Billion dollar scam brewing

After CWG, 2G and Coalgate, the poll-bound UPA government now seems to be preparing itself to face a yet another big-time case of corrupt intent involving changes in cost audit rules in the newly created Companies Act to benefit industry and the corporate sector billions of dollars per annum at the cost of the exchequer and consumers. The draft new rules, if allowed in their current scope and content, will substantially undermine the role of cost audit of products and services with effect from 1 April giving industry liberty to fiddle with cost statements to manipulate prices and profits. They open up the biggest single door of ‘authorised’ corporate corruption, making it potentially a mother of all scams.

The proposed changes in the cost audit rules could have an annual revenue implication of over Rs 1,00,000 crore, even if the data manipulation affects 8 to 10 per cent of the government’s gross tax revenue. The impact on consumers, as a result of loosening cost-price linkage in various sectors, will be several times over. The notorious practice of transfer pricing by multinational (MNC) and large domestic companies could become the order of the day. The Competition Commission (CCI), on the other hand, will have tough time to find industry and individual corporate cost data to conduct investigation into price cartel and segmentation.

A powerful industry lobby is believed to be working over-time with a section of senior bureaucrats in the government to change the rule book underscoring the need for maintaining mandatory cost accounting records on the lines of financial accounting by corporates to escape law with regard to transparency in ultimate cost-price linkage in several areas of industry. These new rules are to be called the ‘Companies (Cost Record and Cost Audit) Rules, 2013. Once gazetted, they will be applicable from fiscal 2014-2015.

Did those powerful ‘babus’ in the department of company affairs and their legal experts officially consult with their counterparts in the central boards of direct taxes (CBDT) and excise and customs (CBEC) under the union finance ministry, the CCI and the department of consumer affairs before rushing into making the new set of rules that heavily undermines the compliance of cost records and cost audit under the guise of new barriers created to provide escape routes to industry and corporate entities? Why are the draft cost audit rules making such a large scale revision of threshold limits for their coverage? Isn’t such an action motivated to help industry circumvent an important governance criterion to encourage corruption through concealment of vital cost records and cost audit information?

Has Arvind Kejriwal’s Aam Aadmi Party’s (AAP) demand last year to run cost audit into Delhi’s three private power supply companies (Discoms), including the one run by the Tatas and the other by Reliance Power, to ascertain the real cost of electricity to consumers as against the high tariffs fixed by the power firms got anything to do with the latest development? The AAP demand has created a spine-chilling effect on very many other corporations across the country covering the whole spectrum of industry and corporate sector. Corporates want industry-friendly cost audit rules on the ground that a stricter set of rules and compliance regime may run counter to the professed market orientation of the economic reform profess. Unfortunately, market economy is often misconstrued as less transparent, exploitative system more for the benefit of producers and suppliers than the market itself. This is exactly what industry and the corporate sector are looking to escape an Arvind Kejriwal-like intervention and from other regulatory agencies.

In fact, cost audit data is very valuable to do costing analysis like comparison of ‘suspect’ companies’ cost of goods sold, input-output ratio, etc. with the peer groups. Cost audit reports filed by companies provide useful insights into manufacturing companies like information on production cost, procedure for accounting of materials, labour, depreciation, overheads and their allocation, apportionment and absorption to products, treatment of by-products, joint products, scrap etc. Such cost data, as distinct from financial audit data, is meant to focus on input-output structures in a firm to understand the correctness of a company’s declared financial results. Cost audit play a critical role in transfer pricing, predatory pricing, fixation of margin of dumping for the purpose of levying anti-dumping duty, free trade agreement, consumer protection, revival of sick companies and corporate governance. The finance ministry made it mandatory to file cost audit report along with tax audit report for the year 2012-13. Then, what is prompting the sudden change?

Curiously, the proposed cost audit rules come with a number of heavy riders making them virtually inapplicable to a wide spectrum of industry totally ignoring the universal value attached to cost analysis to derive efficiency, competitiveness and better corporate governance. Investigations have revealed that deliberate inflation of cost or expenses, under or over pricing of inputs or outputs, under or over-valuation of inventories etc are a common modus operandi adopted by entities to manipulate their earnings. Therefore, cost audit data is useful to back-test the genuineness of a company’s financial reporting. It is feared that a very high threshold-based approach in proposed cost audit rules will result in exclusion of most medium and even many large-sized companies from the purview of cost audit allowing them an easy scope for manipulation of costs and prices.

 The proposed rules are surprisingly lax on such major industries as cement, the cartel-like operation of which is now under CCI investigation, steel, covering base metal leaving aside related products, tyres and tubes, electronics, plantations, food products and a host of engineering items. Few will disagree that all of them need to be covered by mandatory cost audit, at least in public interest. Rules are being framed with a whole lot of riders to protect large sections of industry and institutions from cost audit. They include such important areas of economy as infrastructure, education and healthcare, partly or substantially funded by taxpayers’ funds. 

The UPA government has taken almost 10 years to rewrite the Companies Act to address the current challenges and complexities of economic growth, its long term sustainability and social relevance, and governance concern. It is rather inexplicable why the government is rushing through such rules at the fag end of its tenure that seek to dilute the very purpose of the new act and the concept of good governance by putting restrictions on maintenance of scientific cost records and mandatory cost audit by industry, the corporate sector and institutions.

Unfortunately, at the closing stage of formulating the act, as many as three ministers holding the charge of company affairs were changed in quick succession leaving the incumbent little time to understand the nitty-gritty or the fine prints in the complex act. As usual, departmental bureaucrats and legal advisors hold upper-hand in formulation of rules which ultimately touch stakeholders. It would be unfortunate, if the government ignores the public concern about the development by diluting the most important part of corporate or institutional governance by putting riders on cost audit and maintenance of cost records. IPA