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Session 1999-2000
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Delegated Legislation Committee Debates

Draft Companies Act 1985 (Audit Exemption) (Amendment) Regulations 2000

Second Standing Committee on Delegated Legislation

Monday 15 May 2000

[Mr. John Butterfill in the Chair]

Draft Companies Act 1985 (Audit Exemption) (Amendment) Regulations 2000

4.30 pm

The Chairman: Order. I should say at the start of our proceedings that hon. Members are perfectly at liberty to remove their jackets, should they wish to do so.

4.30 pm

The Minister for Competition and Consumer Affairs (Dr. Kim Howells): I beg to move,

    That the Committee has considered the draft Companies Act 1985 (Audit Exemption) (Amendment) Regulations 2000.

It is a great pleasure, Mr. Butterfill, to serve on a Committee under your chairmanship on such a lovely day. The Opposition spokesman and I have already agreed that we would rather be outside; however, we are inside, and it is kind of you to allow us to take off our jackets.

As hon. Members might recall, my right hon. Friend the Secretary of State for Trade and Industry announced to the House on 4 April proposals to change the existing law on the audit of companies' accounts. We are debating today the regulations that will give effect to those proposals. They are made under the powers in section 257 of the Companies Act 1985. The purpose of the regulations is threefold: first, and most important, to reduce the burdens placed on smaller companies by the audit requirement; secondly, to streamline the law as it applies to dormant companies; and thirdly to require disclosure where a dormant company acts as an agent.

The main changes, in a little more detail, are as follows. First, the regulations raise the threshold for audit exemption from its current level of £350,000 to £1 million. My right hon. Friend made it clear that that is the first part of a two-step process. In the light of consultation, we were persuaded that the balance of argument favoured moving the threshold for audit to the maximum turnover figure permitted under European rules, which is £4.8 million. We made it clear, however, that we wanted to move to that higher figure in the light of the proposals that were being developed by the independent company law review. That review specifically addresses whether another, less burdensome form of assurance might replace the full audit for companies with an annual turnover of between £1 million and £4.8 million. The issue is set out in the latest consultation document from the review, which was published in March. It is a question of weighing the costs and benefits of that lighter-touch, independent assurance. The Government have not yet taken a view: the review will make its final recommendations to the Government in spring next year, and we shall then make a final decision.

Secondly, the regulations simplify the law relating to dormant companies—those that are still on the register at Companies House, but which make no significant accounting transactions during a period. The regulations dispense with the requirement that dormant companies must pass a special resolution to gain exemption from audit. However, they would allow 10 per cent. or more of shareholders to require an audit. For the purposes of determining dormant status, the regulations exclude from the definition of a significant accounting transaction any minor payments to Companies House, including, in particular, the fee that all companies must pay for the annual return. However, they require a dormant company that acts as an agent for a third party to disclose its agency status in its annual accounts.

There is little doubt that the business community will warmly welcome the proposals because they get rid of burdens and remove unnecessary irritations. However, I should emphasise that the changes reflect a careful assessment of the relative costs and benefits. It might help a little if I explain a little of the history and how we have reached our conclusions. I turn first to the increase in the threshold for audit exemption. The Companies Act 1967 introduced for the first time a requirement, not only that all companies should file their accounts at Companies House, but that those accounts should be accompanied by a report signed by a registered independent auditor. In the 1980s, the then Government consulted on three occasions on whether to keep the audit requirement for all companies. On each occasion, it was decided to retain the status quo.

A further consultation in 1993 led to the first cautious step with the exemption of very small private companies from audit—those with a turnover of less than £90,000. At the same time, private companies with turnovers of up to £350,000 were given the option of filing a simpler report by a qualified independent accountant, in place of the full audit report. That intermediate regime was considered unsatisfactory in practice and abolished in 1997, except in respect of charitable companies. That left two types of company: those with a turnover in excess of £350,000 are subject to a full statutory audit, which is optional for those with a turnover of £350,000. That is the present position.

