From 1 October 2012, subsidiary companies will no longer need to have their annual accounts audited provided that, among other things, their parent company agrees to guarantee all liabilities of the subsidiary that are outstanding at the end of that financial year. In addition, companies that qualify as “small” for the purposes of preparing and filing accounts will automatically qualify for exemption from audit. And dormant subsidiaries will not even have to prepare and file accounts if, again, their parent company agrees to guarantee all their outstanding liabilities and certain other conditions are met. It will also be easier for companies to switch between UK GAAP and IFRS when preparing their accounts.
The relaxations will be introduced through amendments to the Companies Act 2006 that will take effect on 1 October 2012 and apply to financial years ending on or after that date. They are part of the Government’s stated commitment to reduce the regulatory burden on UK businesses, and will be achieved partly by taking advantage of certain options afforded to Member States under the Fourth Company Law Directive (78/660/EEC) that the Government has not previously taken up.
Small companies exempt from audit: alignment of conditions in Parts 15 and 16 of the Act
Companies that qualify as “small companies” under Part 15 of the Act (Preparation and content of accounts) can prepare and file simpler, less detailed reports and accounts than those required by large and medium-sized companies. To qualify as a “small company” under Part 15, a company must, among other things:
Satisfy two or more of the following conditions for the financial year in question:
- Its turnover must be £5.6 million or less
- Its assets must total £2.8 million or less
- It must have 50 or fewer employees on average
- It must not be a public company or a financial services company.
- If it is a member of a group, the group must (i) qualify as a “small group” and (ii) not be an “ineligible” group. A group is ineligible if, for example, the parent company has shares admitted to trading on an EEA regulated market, or a member of the group is authorised by the FSA to carry on a regulated activity.
“Financial services company” means, broadly, an authorised insurance company, a banking company, an e-money issuer, a MiFID investment firm, a UCITS management company or a company that carries on insurance market activity. Such companies are subject to more onerous rules because they are considered systemically important.
Certain companies are exempt from the requirement to have their annual accounts audited. These include companies that qualify as “dormant” or “small” under Part 16 of the Act (Requirements for accounts to be audited). The conditions for exemption from audit in Part 16 are more stringent. Under section 477 (in Part 16), a company qualifies as “small” if, in addition to qualifying as a small company under Part 15:
- Its turnover is £6.5 million or less; and
- Its assets total £3.26 million or less.
These conditions, which go further than the minimum requirements set out in the Fourth Company Law Directive, mean that, for example, a company with 45 employees and assets totalling £3 million, but turnover of £7 million, would qualify as a small company for the purposes of Part 15 – and therefore be able to include less information in its reports and accounts – but would not qualify as small for the purposes of Part 16 – and would therefore be required to have its annual accounts audited.
If a company is a member of a group, it qualifies for exemption from audit only if the group, as well as meeting the conditions in Part 15 (that the group qualifies as a “small group” and is not an “ineligible” group), also meets certain conditions as to turnover and assets set out in section 479 (in Part 16).
The Government has decided to remove the additional conditions in Part 16 so that a company will automatically qualify for exemption from audit under Part 16 if:
- where it is not a member of a group, it qualifies as a small company under Part 15; or
- where it is a member of a group, the company qualifies as a small company, and the group qualifies as a small group, under Part 15.
The Government says that these changes will give 36,000 more companies the chance to be exempt from audit.
Subsidiaries of any size exempt from audit if certain conditions satisfied: new provisions
Under new sections 479A-C to be introduced into Part 16 of the Act, a subsidiary company that fulfils all of the following conditions will not be required to have its annual accounts audited:
- It is not a “quoted company” – i.e. its shares are not listed on the UKLA’s Main Market, officially listed in another EEA state or admitted to trading on the NYSE or NASDAQ.
- It is not a financial services company. Where there is an FSA-regulated entity in the group, other qualifying subsidiaries within the group will still be eligible to avail themselves of the exemption from audit provided both the group and the FSA-regulated entity are subject to statutory audit, and provided that the auditor of the group and regulated entity reports certain matters that come to their attention during the statutory audit to the FSA.
