Business Review: Exemption 

 

Under section 388 of the new Companies Ordinance (Cap. 622), companies in general are required to prepare a business review in their directors’ reports which complies with schedule 5 unless specifically exempted under section 388(3) of the ordinance.

 

The following companies are exempted from preparation of a business review which complies with schedule 5 under section 388(3):

 

(a) The company falls within the reporting exemption (as defined in section 359) for the financial year; or

(b) The company is a wholly owned subsidiary of another body corporate in the financial year; or

(c) The company is a private company that does not fall within the reporting exemption for the financial year, and a special resolution (as defined in section 564) is passed by the members (that is passed by a majority of at least 75%) to the effect that the company is not to prepare a business review required by schedule 5 for the financial year.

 

For the purposes of claiming exemption from preparing a business review, a company need only satisfy any one of the three exemption criteria set out in section 388(3). Therefore if a company satisfies either criterion (b) (i.e. it is a wholly owned subsidiary) or criterion (c) (it is a private company and its members have passed a special resolution), it is not necessary to consider whether the company would also have been able to claim exemption under criterion (a) (i.e. to consider whether it would also have fallen within the "reporting exemption".

 

NB: If the purpose is only to claim exemption from preparing a business review, in practice, given the complexity of the size tests and shareholder approval requirements for the reporting exemption, it will generally be more straightforward for a private company to ask its members to pass a special resolution in accordance with section 388(3)(c). There is no need to seek to test whether the company is eligible for the reporting exemption in accordance with sections 359 to 366 of, and Schedule 3 to, the new CO. However, if the purpose is also to claim the reporting exemption from the requirement for the financial statements to give a true and fair view then it will be necessary to comply with the requirements of sections 359 to 366 and Schedule 3.

 

Unlike criteria (c) of section 388(3), criterion (b) is not limited to just private companies. Accordingly, a public company (as defined in section 12) that is a wholly owned subsidiary of another body corporate can obtain the exemption from preparing a business review.

 

Section 388(3)(c) exempts a private company from preparing a business review if a special resolution is passed by members of that company in accordance with the details set out in that section and section 388(4).

 

This resolution has to be passed at least six months before the end of the financial year to which it relates and may only be revoked by a special resolution (section 388(4)).

 

Are all private companies eligible?

 

A private company is defined in section 11 as a company which is not limited by guarantee and whose articles (i) restrict a member's right to transfer shares, (ii) limit the number of its members to 50 and (iii) prohibit any invitation to the public to subscribe for any shares or debentures of the company.

 

All private companies (including those in financial services lines of business listed in section 359(4)) are eligible to gain exemption from preparing a business review provided they satisfy either section 388(3)(b) (i.e. the company is a wholly owned subsidiary) or section 388(3)(c) (it is a private company and its members have passed a special resolution).

 

However, this entitlement may be lost if at any time during a financial year the company acts in a way contrary to the three key elements characterizing a private company listed above, for example, if the membership of the company in practice exceeds 50 members during the year. In such a case, the directors' report relating to that financial year is required to contain a business review, unless the company is also a wholly owned subsidiary of another body corporate in the financial year. This provision is set out in section 389, which also includes further provisions relating to applications that may be made to the Court in this regard.

 

Private companies that do not satisfy either sub-sections (b) or (c) of section 388(3) may still be able to gain exemption under sub-section (a) (i.e. if the company satisfies the size criteria for small private companies or groups under the reporting exemption). However, in this regard, it should be noted that private companies in the financial services lines of business listed in section 359(4) are not eligible for the reporting exemption, even if they satisfy those small size criteria. These types of companies include, for example, corporations licensed under Part V of the Securities and Futures Ordinance to carry on a business in any regulated activity within the meaning of that Ordinance.

 

Using full Hong Kong Financial Reporting Standard (HKFRS) or HKFRS for Private Entities 

 

If the company is eligible for the reporting exemption under sections 359 to 366 of, and Schedule 3 to, the new CO but voluntarily chooses to prepare its financial statements using full Hong Kong Financial Reporting Standard (HKFRS) or HKFRS for Private Entities instead of the SME-FRF & SME-FRS (Revised 2014), it can still claim exemption from preparing a business review under section 388(3)(a).

