Announcement of simplified business terms for companies within company law, accounting and auditing. COM (2007) 394

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1 The European Commission Unit MARKT.F.2 Rue de la Loi 200 B-1049 Brussels Belgium Foreningen af Statsautoriserede Revisorer Kronprinsessegade 8, 1306 København K. Telefon Telefax nr Internet: October 2007 jr/jis/dor (X:\Faglig\Kor\2007\KOM doc) Dear Sirs Announcement of simplified business terms for companies within company law, accounting and auditing. COM (2007) 394 Presentation of the Institute of State Authorized Public Accountants in Denmark (FSR) FSR was established on 12 January The purpose of The FSR is to maintain the professional and natural interests of the audit profession externally as well as internally ensure and contribute to the fulfilment of general and specific audit obligations and by doing so and otherwise improve the standards and reputation the audit profession join together the state authorized public accountants to co-operate on these tasks. Persons who have obtained a licence as state authorized public accountants can be admitted as members of the Institute. Admittance can be granted and membership kept even if the licence is deposited in accordance with section 10, subsection 5 of the State Authorized Public Accountants Act. Membership of The Institute of State Authorized Public Accountants is voluntary. The membership percentage of licensed state authorized public accountants is 95. FSR s Comments The European Commission has asked for an opinion on the above announcement. The announcement has been discussed by FSR s Board of Directors. It is FSR s opinion that the EU code of practice within company law, accounting and auditing is an integrated, coherent, and generally accepted set of rules for companies with limited liability. The rules are motivated by the protection of stakeholders in limited liability companies. If the special terms in question are carried through without further ado, the consequences could be crucial to the interest groups of the companies, such as trading partners, tax authorities, creditors, and minority shareholders.

2 2 At present, considerations are going on about liberalisation and modernisation of the company law field, including the introduction of rather extensive relaxations of company capital adequacy requirements and the opportunity to distribute and dispose of the free equity capital. FSR finds it appropriate that the considerations of the European Commission should be part of the overall considerations in the field of company law (the Modernisation Committee). Part actions in this field might result in unintended consequences. For many years, the company law directives, including the 2 nd, 3 rd, and 6 th directives, have formed a good framework for (harmonized) national company law regulation, including the ensuring of a certain consistent minimum protection of shareholders and creditors. Therefore, FSR finds that these directives should not be abolished totally nor partly. On the contrary as pointed out by the European Commission it will be advantageous to adjust some of the requirements of the directives that are no longer up-to-date, i.a. in relation to the 1 st, 2 nd, 6 th, and 11 th directives. It will be an advantage to update and simplify the accounting rules of the 4 th and 7 th directives. However, the introduction of another category of companies, micro companies, does not seem to be a simplification. The burdens of financial reporting in micro companies and small companies are estimated in the document from the European Commission. To Danish companies the burden of financial reporting is limited in relation to the advantages it gives to the company as well as to its stakeholders. Also, it should be noted that micro companies include far more than half of the Danish companies with limited liability. FSR cannot support the proposal of prolonging the transitional period from 2 to 5 years for companies exceeding the threshold values of being a minor or big company. A 5 year period with the rapid changes characterizing business life is much too long for the stakeholders who need current information about the financial status of the company in the light of the actual size of the company. In particular, FSR cannot support the exemption of small companies or micro companies from the requirements regarding publication of financial statements or annual reports. Many stakeholders are in need of reliable accounting information and the costs of having mutual requirements regarding financial accounting are, in FSR s opinion, less that the costs imposed on trade partners and society by having to find/claim this information themselves. In connection with the current modernisation of company law, the consequences of lack of publication of annual accounts may be fatal to creditors and minority shareholders of the company. Furthermore, FSR cannot support the proposal that certain minor companies ( accounting class C according to the Danish Annual Act) shall be able to use the exceptions contemplated for small companies regarding accounting requirements and publication of annual accounts as well as exemption from auditing. FSR considers it improbable that such companies should not have mentionable external users. Also, the conditions of a company may rapidly change and then it will become an administrative burden to decide whether the criteria of applying the exceptions are fulfilled in the year in question. It should be noted that already in 2006 special terms for auditing was made, and FSR finds it appropriate to await the assessment of the consequences thereof as stipulated in section 6 of the bill, before decision is made about further simplifications. FSR would like to stress that a well-functioning capital market is based on the condition that investors have confidence in the market which presupposes access to reliable information about the companies using the capital.

