Regulatory Frameworks and Financial Management | India

The regulatory frameworks are: 1. Companies Act 2. Industrial Policy of the Govt. of India 3. Securities and Exchange Board of India Guidelines 4. Foreign Exchange Regulation Act 5. Industrial Development and Regulation Act 6. Monopolies and Restrictive Trade Practices Act, 1969 7. Direct and Indirect Taxes.

Regulatory Frameworks in Financial Management:



  1. Companies Act
  2. Industrial Policy of the Govt. of India
  3. Securities and Exchange Board of India Guidelines
  4. Foreign Exchange Regulation Act
  5. Industrial Development and Regulation Act
  6. Monopolies and Restrictive Trade Practices Act, 1969
  7. Direct and Indirect Taxes




Financial Management: Regulatory Framework # 1.

Companies Act:

The Companies Act. 1956 (along with its amendments), has a direct effect on the finance function of a joint stock company in various forms.

We know that the provisions of the Companies Act deal with:

(a) Issue of share capital;

(b) Issue of debentures;

(c) The types of share capital;

(d) Inter-company investments;

(e) Loans and advances;

(f) Payment of dividends;

(g) Re-organisation and re-constructions;

(h) Liquidation;

(i) Amalgamation/ absorption or mergers etc.

We discuss some of the important provisions of the Companies Act which have got direct bearing on the financial management here under:

(i) Only two kinds of shares; viz., equity and preference can be issued by a company.

(ii) Until and unless a prospectus is issued which reveals the necessary information about the company, no company can issue any share.

(iii) A company can issue right share after taking necessary formalities.

(iv) A company can declare dividend only out of profit after transferring certain amount to the Reserve fund.

(v) No company can issue any debenture which has got any voting rights.

(vi) The Companies Act also prohibits a company not to lend more than 30% of its paid- up capital and free reserves to other companies.

(vii) A company must have to prepare a profit and loss account and the balance sheet, according to prescribed format (schedule vi) of the Companies Act which exhibit the financial information of a company.

(viii) A company can purchase the share of an another company only to the extent of 10% of its subscribed capital provided the total investment must not exceed 30% of its subscribed capital.

Financial Management: Regulatory Framework # 2.

Industrial Policy of the Govt. of India:

Industrial Policy means and includes procedures, principles, policies rules and regulations, incentives and punishment, the tariff policy, the labour policy, government attitude towards foreign capital etc. Needless to mention here that a country must introduce industrial policy as an instrument of industrialization.

Thus the industrial policy of the Govt. of India contains:

(i) Legislation:

(a) FERA Act (Foreign Exchange and Regulation act)

(b) MRTP (Monopolies and Restrictive Trade Practices act)

(c) IDRA (Industrial Development and Regulation Act)

(ii) Incentives:

(a) For small sector industries

(b) For export-oriented industries

(c) High Priority industries.

But before presenting the highlights of the present Industrial Policy of 1991 (July 24, 1991), we are to know the previous industrial policy resolution/statements since indepen­dence which were adopted. These are noted below in short.

(i) Industrial Policy Resolution of 1948 (April 30, 1948):

— It gave emphasis on mixed economy. Basic and strategic industries were in the hands of state; whereas key industries were in the hands of private sector. 18 other industries were given to the private sector and the other industries also were left open to the private sector

(ii) Industrial Policy Resolution of 1956 (April 30, 1956):

The Resolution classified industries into three categories having regard to the role which the state will play in each of them.

(a) Schedule A consisting of 17 industries shall be the exclusive responsibility of the state.

(b) Schedule B consisting of 12 industries shall be opened to both private and public sector.

(c) All other industries not included in Schedule A and Schedule B constitute the 3rd category which is left open to private sector.

In short, this Policy Resolution gave to reach the goals for socialistic pattern of society.

(iii) The Industrial Policy Statement of 1973:

This statement acknowledged high priority industries.

(iv) The Industrial Policy Statement of 1977 (December):

It gave emphasis on decentralisation as well as on the cottage and small scale industries.

(v) The Industrial Policy Statement of 1980:

This statement highlighted competition among domestic market along with modernization and technological changes It also encouraged foreign investment.

Besides the above, some changes were also made in 1985 and 1986 for the promotion of the improved quality of the product, reducing costs, increasing productivity etc.

