PRICEWATERHOUSECOOPERS INC.

 

CORPORATE LAWS AMENDMENT BILL – 2006

 

SUBMISSION FOR THE PUBLIC HEARINGS OF THE PORTFOLIO COMMITTEE ON TRADE AND INDUSTRY ON THE CORPORATE LAWS AMENDMENT BILL

 

29 May 2006

 

 

INDEX

 

 

EXECUTIVE SUMMARY OF ISSUES AND RECOMMENDATIONS. 3

1. Accounting Standards applicable to Companies. 3

2. Drafting issues relating to the provision of non-audit services by the auditor 3

DETAILED COMMENTS. 4

1. Accounting Standards applicable to Companies. 4

2. Drafting issues relating to the provision of non-audit services by the auditor 9

3. Drafting suggestions for other sections of the Bill 11

APPENDIX 1. 14

Submission on S275A of the Corporate Laws Amendment Bill 14

 


EXECUTIVE SUMMARY OF ISSUES AND RECOMMENDATIONS

 

1. Accounting Standards applicable to Companies

 

 

1.1        Financial Reporting Standards for Public Interest Companies

 

To enable South African public interest companies to be internationally competitive, the Bill should prescribe compliance with International Financial Reporting Standards for public interest companies.

 

1.2        Accounting Standards for Limited Interest Companies

 

The current provisions of the Bill will not result in a reduced burden on limited interest companies regarding compliance with onerous accounting standards. The Bill should prescribe compliance with standards for limited interest companies developed by the Financial Reporting Standards Council.

 

As these standards do not currently exist, the Department of Trade and Industry should impose a time limit for the development of these accounting standards.

 

1.3        Compliance with accounting standards and fair presentation in financial statements

 

The Bill should not distinguish between compliance with accounting standards and the requirement for financial reports not to be false or misleading as this could cause tension where there was a perceived conflict between the two concepts. Section 287A should be redrafted to state that nothing in this section permits non-compliance with accounting standards.

           

2. Drafting issues relating to the provision of non-audit services by the auditor

 

We recommend that the proposed new section 275A should be deleted in its entirety from the Bill to allow the Independent Regulatory Body for Auditors ("IRBA”) to fulfil its statutory obligations in terms of the Auditing Profession Act 2005 to regulate the auditing profession. 

 

If our recommendation to delete the proposed section 275A(1) from the Bill in its entirety is not accepted, then we recommend that the words  “An auditor” in section 275A(1) should be replaced with the words “The “designated auditor” or the individual Registered Auditor referred to in section 37 of the Auditing Profession Act, 2005 (Act No. 26 of 2005) who is ....” and that the words "tax advisory services" are deleted from section 275A(1).

 


DETAILED COMMENTS

 

1. Accounting Standards applicable to Companies

 

 

1.1        Financial Reporting Standards for Public Interest Companies

 

Background

The “Guidelines for Corporate Law Reform”, issued May 2004, quoted the introduction of the Integrated Manufacturing Strategy (IMS) of the Department of Trade and Industry (dti), said to capture the Government’s vision for the South African economy:

 

‘Our country needs an economy that can sustainably meet the needs of all our economic citizens – our people and their enterprises. This means access to quality work and enterprise opportunities, and access to the capacities and skills to make use of these opportunities. Enterprises of all types and sizes will have to become adaptive, innovative and internationally competitive’. 

 

 

Current wording of the Bill

“ ‘financial reporting standards’ means statements of Generally Accepted Accounting Practice adopted by the Accounting Practices Board prior to the establishment of the Council, and thereafter issued in terms of section 440U(2);”

 

“285A.   (1) A public interest company—

(a) must comply with financial reporting standards;

(b) must comply with the provisions of this Act and Schedule 4 that are applicable to public interest companies;

(c) must prepare financial statements that fairly present the financial position and the results of the operations of the company (and its subsidiaries, if applicable) in accordance with paragraph (a).”