3 3 Finally, it should be noted that FSR does not support the proposals that subsidiaries shall be exempt from preparing and presenting annual reports or abolishing consolidated financial statements for personal holding companies. The proposal that companies shall be allowed to abstain from informing about deferred taxes creates concern like several of the other proposals that the interests of the stakeholders are not served. FSR can accept to raise the information requirement on initial costs and allocation of net turnover on activities and geographical markets. FSR s views are elaborated on and explained in the attached appendix. If FSR s comments and remarks give rise to questions, please do not hesitate to contact us. Furthermore, we are prepared to participate in a meeting if considered appropriate. Yours sincerely Jens Røder President Judith Skou Technical Director

4 Appendix FSR s comments on COM (2007) 394 final Changes in the field of company law paragraph 3 of the European Commission s announcement 3.1. Overall approach to the EU company law The European Commission requests views on whether rules on national mergers and national splits in the 3 rd and 6 th directives rules on quoted companies capital base or at least the capital maintenance system in the 2 nd directive and/or rules on single proprietor companies with limited liability in the 12 th directive should be totally or partly abolished. FSR finds that the rules in the 2 nd, 3 rd, and 6 th directives have formed a good framework for national rules in the areas in question. It will be inappropriate to abolish the existing rules if an alternative EC based frame of reference for future national regulation has not been prepared and decided upon beforehand. The advantage of having a homogeneous frame and accordingly consistent minimum requirements is among other things the increased transparency that is hereby obtained across national capital markets. Even if a merger, a split or a disposition of the company s capital as a starting point is a national decision, there will often be stakeholders in or from other European countries who are affected by the disposition if it is based on rules that can vary a lot from one country to another without a mutual frame of reference. Likewise, it will be an advantage for stakeholders outside the European Community that the regulation of the EC countries is homogeneous due to the fact that it creates a higher level of transparency. For many years the European Community has worked for and towards joint rules to create a single, well-functioning and transparent market. Therefore, we do not understand this attempt to turn down the progress obtained through the years. FSR s overall opinion is that the 2 nd, 3 rd, and 6 th directives should not be abolished. The joint rules imply a certain degree of consistent minimum protection of shareholders and creditors based on a set of rules that has been successful for more than 20 years. We do not find that definite disadvantages or inappropriately heavy costs can be pointed at when applying a joint set of EC rules. It is FSR s opinion that shared frames for minimum protection further the functioning of the single market, including trade, entries and investment across borders even if the field of application of the rules is aimed at national mergers and splits. Moreover, it will imply increased costs if each member state should prepare new individual rules to be incorporated in practice by each company and its advisers etc. If special terms are to be made for mergers and splits, it would be appropriate to expand the exceptions concerning intra-group mergers and splits so that group mergers and splits (i.e. also including subsidiaries) give access to special terms which today are reserved to only those situations where a parent company and a subsidiary merge with the parent company as the surviving company.

5 5 It may seem inappropriate to discuss the abolition of the 2 nd directive before the effect of recent implementations of changes and special terms in connection with the directive has shown its influence. According to Directive 2006/68/EEC, changes shall be implemented by April 2008 at the latest, and in Denmark the implementation is part of the overall discussions concerning company law that are currently taken place in the Modernisation Committee under the auspices of the European Commission. The following matters of the directive may be considered: It should be contemplated whether the minimum capital requirements are outdated at least for quoted companies that are already subject to many requirements regarding openness. FSR finds not problems in the directive leaving this decision for all companies to the member states as the creditor protection said to be included in the minimum capital requirement is extremely modest. The self-financing rules should be specified so that all member states have the same rules. The Danish interpretation has consistently been more restrictive than that of other countries. However, we question whether for instance it should still be prohibited to merge a takeover company (with debts) with the target company? Considerations about special terms for company law requirements should be seen in relation to accounting law requirements, including the accounting directives, about openness in connection with the affairs of the companies. Special terms in the company law field, e.g. with regard to shareholders loans and flexible access to distribution of capital must unavoidably lead to the need of increased demands for transparency and openness in the financial reporting. As for the 12 th directive, it is FSR s opinion that the directive is not of much practical significance in Denmark which is why at present - we do not have comments to the considerations on abolishing the shared European rules on single proprietor companies A more principle oriented and less detailed regulation The European Commission requests views on the proposals in appendix Reporting requirements according to the 3 rd and 6 th company directives FSR agrees that, as far as possible, double reporting should be avoided, e.g. by aggregating the requirements in the 6 th directive on preparing an expert report in accordance with the 2 nd directive as well as a report on the demerger plan into one joint requirement for reporting, cf. appendix 2. The requirements for management to prepare a written report/statement on merger or demerger plans, that a report must be prepared by an independent expert, and that an intermediate balance must be prepared are in FSR s opinion justified with regard to the interest groups that may be affected by a merger or a split. 2. Protection of shareholders and creditors according to the 3 rd and 6 th company directives These considerations cause no immediate comments from FSR.