(vi) The Industrial Policy of 1991:

This liberalised industrial policy was announced by the Govt. of India on July 24, 1991. The new industrial policy has scrapped the asset limit for MRTP companies and abolished industrial licensing of all projects except for 18 specific groups.

It also raised the limit for foreign equity holding demanding a greater participation of foreign capital in the country’s industrial development. The new policy has re­defined the role of the public sector and has asked the private sector to operate even in those fields which are actually reserved for the public sector.

However, the new policy has decided to take initiatives relating to the following:

(i) Industrial licensing;

(ii) Public sector policy;

(iii) MRTP Act;

(iv) Foreign investment;

(v) Foreign technology agreements.

The highlights of the policy are:

(a) Industrial licensing will be abolished for all projects except for a short list of industries (viz., 18 selected sectors).

(b) It provides for automatic clearance for import of capital goods in cases where foreign exchange availability is ensured through foreign equity.

(c) The policy also intends to scrap the assets limit of the MRTP companies.

(d) The policy also states (for the MRTP Act), that the pre-entry scrutiny of investment decisions by the so called MRTP companies will no longer be required.

(e) It also envisages disinvestment of Govt. equity in public sector to mutual funds, financial institutions, general public and workers.

(f) To invite foreign investment in high priority industries which require large investment and advanced technology, it has been decided to provide approval for direct foreign investment up to 51% foreign equity in such industries.

(g) This policy also provide that in locations other than cities of population of more than one million, there will be no requirement for obtaining industrial approvals except for industries subject to compulsory licensing.

Financial Management: Regulatory Framework # 3.

Securities and Exchange Board of India Guidelines:

After the abolition of the Capital Issue (control) Act 1947 due to some snags of its own, and the same practically is replaced by the guidelines issued by the Securities and Exchange Board of India (SEBI).

At present, every company must have to confirm the disclosers. Some of the important guidelines are noted below:

(i) All the shares which are issued must compulsorily be underwritten.

(ii) The contribution of the promoter must be at least 25% if the issue exceeds Rs. 100 crores.

(iii) Each private company which is going to be converted into public company can value their capital issue freely if they have profitable business at least three years.

Financial Management: Regulatory Framework # 4.

Foreign Exchange Regulation Act (FERA):

This Act consolidates and amends the law regulating certain payments, dealings in foreign exchange and securities transactions which indirectly affects foreign exchange and also the export and import of currency and bullion, for the conservation of foreign resources of the country and their proper utilisation for the benefit of the economic development of the country.

The following restrictions (both on dealing and on payment) affect the financial function of a corporate enterprise:

Restrictions on Dealing:

(i) Restrictions on dealing in foreign exchange [Sec. 8(1)]

(ii) Certain transactions to be made with sanction of Central Government [Sec. 8(2)]

(iii) Foreign exchange not to be used for any other purpose [Sec. 8(3)]

(iv) Foreign exchange of goods [Sec. 8(4)]

(v) Foreign exchange from Post office [Sec. 8(5)]

Restrictions on payments:

(i) Restrictions on payments [Sec. 9(1)]

(ii) Not unlawful payment [Sec. 9(2)]

(iii) Mode of Remittance [Sec. 9(3)]

(iv) No Restrictions [Sec. 9(4)]

(v) Securities [Sec. 9(5)]

Restrictions on import and export of certain currency and bullions [Sec 13(1)]:

The Central Govt. may, be notification in the official Gazette, order that subject to such exceptions, if any, as may be specified in the notification, no person shall, except with the general or special permissions of the RBI and on payment of the fee, if any, prescribed, bring or send into India any gold or silver or any foreign exchange on any Indian currency.

There are also certain other sections which affect the finance function of a corporate enterprise, viz. Acquisition by Central Govt. of foreign exchange [Sec. (14)]; Power of Central Govt. to direct payment in foreign currency [Sec. 15(1)] etc.

Financial Management: Regulatory Framework # 5.

Industrial Development and Regulation Act (IDRA):

The object of the Act is to provide for the development and regulation of certain industries.

Financial Management: Regulatory Framework # 6.

Monopolies and Restrictive Trade Practices Act, 1969 (MRTP):

The MRTP Act, 1969, practically was the culmination of a growing concern over the abuse of concentration of economic power which is not desirable. The Directive Principles of state policy expressed in our constitution call upon the state to secure that ownership and control of material resources of the community are to be distributed in such a way so that they will be treated as common good.