 

“Functions of Council

 

440S.    (1) The Council shall—

(a) establish financial reporting standards for public interest companies; and

(b) develop standards for limited interest companies.

 

(2) Financial reporting standards mentioned in subsection (1)(a) shall be in accordance with the International Financial Reporting Standards of the International Accounting Standards Board or its successor body.

 

(3) Standards mentioned in subsection (1)(b) shall be developed in consultation with representatives of limited interest companies.”

 

 

Issues

International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB) are recognised internationally.

 

The objectives of the IASB are to:

 

(a) to develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions;

 

(b) to promote the use and rigorous application of those standards; and

 

(c) in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the special needs of small and medium-sized entities and emerging economies; and 

 

(d) to bring about convergence of national accounting standards and International Accounting Standards and International Financial Reporting Standards to high quality solutions.

 

In South Africa, the JSE Limited requires listed companies to comply with IFRS.

 

The Bill requires Public Interest Companies (PICs) to comply with Financial Reporting Standards (FRS). These standards will be established locally by the Financial Reporting Standards Council (the “Council”). Although the accounting standards for PICs must be “in accordance with” IFRS, PICs will still have to comply with FRS – local accounting standards. The Bill does not allow companies to comply with IFRS as these are not established by the Council. IFRS will therefore not be Financial Reporting Standards as defined.

 

Furthermore, the Bill requires FRS to be Gazetted by the Minister. There could be a substantial time delay between the IASB issuing an IFRS standard, and the Council establishing a similar standard in South Africa. IFRS and FRS will be closely related, but will not necessarily be the same.

 

If South African companies want to be internationally competitive, they will have to use accounting standards that are recognised world-wide. While there will be a tight correlation between FRS and IFRS, PICs financial statements will refer to compliance with South African FRS, not International Financial Reporting Standards. Reference to FRS may not be understood in the international economy.

 

 

Suggestion

The Bill should require PICs to comply with IFRS.

 

The Council should however develop accounting standards for South African specific topics that may not be covered by IFRS. This would be similar to the current accounting standard-setter, the Accounting Practices Board that, for example, developed a local accounting standard on the treatment of BEE transactions.

 

 

1.2        Financial reporting framework for limited interest companies

 

Background

The “Memorandum on the objects of the Corporate Laws Amendment Bill, 2006” states that since the standards imposed on PICs are primarily for the benefit of  investors and since their requirements are onerous, it is necessary to make provision for closely held companies that do not offer their shares to the public.

 

Current wording of the Bill

“S285A(2)  A limited interest company—

(a) must comply with the accounting framework of financial reporting standards;

(b) must comply with the provisions of this Act and Schedule 4 that are applicable to limited interest companies;

(c) must prepare financial statements that fairly present the financial position and the results of operations of the company (and its subsidiaries, if applicable) in accordance with paragraphs (a) and (b).”

 

“Functions of Council

440S. (1) The Council shall—

(a) establish financial reporting standards for public interest companies; and

(b) develop standards for limited interest companies.”

 

 

Issues

There appears to be a discrepancy between S440(S)(1)(b) and S285A(2)(a): The Council is required to develop standards for Limited Interest Companies (LICs) but LICs are not required to comply with these standards.

 

The Bill requires LICs to comply with the accounting framework of FRS. Our understanding is that this refers to the conceptual framework used by the IASB to develop IFRS. This framework sets out the concepts that underlie the preparation and presentation of financial statements, but does not contain guidance on the accounting treatment for any specific items. The requirement of the Bill implies that the onus of determination of accounting policies for all items of assets, liabilities, income and expenses of LICs will rest on the directors of these companies. Each LIC will thus have to be its own accounting “Standard-Setter” – a task that keeps staff employed by the IASB busy on a full-time basis. The envisaged relief for LICs has thus not been achieved by this provision in the Bill. In fact, the provisions of the Bill for LICs could prove to be more burdensome than the requirements for PICs.