6 3.2. Supplementary simplification proposals within the field of company law The European Commission requests views on the proposals in appendix Disclosure requirements according to the 1 st and 11 th company directives 6 FSR supports the abolition of the requirement concerning announcement in the national official gazette assuming that the information is available to third parties in all member states via the electronic registers. Provided that the European Business Register is functioning, FSR supports the Commission s considerations about simplifications concerning publication of information for branch businesses. As a starting point, the member states should trust in each other s registered information so that the companies are not burdened with double registration, expenses for confirmed translations etc. 2. The registered office for the European company according to the statutes These considerations do not cause any immediate comments from FSR. Simpler financial accounting and auditing for SMEs paragraph 4 of the European Commission s announcement The European Commission requests views on the proposals in appendix Introduction of micro companies FSR agrees with the European Commission that IASB s standard for SMEs is hardly leading to a simplification of the financial accounting for these companies. IASB s standard is, however, thought of as an option for instance as an alternative to the requirements regarding EU s accounting directives and not a supplementary requirement. FSR finds that the proposal of the European Commission leaves the impression that the smallest companies if exempt from using the accounting directives can totally omit preparing annual accounts. Obviously, this is not correct as the companies will normally have to prepare tax accounts. The preparation thereof is based on the annual accounts and therefore is not very extensive. If the requirement to present annual accounts is removed, it will imply that the administrative burden is merely moved from the annual accounts to the tax accounts for these minor companies. It should be noted that the limits suggested by the EU for micro companies which are exempt from accounting and auditing obligations are high according to Danish circumstances. Today, the Danish Annual Accounts Act exempts companies with a total balance of up to and a turnover of up to from statutory audit. The limits of micro companies are 2½ times higher. This will mean that a large proportion of Danish companies will be defined as micro companies and according to the considerations of the European Commission they will be exempt from audit and publication of their accounts. Economic operators who have chosen to perform their business as a limited company have probably also emphasized the limited liability which this company form implies. Until now, the price has been society s requirement regarding the separation of the capital from that of

7 7 the owners, a fair minimum-sized capital and publicly accessible accounting information the validity of which is ensured by the statutory audit. If trading partners, creditors and other stakeholders no longer have access to published financial statements prepared in accordance with a homogeneous frame for financial accounting, they are put to an increased administrative expense. FSR finds that the proposals of the European Commission focus solely on the individual company s administrative burden in connection with the preparation of accounting disclosures and completely forget the advantage of several users that the annual accounts are presented in accordance with a homogeneous framework and examined by an independent auditor. Besides, FSR finds it extremely doubtful whether there will be any real administrative costcutting measures, cf. the experience gained in connection with the relief of statutory audit in Denmark. The various interest groups, for instance banks, credit rating agencies and suppliers, each have and therefore will request individual requirements regarding accounting disclosures when there is no homogeneous set of rules. This will cause non-transparency and in FSR s opinion will not be a simplification. It should be noted that abolition of the statutory audit for small companies in Denmark by L 50, 2006/06, in section 6 of the bill contains a provision that the Minister for Economic and Business Affairs introduces a bill regarding review of the provision no earlier than in the parliamentary year of 2009/2010 based on an assessment of whether it is reasonable to proceed with a further reduction of the statutory audit covering more companies from accounting class B. In the notes to the bill it was emphasized that seen from a tax and duty control point of view it must be assessed whether it is reasonable to proceed with a further reduction of the statutory audit. In case the considerations of the European Commission result in a new directive abolishing the statutory audit of all micro companies, Denmark s possibility of preserving the audit for some of these according to Danish standards not quite small companies will be impeded regardless of the result of the adopted assessment. FSR finds it inconsistent to give the member states decision-making competence with regard to whether the micro companies must present financial statements at the same time as the EU decides that these companies shall not be audited. This undermines the proximity principle. A possible exemption from auditing ought to be taken by the individual member state. The size limits are probably low for certain European member states, but in relation to Danish companies a majority of these will be classified as micro companies. The present rules for statutory audit are lower that the EU definition of micro companies which is why more than half of the Danish companies will probably be exempt from publication of the financial statements and the statutory audit. Apparently, the considerations of the European Commission on limitation of the administrative burdens for presenters of financial statements contain no assessment of the consequences for those who benefit from the rules about financial reporting and auditing and who are even protected by them.

