For foreign-owned subsidiaries, the statutory audit is often the busiest compliance event of the year. It overlaps with the parent’s group reporting, the tax audit and transfer pricing, and many of the auditor’s requests relate to areas that are specific to foreign-owned entities. Preparing in advance shortens the audit and reduces the number of qualifications and emphasis paragraphs.
1. Intercompany balances and transactions
Expect the auditor to ask for:
- a reconciliation of all intercompany balances with the parent and other group entities;
- copies of intercompany agreements for services, royalties, cost recharges and loans;
- evidence of board and, where required, shareholder approvals for related-party transactions;
- support for the arm’s length nature of transactions, which links to the transfer pricing documentation.
Mismatches between the subsidiary’s and the parent’s books at year-end are the single largest cause of delay.
2. FEMA compliance
Auditors increasingly ask for:
- FC-GPR acknowledgements for share allotments during the year;
- evidence of filing the FLA return;
- compliance with downstream investment conditions, which the auditor must certify where applicable;
- ECB reporting where the subsidiary has borrowed from the parent.
3. Tax and GST
- reconciliation of TDS deducted with the TDS returns and Form 26AS or its successor statement;
- withholding on payments to non-residents, with the related remittance documentation;
- reconciliation of GST returns with the books, including reverse charge on imported services;
- status of assessments, notices and appeals for disclosure of contingent liabilities.
4. Revenue and cost-plus models
For subsidiaries remunerated on a cost-plus basis, the auditor will check that the cost base and markup are applied consistently with the agreement, and that year-end true-up adjustments are recorded. Pass-through costs and ESOP recharges often need specific explanation.
5. Employee benefits
Gratuity and leave encashment liabilities need actuarial valuation for most entities. Changes in the wage definition under the labour codes may affect these valuations and statutory contributions, and auditors will look at how the company has assessed the impact.
6. Audit trail and records
Accounting software used by the company must have the audit trail feature enabled and preserved as required. Books must be accessible in India and backed up on servers in India where kept electronically.
A pre-audit checklist
| Area | Ready before audit |
|---|---|
| Intercompany | Reconciled balances, agreements, approvals |
| FEMA | FC-GPR, FLA and DI acknowledgements |
| Tax | TDS and GST reconciliations, notices list |
| Cost-plus | Computation and true-up |
| Employee benefits | Actuarial reports |
| Systems | Audit trail confirmation |
Conclusion
Most audit delays in foreign-owned subsidiaries come from intercompany, FEMA and tax reconciliations that could have been completed before the auditor arrived. A pre-audit pack covering these areas will make the audit faster and the parent’s group reporting easier.
The author, N. Sudheer, M.Com., FCS, LL.B. is a Partner at A2 Consultants, Hyderabad, advising foreign-owned companies on audit readiness, FEMA and tax compliance in India. Views are personal.
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