Moreover, the operation of the economic system must not result in the concentration of wealth and means of production to the common purpose for which Monopoly Enquiry Commission was set up by the Central Govt. The Act also provides for regulation and prevention of monopolies trade practice.

In other words, the Act provides that the Central Govt. could give any suitable order to stop /regulate the monopolistic trade practice of any undertaking on the recommendation of MRTP Commission set up by the Central Govt.

Financial Management: Regulatory Framework # 7.

Direct and Indirect Taxes:

Direct Tax:

When the impact and incidence of tax is on the same person it is known as direct tax. e.g.. Income-Tax, Gift Tax, Wealth Tax etc.

Indirect Tax:

When the impact and incidence is on the different persons, it is known as indirect tax. e g : Excise Duty, Sales Tax etc.

In the present study, however, we will highlight the effect of Income-Tax on a corporate enterprise since it is the effect of Income-Tax on a corporate enterprise since it is the most significant aspect in the hands of the corporate management.

Needless to mention that taxes affect the finance functions and the formulation of pay-out policies of all companies as well, because an income of a company is taxed when it is reported by the company and again when it is paid out by way of cash dividend.

In order to reduce the tax bill, a company can retain its funds in the business instead of paying out cash, or, if the firm feels that some form of dividend is necessary, it can issue bonus shares. In both the cases, total taxable bill is reduced.

A company can reduce the taxes of certain shareholders by adopting a stable dividend policy. The net effect of such a policy is to transfer income from high to low brackets which reduces the total taxes.

Evaluation policies also affect the size of the tax bill in the following manner:

(i) The method of evaluating inventory:

At the time of rising-prices, it is better to employ the LIFO (Last-in, First-out) method of costing inventory and, in the opposite case, i.e., at the time of declining prices, FIFO (First-in, First-out) should be followed.

(ii) The method of evaluating fixed assets:

The firms who use an accelerated method of charging depreciation enjoy a definite advantage over the firms who use the straight-line method. This is due to the fact that funds received for several years from today are not as valuable as those received in near future.

As such, the firm should seriously consider the use of such methods. Of course, certain advantages may accrue to the firm who uses the straight- line method rather than an accelerated method. For instance, a firm may be in a low tax bracket at the time when income is low (depreciation charges are high) and high brackets at the time when income is high (depreciation charges are low).

From the discussions made so far, it becomes clear that every firm is to pay tax on its income at a prescribed rate which is determined by the Finance Act passed every year by the Parliament. As such, while raising of funds and its proper utilisation, tax implications arise before us. First of all, we are going to discuss the general observations underlying the said principles.

General Observations:

This can be divided into:

(i) Determinations of Capital Structure;

(ii) Capital Budgeting Decisions;

(iii) Dividend Decisions; and

(iv) Method of Depreciation.

(i) Determination of Capital Structure:

Impact of the tax plays a very significant role at the time of determining capital structure of a firm, i.e., debt-equity mix. We know that funds can be raised either by the issue of shares or by loans and /or debentures.

Now, the dividend which is declared and paid on shares is not an allowable deduction while computing total income whereas the interest which is paid on loans or debenture is allowed as deduction under Income-tax law.

In this context, issuing debentures or taking loans is cheaper than the issues of shares. In case of companies, the rate of corporate tax is not less than 50%, i.e., there will be a substantial difference between the two. Thus, tax implications have a dominant role in determining capital structure planning.

(ii) Capital Budgeting decisions:

Impact of tax should also be considered while planning capital expenditure decision since it has a direct bearing.

For instance, decisions about the investments that are required for a capital projects depends on the following considerations:

a) The amount of tax to be saved in writing off losses on sale of old asset;

b) The amount of tax to be paid on profit that is earned by disposing of the asset;

c) The amount of tax to be saved by way of investment allowance on new plant and machinery etc.;

d) The amount of tax to be saved by way of depreciation on assets which is an allowable deduction under Income-Tax Act.

(iii) Dividend Decisions:

Before taking any decision on the payment of dividend, impact of tax should also be carefully considered by the finance manager. Because, in case of company, income tax is to be paid by it when the income is so earned and tax is paid on dividend when the same is declared and paid to the shareholders.