8 8 FSR finds that this is inadequate and gives a very biased view on a complex economic relationship. It is our opinion that an abolition of the publication of annual accounts presented in accordance with a generally accepted accounting framework combined with further relaxations of the statutory audit will result in a need for increased control from society to avoid accounting and tax fraud. Furthermore, it will result in increased expenses for trading partners, banks and other creditors to ensure that business with this vast group of companies are conducted on a secure and well-founded base. At present, considerations are made about a liberalisation and modernisation of the company law field, including the introduction of various and often far-reaching relaxations of the capital requirements of the companies and their possibilities to distribute and dispose of the free equity capital. FSR finds it appropriate if the considerations of the European Commission could be part of the overall considerations in the field of company law. Part-measures in this field might have unintended consequences. For instance, relaxations in connection with financial reporting and statutory auditing might imply that the consideration of trading partners and users is neglected and result in other restraints of the company law and tax requirements for instance in the binding of paid-up capital, a ban on loans to and limitations in disbursements to shareholders whose interest partners interests must be protected. Nor can it be ruled out that the relaxed companies will experience increased expenses to credits which are considered more risky by the borrowers. Also, we disregard the fact that minority shareholders in such companies are prevented from getting information on and knowledge of a major shareholder who might also represent the daily management who sees no interest in having made a voluntary audit. FSR finds that the administrative burdens of small companies in a number of other fields are far heavier than preparing annual accounts or annual reports. For instance, there is the monthly collection, reporting and payment of A-Skat (tax deducted from income at source), AM-bidrag (Social Security contribution), ATP (contribution to the Labour Market Supplementary Pension Scheme), maternity fund, pupil reimbursement, holiday pay, monthly VAT or payroll tax statements, other often complicated statistical reports, benefit reimbursement statements, etc. Add to this, the tax authority s requirements of differentiated tax depreciations (operating equipment, properties, special installations), various tax deduction limitations (representation, staff cost), etc. In FSR s opinion, relaxation of the statutory audit implies a considerable risk of tax evasion, window dressing (and carelessness) and fraud in minor companies which do not have the resources for heavy internal control. In such companies the audit forms a preventive measure as the risk of being revealed might prevent fraud. With the audit gone, this preventive effect not only disappears, but so does the possibility of the authorities to draw advantage of the accountant s reporting of offences made, including money laundering and other financial crime Thresholds for SMEs FSR is not familiar with situations where the existing system with two-year evaluation periods has led to administrative burdens or unreasonable treatment of companies. FSR finds that a two-year period is an excellent criterion for assessing whether a company exceeds the limits or not. If the period is prolonged, it might result in an unreasonably long period where stakeholders in fast growing companies do not get access to full information or audited financial