 

Suggestion

The Bill should require LICs to comply with the Standards for limited interest companies developed by the Council.

 

Because these standards do not currently exist, the Department of Trade and Industry should put a time limit on the Council for developing these Standards.

 

 

1.3        Compliance with accounting standards and fair presentation

 

Background

The Bill gives legal backing to accounting standards, and states that non-compliance with accounting standards is an offence.

 

Issue

Bill refers to (i) compliance with the standards, (ii) fair presentation of the financial statements and (iii) offences relating to financial reports that are “false” or “misleading”. Refer for example to S285A and S287 & S287A:

 

“287. If any financial statements of a company which are incomplete in any material particular or otherwise do not comply with the requirements of this Act, are issued, circulated or published, the company and every director or officer thereof who is a party to such issue, circulation or publication, shall be guilty of an offence.”

 

 

“False or misleading reports

287A. (1) If any financial report of a company is false or misleading in a material respect, any person who is a party to the preparation, approval, publication, issue or supply of that report and who knows or ought reasonably to suspect that it is false or misleading is guilty of an offence unless subsection (3) applies.”

 

 

The reference to (i) compliance with the accounting standards; (ii) fair presentation in the financial statements and (iii) the prohibition on being “false” or “misleading” could perpetuate the perception that there could be a difference between compliance with the accounting standards and fair presentation in the financial statements (which is measured against a written benchmark), and presentation that is false or misleading (which is measured based on personal beliefs). 

 

Reference to “fair presentation” in the Bill is furthermore unnecessary since the accounting literature already deals with this concept:

 

IAS 1, Presentation of Financial Statements states:

Fair presentation and compliance with IFRSs

.13     Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.”

and

“.15    In virtually all circumstances, a fair presentation is achieved by compliance with applicable IFRSs.”

 

Suggestion

S287A should be redrafted to state that nothing in this section permits non-compliance with accounting standards.

 

Suggested wording for S285, incorporating all of the above comments:

 

‘‘General requirements for financial statements

285A. (1) A public interest company—

(a) must comply with International Financial Reporting Standards;

(b) must comply with the provisions of this Act and Schedule 4 that are applicable to public interest companies;

(c) must prepare financial statements that fairly present the financial position and the results of the operations of the company (and its subsidiaries, if applicable) in accordance with paragraph (a).

(2) A limited interest company—

(a) must comply with the accounting framework standards developed for limited interest companies of financial reporting standards;

(b) must comply with the provisions of this Act and Schedule 4 that are applicable to limited interest companies;

(c) must prepare financial statements that fairly present the financial position and the results of operations of the company (and its subsidiaries, if applicable) in accordance with paragraphs (a) and (b).

(3) Financial statements must clearly state that they have been prepared in accordance with—

(a) this Act prior to its amendment by the Corporate Laws Amendment Act, 2006;

(b) financial reporting standards; or

(c) the requirements of subsection (2)(c).

 


2. Drafting issues relating to the provision of non-audit services by the auditor

 

A detailed explanation is provided in Appendix I

 

Background

The Bill contains a number of amendments to enhance auditor independence.

 

One of these amendments is the stipulation that the auditor appointed to a Public Interest Company may not perform bookkeeping or accounting services, or internal audit or tax advisory services for that company, to the extent that these services would be subject to auditing.

 

Current wording of the Bill

Certain non-audit services not open to current designated auditor of public interest company

 

275A. (1) An auditor appointed to a public interest company may not for the duration of the appointment perform any bookkeeping or accounting (as distinct from auditing) services and, to the extent that these would be subject to its own auditing, internal audit or tax advisory services for that company.

(2) Subsection (1) does not affect the power of an audit committee under section 270A(1)(d) or (e) to further limit the services which an auditor of that company may render."