As such, if dividends are not paid by the company to its shareholders, they do not require to pay tax on the same. As a result, if the shareholders of a company are in high tax-brackets, it is better to retain the earnings rather than distributing the same by way of dividend. Thus, it is better to pay dividend in the form of bonus shares which is subject to low rate of tax rather than to pay cash dividend.

(iv) Method of Depreciation:

Method of depreciation has also tax implication and the same should also be taken into consideration while taking any decision about it.

Relevant Tax Considerations for Setting up New Business Units:

If one is to set up a new business, he must consider good number of factors which are arising from the Direct Tax Laws and Income-Tax Act.

Because, before taking up the appropriate decisions, from the standpoint of sound financial management, the decisions in order to set up a new business enterprise in a particular form of organisation/at a particular place including the choice of nature and types of the unit require a number of tax consi­derations which must be considered.

The discussions that follow will present the important aspect of tax considerations that must be carefully considered by tax payers need taking up the actual decisions for the purpose. The discussions will simply provide some information about the setting up of a new business unit which should be considered by the tax payer while tax planning.

Before setting up a business unit any tax payer need know in advance the following important areas from which he will be able to take the full advantages of tax benefits and concessions/reliefs granted by Income-Tax Law.

They are:

(i) Form of Business Organisation;

(ii) Nature and Type of Business Units;

(iii) Location;

(iv) Sources of finance; and

(v) Concessions, Allowances and Reliefs.

Indirect Taxes:

We know the most significant indirect taxes are:

Customs Duty, Central Excise Duty and Sales Tax.

Customs Duty:

Customs duties are of two types:

Export duties and

Import duties.

Export duties raise the price of one product and reduce their competitive­ness in overseas markets and vice-versa, in the case of import duty. The rates of customs duty, however, on various goods are mentioned in the Customs Tariff Act, 1975, which is ascertained on the basis of classifica­tion of goods and which is taken from the international convention of harmonised commodity description and coding system.

Needless to men­tion here that the duties are levied on the basis of valuation of goods.

That is, if it is ad valorem, the prices of the goods will be that such one which is usually sold in the international trade transactions and which is easily available and the rate of exchange will be considered on the date of the transactions on which import/export takes placed.

Similarly, the Central Govt. has given some concessions in the following cases:

(i) If goods are damaged;

(ii) If goods are destroyed, pilfered or abandoned in-transit;

(iii) If such re-imported goods manufactured in India; and

(iv) Certain goods which are exempted as per Sec. 25 of the said Act.

Central Excise:

The coverage of the excise duty is no doubt wide It is imposed on almost all the commodities that are produced or manufactured in India However, those items on which the State Govts. imposes excise duty are exempted from Central excise duty, following the recommendation of the Chelliah Committee. The budget proposals of recent years aim at simpli­fying the excise structure.

As a measure of simplification, special excise duty levid since 1988 has been merged with the basic excise duty. The excise duty on capital goods including instruments which ranged between 11.5% to 23% has been reduced to a uniform rate of 10%.

Similarly, in order to give relief to the common people, commodities are now exempted from excise duty. The 9th Finance Commission has recommended that 45% of the proceeds of excise duties are to be transferred to the states.

Needless to mention here that the new Central Excise Tariff Act is applicable on the basis of classification of goods which are taken from the harmonized commodity description and coding system.

Excise duties are of two types:

(i) Specific and

(ii) Ad valorem.

A specific duty is determined on the basis of quantity of goods manufactured. On the other hand, ad valorem duty is ascertained on the basis of value price of goods manufactured.

Sales Tax:

We all know that the major sources of income of the State Govt. is the Sales Tax. It is imposed on the goods sold. At its primary stage, sales tax was imposed on goods which were tangible or movable. In course of time, in order to deceive tax, the different kinds of goods are transferred into various kinds of tax-free commodities.

That is why, the 46th Constitutional Amendment of 1982 expanded its definition. That is to say, it is included not only the sale of goods but also certain transactions.

They are:

(i) Hire- purchase and lease transactions

(ii) Transaction relating to contract and

(iii) Supply of foodstuff to hotels and restaurants.

Since it is the major source of revenue of the states, the State Governments have given special attention for its realisation.


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