9 9 statements. It will also lead to a reduction of the non-transparency of the market and reduce the competition. It should also be noted that small companies falling under the threshold in a single year shall apparently not be publishing audited financial statements in accordance with the Annual Accounts Act until 5 years later. In the interim period the company does not have to publish its annual accounts. This seems to be totally unacceptable to the company s creditors and other stakeholders. Furthermore, the companies have typically established book-keeping systems and reporting systems in accordance with the rules they are subjected to and a change thereof might demand adjustments of the book-keeping systems etc. which does not seem to be a simplification in FSR s opinion. FSR has no objections to a simplification of the procedure for adjusting the thresholds as long as the member states are able to choose lower thresholds depending on the size of the local economies Exemption of small companies from the publication requirements It should be noted that the publication requirements are not a burden in themselves if the annual accounts or the annual report have already been prepared. It must be presumed that creditors, trading partners, investors, banks and the public need a financial statement for the company which is why it is performed in some form or other irrespective of any publication requirement. Many stakeholders require information from the public register. Also, to a certain extent credit rating agencies are used which also get part of their information from the public register. If the stakeholders are not able to get the financial statements from a public register, they incur heavier costs and what is more a risk that the financial statement required from the company is not of the same quality as the one which today is prepared in accordance with a recognized framework and subject to control by virtue of auditing and publication. At the same time, a publication requirement has the advantage that the companies must obey certain time limits for the preparation and submittance of the financial statements and are subject to sanctions if these are exceeded without such time limits it is probable that a number of companies do not prepare their financial statements in time, so that in the worst case it leads to worse conditions for trading and credits in the coming year. A non-transparent and more unregulated market will lead to higher financing costs and a less efficient market. As already mentioned, FSR is concerned that the obligation to publish financial statements is removed at the same time as a possible liberalisation of company law (Modernisation Committee) is introduced where capital requirements are relaxed and possibility is given to apply free reserves to acquisition of own shares and of shareholders loans. If the interests of stakeholders (including the tax authorities and other public authorities) are to be protected when the company law regulation is relaxed, there must be more publicity, transparency and information in the financial statements.

10 Expansion of the exceptions to also include medium-sized companies without mentionable external users Medium-sized companies are the so-called class C companies, i.e. companies with up to 250 employees and a balance sheet total of up to 120 million DKK or a turnover of about 240 million DKK. As an introduction it should be noted that this category of companies is not very big which is why a possible reduction of administrative burdens will not show any important effect on the AMVAB measurements. However, the consequence it will have on lending institutions, customers, authorities, etc., is hardly insignificant. At the same time a risk based addition will add new administrative burdens to the companies as a number of criteria must be expected to be fulfilled just as the company creditors and the company capital and cash resources must be taken into consideration. In that case, who should control that the risk assessment is made correctly and that the chosen criteria are reasonable? If class C companies can be exempt from auditing and publication of annual accounts, there is a considerable risk that minority shareholders will not (or cannot) invest in these. This will not be in harmony with the Danish government s plan of action for risk capital (January 2005) according to which it is the goal of the government that Denmark shall have one of Europe s best functioning markets for risk capital by As a part thereof, the government opened up for i.a. investment of pension funds in unquoted shares and partnership shares. Such investments imply statement and reporting to the credit institution of the company s internal value according to the latest annual accounts (L134 04/05). It is FSR s opinion that the annual report contains important information, including disclosure of going concern and events occurring after the balance sheet date which stakeholders and the market need knowledge of. Without publicly accessible and audited annual accounts it will involve considerable costs for the individual users to obtain this important information Simplification for all companies Consolidation Subsidiaries of groups are often important according to Danish conditions and therefore an exemption from auditing and financial reporting may cause considerable risks to the authorities, trading partners and other stakeholders in Denmark. FSR is concerned that companies of this type do not have to apply an internationally recognized framework for their financial reporting. Besides, the reporting systems in subsidiaries are normally organised to meet the requirements of the parent company. With regard to the considerations to abolish consolidated financial statements for personal holding companies, FSR sees a considerable risk of window dressing /fraud if creative principal shareholders can be exempt from preparing group financial statements including eliminations of intra-group profits. Accounting treatment of deferred taxes In FSR s opinion, the accounting treatment of deferred taxes is normally not burdensome. For companies which have already once prepared a statement of deferred taxes it is a very simple statement which furthermore gives the preparer of the accounts good tax reconciliation. As an

11 11 exception the calculation can be more complicated if, for instance, there are changes in the company tax law. Deferred taxes can form very essential contingent liabilities in some companies and express considerable future cash requirements. FSR is surprised that credit institutions and credit rating agencies according to the EU Commission should not find the information about deferred taxes important. FSR supposes that this view is expressed in countries where there is a continued coherence between the tax depreciation methods and the accounting depreciation methods. In the light of the work of the Modernisation Committee where relaxation of possible application of free reserves of the companies is contemplated, lack of registration of a contingent liability as deferred tax makes a risk that too large an amount is distributed, lend or used in another way as the free reserves are overestimated. This is likely to inflict a risk of loss on creditors, including tax authorities and possible minority shareholders. Disclosure requirements FSR finds that a requirement that small companies shall explain initial costs or divide the net turnover into activities and geographical markets is not decisive for companies of this size and sees no problem in abolishing them. FSR 24. september 2007 jis/dor (X:\Faglig\Kor\2007\KOM doc)