 

Issues

Tax advisory services

"Tax advisory services", to the extent that these services would be subject to auditing, has been added to the Bill since the previous draft at the suggestion of the South African Revenue Services. We consider that this is inappropriate as it is generally accepted in both developed countries (e.g. UK & US) and developing countries (Brazil, India, China & Mexico) that most tax services do not affect auditor independence. In addition, we consider that auditor provided tax services enhance audit quality and a prohibition on auditor provided “tax advisory services” would increase Public Interest Companies’ audit costs.

 

Inconsistent references in the heading and the actual text

The heading of section 275A in the current Bill refers to “designated auditor”, whilst the section itself refers to the section applying to the “auditor”.

 

 

Suggestions

We recommend that the proposed new section 275A should be deleted in its entirety from the Bill to allow the Independent Regulatory Body for Auditors ("IRBA”) to fulfil its statutory obligations in terms of the Auditing Profession Act 2005 to regulate the auditing profession.  This would allow a full and transparent debate to take place on auditor independence that involves the participation of all stakeholders such as Government, SARS, the investing public, Public Interest Companies, IRBA, individual Registered Auditors and firms, the SAICA and the JSE Limited.  This debate should take into account the international environment in which many Public Interest Companies operate.

 

If our recommendation to delete the proposed section 275A(1) from the Bill in its entirety is not accepted, then we recommend that the words  “An auditor” in section 275A(1) should be replaced with the words “The “designated auditor” or the individual Registered Auditor referred to in section 37 of the Auditing Profession Act, 2005 (Act No. 26 of 2005) who is ....” and that the words "tax advisory services" are deleted from section 275A(1). This will result in section 275A(1) having the same scope as in the previous draft of the Bill.

 


 

3. Drafting suggestions for other sections of the Bill

 

3.1 Definitions

 

Current wording of the Bill

“‘financial statements’ means annual financial statements, provisional annual financial statements and interim or preliminary reports and includes, where applicable, group and consolidated financial statements;”

 

Suggested Wording

“‘financial statements’ means annual financial statements, provisional annual financial statements and interim or preliminary reports and includes, where applicable, group and consolidated financial statements;”

 

Basis for suggested wording

“Preliminary reports” are not dealt with in the rest of the Bill. These types of reports are mentioned in the JSE Limited Listings Requirements.

 

 

3.2 Section 280

 

Current wording of the Bill

“Section 280 of the Companies Act, 1973, is hereby amended by the substitution

for subsections (2), (3) and (5) of the following subsections respectively:

 

‘‘(2)    An auditor intending to resign shall deliver to the company and to the Registrar a written notification in the prescribed form to the effect that he or she has no reason to believe that in the conduct of the affairs of the company a [material irregularity] reportable irregularity, within the meaning of section 22 of the Auditing Profession Act, 2005 (Act No. 26 of 2005), has taken place or is taking place which has caused or is likely to cause financial loss to the company or to any of its members or creditors, other than an irregularity (if any) which has been reported to the [Public Accountants’ and Auditors’ Board in terms of the Public Accountants’ and Auditors’ Act, 1991 (Act No. 80 of 1991)] Regulatory Board under that Act, and it shall not be necessary that such an auditor shall have carried out, for the purposes of such notification, a special audit subsequent to the date up to which the last annual financial statements on which he or she has already reported, were made up.”

 

Suggested wording

“‘(2)    An auditor intending to resign shall deliver to the company and to the Registrar a written notification in the prescribed form to the effect that he or she has no reason to believe that in the conduct of the affairs of the company a [material irregularity] reportable irregularity, within the meaning of section 22 of  as defined in the Auditing Profession Act, 2005 (Act No. 26 of 2005), has taken place or is taking place which has caused or is likely to cause financial loss to the company or to any of its members or creditors, other than an irregularity (if any) which has been reported to the [Public Accountants’ and Auditors’ Board in terms of the Public Accountants’ and Auditors’ Act, 1991 (Act No. 80 of 1991)] Regulatory Board under that Act, and it shall not be necessary that such an auditor shall have carried out, for the purposes of such notification, a special audit subsequent to the date up to which the last annual financial statements on which he or she has already reported, were made up.”