- Its parent undertaking is incorporated in an EEA state.
- Its shareholders unanimously agree to the accounts for that year not being audited. Such approval will therefore need to be obtained each year.
- Its parent agrees to guarantee all liabilities of the subsidiary that are outstanding at the end of the relevant financial year, in the terms set out in section 479C of the Act (see further below).
- It is included in the consolidated group accounts, and the notes to those accounts state that the subsidiary has taken advantage of the exemption from audit.
The following documents are filed by the directors of the subsidiary at Companies House on or before the date that its accounts are filed:
- written notice of the shareholders’ agreement to the accounts not being audited;
- a statement by the parent that it guarantees the subsidiary’s outstanding liabilities; and
- a copy of the consolidated report and accounts prepared by the parent company, and the auditor’s report on those accounts.
In order to ensure that all such parent company guarantees are consistent in their scope and effect, and to avoid companies having to take legal advice on the wording of the guarantee, new section 479C provides:
“A guarantee given under this section has the effect that:
(a) the parent undertaking guarantees all outstanding liabilities to which the subsidiary company is subject at the end of the financial year to which the guarantee relates, until they are satisfied in full, and
(b) the guarantee is enforceable against the parent undertaking by any person to whom the subsidiary company is liable in respect of those liabilities.”
The Government has decided that the guarantee should cover all “liabilities” (which it says includes liabilities in tort and contingent liabilities), rather than simply all “debts” owed by the subsidiary as a matter of contract (which it had originally proposed). The guarantee is referred to below as the “statutory guarantee”.
A creditor who obtains a judgment against the parent guarantor in the courts of England and Wales, Scotland or Northern Ireland will, as a general principle, be able to enforce that judgment in another EEA jurisdiction without issuing separate proceedings there either by virtue of the Brussels Regulation on the jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Council Regulation (EC) No 44/2001) or the 2007 Lugano Convention on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters.
For the purposes of giving the statutory guarantee, the directors of the parent company will not be required to make any declaration of the parent company’s solvency.
According to the Government’s consultation paper, the Netherlands, Germany and Ireland are among the countries that already allow subsidiaries to be exempt from audit provided a parent company guarantee is given.
When subsidiaries might choose to claim exemption from audit
Every subsidiary in a group, of whatever size, that meets the qualifying conditions will be able to claim exemption from audit. Parent companies will therefore need to decide in respect of each eligible subsidiary, in each year, whether the advantage of not needing to have the subsidiary’s accounts audited outweighs the disadvantage of the parent being liable for the subsidiary’s outstanding liabilities under the statutory guarantee.
If a statutory guarantee is proposed to be given, the parent company will also need to consider:
- whether and how its contingent liability under the guarantee should be reflected in the parent company’s accounts, and the potential impact on the parent’s ability to pay dividends and on its balance sheet generally;
- how the guarantee will impact on the group’s external financing arrangements (e.g. any cross-guarantees) and its relationships with suppliers and other creditors;
- whether the subsidiary is contractually obliged – e.g. under a property lease - to have its accounts audited; and
- whether there might be any other disadvantages from not having the subsidiary’s accounts audited – e.g. whether it might be more difficult for the company to raise equity or debt finance.
In some cases, parent companies may decide that the disadvantage of giving the statutory guarantee and the costs of satisfying the other conditions outweigh the benefits and cost savings of not having the subsidiary’s accounts audited. The Government estimates that about 50%-75% of subsidiaries will decide to exempt themselves from audit, but this estimate may well be optimistic.
Even where a subsidiary does claim exemption from audit, because its financial results must be included in the consolidated group accounts prepared by its parent and those group accounts are likely to be audited (except where the group is small), the financial results of the subsidiary are still likely in practice to be subject to some degree of review by external auditors.
Of course, banks and other external funders may require borrowers to ensure that the annual accounts of their subsidiaries, or at least their principal trading subsidiaries, are audited. And, where a subsidiary is not wholly owned, parent companies will need to bear in mind that under section 476 of the Act shareholders with at least 10% of the subsidiary’s share capital can require the accounts to be audited.
