to report to the concerned regulatory authority.
The laws which are of critical importance will include Fraud, Corruption and Bribery Laws, Money Laundering, Terrorists Financing and Proceeds of Crime, Data Protection, Tax and Pension Liabilities, Environmental Protection and Public Health and Safety etc.
Reporting of frauds directly to the regulator has been prescribed in India for a long time. The Reserve Bank of India requires this in the audits of banks and non-banking finance companies. Sub-section (12) of section 143 of the Companies Act, 2013 requires a fraud to be reported directly to the Secretary Ministry of Corporate Affairs, Government of India. Now such requirement has become part of the Ethics. The proper implementation of this provision rightly needs more engagement with all the stakeholders so that the ultimate objective of bringing in this onerous responsibility is achieved. Hence, the provision has not been implemented as of now.
5 Fee Dependency Limits and Restrictions on Taxation Services
From 40% Cap to 15% Consecutive Fee Threshold
The Code of Ethics, 2009 contained a self-regulatory provision that the fees from one client, with some exceptions, should not exceed forty percent of the total fees. The rationale has been that an excessive dependence on one single client will create a threat.
The revised Code of Ethics now requires that where the fees exceed more than fifteen percent from one client for two consecutive years, the audit firm needs to demonstrate its independence. Thus, against a blanket ban, the new proposal seeks to provide a gateway to demonstrate independence even if the fees exceed the threshold levels. But this concept needs to be limited to those entities where TCWG are different from the management. A strong and independent Audit Committee is a pre-requisite. Therefore, whenever introduced, it will be advisable to make it applicable to the listed companies or those companies which have established Audit Committees.
Tax Services and the Unique Indian Position (Section 44AB)
The tax services rendered to an audit client are also to be restricted from a date to be notified by the Council. Tax services comprise a broad range of services, including:
- Tax return preparation;
- Tax calculations for the purpose of preparing accounting entries;
- Tax planning and other tax advisory services;
- Tax services involving valuations;
- Assistance in the resolution of tax disputes.
Amongst all the above types of services, tax planning and tax services involving valuations may create threats in terms of an audit client. Therefore, the proposed restrictions will only enhance the credibility of the audit services. However, tax return preparation and representation services do not create a threat.
India is probably the only country to have the concept of tax audit, as prescribed under section 44AB of the Income Tax Act. The Council has issued Guidance Note on Tax Audit which is a rich literature bringing out the requirements of the audit. Once the financial statements are audited, then preparation of the tax return does not result in a conflict. Also the Tax laws have evolved over a period of time. In the landmark case of Rajkot Engineering Association [162 ITR 28 (Guj)], the Government of India filed an affidavit to the effect that the views of the tax auditor will not be binding on the assessee. Thus, on an issue where the tax auditor qualifies his report, it is still open to an assessee to take a different position in the tax litigation and under such circumstances if he is being defended by his tax auditor, there cannot be said to be a conflict. Hence, the Indian position is different from the global position. These matters need to be kept in mind as and when the Council decides to implement the above restrictions.
6 Tender Undercutting, Advertisements, and Contingent Fees
The revised IESBA Code has also introduced the concept of Key Audit Partner. The ethical requirements are now more clearly extended to the entire audit team and the said Key Audit Partner. Also the extent of documentation has increased.
As mentioned before, significant amendments were brought in by the Chartered Accountants (Amendment) Act, 2006 which became effective from 17th November 2006. One such amendment was to empower the Council to lay down guidelines for advertisements by Chartered Accountants in practice. The Council issued the guidelines in this regard in 2008 which have been substantially amended by way of Council Guidelines 2020. The issues relating to social media have also been aptly covered in the revised guidelines. The best advertisement is a satisfied client who speaks well of his auditor/advisor, but limited advertisement is the need of the day and has been properly permitted.
Coupled with the empowerment to advertise, the law since 2006 also made competition healthier by doing away with some of the restrictions such as under-cutting to be a professional misconduct. This is based on the premises that once all the members are to adhere to the same technical and ethical standards, the service recipients should be allowed the benefit of cost optimisation and profession should become more competitive. Participation in tenders is permitted with some restrictions. However, the unfortunate reality is that the tenders have seen the fees going down to abnormally low levels. The Institute as a regulator cannot decide the minimum levels of professional fees; at best it can recommend. As professionals, members should strive to see that the client gets more in value than what money he pays, and increase their fees accordingly.
Contingent Fees and Regulation 192
Contingent fees are not a desirable way of charging fees for a professional, more so in case of assurance services. However, the position is completely different in the case of management consultancy services. It is necessary to ensure level playing field between the professional firms and those rendering services in the form of corporate entities. Regulation 192 of the Chartered Accountants Regulations, 1988 permits certain specific services where contingent fees can be charged. Also, the Council is authorised to decide other services where fees can be charged on success basis. Acting as Insolvency Professional has been recently included in this list. The ‘Non-Assurance Services to Non-Audit Client’ can be a basis for Council to decide in future.
Two-Year Cooling Period: Director to Auditor
Keeping the tradition of bringing in Ethical requirements before they become part of the law, the Council has decided that upon laying down the office as director of an entity, one cannot accept the office of auditor of the same entity for a period of two years. This cooling period is necessary to install confidence of the society in the role of the auditor. This is a laudable decision of the Council.
7 Supreme Court Jurisprudence on Disciplinary Mechanism and Conclusion
Schedule I Part IV sub-clause (2) provides that where in the opinion of the Council, a member brings disrepute to the profession or the Institute as a result of his action whether or not related to his professional work, such an action will be regarded as a professional misconduct.
Landmark Supreme Court Ruling on Bringing Disrepute (Schedule I Part IV Clause 2)
Interpreting these provisions, the Hon’ble Supreme Court in a recent case held that where a complaint was made against a Chartered Accountant relating to sale of certain shares, the High Court was not justified in reversing the decision of the Disciplinary Committee which had held him guilty. The Hon’ble High Court had concluded that the said Chartered Accountant was not acting as a Chartered Accountant and was not discharging any functions in relation to his practice. This decision has been reversed and the decision of the Disciplinary Committee has been restored by the Hon’ble Supreme Court. This case demonstrates the robustness of the Institute’s disciplinary mechanism. At the same time it is essential to remind ourselves that all our actions should be in accordance with the highest professional standards.
To conclude, we need to be proud of the robust professional Code of Ethics given to us. It is our bounden duty to ensure proper compliance. I am always confident and optimist that the profession will continue to grow and prosper in the times to come.