 

 

Basis for suggested wording

The references to “reportable irregularities” are inconsistent with the Auditing Profession Act.

 

 

3.3 Sections 303 & 304

 

Current wording of the Bill

“43. Section 303 of the Companies Act, 1973, is hereby amended by the substitution

for the words preceding paragraph (a) of the following words:

 

‘‘Every public interest company [having a share capital], other than a wholly owned subsidiary, shall not later than three months after the expiration of the first period of six months of its financial year send to every member and holder of debentures of the company an interim report [fairly presenting] on the business and operations of the company or, in the case of a holding company, of the company and its subsidiaries, during the said period of six months, and the results thereof: Provided that—’’.

 

“Amendment of section 304 of Act 61 of 1973

44. Section 304 of the Companies Act, 1973, is hereby amended by the substitution for subsections (1) and (2) of the following subsections respectively:

 

‘‘(1) Every public interest company [having a share capital], other than a wholly owned subsidiary, which does not within three months after the end of its financial year issue copies of its annual financial statements in terms of section 302 (1) shall not later than the date on which the said period of three months expires send to every member and holder of debentures of the company a copy of the provisional annual financial statements of the company [fairly presenting the business and operations of the company] or, in the case of a holding company, of the company and its subsidiaries during that accounting period, and the results thereof.”

 

Impact of current wording

Subsidiaries of public interest companies are also “public interest companies”. It is impracticable for all subsidiaries of public interest companies to prepare interim and provisional reports.

 

 

Suggested wording

“43. Section 303 of the Companies Act, 1973, is hereby amended by the substitution

for the words preceding paragraph (a) of the following words:

 

(1)‘‘Every public interest company [having a share capital], other than a wholly owned subsidiaryies of public interest companies, shall not later than three months after the expiration of the first period of six months of its financial year send to every member and holder of debentures of the company an interim report [fairly presenting] on the business and operations of the company or, in the case of a holding company, of the company and its subsidiaries, during the said period of six months, and the results thereof: Provided that—’’.

 

“Amendment of section 304 of Act 61 of 1973

44. Section 304 of the Companies Act, 1973, is hereby amended by the substitution for subsections (1) and (2) of the following subsections respectively:

‘‘(1) Every public interest company [having a share capital], other than a wholly owned subsidiaryies of public interest companies, which does not within three months after the end of its financial year issue copies of its annual financial statements in terms of section 302 (1) shall not later than the date on which the said period of three months expires send to every member and holder of debentures of the company a copy of the provisional annual financial statements of the company [fairly presenting the business and operations of the company] or, in the case of a holding company, of the company and its subsidiaries during that accounting period, and the results thereof.”

 

3.4 Attendance of auditors of annual general meetings

 

Suggestion

For both practical and logistical purposes, we suggest that the Bill be amended to require that questions to be directed to the auditor at an annual general meeting be provided to the auditor prior to the meeting.

 

 

 


APPENDIX 1

 

Submission on S275A of the Corporate Laws Amendment Bill

 

BACKGROUND

 

Proposed section 275A

1.                   Paragraph 29 of the Corporate Laws Amendment Bill B6 – 2006, (“the Bill”) introduced in parliament on 12 May 2006 contains the following proposed new section 275A to the Companies Act, No. 61 of 1973 (“Companies Act”):

 

“Certain non-audit services not open to current designated auditor of public interest company

 

275A. (1) An auditor appointed to a public interest company may not for the duration of the appointment perform any bookkeeping or accounting (as distinct from auditing) services and, to the extent that these would be subject to its own auditing, internal audit or tax advisory services for that company.

        

         (2) Subsection (1) does not affect the power of an audit committee under section 270A(1)(d) or (e) to further limit the services which an auditor of that company may render."

