Exemption from audit by parent guarantee: it could be right for you
Broking Business - Summer 2024
Take up of the parent guarantee to bypass audits is relatively uncommon among insurance intermediaries. But take a closer look.
More and more large consolidators, among them some of our clients, are tending to take a ‘belt and braces’ approach when it comes to audit. Having acquired numerous broking subsidiaries, they’re assuming that every single one should go through the audit process. And this approach is costing them a great deal in fees.
Could the answer be to use the parent guarantee entitlement of the parent company? The option has been available for almost two decades and is detailed in the Companies Act 2006. But awareness of it in the sector is surprisingly low, except among auditors themselves.
So, what are the benefits? Put simply, enacting the guarantee means the parent company can elect certain subsidiaries to be exempt from audit provided those subsidiaries are included in the consolidated accounts prepared in and available in the UK by the parent company.
It is a chance to rationalise the whole audit process by only requesting audits for the more major, or potentially risky, brokers. For the remaining subsidiaries, the parent company assumes the liability, both actual and contingent, for them at the balance sheet date.
Which entities can use the exemption?
Under the Companies Act 2006, there is no limit on the size of a company for the purposes of the exemption. However, certain types of subsidiaries are excluded, including traded companies and authorised insurance and banking companies.
It’s important to note there is no ‘ineligible group’ as such. For example, even if the subsidiary’s parent company or fellow subsidiary is an authorised insurance company, that doesn’t affect its own eligibility for the exemption. There are, though, conditions regarding the status of the parent company. Similar provisions also apply to Limited Liability Partnerships.
What are the conditions for exemption?
For the subsidiary to be exempt, the following criteria (set out in s479A of the Act) must be met:
- the parent company is established under the law of any part of the UK
- all members of the subsidiary agree to the exemption
- the parent company gives a parental guarantee
- the subsidiary is included in the relevant consolidated accounts in accordance with applicable accounting standards
- the parent company discloses in the notes to the consolidated accounts that the company is exempt from the requirements of the Act
- the directors of the subsidiary deliver to the registrar, on or before the date they file the accounts for that year, the documents set out in the Act.
What are the formalities for members agreeing to use the exemption?
The members of the subsidiary must consent unanimously. Separate consent will need to be given for each year the exemption is used because:
- under the Act consent must be specific to the financial year in question
- the exemption from audit applies to each financial year, so to give consent in advance on a prospective basis might trigger a claim of invalidity.
A single document may prove consent by a parent in relation to multiple subsidiaries. But separate copies should be filed at Companies House for each subsidiary claiming the exemption.
There is no prescribed form in which consent must be given but the company will need evidence that it was obtained. A written resolution signed by all the members is one of several options. Companies House specifies that the notice of agreement by members must show the subsidiary company’s name and registered number in a prominent place.
There is no facility in the Act for a member to withdraw consent for a particular financial year once it has been given. But the exemption is subject to certain rules, which allow members holding 10% of any class of shares to request an audit by giving notice to the company at least one month before the end of the financial year in question. This could be used by one or more members, in effect to ‘withdraw their consent’.
What are the deadlines for obtaining the exemption?
The formalities for obtaining the exemption need not be completed before the subsidiary’s year end but must be done before its accounts are filed. It’s important to remember that the consolidated accounts of the parent company must refer to the guarantee and name the relevant subsidiary. So, this may impose an earlier effective deadline.
What are the requirements of the parent?
The guarantee need not be provided by the ultimate parent company, but instead by an intermediate parent. But whichever provides the guarantee must also prepare consolidated accounts. For further conditions, see above.
What disclosures are compulsory for a subsidiary using the audit exemption?
All disclosures must be complete and accurate. If not, they will be rejected by Companies House.
It provides example wording for the balance sheet, as follows:
- For the year ending (dd/mm/yyyy) the company was entitled to exemption from audit under section 479A of the Companies Act 2006 relating to subsidiary companies.
- The members have not required the company to obtain an audit of its accounts for the year in question in accordance with section 476.
- The directors acknowledge their responsibilities for complying with the requirements of the Act with respect to accounting records and the preparation of accounts.
What are the disadvantages of using the parent guarantee?
As we’ve said, the effect of the guarantee is that the parent company assumes all outstanding prospective, actual and contingent liabilities at the end of the financial year in question, until they are fully satisfied.
This requires caution, then, in selecting which subsidiaries should qualify for the exemption. For example, if a consolidator is parent to a group of 50 companies, it may well be that a few of those are ‘central’ companies – and therefore worth auditing – while the others may quite quickly be incorporated by the central ones.
In this case, unless any of those subsidiaries is considered especially ‘risky’, it makes no sense to audit them all. This is particularly true where some may be simple ‘single or few transaction’ companies, which are common in a private equity structure – such as intermediate holding companies. In reality, there’s very unlikely to be any liability for the parent.
But the group should always ensure there’s no other reason why a simple company might need auditing. For example, before it selects its companies for audit exemption, it may need to comply with debt covenant obligations.
What if there’s a change of ownership of a subsidiary covered by the guarantee?
The guarantee remains in force until the liabilities are settled in full, regardless of whether the parent has disposed of that subsidiary. There’s no provision to revoke the guarantee or novate it to another party. It could, though, seek an indemnity from the purchaser of the subsidiary but the former parent would remain liable to its creditors all the same.
If the new parent also enters into a guarantee for a subsequent financial year and there are still outstanding liabilities from a previous balance sheet, it’s possible that the same liabilities may have been guaranteed by more than one parent. A creditor might claim against either guarantor. And that guarantor is given no rights by the Act against the other guarantor but may have an equitable right of contribution from other guarantors of the same outstanding liabilities.
Does the guarantee fall away if the subsidiary later decides to have an audit for the year in question?
No, it doesn’t. There’s no provision in the Act for the parent’s liability to cease except on the full satisfaction of the subsidiary’s liabilities. So, an audit would not change that.
How can we help?
If you have further questions on the parent guarantee, please contact us and we will be happy to advise.
Adopting the parent guarantee would reduce the number of audits you require for your group and therefore save on fees for unnecessary audits. Bear in mind, though, the parent company must produce a group report regardless, so our support would still involve work relating to the exempt subsidiaries.
For further information on how we can help, please contact Paul Goldwin or Lorraine Nixon.