I should stress that exemption from audit removes the need for the directors to engage an independent, professionally qualified person to report on the accounts; however, it does not absolve them of their responsibility to keep proper accounting records, to prepare accounts that show a true and fair view of the state of affairs of the company and of the profit or loss for the year, and otherwise to comply with the requirements of the Companies Act. I should make it clear that not all eligible companies take advantage of audit exemption: roughly half of such companies continue to regard a full audit as offering benefits that outweigh the costs.

What will be the effects of the regulations on audit? We estimate that the increase in the threshold to £1 million will enable a further 150,000 companies, or thereabouts, to take advantage of the exemption from audit. Responses to the consultation suggest that the cost of a typical audit for companies of this size is around £1,500. Our best estimate is that the change offers business potential savings in the order of £180 million in a full year. Some companies, as I have suggested, will continue with an audit; others will judge that they can make better use of specialist accountancy support; yet others might attach more importance to an overall reduction in their costs. The important point is that companies will have the choice; each will be able to decide in the light of its own circumstances.

The consultation exercise also addressed the existing safeguard for minority shareholders, which is that 10 per cent of shareholders can require an audit. We concluded that the protection is still appropriate and the regulations do not change it. We also examined the treatment of groups for audit purposes. Current legislation permits only a parent or a subsidiary company to take advantage of the exemption where the total turnover of the group does not exceed the threshold for individual company exemption. The consultation strongly supported the view that that is the right rule, therefore, the regulations increase group thresholds also to £1 million.

Under current law, public companies and certain financial services companies cannot take advantage of the exemption. That will remain the case. Charitable companies are subject to a slightly different regime under the Act, which reflects their role as stewards of moneys donated by the public. The regulations preserve the existing position for charities. If approved by both Houses, the new threshold will apply for financial periods ending two months or more after the coming into force of the regulations. That will bring the benefits to the majority of small companies as soon as possible. It will also allow time for shareholders who want to exercise their right to demand an audit to do so.

I turn, albeit briefly, to the changes to dormant company status. Section 250 of the 1985 Act draws a distinction between companies that are actively trading and those that are not. Companies that are not trading must satisfy various criteria to be eligible for dormant status, including filing a special resolution at Companies House. Why should anyone be bothered about dormant companies? Roughly 170,000 companies have dormant company status; often, such a body was incorporated to protect a name, or its sole purpose is to own an asset such as the freehold of a building. It might be expected that those dormant companies will get audit exemption under the general provisions, as their turnover must be below the general threshold, but that is not necessarily the case. Many dormant companies are within groups and would not otherwise be eligible for audit exemption.

From what I have said, I hope that it is clear that wide consultation on the proposals has led to a package of practical and appropriate measures that will relieve unnecessary burdens on smaller companies and will command the broad support of the business community. In accordance with the undertakings given by my right hon. Friend the Attorney-General in November, I confirm that the amendments to the Companies Act 1985 proposed in the regulations are compatible with the European convention on human rights.

In our modern economy, small companies are increasingly the vehicles for sustained economic growth and job creation. It is therefore vital that we reduce unnecessary burdens on those companies, so that they can invest in their growth and future. The regulations represent a significant step toward the removal of unnecessary costs placed on business by regulation and they improve the balance that is needed for an appropriate and equitable regulatory framework. I recommend the regulations to the Committee.

4.40 pm

Mr. Nick Gibb (Bognor Regis and Littlehampton): I, too, welcome you to the Committee, Mr. Butterfill. I suspect that it will not be a drawn-out affair, because the Opposition certainly support the basic tenets of the regulations. To be clear, I should state that I have declared in the Register of Members' Interests a six-weekly column with Accountancy Age. I do not think that that is a relevant interest, but, for the sake of safety, I state it now.

The previous Conservative Government recognised that compulsory statutory audits for small companies were unnecessary. The fact that the directors of small companies and the owners were, more often than not, the same people meant that having those companies' accounts audited compulsorily by statute was not necessary and did not add any real value to the company or indeed to UK plc.

I spent the first two years of my career with KPMG—Peat Marwick Mitchell and Co. as it was back then—working on various audits. I counted gold at Mocatta and Goldsmid, and dead sheep and cows at an abattoir owned by Dalgetys. I could regale the Committee with many an audit yarn, but I shall resist the temptation, Mr. Butterfill.


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