 

(NB. Our emphasis added)

 

2.         The proposed section 275A is hereinafter referred to as section 275A.

 

3.         The previous draft of the Bill, which had been circulated to interested parties for comment (including the South African Institute of Chartered Accountants [SAICA] and the Public Accountants and Auditors Board [“PAAB”]) did not include any reference to “tax advisory services”. In addition, the previous draft Bill referred to the prohibition only applying to “an individual” who is “the nominated auditor” , whereas the revised section 275A(1) in the current Bill refers to the section applying to the “auditor”.

 

No definitions

4.         The terms “bookkeeping”, “accounting”, “internal audit” and “tax advisory services” and “to the extent that these would be subject to its own auditing” that appear in section 275A(1) are not defined in the Bill. “Public Interest Company” is defined quite widely and includes listed companies and other public companies and their subsidiaries that are incorporated in South Africa.

 

No materiality requirement

5.         Section 275A(1) is not qualified by any requirement for the tax implications of the subject matter of the advice, or the internal auditing service, to be material to the annual financial statements of the Public Interest Company for the section to apply.

 

 

No transitional arrangements

6.         The Bill contains no transitional arrangements for the introduction of section 275A.

EFFECT OF S275A(1) ON AUDITOR PROVIDED TAX ADVISORY SERVICES

 

Tax advisory services subject to own auditing

7.         Based upon the wording of the current Bill, the effect of the addition to section 275A(1) of tax advisory services would be that the incumbent auditor or auditors of a Public Interest Company would no longer be able to provide any tax advisory services to a Public Interest Company to the extent that these would be subject to its own auditing.

 

8.         The above is contrary to international trends in both developed countries (e.g. UK & US) and developing countries (Brazil, India, China & Mexico) where it is accepted that most tax services do not adversely affect auditor independence. In addition, we consider that auditor provided tax services enhance audit quality and a prohibition on auditor provided tax advisory services” would increase Public interest Companies’ audit costs.

 

EFFECT OF s275A(1) ON AUDITOR PROVIDED BOOKKEEPING OR  ACCOUNTING SERVICES, AND TO THE EXTENT THAT THESE WOULD BE SUBJECT TO ITS OWN AUDITING, INTERNAL AUDIT OR TAX ADVISORY SERVICES

 

Wider scope than intended

9.         As discussed below, due to the current Bill now referring to the section applying to the “auditor”, whereas in the previous draft Bill the prohibition only applied to “an individual” who is “the nominated auditor”,  the scope of section 275A(1) in the current Bill is much wider than our understanding of the intention of the section. This is discussed in detail below.

 

Legal interpretation of section 275A

10.        The heading of section 275A in the current Bill refers to “designated auditor”, whilst the section itself refers to the section applying to the “auditor”.

 

11.        We consider that this inconsistency is inappropriate and is very confusing as, in terms of paragraphs 25 and 26 of the Bill, the proposed section 273(5) of Companies Act, read with the proposed section 274(3), defines the "designated auditor" as “the individual registered auditor (being a member of the firm) who undertakes the audit". Section 274(1) makes it clear that “this section (i.e. s274) only applies where the auditor appointed in terms of section 270(1) is a firm”.

 

12.        The “auditor” is the “firm” referred to in section 274 of the Companies Act, where the auditor is not an individual person. Where the auditor is not a “firm”, the auditor is the individual Registered Auditor. The term “auditor” is not defined, but it is reasonably clear that this means the Registered Auditor (whether an individual  person or a firm) appointed in terms of section 270(1) of the Companies Act.

 

13.        In terms of the paragraph 21 of the Bill, section 269 of the Companies Act is amended by the addition of the following subsections:

 

"(6) No person or firm may be appointed as auditor of a company unless that person or firm is a registered auditor.

(7) In this Chapter "registered auditor", "firm" and "Regulatory Board" have the same meanings as in the Auditing Profession Act, 2005 (Act No. 26 of 2005)." (“APA”).