 

This exemption does not depend on whether the financial statements are prepared in accordance with the SME-FRF & SME-FRS (Revised 2014). The important factor for the purposes of section 388(3)(a) is whether the company (or group) is eligible for the reporting exemption i.e. whether it is not in a financial services line of business listed in section 359(4), whether the company (or group) falls within the size tests and, in some cases, whether the necessary shareholder approvals have been obtained.

 

Company limited by guarantee with revenue of more than HK$25 million

 

A company limited by guarantee with revenue of more than HK$25 million is not eligible to fall within the reporting exemption (i.e. hence exempt from preparing a business review) under section 359(3) as it exceeds the threshold of HK$25 million as specified in section 1(5) of Schedule 3.

 

Section 11 specifically excludes a company limited by guarantee from the definition of a private company. A company limited by guarantee therefore cannot be exempted from preparing a business review by way of passing a special resolution.

 

A company limited by guarantee can only be exempted from preparing a business review by being a wholly owned subsidiary of another body corporate. Under section 357(3) a company limited by guarantee is a wholly owned subsidiary of another body corporate if it has only the following as members:

(a) that other body corporate;

(b) a wholly owned subsidiary of that other body corporate;

(c) a nominee of that other body corporate or such a wholly owned subsidiary.

 

Written resolution

 

Under section 388(3)(c) a private company that does not fall within the reporting exemption can claim exemption from preparing a business review for the directors' report for the financial year by special resolution.

 

Under section 548(3) a resolution may be passed as a written resolution, if a resolution is required to be passed as an ordinary resolution or a special resolution. Accordingly a company can claim the exemption from preparing a business review by written resolution, instead of special resolution. A written resolution can be passed without a meeting and without any previous notice being required.

 

However, a written resolution that is passed for the purposes of section 388(3)(c) must comply with section 388(4) which requires the resolution to be passed at least six months before the end of the financial year to which the directors' report relates.

 

Having said that, passing a written resolution requires all eligible members signify their agreement to it. This is a higher threshold than the special resolution, which needs to be passed by majority of at least 75%. Moreover, for passing a written resolution pursuant to the provisions in subdivision 2 of division 1 in Part 12 of the new CO the company needs to follow other procedures in the subdivision , which include notifying its auditor of the proposed resolution under section 555.

 

Same as for the special resolution, the company under section 622(1)(b) and section 622(2) must deliver a copy of the written resolution to the Companies Registrar for registration within 15 days after it is made or passed.

 

Consequences of missing the “six months before the year-end” deadline for the business review

 

If the directors miss the “six months before the year-end” deadline, then they must comply with the full requirements for that financial year (i.e. they must prepare a business review) or seek legal advice on the consequences of failing to comply with the relevant statutory requirements, unless they are able to claim exemption under either section 388(3)(a) or 388(3)(b). Failure to meet the six months deadline cannot be excused by the members as this is a statutory requirement.

 

Note: As per section 388(3)(a) and (b), private companies can also be exempt from preparing a business review if they meet the size and approval tests for the reporting exemption set out in section 359 or they are a wholly owned subsidiary of another body corporate as defined in section 357(3). These alternative routes should be checked if the directors have failed to take steps to pass the special resolution in time and still wish to be exempt from preparing a business review. Also, it should be noted that failing to meet this deadline in one financial year does not preclude the directors from taking steps to meet them in good time for the next financial year. Also it should be noted that the special resolution that may be passed by private companies in accordance with section 388(3)(c) and (4) in order to claim exemption from preparation of a business review can be worded such that it grants exemption for more than one financial year or until revoked. 

 

 

Source: http://www.hkicpa.org.hk/file/media/section6_standards/technical_resources/ecir1.pdf

             http://www.hkicpa.org.hk/en/standards-and-regulations/standards/new-co/qa-index/pa-director-report/