Companies that are also charities will still be required to have their accounts audited, even if they fall within the exemptions in the Act, unless they also fall below the audit exemption thresholds laid out in section 144 of the Charities Act 2011.
Dormant subsidiaries to be exempt from the obligation to prepare and file annual accounts if certain conditions are satisfied: new provisions
Companies that have been dormant since formation, or since the end of the previous financial year, and which satisfy the conditions in section 480 of the Act, are currently exempt from having their individual accounts audited. To satisfy the conditions, in respect of the financial year in question the company must, among other things: (i) be entitled to prepare accounts in accordance with the small companies regime in Part 15 of the Act; (ii) not be required to prepare group accounts; and (iii) not be a financial services company. A company is dormant if, during the relevant financial period, “it has no significant accounting transaction” – i.e. a transaction that must be entered in the company’s accounting records. Certain fees payable to Companies House, and certain transactions related to subscribers taking shares in the company on incorporation, can be disregarded.
Dormant companies need only prepare and deliver to Companies House an abbreviated balance sheet and notes. They do not have to include a profit and loss account and directors’ report in accounts filed at Companies House, but they must provide a directors’ report to members.
Where a company is a subsidiary and has been dormant throughout the whole of the financial year in question, under new sections 394A-C it will be permitted not to prepare and file accounts at all provided that it satisfies the same conditions as those that apply for a subsidiary to be exempt from audit (described above), including the requirement for the parent company to give a statutory guarantee of the dormant subsidiary’s outstanding liabilities. 67,000 companies are estimated by the Government to qualify for the new exemption.
The Government says that this change will not pose a significant threat to financial transparency because the last set of accounts of a dormant company prior to its becoming dormant will continue to be available at Companies House; and dormant subsidiaries will continue to be reviewed to some extent as part of the group audit, and therefore those with material assets and/or liabilities will remain subject to independent review.
As with exemption from audit, parent companies will need to decide in respect of each dormant subsidiary, in each year, whether the advantage of not needing to prepare and file accounts outweighs the disadvantage of the parent being liable for the subsidiary’s outstanding liabilities under the statutory guarantee and the costs of satisfying the other conditions.
Dormant companies will continue to have to file an annual return each year.
Companies House guidance
Companies House has told the Government that it will publish guidance on its website on how companies can take advantage of the new exemptions.
Switching between UK GAAP and IFRS
At present, individual annual accounts can be prepared in accordance with the Act and UK GAAP (UK GAAP accounts) or with international accounting standards (IFRS) (IFRS accounts). However, once it has produced a set of IFRS accounts, a company can switch to producing UK GAAP accounts in a subsequent financial year only if there is a “relevant change of circumstance” – i.e. the company becomes a subsidiary undertaking of another undertaking that does not prepare IFRS individual accounts; the company ceases to be a company with securities admitted to trading on an EEA regulated market; or a parent undertaking of the company ceases to have its securities admitted to an EEA regulated market. If a company switches from IFRS accounts to UK GAAP accounts, and then back again, it can switch again to UK GAAP accounts only if there is another relevant change of circumstances.
The Government has decided to allow companies more flexibility to switch to UK GAAP accounts. A company that prepares IFRS accounts will now be allowed to switch to UK GAAP for a reason other than a relevant change of circumstance, provided that the company has not, at any time during the five years before the first day of the relevant financial year, prepared UK GAAP accounts. Any change during the preceding five years due to a relevant change of circumstance will be ignored. Parent companies that prepare their consolidated group accounts under IFRS will be allowed a similar flexibility, provided they are not required to continue using IFRS by the IAS Regulation ((EC) 1606/2002).
Same rules for limited liability partnerships
The new rules exempting qualifying subsidiaries from audit, exempting qualifying dormant subsidiaries from preparing and filing accounts, and relaxing the rules on switching between UK GAAP and IFRS, will be extended to LLPs.
BIS consultation paper, “Audit exemptions and change of accounting framework” (October 2011)
BIS response(September 2012)