 

(NB. Our emphasis added)

 

14.        "Firm" is defined in APA as “firm” means a partnership, company or sole proprietor referred to in section 40;”

 

15.        The reference to section 40 is a typing error. It appears that the correct reference should be to Section 38 which reads as follows:

 

"38.      Registration of firms as registered auditors

(1)        The only firms that may become registered auditors are -

(a)       partnerships of which all the partners are individuals who are themselves registered auditors;

            (b)        sole proprietors where the proprietor is a registered auditor; and

            (c)        companies which comply with subsection (3)."

 

16.        Notwithstanding that the heading to section 275A refers to designated auditor, we consider that the prohibition on certain auditor provided non-audit services, as currently worded in the Bill, would apply to:

 

(a)        all “individuals” who are Registered Auditors (as envisaged in section 37 of the APA) who are appointed as the auditor of a Public Interest Company and to all of such auditors staff; and

(b)        all directors, partners and staff of a firm where that firm is appointed as the auditor.

 

17.        As the following extract from section 37 of APA demonstrates, it is clearly envisaged that an individual may register as an auditor in his capacity as an individual, or may register as a sole proprietor firm as envisaged in section 38:

 

“37.      Registration of individuals as registered auditors

 (1)       An individual must apply on the prescribed application form to the Regulatory Board for registration.

(2)        If, after considering an application, the Regulatory Board is satisfied that the applicant -

 (a)       ……..

(e)        has met any additional requirements for registration as prescribed under section 6, the Regulatory Board must, subject to subsections (3) and (5), register the applicant, enter the applicant’s name in the register and issue to the applicant a certificate of registration on payment of the prescribed fee.

 (3)       The Regulatory Board may not register an individual if that individual -

 (a) ………………………………

 

18.        In law, the wording of the actual section 275A(1) in the current Bill, which uses the word “auditor”, would take precedence over the headings in the Bill. As detailed in paragraph 17, we understand however that the intention was for the section to only apply to the “designated auditor” as the original draft Bill on which the Department of Trade & Industry solicited comments referred in section 275A(1) to the prohibition applying to the “nominated auditor”.  In terms of section 273(5) of the original Bill, read with section 274(2), the “nominated auditor” was “the individual registered auditor (being a member of the firm) who undertakes the audit.”

 

Intention of section 275A

19.        Based on informal enquiries we have made of the South African Institute of Chartered Accountants (“SAICA”), we understand that their understanding of the intention of section 275A(1) is that it should only apply to the “designated auditor” as defined in the Bill. We understand that this was also the intention of the the Department of Trade and Industry. This understanding is consistent with the changing of the word “auditor” in the heading in the original bill to “designated auditor” in the current Bill.

 

20.        We understand from the Summary of Submissions on the original draft Bill that was provided to us, and the other firms and individuals who commented on the original draft Bill, by the Department of Trade & Industry, that tax advisory services to the extent that these would be subject to its own auditing, were added to section 275A(1) at the suggestion of the South African Revenue Service (“SARS”). The views of the South African Revenue Service (“SARS”) on this matter are thus relevant to the current debate.

 

21.        We understand from informal discussions with the Commissioner of SARS’s office (M Kingon and F Tomasek) that SARS’s intention in relation to the addition of tax advisory services to section 275A(1) was that the proposed prohibition should only apply to tax advisory services provided by the designated auditor and not to such services provided by the firm where the firm was appointed as the auditors. We further understand that SARS intend advising the Portfolio Committee that their intention was that section 275A(1) should only apply to the designated auditor.

 

Individuals, “firms”, and “designated auditors”

22.        If our understanding of the intention is correct (i.e. that the section should only apply to the designated auditor), the section as currently drafted would adversely affect firms of auditors, (whether with more than one partner or a firm that is a sole proprietor), as in this case the designated auditor (i.e. Registered Auditor responsible for the audit) would be prohibited from providing the services referred to in section 275A(1), including tax advisory services.  These adverse consequences would arise as an individual who was appointed as auditor in his or her individual capacity as a Registered Auditor (in terms of section 37 of APA), as opposed to a firm, would not be prohibited from providing the services referred to in section 275A(1), including tax advisory services, as (for the reasons set out in paragraph 9) he or she would not be the designated auditor as defined.

 

23.        The adverse effects on  firms of auditors compared to an individual Registered Auditor can be eliminated by changing the words “An auditor” in section 275A(1) of the current Bill to the words “The designated auditor or the individual Registered Auditor referred to in section 37 of the Auditing Profession Act, 2005 (Act No. 26 of 2005 who is .......”.  If this suggested change is made, partners of a firm that had been appointed as the auditor of a Public Interest Company (other than the partner of the firm who is the designated auditor) would be permitted (or at least not be prohibited) by the Companies Act from providing tax advisory, bookkeeping, accounting and internal audit services to their audit client.

 

24.        The change suggested in paragraph 22, would however create a significant practical difficulty for both individual Registered Auditors who are not part of a firm and for a sole proprietor Registered Auditor who practices as a firm. The difficulty that would arise in both of these cases is that to the extent that such an individual or sole proprietor firm was the designated auditor of a Public Interest Company, he or she would not be able to provide any of the services listed in section 275A(1) to his/her Public Interest Company audit client. As we understand, however, that the intention of the section is to prevent the specified non-audit services from being provided by the individual Registered auditor who is responsible for the Audit of a Public Interest Company this consequence appears to us to be unavoidable as the intention of section 275A is to prevent the services specified in the section from being provided by the individual person who is responsible for the Public Interest Company Audit.

 

Role of IRBA pre-empted

25.        Parliament has recently passed the Auditing Professions Act 26 of 2005 (“APA), which established the Independent Regulatory Board for Auditors (“IRBA”) to replace the Public Accountants & Auditors Board. Section 21 of APA requires the IRBA to establish an Auditor Ethics Committee, which must set a Code of Conduct. This Code will deal, inter alia, with auditor independence.  The role of IRBA in regulating audits and formulating measures to ensure good ethics in the auditing profession will effectively be partially pre-empted by the proposed section 275A, so far as the subsequent determination by IRBA of specific non-audit services that the auditor of a Public Interest Company may not provide to such a company is concerned.  If section 275A becomes law, this Auditor Ethics Committee may then have to motivate further legislative changes to the Companies Act to implement any proposed auditor independence rules that it may possibly determine are appropriate.

 

26.        For the ethics standard setting process to be transparent and IRBA to fulfil one of the main objectives for which it was created, it should in our view be allowed to make this determination rather than this being done by way of Companies Act amendments. We understand from their submissions on the earlier drafts of the Bill that the PAAB and SAICA also share this concern.

 

Conclusion & recommendations

Deletion of section 275A

27.        We recommend that the proposed new section 275A should be deleted in its entirety from the Bill to allow the Independent Regulatory Body for Auditors ("IRBA) to fulfil its statutory obligations in terms of the Auditing Profession Act 2005 to regulate the auditing profession.  This would allow a full and transparent debate to take place on auditor independence that involves the participation of all stakeholders such as Government, SARS, the investing public, Public Interest Companies, IRBA, individual Registered Auditors and firms, SAICA and the JSE Limited. This debate should take into account the international environment in which many Public Interest Companies operate.

 

28         If our recommendation to delete the proposed section 275A(1) from the Bill in its entirety is not accepted, then we recommend that the words “An auditor” in section 275A(1) should be replaced with the words “The “designated auditor” or the individual Registered Auditor referred to in section 37 of the Auditing Profession Act, 2005 (Act No. 26 of 2005) who is ....” and that the words "tax advisory services" are deleted from section 275A(1). This would result in section 275A(1) having the same scope as in the previous draft of the Bill.